XNAS:HITK Quarterly Report 10-Q Filing - 7/31/2012

Effective Date 7/31/2012

Table of Contents

 

 

United States

Securities and Exchange Commission

Washington, D.C. 20549

 

 

Form 10-Q

 

 

 

    x     QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended July 31, 2012

OR

 

    ¨     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from          to         

Commission File Number 0-20424

 

 

Hi-Tech Pharmacal Co., Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   11-2638720

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

369 Bayview Avenue, Amityville, New York 11701

(Address of principal executive offices) (zip code)

631 789-8228

(Registrant’s telephone number including area code)

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

 

 

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 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  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted 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 and post such files).    Yes  x    No  ¨

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 definition of “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.):    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: Common Stock, $.01 Par Value — 13,186,000 shares outstanding as of September 4, 2012

 

 

 


Table of Contents

INDEX

HI-TECH PHARMACAL CO., INC.

 

          Page  

PART I. FINANCIAL INFORMATION

  

Item 1.

   Financial Statements      3   
  

Condensed consolidated balance sheets—July 31, 2012 (unaudited) and April 30, 2012

     3   
  

Condensed consolidated statements of operations—Three months ended July 31, 2012 and 2011 (unaudited)

     4   
  

Condensed consolidated statements of comprehensive income —Three months ended July 31, 2012 and 2011 (unaudited)

     5   
  

Condensed consolidated statements of cash flows—Three months ended July 31, 2012 and 2011 (unaudited)

     6   
  

Notes to condensed consolidated financial statements (unaudited)

     7   

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      17   

Item 3.

   Quantitative and Qualitative Disclosures About Market Risk      21   

Item 4.

   Controls and Procedures      22   

PART II. OTHER INFORMATION

  

Item 1.

   Legal Proceedings      22   

Item 1A.

   Risk Factors      22   

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds      22   

Item 3.

   Defaults Upon Senior Securities      22   

Item 4.

   Mine Safety Disclosures      22   

Item 5.

   Other Information      22   

Item 6.

   Exhibits      22   
  

Signatures

     23   
  

Certifications

  


Table of Contents

PART I. ITEM 1.

HI-TECH PHARMACAL CO., INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

 

     July 31,
2012
    April 30,
2012
 
     (unaudited)        
ASSETS     

CURRENT ASSETS:

    

Cash and cash equivalents

   $ 92,251,000      $ 87,549,000   

Accounts receivable, less allowances

     57,785,000        60,106,000   

Inventory

     41,091,000        39,281,000   

Deferred income taxes

     6,014,000        5,931,000   

Prepaid income taxes

     3,069,000        5,918,000   

Other current assets

     2,936,000        3,045,000   
  

 

 

   

 

 

 

TOTAL CURRENT ASSETS

   $ 203,146,000      $ 201,830,000   

Property and equipment—net

     30,257,000        29,980,000   

Intangible assets—net

     44,401,000        46,058,000   

Deferred income taxes

     730,000        830,000   

Other assets

     369,000        419,000   
  

 

 

   

 

 

 

TOTAL ASSETS

   $ 278,903,000      $ 279,117,000   
  

 

 

   

 

 

 
LIABILITIES AND STOCKHOLDERS’ EQUITY     

CURRENT LIABILITIES:

    

Accounts payable

   $ 9,667,000      $ 16,594,000   

Accrued expenses

     12,745,000        14,441,000   

Current portion of long-term debt

     355,000        355,000   

Current portion of contingent payment liability

     2,875,000        2,875,000   
  

 

 

   

 

 

 

TOTAL CURRENT LIABILITIES

   $ 25,642,000      $ 34,265,000   

Contingent payment liability, net of current portion

     6,644,000        7,228,000   

Long-term debt, net of current portion

     1,154,000        1,243,000   
  

 

 

   

 

 

 

TOTAL LIABILITIES

   $ 33,440,000      $ 42,736,000   
  

 

 

   

 

 

 

Commitments and Contingencies (Note 14)

    

STOCKHOLDERS’ EQUITY

    

Preferred stock, par value $.01 per share; authorized 3,000,000 shares, none issued

    

Common stock, par value $.01 per share; authorized 50,000,000 shares, issued 15,627,000 at July 31, 2012 and 15,502,000 at April 30, 2012, respectively

     156,000        155,000   

Additional paid-in capital

     90,073,000        86,996,000   

Retained earnings

     178,234,000        172,230,000   

Treasury stock, 2,456,000 shares of common stock, at cost on July 31, 2012 and April 30, 2012

     (23,000,000     (23,000,000
  

 

 

   

 

 

 

TOTAL STOCKHOLDERS’ EQUITY

   $ 245,463,000      $ 236,381,000   
  

 

 

   

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

   $ 278,903,000      $ 279,117,000   
  

 

 

   

 

 

 

See notes to condensed consolidated financial statements

 

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Table of Contents

HI-TECH PHARMACAL CO., INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

 

     Three months ended
July 31,
 
     2012     2011  

NET SALES

   $ 52,043,000      $ 56,211,000   

Cost of goods sold

     26,722,000        22,975,000   
  

 

 

   

 

 

 

GROSS PROFIT

     25,321,000        33,236,000   
  

 

 

   

 

 

 

COST AND EXPENSES:

    

Selling, general and administrative expenses

     10,631,000        8,796,000   

Amortization expense

     1,757,000        775,000   

Research and product development costs

     4,472,000        3,399,000   

Royalty income

     (635,000     (566,000

Contract research income

     —          (27,000

Interest expense

     156,000        15,000   

Interest income and other

     (46,000     (24,000
  

 

 

   

 

 

 

TOTAL

     16,335,000        12,368,000   
  

 

 

   

 

 

 

Income before income tax expense

     8,986,000        20,868,000   

Income tax expense

     2,982,000        7,095,000   
  

 

 

   

 

 

 

NET INCOME

   $ 6,004,000      $ 13,773,000   
  

 

 

   

 

 

 

BASIC INCOME PER SHARE

   $ 0.46      $ 1.08   
  

 

 

   

 

 

 

DILUTED INCOME PER SHARE

   $ 0.44      $ 1.05   
  

 

 

   

 

 

 

Weighted average common shares outstanding—basic

     13,069,000        12,726,000   

Effect of potential common shares

     481,000        423,000   
  

 

 

   

 

 

 

Weighted average common shares outstanding—diluted

     13,550,000        13,149,000   
  

 

 

   

 

 

 

See notes to condensed consolidated financial statements

 

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HI-TECH PHARMACAL CO., INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited)

 

     Three Months Ended July 31,  
     2012      2011  

NET INCOME

   $ 6,004,000       $ 13,773,000   

Other comprehensive income, net of tax

     —           —     
  

 

 

    

 

 

 

TOTAL COMPREHENSIVE INCOME

   $ 6,004,000       $ 13,773,000   
  

 

 

    

 

 

 

See notes to consolidated financial statements

 

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Table of Contents

HI-TECH PHARMACAL CO., INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

 

     Three months ended
July 31,
 
     2012     2011  

NET CASH FLOWS PROVIDED BY OPERATING ACTIVITIES

   $ 4,043,000      $ 19,181,000   
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

    

Purchases of property, plant and equipment

     (1,210,000     (2,427,000

Proceeds from the sale of intangible assets

     —          1,685,000   

Purchase of intangible assets

     (100,000     (2,973,000

Purchase of ECR Pharmaceuticals assets

     —          (498,000
  

 

 

   

 

 

 

NET CASH (USED IN) INVESTING ACTIVITIES

     (1,310,000     (4,213,000
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

    

Issuance of common stock on exercise of options

     2,017,000        555,000   

Tax benefits of stock incentives

     625,000        207,000   

Payments of long-term debt

     (673,000     (37,000
  

 

 

   

 

 

 

NET CASH PROVIDED BY FINANCING ACTIVITIES

     1,969,000        725,000   
  

 

 

   

 

 

 

NET INCREASE IN CASH AND CASH EQUIVALENTS

     4,702,000        15,693,000   

Cash and cash equivalents at beginning of the period

     87,549,000        62,304,000   
  

 

 

   

 

 

 

CASH AND CASH EQUIVALENTS AT END OF PERIOD

   $ 92,251,000      $ 77,997,000   
  

 

 

   

 

 

 

Supplemental disclosures of cash flow information:

    

Interest paid

   $ 46,000      $ 15,000   

Income taxes paid

   $ —        $ 2,153,000   

Supplemental disclosures of non-cash investing transactions:

    

Obligation related to purchase of intangible assets included in accrued expenses

   $ —        $ 2,355,000   

See notes to condensed consolidated financial statements

 

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HI-TECH PHARMACAL CO., INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

July 31, 2012

1. BASIS OF PRESENTATION:

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“US GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by US GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. The preparation of the Company’s financial statements in conformity with US GAAP necessarily requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the balance sheet dates and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from these estimates and assumptions. Operating results for the three month period ended July 31, 2012 are not necessarily indicative of the results that may be expected for the year ending April 30, 2013. For further information, refer to the consolidated financial statements and footnotes thereto for the year ended April 30, 2012 in the Company’s Annual Report on Form 10-K.

2. BUSINESS:

Hi-Tech Pharmacal Co., Inc. (“Hi-Tech” or the “Company”, which may be referred to as “we”, “us” or “our”), a Delaware corporation, incorporated in April 1982, is a specialty pharmaceutical company developing, manufacturing and marketing generic and branded prescription and OTC products. The Company specializes in the manufacture of liquid and semi-solid dosage forms and produces a range of sterile ophthalmic, otic and inhalation products. The Company’s Health Care Products division is a developer and marketer of branded prescription and OTC products for the diabetes marketplace. Hi-Tech’s ECR Pharmaceuticals subsidiary markets branded prescription products.

3. REVENUE RECOGNITION:

Revenue is recognized for product sales upon shipment and passing of title and risk of loss to the customer and when estimates of discounts, rebates, promotional adjustments, price adjustments, returns, chargebacks, and other potential adjustments are reasonably determinable, collection is reasonably assured and the Company has no further performance obligations. These estimates are presented in the financial statements as reductions to net revenues and accounts receivable. Contract research income is recognized as work is completed and as billable costs are incurred. In certain cases, contract research income is based on attainment of designated milestones. Advance payments may be received to fund certain development costs.

Royalty income is related to sales of divested products which are sold by third parties. For those agreements, the Company recognizes revenue based on royalties reported by those third parties and earned during the applicable period.

4. NET INCOME PER SHARE:

Basic net income per common share is computed based on the weighted average number of common shares outstanding and on the weighted average number of common shares and share equivalents (stock options) outstanding for diluted earnings per share. The weighted average number of shares outstanding used in the computation of diluted net earnings per share does not include the effect of potentially outstanding common stock whose effect would have been antidilutive. Such outstanding potential shares consisted of options totaling 482,000 and 0 shares at July 31, 2012 and 2011, respectively.

5. ACCOUNTS RECEIVABLE:

We recognize revenue for product sales when title and risk of loss have transferred to our customers, when reliable estimates of rebates, chargebacks, returns and other adjustments can be made, and when collectability is reasonably assured. This is generally at the time that products are received by our direct customers. Upon recognizing revenue from a sale, we record estimates for chargebacks, rebates and incentive programs, product returns, cash discounts and other sales reserves that reduce accounts receivable.

 

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At July 31, 2012 and April 30, 2012, accounts receivable balances, net of returns and allowances and allowance for doubtful accounts, are as follows:

 

     July 31, 2012     April 30, 2012  

Accounts receivable, gross

   $ 83,109,000      $ 78,641,000   

Adjustment for returns and price allowances (a)

     (24,824,000     (18,035,000

Allowance for doubtful accounts

     (500,000     (500,000
  

 

 

   

 

 

 

Accounts receivable, net

   $ 57,785,000      $ 60,106,000   
  

 

 

   

 

 

 

 

(a) directly reduces gross revenue

Our product revenues are typically subject to agreements with customers allowing chargebacks, rebates, rights of return, pricing adjustments and other allowances. Based on our agreements and contracts with our customers, we calculate adjustments for these items when we recognize revenue and we book the adjustments against accounts receivable and revenue. Chargebacks, primarily from wholesalers, are the most significant of these items. Chargebacks result from arrangements we have with end users establishing prices for products for which the end user independently selects a wholesaler from which to purchase. A chargeback represents the difference between our invoice price to the wholesaler, which is typically stated at wholesale acquisition cost, and the end customer’s contract price, which is lower. We credit the wholesaler for purchases by end customers at the lower price. Therefore, we record these chargebacks at the time we recognize revenue in connection with our sales to wholesalers.

The reserve for chargebacks is computed in the following manner. The Company obtains wholesaler inventory data for the wholesalers which represent approximately 95% of our chargeback activity. This inventory is multiplied by the historical percentage of units that are charged back and by the price adjustment per unit to arrive at the chargeback accrual. This calculation is performed by product by customer. The calculated amount of chargebacks could be affected by other factors such as:

 

   

a change in retail customer mix

 

   

a change in negotiated terms with retailers

 

   

product sales mix at the wholesaler

 

   

retail inventory levels

 

   

changes in Wholesale Acquisition Cost (“WAC”)

The Company continually monitors the chargeback activity and adjusts the provisions for chargebacks when we believe that the actual chargebacks will differ from our original provisions.

Consistent with industry practice, the Company maintains a return policy that allows our customers to return product within a specified period. The Company’s estimate for returns is based upon its historical experience with actual returns. The Company continually monitors its estimates for returns and makes adjustments when it believes that actual product returns may differ from the established accruals.

Included in the adjustment for sales allowances and returns is a reserve for credits taken by our customers for rebates, return authorizations and other discounts.

Sales discounts are granted for prompt payment. The reserve for sales discounts is based on invoices outstanding and assumes that 100% of available discounts will be taken.

Price adjustments, including shelf stock adjustments, are credits issued from time to time to reflect decreases in the selling prices of our products which our customer has remaining in its inventory at the time of the price reduction. Decreases in our selling prices are discretionary decisions made by us to reflect market conditions. Amounts recorded for estimated price adjustments are based upon specified terms with direct customers, estimated launch dates of competing products, estimated declines in market price and inventory held by the customer. The Company analyzes this on a case by case basis and makes adjustments to reserves as necessary.

The Company adequately reserves for chargebacks, discounts, allowances and returns in the period in which the sales takes place. No material amounts included in the provision for chargebacks and the provision for sales discounts recorded in the current period relate to sales made in the prior periods. The provision for sales allowances and returns includes reserves for items sold in the current and prior periods. The Company has substantially and consistently used the same estimating methods. We have refined the methods as new data became available. There have been no material differences between the estimates applied and actual results.

The Company determines amounts that are material to the financial statements in consideration of all relevant circumstances including quantitative and qualitative factors. Among the items considered is the impact on individual financial statement classification, operating income and footnote disclosures and the degree of precision that is attainable in estimating judgmental items.

 

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Table of Contents

The following table presents the roll forward of each significant estimate as of July 31, 2012 and July 31, 2011 and for the three months then ended, respectively.

 

For the three months ended July 31, 2012

   Beginning
Balance
May 1
     Current
Provision
     Actual Credits
in Current
Period
    Ending
Balance
July 31
 

Chargebacks

   $ 10,477,000       $ 38,460,000       $ (35,221,000   $ 13,716,000   

Sales discounts

     1,813,000         2,337,000         (2,230,000     1,920,000   

Sales allowances & returns

     5,745,000         13,787,000         (10,344,000     9,188,000   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total adjustment for returns & price allowances

   $ 18,035,000       $ 54,584,000       $ (47,795,000   $ 24,824,000   
  

 

 

    

 

 

    

 

 

   

 

 

 

For the three months ended July 31, 2011

                          

Chargebacks

   $ 8,588,000       $ 34,908,000       $ (31,422,000   $ 12,074,000   

Sales discounts

     2,353,000         2,275,000         (2,900,000     1,728,000   

Sales allowances & returns

     6,159,000         7,193,000         (5,787,000     7,565,000   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total adjustment for returns & price allowances

   $ 17,100,000       $ 44,376,000       $ (40,109,000   $ 21,367,000   
  

 

 

    

 

 

    

 

 

   

 

 

 

6. INVENTORY:

The components of inventory consist of the following:

 

     July 31,
2012
     April 30,
2012
 

Finished goods

   $ 14,958,000       $ 13,015,000   

Work in process

     720,000         440,000   

Raw materials

     25,413,000         25,826,000   
  

 

 

    

 

 

 

Total inventory

   $ 41,091,000       $ 39,281,000   
  

 

 

    

 

 

 

7. PROPERTY AND EQUIPMENT:

The components of property and equipment consist of the following:

 

     July 31,
2012
     April 30,
2012
 

Land and building and improvements

   $ 20,972,000       $ 20,392,000   

Machinery and equipment

     31,468,000         30,934,000   

Transportation equipment

     69,000         55,000   

Computer equipment and systems

     6,189,000         6,131,000   

Furniture and fixtures

     1,257,000         1,237,000   
  

 

 

    

 

 

 
   $ 59,955,000       $ 58,749,000   

Accumulated depreciation and amortization

     29,698,000         28,769,000   
  

 

 

    

 

 

 

Total property and equipment

   $ 30,257,000       $ 29,980,000   
  

 

 

    

 

 

 

The Company incurred depreciation expense of $929,000 and $772,000 for the three months ended July 31, 2012 and 2011, respectively. No depreciation is taken on land with a carrying value of $1,860,000 at July 31, 2012 and April 30, 2012.

8. INTANGIBLE ASSETS:

The components of net intangible assets are as follows:

 

     July 31,
2012
     April 30,
2012
     Amortization Period  

TussiCaps® intangible assets

   $ 19,386,000       $ 20,134,000         5-10 years   

ECR intangible assets

     5,325,000         5,506,000         10 years   

MagOx® intangible assets

     3,109,000         3,212,000         10 years   

Clobetasol intangible assets

     3,100,000         3,200,000         10 years   

Orbivan® and Zolvit® intangible assets

     2,971,000         3,014,000         3-10 years   

 

 

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Table of Contents
     July 31,
2012
     April 30,
2012
     Amortization Period  

Sinus Buster® intangible assets

     2,448,000         2,513,000         10 years   

Zolpimist® intangible assets

     2,438,000         2,531,000         10 years   

Zostrix® intangible assets

     1,988,000         2,175,000         3-11.5 years   

KVK License intangible assets

     1,500,000         1,500,000         10 years   

Midlothian intangible assets

     640,000         669,000         3-10 years   

Vosol® and Vosol® HC intangible assets

     385,000         402,000         10 years   

Partnered ANDA intangible assets

     375,000         375,000         10 years   

Other intangible assets

     736,000         827,000         0.5-10 years   
  

 

 

    

 

 

    

Total intangible assets

   $ 44,401,000       $ 46,058,000      
  

 

 

    

 

 

    

Intangible assets are stated at cost, net of amortization using the straight line method over the expected useful lives of the product rights, once the related products begin to sell. Amortization expense of the intangible assets for the three months ended July 31, 2012 and 2011 was $1,757,000 and $775,000, respectively. The Company tests for impairment of intangible assets annually and when events or circumstances indicate that the carrying value of the assets may not be recoverable.

On June 28, 2011, the Company acquired marketing and distribution rights to several unique branded products for the treatment of pain from Atley Pharmaceuticals. Some products were approved at the time of acquisition and others were subsequently approved by the Food and Drug Administration (“FDA”). The Company paid $3,220,000 in cash for rights to the products and inventory. Inventory acquired was valued at $298,000. The Company also paid an additional $200,000 for Orbivan® CF during the 2012 fiscal year and $100,000 for Orbivan® with Codeine in the quarter ended July 31, 2012. The Company agreed to pay an additional $355,000 within 180 days, less any amount which has been offset by certain claims. The Company will pay royalties for certain of these products under a license agreement it has assumed. In July 2011, the Company exercised its option to buy out one of the royalty streams related to one of the products for the amount of $500,000, which was paid in August 2011. Such amount has been presented as prepaid royalties.

On July 29, 2011, the Company acquired marketing and distribution rights to an ANDA filing from KVK-Tech, Inc. for dexbrompheniramine maleate 6 mg/pseudoephedrine sulfate 120 mg extended release tablets for $2,000,000. Upon approval from the FDA, the product will be marketed by ECR Pharmaceuticals, the Company’s branded sales and marketing subsidiary, under the Lodrane® brand name. The agreement provided for certain amounts to be refunded to Hi-Tech if the product had not been approved by the FDA by certain dates. As of July 31, 2012, the Company had received refunds of $500,000; therefore, the intangible asset is presented at a $1,500,000 value. The product has not been approved, and the Company may receive further refunds of up to $500,000.

On August 19, 2011, the Company acquired Tussicaps® extended-release capsules and some inventory from Mallinckrodt LLC (“Mallinckrodt”). The Company paid $11,600,000 in cash at the time of acquisition, has made through July 31, 2012 aggregate quarterly payments of $2,157,000 and may make additional payments of up to $10,344,000 over the next four years depending on the competitive landscape and sales performance. On the acquisition date, the Company had recorded a preliminary contingent liability of $11,993,000, which was adjusted to $11,189,000 during the third quarter of fiscal 2012, with the reduction of the contingent liability being offset by a reduction of the related intangible. The fair value of the contingent payment was estimated using the present value of management’s projection of the expected payments pursuant to the term of the agreement. As of July 31, 2012, the contingent payment liability amounted to $9,519,000, of which $2,875,000 is classified as a current liability. The decrease in the carrying amount was the result of payment made, offset by the accrual of interest on the outstanding balance. Tussicaps® is covered by a patent which will expire in September 2024. The Company and Mallinckrodt entered into a manufacturing agreement pursuant to which Mallinckrodt will manufacture and supply the Tussicaps® products to the Company for at least seven years.

On November 28, 2011, the Company entered into an asset purchase agreement to acquire an ANDA for a product and all product intellectual property. The purchase price of the ANDA and interest in the intellectual property is up to $3,000,000, under certain conditions and is payable in installments over 24 months. In connection with this asset purchase, the Company has entered into a collaboration agreement and profit sharing agreement with another party. The Company and the other party will each own 50% of the product and will each pay equal amounts in satisfaction of the purchase price obligation. The other party will also pay 50% of the development costs and share in 50% of the net profits. The Company made an initial payment of $375,000 on November 29, 2011. The Company has the right to terminate this agreement at any time and not pay subsequent installments. Upon termination by the Company, all interests in the assets acquired will be transferred back to the seller.

On March 7, 2012, the Company acquired several homeopathic branded nasal spray products including Sinus Buster® and Allergy Buster® from Dynova Laboratories, Inc. for $1,344,000 in cash and an additional $1,250,000 deposited in an escrow account to pay for potential expenses. Hi-Tech will also pay a 12% royalty on net sales for 3 1/2 years, or $1,750,000, whichever is reached first. The brands are being sold through the Company’s Health Care Products OTC division.

 

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9. LONG-TERM DEBT:

The Company entered into a Revolving Credit Agreement, effective as of June 1, 2010, with JPMorgan Chase (the “Revolving Credit Agreement”). The Revolving Credit Agreement permits the Company to borrow up to $10,000,000 pursuant to a revolving credit note (“Revolving Credit Note”) for, among other things within certain sublimits, general corporate purposes, acquisitions, research and development projects and future stock repurchase programs. Loans shall bear interest at a rate equal to, at the Company’s option, in the case of a CB Floating Rate Loan, as defined in the Revolving Credit Agreement, the Prime Rate, as defined in the Revolving Credit Agreement; provided that, the CB Floating Rate shall never be less than the Adjusted One Month LIBOR, or for a LIBOR Loan, at a rate equal to the Adjusted LIBOR plus the Applicable Margin, as such terms are defined in the Revolving Credit Agreement. The Revolving Credit Agreement contains covenants customary for agreements of this type, including covenants relating to a liquidity ratio, a debt service coverage ratio and a minimum consolidated net income. Borrowings under the Revolving Credit Agreement mature on May 27, 2013.

If an event of default under the Revolving Credit Agreement shall occur and be continuing, the commitments under the Revolving Credit Agreement may be terminated and the principal amount outstanding under the Revolving Credit Agreement, together with all accrued unpaid interest and other amounts owing under the Revolving Credit Agreement and related loan documents, may be declared immediately due and payable.

As of July 31, 2012, there were no borrowings under the Revolving Credit Agreement.

The Company entered into a $5,000,000 equipment financing agreement with JPMorgan Chase on June 1, 2010. Loans bear interest at a rate equal to, at the Company’s option, in the case of a CB Floating Rate Loan, as defined in the agreement, the Prime Rate, as defined in the agreement; provided that, the CB Floating Rate shall never be less than the Adjusted One Month LIBOR, or for a LIBOR Loan, at a rate equal to the Adjusted LIBOR plus the Applicable Margin, as such terms are defined in the agreement. On June 15, 2010 the Company drew down $621,000 of the equipment financing line to fund a down payment for new filling and packaging equipment. On October 13, 2011, the Company borrowed an additional $1,155,000 to finance the remaining payments for the equipment. Total borrowings under the equipment financing agreement amount to $1,509,000 as of July 31, 2012. Borrowings under the equipment financing agreement mature on October 6, 2016 and require repayments in the amount of approximately $30,000 per month. In connection with this agreement, the Company has classified $355,000 as current portion of long-term debt.

10. FREIGHT EXPENSE:

Outgoing freight costs amounted to $1,308,000 and $985,000 for the three months ended July 31, 2012 and 2011, respectively, and are included in selling, general, and administrative expense. Incoming freight is included in cost of goods sold.

11. STOCK-BASED COMPENSATION:

US GAAP requires the measurement and recognition of compensation expense for all share-based payment awards made to employees, non-employee directors, and consultants, including employee stock options. Stock compensation expense based on the grant date fair value estimated in accordance with the provisions of US GAAP is recognized as an expense over the requisite service period.

For stock options granted as consideration for services rendered by non-employees, the Company recognizes compensation expense in accordance with the requirements of the applicable accounting guidance.

The Company’s employee stock options are considered incentive stock options unless they do not meet the requirements for incentive stock options under the Internal Revenue Code. With incentive stock options, there is no tax deferred benefit associated with recording the stock-based compensation.

 

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The Company recognized stock-based compensation for awards issued under the Company’s Stock Option Plans and Employee Stock Purchase Plan in the following line items in the condensed consolidated statements of operations:

 

     Three months
ended
July 31,
2012
     Three months
ended
July 31,
2011
 

Cost of goods sold

   $ 92,000       $ 87,000   

Selling, general and administrative expenses

     536,000         566,000   

Research and product development costs

     157,000         83,000   
  

 

 

    

 

 

 

Stock-based compensation expense

   $ 785,000       $ 736,000   
  

 

 

    

 

 

 

The Company has elected to use the Black-Scholes option-pricing model, which incorporates various assumptions including volatility, expected life, and interest rate. The expected volatility is based on the historical volatility of the Company’s common stock. The interest rates for periods within the contractual life of the award are based on the United States Treasury yield on the date of each option grant. The expected term of options represents the period that the Company’s stock-based awards are expected to be outstanding and was determined based on historical experience and vesting schedules of similar awards.

All options granted through July 31, 2012 had exercise prices equal to the fair market value of the stock on the date of grant, a contractual term of ten years and generally a vesting period of four years. In accordance with US GAAP the Company adjusts share-based compensation on a quarterly basis for changes to the estimate of expected equity award forfeitures based on actual forfeiture experience. The effect of adjusting the forfeiture rate for all expense amortization after May 1, 2006 is recognized in the period the forfeiture estimate is changed. As of July 31, 2012, the weighted average forfeiture rate was 9% and the effect of forfeiture adjustments for the three months ended July 31, 2012 and 2011 was insignificant. On July 16, 2012 the Company granted 442,000 options to directors and employees for an exercise price of $32.59. The Company did not grant any options during the three months ended July 31, 2011.

The intrinsic value of options exercised for the Amended and Restated Stock Option Plan, the 2009 Stock Option Plan and the 1994 Directors Stock Option Plan, as amended was $1,736,000 and $583,000 for the three month periods ended July 31, 2012 and 2011, respectively. As of July 31, 2012, $10,352,000 of total unrecognized compensation cost related to stock options for both plans is expected to be recognized over a weighted average period of 3.1 years.

12. PRODUCT DIVESTITURES:

On July 3, 2009 the Company entered into an agreement whereby the Company has granted the marketing rights to certain nutritional products previously marketed by our division, Midlothian Laboratories (“Midlothian”), in exchange for a series of payments totaling $1,000,000 over the course of one year. In addition, the Company received a royalty on the sales of these products, not to exceed $1,500,000 per year for three years ended June 30, 2012. Royalty income earned under this agreement amounted to $54,000 and $110,000 for the three months ended July 31, 2012 and 2011, respectively. The Company retained this royalty stream when it divested its Midlothian business.

Effective May 1, 2011, the Company divested Midlothian in exchange for a cash payment of $1,700,000. No gain or loss was recognized on the divesture as the Company had recorded an impairment charge of approximately $1,300,000 at April 30, 2011. The Company retained marketing and distribution rights to generic buprenorphine sublingual tablets, an ANDA that is filed with the FDA, an ANDA that is in development and a royalty stream from products previously divested, as discussed above. Metrics, Inc. acquired Midlothian from the Company.

13. INCOME TAXES:

The Company estimated its effective tax rate to be approximately 33% for the year ending April 30, 2013. The decline in the effective tax rate compared to the prior period is due to a higher benefit from the domestic production activities tax credit and the exercise of stock options in the current period. On May 1, 2008, the Company adopted the provisions of ASC Topic 740-10, “Income Taxes” relating to recognition thresholds and measurement attributes for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Company has elected an accounting policy to classify interest and penalties related to unrecognized tax benefits as interest expense. At July 31, 2012 and April 30, 2012, the Company did not have any amount recorded for uncertain tax positions. The Company is no longer subject to U.S. federal, state or local income tax examination for years ended prior to April 30, 2008.

14. CONTINGENCIES AND OTHER MATTERS:

[1] Government regulation:

The Company’s products and facilities are subject to regulation by a number of Federal and State governmental agencies. The Food and Drug Administration (“FDA”), in particular, maintains oversight of the formulation, manufacture, distribution, packaging and labeling of all of the Company’s products. The Drug Enforcement Administration (“DEA”) maintains oversight over the Company’s products that are considered controlled substances.

 

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On March 2, 2011, the FDA indicated in its MedWatch publication that the FDA removed approximately 500 currently marketed cough/cold and allergy related products including Lodrane® products. Three of these were marketed by ECR Pharmaceuticals under the brand name Lodrane®. ECR Pharmaceuticals stopped shipping these products as of August 31, 2011. Sales of Lodrane® products amounted to approximately $0 and $2,400,000 for the three months ended July 31, 2012 and 2011, respectively.

On October 3, 2011 through October 19, 2011, the Company was subject to an inspection by the FDA. The inspection resulted in seven observations on Form 483, an FDA form on which deficiencies are noted after an FDA inspection, with inspector observations. The Company responded to those observations on November 7, 2011 and believes that its response to these observations was adequate.

[2] Legal Proceedings:

On June 8, 2012, plaintiff Mathew Harrison, on behalf of himself and all others similarly situated, brought a class action lawsuit, Civil Action No. 12-2897, in the U.S. District Court for the Eastern District of New York, against Wayne Perry, Dynova Laboratories, Inc., Sicap Industries, LLC, Walgreens Co. and the Company, alleging, among other things, that their Sinus Buster® products are improperly marketed, labeled and sold as homeopathic products, and that these allegations support claims of fraud, unjust enrichment, breach of express and implied warranties and alleged violations of various state and federal statutes. The Company answered the complaint on July 17, 2012, and asserted cross-claims against the other defendants, except Walgreens which was dismissed from the case. The Company believes the complaint is without merit and intends to vigorously defend against the allegations in the complaint. The Company cannot predict the outcome of the action.

On May 16, 2012, plaintiff David Delre, on behalf of himself and all others similarly situated, brought a class action lawsuit, Civil Action No. 12-2429, in the U.S. District Court for the Eastern District of New York, against Wayne Perry, Dynova Laboratories, Inc., Sicap Industries, LLC, and the Company, alleging, among other things, that their Sinus Buster® products are improperly marketed, labeled and sold as homeopathic products, and that these allegations support claims of fraud, unjust enrichment, breach of express and implied warranties and alleged violations of various state and federal statutes. The Company answered the complaint on June 26, 2012, and asserted cross-claims against the other defendants. The Company believes the complaint is without merit and intends to vigorously defend against the allegations in the complaint. The Company cannot predict the outcome of the action.

On June 1, 2012, the Company received a notice to preserve documents and electronically stored information in conjunction with a confidential civil investigative demand under the Texas Medicaid Fraud Prevention Act, Texas Human Resources Code, §36.001, et seq. relating to the submission of prices to Texas Medicaid in claims for reimbursement for prescription drugs. The Company has no estimate at this time of its potential exposure and cannot, at this time, predict the outcome of this matter.

On March 13, 2012, Allergan, Inc. (“Allergan”) filed a complaint against the Company in the United States District Court for the Middle District of North Carolina in response to the Company’s Paragraph IV certifications in its ANDA for Bimatoprost Topical Solution 0.03%, alleging infringement of U.S. Patents Nos. 8,038,988 for Allergan’s product, Latisse. On April 11, 2012 the Company answered the complaint. The Company believes the complaint is without merit and intends to vigorously defend against the allegations in the complaint. The Company cannot predict the outcome of the action.

On May 16, 2012, Allergan filed a complaint against the Company in the United States District Court for the Middle District of North Carolina in response to the Company’s Paragraph IV certifications in its ANDA for Bimatoprost Topical Solution 0.03%, alleging infringement of U.S. Patents Nos. 8,101,161 for Allergan’s product, Latisse. The Company answered the complaint on June 14, 2012. The Company believes the complaint is without merit and intends to vigorously defend against the allegations in the complaint. The Company cannot predict the outcome of the action.

On January 27, 2012, Allergan filed a complaint against the Company in the U.S. District Court for the Eastern District of Texas for infringement of U.S. Patent No. 7,851,504 (“Enhanced Bimatoprost Ophthalmic Solution,” issued December 14, 2010) following a Paragraph IV certification as part of the Company’s filing of an ANDA to manufacture a generic version of Allergan’s Lumigan® 0.01%. On February 23, 2012, the Company answered the complaint. The Company believes the complaint is without merit and intends to vigorously defend against the allegations in the complaint. The Company cannot predict the outcome of the action.

 

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On August 17, 2011, Allergan and Duke University filed a complaint against the Company in the United States District Court for the Middle District of North Carolina in response to the Company’s Paragraph IV certifications in its ANDA for Bimatoprost Topical Solution 0.03%, alleging infringement of U.S. Patents Nos. 7,351,404; 7,388,029; and 6,403,649 for Allergan’s product, Latisse. On October 7, 2011, the Company answered the complaint asserting counterclaims. The plaintiffs responded to the counterclaims on October 31, 2011. The claims with respect to U.S. Patent No. 6,403,649 for Allergan’s product were dismissed on February 1, 2012. The Company believes the complaint is without merit and intends to vigorously defend against the allegations in the complaint. The Company cannot predict the outcome of the action.

On October 31, 2011, Senju Pharmaceutical Co.; Kyorin Pharmaceutical Co.; and Allergan filed a complaint in the District Court of Delaware, Civil Action No. 1:11-cv-01059, in response to the Company’s Paragraph IV certification as part of its filing of an ANDA to manufacture a generic version of Allergan’s Zymar® (gatifloxacin ophthalmic solution, 0.3% ). The complaint alleges infringement of U.S. Patent Nos. 6,333,045 (“Aqueous Liquid Pharmaceutical Composition Comprised of Gatifloxacin,” issued on December 25, 2001) and 5,880,283 (“8-Alkoxyquinolonecarboxylic Acid Hydrate With Excellent Stability And Process For Producing The Same,” issued March 9, 1999), licensed to Allergan. On December 16, 2011, the Company answered the complaint. On August 28, 2012, the claims on U.S. patent No. 5,880,283 were dismissed. The Company believes the complaint is without merit and intends to vigorously defend against the allegations in the complaint. The Company cannot predict the outcome of the action.

On October 11, 2011, Senju Pharmaceutical Co.; Kyorin Pharmaceutical Co.; and Allergan filed a complaint in the District Court of Delaware, Civil Action No. 1:11-cv-00926; in response to the Company’s Paragraph IV certification as part of its filing of an ANDA to manufacture a generic version of Allergan’s Zymaxid® (gatifloxacin ophthalmic solution, 0.5%). The complaint alleges infringement of U.S. Patent Nos. 6,333,045 (“Aqueous Liquid Pharmaceutical Composition Comprised of Gatifloxacin,” issued December 25, 2001) and 5,880,283 (“8-Alkoxyquinolonecarboxylic Acid Hydrate With Excellent Stability and Process for Producing the Same,” issued March 9, 1999), licensed to Allergan. On December 16, 2011, the Company answered the complaint. On August 28, 2012, the claims on U.S. patent No. 5,880,283 were dismissed. The Company believes the complaint is without merit and intends to vigorously defend against the allegations in the complaint. The Company cannot predict the outcome of the action.

On February 9, 2010, in the United States District Court for the District of Massachusetts (the “Federal District Court”), a “Partial Unsealing Order” was issued and unsealed in a civil case naming several pharmaceutical companies as defendants under the qui tam provisions of the federal civil False Claims Act (the “Qui Tam Complaint”). The qui tam provisions permit a private person, known as a “relator” (sometimes referred to as a “whistleblower”), to file civil actions under this statute on behalf of the federal and state governments. Pursuant to the Order, a Revised Corrected Seventh Amended Complaint was filed by the relator and unsealed on February 10, 2010. The relator in the Complaint is Constance A. Conrad. The Complaint alleges that several pharmaceutical companies submitted false records or statements to the United States through the Center for Medicare and Medicaid Services (“CMS”) and thereby caused false claims for payments to be made through state Medicaid Reimbursement programs for unapproved or ineffective drugs or for products that are not drugs at all. The Complaint alleges that the drugs were “New Drugs” that the FDA had not approved and that are expressly excluded from the definition of “Covered Outpatient Drugs”, which would have rendered them eligible for Medicaid reimbursement. The Complaint alleges these actions violate the federal civil False Claims Act. The Revised Corrected Seventh Amended Complaint did not name the Company as a defendant.

On February 9, 2010, the Court also unsealed the “United States’ Notice of Partial Declination” in which the government determined not to intervene against 68 named defendants, including the Company. On July 23, 2010, the relator further amended the Complaint, which, as amended, named the Company, including a subsidiary of the Company, as a defendant. On January 6, 2011, the Court issued an order unsealing the government’s notice of election to intervene as to a previously unnamed defendant. On July 25, 2011, the Court issued an order stating, among other things, that all parties agreed that the only defendant against whom the United States has elected to intervene is the previously unnamed defendant. On July 26, 2011, the relator filed its Tenth Amended Complaint, which removed the allegations against the Company’s subsidiary, but not the Company, realleging them against another party. The Company intends to vigorously defend against the remaining allegations in the relator’s Complaint. The Company cannot predict the outcome of the action.

 

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[3] Commitments and Contingencies:

The Company’s ECR Pharmaceuticals subsidiary currently leases approximately 12,000 square feet in Richmond, VA. This lease ends August 31, 2014.

In June 2010, the Company entered into an agreement to lease a parking lot in Amityville, NY. The Company will pay $90,000 over a five year period.

In the course of its business, the Company enters into agreements which require the Company to make royalty payments which are generally based on net sales or gross profits of certain products.

In connection with the Tussicaps® acquisition, the Company entered into a manufacturing agreement which requires the Company to make a minimum purchase of $500,000 in the first year and $1,000,000 per year over the next four years.

15. RECENT ACCOUNTING PRONOUNCEMENTS:

In December 2011, the Financial Accounting Standards Board (“FASB”) updated the accounting guidance relating to offsetting assets and liabilities in financial statements. The updated guidance requires companies to disclose both gross and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. The updated guidance is effective for the Company beginning in the third quarter of fiscal year 2013. The adoption of this guidance is not expected to have a material impact on the Company’s consolidated financial statements.

In July 2012, the FASB issued accounting guidance to simplify the testing for a drop in value of indefinite-lived intangible assets. Under the updated guidance, an entity has the option of first performing a qualitative assessment to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired before proceeding to the quantitative impairment test under which it would calculate the asset’s fair value. When performing the qualitative assessment, the entity must evaluate events and circumstances that may affect the significant inputs used to determine the fair value of the indefinite-lived intangible asset. This guidance is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted. We do not expect this guidance to have a material impact on our financial statements.

16. SIGNIFICANT CUSTOMERS AND CONCENTRATION OF CREDIT RISK:

For the three months ended July 31, 2012, four customers, McKesson, Cardinal Health, Walgreens and AmerisourceBergen, accounted for net sales of approximately 23%, 15%, 13% and 12%, respectively. These customers represented approximately 75% of accounts receivable at July 31, 2012. For the three months ended July 31, 2011, three customers, McKesson, AmerisourceBergen and Cardinal Health, accounted for net sales of approximately 15%, 11% and 10%, respectively. These customers represented approximately 62% of accounts receivable at April 30, 2012.

The Company maintains cash and cash equivalents primarily with major financial institutions. Such amounts exceed FDIC limits.

17. FAIR VALUE MEASUREMENTS:

The accounting guidance under ASC “Fair Value Measurements and Disclosures” (“ASC 820-10”) utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. A brief description of those levels is as follows:

 

   

Level 1: Observable inputs such as quoted prices in active markets for identical assets or liabilities.

 

   

Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly

 

   

Level 3: Significant unobservable inputs.

 

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The Company’s financial liabilities subject to fair value measurements as of July 31, 2012 was as follows:

 

Fair Value Measurements Using Fair Value Hierarchy

 
     Fair Value      Level 3  

Contingent payment liability

   $ 9,519,000       $ 9,519,000   
  

 

 

    

 

 

 

The Company’s financial liabilities subject to fair value measurements as of April 30, 2012 were as follows:

 

Fair Value Measurements Using Fair Value Hierarchy

 
     Fair Value      Level 3  

Contingent payment liability

   $ 10,103,000       $ 10,103,000   
  

 

 

    

 

 

 

The fair value of the contingent payment liability was estimated using the present value of management’s projection of the expected payments pursuant to the term of the Tussicaps® agreement (see Note 8). The present value of the contingent liability was computed using a discount rate of 5.2%.

The carrying value of certain financial instruments such as cash and cash equivalents, accounts receivable and accounts payable approximate their fair values due to their short-term nature of their underlying terms. The carrying value of the long-term debt approximate its fair value based upon its variable market interest rates, which approximates current market interest.

18. SEGMENT INFORMATION:

The Company operates in three reportable business segments: generic pharmaceuticals (referred to as “Hi-Tech Generics”), OTC branded pharmaceuticals (referred to as “Health Care Products”, or “HCP”) and prescription brands (referred to as “ECR”). Branded products are marketed under brand names through marketing programs that are designed to generate physician and consumer loyalty. Generic pharmaceutical products are the chemical and therapeutic equivalents of corresponding brand drugs. Our Chief Operating Decision Maker is our Chief Executive Officer.

The business segments were determined based on management’s reporting and decision-making requirements in accordance with FASB ASC 280-10 Segment Reporting. The generic products represent a single operating segment because the demand for these products is mainly driven by consumers seeking a lower cost alternative to brand name drugs. Certain of our expenses, such as the direct sales force and other sales and marketing expenses and specific research and development expenses, are charged directly to the respective segments. Other expenses, such as general and administrative expenses are included under the Corporate and other cost center.

 

     Hi-Tech      HCP     ECR     Corp/Other     Total  

For the three months ended July 31, 2012

           

Net sales

   $ 45,922,000       $ 3,026,000      $ 3,095,000      $ —        $ 52,043,000   

Cost of goods sold

     24,724,000         1,340,000        658,000        —          26,722,000   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

   $ 21,198,000       $ 1,686,000      $ 2,437,000      $ —        $ 25,321,000   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss) before income taxes

   $ 14,814,000       $ (743,000   $ (1,797,000   $ (3,288,000   $ 8,986,000   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

For the three months ended July 31, 2011

           

Net sales

   $ 48,969,000       $ 3,535,000      $ 3,707,000      $ —        $ 56,211,000   

Cost of goods sold

     19,927,000         1,523,000        1,525,000        —          22,975,000   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

   $ 29,042,000       $ 2,012,000      $ 2,182,000      $ —        $ 33,236,000   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss) before income taxes

   $ 23,730,000       $ 253,000      $ (243,000   $ (2,872,000   $ 20,868,000   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Report on Form 10-Q and certain information incorporated herein by reference contain forward-looking statements which are not historical facts made pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not promises or guarantees and investors are cautioned that all forward-looking statements involve risks and uncertainties, including but not limited to the impact of competitive products and pricing, product demand and market acceptance, new product development, the regulatory environment, including without limitation, reliance on key strategic alliances, availability of raw materials, fluctuations in operating results and other risks detailed from time to time in the Company’s filings with the Securities and Exchange Commission. These statements are based on management’s current expectations and are naturally subject to uncertainty and changes in circumstances. We caution you not to place undue reliance upon any such forward-looking statements which speak only as of the date made. Hi-Tech is under no obligation to, and expressly disclaims any such obligation to, update or alter its forward-looking statements, whether as a result of new information, future events or otherwise.

RESULTS OF OPERATIONS FOR THREE MONTHS ENDED JULY 31, 2012 AND 2011

Revenue

 

     July 31, 2012      July 31, 2011      Change     % Change  

Hi-Tech Generics

   $ 45,922,000       $ 48,969,000       $ (3,047,000     (6 )% 

Health Care Products

     3,026,000         3,535,000         (509,000     (14 )% 

ECR Pharmaceuticals

     3,095,000         3,707,000         (612,000     (17 )% 
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 52,043,000       $ 56,211,000       $ (4,168,000     (7 )% 
  

 

 

    

 

 

    

 

 

   

 

 

 

Net sales of Hi-Tech generic pharmaceutical products decreased primarily due to lower sales of Fluticasone Propionate nasal spray which decreased to $22,000,000 from $26,200,000 in the comparable quarter as the Company sold more units at a lower average price. In January 2012, a fourth competitor entered the generic Fluticasone Propionate nasal spray market which may lead to additional price reductions for this product. The Company also experienced lower volumes and prices on Dorzolamide products during the quarter ended July 31, 2012. Partially offsetting these declines were sales of new products such as Lidocaine sterile jelly, launched in September 2011, Nystatin oral suspension, launched in February 2012 and Lidocaine 5% ointment, launched in March 2012.

Net sales of the Health Care Products division, which markets the Company’s branded OTC products, decreased due to end customer discounts and promotional pricing on Nasal Ease®. Sales of Multibetic®, Diabetiderm®, and Diabetic Tussin® declined as well. These declines were partially offset by sales of our new product Sinus Buster®, acquired in March 2012.

Net sales of ECR Pharmaceuticals, which sells branded prescription products, declined due to the discontinuation of Lodrane® extended release antihistamines. ECR Pharmaceuticals stopped shipping the Lodrane® products as of August 31, 2011. Sales of the discontinued Lodrane® products amounted to approximately $2,400,000 for the three months ended July 31, 2011. Increased sales of Bupap® and Dexpak® and sales from newly acquired Tussicaps® and Orbivan® partially offset the decrease in sales for the period.

Cost of Goods Sold

 

     July 31, 2012     July 31, 2011  
     $      % of sales     $      % of sales  

Cost of goods sold

     26,722,000         51     22,975,000         41

The increase in cost of goods sold as a percentage of net sales is primarily due to pricing declines for both Fluticasone Propionate nasal spray and Dorzolamide ophthalmic products. The Company anticipates that the cost to manufacture Fluticasone Propionate nasal spray will decline in the second half of the fiscal year due to lower input costs and new manufacturing equipment which will enable productivity improvements. Additionally, consumer discounts lowered margins in the HCP division.

Expense Items

 

     July 31, 2012     July 31, 2011     Change     % Change  

Selling, general and administrative expense

   $ 10,631,000      $ 8,796,000      $ 1,835,000        21

Amortization expense

   $ 1,757,000      $ 775,000      $ 982,000        127

Research and product development costs

   $ 4,472,000      $ 3,399,000      $ 1,073,000        32

Royalty income

   $ (635,000   $ (566,000   $ (69,000     12

Contract research income

   $ —        $ (27,000   $ 27,000        (100 )% 

Interest expense

   $ 156,000      $ 15,000      $ 141,000        940

Interest income and other

   $ (46,000   $ (24,000   $ (22,000     92

Provision for income tax expense

   $ 2,982,000      $ 7,095,000      $ (4,113,000     (58 )% 

 

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The increase in selling, general and administrative expenses was primarily due to 30 contract sales representatives hired in October 2011 in the ECR subsidiary to expand its sales force to new areas of the country. These 30 representatives were terminated at the end of July 2012.

Amortization expense increased due to intangible asset purchases over the last year including Tussicaps®, purchased in August 2011 and Sinus Buster®, purchased in March 2012.

Advertising expense increased to $1,861,000 in the quarter ended July 31, 2012 from $1,339,000 in the quarter ended July 31, 2011 primarily in the HCP division to support the re-launch of Nasal Ease©.

The increase in Research and Development expenditures is due to increased spending on internal projects for the generic division, which include four projects that require clinical trails. Three of these projects requiring clinical trails were undertaken in partnership with other companies. Spending included licensing fees and expenses paid to third parties for the new project requiring clinical trails.

Royalty income was relatively flat, but will decrease in the future as royalties on sales of certain products divested by its previously owned Midlothian division came to an end in June 2012.

The effective tax rate declined to approximately 33% from 34% as the Company recorded a higher benefit from the exercise of stock options in the current period.

Income Analysis

 

     July 31, 2012      July 31, 2011      Change     % Change  

Net income

   $ 6,004,000       $ 13,773,000       $ (7,769,000     (56 )% 

Basic earnings per share

   $ 0.46       $ 1.08       $ (0.62     (57 )% 

Diluted earnings per share

   $ 0.44       $ 1.05       $ (0.61     (58 )% 

Weighted average common shares outstanding, basic

     13,069,000         12,726,000         343,000        3

Effect of potential common shares

     481,000         423,000         58,000        14

Weighted average common shares outstanding, diluted

     13,550,000         13,149,000         401,000        3

Shares outstanding increased due to the exercise of options and the current year stock option grant.

LIQUIDITY AND CAPITAL RESOURCES

The Company’s operations are historically financed principally by cash flow from operations. At July 31, 2012 and April 30, 2012, working capital was approximately $177,504,000 and $167,565,000, respectively, an increase of $9,939,000 during the three months ended July 31, 2012.

Cash flows provided by operating activities were approximately $4,043,000 which is primarily due to net income in the period and a decrease in accounts receivable. Accounts payable decreased by $6,927,000 due to the timing of payments for raw materials.

Cash flows used in investing activities were $1,310,000 and were mostly for capital expenditures primarily related to capacity expansion at the Company’s Amityville and Copiague facilities.

Cash flows provided by financing activities of $1,969,000 related primarily to the proceeds from exercise of stock options and the related tax benefits.

The Company believes that its financial resources consisting of current working capital and anticipated future operating revenue will be sufficient to enable it to meet its working capital requirements for at least the next 12 months. Additionally, the Company has a $10,000,000 revolving line of credit with JPMorgan Chase which remains undrawn, and an additional $3,491,000 of the equipment financing line from JPMorgan Chase. The revolving line of credit agreement expires May 27, 2013, while borrowings under the equipment line mature October 6, 2016.

REVOLVING CREDIT FACILITY

The Company entered into a Revolving Credit Agreement, effective as of June 1, 2010, with JPMorgan Chase (the “Revolving Credit Agreement”). The Revolving Credit Agreement permits the Company to borrow up to $10,000,000 pursuant to a revolving credit note (“Revolving Credit Note”) for, among other things within certain sublimits, general corporate purposes, acquisitions, research and development projects and future stock repurchase programs. Loans shall bear interest at a rate equal to, at the Company’s option, in the case of a CB Floating Rate Loan, as defined in the Revolving Credit Agreement, the Prime Rate, as defined in the Revolving Credit Agreement; provided that, the CB Floating Rate shall never be less than the Adjusted One Month LIBOR, or for a LIBOR Loan, at a rate equal to the Adjusted LIBOR plus the Applicable Margin, as such terms are defined in the Revolving Credit

 

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Agreement. The Revolving Credit Agreement contains covenants customary for agreements of this type, including covenants relating to a liquidity ratio, a debt service coverage ratio and a minimum consolidated net income. Borrowings under the Revolving Credit Agreement mature on May 27, 2013.

If an event of default under the Revolving Credit Agreement shall occur and be continuing, the commitments under the Revolving Credit Agreement may be terminated and the principal amount outstanding under the Revolving Credit Agreement, together with all accrued unpaid interest and other amounts owing under the Revolving Credit Agreement and related loan documents, may be declared immediately due and payable.

The Company also entered into a $5,000,000 equipment financing agreement with JPMorgan Chase on June 1, 2010. This agreement has similar interest rates. On June 15, 2010 the Company drew down $621,000 of the equipment financing line to fund a down payment for new filling and packaging equipment. On October 13, 2011, the Company borrowed an additional $1,155,000 to finance the remaining payments for the equipment. Total borrowings under the equipment financing agreement amount to $1,509,000 as of July 31, 2012. Borrowings under the equipment financing agreement are payable in monthly installments of $30,000 through October 6, 2016.

The Company may not declare or pay dividends or distributions, other than dividends payable solely in capital stock, so long as the Revolving Credit Note remains unpaid.

RECENT ACCOUNTING PRONOUNCEMENTS:

In December 2011, the FASB updated the accounting guidance relating to offsetting assets and liabilities in financial statements. The updated guidance requires companies to disclose both gross and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. The updated guidance is effective for the Company beginning in the third quarter of fiscal year 2013. The adoption of this guidance is not expected to have a material impact on the Company’s consolidated financial statements.

In July 2012, the FASB issued accounting guidance to simplify the testing for a drop in value of indefinite-lived intangible assets. Under the updated guidance, an entity has the option of first performing a qualitative assessment to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired before proceeding to the quantitative impairment test under which it would calculate the asset’s fair value. When performing the qualitative assessment, the entity must evaluate events and circumstances that may affect the significant inputs used to determine the fair value of the indefinite-lived intangible asset. This guidance is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted. We do not expect this guidance to have a material impact on our financial statements.

SEASONALITY

The Company’s largest selling product is Fluticasone Propionate nasal spray, an allergy medication. Sales of Fluticasone Propionate nasal spray vary from quarter to quarter due to the stronger demand for the product during the spring and fall allergy seasons. The Company also sells cough, cold and flu products which have historically experienced stronger net sales in September through March. The cough, cold and flu season in the late 2011 and early 2012 period was particularly mild. Allergy seasons and cough, cold and flu seasons vary from year to year and because of these changes in product mix and product seasonality, period-to-period comparisons within the same fiscal year are not necessarily meaningful and should not be relied on as indicative of future results.

CRITICAL ACCOUNTING POLICIES

In preparing financial statements in conformity with generally accepted accounting principles in the United States of America, we are required to make estimates and assumptions that affect reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses for the reporting period covered thereby. As a result, these estimates are subject to an inherent degree of uncertainty. We base our estimates and judgments on our historical experience, the terms of existing contracts, our observance of trends in the industry, information that we obtain from our customers and outside sources, and on various assumptions that we believe to be reasonable and appropriate under the circumstances, the results of which form the basis for making judgments which impact our reported operating results and the carrying values of assets and liabilities. These assumptions include but are not limited to the percentage of new products which may have chargebacks and the percentage of items which will be subject to price decreases. Actual results may differ from these estimates.

Revenue recognition and accounts receivable, adjustments for returns and price adjustments, allowance for doubtful accounts and carrying value of inventory represent significant estimates made by management.

Revenue Recognition and Accounts Receivable: Revenue is recognized for product sales upon shipment and when title and risk of loss is passed to the customer and when estimates of discounts, rebates, promotional adjustments, price adjustments, returns, chargebacks, and other potential adjustments are reasonably determinable, collection is reasonably assured and the Company has no further

 

19


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performance obligations. These estimates are presented in the financial statements as reductions to net revenues and accounts receivable. Estimated sales returns, allowances and discounts are provided for in determining net sales. Contract research income is recognized as work is completed and billable costs are incurred. In certain cases, contract research income is based on attainment of designated milestones.

Royalty income is related to the sale or use of our products under license agreements with third parties. For those agreements where royalties are reasonably estimable, the Company recognizes revenue based on estimates of royalties earned during the applicable period.

Adjustments for Returns and Price Adjustments: Our product revenues are typically subject to agreements with customers allowing chargebacks, rebates, rights of return, pricing adjustments and other allowances. Based on our agreements and contracts with our customers, we calculate adjustments for these items when we recognize revenue and we book the adjustments against accounts receivable and revenue. Chargebacks, primarily from wholesalers, are the most significant of these items. Chargebacks result from arrangements we have with retail customers establishing prices for products for which the end user independently selects a wholesaler from which to purchase. A chargeback represents the difference between our invoice price to the wholesaler, which is typically stated at wholesale acquisition cost, and the end customer’s contract price, which is lower. We credit the wholesaler for purchases by end customers at the lower price. Therefore, we record these chargebacks at the time we recognize revenue in connection with our sales to wholesalers.

The reserve for chargebacks is computed in the following manner. The Company obtains wholesaler inventory data for the wholesalers which represent approximately 95% of our chargeback activity. This inventory is multiplied by the historical percentage of units that are charged back and by the price adjustment per unit to arrive at the chargeback accrual. This calculation is performed by product for each customer.

The calculated amount of chargebacks could be affected by other factors such as:

 

   

A change in retail customer mix

 

   

A change in negotiated terms with retailers

 

   

Product sales mix at the wholesaler

 

   

Retail inventory levels

 

   

Changes in Wholesale Acquisition Cost (WAC)

The Company continually monitors the chargeback activity and adjusts the provisions for chargebacks when we believe that the actual chargebacks will differ from our original provisions.

Consistent with industry practice, the Company maintains a return policy that allows our customers to return product within a specified period. The Company’s estimate for returns is based upon its historical experience with actual returns. While such experience has allowed for reasonable estimation in the past, history may not always be an accurate indicator of future returns. The Company continually monitors its estimates for returns and makes adjustments when it believes that actual product returns may differ from the established accruals.

Included in the adjustment for sales allowances and returns is a reserve for credits taken by our customers for rebates, return authorizations and other.

Sales discounts are granted for prompt payment. The reserve for sales discounts is based on invoices outstanding and assumes that 100% of available discounts will be taken.

Price adjustments, including shelf stock adjustments, are credits issued from time to time to reflect decreases in the selling prices of our products which our customer has remaining in its inventory at the time of the price reduction. Decreases in our selling prices are discretionary decisions made by us to reflect market conditions. Amounts recorded for estimated price adjustments are based upon specified terms with direct customers, estimated launch dates of competing products, estimated declines in market price and inventory held by the customer. The Company analyzes this on a case by case basis and makes adjustments to reserves as necessary.

The Company adequately reserves for chargebacks, discounts, allowances and returns in the period in which the sales takes place. No material amounts included in the provision for chargebacks and the provision for sales discounts recorded in the current period relate to sales made in the prior periods. The current provision for sales allowances and returns includes reserves for items sold in the current period, while the ending balance includes reserves for items sold in the current and prior periods. The Company has substantially and consistently used the same estimating methods. We continue to refine the methods as new data becomes available. There have been no material differences between the estimates applied and actual results.

 

20


Table of Contents

The Company determines amounts that are material to the financial statements in consideration of all relevant circumstances including quantitative and qualitative factors. Among the items considered is the impact on individual financial statement classification, operating income and footnote disclosures and the degree of precision that is attainable in estimating judgmental items.

The following table presents the roll forward of each significant estimate as of July 31, 2012 and July 31, 2011 and for the three months then ended, respectively.

 

For the three months ended July 31, 2012

   Beginning
Balance
May 1
     Current
Provision
     Actual Credits
in Current
Period
    Ending
Balance
July 31
 

Chargebacks

   $ 10,477,000       $ 38,460,000       $ (35,221,000   $ 13,716,000   

Sales discounts

     1,813,000         2,337,000         (2,230,000     1,920,000   

Sales allowances & returns

     5,745,000         13,787,000         (10,344,000     9,188,000   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total adjustment for returns & price allowances

   $ 18,035,000       $ 54,584,000       $ (47,795,000   $ 24,824,000   
  

 

 

    

 

 

    

 

 

   

 

 

 

For the three months ended July 31, 2011

                          

Chargebacks

   $ 8,588,000       $ 34,908,000       $ (31,422,000   $ 12,074,000   

Sales discounts

     2,353,000         2,275,000         (2,900,000     1,728,000   

Sales allowances & returns

     6,159,000         7,193,000         (5,787,000     7,565,000   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total adjustment for returns & price allowances

   $ 17,100,000       $ 44,376,000       $ (40,109,000   $ 21,367,000   
  

 

 

    

 

 

    

 

 

   

 

 

 

Allowance for Doubtful Accounts: We have historically provided credit terms to customers in accordance with what management views as industry norms. Financial terms for credit-approved customers are generally on either a net 30, 60 or 90 day basis, though most customers are entitled to a prompt payment discount. Management periodically and regularly reviews customer account activity in order to assess the adequacy of allowances for doubtful accounts, considering factors such as economic conditions and each customer’s payment history and creditworthiness. If the financial condition of our customers were to deteriorate, or if they were otherwise unable to make payments in accordance with management’s expectations, we would have to increase our allowance for doubtful accounts.

Inventories: We state inventories at the lower of average cost or market, with cost being determined based upon the average method. In evaluating whether inventory is to be stated at cost or market, management considers such factors as the amount of inventory on hand, estimated time required to sell existing inventory and expected market conditions, including levels of competition. We establish reserves for slow-moving and obsolete inventories based upon our historical experience, product expiration dates and management’s assessment of current product demand.

Intangible Assets: The Company’s intangible assets consist primarily of acquired product rights. Intangible assets are stated at cost and amortized using the straight line method over the expected useful lives of the product rights. We regularly review the appropriateness of the useful lives assigned to our product rights taking into consideration potential future changes in the markets for our products. The Company reviews each intangible asset with finite useful lives for impairment by comparing the undiscounted cash flows of each asset to the respective carrying value. The Company performs this impairment testing when events occur or circumstances change that would more likely than not reduce the undiscounted cash flows of the asset below its carrying value.

CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS

The Company’s contractual obligations and commitments are detailed in the Company’s Annual Report on Form 10-K for the year ended April 30, 2012. As of July 31, 2012, the Company’s remaining contractual obligations have not materially changed since April 30, 2012.

As part of our ongoing business, we do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of July 31, 2012 we are not involved in any material unconsolidated transactions.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company invests in U.S. treasury notes, government asset backed securities and corporate bonds, all of which are exposed to interest rate fluctuations. The interest earned on these investments may vary based on fluctuations in the market interest rate.

 

21


Table of Contents
ITEM 4. CONTROLS AND PROCEDURES

Under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures within 90 days of the filing date of this quarterly report, and, based on their evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are effective. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.

PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

The disclosure under Note 14, Contingencies and Other Matters, Legal Proceedings, included in Part I of this report, is incorporated in this Part II, Item 1 by reference.

 

ITEM 1A. RISK FACTORS

Not applicable

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

There were no sales of equity securities during the quarter ended July 31, 2012 that were not registered under the Securities Act of 1933.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

 

ITEM 4. MINE SAFETY DISCLOSURES

Not Applicable

 

ITEM 5. OTHER INFORMATION

None

 

ITEM 6. EXHIBITS

 

(a) Exhibits

 

  31.1   Rule 13A-14(a)/15D-14(a) Certification
  31.2   Rule 13A-14(a)/15D-14(a) Certification
  32   Certification of Officers Pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2003
101.INS**   XBRL Instance Document.
101.SCH**   XBRL Taxonomy Extension Schema Document.
101.CAL**   XBRL Taxonomy Extension Calculation Linkbase Document.
101.LAB**   XBRL Taxonomy Extension Label Linkbase Document.
101.PRE**   XBRL Taxonomy Extension Presentation Linkbase Document.
101.DEF**   XBRL Taxonomy Extension Definition Linkbase Document.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934,

the registrant has duly caused this report to be signed on its behalf

by the undersigned thereunto duly authorized.

HI-TECH PHARMACAL CO., INC.

(Registrant)

Date: September 7, 2012

 

By:  

/S/ DAVID S. SELTZER

 

David S. Seltzer

(President and Chief Executive Officer)

Date: September 7, 2012

 

By:  

/S/ WILLIAM PETERS

 

William Peters

(Vice President and Chief Financial Officer)

 

23

XNAS:HITK Quarterly Report 10-Q Filling

XNAS:HITK Stock - Get Quarterly Report SEC Filing of XNAS:HITK stocks, including company profile, shares outstanding, strategy, business segments, operations, officers, consolidated financial statements, financial notes and ownership information.

XNAS:HITK Quarterly Report 10-Q Filing - 7/31/2012
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