Lannett Drops After FDA Approval With More Decisions Pending

| About: Lannett Company, (LCI)

Shares of Lannett (NYSEMKT:LCI) have slumped back to the $5 range following FDA approval news of its 505(b)(2) NDA last week for morphine sulfate oral solution, which has estimated annual sales of $31.7 million. I have emailed both the CEO and CFO for an update on the timeline for additional FDA approvals and new filings that are expected this year and will provide an update for any response that I may receive.

Specifically, I emailed the company for updates on timelines for the ANDA approvals (CEO previously expected two of these to be approved along with morphine upon successful completion of the pre-approval inspections). I am also seeking to confirm the anticipated timeline to submit new 505(b)(2) filings for Hydromorphone nasal delivery product and Oxycodone oral spray w/ delivery device (2H11 estimate currently).

Finally, there is the pending citizen's petition (filed during 1Q11) to reactivate the use of a dormant antibiotic drug (chloramphenicol) for second/third-line use in serious MRSA (methicillin-resistant Staphylococcus aureus) infections where patients have few or no other options.

Based on previous guidance from the company, I expect that at least two generic products (ANDAs) will get approved in the near-term (next month or so), while it is harder to predict the timing for a FDA response on chloramphenicol, but the next few weeks to months through the year's end should have plenty of news and catalysts to move the stock along with an expected return to consistent sales and profit growth for morphine and other pending approvals for high margin, low competition drugs.

Finally, LCI provided guidance on the most recent quarterly conference call for an early-mid 2012 505(b)(2) NDA filing for C-Topical (LCI currently markets as grandfathered product similar to the status of morphine prior to FDA action to require formal approval). Based on previous years, LCI should report its fiscal year 2011 fourth quarter and full-year results during the second week of September.

During the second week of May, LCI reported its 3Q fiscal year 2011 results that included a small net loss ($362,000) due to FDA approval delays on revenue of $25.9M (vs. year-ago sales of $31.3M, which included the sale of morphine sulfate oral solution since this product was removed from the market at the request of FDA in July 2010). Key product segments during the 3Q included thyroid – levothyroxine ($12.3M), heart failure – digoxin ($3M), and pain management – oxycodone oral solution ($2.7M).

As of 3/31/11, LCI had $22.8M cash/equivalents plus investments, total debt of $3M ($2.7M long-term plus $0.3M current portion), and 28.4M shares of common stock outstanding. At a stock price of $5 per share, LCI trades at a discount to the generic drug industry based on public-traded companies and recent acquisition premiums paid in the space and the company is valued at a market cap of $142M and enterprise value (market cap plus debt minus cash) of approx. $122M with trailing 12-month sales of $115M and net income of $4.4M.

As an example of a recent small-cap acquisition in the generic drug space, Endo Pharma (NASDAQ:ENDP) paid approximately 3X sales to acquire privately held Qualitest Pharma last September.

I expect the morphine sulfate oral solution approval could add 10-15% to sales over the next year based on fewer competing FDA approved products in the market and better pricing than a year ago since the FDA action to require formal approval for this product has eliminated most of the competing products and the drug occupies a niche market ($31.7M annual sales) that is not going to attract many companies to bother with the 505(b)(2) NDA process.

In addition, at least two generic product ANDAs should be approved shortly since the pre-approval inspection has been successfully concluded and other 505(b)(2) NDA filings provide additional potential upside catalysts for the stock. While the stock price reaction has been disappointing and the morphine NDA process dragged on for nearly 16 months before receiving FDA approval; the fundamentals, valuation, and upcoming catalyst for LCI should result in a higher stock price by year-end or sooner from the current range in the low-mid $5s.

Other wild cards for LCI include the potential for research analyst upgrades or new coverage and the looming potential for a buyout in the rapidly consolidating generic drug industry by an acquisition-focused company like ENDP (which is also based in eastern Pennsylvania) or others focused in the generic/specialty pharma space focused on pain drugs.

Obviously hoping for a buyout is not a reliable investing strategy so the additional FDA catalysts for LCI provide more reliable potential upside catalysts in the near-term, since the approval of the morphine NDA indicates there are no remaining issues from the pre-approval inspections, which were also relevant to the ANDA approvals (although this is a separate division within the FDA compared to new drug reviews – Office of Generic Drugs or OGD vs. Center for Drug Evaluation and Research or CDER).

Disclosure: I am long LCI.