One risk related to Lannett (NYSE: LCI) is that over 50% of its revenue (before the Kremers Urban acquisition) comes from one single supplier, Jerome Stevens Pharmaceutical, Inc ("JSP"). In this article I will discuss this partnership and analyze potential risks related to it.
- The banding between JSP and LCI are relatively strong
- Two parties will renegotiate contract in 2019
- We can't rule out the case that JSP will ask a bigger piece of the pie, but the possibility is limited
#1) Why did it begin?
Levothyroxine ("Levo") Sodium Tablets are used to treat hypothyroidism and other thyroid disorders. It is one of the most prescribed drugs in the United States with over 13 million patients.
JSP's Unithroid® was the first FDA approved (August 2000) Levothyroxine Sodium Tablet formulation. Both Synthroid® from Abbott Laboratories' and Levoxyl® from Monarch Pharmaceutical were approved by the FDA in the following years.
However, the sales of JSP's Levo products didn't take off. Subsequently JSP filed supplementary application for generic version of Levo .
Since 2002, LCI has been distributing a number of JSP products. And in 2004, LCI and JSP executed a contract that provides LCI with exclusive distribution rights in the United States for the current line of JSP products. The agreement was for a period of ten years.
As a compensation, Lannett granted JSP four million shares of Lannett's authorized, unissued common stock.
In 2014, these two parties extended a 5-year contract, for which LCI issued 1.5 million shared to JSP and $20.1 non-recurring contract extension cost . LCI also announced If the parties agree to a second five year extension from March 23, 2019 to March 23, 2024, LCI is required to issue to JSP or its designees an additional 1.5 million shares of LCI's common stock.
Furthermore, LCI is required to purchase, in the aggregate, $31 million of products from JSP each year. If LCI does not meet the minimum purchase requirements, JSP's sole remedy is to terminate the agreement. This translates into ~$150 million annual sales, reasonable at current stage.
#2) How strong is the partnership?
From JSP's website, we found LCI has been distributing most of JSP's products. Moreover, JSP's 5.5 million shares represent ~15% of LCI's outstanding shares.
#3) Is there a possibility that JSP will impact LCI's profit margin in the long-run?
The sub-questions will be:
#a) when they renegotiate the contract in 2019, will JSP eat up the profit margin that LCI is enjoying now?
#b) What's the chance that JSP would abandon LCI and let another distributor to sell its products, or sell its products by itself?
The answer really depends on the negotiation power of management. Since JSP is a family-owned business and they had chosen to get equity from LCI from the beginning, I lean towards a sustainable partnership between these two parties.
To put it simple, JSP is unlikely to squeeze LCI in the year 2019 contract renew. I would put a decent margin for related products in the base case valuation.