Lannett Company Inc (LCI) 2010 Q3 法說會逐字稿

Welcome to the Lannett Company fiscal 2010 third quarter conference call. I'll be your operator for today's conference. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. I would now like to turn the call over to Robert Jaffe, Investor Relations with Lannett. Mr. Jaffe, you may begin.

Thanks, Mitch. Good afternoon, everyone, and thank you for joining us today to discuss Lannett Company's fiscal 2010 third 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 Web site. 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, then Keith will discuss the financial results for the quarter in more detail followed by Arthur's 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. Our top-line growth in the fiscal 2010 third quarter was primarily driven by strong sales of our pain management products as well as certain base business pharmaceutical products.

In December, quota issues were resolved with the DEA which allowed us to resume manufacturing and shipping pain management products produced in our Cody Laboratory's subsidiary. I am pleased to announce that Cody achieved profitability in the quarter and we expect Cody to be profitable for the foreseeable future.

While overall sales grew quarter-over-quarter, demand for our OB-natal one product decreased. As we discussed in our last call, the manufacturer of the brand version ceased marketing and promoting its product in December 2008, leading to a decrease in demand for our OB-natal one. Even though we now command 95% of that market, the market size has dropped considerably.

We are exploring the possibility of selling this to a marketing firm that can resume detailing the drug or discontinuing the drug. We recorded strong sales of our Levothyroxine and Pilocarpine products, and we were able to raise prices of certain other products. We continue to invest in product development, which you will see in the increased R&D expenses line.

Currently, we have one new drug application and 17 abbreviated new drug applications pending at the FDA, two of which we believe are first-time generics. We have an additional 60 product candidates in various stages of development.

This is the largest number of products we have ever had in development and compares favorably to companies much larger than Lannett. With that, I'd like to turn the call over to Keith for an overview of our third quarter financial results. Keith?

Thank you, Arthur, and good afternoon, everyone. For the fiscal 2010 third quarter ended March 31, 2010, net sales were $31.3 million compared with $28.8 million in the same quarter of fiscal 2009. Gross profit was $10.4 million compared with $11.6 million for the same period in the prior year.

Research and development expenses increased to $3.4 million from $2.0 million in the 2009 fiscal third quarter. Selling, general and administrative expenses decreased significantly to $4.4 million from $7.5 million in the same quarter of the prior year.

A brief explanation regarding the significant decrease in SG&A. In fiscal 2009, we incurred professional fees related to the patent challenge with KV Pharmaceuticals of $2.5 million and $5.7 million for the third quarter and the nine-month periods respectfully. Last year's results also include $452,000 of severance costs related to a former executive.

Operating income rose to $2.7 million compared with $2.2 million in the fiscal 2009 third quarter. In the fiscal 2010 third quarter, the Company reached a settlement with the IRS related to its audit of our federal income tax return for fiscal 2008. As a result of the settlement, we recorded certain additional credits and reversed certain valuation allowances.

Accordingly, our effective tax rate for the three months ended March 31, 2010 was approximately 20%. We expect our overall effective tax rate will be approximately 40% to 42% for the full year ended June 30, 2010. Net income was $2.1 million or $0.08 per diluted share compared with $1.3 million or $0.05 per diluted share for the prior year third quarter.

Turning now to the financial results for the first nine months of fiscal 2010, net sales increased to $91.4 million from $83.6 million for the comparable period in 2009. Gross profit was $30 million compared with $31.6 million for the same period in the prior year. R&D expenses increased to $9.1 million from $5.7 million in the first nine months of fiscal 2009. SG&A expenses decreased to $12.2 million from $19.1 million in the same period of the prior year.

Net income grew to $5 million or $0.20 per diluted share, from $4.1 million or $0.17 per diluted share for the first nine months of the prior year. Turning to the balance sheet, the Company has approximately $19.5 million in cash, cash equivalents and short-term investment securities available for sale and approximately $8 million of long-term debt, including the current portion.

With that brief financial overview, I'll now turn the call back over to Arthur. Arthur?

Thank you, Keith. Last month we announced that we received FDA approval of Ondansetron Injection USP, 2 mg/mL, Multi-Dose Vials. The Ondansetron Injection is the first injectable product for which Lannett has filed an ANDA, an Abbreviated New Drug Application, and the first product candidate approved for marketing from our joint venture with Wintac Limited.

While a launch date for the product has not yet been set, the addition of an injectable drug to our product offering will enhance our ability to build our hospital-based business. On a related note, we have a product application pending at the FDA for a single-dose vial of Ondansetron Injection, and an approval is expected shortly.

With regard to our shelf registration, we continue to review our needs for additional funds to more rapidly exploit the potential for vertically integrating our operations. While historically we have used cash generated from operations to fund our growth, we are exploring potential acquisitions of complementary products and/or companies and evaluating the benefits of upgrading our facilities and expanding our pain management business.

Our pain management business has attracted interest from others in our industry. We are encouraged by this recognition as it confirms our strong belief in the opportunity that pain management offers. We believe we are just beginning to realize the upside of this part of our business and we are committed to its growth.

We can accelerate that growth over the medium to long term by investing in infrastructure and continuing to add active pharmaceutical suites. The pain management space is underserved, and we believe in investment in our Cody Laboratory subsidiary will allow us to, over time, garner a larger portion of the market.

Before we open the call to questions, let me close by saying Lannett is well positioned in a challenging economy. We have expanded our business, added staff and filed a number of product applications with the FDA.

We remain a cGMP compliant Company with a vigilant eye on avoiding the pitfalls and problems plaguing our competition. Everyone at Lannett takes quality seriously and I wish to thank our entire team for their efforts. With the time available, we would now 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 of Roth Capital. Please go ahead.

Thank you, and good afternoon. I guess, just for starters, the two anchor franchises, Digoxin and Levothyroxine, how is the outlook from a competitive standpoint for those products over the remainder of, I guess, the 2010 calendar year, any new developments there, or maintaining the status quo?

Well, for the moment, it's status quo. The Levothyroxine sales have increased. The Digoxin market remains stable. No additional competitors have entered either markets at this time.

While we do expect the Digoxin market to have additional competition that hasn't been realized yet, and as far as the remainder of the calendar year, going through December, while I can't predict the future, I certainly don't expect any additional changes in Levothyroxine. So we expect to see some growth there.

And the Digoxin market, we don't expect any major threats until at least the final quarter. So it will be sometime in October. We don't really see a major impact from that as well, because most of our customers would have placed their orders with us at that point in time. So I would say for the calendar year, we're looking like it's business as usual with a slight increase in both items.

Okay. Thank you. And then, on the SG&A line, I know it's significantly down from last year at $4.4 million, but Q1 was closer to $3.7 million. How should we think about SG&A going forward? Is it likely to continue to be greater than $4 million, or could we start to see it dip under that rate again?

The increase from the $3.7 million to over $4 million, some of it is is on the stock compensation expense line. We have an annual plan that gives awards to both select management employees as well as board members. That grant is done in October. That will slightly increase each year, but, again, it's non-cash.

Well, I mean, this quarter ended in March. How does October factor into it?

Well, because they divest over three years. So the expense is spread out over three years. So it will impact each quarter going forward for the next three years, and then it will grant more this coming October, generally and ones from three years will fall off, and ones for the grants for this year will come on as expense for the next three years.

Okay. So should I understand that it's, the $4.4 million for this quarter is probably a good go-forward rate? It sounds like it's not going to go back down?

Yes, I would put it in the $4.2 million to $4.4 million running rate going forward, yes, as a base level.

All right. And how should we think about Q4 relative to Q3? Just in broad terms, is there any reason to think -- I mean, it sounds like the pain business is doing better?

And we're talking about fiscal year. And the other businesses should be pretty similar, so should we see sequential growth Q4 over Q3, or is there any kind of one-time events? Obviously, the tax rate will probably be a little higher next quarter.

Yes. Tax rate will -- I don't see anything that's going to occur in this quarter. It will normalize for this quarter, and that's why we stated earlier in the call that we should come in at around the 40% to 42% effective tax rate for the year. As to a prediction of revenue, Arthur, do you want to --

Yes, I would say we'll see a stronger fourth quarter than the third quarter.

Okay. All right. And I guess the final question, perhaps for Arthur, when we think about the pain management business and we think about the growth, you're thinking -- at what level of magnitude could that franchise be at, say, fiscal year 2011? Could you see it creep into the double-digits in millions, maybe $10 million to $15 million?

I'm just trying to get an understanding of -- I mean, on a relative basis, it's clear that it's getting better, but on an absolute basis, what level is it picking up to?

When you see -- we're going to public our 10-Q here in a couple of days. Actually by the end of the day tomorrow. You'll see that the pain management, if I remember correctly, increased to about 10%, somewhere between 8% to 10% for the current quarter's revenue. I don't want to predict the whole next year, we do see the pain management products continuing to be a bigger and bigger part of our revenue stream going toward.

So that would imply it's already at close to a $10 million to $12 million run rate?

That would imply that, yes.

Okay. Great. Thank you, guys, for taking the questions.

Okay. Thank you.

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

Yes. Good afternoon. I guess you answered my first question by saying what pain management was as a percentage of revenue, but could you talk about the R&D increase and what was going on there and what your outlook is for R&D absolutely and as a percentage of sales going forward?

Okay. I'm not sure where the Greek connection is. We don't have any R&D going on there, but --

But explain what that $3.3 million was spent on in the quarter?

We have, in R&D most of the expense actually is bioequivalency studies. We're pursuing larger volume sales. For example, drugs that are doing $400 million and $500 million annually, those bio studies tend to be a little more expensive than the ones we traditionally did.

So the bulk of the investment really is in bioequivalency studies that we've been spending as well as the research and development, and in some cases, some of the APR, the active pharmaceutical ingredients, for some of the projects we're working on are extremely expensive. I mean, this quarter was impacted by just one of those particular APIs and finished dosage forms we have to buy to do the bioequivalency study.

So as we spend more money it impacts our earnings, but we're not looking at earnings per se, we're looking to grow a business, and if we don't go after these larger-volume products, it will be very difficult to get our sales to grow. We still have an eye towards keeping the profits.

How many bioequivalency studies were going on in the quarter?

It's tough to give you a number. Sometimes you'll do multiple studies for a specific product. You might do a fed and a fast. You may only have to do one study, so I don't know if I can give you a specific number as going to give you any data because I might tell you that we only did seven this quarter, but we might have done 15 last quarter.

These are made-up numbers, to be honest with you. It really matters as to the breadth of the study, the cost of the study, and I guess, the underlying product.

So I guess it's correct to say you don't have the money to do the bioequivalency studies you'd like to because they're so expensive for 60 drugs under development?

That's true. For this year, we went into the year with a budget that was rather aggressive, let's say. And we had to cut it down before we submitted our annual operating plan to the board. And we cut it back by $7 million in spend. This year we have a similar situation where we could spend considerably more than we have the wherewithal to spend.

We even could file a record number of applications this year which for a Company our size absolutely is extraordinary. But, again, it means either adding staff or putting in additional hours, spending more money on bio studies, and you always have to have an eye towards husbanding some of the cash. Clearly what's going on in Greece concerns everybody in the world.

Nevertheless, it's a small economy there. I don't think it bodes ill for the rest of the world. I believe it will be dealt with. California has big debts. New York has big debts, New Jersey has big debts, far greater than the country of Greece. But nevertheless, we're not immune to those impacts.

Certainly feeling it when it comes to borrowing abilities, dealing with bankers. It's certainly a stock market issue. People are afraid to invest in the stock market. Those things impact us in an indirect way.

But as far as Lannett's plan is concerned, we continue to spend all of the money that we earn on growing this Company. We don't borrow money. We've only borrowed for mortgages, and that's very difficult when you're trying to grow a Company.

But we've grown from roughly $10 million in eight years to $120 million. Not predicting this year's numbers. That would be last year's numbers. By not borrowing any money, doing it all with our own profit margins, I mean our own gross profit and net profit. So we continue to do the same thing. We spend as carefully as we can because we have to be careful with the money, but we need to get the most bang for the buck.

But we are very aggressive in R&D, because if we're not, we're not going to get any approvals, and the Agency's backlog is really suffocating companies like Lannett, because when you have to add another year in waiting for an approval because they have a backlog, it causes the payback to be delayed by an extra year.

It causes you to have to wait for that revenue to come into your coffers in order to spend it on future R&D. Not to be too negative about the backlog and what have you, we're still getting approvals, we still see good things ahead for Lannett, and we're achieving all the goals we've set for ourselves.

Well, great. I think you're doing a really good job, and I'll get back in queue.

Thank you.

Our next question comes from George [Gaspar], private investor. Please go ahead.

Yes. Good afternoon, Arthur and company.

Good afternoon.

First question is, on the foreign currency gain, can you explain the ramification, what generated that to the extent it happened for the quarter?

We don't have a foreign --

We opened up a, I'll say, the start of a lab in a foreign country which we do not name at the current time. It's small.

Right now, the foreign currency gain or loss is just being created on the investment that we've made into that subsidiary to date. Relatively small as you can see from the financial statements.

Right, okay.

We've had a stability laboratory overseas in a third-world country for some time, going on four years now, and we're increasing our investments in that country to include bioequivalency studies that we plan to do for ourselves.

Because of cost of the bioequivalency studies being so high, we're looking at ways to reduce those costs, and in this particular country, we believe we can be able to do some of the scientific work for ourselves and still use an outside clinic to do the actual dosing of the test subjects. And it will bring some savings to us, or actually some profits to the subsidiary.

Okay. And so can we expect something to be in the next quarter on the foreign currency situation?

You may see just some minor P&L run-through like you saw this current quarter?

Okay.

On what happens between the US dollar and that specific currency, but we will not be operating that subsidiary fully or even operating it during this next quarter.

Okay. All right. The next question is, Cody and facilities expansion in Philadelphia, now you're finally getting into the profit column at Cody.

You're implying that you may want to do something that gets you into a position to spend more money at Cody on expansion. At what capacity level are you right now at Cody on a pain production basis? Can you describe any of your thoughts and where you might want to go there? And also can you update us on Philadelphia? How far along is your expansion program, and how are you going to utilize that?

Okay. Let's start with Cody first. Cody Laboratory is not operating at its capacity in terms of its plant space. It does occupy 75,000 square feet on 16 acres. So it has plenty of room there.

But in the API business, the active pharmaceutical ingredient business, every time they decide to embark on making an additional material, they need to set up a suite, they need to validate that suite. That investment doesn't always get paid back within the same year, and clearly the benefits of investing in those suites will be realized in greater gross profit margins for Lannett.

So the dilemma is, if you spend the money in Cody and spend more than you're earning in Cody, then you end up going into the loss column, which nobody would be happy with. So it's a balance act, making sure we spend the revenue that Cody is generating, the profits that it generates, to embark on additional products.

Unless I were to raise money privately or in the public markets or take out a loan, where I would make a large investment in Cody, I generally will try to grow Cody with its profits and with the profits that Lannett produces. Again, that's a conservative way of doing it, because no one wants to see Cody go back into the loss column. But to really exploit Cody would require the decision to actually invest more in Cody and bite the bullet. Set up a number of suites so that the following years going into the future you have a lot more products that could be realized. But then you run up against the FDA backlog.

What we're trying to do is not have Cody so far advanced that I have products ready to be approved, and they are sitting at the Agency. And now I'm faced with another dilemma.

Until the Agency approves the application for the dosage form, Cody can't supply me any raw material, so they've set up and made those investments -- that they expect to get paid in a year or two, now are going to take three or four years. And that's one of the reasons we're kind of watching what's going on with the Agency.

With regard to Lannett, we're moving out of our Torresdale facility. We name each one of them based on the road they are, State Road being the original facility. We have our offices there. We'll be moving our offices next week to the Townsend Road, the new facility. We'll be moving the warehouse out of Torresdale to the Townsend facility following the office move.

So within a month, we'll have those two things set up in Townsend. Then the goal is to set up some additional manufacturing suites in the roughly 28,000 feet of space that the warehouse is vacating in Torresdale and turn that into manufacturing suites that include narcotic drugs, for example, as well as potent drugs, where you have to have separate suites.

That investment has not been budgeted yet, but we do have the numbers, we have the quotes, and we will start to invest in the Torresdale facility based on our needs. Again, when you're a small Company trying to husband your cash, you cannot do everything everybody wants you to do all at once. But that's one of the reasons we did file the shelf.

We felt, at some point, if we decided we wanted to expedite everything and exploit these opportunities and it made sense to do that and the shareholders would agree, then we would borrow or sell additional shares to do all the those things at once. But at the moment, we're planning to spend from our earnings in each one of those areas.

But certainly Torresdale would require a significant expenditure for the fit up there. We've just received some quotes from just one supplier at this point, so we don't even have those numbers nailed down yet.

All right. Thank you. I'll get back in queue. Thank you.

Thank you.

(Operator Instructions) We have a question from Kevin McDevitt of UBS. Please go ahead.

Hi, Arthur. Well, congratulations for the quarter.

Thank you.

I had a question about Synthroid. Is there any comment you can make about whether they were approved to produce? They were on, with the FDA, they had to reformulate their product? Is there any comments on that? Are they selling their product?

Well, that's a little peculiar. We've encountered situations where they're back ordering severely at certain locations and not supplying the product. We have not seen any supplemental approvals come from the Agency, not that I've noticed or have been brought to my attention, on any changed formulas, that we know, that their formula needed to be reworked.

A reformulation would have required a supplemental approval. So we're not sure what's going on there. It's possible they continue to make the product with the short expiration date they started with. What that does, so you understand, is if you have a product that's not stable, if you put a two-year expiration date and it falls below the label claim within two years, you have to recall your product.

If you reduce the expiration date to -- I believe theirs was seven and nine months, then as long as it's stable for seven months or nine months, you don't have to recall the product. If it goes sub-potent -- it becomes less stable at ten months, the product is already expired. So we're not sure at this point if that's what they've continued to do. We've been trying to get information but so far it's sporadic.

We do know that they're not a factor in the marketplace. We seem to believe they're losing market share further to the generic industry and to us as well. So I believe that they haven't solved the problem, but that's a guess on my part.

Is it out of line to get clarity from the FDA on that?

No. They won't talk about anybody else's applications. And when we talk to customers, we've had some customers say, oh, yes, they are not back ordering everything. The you call another customer and he goes, "Are you kidding me? They hardly have anything in stock."

We're getting confusing information. It may be that Abbott is restricting who they're selling it to. That's a possibility. They service certain customers so they don't lose them.

They don't service others. For example, you don't want to lose a chain customer, so you give them all the product. And then the wholesalers don't get anything and they're the ones saying, "Hey, I don't have anything in stock."

So I don't have enough information to tell you. We didn't see any recalls from anyone in the industry. We know that as of October they hadn't manufactured a new product. So we're presuming everyone (inaudible) the new specs as of October.

Okay, thanks. What about, can you comment on your share buyback program?

Yes. I can tell you that during the quarter ended March 31, we bought back about 11,000 shares and calendar to date, as we sit here today, it's a total of about 20,000 shares.

And obviously that's still in place. Is there plans to execute then?

Yes. The problem is, when you're buying back shares there's certain restrictions in terms of how many shares you can buy because it's based on your volume, and the restrictions are based on your volume. You're unable to buy certain amounts.

When we put in orders to buy the stock at a set price, the stock goes up. We're unable to execute at that point. That's some of the difficulty, buying back some of the stock has been met with frustration, and we were buying the stock only because we felt that the price was very attractive.

But unfortunately, when we went into the market, we weren't able to get all the shares we were trying to purchase, and I don't really understand that. I've talked to the specialists quite a number of times.

It does seem to be odd. Sometimes there's a block that's offered, you go to buy it, and then it's taken off the market, but unfortunately no one can tell us by whom these shares are offered or why they are suddenly removed.

We continue to support the stock when we see stock levels attractive enough for us to make purchases.

Well, thank you. And how about -- you talked about -- you just got approved for this injectable, which is your first. Is there any reason why you don't have a date of when that's going into production? Is that confidential, or is that -- is there issues with that?

No, it's not confidential. But, first of all, when you have two products in the family, you tend to want to launch both of them at the same time.

Okay.

We wanted to wait until we at least had both vials available, the single dose and the multidose, because otherwise customers say I want to buy one from you and one from the other vendor. The market is very competitive in that. When that product was approved two years ago, 11 people got approved at first. An additional two approved. That's 13. We're now the 14th approval on that product.

So the market prices are rather aggressive out there, and I don't want to sell a product just to lose money because I filed an ANDA. But we know that we will sell the product. We're working with our vendor to see what they can do to reduce the transfer cost to us as well in recognizing what's going on in the marketplace.

So far, none of these 13 people have dropped out of the market. So we know the market is viable. We certainly see an opportunity for us to sell, and it's also -- with injectables, it's a bidding process, so all of the buying groups put it out on contract.

It's not something you can easily just step into the market and say, "I'm here now. Let me sell it to you." You have to wait for another bid cycle to come about. But injectables open up an avenue for us as well as the pending ophthalmic products for additional dosage forms, more avenues to sell our products.

So even if I'm not selling the Ondansetron I'll probably be selling other products to a new customer base. That's one of the reasons we went into these areas.

That all makes sense. Thanks. And one more question. Last year, you had quite a bit of vitamin sales and, I know also the expenses that went along with that. What were the vitamin sales this quarter versus last quarter? Last year, same quarter?

The sales would be down this quarter versus last year, because last year we had launched the product.

Right.

This year then, of course, KV would recall the product. So without the brand in the marketplace there was no opportunity for the generic. Eventually the doctors stopped prescribing the brand, so my product doesn't get substituted for it. Keith, do you have the actual number for this quarter? Otherwise, I have a fair idea.

Yes. Let me come up with a percentage decrease .

While Keith is looking for that, do you have any other questions?

No. That's it. That's it.

We experienced -- if you're comparing it -- the third quarter last year to third quarter this year, we've experienced over a 70% decrease in the sale of that vitamin.

Yes. I mean, I was just kind of curious because when you're comparing total sales to last quarter, I mean, we were obviously up, and last year you had the vitamin sales and you didn't this year, so you're getting incremental sales without the vitamin.

Yes.

That was my.

We're getting growth on Digoxin, on Levothyroxine, and two of our pain management products. That's significantly grown this quarter over previous quarters.

Okay. Thanks, guys.

Okay. Thank you.

All right.

Our next question comes from George [Gaspar], private investor. Please go ahead.

Thank you. Just ongoing -- ongoing from Kevin's last question, which was very good. It's quite obvious that you're making some pretty good progress on generating sales in primary product area as this vitamin sales volume declines, and showing the progress that you are, so it's implying that you're really making some progress if you read between the lines on what has been said here.

And then, Arthur, I would like to talk to you a little bit more about Cody. There was some, I guess, implying that there might have been a hold on some product throughput or the ability to get product throughput still in the last quarter. Maybe because of inability to get raw material.

Is that a right assumption on my part? And, secondly, it sounds like maybe that's not the case now, so going forward with the fourth quarter here, that there would be a better run rate and raw material availability so that we could look at Cody's sales escalating this quarter and maybe being impactful at the bottom line?

Yes. If you go back to our comments earlier today as well as our previous quarter's earnings call, we did have two months in our second quarter where we did not have quota from the DEA in order to manufacture specifically mostly the morphine sulfate product. Those quota issues were resolved with the DEA by December.

I see.

And by January, Cody was up and running. And I would tell you they're almost -- can't say full capacity, but they were almost back to the levels of revenues to us that we had seen prior to the quota issues. I would tell you, by February, they actually surpassed any previous month's revenue levels to us.

We experienced that through February and March, and we expect to continue to see that through here in the fourth quarter. And literally, on many of their product -- on a couple of their product lines that they're shipping to us, as soon as we get them in, we ship them back out.

Okay. And then ongoing with the most recent approval from the FDA, and you're not in the market with that product yet, and then the injectable opportunity. I would think that, would both -- these both -- when you start up will potentially positively impact [Cody DMR]. Correct?

No. The injectable won't impact Cody. Cody's growth is coming through the growth of the sales of the pain management products at our end.

I see.

In other words, we're selling more than Cody is able to produce, quite frankly. Our sales expectations have grown dramatically because of Cody's ability to supply, but it's currently well ahead of Cody's ability to supply currently. Your question regarding the prenatal, the OB-natal one product, Lannett tends to be an opportunistic Company.

I need to get earnings. Shareholders want to see me make profit and sometimes there are opportunities that have nothing to do with being a vertically integrated pain management Company. Nevertheless, they bring in revenue and profits, so we'll pursue those opportunities, and we'll exploit them for the time period we can exploit them.

In the case of the prenatal product, we exploited that opportunity. No one could have predicted that KV would have fall on such difficult times and recall the product. Otherwise, we would continue to enjoy those fruits. Nevertheless, it didn't hurt us. We made a nice profit. We moved on.

We're still going down on that path to be vertically integrated pain management. Cody will continue to supply products to us going forward. We do expect Cody to continue to enhance our earnings and our profits, so it's really -- it's more than turned a corner. It's really now part and parcel of our future.

With regards to their capacity, and putting more products together, new APIs, we have to continue to invest in Cody to keep growing that opportunity. It just goes to show that what we've said we can do with Cody, we're able to do. And now the question is to continue to do it. It is a step we're climbing here.

We keep going higher and higher with the ability to sell more and increase the profit margins on the way up as well. And then we will have realized the expectations from Cody that the shareholders want and I want.

Okay. All right. And then one question, exploiting the Philadelphia expansion again here, when this is completed and you're able to utilize in terms of manufacturing point of view, the additional space, do you envision getting into contract manufacturing opportunities? I mean, is that a viable opportunity for you as you make this additional space available?

Actually, no, and maybe, yes. It's not a part of our plan to be a contract manufacturer, so let me put that clearly on the table. However, we have dealt with two of our competitors in the industry, and we have offered our services to one of them to make a dosage form for them.

It's -- both of them are in the narcotic field and another competing company of ours approached us about making another product. So one of them would really just be a contract manufacturing role. It's, let's just say the colleague in the industry, and you never know when you need each other.

The other one is more like a joint alliance, because they're offering us the opportunity to engage in, shall we say, a patent challenge with regards to the product. So it's possible that we might be a little more involved as a partner or alliance partner with one company, and on the other one just a contract manufacturer, because we're able to make a narcotic product that they need us to make. But that's not the plan.

Again, that's an opportunistic thing. Sometimes you work with companies because you have needs to work with competing firms in the industry, and that's why those came about. But the answer to your question is, in a general sense, no, we're not going to become, nor will we need to. We feel we'll be quite busy with the 60 products in product development.

Most of those products are involving the manufacturing here in our facilities . Some of them, like the ophthalmic products and topicals and the injectables will be manufactured for us. But our goal is to be a manufacturer of most of the products that we license and hold the NDAs for.

Okay. All right. Thanks, Art, thank you all.

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

Keith, can you explain why the gross margin went down quarter-over-quarter in the March quarter?

From March of last year to March of this year?

Yes.

Okay. It's primarily the OB-natal one product. If you remember correctly, we had launched that product in October of 2008. We sold it at a high price, at almost royalty free all of the March 2009 quarter.

If you're comparing it now to this quarter, sales are significantly off. There is a royalty on the sales that we have, and there -- I won't say significantly, but there has been a price decrease in the marketplace.

That explains it right there. Okay. And then the other thing was -- two things related to Cody.

Number one, your raw material suppliers, like some of your narcotics are not made from opium straw, they're made from other stuff, and do you have any problems with your suppliers for the key ingredients when you're buying active product ingredients from others?

Would that be a constraint? And then finally, my question is what is the number of dedicated suites you have in Cody?

On the API side, yes, there's one vendor in particular that's been giving us fits with one of our products, and unfortunately we ended up going into back order on that item. And I hate to mention who they are, but they're a very substantial company in the API industry. Nevertheless, their products are being rejected by my laboratory.

In those cases, though, we had already put into place a backup source. We tend to have a policy of making sure we have two API suppliers for each one of our licenses, but that takes an awful lot of extra labor. It's almost like filing another application to get all that data collected from another raw material source.

But my ANDA is worthless if my supplier doesn't supply me material. And we were lucky in this particular case that we've already received approval from the FDA for another source and have already sourced that raw material. It's in the building and the product's being made as we speak, and it'll be shipped by June.

But, yes, it does happen, but Lannett has been a very smart Company throughout its history and the spurt of growth we had going back to 2002 was directly attributable to our having a secondary source for an ANDA. When everyone else in the country couldn't make this product because they all relied on one vendor, we were in the market exclusively with that product just because of that.

So we believe that's the only way to protect your investment here. So we're doing that. Trying to remember the second part of your question?

The number of dedicated suites.

Dedicated suites at Cody. I believe there's four dedicated suites at Cody at the moment. Two are being assembled now to make two additional APIs that are very significant contributors. And one of them, of course, does the dosage forms, the oral solutions.

The other one does the current Hydromorphone. And some of the suites are capable of doing other products but we try to dedicate them. So I would say you're looking at four suites as we're speaking today at Cody, and looking to add more. But, again, we're going to have to decide when to add that suite, when to work on that API depending on the backlog and when I will be filing applications.

One of our products, for example, I can file 18 ANDAs that do not require for bio studies for one raw material that Cody can make for me. So clearly I'm going to prioritize that. However, if those 18 sit down at the Agency for almost three years, then you can see the dilemma here in not rushing into investing money in Cody and have to wait three years for a payback.

It's a tough choice because of this backlog, we're [pace] we have to be careful that people don't say you're spending money, but you're not realizing a benefit from it. And that's one of the difficulties we're facing.

And your secondary source for the ANDA that you just alluded to, did that cost more than the one that you were rejecting?

No. It was actually the same price.

We had already negotiated a low price from the original vendor because it was one of those cases where a company acquired another company, and then moved the API production to their own facility and said they didn't make any changes, but unfortunately that wasn't truthful.

They did make some changes that apparently impacted the raw material, and it's failing its tests. But then the other company's material was already approved at a same price. So, no, it won't impact us at all.

Okay. Thank you.

You're welcome.

Our next question comes from George [Gaspar], private investor. Please go ahead.

Thank you. Arthur, post the health care bill, can you give us just a general view on how you see the generic business at this point in time and what opportunity you see that wasn't there before or what subtraction might be there because of the health care bill?

Quite frankly, first of all, I see the health care bill -- any of these health care bills always benefiting the generic industry as a whole because the emphasis is on reducing costs, and that's where we really do our best jobs. Sometimes I might disagree with that because of the margin attacks from our competitors, but it is one of the best jobs we do.

But with regards to any benefit, I don't believe, for example, that people are going without medication in this country. If they were seriously ill, they would be getting to an emergency room.

I don't think I'm going to see any incremental increase in the use of generic drugs or in the use of drugs in general by the population that's now covered by insurance because I believe the medication was there anyway. And most people don't have the difficulty purchasing the generic medication.

Where the difficulty lies is the more exotic products, the biotech drugs that are very pricey or the drugs that the FDA approves and gives to one firm, some of these old grandfather drugs, for example, have been up in the news lately where the price increases have taken a $5 prescription and brought it up to $50 a prescription. I just -- I see those things as just bumps in the road, some hurdles to overcome. But overall, our industry will continue to expand with or without this health care plan in place.

I don't really see it is going to have a major impact. Probably the Medicaid plan of a few years ago had a bigger impact in terms of the use of generic drugs than anything else did. So, again, I see it as positive for us, but nothing extraordinary.

Okay. Thank you.

You're welcome.

(Operator Instructions) I'm showing no further questions.

Okay. Let me 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 or at PondelWilkinson. 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 now disconnect.