LCI Lannett Company Inc

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

x      ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended June 30, 2019

OR

o         TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to

Commission File No. 001-31298

LANNETT COMPANY, INC.

(Exact name of registrant as specified in its charter)

9000 State Road

Philadelphia, Pennsylvania 19136

Registrant’s telephone number, including area code: (215) 333-9000

(Address of principal executive offices and telephone number)

Securities registered under Section 12(b) of the Exchange Act:

Securities registered under Section 12(g) of the Exchange Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o  No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o  No x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes x  No o

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

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

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

Aggregate market value of common stock held by non-affiliates of the registrant, as of December 31, 2018 was $155,045,696 based on the closing price of the stock on the NYSE.

As of July 31, 2019, there were 40,405,663 shares of the registrant’s common stock, $.001 par value, outstanding.

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K contains forward-looking statements.  Any statements made in this Annual Report that are not statements of historical fact or that refer to estimated or anticipated future events are forward-looking statements.  We have based our forward-looking statements on management’s beliefs and assumptions based on information available to them at this time.  Without limiting the generality of the foregoing, words such as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “could,” “would,” “estimate,” “continue,” or “pursue,” or the negative other variations thereof or comparable terminology, are intended to identify forward-looking statements.  Such forward-looking statements reflect our current perspective of our business, future performance, existing trends and information as of the date of this filing.  These include, but are not limited to the impact of the nonrenewal of the exclusive distribution agreement with Jerome Stevens Pharmaceuticals on our future business and prospects, our beliefs about future revenue and expense levels, growth rates, prospects related to our strategic initiatives and business strategies, express or implied assumptions about government regulatory action or inaction, anticipated product approvals and launches, business initiatives and product development activities, assessments related to clinical trial results, product performance and competitive environment, anticipated financial performance and integration of acquisitions.  The statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict.  We caution the reader that certain important factors may affect our actual operating results and could cause such results to differ materially from those expressed or implied by forward-looking statements.  We believe the risks and uncertainties discussed under the “Item 1A - Risk Factors” and other risks and uncertainties detailed herein and from time to time in our SEC filings may affect our actual results.

We disclaim any obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.  We also may make additional disclosures in our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and in other filings that we may make from time to time with the SEC.  Other factors besides those listed here could also adversely affect us.

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Leverage our Flexibility and Speed.  We believe flexibility and speed in decision-making are critical success factors in the generic industry.  Our mid-sized scale and relatively less complex organizational structure as a U.S. based organization results in a nimbler response to securing market opportunities.

Extensive Experience with Productive Partnerships.  We continue to grow, diversify and strengthen our business by entering into partnerships to distribute both externally developed products and authorized generic equivalents of brand products.  In fiscal year 2019, we successfully launched 18 new products, many of which are sourced from external parties, including Vardenafil IR (Levitra®), Amphetamine IR (Adderall®) and an AB-rated version of Methylphenidate ER (Concerta®).  We believe that our success with these products, along with existing alliances, has established us as a strong development and marketing partner creating the foundation for continued productive partnership alliances in the future.

Ability to Develop Successful Products.  We believe that our abilities to select viable products for internal development, efficiently develop such products, including obtaining any applicable regulatory approvals and achieve economies of scale in production, are critical to our success in the generic pharmaceutical industry.  We intend to focus on long-term profitability driven in part by securing market positions where fewer competitors are expected.

Strong Track Record of Obtaining Regulatory Approvals for New Products.  During the past three fiscal years, we have received 18 ANDA approvals from the Food and Drug Administration (the “FDA”).  Although the timing of ANDA approvals by the FDA is uncertain, we currently expect to continue to receive more during Fiscal 2020.  These regulatory approvals will enable us to manufacture and supply a broader portfolio of generic pharmaceutical products.

Efficient Development Systems and Manufacturing Expertise for New Products.  We believe that our U.S.-based manufacturing expertise, low overhead expenses and skilled product development capabilities will help us remain competitive in the generic pharmaceutical market.  We intend to dedicate significant resources toward developing new products because we believe our success is linked to our ability to continually introduce new generic products into the marketplace.

Business Strategies

Focus on the large US Generic Market

We believe oral generics are the foundation of efficient pharmaceutical care and are estimated to be approximately 90% of all US pharmaceutical volume with an IQVIA value of approximately $56 billion for the 12-month period ending June 30, 2019.  While that estimate likely well exceeds actual market size, Lannett’s opportunity is significant relative to Lannett’s size.

We are focused on increasing our market share in the generic pharmaceutical industry while directing additional resources on the development of new products.  We continue to improve our financial performance by expanding our line of generic products, increasing unit sales to current customers, creating manufacturing efficiencies and managing our overhead and administrative costs.

Focus on In-Line Execution

We have a broad portfolio of existing generics and we continually look to optimize the share and value of our existing portfolio.  We look to capitalize on competitor supply disruptions which occur frequently in the industry of both a shorter and longer duration.  We seek to reduce the cost of our products through various life cycle management approaches including increasing the efficiency of our plant, and our product manufacturing yields, and lowering incipient and API costs from third-party suppliers.

Strategic Expansion of our Product Offering

We have three primary strategies for expanding our product offerings: (1) deploying our experienced Research and Development (“R&D”) staff to develop products in-house; (2) entering into product development agreements or strategic alliances with third-party product developers and formulators; and (3) purchasing ANDAs or New Drug Applications (“NDA”) from other manufacturers.  We expect that each strategy will facilitate our identification, selection and development of additional pharmaceutical products that we may sell to our existing network of customers.

Between January 2018 and June 2019, the number of alliances that our business development efforts have secured increased significantly and we have acquired or in-licensed over 40 ANDA products as a result of these efforts.

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Opportunistically, we may increase our focus on specialty markets within the pharmaceutical industry.  As a result, in Fiscal 2018, the Company filed its first NDA for Numbrino (cocaine hydrochloride solution); the product application continues to progress at the FDA.  The Company plans to begin marketing the product shortly after receiving approval, which is expected around the end of calendar year 2019.  In August 2019, the Company ceased distributing our unapproved cocaine hydrochloride solution product in compliance with an FDA request.

Similarly, in 2016, the Company announced a strategic partnership with YiChang HEC ChangJiang Pharmaceutical Co., Ltd, an HEC Group company, to co-develop a biosimilar insulin glargine pharmaceutical product for the U.S. market.  The product is currently in development, and a healthy human Pharmacokinetic/Pharmacodynamic modeling (“PK/PD”) clinical trial is underway in South Africa.  It is the first clinical study to directly compare the Lannett/HEC insulin glargine to U.S. Lantus® as part of the effort to file a biosimilar Biologics License Application (“BLA”) with the U.S. FDA.  Study results are expected in September 2019.  The Company plans to manage the clinical and regulatory steps specific for an FDA approval to market and will have the exclusive U.S. marketing rights to the product.  In addition, we will market other generic products developed by HEC with several launches expected over the next few years.

In July 2019, the Company entered into an agreement with Cediprof, Inc. (“Cediprof”) to distribute Levothyroxine Sodium Tablets USP beginning not later than August 1, 2022.  Levothyroxine is one of the largest generics sold in the USA.  The product has several technical attributes that make receiving an FDA approval and continuous manufacturing challenging.  The Cediprof product is already approved and has been sold in the U.S. by its current partner for the past several years.

We have several other existing supply and development agreements with both international and domestic companies; in addition, we are currently in negotiations on similar agreements with other companies through which we can market and distribute future products.  We intend to capitalize on our strong customer relationships to build our market share for such products.

Due to the expiration of the JSP Distribution Agreement in March 2019, management reassessed its overall business strategies to offset the impact of the loss on a short- and long-term basis.  These plans currently include, among other things, an emphasis on reducing cost of sales, R&D and selling, general and administrative (“SG&A”) expenses; continuing to accelerate new product launches; increasing the level of strategic partnerships; and reducing capital expenditures.  Management will also continue its emphasis on accelerating ANDA filings.  In addition, management plans to attempt, at the appropriate time, to refinance all or a significant portion of its outstanding long-term debt to reduce principal repayment requirements and establish more flexibility around financial covenants.  These actions may increase related interest expense, but are expected to positively impact cash flows.

A Change from a Vertically Integrated Manufacturer, Supplier and Distributor of Controlled Substance Products.

We are in the process of closing the Cody Labs subsidiary, our controlled substance products API business.  We have signed an agreement to sell the Cody Labs’ equipment and we currently intend to retain, until our pending cocaine hydrochloride solution Section 505(b)(2) NDA application is approved, the main facility and a small portion of workforce as well the intellectual property related to the business.  We have begun the transfer of certain products to our Carmel facility.

Mergers and Acquisitions.

We evaluate potential mergers and acquisitions opportunities that are a strategic fit and accretive to our business.  During Fiscal 2016, we completed the acquisition of KUPI, the former subsidiary of global biopharmaceuticals company UCB S.A.  KUPI is a U.S. specialty pharmaceuticals manufacturer focused on the development of products that are difficult to formulate or utilize specialized delivery technologies.  Strategic benefits of the acquisition include expanded manufacturing capacity, a diversified product portfolio and pipeline and complementary R&D expertise.

Key Products

Key products were selected based on current and future sales and profitability.  In aggregate, excluding Levothyroxine, the 11 products noted below accounts for approximately 37% of Lannett sales in Fiscal 2019.

Levothyroxine Sodium Tablets

Levothyroxine Sodium tablets, which are used for the treatment of thyroid deficiency by patients of various ages and demographic backgrounds, are one of the most prescribed drugs in the United States.  The product is manufactured by JSP and was distributed under the JSP Distribution Agreement and was produced and marketed in 12 potencies.  Net sales of Levothyroxine Sodium tablets totaled $197.5 million in fiscal year 2019.  In our distribution of these products, we primarily competed with two brand Levothyroxine Sodium products, AbbVie’s Synthroid® and Pfizer’s Levoxyl®, as well as generic products from Mylan and Sandoz, each of which have multiple AB ratings.  On November 12, 2018, the Company announced a transition services agreement with Amneal Pharmaceuticals (“Amneal”) to transition distribution of Levothyroxine to trade customers to Amneal as of December 2019 ahead of the expiration of the JSP Distribution Agreement which expired on March 23, 2019.

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In July 2019, the Company entered into an agreement with Cediprof, Inc. (“Cediprof”) for the exclusive right, commencing no later than August 1, 2022, to market and supply Levothyroxine Sodium Tablets USP.  See Note 22. “Subsequent Events”

Fluphenazine Tablets

Fluphenazine tablets are used for the management of manifestations of psychotic disorders.  Net sales of Fluphenazine tablets represented approximately 10% of total net sales in fiscal year 2019.

Verapamil SR Tablets

Verapamil SR tablets are a calcium channel blocker used in the treatment of high blood pressure, arrhythmia and angina.  We market the authorized generic of Verelan PM.

Ursodiol Capsules

Ursodiol Capsules are produced and marketed in 300 mg capsules and are used for the treatment and prevention of gallstones.  The product is a generic version of the branded drug Atigall®.  This product has seen increased competition over the last year.

Methylphenidate CD Capsules

Methylphenidate CD is a central nervous system (“CNS”) stimulant indicated for the treatment of Attention Deficit Hyperactivity Disorder (“ADHD”).  This product is the authorized generic version of the brand Metadate CD®.

Omeprazole Capsules

Omeprazole is a proton pump inhibitor.  The product is a generic version of the branded drug Prilosec®.  It is indicated for the treatment of certain diseases of the esophagus and stomach ulcers as well as pathologic hypersecretory conditions.  KUPI produces Omeprazole DR capsules in 10mg, 20mg and 40mg dosages.

Pantoprazole Sodium DR Tablets

Pantoprazole is a proton pump inhibitor.  The product is a generic version of the branded drug Nexium®.  It is indicated for the treatment of certain diseases of the esophagus and pathological hypersecretory conditions.  KUPI produces Pantoprazole tablets in 20mg and 40mg dosages.

Sumatriptan Nasal Spray

Sumatriptan Nasal Spray is indicated for the acute treatment of migraine attacks.  This product is a generic version of Imitrex® Nasal Spray.  The Company distributes the 5mg and 20mg dosages.

Dicyclomine Tablets and Capsules

Dicyclomine tablets and capsules are both indicated for the treatment of irritable bowel syndrome.  They are the generic versions of Bentyl®, tablets and capsules.

Metolazone Tablets

Metolazone is a diuretic medication.  It is indicated for the treatment of hypertension, alone or in combination with other anti-hypertensives.  We market the authorized generic version of Zaroxolyn®.  We launched this product in the last month of fiscal year 2018.

Methylphenidate Hydrochloride ER

Methylphenidate ER is a CNS stimulant indicated for the treatment of ADHD in children six years of age and older, adolescents and adults up to the age of 65.  The product is a generic version of the branded drug Concerta®.

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The Company markets one form of the product which was designated “BX.”  Per a teleconference on November 2014, the FDA informed KUPI that it was changing the therapeutic equivalence rating of its product from “AB” (therapeutically equivalent) to “BX.”  A BX-rated drug is a product for which data are insufficient to determine therapeutic equivalence; it is still approved and can be prescribed, but the FDA does not recommend it as automatically substitutable for the brand-name drug at the pharmacy.

The Company has been working with the FDA to regain the “AB” rating, and in the meantime, maintain the drug on the U.S. market with a BX rating.  However, there can be no assurance as to when or if the Company will regain the “AB” rating or be permitted to remain on the market.  If the Company were to receive the “AB” rating, net sales of the product could increase subject to market factors existing at that time.  The Company also agreed to potential acquisition-related contingent payments to UCB related to Methylphenidate ER if the FDA reinstates the AB-rating and certain sales thresholds are met.  Such potential contingent payments are set to expire after December 31, 2020.

In August 2018, the Company entered into an exclusive perpetual licensing agreement with Andor Pharmaceuticals, LLC for Methylphenidate Hydrochloride Extended Release (ER) tablets USP (CII) in 18 mg, 27 mg, 36 mg and 54 mg strengths.  Andor’s ANDA of Methylphenidate was approved by the FDA on April 24, 2019 as an AB-rated generic equivalent to the brand Concerta®.  Lannett commenced marketing of this product on May 29, 2019.

Under the licensing agreement, Lannett is providing sales, marketing and distribution support of Andor’s Methylphenidate ER product, for which it will receive a percentage of the net profits.

Cocaine Hydrochloride Solution

Cocaine hydrochloride solution was produced and marketed under a preliminary new drug application (“PIND”) in two different strengths and two different size containers.  Cocaine hydrochloride solution is utilized primarily for the anesthetization of the patient during ear, nose or throat surgery, sinuplasty and in emergency rooms.

In December 2017, a competitor received approval from the FDA to market and sell a cocaine hydrochloride solution product.  This approval affects the Company’s right to market and sell its unapproved cocaine hydrochloride colution product.  According to FDA guidance, the FDA allowed the Company to continue marketing its unapproved product for a period of time following approval of the competitor’s product.  Upon the recent request of the FDA to cease manufacturing and distributing our unapproved cocaine hydrochloride solution product as a result of an approved product on the market, the Company committed to not manufacture or distribute cocaine hydrochloride 10% solution, which has not been sold during Fiscal 2019, as of April 15, 2019.  The Company has also agreed to cease manufacturing its unapproved cocaine hydrochloride 4% solution on June 15, 2019 and cease distributing the product on August 15, 2019.  The Company does not believe the discontinuation will have a material impact on our future expected results of operations as we had anticipated the withdrawal of this product.

Meanwhile, the FDA continues to review the Company’s Section 505(b)(2) NDA application, and in July 2018 issued a Complete Response Letter which required an additional study and other information.  The additional study was completed and we have provided a full response to the FDA.  The Company is awaiting FDA approval of the NDA application but cannot say for certain when or if the application will be approved.

The competitor filed a Citizen Petition with the FDA in February 2019, claiming that the grant of the New Chemical Entity (“NCE”) exclusivity blocks the approval of the Company’s application for five years and requesting that the FDA refuse to accept any further submissions in furtherance of the Company’s Section 505(b)(2) NDA application, treat as withdrawn any submissions made by the Company after December 2017 and withdraw the Company’s Section 505(b)(2) application.  On April 24, 2019, the Company filed an opposition to the Citizen Petition requesting that it be denied.  On July 3, 2019, the FDA denied the competitor’s citizen petition.

Sales & Marketing and Customers

We sell our pharmaceutical products to generic pharmaceutical distributors, drug wholesalers, chain drug retailers, private label distributors, mail-order pharmacies, other pharmaceutical companies, managed care organizations, hospital buying groups, governmental entities and health maintenance organizations.  The pharmaceutical industry’s largest wholesale distributors, Amerisource Bergen, McKesson and Cardinal Health, accounted for 21%, 18% and 10%, respectively, of our total net sales in fiscal year 2019, 29%, 17% and 6%, respectively, of our total net sales in fiscal year 2018 and 28%, 21% and 6%, respectively, of our total net sales in fiscal year 2017.

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Sales to wholesale customers include “indirect sales,” which represent sales to third-party entities, such as independent pharmacies, managed care organizations, hospitals, nursing homes and group purchasing organizations, collectively referred to as “indirect customers.”

We enter into definitive agreements with our indirect customers to establish pricing for certain covered products.  Under such agreements, the indirect customers independently select a wholesaler from which to purchase the products at these agreed-upon prices.  We will provide credit to the wholesaler for the difference between the agreed-upon price with the indirect customer and the wholesaler’s invoice price.  This credit is called a “chargeback.”  For more information on chargebacks, see the section entitled “Critical Accounting Policies” in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-K.  These indirect sale transactions are recorded on our books as sales to wholesale customers.

We promote our products through direct sales, trade shows and group purchasing organizations’ bidding processes.  We also have a limited number of products that are marketed as part of our customers’ “private label” programs.  Private label products are manufactured by Lannett but distributed to the customer with a label typically containing the name and logo of the customer.  Private label allows us to leverage our internal sales efforts by using the sales and marketing efforts of those customers.

Strong and dependable customer relationships have created a positive platform for us to increase our sales volumes.  Historically and in fiscal years 2019, 2018 and 2017, our advertising expenses have been immaterial.  When our sales representatives make contact with a customer, we will generally offer to supply the customer our products at fixed prices.  If accepted, the customer’s purchasing department will coordinate the purchase, receipt and distribution of the products throughout its distribution centers and retail outlets.  Once a customer accepts our supply of a product, the customer typically expects a high standard of service, including timely receipt of products ordered, availability of convenient, user-friendly and effective customer service functions and maintaining open lines of communication.

We believe that retail-level consumer demand dictates the total volume of sales for various products.  In the event that wholesale and retail customers adjust their purchasing volumes, we believe that consumer demand will be fulfilled by other wholesale or retail sources of supply.  As a result, we attempt to develop and maintain strong relationships with most of the major retail chains, wholesale distributors and mail-order pharmacies in order to facilitate the supply of our products through whatever channel the consumer prefers.  Although we have agreements with customers governing the transaction terms of our sales, generally there are no minimum purchase quantities applicable to these agreements.  Our practice of maintaining adequate inventory levels, employing a responsive order filling system and prioritizing timely fulfillment of those orders have contributed to a strong reputation among our customers as a dependable supplier of high-quality generic pharmaceuticals.

Competition

The manufacturing and distribution of generic pharmaceutical products is a highly competitive industry.  Competition is based primarily on a reliable supply and price.  In addition to competitive pricing, our competitive advantages are our ability to provide strong and dependable customer service by maintaining adequate inventory levels, employing a responsive order filling system and prioritizing timely fulfillment of orders.  We ensure that our products are available from national wholesale, chain drug and mail-order suppliers as well as our own warehouse.  The modernization of our facilities, hiring of experienced staff and implementation of inventory and quality control programs have improved our competitive cost position.  Our primary competitors across our product portfolio are Teva Pharmaceutical Industries Ltd., Mylan N.V., and Sandoz International GmbH.

Validated Pharmaceutical Capabilities

The Company’s 432,000 square foot Seymour, Indiana facility contains approximately 107,000 square feet of manufacturing space as well as a leased 116,000 square foot temperature/humidity-controlled storage warehouse.  The Seymour facility has had satisfactory inspections conducted by the FDA and EMA and similar regulatory authorities of Japan, Taiwan, Brazil, China, Korea and Turkey.  As of June 30, 2019, the facility has a production capacity of approximately 4.0 billion doses.

The Company has an 110,000 square foot manufacturing facility located in Carmel, New York, which sits on 25.8 acres of land.  The facility specializes in liquid products and currently houses manufacturing, packaging, quality and research and development and has capacity for additional manufacturing space, if needed.

Lannett owns several facilities in Philadelphia, Pennsylvania.  Certain administrative functions, manufacturing and research and development facilities are located in a 31,000 square foot facility at 9000 State Road, Philadelphia, PA.  In the second quarter of Fiscal 2019, the Company ceased manufacturing functions at its 9000 State Road facility.  A second, 63,000 square foot facility is located within one mile of the State Road facility at 9001 Torresdale Avenue, Philadelphia, PA and contains our analytical research and development and quality control laboratories.  The facility has capacity for additional manufacturing, packaging or laboratory space, if needed.  We also own a building at 13200 Townsend Road in Philadelphia, PA consisting of 66,000 square feet on 7.3 acres of land formerly used for warehouse space and shipping.  The building is currently under contract to be sold with an expected closing date in the first quarter of Fiscal 2020.

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The manufacturing facility of our wholly-owned subsidiary, Cody Labs, consists of a 73,000 square foot structure located on approximately 15.0 acres in Cody, Wyoming.  In June 2019, the Company announced the Cody API Restructuring Plan, as further described in Note 3. “Restructuring Charges.” As part of the plan, the Company intends to sell the manufacturing facility and cease all operations at Cody Labs.

We have adopted many processes in support of regulations relating to cGMPs in the last several years and we believe we are operating our facilities in substantial compliance with the FDA’s cGMP regulations.  In designing our facilities, full attention was given to material flow, equipment and automation, quality control and inspection.

Raw Materials and Finished Goods Suppliers

Our use of raw materials in the production process consists of pharmaceutical chemicals in various forms that are generally available from several sources.  In addition to the raw materials we purchase for the production process, we purchase certain finished dosage inventories.  We sell these finished dosage form products directly to our customers along with the finished dosage form products manufactured in-house.  We generally take precautionary measures to avoid a disruption in raw materials and finished goods, such as finding secondary suppliers for certain raw materials or finished goods when available and maintaining adequate inventory levels.

The Company’s primary finished goods inventory supplier was JSP, in Bohemia, New York.  Purchases of finished goods from JSP accounted for 29% of our inventory purchases in fiscal year 2019, 37% in fiscal year 2018 and 36% in fiscal year 2017. On March 23, 2019, the JSP Distribution Agreement expired and was not renewed.

Over time, we have entered into supply and development agreements with Summit Bioscience LLC, HEC Pharm Group, Andor Pharmaceuticals LLC, Dexcel Pharma, Elite Pharmaceuticals, RivoPharm and various other international and domestic companies.  The Company is currently in negotiations on similar agreements with other companies and is actively seeking additional strategic partnerships, through which it will market and distribute products manufactured in-house or by third parties.  The Company plans to continue evaluating ways to improve its capital structure and consider potential merger and acquisition opportunities.  The Company also continues to assess product acquisitions that are a strategic fit and accretive to the business.

Research and Development Process

Over the past several years, we have invested in R&D projects.  The costs of these R&D efforts are expensed during the periods incurred.  We believe that such costs may be recovered in future years when we receive approval from the FDA to manufacture and distribute such products.  We have embarked on a plan to grow in future years, which includes organic growth to be achieved through our R&D efforts.  We expect that our growing list of generic products under development will drive future growth.  Over the past several years, we have hired additional personnel in product development, production and formulation.  The following steps outline the numerous stages in the generic drug development process:

1.)          Formulation and Analytical Method Development.  After a drug candidate is selected for future sale, product development scientists perform various experiments to incorporate excipients with the APIs to produce a robust, stable and bioequivalent dosage form that will be therapeutically equivalent to the brand name drug, and meet all FDA requirements for approval.  These experiments will result in the creation of a number of product formulations to determine which formula will be most suitable for our subsequent development process.  Various formulations are tested in the laboratory to measure results against the innovator brand drug.  During this time, we may use reverse engineering methods on samples of the innovator drug to determine the type and quantity of inactive ingredients.  During the formulation phase, our R&D chemists begin to develop an analytical, laboratory testing method.  The successful development of this test method will allow us to test developmental and commercial batches of the product in the future.  All of the information used in the final formulation, including the analytical test methods adopted for the generic drug candidate, will be included as part of the Chemistry, Manufacturing and Controls (“CMC”) section of the ANDA submitted to the FDA.

2.)          Scale-up and Tech Transfer.  After product development, R&D formulators and the R&D chemists agree on a final formulation for use in moving the drug candidate forward in the developmental process, we then attempt to increase the batch size of the product.  The batch size represents the standard magnitude to be used in manufacturing a batch of the product.  The determination of batch size affects the amount of raw material that is used in the manufacturing process and the number of expected dosages to be created during the production cycle.  We attempt to determine batch size based on the amount of active ingredient in each dosage, the available production equipment and unit sales projections.  The scaled-up batch is then generally produced in our commercial manufacturing facilities.  During this manufacturing process, we document the equipment used, the amount of time in each major processing step and any other steps needed to consistently produce a batch of that product.

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3.)          Bio equivalency and Clinical Testing.  After a successful scale-up of the generic drug batch, we schedule and perform generally required bio equivalency testing on the product and in some cases, clinical testing, if required by the FDA.  These procedures, which are generally outsourced to third parties, include testing the absorption rate and extent of the generic product in the human bloodstream compared to the absorption of the innovator drug.  The results of this testing are then documented and reported to us to determine the “success” of the generic drug product.  Success, in this context, means that we are able to demonstrate that our product is comparable to the innovator product in dosage form, strength, route of administration, quality, performance characteristics and intended use.

Bioequivalence (meaning that the product has the same blood levels and dosage form as the innovator drug) and a stable formula are the primary requirements for a generic drug approval (assuming the manufacturing plant is in compliance with the FDA’s cGMP regulations).  Lengthy and costly clinical trials proving safety and efficacy, which are required by the FDA for NDAs (and may include 505(b)(2)NDAs), are typically unnecessary for generic companies.  If the results are successful, we will continue the collection of information and documentation for assembly of the drug application.

4.)          Submission of the ANDA for FDA Review and Approval.  An ANDA is a comprehensive submission that contains, among other things, data and information pertaining to the proposed labeling, active pharmaceutical ingredient, excipients, container/closure, drug product formulation, drug product testing specification, methodology and results.  Bioequivalence study reports are also included in the ANDA submission.

Our ANDAs and NDAs are submitted to the FDA electronically using the most current Electronic Common Technical Document standards.  Lannett strives to achieve a first cycle approval for each ANDA under the Generic Drug User Fee Amendments of 2012 (“GDUFA”) review metrics.

In fiscal year 2019, we launched several products from internal and external sources.  The following summary contains more specific details regarding our latest product launches.  Market data was obtained from IQVIA.

*Only small quantities of these products were shipped in Fiscal 2019.  Moreover, the Company has subsequently de-emphasized the Oxycodone and Hydrocodone products, both of which are in the Pain Management category.

We have additional products of various dosage forms currently under development.  Our developmental drug products are intended to treat a diverse range of indications.  The products under development are at various stages in the development cycle—formulation, scale-up, clinical testing and/or FDA review.

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The cost associated with each product that we are currently developing is dependent on numerous factors, including but not limited to, the complexity of the active ingredient’s chemical characteristics, the price of the raw materials and the FDA-mandated requirement of bioequivalence studies (depending on the FDA’s Product Specific Guidance).  With the introduction of GDUFA and additional guidance issued by the FDA, the cost to develop a new generic product varies but can total several million dollars.

In addition, we currently own several ANDAs for products that are not currently marketed and noted as Discontinued in FDA’s Orange Book.  Occasionally, we review such discontinued products to determine if the market potential for any of these products has recently changed to make it attractive for us to reconsider manufacturing and selling.  If we decide to commercially market one of these products, we evaluate the requirements necessary for commercial launch, including a filing strategy to properly report the relaunch to the FDA so that the product is moved to the Active section of the Orange Book.

In addition to the efforts of our internal product development group, we have contracted with numerous outside firms for the formulation and development of several new generic drug products.  These outsourced R&D products are at various stages in the development cycle—formulation, analytical method development and testing and manufacturing scale-up.  These products include orally administered solid dosage products, injectables and nasal delivery products that are intended to treat a diverse range of medical indications.

We intend to ultimately transfer the formulation technology and manufacturing process for some of these R&D products to our own commercial manufacturing sites.  We initiated these outsourced R&D efforts to complement the progress of our own internal R&D efforts.

We recorded R&D expenses of $38.8 million in fiscal year 2019, $29.2 million in fiscal year 2018 and $42.1 million in fiscal year 2017.  These amounts included expenses associated with bioequivalence studies, internal development resources as well as outsourced development.  While we manage all R&D from our principal executive office in Philadelphia, Pennsylvania, we have also been taking steps to capitalize on favorable development costs in other countries.  We have strategic relationships with various companies that either act as contract research organizations or API suppliers as well as dosage form manufacturers.  In addition, U.S.-based research organizations have been engaged for product development to enhance our internal development.  Fixed payment arrangements are established between Lannett and these research organizations and in some cases include a royalty provision.  Development payments are normally scheduled in advance, based on attaining development milestones.

Government Regulation

Pharmaceutical manufacturers are subject to extensive regulation by the federal government, including the FDA and, in cases of controlled substance products the DEA, as well as other federal regulatory bodies and state governments.  The Federal Food, Drug and Cosmetic Act (the “FDCA”), the Controlled Substance Act (the “CSA”) and other federal statutes and regulations govern or influence the testing, manufacture, safety, labeling, storage, record keeping, approval, advertising and promotion of our generic drug products.  Non-compliance with applicable regulations can result in fines, product recalls and seizure of products, total or partial suspension of production, personal and/or corporate prosecution and debarment and refusal of the government to approve applications.  The FDA also has the authority to revoke previously approved drug applications.

Generally, FDA approval is required before a drug can be marketed.  A new drug is one not generally recognized by qualified experts as safe and effective for its intended use and is submitted to the FDA as a NDA.  The FDA review process for new drugs is very extensive and requires a substantial investment to research and test the drug candidate.  A less burdensome approval pathway is used for generic drug products, the ANDA.  Typically, the investment required to develop a generic drug is less costly than the new drug. Some drug products may be submitted as a 505(b)(2) NDA, allowing some of the required research and testing to be waived by relying on FDA’s previous findings of safety and efficacy and literature.  For additional information on the FDA approval pathways, refer to section 505(b)(1) and 505(b)(2) of the FD&C Act for NDAs, section 505(j) for ANDAs and resources available on the FDA website, www.fda.gov.

Manufacturing cGMP Requirements

Among the requirements for a new drug approval, facilities identified in each application that perform operations related to the drug product, including drug substance manufacturers and outside contract facilities, must conform to FDA cGMP regulations.  The FDA may perform general GMP and/or pre-approval inspections to assess a company’s compliance with cGMP regulations.  These inspections include reviews of procedures, operations, and data used to support the application and ongoing drug product manufacturing and testing.  FDA’s cGMP regulations require, among other things, quality control and quality assurance systems as well as the corresponding records and documentation.  In complying with the evolving standards set forth in the cGMP regulations, we must continue to expend time, money and effort in many areas to ensure compliance.

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Failure to comply with statutory and regulatory requirements subject a manufacturer to possible legal or regulatory action, including but not limited to, warning letters, consent decrees placing significant restrictions on or suspending manufacturing operations, injunctions, the seizure of non-complying drug products and/or civil and criminal penalties.

Adverse experiences with the product and certain non-compliance events may need to be reported to the FDA and could result in regulatory actions such as labeling changes or FDA request for application withdrawal or product removal.

Other Regulatory Requirements

With respect to post-market product advertising and promotion, the FDA imposes a number of complex regulations on entities that advertise and promote pharmaceuticals, which include, among others, standards for direct-to-consumer advertising, off-label promotion, industry-sponsored scientific and educational activities and promotional activities involving the internet.  The FDA has very broad enforcement authority under the FDCA and failure to abide by these regulations can result in penalties, including the issuance of a warning letter directing entities to correct deviations from FDA standards, a requirement that future advertising and promotional materials be pre-cleared by the FDA and state and/or federal civil and criminal investigations and prosecutions.  Some of our products require participation in Risk Evaluation and Mitigation Strategies (“REMS”) programs, including our opioid products. A shared system REMS encompasses multiple prescription drug products and is developed and implemented jointly by two or more companies marketing the same products.  These programs can add significant costs for the Company, depending on market share and complexity of the program.

Any one or a combination of FDA regulatory or enforcement actions against the Company could have a material adverse effect on our financial results.

DEA Regulation

We maintain registrations and quota (limitations on purchases of controlled substances) with the DEA that enable us to receive, manufacture, store, develop, test and distribute controlled substances in connection with our operations.  Controlled substances are those drugs that appear on one of five schedules promulgated and administered by the DEA under the CSA.  The CSA governs, among other things, the distribution, recordkeeping, quota, handling, security and disposal of controlled substances.  We are subject to periodic and ongoing inspections by the DEA and similar state drug enforcement authorities to assess our ongoing compliance with the DEA’s regulations.  Any failure to comply with these regulations could lead to a variety of sanctions, including the revocation or a denial of renewal of our DEA registration or quota, injunctions, or civil or criminal penalties.  We are subject to an allocation of national (aggregate) quota for several products in our portfolio.  Our quota requests require DEA approval in full for us to meet our forecasted customer demands. The DEA may or may not approve our quota requests in full based on factors that we do not control.

Fraud and Abuse Laws

Because of the significant federal and state funding involved in the provision of health care services, including Medicare and Medicaid funding, Congress and state legislatures have enacted and federal and state governments actively enforce, a number of laws whose purpose is to eliminate fraud and abuse in federal health care programs.  Our business is subject to compliance with these laws, including both federal and state level Anti-Kickback Statutes, as well as other laws aimed at eliminating fraud and abuse such as the False Claims Act and the Foreign Corrupt Practices Act (“FCPA”).

Anti-Kickback Statutes and Federal False Claims Act

One of the primary federal laws aimed at curbing fraud and abuse in the federal health care programs is the federal Anti-Kickback Statute, 42 U.S.C. § 1320a–7b(b), which prohibits persons from knowingly and willfully soliciting, offering, receiving, or providing remuneration, directly or indirectly, in exchange for or to induce either the referral of an individual, or the furnishing or arranging for a good or service, for which payment may be made under a federal health care program such as Medicare, Medicaid or TRICARE.  The definition of “remuneration” has been broadly interpreted to include anything of value, including for example gifts, certain discounts, the furnishing of free supplies, equipment or services, credit arrangements, payment of cash and waivers of payments, including copayments.  Several courts have interpreted the statute’s intent requirement to mean that if any one purpose of an arrangement involving remuneration is to induce referrals of federal health care covered business, the statute has been violated.  Penalties for violations include criminal penalties and civil sanctions such as fines, imprisonment and possible exclusion from Medicare, Medicaid and other federal health care programs.  In addition, violations of the Anti-Kickback Statute are per se violations of the Federal False Claims Act, discussed in more detail below.

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The federal Anti-Kickback Statute is broad and prohibits many arrangements and practices that are lawful in businesses outside of the health care industry.  Recognizing that the Anti-Kickback Statute is broad and may technically prohibit many innocuous or beneficial arrangements, Congress incorporated several statutory exceptions into the federal Anti-Kickback Statute’s framework, which protect certain types of business arrangements.  Congress also authorized the Office of Inspector General of the U.S. Department of Health and Human Services (“OIG”) to issue a series of “regulatory safe harbors.”  Both the statutory exceptions and regulatory safe harbors set forth provisions that, if all of their applicable requirements are met, will assure health care providers and other parties to the arrangement that the federal Anti-Kickback Statute has not been violated and that that they will not be prosecuted under the Anti-Kickback Statute.  The failure of a transaction or arrangement to fit precisely within one or more safe harbors does not necessarily mean that it is illegal or that prosecution will be pursued.  However, conduct and business arrangements that do not fully satisfy each applicable safe harbor may result in increased scrutiny by government enforcement authorities such as OIG.

Many states have adopted laws similar to the federal Anti-Kickback Statute.  Some of these state prohibitions apply to referrals of patients for health care items or services reimbursed by any source, including commercial payers and private pay patients.

Government officials have focused their Anti-Kickback Statute enforcement efforts on marketing of health care services and products, among other activities and recently have brought cases against companies and certain sales, marketing and executive personnel, for allegedly offering unlawful inducements to potential or existing customers in an attempt to procure their business.

In addition to applying federal and state Anti-Kickback Statutes in enforcement actions involving the marketing of healthcare services and products, the federal government and various states also have enacted laws specifically regulating the sales and marketing practices of pharmaceutical companies.  These laws and regulations may limit financial interactions between manufacturers and health care providers, require disclosure to the federal or state government and the public of such interactions (e.g. federal and state “Sunshine” laws), or require the adoption of compliance standards or programs.  Many of these laws and regulations contain ambiguous requirements or require administrative guidance for implementation and, given the lack of clarity, our activities could be subject to the penalties under the pertinent laws and regulations.

Another development affecting the health care industry is the increased use of the Federal False Claims Act (“FFCA”) and in particular, action brought pursuant to the FFCA’s “Whistleblower” or “Qui Tam” provisions.  The FFCA imposes liability on any person or entity who, among other things, knowingly presents, or causes to be presented, a false or fraudulent claim for payment by a federal health care program.  The Qui Tam provisions of the FFCA allow a private individual to bring actions on behalf of the federal government alleging that the defendant has submitted a false claim to the federal government and to share in any monetary recovery.  In recent years, the number of suits brought against health care providers by private individuals has increased dramatically, and in Fiscal 2018, the federal government recovered more than $2.5 billion in judgements and settlements related to FFCA violations in the health care industry.  In addition to the FFCA, various states have enacted false claims laws analogous to the FFCA, and many of these state laws apply where a claim is submitted to any third-party payer and not merely a federal health care program.

When an entity is determined to have violated the FFCA, it may be required to pay up to three times the actual damages sustained by the government, plus civil penalties of between approximately $11,000 and $20,000 per claim, as adjusted annually.  Liability arises, primarily, when an entity knowingly submits or causes another to submit a false claim for reimbursement to the federal government.  The federal government has used the FFCA to assert liability on the basis of inadequate care, kickbacks and other improper referrals; improper use of Medicare numbers by the provider of services; as well as allegations regarding misrepresentations with respect to the services rendered.  In addition, the federal government has prosecuted companies under the FFCA in connection with off-label promotion of products.  Our future activities relating to the reporting of wholesale or estimated retail prices of our products, the reporting of discount and rebate information and other information affecting federal, state and third-party reimbursement of our products and the sale and marketing of our products may be subject to scrutiny under these laws.  We are unable to predict whether we will be subject to actions under the FFCA or a similar state law, or the impact of such actions.  However, the costs of defending such claims, as well as any sanctions imposed, could significantly affect our financial performance.

Foreign Corrupt Practices Act

The U.S. Foreign Corrupt Practices Act of 1977, as amended, and similar anti-bribery laws in other jurisdictions generally prohibit certain classes of persons and entities, and their intermediaries, from making payments to foreign government officials to assist in obtaining or retaining business.  Specifically, the anti-bribery provisions of the FCPA prohibit the bribery of government officials.  If we are found to be liable for FCPA or other violations, we could suffer from civil and criminal penalties or other sanctions, including contract cancellations or debarment, and loss of our reputation, any of which could have a significant impact on our business, financial condition and operations.

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HIPAA and Other Fraud and Privacy Regulations

The Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) created two new federal crimes: health care fraud and false statements relating to health care matters.  The HIPAA health care fraud statute prohibits, among other things, knowingly and willfully executing, or attempting to execute, a scheme to defraud any health care benefit program, including private payment programs.  A violation of this statute is a felony and may result in fines, imprisonment and/or exclusion from government-sponsored programs.  The HIPAA false statements statute prohibits knowingly and willfully falsifying, concealing, or covering up a material fact or making any materially false, fictitious, or fraudulent statement or representation in connection with the delivery of or payment for health care benefits, items, or services.  A violation of this statute is a felony and may result in fines and/or imprisonment.

Pricing

In the United States, our sales are dependent upon the availability of coverage and reimbursement for our products from third-party payors, including federal and state programs such as Medicare and Medicaid and private organizations such as commercial health insurance and managed care companies.  Such third-party payors increasingly challenge the price of medical products and services and instituting cost containment measures to control or significantly influence the purchase of medical products and services.

Over the past several years, the rising costs of providing health care services has triggered legislation to make certain changes to the way in which pharmaceuticals are covered and reimbursed, particularly by government programs.  For instance, federal legislation and regulations have created a voluntary prescription drug benefit, Medicare Part D, which revised the formula used to reimburse health care providers and physicians under Medicare Part B and imposed significant revisions to the Medicaid Drug Rebate Program.  These changes have resulted in and may continue to result in, coverage and reimbursement restrictions and increased rebate obligations by manufacturers.

In addition, there continues to be legislative and regulatory proposals at the federal and state levels directed at containing or lowering the cost of health care.  Examples of how limits on drug coverage and reimbursement in the United States may cause reduced payments for drugs in the future include:

·                  changing Medicare reimbursement methodologies;

·                  revising drug rebate calculations under the Medicaid program;

·                  reforming drug importation laws;

Also, over the last few years, several states have passed legislation or have proposed legislation that have imposed price reporting requirements for both generic and brand pharmaceutical products and that include price transparency, price increase notification and supplement rebate requirements.

We cannot predict the likelihood or pace of such additional changes or whether there will be significant legislative or regulatory reform impacting our products, nor can we predict with precision what effect such governmental measures would have if they were ultimately enacted into law.  However, in general, we believe that legislative and regulatory reform activity likely will continue.

Current or future federal or state laws and regulations may influence the prices of drugs and, therefore, could adversely affect the prices that we receive for our products. Programs in existence in certain states seek to set prices of all drugs sold within those states through the regulation and administration of the sale of prescription drugs. Expansion of these programs, in particular, state Medicaid programs, or changes required in the way in which Medicaid rebates are calculated under such programs, could adversely affect the price we receive for our products and could have a material adverse effect on our business, results of operations and financial condition. Further, generic pharmaceutical drug prices have been the focus of increased scrutiny by certain states’ attorney generals, the U.S. Department of Justice and Congress. Decreases in health care reimbursements or prices of our prescription drugs could limit our ability to sell our products or could decrease our revenues, which could have a material adverse effect on our business, results of operations and financial condition.

The Company believes that under the current regulatory environment, the generic pharmaceutical industry as a whole will be the target of increased governmental scrutiny, especially with respect to state and federal anti-trust and price-fixing claims.

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See Note 11 “Legal, Regulatory Matters and Contingencies” for a description of current state and federal anti-trust and price-fixing claims.

Other Applicable Laws

We are also subject to federal, state and local laws of general applicability, including laws regulating working conditions and the storage, transportation, or discharge of items that may be considered hazardous substances, hazardous waste, or environmental contaminants.  We monitor our compliance with laws and we believe we are in substantial compliance with all regulatory bodies.

As a publicly-traded company, we are also subject to significant regulations and laws, including the Sarbanes-Oxley Act of 2002.  Since its enactment, we have developed and instituted a corporate compliance program based on what we believe are the current best practices and we continue to update the program in response to newly implemented or changing regulatory requirements.

Employees

As of June 30, 2019, we had 1,020 full-time employees.

Securities and Exchange Act Reports

We maintain a website at www.lannett.com.  We make available on or through our website our current and periodic reports, including any amendments to those reports, that are filed with the Securities and Exchange Commission (the “SEC”) in accordance with the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  These reports include annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K.  This information is available on our website free of charge as soon as reasonably practicable after we electronically file the information with, or furnish it to, the SEC.

The contents of our website are not incorporated by reference in this Form 10-K and shall not be deemed “filed” under the Exchange Act.

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·                  require us to use a substantial portion of cash flow from operations to service our indebtedness, thereby reducing our ability to fund working capital, capital expenditures and other expenses;

·                  limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;

·                  place us at a competitive disadvantage compared to competitors that have less indebtedness; and

·                  limit our ability to borrow additional funds that may be needed to operate and expand our business.

The Amended Senior Secured Credit Facility imposes operating and financial restrictions, which may prevent us from pursuing certain business opportunities and taking certain actions that may be potentially profitable or in our best interests.

The operating and financial restrictions and covenants in our Amended Senior Secured Credit Facility restrict and future debt instruments may restrict, subject to certain important exceptions and qualifications, our and our subsidiaries’ ability to, among other things:

·                  incur or guarantee additional indebtedness;

·                  make certain investments or acquisitions;

·                  grant or permit certain liens on our assets;

·                  enter into certain transactions with affiliates;

·                  pay dividends, redeem our equity or make other restricted payments;

·                  prepay, repurchase or redeem contractually subordinated debt and certain other debt;

·                  merge, consolidate or transfer substantially all of our assets;

·                  transfer, sell or dispose of property and assets; and

·                  change the business we conduct or enter into new kinds of business.

These covenants could adversely affect our ability to finance our future operations or capital needs, withstand a future downturn in our business or the economy in general, engage in business activities, including future opportunities that may be in our interest and plan for or react to market conditions or otherwise execute our business strategies. Our ability to comply with these covenants may be affected by events beyond our control.  A breach of any of these covenants could result in a default in respect of the related indebtedness.  If an event of default occurs, the relevant lenders or holders of such indebtedness could elect to declare the indebtedness, together with accrued interest, fees and other liabilities, to be immediately due and payable and proceed against any collateral securing that indebtedness. Acceleration of our other indebtedness could result in a default under the terms of the Amended Senior Secured Credit Facility. There is no guarantee that we would be able to satisfy our obligations if any of our indebtedness is accelerated.

In addition, the limitations imposed in the Amended Senior Secured Credit Facility on our ability to incur certain additional debt and to take other corporate actions might significantly impair our ability to obtain other financing.  If, for any reason, we are unable to comply with the restrictions in the Amended Senior Secured Credit Facility, we may not be granted waivers or amendments to such restrictions or we may not be able to refinance our debt on terms acceptable to us, or at all.  The lenders under the Amended Senior Secured Credit Facility also have the right in these circumstances to terminate any commitments they have to provide further borrowings.  If we fail to meet any covenants in our Amended Senior Secured Credit Facility and cannot secure a waiver for such failure, the lenders under our Amended Senior Secured Credit Facility would be entitled to exercise various rights, including causing the amounts outstanding under the entire Amended Senior Secured Credit Facility to become immediately due and payable.  If we were unable to pay such amounts, the lenders under the Amended Senior Secured Credit Facility could recover amounts owed to them by foreclosing against the collateral pledged to them.  We have pledged a substantial portion of our assets to the lenders under the Amended Senior Secured Credit Facility, including the equity of our subsidiaries.

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Our Amended Senior Secured Credit Facility contains financial covenants and other restrictive covenants that may limit our flexibility. We may not be able to comply with these covenants, which could result in the amounts outstanding under our Amended Senior Secured Credit Facility becoming immediately due and payable.

Our Revolving Credit Facility requires us to comply with a first lien net leverage ratio not to exceed 3.75:1.00 when there are outstanding loans and letters of credit (other than (i) drawn letters of credit that have been cash collateralized and (ii) up to $5.0 million of undrawn letters of credit) thereunder that exceed 30% of the aggregate commitment amount under the Revolving Credit Facility of $125.0 million as of the last day of the applicable fiscal quarter (with a step-down, occurring as of December 31, 2019, to 3.25:1.00).

In addition, the Amended Senior Secured Credit Facility is subject to a financial performance covenant, which pursuant to the December 10, 2018 Amendment, provides that the Company shall not permit its secured net leverage ratio as of the last day of any four consecutive fiscal quarters to be greater than 3.75:1.00 (with a step-up, occurring as of December 31, 2019, to 4.25:1.00 and a step-down, occurring as of September 30, 2020, to 4.00:1.00).

Lastly, the Amended Senior Secured Credit Facility, as amended on December 10, 2018 is also subject to a minimum liquidity covenant, which provides that the Company shall not permit its liquidity as of the last day of any fiscal quarter to be less than $75.0 million.  For purposes of this covenant liquidity is defined as the sum of availability under the Revolving Credit Facility (calculated in the manner described in the following sentence) plus unrestricted cash.  For purposes of this covenant, availability under the Revolving Credit Facility is calculated as the amount available to be drawn other than any amount which if drawn would result in a breach of the Revolving Credit Facility financial covenant on a pro forma basis.

Accordingly, if our liquidity and performance significantly worsens, we could become non-compliant with such covenants.

As of June 30, 2019, the Company was in compliance with the financial and other covenants included in our debt agreements.  See Note. 10 “Long-Term Debt.” Based on our current projections, the Company expects to have sufficient liquidity and cash flows to be able to meet our debt service requirements through June 30, 2020 and expects to be in compliance with its financial covenants throughout Fiscal 2020.  If actual results for the year ending June 30, 2020 are less than the Company’s current projections and/or if management’s plans to offset the loss of the revenues and cash flows from the products distributed under the JSP Distribution Agreement are not successful, the Company could be in violation of its covenants, which may require significant accelerated payments of debt.

We are also subject to requirements to make mandatory prepayments, with the net proceeds of certain asset sales, excess cash flows and debt issuances.  These requirements could limit our ability to obtain future financing, make acquisitions or needed capital expenditures, withstand any downturns in our business or the economy in general, conduct operations or otherwise take advantage of business opportunities that may arise, any of which could place us at a competitive disadvantage relative to our competitors that have less debt and are not subject to such restrictions.

Our variable rate indebtedness subjects us to interest rate risk, which could cause our debt service obligations to increase significantly.

Borrowings under the Amended Senior Secured Credit Facility are at variable rates of interest and expose us to interest rate risk. If interest rates increase, our debt service obligations on our variable rate indebtedness will increase even though the amount borrowed remained the same and our net income and cash flows, including cash available for servicing our indebtedness, will correspondingly decrease.  Based on total outstanding debt as of June 30, 2019 and the assumption that interest rates are above the interest rate floor set forth in the Amended Senior Secured Credit Facility, each 1/8th percentage point change in interest rates would result in a $1.0 million change in annual interest expense on our outstanding debt under the Amended Senior Secured Credit Facility.

Due to many factors beyond our control, we may not be able to generate sufficient cash to service all of our indebtedness and meet our other ongoing liquidity needs and we may be forced to take other actions to satisfy our obligations under our debt agreements, which may not be successful.

Our ability to make payments on and to refinance, our indebtedness and to fund planned capital expenditures will depend on our ability to generate cash in the future. This is subject to general economic, financial, competitive, legislative, regulatory and other factors, many of which are beyond our control.

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Our business may not generate sufficient cash flow from operations and we may not have available to us future borrowings in an amount sufficient, to enable us to pay our indebtedness or to fund our other liquidity needs. In these circumstances, we may need to refinance all or a portion of our indebtedness on or before maturity.  Any refinancing of our debt could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations. Our ability to refinance our indebtedness or obtain additional financing will depend on, among other things:

·                  our financial condition at the time;

·                  restriction in the agreements governing our indebtedness;

·                  the condition of the financial markets and the industry in which we operate; and

·                  our debt credit ratings

As a result, we may not be able to refinance any of our indebtedness on commercially reasonable terms or at all.  In such a case, we could be forced to sell assets, reduce or delay capital expenditures or issue equity securities to make up for any shortfall in our payment obligations under unfavorable circumstances.  The terms of the Amended Senior Secured Credit Facility limit our ability to sell assets. In addition, we may not be able to sell assets quickly enough or for sufficient amounts to enable us to meet our obligations. Any failure to make scheduled payments of interest and principal on our outstanding indebtedness when due would permit the holders of such indebtedness to declare an event of default and accelerate the indebtedness.  This could result in the lenders under the Amended Senior Secured Credit Facility terminating their commitments to lend us money and foreclosing against the assets securing the borrowings and we could be forced into bankruptcy or other insolvency proceedings.  In addition, any failure to make payments of interest and principal on our outstanding indebtedness on a timely basis would likely result in a reduction of our credit rating, which could harm our ability to incur additional indebtedness on acceptable terms.  In August 2018, both Moody’s and S&P reduced the Company’s debt credit rating to “B3” and “B-”, respectively.  See Note 22. “Subsequent Events” for more information related to the JSP Distribution Agreement, which expired and was not renewed.

If our intangible assets become impaired, we may be required to record a significant charge to earnings.

Under accounting principles generally accepted in the U.S. (“U.S. GAAP”), we review our indefinite-lived intangible assets for impairment at least annually and when there are changes in circumstances.  We may be required to record additional significant charges to earnings in our financial statements during the period in which any impairment of our indefinite-lived intangible assets is determined, resulting in a negative effect on our results of operations.  Changes in market conditions or other changes in the future outlook of value may lead to further impairments in the future.  In addition, we continue to review the potential divestment of certain assets as part of our future plans, which may lead to additional impairments.  Future events or decisions may lead to asset impairments and/or related charges.  For assets that are not impaired, we may adjust the remaining useful lives.  Certain non-cash impairments may result from a change in our strategic goals, business direction or other factors relating to the overall business environment.  Any significant impairment could have a material adverse effect on our results of operations.

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

Our future results of operations, financial condition and cash flows depend to a significant extent upon our product sales mix.  Sales of certain products that we manufacture tend to create higher gross margins than the products we purchase and resell.  As a result, our sales mix will significantly impact our gross profit from period to period.

Factors that may cause our sales mix to vary include:

·                  the level of competition in the marketplace for certain products;

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

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

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The Company is continuously seeking to keep product costs low, however there can be no guarantee that gross profit percentages will stay consistent in future periods. Pricing pressure from competitors, changes in product mix and the costs of producing or purchasing new drugs may also fluctuate in future periods.

The generic pharmaceutical industry is highly competitive.

We face strong competition in our generic product business.  Revenues and gross profit derived from the sales of generic pharmaceutical products tend to follow a pattern based on certain regulatory and competitive factors. Typically, as patents for brand-name products and related exclusivity periods expire or fall under patent challenges, the first generic manufacturer to receive regulatory approval for generic equivalents of such products is generally able to achieve significant market penetration.  As competing off-patent manufacturers receive regulatory approvals on similar products or as brand manufacturers launch generic versions of such products (for which no separate regulatory approval is required), market share, revenues and gross profit typically decline, in some cases dramatically.  Accordingly, the level of market share, revenue and gross profit attributable to a particular generic product is normally related to the number of competitors in that product’s market and the timing of that product’s regulatory approval and launch, in relation to competing approvals and launches.  Consequently, we must continue to develop and introduce new products in a timely and cost-effective manner to maintain our revenues and gross margins.

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

Our future results of operations will depend to a significant extent upon our ability to successfully commercialize new generic products in a timely manner.  There are numerous difficulties in developing and commercializing new products, including:

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

·                  receiving requisite regulatory approvals for such products in a timely manner;

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

·                  developing and commercializing a new product is time consuming, costly and subject to numerous factors that may delay or prevent the successful commercialization of new products; and

·                  commercializing generic products may be substantially delayed by unexpired patents covering the brand drug.

As a result of these and other difficulties, products currently in development by Lannett may or may not receive the regulatory approvals necessary for marketing.  If any of our products, when developed and approved, cannot be successfully or timely commercialized, our operating results could be adversely affected.  We cannot guarantee that any investment we make in developing products will be recouped, even if we are successful in commercializing those products.

Extensive industry regulation has had and will continue to have, a significant impact on our business in the area of cost of goods, especially our product development, manufacturing and distribution capabilities.

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

The process for obtaining governmental approval to manufacture and market pharmaceutical products is rigorous, time-consuming and costly and we cannot predict the extent to which we may be affected by legislative and regulatory developments.  We are dependent on receiving FDA and other governmental or third-party approvals prior to manufacturing, marketing and shipping our products.  The FDA approval process for a particular product candidate can take several years and requires us to dedicate substantial resources to complete all activities necessary to secure approvals and we may not be able to obtain regulatory approval for our product candidates in a timely manner, or at all.  In order to obtain approval for our generic product candidates, we must demonstrate that our drug product is therapeutically equivalent and bioequivalent to a drug previously approved by the FDA through the drug approval process, known as the reference listed drug (“RLD”) or reference standard drug (“RS”).  Bioequivalence may be demonstrated in vivo or in vitro by comparing the generic product candidate to the innovator drug product.  During the FDA review process, the FDA may request additional information and studies to support approval of an application, which could delay approval of the product and impair our ability to compete with other versions of the generic drug product.

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Consequently, there is always the chance that we will not obtain FDA or other necessary approvals, or that the rate, timing and cost of such approvals will adversely affect our product introduction plans or results of operations.  We carry inventories of certain products in anticipation of launch and if such products are not subsequently launched, we may be required to write-off the related inventory.  Furthermore, the FDA also has the authority to withdraw drug approvals previously granted after a hearing and require a firm to remove these products from the market for a variety of reasons, including a failure to comply with applicable regulations or the discovery of previously unknown safety problems with the product.

Additionally, certain products marketed prior to the enactment of the 1962 amendments to the FDCA may be considered “generally recognized as safe and effective based on published scientific literature” or “GRASE.”  GRASE products are those “old drugs that do not require prior approval from the FDA in order to be marketed.”  Similarly, pursuant to 21 U.S.C. § 321(p)(1), also known as the “grandfather clause”, a product is exempted from the “effectiveness requirements [of the act] if its composition and labeling have not changed since 1962 and if, on the day before the 1962 amendments became effective, it was (1) used or sold commercially in the United States, (2) not a new drug as defined by the act at that time and (3) not covered by an effective application.”  Recently, the FDA has increased its efforts to force companies to file and seek FDA approval for Grandfathered products.  Efforts have included issuing notices to companies currently producing these products to cease its distribution of said products.  Lannett currently manufactures and markets the unapproved product hyosyne solution/elixir.

In addition, facilities used to manufacture and/or test materials and drug products we market are subject to periodic inspection of facilities by the FDA, the DEA and other authorities to confirm that firms are in compliance with all applicable regulations.  The FDA conducts pre-approval and/or post-approval inspections to determine whether systems and processes are in compliance with cGMP and other FDA regulations.  A Form 483 notice is generally issued at the conclusion of a FDA inspection and lists conditions the FDA inspectors believe may violate cGMP or other FDA regulations.  If more serious violations are identified, the FDA may take additional action, such as issuing warning letters, import alerts, etc.  The DEA and comparable state-level agencies also heavily regulate the manufacturing, holding, processing, security, record-keeping and distribution of drugs that are controlled substances.  Lannett manufactures and/or distributes a variety of controlled substances.  The DEA periodically inspects facilities for compliance with its regulations.  If our manufacturing facilities or those of our suppliers fail to comply with applicable regulatory requirements, it could result in regulatory action and additional costs.

Our inability or the inability of our suppliers to comply with applicable FDA and other regulatory requirements can result in, among other things, delays in or denials of new product approvals, warning letters, import alerts, fines, consent decrees restricting or suspending manufacturing operations, injunctions, civil penalties, recall or seizure of products, total or partial suspension of sales and/or criminal prosecution.  Any of these or other regulatory actions could materially harm our operating results and financial condition.  Although we have instituted internal compliance programs, if these programs do not meet regulatory agency standards or if compliance is deemed deficient in any significant way, it could materially harm our business.  Additionally, if the FDA were to undertake additional enforcement activities with Lannett’s Grandfathered products, their actions could result in, among other things, removal of some products from the market, seizure of the product and total or partial suspension of sales.  Any of these regulatory actions could materially harm our operating results and financial condition.

Our manufacturing operations as well as our suppliers’ manufacturing operations are subject to establishment registration by the FDA and periodic inspections by the FDA to assure compliance regarding the manufacturing of our products.  If we or our suppliers do not maintain the current registrations or if we or our partners receive notices of manufacturing and quality-related observations following inspections by the FDA, our operating results would be materially negatively impacted.

All of our facilities as well as applicable contract/supplier facilities, rely on maintaining current FDA registration and other licenses to produce and develop generic drugs.  If the Company does not successfully renew its FDA registrations, the financial results of Lannett would be negatively impacted.  We and our third-party manufacturers are subject to periodic inspection by the FDA to assure regulatory compliance regarding the manufacturing, distribution, and promotion of pharmaceutical products. The FDA imposes stringent mandatory requirements on the manufacture and distribution of pharmaceutical products to ensure their safety and efficacy.  If we or our partners receive similar notices of manufacturing and quality-related observations and correspondence in the future, and if we are unable to resolve these observations and address the FDA’s concerns in a timely fashion, our business, financial results and/or stock  price could be materially affected.

We have and will continue to enter into strategic alliances and collaborations with third parties for the commercialization of some of our drug candidates.  If those collaborations are not successful, we may not be able to capitalize on the market potential of these drug candidates.

We previously have and will continue in the future to seek third-party collaborators for the commercialization of some of our drug candidates on a selected basis, which adds a level of complexity to our supply network.  If we do enter into any such arrangements with any third parties, we will likely have limited control over the amount and timing of resources that our collaborators dedicate to the development of our drug candidates.  Our ability to generate revenues from these arrangements will depend on our collaborators’ abilities and efforts to successfully perform the functions assigned to them in these arrangements.  Many risks associated with relying on third-party collaborators for developing new products are beyond our control.  For example, some of our collaboration partners may decide to make substantial changes to a product’s formulation or design, may experience supply interruptions or financial difficulties or may have limited financial resources.  Any of the foregoing may delay the development of new products or interrupt their market supply.  In addition, if a third-party collaborator on a new product terminates our collaboration agreement or does not perform under the agreement, we may experience delays and additional costs in developing or replacing that product.

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The loss of key personnel could cause our business to suffer.

The success of our present and future operations will depend, to a significant extent, upon the experience, abilities and continued services of our key personnel.  If we lose the services of our key personnel, or if they are unable to devote sufficient attention to our operations for any other reason, our business may be significantly impaired.  If the employment of any of our current key personnel is terminated, we cannot assure you that we will be able to attract and replace the employee with the same caliber of key personnel.  As such, we have entered into employment agreements with all of our senior executive officers in order to help retain these key individuals.

If brand pharmaceutical companies are successful in limiting the use of generics through their legislative and regulatory efforts, our sales of generic products may suffer.

Many brand pharmaceutical companies have increasingly used state and federal legislative and regulatory means to delay generic competition.  These efforts have included:

·                  pursuing new patents for existing products which may be granted just before the expiration of one patent which could extend patent protection for additional years or otherwise delay the launch of generics;

·                  using the Citizen Petition process to request amendments to FDA standards;

·                  seeking changes to U.S. Pharmacopeia, an organization which publishes industry recognized compendia of drug standards;

·                  attaching patent extension amendments to non-related federal legislation;

·                  engaging in state-by-state initiatives to enact legislation that restricts the substitution of some generic drugs, which could have an impact on products that we are developing

·                  persuading regulatory bodies to withdraw the approval of brand-name drugs for which the patents are about to expire and converting the market to another product of the brand company on which longer patent protection exists;

·                  entering into agreements whereby other generic companies will begin to market an AG, a generic equivalent of a branded product, at the same time or after generic competition initially enters the market;

·                  filing suits for patent infringement and other claims that may delay or prevent regulatory approval, manufacture and/or scale of generic products; and,

·                  introducing “next-generation” products prior to the expiration of market exclusivity for the reference product, which often materially reduces the demand for the generic or the reference product for which we seek regulatory approval.

In the U.S., some pharmaceutical companies have lobbied Congress for amendments to the Hatch-Waxman Act that would give them additional advantages over generic competitors. For example, although the term of a company’s drug patent can be extended to reflect a portion of the time an NDA is under regulatory review, some companies have proposed extending the patent term by a full year for each year spent in clinical trials rather than the one-half year that is currently permitted.

If proposals like these were to become effective, or if any other actions by our competitors and other third parties to prevent or delay activities necessary to the approval, manufacture, or distribution of our products are successful, our entry into the market and our ability to generate revenues associated with new products may be delayed, reduced, or eliminated, which could have a material adverse effect on our business, financial condition, results of operations, cash flows and/or share price.

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The generic pharmaceutical industry is characterized by intellectual property litigation and third parties may claim that we infringe on their proprietary rights which could result in litigation that could be costly, result in the diversion of management’s time and efforts, require us to pay damages or prevent us from marketing our existing or future products.

Our commercial success will depend in part on not infringing or violating the intellectual property rights of others. The manufacture, use and sale of new products that are the subject of conflicting patent rights have been the subject of substantial litigation in the pharmaceutical industry. These lawsuits relate to the validity and infringement of patents or proprietary rights of third parties. We may have to defend against charges that we violated patents or proprietary rights of third parties. This is especially true in the case of generic products on which the patent covering the brand product is expiring, an area where infringement litigation is prevalent and in the case of new brand products in which a competitor has obtained patents for similar products. Our competitors, some of which have substantially greater resources than we do and have made substantial intellectual property investments in competing technologies, may have applied for or obtained, or may in the future apply for and obtain, patent rights and other intellectual property that will prevent, limit or otherwise interfere with our ability to make, use and sell our products. We may not be aware of whether our products do or will infringe existing or future patents or the intellectual property rights of others. In addition, patent applications can be pending for many years and may be confidential for a number of months after filing and because pending patent claims can be revised before issuance, there may be applications of others now pending of which we are unaware that may later result in issued patents that will prevent, limit or otherwise interfere with our ability to make, use or sell our products. Even if we prevail, litigation may be costly and time-consuming and could divert the attention of our management and technical personnel. Any potential intellectual property litigation also could force us to do one or more of the following:

·                  stop making, selling or using products or technologies that allegedly infringe the asserted intellectual property;

·                  lose the opportunity to license our technology to others or to collect royalty payments based upon successful protection and assertion of our intellectual property rights against others;

·                  incur significant legal expenses;

·                  pay substantial damages or royalties to the party whose intellectual property rights we may be found to be infringing;

·                  pay the attorney fees and costs of litigation to the party whose intellectual property rights we may be found to be infringing;

·                  redesign or rename, in the case of trademark claims, those products that contain the allegedly infringing intellectual property, which could be costly, disruptive and/or infeasible; or

·                  attempt to obtain a license to the relevant intellectual property from third parties, which may not be available on reasonable terms or at all.

Any litigation or claim against us, even those without merit, may cause us to incur substantial costs and could place a significant strain on our financial resources, divert the attention of management from our core business and harm our reputation.  If we are found to infringe the intellectual property rights of third parties, we could be required to pay substantial damages and/or substantial royalties and could be prevented from selling our products unless we obtain a license or are able to redesign our products to avoid infringement. If we fail to obtain any required licenses or make any necessary changes to our products or technologies, we may have to withdraw existing products from the market or may be unable to commercialize one or more of our products, all of which could have a material adverse effect on our business, results of operations and financial condition.

Although the parties to patent and intellectual property disputes in the pharmaceutical industry have often settled their disputes through licensing or similar arrangements, the costs associated with these arrangements may be substantial and could include ongoing royalties. Any such license may not be available on reasonable terms, if at all and there can be no assurance that we would be able to redesign our products in a way that would not infringe the intellectual property rights of others. Even if we were able to obtain rights to the third-party’s intellectual property, these rights may be non-exclusive, thereby giving our competitors access to the same intellectual property. As a result, an adverse determination in a judicial or administrative proceeding or failure to obtain necessary licenses could prevent us from manufacturing and selling a number of our products, or force us to redesign or rename our products to avoid infringing the intellectual property rights of third parties, which, even if it is possible to so redesign or rename our products, which could harm our business, financial condition, results of operations and cash flows.

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

We are required to identify the supplier(s) of all the raw materials for our products in our applications with the FDA.  To the extent practicable, we attempt to identify more than one supplier in each drug application.  However, some products and raw materials are available only from a single source and, in some of our drug applications, only one supplier of products and raw materials has been identified, even in instances where multiple sources exist.  To the extent any difficulties experienced by our suppliers cannot be resolved within a reasonable time and at reasonable cost, or if raw materials for a particular product become unavailable from an approved supplier and we are required to qualify a new supplier with the FDA, our profit margins and market share for the affected product could decrease and our development and sales and marketing efforts could be delayed.

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

Based on industry practice, generic drug manufacturers have liberal return policies and have been willing to give customers post-sale inventory allowances.  Under these arrangements, from time to time we give our customers credits on our generic products that our customers hold in inventory after we have decreased the market prices of the same generic products due to competitive pricing.  Therefore, if new competitors enter the marketplace and significantly lower the prices of any of their competing products, we would likely reduce the price of our products.  As a result, we would likely be obligated to provide credits to our customers who are then holding inventories of such products, which could reduce sales revenue and gross margin for the period the credit is provided.  Like our competitors, we also give credits for chargebacks to wholesalers that have contracts with us for their sales to hospitals, group purchasing organizations, pharmacies or other customers.

A chargeback is the difference between the price the wholesaler pays and the price that the wholesaler’s end-customer pays for a product.  Although we establish reserves based on our prior experience and our best estimates of the impact that these policies may have in subsequent periods, we cannot ensure that our reserves are adequate or that actual product returns, allowances and chargebacks will not exceed our estimates.

Health care initiatives and other third-party payor cost-containment pressures have and could continue to cause us to sell our products at lower prices, resulting in decreased revenues.

Some of our products are purchased or reimbursed by state and federal government authorities, private health insurers and other organizations, such as health maintenance organizations, or HMOs and managed care organizations, or MCOs.  Third-party payors increasingly challenge pharmaceutical product pricing.  There also continues to be a trend toward managed health care in the United States.  Pricing pressures by third-party payors and the growth of organizations such as HMOs and MCOs could result in lower prices and a reduction in demand for our products.

One such governmental program, known as the 340B Program, requires pharmaceutical manufacturers to enter into an agreement, called a pharmaceutical pricing agreement (PPA), with the Secretary of Health and Human Services.  Under the PPA, the manufacturer agrees to provide front-end discounts on covered outpatient drugs purchased by specified providers, called “covered entities,” that serve the nation’s most vulnerable patient populations.  Outpatient prescription drugs, over the counter drugs (accompanied by a prescription), and clinic-administered drugs within eligible facilities are covered.

In addition, legislative and regulatory proposals and enactments to reform health care and government insurance programs could significantly influence the manner in which pharmaceutical products and medical devices are prescribed and purchased.  We expect there will continue to be federal and state laws and/or regulations, proposed and implemented, that could limit the amounts that federal and state governments will pay for health care products and services.  The extent to which future legislation or regulations, if any, relating to the health care industry or third-party coverage and reimbursement may be enacted or what effect such legislation or regulation would have on our business remains uncertain.  For example, H.R.987,  the “Strengthening Health Care and Lowering Prescription Drug Costs Act,” which incorporated a bipartisan effort to address prescription drug pricing combined with broader provisions protecting the Affordable Care Act, was passed by the House of Representatives on May 16, 2019, but it is not expected to pass in the Senate.  The bill does represent bipartisan consensus on the need to reform the drug pricing system.   Such measures or other health care system reforms that are adopted could have a material adverse effect on our industry generally and our ability to successfully commercialize our products or could limit or eliminate our spending on development projects and affect our ultimate profitability.

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We may need to change our business practices to comply with changes to fraud and abuse laws.

We are subject to various federal and state laws pertaining to health care fraud and abuse, including the Medicare and Medicaid Anti-Kickback Statute (the “Anti-Kickback Statute”), which apply to our sales and marketing practices and our relationships with physicians and other referral sources.  At the federal level, the Anti-Kickback Statute prohibits any person or entity from knowingly and willfully soliciting, receiving, offering, or paying any remuneration, including a bribe, kickback, or rebate, directly or indirectly, in return for or to induce the referral of patients for items or services covered by federal health care programs, or the furnishing, recommending, or arranging for products or services covered by federal health care programs.  Federal health care programs have been defined to include plans and programs that provide health benefits funded by the federal government, including Medicare and Medicaid, among others.  The definition of “remuneration” has been broadly interpreted to include anything of value, including, for example, gifts, discounts, the furnishing of supplies or equipment, credit arrangements, payments of cash and waivers of payments.  Several courts have interpreted the federal Anti-Kickback Statute’s intent requirement to mean that if even one purpose in an arrangement involving remuneration is to induce referrals or otherwise generate business involving goods or services reimbursed in whole or in part under federal health care programs, the statute has been violated.  The federal government has issued regulations, commonly known as safe harbors that set forth certain provisions which, if fully met, will assure parties that they will not be prosecuted under the federal Anti-Kickback Statute.  The failure of a transaction or arrangement to fit within a specific safe harbor does not necessarily mean that the transaction or arrangement will be illegal or that prosecution under the federal Anti-Kickback Statute will be pursued, but such transactions or arrangements face an increased risk of scrutiny by government enforcement authorities and an ongoing risk of prosecution.  If our sales and marketing practices or our relationships with physicians are considered by federal or state enforcement authorities to be knowingly and willfully soliciting, receiving, offering, or providing any remuneration in exchange for arranging for or recommending our products and services and such activities do not fit within a safe harbor, then these arrangements could be challenged under the federal Anti-Kickback Statute.

If our operations are found to be in violation of the federal Anti-Kickback Statute we may be subject to civil and criminal penalties including fines of up to $25 thousand per violation, civil monetary penalties of up to $50 thousand per violation, assessments of up to three times the amount of the prohibited remuneration, imprisonment and exclusion from participating in the federal health care programs.  Violations of the Anti-Kickback Statute also may result in a finding of civil liability under the FFCA (as further discussed below) and the potential imposition of additional civil fines and monetary penalties that could be substantial.  Falsely certifying compliance with the Anti-Kickback Statute in connection with a claim submitted to a federally funded insurance program is actionable under the FFCA.  In addition, HIPAA and its implementing regulations created two new federal crimes: health care fraud and false statements relating to health care matters.  The HIPAA health care fraud statute prohibits, among other things, knowingly and willfully executing, or attempting to execute, a scheme to defraud any health care benefit program, including private payors.  A violation of this statue is a felony and may result in fines, imprisonment and/or exclusion from government-sponsored programs.  The HIPAA false statements statute prohibits, among other things, knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement or representation in connection with the delivery of or payment for health care benefits, items, or services.

A number of states also have anti-fraud and anti-kickback laws similar to the federal Anti-Kickback Statute that prohibit certain direct or indirect payments if such arrangements are designed to induce or encourage the referral of patients or the furnishing of goods or services.  Some states’ anti-fraud and anti-kickback laws apply only to goods and services covered by Medicaid.  Other states’ anti-fraud and anti-kickback laws apply to all health care goods and services, regardless of whether the source of payment is governmental or private.  Due to the breadth of these laws and the potential for changes in laws, regulations, or administrative or judicial interpretations, we may have to change our business practices or our existing business practices could be challenged as unlawful, which could materially adversely affect our business.

Certain federal and state governmental agencies, including the U.S. Department of Justice and the U.S. Department of Health and Human Services, have been investigating issues surrounding pricing information reported by drug manufacturers and used in the calculation of reimbursements as well as sales and marketing practices.  For example, many government and third-party payors, historically including Medicare and Medicaid, reimburse doctors and others for the purchase of certain pharmaceutical products based on the product’s average wholesale price (“AWP”) reported by pharmaceutical companies, although the Company has not used the term AWP since 2000.  Medicare currently uses average sales price (“ASP”) and wholesale acquisition cost (“WAC”) when ASP data is unavailable.  The federal government, certain state agencies and private payors are investigating and have begun to file court actions related to pharmaceutical companies’ reporting practices with respect to AWP, alleging that the practice of reporting prices for pharmaceutical products has resulted in a false and overstated AWP, which in turn is alleged to have improperly inflated the reimbursement paid by Medicare beneficiaries, insurers, state Medicaid programs, medical plans and others to health care providers who prescribed and administered those products. In addition, some of these same payors are also alleging that companies are not reporting their “best price” to the states under the Medicaid program.

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Furthermore, under the FDCA, it is illegal for pharmaceutical companies to promote their products for uses that are not approved by the FDA, and companies that market drugs for so-called “off-label” indications may be subject to civil liability under the FFCA (as further discussed below), as well as to criminal penalties.  Over the past decade, numerous lawsuits have been filed against pharmaceutical companies challenging their off-label promotional activities, and pharmaceutical companies, in the aggregate, have paid billions of dollars to defend and settle these cases.

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

We are subject to state and federal laws that govern the submission of claims for reimbursement.  The FFCA imposes civil liability on individuals or entities that knowingly submit, or cause to be submitted, false or fraudulent claims for payment to the government.  Violations of the FFCA and other similar laws may result in criminal fines, imprisonment and substantial civil penalties for each false claim submitted (including civil penalties presently in excess of $22 thousand per claim, plus treble damages, plus liability for attorney’s fees) and exclusion from federally funded health care programs, including Medicare and Medicaid.  The FFCA also allows private individuals to bring a suit on behalf of the government against an individual or entity for violations of the FFCA.  These suits, also known as Qui Tam or whistleblower actions, may be brought by, with only a few exceptions, any private citizen who has material information of a false claim that has not yet been previously disclosed.  These suits have increased significantly in recent years because the FFCA allows an individual to share in the amounts paid to the federal government in fines or settlement as a result of a successful Qui Tam action, in addition to the recovery of legal fees in bringing such an action.  If our past or present operations are found to be in violation of any of such laws or any other governmental regulations that may apply to us, we may be subject to penalties, including civil and criminal penalties, damages, fines, exclusion from federal health care programs and/or the curtailment or restructuring of our operations.  Any penalties, damages, fines, curtailment, or restructuring of our operations could adversely affect our ability to operate our business and our financial results.  Action against us for violation of these laws, even if we successfully defend against them, could cause us to incur significant legal expenses and divert our management’s attention from the operation of our business.

Recently, the Department of Justice has begun to use the 1961 federal Travel Act as a tool to pursue criminal charges in the case of health care kickback and commercial bribery allegations.  This law was enacted as part of the Kennedy administration’s war on organized crime.  It formed the basis for a federal enforcement action against a Texas physician-owned specialty hospital and a number of surgeons and administrators, who were convicted of conspiring to pay or receive bribes in exchange for referrals of patients in violation of a state commercial bribery law.  Importantly, this case was not limited to claims covered under federal programs, and the failure of the state to bring charges under its own statute did not prevent the federal case from proceeding.  The Travel Act may be used by the Justice Department as a way to expand its reach to penalize kickbacks and similar arrangements even when the Anti-Kickback Statute and FFCA would not apply.   These efforts could increase our vulnerability to litigation and penalties if our past or present operations are found to be in violation of applicable law.

Sales of our products may continue to be adversely affected by the continuing consolidation of our distribution network and the concentration of our customer base.

Our principal customers are wholesale drug distributors, major retail drug store chains and mail order pharmacies.  These customers comprise a significant part of the distribution network for pharmaceutical products in the U.S.  This distribution network has undergone significant consolidation marked by mergers and acquisitions among wholesale distributors and the growth of large retail drug store chains.  As a result, a small number of large wholesale distributors control a significant share of the market and the number of independent drug stores and small drug store chains has decreased.  We expect that consolidation of drug wholesalers and retailers will increase pricing and other competitive pressures on drug manufacturers, including Lannett.

Our net sales may also be affected by fluctuations in the buying patterns of retail chains, mail order distributors, wholesalers and other trade buyers, whether resulting from pricing, wholesaler buying decisions or other factors.

Our three largest customers accounted for 21%, 18% and 12%, respectively, of our total net sales for Fiscal 2019 and 29%, 17% and 6%, respectively, of our total net sales for Fiscal 2018.  The loss of any of these customers, any financial difficulties experienced by any of these customers or any delay in receiving payments from such customers could materially adversely affect our business, results of operations and financial condition and our cash flows.  In addition, the Company generally does not enter into long-term supply agreements with its customers that would require them to purchase our products.

A relatively small group of products may represent a significant portion of our revenues, gross profit, or net earnings from time to time.

Sales of a limited number of our products from time to time represent a significant portion of our revenues, gross profit and net earnings.  For Fiscal 2019, 2018 and 2017, our top five products in terms of sales, in the aggregate, represented approximately 52%, 58% and 53%, respectively, of our total net sales.  If the volume or pricing of our largest selling products decline in the future, our business, financial condition, results of operations, cash flows and/or share price could be materially adversely affected.  See Item 1. Description of Business for more information on our top products.

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We are increasingly dependent on information technology and our systems and infrastructure face certain risks, including cybersecurity and data leakage risks.

Significant disruptions to our information technology systems or breaches of information security could adversely affect our business. We are increasingly dependent on information technology systems and infrastructure to operate our business. In the ordinary course of business, we collect, store and transmit large amounts of confidential information (including trade secrets or other intellectual property, proprietary business information and personal information) and it is critical that we do so in a secure manner to maintain the confidentiality and integrity of such confidential information. We could be susceptible to third-party attacks on our information technology systems, which attacks are of ever-increasing levels of sophistication and are made by groups and individuals with a wide range of motives and expertise, including state and quasi-state actors, criminal groups, “hackers” and others. Maintaining the security, confidentiality and integrity of this confidential information (including trade secrets or other intellectual property, proprietary, business information and personal information) is important to our competitive business position. There can be no assurance that we can prevent service interruptions or security breaches in our systems or the unauthorized or inadvertent wrongful use or disclosure of confidential information that could adversely affect our business operations or result in the loss, misappropriation and/or unauthorized access, use or disclosure of, or the prevention of access to, confidential information. A breach of our security measures or the accidental loss, inadvertent disclosure, unapproved dissemination, misappropriation or misuse of trade secrets, proprietary information, or other confidential information, whether as a result of theft, hacking, fraud, trickery or other forms of deception, or for any other cause, could enable others to produce competing products, use our proprietary technology or information and/or adversely affect our business position. Further, any such interruption, security breach, or loss, misappropriation and/or unauthorized access, use or disclosure of confidential information could result in financial, legal, business and reputational harm to us and could have a material adverse effect on our business, financial condition and results of operations.

The design, development, manufacture and sale of our products involves the risk of product liability claims by consumers and other third parties and insurance against such potential claims is expensive and may be difficult to obtain.

The design, development, manufacture and sale of our products involve an inherent risk of product liability claims and the associated adverse publicity.  Insurance coverage is expensive and may be difficult to obtain and may not be available in the future on acceptable terms, or at all.  Although we currently maintain product liability insurance for our products in amounts we believe to be commercially reasonable, if the coverage limits of these insurance policies are not adequate, a claim brought against Lannett, whether covered by insurance or not, could have a material adverse effect on our business, results of operations, financial condition and cash flows.

Rising insurance costs, as well as the inability to obtain certain insurance coverage for risks faced by us, could negatively impact profitability.

The cost of insurance, including workers compensation, product liability and general liability insurance, has risen in recent years and may increase in the future.  In response, we may increase deductibles and/or decrease certain coverage to mitigate these costs.  These increases and our increased risk due to increased deductibles and reduced coverage, could have a negative impact on our results of operations, financial condition and cash flows.

Additionally, certain insurance coverage may not be available to us for risks faced by us.  Sometimes the coverage we obtain for certain risks may not be adequate to fully reimburse the amount of damage that we could possibly sustain.  Should either of these events occur, the lack of insurance to cover our entire cost would adversely affect our results of operations and financial condition.

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

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

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We expend a significant amount of resources on research and development efforts that may not lead to successful product introductions.

We conduct R&D primarily to enable us to gain approval for, manufacture, and market pharmaceuticals in accordance with applicable laws and regulations. We also partner with third parties to develop products. We cannot be certain that any investment made in developing products will be recovered, even if we are successful in commercialization. To the extent that we expend significant resources on R&D efforts and are not able, ultimately, to introduce successful new and/or complex products as a result of those efforts, there could be a material adverse effect on our business, financial condition, results of operations, cash flows, and/or the price of our common stock.

Investigations of the calculation of average wholesale prices may adversely affect our business.

Many government and third-party payers, including Medicare, Medicaid, Health Maintenance Organization and Managed Care Organization, have historically reimbursed doctors, pharmacies and others for the purchase of certain prescription drugs based on a drug’s AWP or WAC.  In the past several years, state and federal government agencies have conducted ongoing investigations of manufacturers’ reporting practices with respect to AWP and WAC, in which they have suggested that reporting of inflated AWP’s or WAC’s has led to excessive payments for prescription drugs.  For a description of current and federal and state investigations and claims by private parties, see Note 11 “Legal, Regulatory Matters and Contingencies.”  Additional actions are possible.  These actions, if successful, could adversely affect us and may have a material adverse effect on our business, results of operations, financial condition and cash flows.

The market price of our common stock has been volatile and may continue to be volatile in the future, and the value of any investment in our common stock could decline significantly.

The market price for our shares of common stock listed on the NYSE has fluctuated significantly from time to time, for example, varying between an intra-day high of $14.55 to an intra-day low of $3.33 during Fiscal 2019.  Material amounts of short-selling of our common stock over the past few years has also increased the volatility of the market price for our common stock.  The market price of our common stock is likely to continue to be volatile and subject to significant price and volume fluctuations in response to market, industry and other factors, including the risks described in this section.  Further, the stock market for pharmaceutical companies has recently experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies.  In particular, recent negative publicity regarding pricing and price increases by pharmaceutical companies has negatively impacted, and may continue to negatively impact, the market for pharmaceutical companies.  These broad market and industry factors have negatively impacted, and in the future may seriously negatively impact, the market price of our common stock, regardless of our operating performance.  Our stock market price may also be dependent upon the valuations and recommendations of the analysts who cover our business.  If our results do not meet these analysts’ forecasts, the expectations of our investors or the financial guidance we provide to investors in any period, the market price of our common stock could decline.  In the past, following periods of volatility in the market or significant price decline, securities class-action litigation has often been instituted against companies and we have been subject to one such suit, as further described in Note 11 “Legal, Regulatory Matters and Contingencies.”  Such suits could result in substantial costs and diversion of management’s attention and resources, which could materially and adversely affect our business, results of operations and financial condition.

The recent enactment of State laws affecting the pricing of our products could have the effect of reducing our profitability.

Since 2016, several state legislatures have enacted laws regulating the pricing of various types of pharmaceutical products, including generic pharmaceutical products.  These laws vary in applicability and scope, and generally require manufacturers to notify various state agencies of price increases over a given threshold for a given period of time and to include a justification for any price increases.  At least one state law (subsequently struck by the court) authorized the state attorney general to seek civil penalties and disgorgement in the event a price increase is deemed unconscionable.  To the extent these laws apply to our products, they could limit the prices which the company may charge for its products and reduce the company’s profitability and could have a material adverse effect on our financial condition, results of operations and growth prospects.

Other manufacturers and distributors of pain management products have had complaints filed against and investigations commenced on them, and if similar actions are taken against us, it could reduce our revenue and future profitability.

During the past few years, a number of complaints have been filed with respect to sales and distribution of various types of pain management medications against various pharmaceutical companies (not including Lannett), by a number of cities, counties and states across the country alleging among other things that such companies failed to develop and implement systems sufficient to identify suspicious orders of such products and prevent the diversion of such products to individuals who used them for other than legitimate medical purposes.  The complaints generally contend that the defendants allegedly engaged in improper marketing of pain management products, and seek a variety of remedies, including restitution, civil penalties, disgorgement of profits, treble damages, attorneys’ fees and injunctive relief.  In addition, a number of State Attorneys General, including a coordinated multistate effort, have initiated investigations into sales and marketing practices of various pharmaceutical companies (not including Lannett) with respect to such pain management products.  If any similar investigations or claims are commenced against us, it could result in reputational harm and reduced market acceptance and demand for our products, could harm our ability to market our products in the future, could cause us to incur significant expense, could cause our senior management to be distracted from execution of our business strategy, and could have a material adverse effect on our business, financial condition, results of operations and growth prospects.

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Guidelines and recommendations published by various organizations can reduce the use of our pain management products.

Government agencies promulgate regulations and guidelines directly applicable to us and to our products.  In addition, professional societies, practice management groups, private health and science foundations and organizations from time to time may also publish guidelines or recommendations to the healthcare and patient communities.  Recommendations of government agencies or these other groups or organizations may relate to such matters as usage, dosage, route of administration and use of concomitant therapies.  For example, the Centers for Disease Control and Prevention has issued guidelines about the use of pain management products for chronic pain, the FDA has issued an Opioid Action Plan and in 2017 President Trump signed an executive order establishing the President’s Commission on Combatting Drug Addiction.  Additionally, the FDA has required all opioid products, including immediate release drugs, to join a shared REMS program that educates healthcare providers to reduce serious adverse outcomes resulting from inappropriate prescribing, misuse, and abuse of opioid analgesics while maintaining patient access to pain medications. REMS participation has added significant costs to the Company.  Recommendations or guidelines suggesting the reduced use of our products or the use of competitive or alternative products as the standard of care to be followed by patients and healthcare providers could result in decreased use of our products and could have a material adverse effect on our business, financial condition, results of operations and growth prospects.

Acquisitions could result in operating difficulties, dilution and other harmful consequences that may adversely impact our business and results of operations.

Acquisitions are an important element of our overall corporate strategy and use of capital.  These transactions could be material to our financial condition and results of operations.  We also expect to continue to evaluate and enter into discussions regarding a wide array of potential strategic transactions.  We may compete for certain acquisition targets with companies having greater financial resources than us or other advantages over us that may hinder or prevent us from acquiring a target company or completing another transaction, which could also result in significant diversion of management time, as well as substantial out-of-pocket costs.  The process of integrating an acquired company, business, or technology may create unforeseen operating difficulties and expenditures.  The areas where we may face risks include but are not limited to (i) diversion of management time and focus from operating our business to acquisition integration challenges, (ii) implementation or remediation of controls, procedures and policies at the acquired company, (iii) integration of the acquired company’s accounting, human resource and other administrative systems and coordination of product, engineering and sales and marketing functions, (iv) transition of operations, users and customers onto our existing platforms, (v) failure to obtain required approvals from governmental authorities under competition and antitrust laws on a timely basis, if at all, which could, among other things, delay or prevent us from completing a transaction, or otherwise restrict our ability to realize the expected financial or strategic goals of an acquisition, (vi) cultural challenges associated with integrating employees from the acquired company into our organization and retention of employees from the businesses we acquire and (vii) liability for activities of the acquired company before the acquisition, including infringement claims, violations of laws, commercial disputes, tax liabilities, claims from current and former employees and customers and other known and unknown liabilities.

Our failure to address these risks or other problems encountered in connection with our past or future acquisitions could cause us to fail to realize the anticipated benefits of such acquisitions, incur unanticipated liabilities and harm our business generally.  Future acquisitions could also result in dilutive issuances of our equity securities, the incurrence of debt, contingent liabilities, or amortization expenses, or write-offs of goodwill, any of which could harm our financial condition.  Also, the anticipated benefit of many of our acquisitions may not materialize.

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The phase out of the London Interbank Offered Rate (LIBOR), or the replacement of LIBOR with a different reference rate, may adversely affect interest rates.

On July 27, 2017, the Financial Conduct Authority (the authority that regulates LIBOR) announced that it would phase out LIBOR by the end of 2021. It is unclear whether new methods of calculating LIBOR will be established such that it continues to exist after 2021, or if alternative rates or benchmarks will be adopted. Changes in the method of calculating LIBOR, or the replacement of LIBOR with an alternative rate or benchmark, may adversely affect interest rates and result in higher borrowing costs. This could materially and adversely affect the Company’s results of operations, cash flows and liquidity. We cannot predict the effect of the potential changes to LIBOR or the establishment and use of alternative rates or benchmarks.

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The following table sets forth certain information with respect to the Company’s share repurchase activity.

*Shares were repurchased to settle employee tax withholding obligations pursuant to equity award programs.

Stock Performance Chart

The following graph presents a comparison of the cumulative total stockholder return on the Company’s stock with the cumulative total return of various indexes for the period of five fiscal years commencing July 1, 2014 and ending June 30, 2019.  The graph assumes that $100 was invested on July 1, 2014 in each of the various indexes.

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Based on its projections for the next 12 months, the Company expects to have sufficient liquidity and cashflows to meet its operating and debt service requirements for at least the next 12 months from the issuance of the June 30, 2019 consolidated financial statements.  The Company also expects to be in compliance with its financial covenants during the same period.

Although management cannot predict with certainty the precise impact its plans will have on offsetting the loss of the JSP Distribution Agreement, management is continuing to execute on plans to offset the impact of the loss on a short- and long-term basis.  These plans currently include, among other things, an emphasis on reducing cost of sales, R&D and SG&A expenses; continuing to accelerate new product launches; increasing the level of strategic partnerships; and reducing capital expenditures. To that end, the Company has already launched 25 new products since January 2018, which are expected to generate annualized net sales of approximately $100 million, and plans to maintain this pace going forward.  The Company has also signed several distribution and in-licensing agreements during this fiscal year that will provide immediate contribution margins in the near future.  Additionally, the Company continues to supplement existing in-process cost reduction plans with additional cost savings initiatives, which are expected to generate annualized cost savings of approximately $66.0 million by the end of Fiscal 2020 when compared to the Fiscal 2018 expenses, of which approximately half will be reinvested into other business growth opportunities. Management will also continue its emphasis on accelerating ANDA filings, as evidenced by the nine ANDAs filed with the FDA in Fiscal 2019.  Management also plans to attempt, at the appropriate time, to refinance a significant portion of its outstanding long-term debt to reduce principal repayment requirements and establish more flexibility around financial covenants.  These actions may increase related interest expense, but will positively impact short-term cash flows.

Cody Restructuring Plan

On June 29, 2018, the Company announced a restructuring plan related to the future of its wholly-owned subsidiary Cody Laboratories, Inc.  (“Cody Labs”) and the Company’s operations (the “Cody Restructuring Plan”).  The plan focuses on a more select set of opportunities which will result in streamlined operations, improved efficiencies and a reduced cost structure.  The Company incurred approximately $2.5 million of severance and employee-related costs under this plan.

Cody API Restructuring Plan

On June 11, 2019, the Company approved an additional restructuring plan (the “Cody API Restructuring Plan”) with respect to Cody Labs.  In September 2018, the Company approved a plan to sell the active pharmaceutical ingredient manufacturing distribution business of Cody Labs (the “Cody API business”).  The Company was unable to sell the Cody API business as an ongoing operation.  The Company intends to sell the real estate utilized by the Cody API business upon receiving approval of the Company’s cocaine hydrochloride solution Section 505(b)(2) NDA application and to have Cody Labs cease all operations.  In connection with the Cody API Restructuring Plan, there has been a reduction of almost 70 positions at Cody Labs.  The Company expects that the actions contemplated under the Cody API Restructuring Plan will be substantially completed by September 30, 2019.  In July 2019, the Company completed the sale of the equipment associated with the Cody API business for approximately $3.0 million.

The Company currently estimates that it will incur approximately $6.0 million of total costs to implement the Cody API Restructuring Plan, including approximately $3.5 million of severance and employee-related costs and approximately $2.0 million of contract termination costs, as well as approximately $0.5 million of costs to be incurred in connection with moving equipment and other property to other Company-owned facilities that were originally anticipated to be incurred in connection with the Cody Restructuring Plan announced in June 2018, but that have not yet been incurred thereunder.

2016 Restructuring Plan

On February 1, 2016, in connection with the acquisition of KUPI, the Company announced a plan related to the future integration of KUPI and the Company’s operations (the “2016 Restructuring Program”). The plan focused on the closure of KUPI’s corporate functions and the consolidation of manufacturing, sales, research and development and distribution functions. The restructuring activities under the 2016 Restructuring Program were completed as of March 31, 2019. The Company incurred an aggregate of approximately $21.0 million in restructuring charges for actions that have been announced or communicated since the 2016 Restructuring Program began.  Of this amount, approximately $11.0 million related to employee separation costs, approximately $1.0 million related to contract termination costs and approximately $9.0 million related to facility closures costs and other actions.

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In the second quarter of Fiscal 2019, the Company ceased manufacturing functions at its State Road facility in Philadelphia, Pennsylvania.  The Company discontinued distribution from its Townsend Road facility in Philadelphia, Pennsylvania as of January 31, 2019.  The Company has entered into an agreement to sell its Townsend Road facility and expects to finalize the sale in the first quarter of Fiscal 2020.

Financial Summary

For Fiscal 2019, net sales decreased to $655.4 million compared to $684.6 million in the same prior-year period. Gross profit decreased $45.1 million to $243.6 million compared to the prior-year period and gross profit percentage decreased to 37% compared to 42% in Fiscal 2018.  R&D expenses increased 33% to $38.8 million compared to the prior-year period while SG&A expenses increased 7% to $87.6 million. Restructuring expenses decreased 42% to $4.1 million compared to the prior-year period. Operating loss for Fiscal 2019, which included a $375.4 million assets impairment charge, was $262.3 million compared to operating income of $129.7 million in the prior-year period, which included a $15.5 million loss on sale of an intangible asset and a $25.0 million assets impairment charge.  Net loss for Fiscal 2019 was $272.1 million, or $7.20 per diluted share.  Comparatively, net income in the prior-year period was $28.7 million, or $0.75 per diluted share.

A more detailed discussion of the Company’s financial results can be found below.

Results of Operations — Fiscal 2019 compared to Fiscal 2018

Net sales decreased 4% to $655.4 million for the fiscal year ended June 30, 2019.  The following table identifies the Company’s net product sales by medical indication for the fiscal years ended June 30, 2019 and 2018:

The decrease in net sales was driven by decreased average selling price of products of $80.2 million, partially offset by increased volumes of $51.0 million.  Average selling prices were negatively impacted by product mix, changes within distribution channels and competitive pricing pressures. Volumes were favorably impacted due to product launches during Fiscal 2019 and increased market share in several key products, partially offset by lower volumes of Levothyroxine due to the expiration of the JSP Distribution Agreement in March 2019.

In January 2017, a provision in the Bipartisan Budget Act of 2015 required drug manufacturers to pay additional rebates to state Medicaid programs if the prices of their generic drugs rise at a rate faster than inflation.  The provision negatively impacted the Company’s net sales by $30.8 million and $31.0 million in Fiscal 2019 and Fiscal 2018, respectively, which contributed to the overall decreased average selling price.

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The following chart details price and volume changes by medical indication between Fiscal 2019 and Fiscal 2018:

The Company sells its products to customers through various distribution channels.  The table below presents the Company’s net sales to each distribution channel for the fiscal year ended June 30:

Net sales to wholesalers/distributors increased primarily due to the transition services agreement with Amneal, which shifted all sales of Levothyroxine in the third quarter of Fiscal 2019 from other distribution channels into a single distributor.  Net sales to retail chains decreased significantly as a result of additional sales in the year ended June 30, 2018 to a customer that was unable to obtain supply from a competitor due to a temporary disruption in the competitor’s supply chain.

Central Nervous System.  Methylphenidate Hydrochloride Extended Release Tablets (“Methylphenidate ER”)

The Company markets one form of the product which is designated “BX.” Per a teleconference in November 2014, the FDA informed KUPI that it was changing the therapeutic equivalence rating of its Methylphenidate ER product from “AB” (therapeutically equivalent) to “BX.”  A BX-rated drug is a product for which data is insufficient to determine therapeutic equivalence; it is still approved and can be prescribed, but the FDA does not recommend it as automatically substitutable for the brand-name drug at the pharmacy.

The Company has been working with the FDA to regain the “AB” rating, and in the meantime, maintain the drug on the U.S. market with a BX rating.  However, there can be no assurance as to when or if the Company will regain the “AB” rating or be permitted to remain on the market.  The Company agreed to potential acquisition-related contingent payments to UCB related to Methylphenidate ER if the FDA reinstates the AB-rating and certain sales thresholds are met.  Such potential contingent payments are set to expire after December 31, 2020.

In August 2018, the Company entered into an exclusive perpetual licensing agreement with Andor Pharmaceuticals, LLC (“Andor”) for Methylphenidate ER tablets USP (CII) in 18 mg, 27 mg, 36 mg and 54 mg strengths.  Andor’s ANDA of Methylphenidate included all bioequivalence metrics recommended by the FDA and is an AB-rated generic equivalent to the brand Concerta®.  In April 2019, Andor received approval from the FDA of its Methylphenidate ER tablets USP (CII) ANDA.  The Company commenced the launch of the product in 18mg, 27mg, 36mg and 54mg strengths in May 2019.

Under the licensing agreement with Andor, Lannett will primarily provide sales, marketing and distribution support of Andor’s Methylphenidate ER product, for which it will receive a percentage of the net profits.

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Pain Management. Cocaine Hydrochloride Solution

In December 2017, a competitor received approval from the FDA to market and sell a cocaine hydrochloride solution product.  This approval affects the Company’s right to market and sell its unapproved cocaine hydrochloride solution product.  According to FDA guidance, the FDA allowed the Company to continue marketing its unapproved product for a period of time following approval of the competitor’s product.  Upon the recent request of the FDA to cease manufacturing and distributing our unapproved cocaine hydrochloride solution product as a result of an approved product on the market, the Company committed to not manufacture or distribute cocaine hydrochloride 10% solution, which has not been sold during Fiscal 2019, as of April 15, 2019.  The Company has also agreed to cease manufacturing its unapproved cocaine hydrochloride 4% solution on June 15, 2019 and cease distributing the product on August 15, 2019.  The Company does not believe the discontinuation will have a material impact on our future expected results of operations as we had anticipated the withdrawal of this product.  During the fiscal years ended June 30, 2019, 2018 and 2017, the Company’s net sales of the unapproved cocaine hydrochloride solution product were $13.6 million, $18.9 million and $21.5 million, respectively.

Meanwhile, the FDA continues to review the Company’s Section 505(b)(2) NDA application, and in July 2018 issued a Complete Response Letter (“CRL”) which required an additional study and other information.  In June 2019, the Company submitted a response to the Complete Response Letter and received a new Prescription Drug User Fee Act (“PDUFA”) date of December 21, 2019.  The Company cannot say for certain when or if the application will be approved.

The competitor filed a Citizen Petition with the FDA in February 2019, claiming that the grant of the NCE exclusivity blocks the approval of the Company’s application for five years and requesting that the FDA refuse to accept any further submissions in furtherance of the Company’s Section 505(b)(2) NDA application, treat as withdrawn any submissions made by the Company after December 2017 and withdraw the Company’s Section 505(b)(2) application.  On April 24, 2019, the Company filed an opposition to the Citizen Petition requesting that it be denied. On July 3, 2019, the FDA denied the competitor’s citizen petition.

Gastrointestinal. Polyethylene Glycol (PEG)3350 (“Glycolax”)

On April 2, 2018, the FDA issued a Federal Register notice (Docket No. FDA-2008-N-0549) indicating that it was affirming a preliminary summary judgment decision that the FDA issued in 2014, denying a hearing, and withdrawing all ANDAs for prescription PEG 3350 products, including the Company’s Glycolax product.  The FDA’s decision is based on the FDA finding that there are no meaningful differences between Rx PEG 3350 products and OTC PEG 3350 products and, therefore, that the Rx products are misbranded.  The FDA ordered the Company’s ANDA withdrawn effective May 2, 2018, after which the Company would no longer be permitted to market or sell its Glycolax product.  The Company disputes the FDA’s finding that there are no meaningful differences and disputes that summary judgment was appropriate in light of the factual issues raised by the ANDA holders.  On April 9, 2018, the Company, along with three other PEG 3350 ANDA holders, filed a request for a stay of the FDA order pending appeal of the decision to the District of Columbia Circuit Court of Appeals.  On April 16, 2018, the FDA granted a stay of its order withdrawing the Company’s ANDA through November 2, 2018, after which the Company will no longer be permitted to market or sell its Glycolax product.  The Company filed an appeal of the FDA withdrawal order to the United States Court of Appeals for the District of Columbia.  In July 2018, the Company filed a brief in support of the appeal.  All briefing was completed by September 15, 2018 and an argument hearing was held on October 12, 2018. In October 2018, the Appeals Court issued a ruling affirming the FDA’s withdrawal of the ANDA and on November 2, 2018, the ANDA was withdrawn and the Company ceased marketing the product.  The Company continues to market its OTC PEG 3350 products.  During the fiscal years ended June 30, 2019, 2018 and 2017, the Company’s net sales of Rx PEG 3350 were $7.1 million, $17.6 million and $17.7 million, respectively, although gross profit percentages for this product were in the single-digits in each of these periods.

Thalomid®

The Company filed with the FDA an ANDA No. 206601, along with a paragraph IV certification, alleging that the fifteen patents associated with the Thalomid drug product are invalid, unenforceable and/or not infringed.  On January 30, 2015, Celgene Corporation and Children’s Medical Center Corporation filed a patent infringement lawsuit in the United States District Court for the District of New Jersey, alleging that the Company’s filing of ANDA No. 206601 constitutes an act of patent infringement and seeking a declaration that the patents at issue are valid and infringed.  A settlement agreement was reached and the Court dismissed the lawsuit in October 2017.  Pursuant to the settlement agreement, the Company entered into a license agreement that permits Lannett to manufacture and market in the U.S. its generic thalidomide product as of August 1, 2019 or earlier under certain circumstances.  In the second quarter of Fiscal 2019, the Company received a Major CRL related to issues at its API supplier. The Company filed a response to the CRL.  The Company received a second Major CRL in the first quarter of Fiscal 2020 related to continued issues at the API supplier, as well as issues with the REMS program hosted by Celgene.  The Company is working on addressing the FDA comments and expects its product launch to be delayed until fiscal year 2021.

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Cost of Sales, including amortization of intangibles.  Cost of sales, including amortization of intangibles, for Fiscal 2019 increased 4% to $411.8 million from $395.9 million in the same prior-year period.  The increase was primarily attributable to increased product royalties, and to a lesser extent, higher volumes of products sold, offset by manufacturing efficiencies as a result of cost reduction initiatives as well as product mix.  Product royalties expense included in cost of sales totaled $43.6 million for Fiscal 2019 and $29.7 million for Fiscal 2018.  Amortization expense included in cost of sales totaled $32.2 million for Fiscal 2019 and $32.1 million for Fiscal 2018.

Gross Profit.  Gross profit for Fiscal 2019 decreased 16% to $243.6 million or 37% of total net sales.  In comparison, gross profit for Fiscal 2018 was $288.7 million or 42% of total net sales.  The decrease in gross profit percentage was primarily a result of the expiration of the JSP Distribution Agreement as well as lower average selling prices of certain key products and increased product royalties related to distribution agreements.

Research and Development Expenses.  Research and development expenses increased 33% to $38.8 million in Fiscal 2019 from $29.2 million in Fiscal 2018.  The increase was primarily due to lower R&D expense in Fiscal 2018 related to a cancelled order for pre-launch inventory purchased in Fiscal 2017, and to a lesser extent, higher incentive-based compensation in Fiscal 2019.

Selling, General and Administrative Expenses.  Selling, general and administrative expenses increased 7% to $87.6 million in Fiscal 2019 compared with $82.2 million in Fiscal 2018.  The increase was primarily due to higher incentive-based compensation, depreciation related to software integration costs, and increased legal and financial advisory costs, partially offset by a reduction of selling and marketing expenses related to headcount reductions in product salesforce.

The Company is focused on controlling operating expenses and has executed on its 2016 Restructuring Plan, Cody Restructuring Plan and Cody API Restructuring Plan as noted above; however, increases in personnel and other costs to facilitate enhancements in the Company’s infrastructure and expansion may impact operating expenses in future periods.

Restructuring Expenses.  Restructuring expenses decreased $3.0 million to $4.1 million for Fiscal 2019 compared with $7.1 million in Fiscal 2018 primarily due to lower facility closure costs associated with the completion of the 2016 Restructuring Program.  See Note 3 “Restructuring Charges” for more information.

Asset impairment charges.  In the first quarter of Fiscal 2019, the Company approved a plan to sell the Cody API business.  As such, all assets and liabilities associated with the Cody API business are recorded in the assets and liabilities held for sale captions in the Consolidated Balance Sheet as of June 30, 2019.  As part of the held for sale classification, the Company recorded the assets of the Cody API business at fair value less costs to sell.  The Company performed a fair value analysis which resulted in a $29.9 million impairment of the Cody long-lived assets in Fiscal 2019.  In the fourth quarter of Fiscal 2019, the Company recorded an additional $2.9 million impairment of the Cody API assets.  See Note 21 “Assets Held for Sale” for more information.

On August 17, 2018, JSP notified the Company that it would not extend or renew the JSP Distribution Agreement when the current term expires on March 23, 2019.  The Company determined that JSP’s decision represented a triggering event under U.S. GAAP to perform an analysis to determine the potential for impairment of goodwill. On October 4, 2018, the Company completed the analysis based on market data and concluded that it would record a full impairment of goodwill totaling $339.6 million during Fiscal 2019.  See Note 9 “Goodwill and Intangible Assets” for more information.

Other Income (Loss).  Interest expense for the period ended June 30, 2019 totaled $84.6 million compared to $85.6 million for the period ended June 30, 2018.  The weighted average interest rate for Fiscal 2019 and 2018 was 9.7% and 8.7%, respectively. Investment income totaled $3.2 million in Fiscal 2019 compared with $4.8 million in Fiscal 2018.

Income Tax.  The Company recorded income tax benefit in Fiscal 2019 of $74.1 million compared to income tax expense of $22.4 million in Fiscal 2018.  The effective tax rate for Fiscal 2019 was 21.4%, compared to 43.8% for Fiscal 2018.  The effective tax rate for the period ended June 30, 2019 was lower compared to the same prior-year period primarily due to the application of 2017 Tax Reform in Fiscal 2018, which resulted in a revaluation of the Company’s net long term deferred tax assets.  In addition, the federal statutory tax rate for the Fiscal 2019 was 21% compared to a blended federal statutory tax rate of 28% in the prior-year period.

Net Income (Loss).  For the period ended June 30, 2019, the Company reported net loss of $272.1 million, or $7.20 per diluted share.  Comparatively, net income in the corresponding prior-year period was $28.7 million, or $0.75 per diluted share.

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Results of Operations — Fiscal 2018 compared to Fiscal 2017

Total net sales increased to $684.6 million from $633.3 million in the prior-year period, which included a $4.0 million reduction for a settlement agreement adjustment.

Net sales increased 7% to $684.6 million for the fiscal year ended June 30, 2018.  The following table identifies the Company’s net product sales by medical indication for the fiscal years ended June 30, 2018 and 2017:

The increase in net sales was driven by increased volumes of $109.5 million, partially offset by decreased average selling price of products in several key products of $62.2 million.  Volumes were favorably impacted due to a temporary disruption of our competitor’s supplies in the Thyroid Deficiency and Migraine medical indications, additional sales in the Cardiovascular medical indication related to a distribution agreement entered into with Aralez in November 2017 as well as increased customer orders in June 2018, with an estimated impact of approximately $15.0 million, in advance of a mid-week holiday as well as a related maintenance shutdown of the Company’s Seymour, Indiana manufacturing facility in the first week of July 2018.  On August 10, 2018, Aralez filed a Chapter 11 petition in the United States Bankruptcy Court for the Southern District of New York and continues to operate its business in the normal course.   The Company does not believe this will materially affect our distribution agreement with Aralez.  Average selling prices were impacted by competitive pricing pressure across a number of products, product mix and changes within distribution channels.  Although the Company has benefited in the past from favorable pricing trends, these trends have reversed.

In January 2017, a provision in the Bipartisan Budget Act of 2015 required drug manufacturers to pay additional rebates to state Medicaid programs if the prices of their generic drugs rise at a rate faster than inflation.  The provision negatively impacted the Company’s net sales by $31.0 million in Fiscal 2018 and $10.2 million in Fiscal 2017.

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The following chart details price and volume changes by medical indication:

The Company sells its products to customers through various distribution channels.  The table below presents the Company’s net sales to each distribution channel for the fiscal year ended June 30:

Net sales to retail chains increased significantly as a result of additional sales to a customer that was unable to obtain supply from a competitor due to a temporary disruption in the competitor’s supply chain, and to a lesser extent, additional sales of a product in the Cardiovascular medical indication related to a distribution agreement entered into with Aralez in November 2017.

Cost of Sales, including amortization of intangibles.  Cost of sales, including amortization of intangibles, for Fiscal 2018 increased 19% to $395.9 million from $332.1 million in the same prior-year period.  The increase was primarily attributable to higher sales as well as increased product royalties.  Product royalties expense included in cost of sales totaled $29.7 million for Fiscal 2018 and $19.0 million for Fiscal 2017.  Amortization expense included in cost of sales totaled $32.1 million for Fiscal 2018 and for Fiscal Year 2017.

Gross Profit.  Gross profit for Fiscal 2018 decreased 4% to $288.7 million or 42% of total net sales.  In comparison, gross profit for Fiscal 2017 was $301.2 million or 48% of total net sales.  The decrease in gross profit percentage was primarily attributable to lower average selling prices of certain key products as well as additional product royalties related to a distribution agreement entered into with Aralez in November 2017.

Research and Development Expenses.  Research and development expenses decreased 31% to $29.2 million in Fiscal 2018 from $42.1 million in Fiscal 2017.  The decrease was primarily due to lower product development expenses as well as decreased spend related to the cocaine hydrochloride solution clinical trials.  Research and development expenses decreased due to a credit in Fiscal 2018 for a cancelled order of pre-launch inventory purchased in Fiscal 2017.

Selling, General and Administrative Expenses.  Selling, general and administrative expenses increased 12% to $82.2 million in Fiscal 2018 compared with $73.5 million in Fiscal 2017.  The increase was primarily driven by approximately $5.1 million related to separation benefits for former executive officers as well as other former employees.  Additional headcount in Fiscal 2018 also contributed to an increase in selling, general and administrative expenses.

The Company is focused on controlling operating expenses and has implemented its 2016 Restructuring Plan and Cody Restructuring Plan as noted above, however increases in personnel and other costs to facilitate enhancements in the Company’s infrastructure and expansion may continue to impact operating expenses in future periods.

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Acquisition and Integration-related Expenses.  Acquisition and integration-related expenses decreased $3.9 million as compared to the prior-year period.  The decrease was due to the timing of the acquisition of KUPI.

Restructuring Expenses.  Restructuring expenses of $7.1 million for Fiscal Year 2018 were consistent to the prior-year period primarily due to higher employee separation costs incurred in connection with the 2016 Restructuring Program during Fiscal 2017, offset by an additional $3.1 million of employee separation costs incurred in connection with the Cody Restructuring program in Fiscal 2018.

Loss on sale of intangible asset.  In the third quarter of Fiscal 2018, the Company sold an intangible asset acquired as part of the KUPI acquisition.  In connection with the transaction, the Company recorded a $15.5 million loss on sale of intangible asset.

Asset impairment charges.  In the fourth quarter of Fiscal 2018, the Company recorded impairment charges totaling $25.0 million, of which $21.5 million relates to the Cody Restructuring Plan and $3.5 million resulting from the consolidation of the Company’s manufacturing activities with respect to plant-related assets located at the Company’s Townsend Road facility.

In Fiscal 2017, as a result of a notice from the FDA that it will seek to withdraw approval of the Company’s ANDA for Methylphenidate ER, the Company recorded a $65.1 million impairment charge in the first quarter of Fiscal 2017.  Additionally, the Company abandoned a project within KUPI’s in-process research and development portfolio, which resulted in a $23.0 million impairment charge in the second quarter of Fiscal 2017.

Other Income (Loss).  Interest expense for the period ended June 30, 2018 totaled $85.6 million compared to $89.4 million for the period ended June 30, 2017.  The weighted average interest rate for Fiscal 2018 and 2017 was 8.7% and 8.0%, respectively. Investment income totaled $4.8 million in Fiscal 2018 compared with $3.8 million in Fiscal 2017.  In December 2017, the Company received $3.5 million as part of the settlement of a patent litigation.

Income Tax.  The Company recorded income tax expense in Fiscal 2018 of $22.4 million compared to income tax expense of $1.1 million in Fiscal 2017.  The effective tax rate for Fiscal 2018 was 43.8%, compared to 199.5% for Fiscal 2017.  The effective tax rate for the period ended June 30, 2018 was lower compared to the same prior-year period primarily due to the impact of higher pre-tax income and a lowered blended U.S. statutory rate from 35.0% to 28.1% as a result of the 2017 Tax Reform, partially offset by a $13.1 million re-measurement of the U.S. deferred tax assets, or 25.6% as a result of the 2017 Tax Reform.  Overall, the Company anticipates the decrease in the U.S. federal statutory rate, which is 21% for the entire Fiscal 2019, will have a favorable impact on future U.S. tax expense and operating cash flows.

Net Income.  For the period ended June 30, 2018, the Company reported net income attributable to Lannett Company, Inc. of $28.7 million, or $0.75 per diluted share.  Comparatively, net loss attributable to Lannett Company, Inc. in the corresponding prior-year period was $0.6 million, or $0.02 per diluted share.

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Net cash used in financing activities of $127.3 million for the fiscal year ended June 30, 2019 was primarily due to debt repayments of $126.7 million, of which $59.9 million were open market repurchases of debt, payments of debt issuance costs totaling $1.1 million and purchases of treasury stock totaling $0.6 million, partially offset by proceeds from issuance of stock pursuant to stock compensation plans of $1.1 million.  Net cash used in financing activities of $86.2 million for the fiscal year ended June 30, 2018 was primarily due to debt repayments of $85.7 million and purchases of treasury stock totaling $4.6 million, partially offset by proceeds from issuance of stock pursuant to stock compensation plans of $4.1 million.

Credit Facility and Other Indebtedness

The Company has previously entered into and may enter future agreements with various government agencies and financial institutions to provide additional cash to help finance the Company’s various capital investments and potential strategic opportunities.  These borrowing arrangements as of June 30, 2019 are as follows:

Amended Senior Secured Credit Facility

On November 25, 2015, in connection with its acquisition of KUPI, Lannett entered into a credit and guaranty agreement (the “Credit and Guaranty Agreement”) among certain of its wholly-owned domestic subsidiaries, as guarantors, Morgan Stanley Senior Funding, Inc., as administrative agent and collateral agent and other lenders providing for a senior secured credit facility (the “Senior Secured Credit Facility”).  The Senior Secured Credit Facility consisted of Term Loan A in an aggregate principal amount of $275.0 million, Term Loan B in an aggregate principal amount of $635.0 million and a revolving credit facility providing for revolving loans in an aggregate principal amount of up to $125.0 million.  As of June 30, 2019, there was no balance outstanding under the revolving credit facility.

On June 17, 2016, Lannett amended the Senior Secured Credit Facility and the Credit and Guaranty Agreement to raise an incremental term loan in the principal amount of $150.0 million (the “Incremental Term Loan”) and amended certain sections of the agreement (the “Amended Senior Secured Credit Facility”).  The terms of this Incremental Term Loan are substantially the same as those applicable to the Term Loan B.  The Company used the proceeds of the Incremental Term Loan and cash on hand to repurchase the outstanding $250.0 million aggregate principal amount of Lannett’s 12.0% Senior Notes due 2023 (the “Senior Notes”) issued in connection with the KUPI acquisition.

The Term Loan A Facility will mature on November 25, 2020.  The Term Loan A Facility amortizes in quarterly installments from January 1, 2018 through September 30, 2020 in amounts equal to 2.50% of the original principal amount of the Term Loan A Facility, with the balance payable on November 25, 2020.  The Term Loan B Facility will mature on November 25, 2022.  The Term Loan B Facility amortizes in equal quarterly installments in amounts equal to 1.25% of the original principal amount of the Term Loan B Facility with the balance payable on November 25, 2022.  Any outstanding Revolving Loans will mature on November 25, 2020.

The Amended Senior Secured Credit Facility is guaranteed by all of Lannett’s significant wholly-owned domestic subsidiaries (the “Subsidiary Guarantors”) and is collateralized by substantially all present and future assets of Lannett and the Subsidiary Guarantors.

The interest rates applicable to the Amended Term Loan Facility are based on a fluctuating rate of interest of the greater of an adjusted LIBOR and 1.00%, plus a borrowing margin of originally 4.75% (for Term Loan A Facility, 5.00% as amended on December 10, 2018) or 5.375% (for Term Loan B Facility).  The interest rates applicable to the Revolving Credit Facility is based on a fluctuating rate of interest of an adjusted LIBOR plus a borrowing margin of 4.75%.  The interest rate applicable to the unused commitment for the Revolving Credit Facility was initially 0.50%.  Since March 2016, the interest margins and unused commitment fee on the Revolving Credit Facility have been subject to a leveraged based pricing grid.

The Amended Senior Secured Credit Facility contains a number of covenants that, among other things, limit the ability of Lannett and its restricted subsidiaries to: incur more indebtedness; pay dividends; redeem stock or make other distributions of equity; make investments; create restrictions on the ability of Lannett’s restricted subsidiaries that are not Subsidiary Guarantors to pay dividends to Lannett or make intercompany transfers; create negative pledges; create liens; transfer or sell assets; merge or consolidate; enter into sale leasebacks; enter into certain transactions with Lannett’s affiliates; and prepay or amend the terms of certain indebtedness.

The Amended Senior Secured Credit Facility contains a financial performance covenant that is triggered when the aggregate principal amount of outstanding Revolving Credit Facility and outstanding letters of credit as of the last day of the most recent fiscal quarter is greater than 30% of the aggregate commitments under the Revolving Credit Facility.  The covenant provides that Lannett shall not permit its first lien net senior secured leverage ratio as of the last day of any four consecutive fiscal quarters (i) from and after December 31, 2017 to be greater than 3.75:1.00 and (ii) from and after December 31, 2019 to be greater than 3.25:1.00. The Amended Senior Secured Credit Facility also contains a financial performance covenant for the benefit of the Term Loan A Facility lenders which provides that Lannett shall not permit its Net Senior Secured Leverage Ratio as of the last day of any four consecutive fiscal quarters (i) as of December 31, 2017 and prior to December 31, 2019 to be greater than 3.75:1.00 and (ii) as of December 31, 2019 and thereafter to be greater than 3.25:1.00. The Amended Senior Secured Credit Facility also contains certain affirmative covenants, including financial and other reporting requirements.

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On December 10, 2018, the Company entered into an amendment to the Senior Secured Credit Facility and the Credit and Guaranty Agreement.  Pursuant to the amendment, the Secured Net Leverage Ratio applicable to the financial leverage ratio covenant was increased from 3:25:1.00 to 4.25:1.00 as of December 31, 2019 and prior to September 30, 2020, and then to 4:00:1:00 as of September 30, 2020.  In exchange, the Company agreed to include a minimum liquidity covenant of $75 million, a 25-basis point increase to the interest rate margin paid on the Term A Loans and pay a consent fee equal to 50 basis points, paid only to consenting lenders.

In February 2019, a Special Committee of the Board of Directors authorized the Company to repurchase up to $50 million of its Term Loans.  In March 2019, the Company completed the purchase of $24.2 million principal amount of its Term Loans in open market transactions. The purchases comprised $8.0 million and $16.2 million of the Term A Loans and Term B Loans, respectively.  In May 2019, the Company repurchased an additional $37.8 million of its Term A Loans upon authorization from the Special Committee of the Board of Directors.  In order to reduce future cash interest payments, as well as future amounts due at maturity, Lannett may, from time to time, purchase our debt for cash in open market purchases and/or privately negotiated transactions. Lannett will evaluate any such transactions in light of then-existing market conditions, taking into account the Company’s current liquidity among other factors. The amounts involved in any such transactions, individually or in the aggregate, may be material.

Other Liquidity Matters

Refer to the “JSP Distribution Agreement” section above for the impact of the nonrenewal of the JSP agreement on our future liquidity.

Future Acquisitions

We are continuously evaluating the potential for product and company acquisitions as a part of our future growth strategy.  In conjunction with a potential acquisition, the Company may utilize current resources or seek additional sources of capital to finance any such acquisition, which could have an impact on future liquidity.

We may also from time to time depending on market conditions and prices, contractual restrictions, our financial liquidity and other factors, seek to prepay outstanding debt or repurchase our outstanding debt through open market purchases, privately negotiated purchases, or otherwise.  The amounts involved in any such transactions, individually or in the aggregate, may be material and may be funded from available cash or from additional borrowings.

(1)         Long-term debt and interest on obligations amounts above primarily relate to the Company’s Amended Senior Secured Credit Facility.  Refer to Note 10 “Long-Term Debt” for additional information.  Interest on obligations was calculated based on interest rates in effect at June 30, 2019.

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(2)         The purchase obligations above are primarily related to noncancelable open purchase orders for API and ongoing capital expenditure projects.  The asset purchase payment obligation above refers to the consideration due to Andor Pharmaceuticals, LLC for the AB-rated Methylphenidate Hydrochloride perpetual license agreement.  See Note 9 “Goodwill and Intangible Assets” for more information.

(3)         Operating lease obligations primarily relate to a 116,000 square foot leased warehouse in Seymour, Indiana as well as a 25-year lease with Forward Cody, which commenced on April 2015.

Research and Development Arrangements

In the normal course of business, the Company has entered into certain research and development and other arrangements.  As part of these arrangements, the Company has agreed to certain contingent payments which generally become due and payable only upon the achievement of certain developmental, regulatory, commercial and/or other milestones.  In addition, under certain arrangements, we may be required to make royalty payments based on a percentage of future sales, or other metric, for products currently in development in the event that the Company begins to market and sell the product.  Due to the inherent uncertainty related to these developmental, regulatory, commercial and/or other milestones, it is unclear if the Company will ever be required to make such payments.

In the second quarter of Fiscal 2019, the Company entered into an agreement in principle with North South Brother Pharmacy Investment Co., Ltd. and HEC Group PTY, Ltd. (collectively, “HEC”) to develop an insulin glargine product that would be biosimilar to Lantus Solostar pursuant to a License and Collaboration Agreement to be executed by the parties.  This agreement modifies and supersedes a May 3, 2016 Collaboration and Supply Agreement with HEC.  Under the terms of the deal, among other things, the Company shall fund up to $32 million of the development costs and split 50/50 any development costs in excess thereof.  Lannett shall receive an exclusive license to distribute and market the product in the United States upon FDA approval under the 50/50 profit split for the first ten years following commercialization, followed by a 60/40 split in favor of HEC for the following five years.

Critical Accounting Policies

The preparation of our consolidated financial statements in accordance with accounting principles generally accepted in the United States and the rules and regulations of the U.S. Securities & Exchange Commission requires the use of estimates and assumptions.  A listing of the Company’s significant accounting policies are detailed in Note 2 “Summary of Significant Accounting Policies.”  A subsection of these accounting policies have been identified by management as “Critical Accounting Policies.”  Critical accounting policies are those which require management to make estimates using assumptions that were uncertain at the time the estimates were made and for which the use of different assumptions, which reasonably could have been used, could have a material impact on the financial condition or results of operations.

Management has identified the following as “Critical Accounting Policies”: Revenue Recognition, Inventories, Income Taxes, Business Combinations, Valuation of Long-Lived Assets, including Goodwill and Intangible Assets, In-Process Research and Development and Share-based Compensation.

Revenue Recognition

On July 1, 2018, the Company adopted Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers, which superseded ASC Topic 605, Revenue Recognition.  Under ASC 606, the Company recognizes revenue when title and risk of loss of promised goods or services have transferred to the customer at an amount that reflects the consideration the Company is expected to be entitled.  Our revenue consists almost entirely of sales of our pharmaceutical products to customers, whereby we ship product to a customer pursuant to a purchase order.  Revenue contracts such as these do not generally give rise to contract assets or contract liabilities because: (i) the underlying contracts generally have only a single performance obligation and (ii) we do not generally receive consideration until the performance obligation is fully satisfied.  The new revenue standard also impacts the timing of the Company’s revenue recognition by requiring recognition of certain contract manufacturing arrangements to change from “upon shipment or delivery” to “over time.”  However, the recognition of these arrangements over time does not currently have a material impact on the Company’s consolidated results of operations or financial position. The Company adopted ASC 606 using the modified retrospective method.  Refer to the “Recent Accounting Pronouncements” section of this footnote for further discussion of the impact of the adoption.

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When revenue is recognized, a simultaneous adjustment to gross sales is made for estimated chargebacks, rebates, returns, promotional adjustments and other potential adjustments.  These provisions are primarily estimated based on historical experience, future expectations, contractual arrangements with wholesalers and indirect customers and other factors known to management at the time of accrual.  Accruals for provisions are presented in the Consolidated Financial Statements as a reduction to gross sales with the corresponding reserve presented as a reduction of accounts receivable or included as rebates payable, depending on the nature of the reserve.

Provisions for chargebacks, rebates, returns and other adjustments require varying degrees of subjectivity.  While rebates generally are based on contractual terms and require minimal estimation, chargebacks and returns require management to make more subjective assumptions.  Each major category is discussed in detail below:

Chargebacks

The provision for chargebacks is the most significant and complex estimate used in the recognition of revenue. The Company sells its products directly to wholesale distributors, generic distributors, retail pharmacy chains and mail-order pharmacies. The Company also sells its products indirectly to independent pharmacies, managed care organizations, hospitals, nursing homes and group purchasing organizations, collectively referred to as “indirect customers.” The Company enters into agreements with its indirect customers to establish pricing for certain products. The indirect customers then independently select a wholesaler from which to purchase the products. If the price paid by the indirect customers is lower than the price paid by the wholesaler, the Company will provide a credit, called a chargeback, to the wholesaler for the difference between the contractual price with the indirect customers and the wholesaler purchase price. The provision for chargebacks is based on expected sell-through levels by the Company’s wholesale customers to the indirect customers and estimated wholesaler inventory levels. As sales to the large wholesale customers, such as Cardinal Health, AmerisourceBergen and McKesson increase (decrease), the reserve for chargebacks will also generally increase (decrease). However, the size of the increase (decrease) depends on product mix and the amount of sales made to indirect customers with which the Company has specific chargeback agreements. The Company continually monitors the reserve for chargebacks and makes adjustments when management believes that expected chargebacks may differ from the actual chargeback reserve.

Rebates

Rebates are offered to the Company’s key chain drug store, distributor and wholesaler customers to promote customer loyalty and increase product sales. These rebate programs provide customers with credits upon attainment of pre-established volumes or attainment of net sales milestones for a specified period. Other promotional programs are incentive programs offered to the customers. Additionally, as a result of the Patient Protection and Affordable Care Act (“PPACA”) enacted in the U.S. in March 2010, the Company participates in a new cost-sharing program for certain Medicare Part D beneficiaries designed primarily for the sale of brand drugs and certain generic drugs if their FDA approval was granted under a NDA or 505(b) NDA versus an ANDA.  Because our drugs used for the treatment of thyroid deficiency pursuant to the JSP Distribution Agreement and our Morphine Sulfate Oral Solution product were both approved by the FDA as 505(b)(2) NDAs, they are considered “brand” drugs for purposes of the PPACA. Drugs purchased within the Medicare Part D coverage gap (commonly referred to as the “donut hole”) result in additional rebates. The Company estimates the reserve for rebates and other promotional credit programs based on the specific terms in each agreement when revenue is recognized. The reserve for rebates increases (decreases) as sales to certain wholesale and retail customers increase (decrease). However, since these rebate programs are not identical for all customers, the size of the reserve will depend on the mix of sales to customers that are eligible to receive rebates.

Returns

Consistent with industry practice, the Company has a product returns policy that allows customers to return product within a specified time period prior to and subsequent to the product’s expiration date in exchange for a credit to be applied to future purchases. The Company’s policy requires that the customer obtain pre-approval from the Company for any qualifying return. The Company estimates its provision for returns based on historical experience, changes to business practices, credit terms and any extenuating circumstances known to management. While historical experience has allowed for reasonable estimations in the past, future returns may or may not follow historical trends. The Company continually monitors the reserve for returns and makes adjustments when management believes that actual product returns may differ from the established reserve. Generally, the reserve for returns increases as net sales increase.

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Other Adjustments

Other adjustments consist primarily of price adjustments, also known as “shelf-stock adjustments” and “price protections,” which are both credits issued to reflect increases or decreases in the invoice or contract prices of the Company’s products.  In the case of a price decrease, a credit is given for product remaining in customer’s inventories at the time of the price reduction.  Contractual price protection results in a similar credit when the invoice or contract prices of the Company’s products increase, effectively allowing customers to purchase products at previous prices for a specified period of time.  Amounts recorded for estimated shelf-stock adjustments and price protections are based upon specified terms with direct customers, estimated changes in market prices and estimates of inventory held by customers.  The Company regularly monitors these and other factors and evaluates the reserve as additional information becomes available.  Other adjustments also include prompt payment discounts and “failure-to-supply” adjustments.  If the Company is unable to fulfill certain customer orders, the customer can purchase products from our competitors at their prices and charge the Company for any difference in our contractually agreed upon prices.

Inventories

Inventories are stated at the lower of cost or net realizable value determined by the first-in, first-out method.  Inventories are regularly reviewed and write-downs for excess and obsolete inventory are recorded based primarily on current inventory levels and estimated sales forecasts.

Income Taxes

The Company uses the liability method to account for income taxes as prescribed by ASC 740, Income Taxes.  Deferred taxes are recorded to reflect the tax consequences on future years of events that the Company has already recognized in the financial statement or tax returns.  Deferred income tax assets and liabilities are adjusted to recognize the effect of changes in tax law or tax rates in the period during which the new law is enacted.  Under ASC 740, Income Taxes, a valuation allowance is required when it is more likely than not that all or some portion of the deferred tax assets will not be realized through generating sufficient future taxable income.  Failure to achieve forecasted taxable income in applicable tax jurisdictions could affect the ultimate realization of deferred tax assets and could result in an increase in the Company’s effective tax rate on future earnings.

The Company may recognize the tax benefit from an uncertain tax position claimed on a tax return only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position.  The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement.  The benefit from uncertain tax positions recorded in the financial statements was immaterial for all periods presented.

The Company’s future effective income tax rate is highly reliant on future projections of taxable income, tax legislation, and potential tax planning strategies.  A change in any of these factors could materially affect the effective income tax rate of the Company in future periods.

Business Combinations

Acquired businesses are accounted for using the acquisition method of accounting, which requires that the assets acquired and liabilities assumed be recorded at the date of acquisition at their respective estimated fair values.  The fair values and useful lives assigned to each class of assets acquired and liabilities assumed are based on, among other factors, the expected future period of benefit of the asset, the various characteristics of the asset and projected future cash flows.  Significant judgment is employed in determining the assumptions utilized as of the acquisition date and for each subsequent measurement period.  Accordingly, changes in assumptions described above could have a material impact on our consolidated results of operations.

Valuation of Long-Lived Assets, including Goodwill and Intangible Assets

The Company’s long-lived assets primarily consist of property, plant and equipment, definite and indefinite-lived intangible assets and goodwill.

Property, plant and equipment are stated at cost less accumulated depreciation.  Depreciation is computed on a straight-line basis over the assets’ estimated useful lives, generally for periods ranging from 5 to 39 years.  Definite-lived intangible assets are stated at cost less accumulated amortization and are amortized on a straight-line basis over the assets’ estimated useful lives, generally for periods ranging from 10 to 15 years.  The Company continually evaluates the reasonableness of the useful lives of these assets.

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Property, plant and equipment and definite-lived intangible assets are reviewed for impairment whenever events or changes in circumstances (“triggering events”) indicate that the carrying amount of the asset may not be recoverable.  The nature and timing of triggering events by their very nature are unpredictable; however, management regularly considers the performance of an asset as compared to its expectations, industry events, industry and economic trends, as well as any other relevant information known to management when determining if a triggering event occurred.

If a triggering event is determined to have occurred, the first step in the impairment test is to compare the asset’s carrying value to the undiscounted cash flows expected to be generated by the asset.  If the carrying value exceeds the undiscounted cash flows of the asset, then an impairment exists.  An impairment loss is measured as the excess of the asset’s carrying value over its fair value, which in most cases is calculated using a discounted cash flow model.  Discounted cash flow models are highly reliant on various assumptions which are considered Level 3 inputs, including estimates of future cash flows (including long-term growth rates), discount rates and the probability of achieving the estimated cash flows.  The judgments made in determining the estimated fair value can materially impact our results of operations.  There can be no assurances as to when, or if, future impairments may occur.

Goodwill and indefinite-lived intangible assets, including in-process research and development, are not amortized.  Instead, goodwill and indefinite-lived intangible assets are tested for impairment annually during the fourth quarter of each fiscal year, or more frequently whenever events or triggering events indicate that the asset might be impaired.  The Company utilizes a quantitative assessment to determine the fair value of our reporting unit (generic pharmaceuticals).  If the net book value of our reporting unit exceeds its fair value, the difference will be recorded as a goodwill impairment, not to exceed the carrying amount of goodwill.  The Company’s fair value assessments are highly reliant on various assumptions which are considered Level 3 inputs, including estimates of future cash flows (including long-term growth rates), discount rates and the probability of achieving the estimated cash flows.  The judgments made in determining the estimated fair value of goodwill and indefinite-lived intangible asset can materially impact our results of operations.  There can be no assurances as to when, or if, future impairments may occur.  The Company has one reportable segment and one reporting unit, generic pharmaceuticals.

In-Process Research and Development

Acquired businesses are accounted for using the acquisition method of accounting.  The acquisition purchase price is allocated to the net assets of the acquired business at their respective fair values.  Amounts allocated to in-process research and development are recorded at fair value and are considered indefinite-lived intangible assets subject to the impairment testing in accordance with the Company’s impairment testing policy for indefinite-lived intangible assets as described above.  As products in development are approved for sale, amounts will be allocated to product rights and will be amortized over their estimated useful lives. Definite-lived intangible assets are amortized over the expected life of the asset.  The Company’s fair value assessments are highly reliant on various assumptions which are considered Level 3 inputs, including estimates of future cash flows (including long-term growth rates), discount rates and the probability of achieving the estimated cash flows.  The judgments made in determining the estimated fair value of in-process research and development, as well as asset lives, can materially impact our results of operations.  There can be no assurances as to when, or if, future impairments may occur.

Share-based Compensation

Share-based compensation costs are recognized over the vesting period, using a straight-line method, based on the fair value of the instrument on the date of grant less an estimate for expected forfeitures.  The Company uses the Black-Scholes valuation model to determine the fair value of stock options, the stock price on the grant date to value restricted stock and the Monte-Carlo simulation model to determine the fair value of performance-based shares.  The Black-Scholes valuation and Monte-Carlo simulation models include various assumptions, including the expected volatility, the expected life of the award, dividend yield and the risk-free interest rate.

Expected volatility is based on the historical volatility of the price of our common shares during the historical period equal to the expected term of the option.  The Company uses historical information to estimate the expected term, which represents the period of time that options granted are expected to be outstanding.  The risk-free rate for the period equal to the expected life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.  The forfeiture rate assumption is the estimated annual rate at which unvested awards are expected to be forfeited during the vesting period.  This assumption is based on our actual forfeiture rate on historical awards.  Periodically, management will assess whether it is necessary to adjust the estimated rate to reflect changes in actual forfeitures or changes in expectations.  Additionally, the expected dividend yield is equal to zero, as the Company has not historically issued and has no immediate plans to issue, a dividend.  These assumptions involve inherent uncertainties based on market conditions which are generally outside the Company’s control.  Changes in these assumptions could have a material impact on share-based compensation costs recognized in the financial statements.

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Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU 2014-09, which created ASC Topic 606 Revenue from Contracts with Customers.  The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  The authoritative guidance is effective for annual reporting periods beginning after December 15, 2017.  Based on a review of the contracts representing a substantial portion of our revenues, which is primarily generated from product sales, the Company determined that the updated guidance does not have a material impact on our disclosures or the timing and recognition of our revenues. Under the new standard, the Company estimates certain amounts as variable consideration, specifically any “failure-to-supply” adjustments at the point of product sale in future periods.

The new revenue standard also impacts the timing of the Company’s revenue recognition by requiring recognition of certain contract manufacturing arrangements to change from “upon shipment or delivery” to “over-time.”  However, the recognition of these arrangements over-time does not currently have a material impact on the Company’s consolidated results of operations or financial position.

The cumulative impact of the adoption of ASC 606 resulted in a $2.3 million adjustment, net of tax, to opening retained earnings on July 1, 2018.

In February 2016, the FASB issued ASU 2016-02, Leases.  ASU 2016-02 requires an entity to recognize right-of-use assets and liabilities on its balance sheet for all leases with terms longer than 12 months.  Lessees and lessors are required to disclose quantitative and qualitative information about leasing arrangements to enable a user of the financial statements to assess the amount, timing and uncertainty of cash flows arising from leases.  ASU 2016-02 is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period and requires a modified retrospective application, with early adoption permitted.  In December 2018, the FASB issued ASU 2018-20, Leases — Narrow Scope Improvements for lessors, which allows entities to choose an additional transition method of adoption, under which an entity initially applies the new standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The Company is in the process of finalizing the analysis of its lease portfolio and updating its accounting policies to comply with this standard.  Upon adoption, the Company expects to recognize an initial right-of-use asset and lease liability on its consolidated balance sheet of approximately $6 million to $8 million as of July 1, 2019.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows — Classification of Certain Cash Receipts and Cash Payments.  ASU 2016-15 addresses how certain cash receipts and cash payments are presented and classified in the statement of cash flows.  The standard was adopted on July 1, 2018 and did not have an impact on the Company’s consolidated financial statements.

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