It has long been said, and as history proves, bad things happen to good people. And it follows that bad things happen to good companies. Good companies fail. Evidence? How about a quick comparison of the Fortune 25 for the year 2000 to that for the year 2019 finds only 8 companies from the 2000 list still exist on the 2019 list. The other 17 companies? They were either acquired, dropped down the list due to competitors beating them, or they went bankrupt.
So, it is not unfathomable that a 70-plus year-old company like Lannett (NYSE:LCI) could have enough bad things happen to cause them to fail. Some suggested a few months ago that LCI was “circling the drain.” But as Mark Twain, the great American humorist once said… “The reports of my death have been greatly exaggerated.”
And, so it is for Lannett.
This is not to say the threats are not real, they are. However, the suggestions that the threats Lannett faces are existential and insurmountable are hyperbole. Personally, I find the term – existential – overused. All companies face threats. Rather, it is the ability to overcome threats that is evidence of effective management and endemic to good companies.
So, let’s take a look at the more substantial threats and what Lannett is doing to make them surmountable.
Let’s begin with the easiest to address…
That is, concern about the potential costs related to the big bad opioid abuse matter in litigation across the nation. Though admittedly any lawsuit is a concern, and opioid abuse is a big one, it remains a concern; particularly for any substantial litigation award that some have suggested could throw LCI into insolvency.
Regarding that threat, according to Tim Crew’s response in the Q4 2019 conference call, they have a single opioids lawsuit and it involves a Kremer Urban subsidiary with a single hospital. It is LCI’s opinion, as posited by CEO Crew, that Kremer Urban was named in error. Moreover, LCI is not named in any other opioid lawsuit.
While it remains that anything opioid related is a concern, context matters. LCI has limited exposure.
Now it gets tougher...
The allegation that Lannett was involved in a conspiracy to set generic prices.
It is true that the generics business has long operated on thin margins; which is attributed to the fact that it competes on price. If a business fails to control its operating costs and, thus, inflates its expenses, such action would narrow the profit margins; often leading to the need for raising drug prices. This is a problem because it might lead prescribers to substitute a cheaper generic for the costly one and with it the company with the pricier drug will suffer lost revenues.
It is due to this dynamic that some may assume that generic firms would have to collude to set prices and ensure profits. But this infers a malevolent intent to all generic drug companies; irrespective of market exposure. I suspect this is not surprising, as we often see the "mayo effect" and the inevitable comparisons with the “big tobacco” conspiracy and with it an effort to arrange a settlement "in the interests of all." So it is with the allegations of collusions over generic pricing.
While it is not within the scope of my analysis or my ability to prognosticate the future or offer evidence to confirm or deny such claims, providing some context is necessary.
First, Lannett has acknowledged the inquiry made by the government. But, those who might have been involved no longer work there. Plus, the drugs in question are limited. Even in the question of collusion, nowhere in the media has Lannett’s exposure been discussed as equivalent to that of the others.
In fact, as this notes… the charges put the bullseye squarely on Teva (TEVA), citing the existence of an internal competitor ranking system; which assessed whether fellow generics companies would raise prices when Teva did. The various state attorneys general claim that between 2012 and 2015 the prices of more than 100 drugs were artificially inflated by Teva, Novartis (NVS) Sandoz unit, Pfizer (PFE), Mylan (MYL), Glenmark (OTC:GLKQY), Taro (TARO) and the Actavis generics unit (acquired by Allergan (AGN) and later sold to Teva) and others (Lannett is an “other”). According to the charges, Teva had conducted internal analyses ratings on which drugs they would be able to successfully raise prices, based on the number of competitors in the specific market and the quality of their relationships with those companies.
Mylan, Novartis' Sandoz unit, Glenmark, Taro and the Actavis generics unit were all rated highest in this analysis, and others joined based on their willingness to cooperate, the lawsuit says. If there is a settlement (and it would not go to trial because that is not how the government plays these things, as anyone following legal history should know), there would be some level of apportionment for responsibility, based on a drug by drug analysis. On that basis, LCI would have limited financial exposure. Still, LCI noted…
“The Company is also subject to various legal proceedings arising out of the normal course of its business including, but not limited to, product liability, intellectual property, patent infringement claims and antitrust matters. It is not possible to predict the outcome of these various proceedings. An adverse determination in any of these proceedings in the future could have a significant impact on the financial position, results of operations and cash flows of the Company.”
But acknowledging that is part of being open and transparent. Every company says they can fail for myriad reasons. LCI might fail due to the litigation, but I am guessing they will not, nor likely any other major generics firm. Why? Because the cost of drugs is a major political consideration and litigation that seeks the bankruptcy of top generic companies would be catastrophic on everything from pricing (based on supply and demand) to availability; not to mention it defies common sense.
In fact, the 1984 Hatch-Waxman Act (officially called the Drug Price Competition and Patent Term Restoration Act) aimed to balance two seemingly contradictory interests: encouraging drug innovation and promoting competition between brand and generic drugs in order to lower drug prices. The act succeeded in both of its goals. After the law was enacted, generic drugs moved from being less than 20% of all prescriptions filled in the U.S. to nearly 90% of prescriptions filled and generic medicines have been said to save consumers more than $200 Billion a year; which means generics are at the heart of the effort to reduce drug costs.
So, to insinuate the government would seek to prosecute and fine generic drug companies into bankruptcy would not make sense because the real effort is about ensuring that the cost of drugs remains affordable for the masses, and that means companies must be able to continue providing drugs that save money and lives. Lannett will survive this issue, even if at some cost.
The loss of a key customer – Jerome Stevens Pharma
It is a legitimate concern when a company loses a principle customer that accounts for more than 20+% of annual revenues. Without question, such an event often reflects negatively on management, but can happen due to changes in the competitive environment or within the companies involved, or both.
For example, in an effort to develop its coffee business, Starbucks engaged in partnerships with PepsiCo (PEP) and Kraft Foods (NASDAQ:KHC), to take advantage of the different distribution systems of each firm. Today, Starbucks partnership with PepsiCo remains in place. However, because they wanted more control, despite significant organic growth, SBUX terminated their agreement with Kraft.
It can sometimes happen that a company gets involved with a customer and both beneficially grow due to the relationship. However, one company can decide to vertically integrate downstream; thus, eliminating the need to continue the relationship. Such as it was with FedEx (FDX) and their relationship with Amazon (AZN). The exponential growth of Amazon as the quintessential online retailer meant significant revenues for FedEx. Yet, we saw that relationship come to an end, more to the deficit of FedEx; which has found itself trying to find news sources of revenue to replace what was lost. FedEx is still working on that.
But this article is not about Starbucks or FedEx, it is about Lannett and the question is: What is LCI doing to replace the lost revenue for Levothyroxine resulting from the termination of their contract with Jerome Stevens Pharma (JSP)?
As LCI noted in their 2019 annual report, there is a hole in their revenue stream…
“Net sales of JSP products totaled $202.5 million in fiscal year 2019, $253.1 million in fiscal year 2018 and $187.0 million in fiscal year 2017. Our Distribution Agreement with JSP was not renewed when it expired on March 23, 2019. Management has implemented plans to offset the impact of the nonrenewal of the JSP Distribution Agreement. These plans currently include, among other things, an emphasis on reducing cost of sales, research and development (“R&D”) and selling, general and administration (“SG&A”) expenses, continuing to accelerate new product launches, increasing its level of strategic partnerships and reducing capital expenditures. Management will also continue its emphasis on accelerating ANDA filings. However, the impact that these actions will have cannot be assured and they may not be sufficient to offset the impact, in whole or in part, of the loss of net sales, earnings or cash flows resulting from the nonrenewal of the JSP Distribution Agreement.”
Much of LCI’s gross profit disappeared and attempting to replace it no small challenge. While cost reductions are beneficial and LCI has made some, it remains that companies cannot save themselves to prosperity. At some point, growth must come from an increase in revenues. This begs the question: What is LCI doing to grow revenues?
Glad you asked...
LCI has been busy this past year working to create additional revenue producing opportunities – both through partnerships and internal development that will provide a more diversified portfolio; one less reliant upon a single customer.
The effort undertaken to grow the business has been notable. In chronologically descending order:
On 11.26.19: Lannett announced it entered into a new collaboration and license agreement with HEC. The deal replaces an agreement in principle the two previously entered into, with respect to development, commercialization and distribution of HEC's insulin glargine product in the United States.
In the deal, the two will share responsibility for control of development; Lannett will pay development costs up to $32M and split amounts over that 50/50 for the next $13M in costs; HEC will make the product; and Lannett will prepare the BLA filing that HEC will submit.
Also, Lannett will become the exclusive distributor in the U.S. and have sole responsibility for commercializing it there; the two will share profits and losses for the first 10 years, and after that split 60/40 in favor of HEC; and Lannett will own IP rights tied to certain developed drug delivery devices associated with the product.
On 10.1.19: Lannett entered into an exclusive U.S. distribution agreement for the therapeutically equivalent generic of ADVAIR DISKUS (Fluticasone Propionate – Salmeterol Xinafoate Powder Inhaler) of privately held Respirent Pharmaceuticals.
Under the agreement, Lannett will make an upfront payment, as well as future milestone payments, and receive a portion of the net profits once it commences distribution. The term of the agreement is 10 years. Other terms were not disclosed.
ADVAIR DISKUS is a registered trademark of GlaxoSmithKline. It had U.S. sales of $3.6B for the 12 months ending July 2019, according to IQVIA.
On 8.28.19: Lannett entered into an agreement with Sinotherapeutics Inc., a China-based specialty pharmaceutical company, to be the exclusive U.S. distributor of Posaconazole Delayed-Release Tablets 100mg.
Sinotherapeutics has received final approval from the FDA of its ANDA for Posaconazole Tablets 100mg, which is an AB-rated generic equivalent of Merck's (MRK) Noxafil Delayed-Release Tablets. Lannett expects to commence shipping the product shortly.
Under the agreement, Lannett will make milestone payments based on market dynamics and performance. The company will provide sales, marketing and distribution and will receive a share of the profits. Other terms were not disclosed.
On 8.27.19: Lannett entered into a three-year advisory services agreement with Cediprof, Inc., a wholly owned subsidiary of privately held Neolpharma Group of Mexico.
Under the new agreement, Lannett will advise on matters broadly related to assisting Cediprof and its affiliated entities to further develop and commercialize products for the U.S. generic market. Lannett will receive an advisory fee for its services. This is LCI’s second agreement with Neolpharma.
On 7.8.19: Lannett entered into a future exclusive supply and distribution agreement for Levothyroxine Sodium Tablets USP of Cediprof, Inc., a wholly owned subsidiary of Neolpharma Pharmaceutical Group (and competitor of their former partner, Jerome Stevens Pharma).
Under the agreement, Lannett will commence U.S. distribution no later than August 1, 2022. The Company will make an upfront payment of $20M and will receive a portion of the net profits.
The term of the agreement is 10 years, which begins upon commencement of distribution. Other terms were not disclosed.
On 6.28.19: Lannett entered into a three-year agreement with Elite Pharmaceuticals (OTCQB:ELTP) to be the exclusive U.S. distributor of Dantrolene Capsules 25 mg, 50 mg and 100 mg, a therapeutic equivalent to Par Pharmaceuticals', Dantrium Capsules 25 mg, 50 mg and 100 mg.
Total U.S. sales of Dantrolene Capsules was about $6.4M for the 12 months ended April 2019, according to IQVIA.
Under the agreement, Lannett will primarily provide sales, marketing and distribution support for the product, for which it will receive a share of the profits. Other financial terms were not disclosed.
This is LCI’s second agreement with Elite.
On 5.29.19: Lannett commenced marketing Methylphenidate Hydrochloride Extended Release (ER) tablets USP in 18 mg, 27, 36 and 54 mg strengths, an AB-rated generic equivalent to the brand Concerta; which LCI expects to be a “top contributor.”
Total U.S. sales of Methylphenidate Hydrochloride ER tablets were about $1.4B for year ended February 2019, according to IQVIA.
The marketing application was submitted by privately held alliance partner Andor Pharmaceuticals, LLC. Under an August 2018 license agreement, Lannett will provide sales, marketing and distribution support for Andor's product in exchange for a portion of the profits.
Per IQVIA, the U.S. market is about $1.4B.
On 3.27.19: Lannett received FDA approval for its own ANDA for Aspirin and Extended-Release Dipyridamole Capsules, 25 mg/200 mg, the therapeutic equivalent to, Aggrenox Capsules, 25 mg/200 mg, of privately held Boehringer Ingelheim Pharmaceuticals.
According to IQVIA, total U.S. sales of Aspirin and Extended-Release Dipyridamole Capsules was about $174.6M for the year ended January 2019.
On 3.11.19: Lannett entered into an agreement with Elite Pharmaceuticals and privately held SunGen Pharma to be the exclusive U.S. distributor of a generic version of Adderall, an immediate-release mixed salt of a single entity Amphetamine tablet product, with strengths of 5 mg, 7.5, 10, 12.5, 15, 20 and 30 mg tablets.
Under the agreement, Lannett will provide sales, marketing and distribution support for the product, for which it will receive a share of the profits. Other financial terms were not disclosed.
Adderall, a registered trademark of Teva Pharmaceutical Industries, is a central nervous system stimulant, indicated for the treatment of Attention Deficit Hyperactivity Disorder and Narcolepsy. According to IQVIA data, the Adderall and its equivalents had total U.S. sales of $361 million for the twelve months ending January 2019.
On 11.12.18: Lannett reached an agreement with Amneal Pharmaceuticals (AMRX), under which the latter will be its sole customer for Levothyroxine Sodium beginning December 1 through March 23, 2019. Amneal will resell the product to its customers.
Under the terms of the deal, Lannett will receive $50M upfront. Other terms are not disclosed.
What makes the last deal so interesting is this…
Privately held Jerome Stevens Pharmaceuticals entered into a 10-year distribution agreement with Amneal Pharmaceuticals (AMRX) for Levothyroxine sodium tablets beginning on March 22, 2019, transitioning from Lannett Company.
Under the terms of the agreement, Jerome Stevens will receive an upfront payment upon commercialization by Amneal and a share of the profits. Specific financial terms are not disclosed.
The U.S. brand and generic market for Levothyroxine sodium tablets is estimated to be approximately $2.6 billion in annual sales and 122 million annual prescriptions, according to IQVIA™ for the 12 months ending June 30, 2018.
So, based on two different relationships, LCI will be back in the Levothyroxine business. Imagine that!
All of these relationships will serve LCI well, as they noted in the Q1 2020 filing…
“As of today, including our partnerships, we have approximately 20 ANDAs that have FDA approval and not yet launched; another 20 ANDAs that are filed with the FDA and pending approval; and finally, we have about 20 more product candidates in our active development portfolio. These 60 products, relative to the size of our company, gives us the confidence that we can maintain our recent rate and impact of new product launches well into the future.
Our Business Development team is in ever-ongoing negotiations to in-license even more products, and we believe we have demonstrated that our company is well positioned as a partner of choice.
In the medium and longer term, we have several opportunities that represent meaningful upside to our business. These include the continuing submission of product applications to the FDA, with efforts targeting areas where we have expertise and strength. Our R&D teams have already submitted five ANDAs in the first half of the fiscal year, a substantial increase over the recent past. Beyond our ANDA portfolio, our New Drug Application (NDA) for Cocaine Hydrochloride Topical Solution, with a proposed trade name of Numbrino, continues to advance at the FDA. Additionally, our efforts to co-develop a biosimilar Insulin Glargine product referencing Sanofi’s Lantus are progressing.”
So, kudos to LCI’s management. Based on reasonable projections over the wealth of agreements they have entered, they should grow revenues across a diversified range of products, not marginally but exponentially over time. And, they are just getting started…
LCI beat expectations in Q1 2020… with revenues of $127.34M (-17.9% Y/Y) beats by $6.56M and, over the last 2 years, LCI has beaten EPS estimates 88% of the time and has beaten revenue estimates 63% of the time.
Which is a nice segue to the final threat…
Lannett’s debt is going to cause it to go bankrupt
This premise is based on the theory that LCI is simply too leveraged to generate enough cash flows to offset massive erosion of its revenue streams.
As the aforementioned discussion of the new business opportunities born of partnerships and internal product development should make evident, LCI is positioned to fill the revenue hole caused with the termination of the Jerome Stevens contract over time, and substantially improve their overall net revenues.
Still, it is important to recognize the debt situation. On that, LCI acknowledged the following…
"Our substantial indebtedness may have important consequences for us. For example, it may:
To that end, LCI also indicated…
“We completed a $86.3 million offering of convertible notes, the net proceeds of which we use to pay down half of the outstanding balance of our Term A loans. After the pay down, the remaining balance of the Term A loans was approximately $69.5 million, an amount that is lower than our cash position of $101 million.
This transaction has several benefits. First, the convertible notes mature in seven years or 2026 versus the Term A loans which mature in about one year. Second, the convertible notes have a lower interest rate than the Term A loans. Third, the convertible notes are unsecured debt and do not count towards the covenant calculations, all of which have significantly improved our financial flexibility.
As we have previously said, we will continue to be proactive and disciplined on extending the maturity profile of our existing debt and we’ll continue to look for opportunities to further improve our capital structure.”
Going forward, LCI expects net annual sales in the range of $525 million to $545 million, adjusted gross margin as a percentage of net sales of approximately 40% to 42%, adjusted R&D expense in the range of $34 million to $36 million, adjusted SG&A expense ranging from $63 million to $66 million, adjusted interest expense in the range of $54 million to $56 million down from $56 million to $58 million. The full year adjusted effective tax rate in the range of 22% to 23%. Adjusted EBITDA in the range of $145 million to $160 million, and lastly, capital expenditures to be approximately $20 million to $25 million.
Regarding the phasing of the quarters, LCI expects "net sales in Q2 to be comparable to Q1 and increase in the second half of the year as a higher number of product launches are expected in Q3 and Q4." With regard to gross margin, they expect Q2 to be slightly higher than Q1 and decrease modestly over the balance of the year. They also expect "EPS and adjusted EBITDA to increase sequentially quarter-over-quarter" for the remainder of the year.
Finally, at the end of the Q1 2020 call, on the Q&A, the analyst questions were focused on business development and revenue growth through new drug development and partnerships. Not a single question was about whether LCI would be able to manage its debt or whether debt would impair its ability to continue as a going concern. So, it seems that even the analysts believe LCI’s prospective business development should lead to increasing revenues that will enable the company to meet its debt obligations, fund business development, and return value to shareholders.
Sure, LCI has debt, but so do most companies (debt is cheaper than equity, my CFO would say, that's why we finance our cars and homes). But there are many other challenges inherent to any business and, whether external threats or internal weaknesses, each will require effective management and leadership. At this point, the effort by the management team put in place by CEO Tim Crew, and the business results evident since he took office, suggest the company remains a well-positioned, solidly mid-sized, reliably reputable, and growing generic pharmaceutical firm.
While I do not know if Tim Crew is an ardent reader of Sun Tzu or a follower of Bill Belichick, I suspect that he, like them, recognizes that all threats must be met by effectively employing strategies that engage the organization’s strengths. It would seem he also understands it is essential to have the “right people on the bus,” as Jim Collins said long ago. And, as generics are sold on a cost basis, there is a need to manage and control costs, even when expanding the business through myriad partnerships and internal product development. That is what effective companies do and it is what LCI is doing.
As an addendum to the summary, I would be remiss in not acknowledging that my interest in LCI was born of an investment in a small company that is now an LCI business partner. As noted in the discussion of Threat Three in the article, that company is Elite Pharma (OTCQB:ELTP), a small OTC company that is extremely undervalued and, likely, worthy of an article for its a major turnaround. But for now, it suffices to say Elite has multiple drugs being commercialized by LCI, including generic Adderall. Moreover, Elite and its privately held partner SunGen Pharma are expecting FDA approval later this month for an extended-release CNS ANDA that, according to IQVIA data, has an annual market of $1.6B and will be commercialized by Lannett.
Indeed, this shows how astutely LCI is building its business, with key partnerships and targeted internal development. Without question, this should translate well into future revenue growth for the company. While growth does not cure all ills or ameliorate all threats, it does rhyme.
This article was written by
Disclosure: I am/we are long LCI, ELTP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.