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EX-32 - CERTIFICATION OF OFFICERS PURSUANT TO 18 U.S.C. SECTION 1350 - HI TECH PHARMACAL CO INCdex32.htm
EX-3.1 - CERTIFICATE OF INCORPORATION - HI TECH PHARMACAL CO INCdex31.htm
EX-31.2 - RULE 13A-14(A)/15D-14(A) CERTIFICATION - HI TECH PHARMACAL CO INCdex312.htm
EX-31.1 - RULE 13A-14(A)/15D-14(A) CERTIFICATION - HI TECH PHARMACAL CO INCdex311.htm
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 January 31, 2011

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 Data 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  ¨    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 — 12,670,000 shares outstanding as March 8, 2011

 

 

 


Table of Contents

INDEX

HI-TECH PHARMACAL CO., INC.

 

     Page  

PART I. FINANCIAL INFORMATION

  
Item 1.   Financial Statements      2   
  Condensed consolidated balance sheets—January 31, 2011 (unaudited) and April 30, 2010      2   
 

Condensed consolidated statements of operations—Three months and nine months ended January 31, 2011 and 2010 (unaudited)

     3   
  Condensed consolidated statements of cash flows—Nine months ended January 31, 2011 and 2010 (unaudited)      4   
  Notes to condensed consolidated financial statements (unaudited)      5   
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations      12   
Item 3.   Quantitative and Qualitative Disclosures About Market Risk      19   
Item 4.   Controls and Procedures      19   
PART II. OTHER INFORMATION   
Item 1.   Legal Proceedings      20   
Item 1A.   Risk Factors      20   
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds      20   
Item 3.   Defaults Upon Senior Securities      20   
Item 4.   (Removed and Reserved)      20   
Item 5.   Other Information      20   
Item 6.   Exhibits      20   
  Signatures      21   
  Certifications      22   

 

1


Table of Contents

PART I.

ITEM 1.

HI-TECH PHARMACAL CO., INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

 

     January 31,
2011
    April 30,
2010
 
     (unaudited)        
ASSETS     

CURRENT ASSETS:

    

Cash and cash equivalents

   $ 59,021,000      $ 36,018,000   

Accounts receivable, less allowance for doubtful accounts

     41,306,000        40,452,000   

Inventory

     25,353,000        20,355,000   

Prepaid income taxes

     1,507,000        —     

Deferred income taxes

     4,916,000        4,219,000   

Other current assets

     3,814,000        3,129,000   
                

TOTAL CURRENT ASSETS

   $ 135,917,000      $ 104,173,000   

Property and equipment—net

     23,012,000        20,427,000   

Intangible assets—net

     24,158,000        24,322,000   

Deferred income taxes

     999,000        883,000   

Other assets

     476,000        479,000   
                

TOTAL ASSETS

   $ 184,562,000      $ 150,284,000   
                
LIABILITIES AND STOCKHOLDERS’ EQUITY     

CURRENT LIABILITIES:

    

Accounts payable

   $ 4,260,000      $ 5,484,000   

Accrued expenses

     12,554,000        8,924,000   

Current portion of long-term debt

     87,000        193,000   

Income taxes payable

     —          880,000   
                

TOTAL CURRENT LIABILITIES

   $ 16,901,000      $ 15,481,000   

Long-term debt

     621,000        37,000   
                

TOTAL LIABILITIES

   $ 17,522,000      $ 15,518,000   
                

Commitments and Contingencies (Note 13)

    

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 15,123,000 at January 31, 2011 and 15,017,000 at April 30, 2010, respectively

     151,000        150,000   

Additional paid-in capital

     78,675,000        75,345,000   

Retained earnings

     111,214,000        82,425,000   

Accumulated other comprehensive loss, net of tax

     —          (154,000

Treasury stock, 2,456,000 shares of common stock, at cost on January 31, 2011 and April 30, 2010

     (23,000,000     (23,000,000
                

TOTAL STOCKHOLDERS’ EQUITY

   $ 167,040,000      $ 134,766,000   
                

LIABILITIES AND STOCKHOLDERS’ EQUITY

   $ 184,562,000      $ 150,284,000   
                

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
January 31,
    Nine months ended
January 31,
 
   2011     2010     2011     2010  

NET SALES

   $ 50,032,000      $ 38,820,000      $ 135,322,000      $ 123,172,000   

Cost of goods sold

     21,761,000        16,269,000        58,855,000        51,673,000   
                                

GROSS PROFIT

     28,271,000        22,551,000        76,467,000        71,499,000   
                                

Selling, general and administrative expenses

     11,267,000        11,983,000        29,871,000        34,845,000   

Research and product development costs

     2,742,000        1,718,000        7,207,000        5,184,000   

Royalty income

     (1,557,000     (1,596,000     (3,778,000     (2,539,000

Contract research (income)

     (50,000     (581,000     (667,000     (894,000

Interest expense

     12,000        9,000        34,000        24,000   

Other (income) expense

     227,000        52,000        (89,000     (1,233,000
                                

TOTAL

   $ 12,641,000      $ 11,585,000      $ 32,578,000      $ 35,387,000   
                                

Income before income tax expense

     15,630,000        10,966,000        43,889,000        36,112,000   

Income tax expense

     5,492,000        2,426,000        15,100,000        11,500,000   
                                

NET INCOME

   $ 10,138,000      $ 8,540,000      $ 28,789,000      $ 24,612,000   
                                

BASIC INCOME PER SHARE

   $ 0.80      $ 0.70      $ 2.29      $ 2.10   
                                

DILUTED INCOME PER SHARE

   $ 0.79      $ 0.67      $ 2.22      $ 2.01   
                                

Weighted average common shares outstanding—basic

     12,632,000        12,179,000        12,595,000        11,732,000   

Effect of potential common shares

     242,000        521,000        399,000        533,000   
                                

Weighted average common shares outstanding—diluted

     12,874,000        12,700,000        12,994,000        12,265,000   
                                

See notes to condensed consolidated financial statements

 

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Table of Contents

HI-TECH PHARMACAL CO., INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

 

     Nine months ended
January 31,
 
   2011     2010  

NET CASH FLOWS PROVIDED BY OPERATING ACTIVITIES

   $ 26,592,000      $ 20,711,000   
                

CASH FLOWS FROM INVESTING ACTIVITIES:

    

Purchases of property, plant and equipment

     (4,662,000     (2,669,000

Proceeds from the sale of intangible assets

     156,000        2,187,000   

Purchase of intangible assets

     (36,000     (7,180,000

Purchase of ECR Pharmaceuticals assets

     (1,021,000     (5,042,000
                

NET CASH (USED IN) INVESTING ACTIVITIES

   $ (5,563,000   $ (12,704,000
                

CASH FLOWS FROM FINANCING ACTIVITIES:

    

Issuance of common stock and exercise of options

     1,197,000        10,934,000   

Payment under capital lease obligation

     (143,000     (134,000

Tax benefit of stock incentives

     299,000        2,854,000   

Borrowings under long term debt

     621,000        —     
                

NET CASH PROVIDED BY FINANCING ACTIVITIES

   $ 1,974,000      $ 13,654,000   
                

NET INCREASE IN CASH AND CASH EQUIVALENTS

     23,003,000        21,661,000   

Cash and cash equivalents at beginning of the period

     36,018,000        17,891,000   
                

CASH AND CASH EQUIVALENTS AT END OF PERIOD

   $ 59,021,000      $ 39,552,000   
                

Supplemental and non cash disclosures of cash flow information:

    

Interest paid

   $ 34,000      $ 24,000   

Income taxes paid

   $ 18,015,000      $ 10,164,000   

Other receivable from the sale of marketing rights

   $ —        $ 312,000   

ECR Pharmaceuticals contingent consideration accrual

   $ 918,000      $ 1,045,000   

See notes to condensed consolidated financial statements

 

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Table of Contents

HI-TECH PHARMACAL CO., INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

January 31, 2011

1. BASIS OF PRESENTATION:

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles 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 generally accepted accounting principles 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 generally accepted accounting principles 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 expense during the reporting periods. Actual results could differ from these estimates and assumptions. Operating results for the three and nine month periods ended January 31, 2011 are not necessarily indicative of the results that may be expected for the year ending April 30, 2011. For further information, refer to the financial statements and footnotes thereto for the year ended April 30, 2010 in the Company’s Annual Report on Form 10-K.

2. BUSINESS:

Hi-Tech 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. Hi-Tech’s Midlothian Laboratories division sources and markets generic prescription products.

The following table presents sales data for the Company by division:

 

     Nine months
ended
January 31, 2011
     Nine months
ended
January 31, 2010
 

Hi-Tech Generics

   $ 109,392,000       $ 99,146,000   

Health Care Products

     10,553,000         8,597,000   

Midlothian Laboratories

     1,657,000         3,192,000   

ECR Pharmaceuticals

     13,720,000         12,237,000   
                 

TOTAL

   $ 135,322,000       $ 123,172,000   
                 

3. REVENUE RECOGNITION:

Revenue is recognized for product sales upon shipment and passing of risk 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 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.

4. NET INCOME PER SHARE:

Basic 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 226,000 and 261,000 shares at January 31, 2011 and 2010, respectively.

 

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Table of Contents

5. INVENTORY:

The components of inventory consist of the following:

 

     January 31,
2011
     April 30,
2010
 

Finished products

   $ 10,292,000       $ 8,057,000   

Work in process

     1,372,000         740,000   

Raw materials

     13,689,000         11,558,000   
                 

TOTAL INVENTORY

   $ 25,353,000       $ 20,355,000   
                 

6. PROPERTY AND EQUIPMENT:

The components of property and equipment consist of the following:

 

     January 31,
2011
     April 30,
2010
 

Land and building and improvements

   $ 17,136,000       $ 15,741,000   

Machinery and equipment

     24,024,000         21,331,000   

Transportation equipment

     37,000         37,000   

Computer equipment and systems

     5,479,000         4,982,000   

Furniture and fixtures

     1,134,000         1,057,000   
                 
   $ 47,810,000       $ 43,148,000   

Accumulated depreciation and amortization

     24,798,000         22,721,000   
                 

TOTAL PROPERTY AND EQUIPMENT

   $ 23,012,000       $ 20,427,000   
                 

The Company incurred depreciation expense of $2,077,000 and $1,990,000 for the nine months ended January 31, 2011 and January 31, 2010, respectively. Depreciation expense for the three months ended January 31, 2011 and January 31, 2010 was $673,000 and $625,000, respectively. No depreciation is taken on land with a carrying value of $1,754,000 at January 31, 2011 and January 31, 2010.

7. INTANGIBLE ASSETS:

The components of net intangible assets are as follows:

 

     January 31,
2011
     April 30,
2010
     Amortization Period  

ECR intangible assets

   $ 6,414,000       $ 4,937,000         8-10 years   

MagOx® intangible assets

     3,725,000         4,032,000         10 years   

Clobetasol intangible asset

     3,700,000         4,000,000         10 years   

Midlothian intangible asset

     3,138,000         3,490,000         3-10 years   

Zolpimist® intangible asset

     3,000,000         3,000,000         7-10 years   

Zostrix® intangible assets

     2,727,000         3,069,000         3-11.5 years   

Vosol® and Vosol® HC intangible assets

     490,000         543,000         10 years   

Other license agreements

     964,000         1,251,000         5-10 years   
                    

TOTAL INTANGIBLE ASSETS

   $ 24,158,000       $ 24,322,000      
                    

Intangible assets are stated at cost and amortized using the straight line method over the expected useful lives of the product rights. Amortization expense of the intangible assets for the nine months ended January 31, 2011 and January 31, 2010 was $1,940,000 and $1,087,000, respectively. Amortization expense for the three months ended January 31, 2011 and January 31, 2010 was $676,000 and $363,000, respectively. Amortization is included in selling, general and administrative expenses for all periods presented. The Company amortizes intangible assets when the related products begin to sell. The Company tests for impairment of intangible assets when events or circumstances indicate that the carrying value of the assets may not be recoverable. During the nine months ended January 31, 2011, the Company determined that the value of Tanafed®, which is included in other license agreements, was impaired. The Company wrote down the value of the intangible asset by $221,000.

 

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Included in ECR intangible assets is an earn-out of $4,000,000 in connection with the acquisition of the assets of ECR Pharmaceuticals, of which $1,938,000 was earned in the nine months ended January 31, 2011 of which $545,000 is classified to goodwill. No additional obligation exists with respect to the earn-out at January 31, 2011.

8. 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 January 31, 2011, 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. The Company anticipates drawing down an additional $1,379,000 to finance the remaining payments for the equipment. The effective interest rate was 1.82% for the nine months ended January 31, 2011.

9. FREIGHT EXPENSE:

Outgoing freight costs are included in selling, general, and administrative expense. Incoming freight is included in cost of goods sold.

10. STOCK-BASED COMPENSATION:

The Company follows the provisions of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 718, “Compensation — Stock Compensation” (“ASC 718”). ASC 718 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 ASC 718 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 FASB ASC Topic 505-50, “Equity Based Payments to Non- Employees”.

Non-employee option grants that do not vest immediately upon grant are recorded as an expense over the vesting period of the underlying stock options. At the end of each financial reporting period prior to vesting, the value of these options, as calculated using the Black-Scholes option-pricing model, is re-measured using the fair value of the Company’s common stock and the non-cash compensation recognized during the period is adjusted accordingly. Since the fair market value of options granted to non-employees is subject to change in the future, the amount of the future compensation expense includes fair value re-measurements until the stock options are fully vested.

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.

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 Statement of Operations:

 

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     Nine months
ended
January 31,
2011
     Nine months
ended
January 31,
2010
 

Cost of sales

   $ 230,000       $ 350,000   

Selling, general and administrative expenses

     1,385,000         1,338,000   

Research and product development costs

     220,000         122,000   
                 

STOCK-BASED COMPENSATION EXPENSE

   $ 1,835,000       $ 1,810,000   
                 

Stock-based compensation expense resulted in a decrease of $0.14 and $0.15 in basic and diluted net income per share, respectively, for the nine months ended January 31, 2011 and a decrease of $0.15 in basic and diluted net income per share for the nine months ended January 31, 2010.

 

     Three months
ended
January 31,
2011
     Three months
ended
January 31,
2010
 

Cost of sales

   $ 104,000       $ 144,000   

Selling, general and administrative expenses

     584,000         463,000   

Research and product development costs

     90,000         50,000   
                 

STOCK-BASED COMPENSATION EXPENSE

   $ 778,000       $ 657,000   
                 

Stock-based compensation expense resulted in a decrease of $0.06 in basic and diluted net income per share for the three months ended January 31, 2011 and a decrease of $0.05 in basic and diluted net income per share for the three months ended January 31, 2010.

The following weighted average assumptions were used for stock option granted during the three and nine months ended January 31, 2011 and 2010:

 

     Three months  ended
January 31,
    Nine months ended
January  31,
 
   2011     2010     2011     2010  

Dividend yield

     None        None        None        None   

Expected volatility

     58     58     58     58

Risk-free interest rate

     2.65     2.28     2.65     2.28

Expected term

     5.0        5.0        5.0        5.0   

Weighted average fair value per share at grant date

   $ 11.55      $ 10.07      $ 11.55      $ 10.07   

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 U.S. Treasury yield on the date of each option grant.

All options granted through January 31, 2011 had exercise prices equal to the fair market value of the stock on the date of grant, a contractual term of ten years and a vesting period of four years. The Company adjusts stock-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 January 31, 2011, the weighted average forfeiture rate was 9% and the effect of forfeiture adjustments for the three and nine months ended January 31, 2011 was insignificant. The Company granted 414,000 options under the employee plan and 50,000 under the director plan at an exercise price of $22.25 during the three and nine months ended January 31, 2011. The Company granted 318,000 options to employees and 50,000 to directors during the three and nine months ended January 31, 2010.

The intrinsic value of options exercised for the 1992 Stock Option Plan, the 1994 Stock Option Plan and the 2009 Stock Option Plan was $1,368,000 and $12,111,000 for the nine month periods ended January 31, 2011 and January 31, 2010, respectively.

As of January 31, 2011, $8,036,000 of total unrecognized compensation cost related to stock options for both plans is expected to be recognized over a weighted average period of 3.2 years.

 

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11. 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 Midlothian Laboratories, in exchange for a series of payments totaling $1,000,000 over the course of one year. In addition, the Company will receive a royalty on the sales of these products, not to exceed $1,500,000 per year for three years. These products contributed approximately $600,000 and $1,600,000 in sales for the Midlothian Laboratories division for the years ended April 30, 2010 and April 30, 2009, respectively. These products contributed $0 and $600,000 in sales for the nine months ended January 31, 2011 and January 31, 2010, respectively. The Company recognized a gain of $1,000,000 from this agreement in the first quarter of fiscal 2010, recorded in interest income and other on the Condensed Consolidated Statement of Operations. Royalty income earned under this agreement amounted to $1,372,000 and $774,000 for the nine months ended January 31, 2011 and January 31, 2010, respectively.

12. INCOME TAXES:

The Company estimated its effective tax rate to be approximately 34% for the year ended April 30, 2011. 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 January 31, 2011 and April 30, 2010, the Company had recorded a $32,000 and $163,000 liability, respectively, for uncertain tax positions related to research and development credits taken by the Company.

In July 2010, the Company paid approximately $160,000 to settle liabilities relating to the examination of the years ended April 30, 2004 and 2005. The Company is no longer subject to U.S. federal, state or local income tax examination for years ended prior to April 30, 2005. The Company is currently under examination by the Internal Revenue Service for the taxable years ending April 30, 2006, 2007, 2008 and 2009.

13. 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.

On June 30, 2010, the Company received a warning letter from the FDA. The warning letter primarily dealt with the marketing of several products that the FDA states require FDA approval and manufacturing practices related to those products. The Company suspended sales of certain products as a result of the warning letter. Sales of these products totaled approximately $5,000,000 in fiscal year 2010. The Company incurred an expense of $534,000 to write off the value of the inventory used in the manufacturing of these products during the three months ended July 31, 2010. Other than the suspended products, the Company does not anticipate any interruption in sales of its other products. The Company responded to the warning letter and has met with FDA officials to determine how best to resolve these issues. In November, 2010, the Company was the subject of an FDA inspection. The inspection was a follow up to the warning letter received on June 30, 2010 as well as a general GMP inspection. The Company received a Form 483, an FDA form on which deficiencies are noted after an FDA inspection, with inspector observations. The Company responded to those observations. Subsequent to these actions, the Company received approvals for Levofloxacin ophthalmic solution and Gabapentin oral solution.

On July 7, 2009, the Company received a subpoena duces tecum demanding production of its business records in connection with an investigation by the Office of the Attorney General of the State of California, Department of Justice, relating to drugs not approved by the FDA and the potential filing of false claims with California’s Medicaid (Medi-Cal) program. The Company has responded to the subpoena. No claims for damages have been made. The Company has been advised that this investigation has been closed.

[2] Legal Proceedings:

On March 19, 2010 the Midlothian Laboratories Division of the Company (“Midlothian”) received a subpoena duces tecum demanding production of Midlothian business records in connection with an investigation by the Office of Inspector General of the United States Department of Health & Human Services relating to Medicare or Medicaid reimbursement for certain drugs. The Company has produced documents in response to the subpoena. No claims for damages have been made. The Company has no estimate at this time of its potential exposure and cannot, at this time, predict the outcome of this matter.

 

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On March 5, 2010 in the United States District Court for the Northern District of California, a complaint was filed naming the Company and several pharmaceutical and other companies as defendants under the qui tam provisions of the federal civil False Marking Statute. A private plaintiff, San Francisco Technology Inc., is filing the civil action under the Statute on behalf of the federal government. The complaint alleges that the Company falsely marked the packaging of a product with regard to patents that had expired. The product was marketed by the Company’s Health Care Products Division under the Zostrix® Neuropathy brand. The complaint alleges these actions violate the federal civil False Marking Statute. The Company was served with the Complaint on March 22, 2010. On July 19, 2010, the judge ordered that the Company be severed from the action and transferred to the Eastern District of New York. On November 15, 2010, the Company moved to dismiss or stay the action and on December 6, 2010, the plaintiff filed a motion in opposition to dismiss or stay the action. On February 4, 2011, the Court granted the Company’s motion to dismiss the action. The plaintiff was also granted a 30 day leave to amend its complaint. The plaintiff filed an amended complaint on March 8, 2011. The Company intends to defend against such allegations and believes it has meritorious defenses. The Company has no estimate at this time of its potential exposure and cannot, at this time, predict the outcome of such 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. The Notice stated that the relator has filed a Motion for Voluntary Dismissal of 55 of the 68 named defendants. To our knowledge, the relator’s Motion for Voluntary Dismissal remains under seal. The government’s declination Notice also stated that it had not yet made an election decision as to “certain other defendants.”

On July 23, 2010, the relator, Constance A. Conrad, further amended the Complaint, which, as amended, includes the addition of the Company, including a subsidiary or affiliate 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, and instructed the relator to file an unredacted version of her latest amended complaint, which was to be unsealed. On January 14, 2011, the relator filed a Ninth Amended Complaint, which was unsealed, and which includes the Company and a subsidiary of the Company. To our knowledge, at this time, there have been no changes to the government’s Notice of Declination, other than its notice of intervention as to the previously unnamed defendant. Should this Qui Tam action proceed, the Company intends to vigorously defend against the allegations in the Complaint. The Company cannot predict the outcome of the action.

On June 5, 2009, Allergan, Inc. (“Allergan”) filed a complaint against the Company in the United States District Court for the Eastern District of Texas, Civil Action No. 2:09-cv-182, in response to the Company’s Paragraph IV certifications in ANDA No. 91-086 (the “ANDA”) alleging noninfringement or invalidity of the United States patents identified in the Orange Book on Allergan’s product, Combigan®. In counts one and two of the complaint, Allergan alleges that the Company’s submission of the ANDA to the FDA under Section 505(j) of the Food, Drug & Cosmetic Act (“FDCA”) to obtain approval to engage in the commercial manufacture, use or sale of the Company’s generic Brimonidine Tartrate/Timolol Maleate Ophthalmic Solution 0.2%/0.5% product infringes U.S. Patents No. 7,030,149 and 7,320,976. The Company believes the complaint is without merit. On July 25, 2009, the Company filed a motion to dismiss the action based on lack of personal jurisdiction and improper venue. Allergan responded on September 8, 2009 opposing Hi-Tech’s motion to dismiss. The Company withdrew its motion to dismiss on November 19, 2009, and on November 20, 2009, Allergan filed an amended complaint adding a claim for infringement of U.S. Patent No. 7,323,463. The Company answered the amended complaint on December 10, 2009, asserting counterclaims of non-infringement and invalidity as to all asserted patents. Allergan replied to the Company’s counterclaims on January 4, 2010. Discovery has commenced. On March 17, 2010, Allergan filed a second complaint adding allegations of infringement of U.S. Patent No. 7,642,258. The Company answered on March 19, 2010 denying infringement of any valid claims.

 

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[3] Commitments and Contingencies:

The Company’s Midlothian division signed a lease for a 12,000 square foot facility in Montgomery, AL commencing on December 1, 2008 and terminating on November 30, 2013.

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 fiscal 2008, the Company entered into two software lease obligations to partially finance a new computer system.

At January 31, 2011, the Company had entered into a purchase commitment for bottling, labeling and packaging equipment for approximately $1,620,000.

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.

14. RECENT ACCOUNTING PRONOUNCEMENTS:

In June 2009, the FASB amended Topic 810 “Consolidation”, which modifies how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The guidance clarifies that the determination of whether a company is required to consolidate an entity is based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance. It requires an ongoing reassessment of whether a company is the primary beneficiary of a variable interest entity. It also requires additional disclosures about a company’s involvement in variable interest entities and any significant changes in risk exposure due to that involvement. The guidance is effective for fiscal years beginning after November 15, 2009 and is effective for the Company on May 1, 2010. The adoption of the guidance did not have any material impact on the Company’s financial condition, results of operations, and disclosures.

In December of 2010, the FASB issued Accounting Standards Update 2010-28, “When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts” (“ASU 2010-28”). ASU 2010-28 modifies Step 1 of the goodwill impairment test, which requires an entity to compare the fair value of a reporting unit with its carrying amount, including goodwill. For reporting units with zero or negative carrying amounts, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. Step 2 requires an entity to compare the fair value of a reporting unit goodwill with the carrying amount of that goodwill. The implied fair value of goodwill is determined by assigning a fair value to all the assets and liabilities of the reporting unit as if the reporting unit had been acquired in a business combination. The adoption of ASU 2010-28, which became effective for the Company on May 1, 2011, is not expected to have a material impact on our Consolidated Financial Statements.

In December of 2010, the FASB issued ASU 2010-29, “Disclosure of Supplementary Pro Forma Information for Business Combinations.” ASU 2010-29 specifies that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. ASU 2010-29 also expands the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The adoption of ASU 2010-29, which became effective for the Company on May 1, 2011, is not expected to have a material impact on our Consolidated Financial Statements.

15. COMPREHENSIVE INCOME:

In accordance with FASB ASC Topic 220-10, “Comprehensive Income,” the Company is required to report all changes in equity during a period, except those resulting from investment by owners and distribution to owners, for the period in which they are recognized. Comprehensive income is the total of net income and all other non-owner changes in equity (or other comprehensive income) such as unrealized gains/losses on securities classified as available for sale.

The Company’s investment in Neuro-Hitech, Inc., a marketable security is measured at fair value. The Company wrote off the investment in Neuro-Hitech, Inc. during the three months ended January 31, 2011 based on the decline in the stock price and the limited trading activity. The Company recognized a $250,000 loss relating to this write-off recorded in other (income) and expense.

 

     Three months ended
January 31,
     Nine months ended
January 31,
 
   2011      2010      2011      2010  

Net income

   $ 10,138,000       $ 8,540,000       $ 28,789,000       $ 24,612,000   

Other comprehensive gain (loss), net of tax

     —           9,000         —           (70,000
                                   

COMPREHENSIVE INCOME

   $ 10,138,000       $ 8,549,000       $ 28,789,000       $ 24,542,000   
                                   

16. SIGNIFICANT CUSTOMERS AND CONCENTRATION OF CREDIT RISK:

For the nine months ended January 31, 2011, two customers, AmerisourceBergen and McKesson, accounted for net sales of approximately 12% and 11%, respectively. These customers represented approximately 44% of accounts receivable at January 31, 2011. For the nine months ended January 31, 2010, four customers, McKesson, AmerisourceBergen, Cardinal Health and Walgreens, accounted for net sales of approximately 24%, 19%, 17% and 11%, respectively. At January 31, 2010, trade receivables from these customers were approximately 69% of total receivables.

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

 

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17. FAIR VALUE MEASUREMENTS:

The carrying value of certain financial instruments such as cash and cash equivalents, accounts receivable, investments, notes payable and accounts payable approximate their fair values due to their short-term nature or their underlying terms.

The fair value of long-term debt is deemed to be the carrying value due to the variable interest rate on such borrowings which is aligned with market fluctuation of interest rates.

18. SUBSEQUENT EVENTS:

On March 2, 2011 the US Food and Drug Administration, (FDA) has indicated, in its MedWatch publication, that the Agency intends to remove approximately 500 currently marketed cough/cold and allergy related products. Three of these are currently marketed by ECR Pharmaceuticals, a wholly owned subsidiary of Hi-Tech Pharmacal, Co., Inc. The affected products are:

 

Product

  

Active Ingredient, Strength

Lodrane® 24 capsules

   Brompheniramine maleate, 12mg

Lodrane® 24 D capsules

   Brompheniramine maleate, 12mg/pseudoephedrine HCl, 90mg

Lodrane® 12 D tablets

   Brompheniramine maleate, 12mg/pseudoephedrine HCl, 45mg

According to the FDA press release, ECR Pharmaceuticals must stop shipping these products within 180 days after March 2, 2011. Sales of these products totaled $11,800,000 for the nine months ended January 31, 2011 and $8,500,000 for the nine months ended January 31, 2010.

In 2010 Hi-Tech’s ECR Pharmaceutical subsidiary initiated a formal approval process with the FDA regarding Lodrane® 24 and Lodrane® 24D. The Company will continue to actively pursue approval for both products.

 

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 JANUARY 31, 2011 AND 2010

Revenue

 

     January 31, 2011      January 31, 2010      Change     % Change  

Hi-Tech Generics

   $ 40,546,000       $ 30,449,000       $ 10,097,000        33

Health Care Products

     3,673,000         2,894,000         779,000        27

Midlothian Laboratories

     332,000         1,052,000         (720,000     (68 )% 

ECR Pharmaceuticals

     5,481,000         4,425,000         1,056,000        24
                                  

TOTAL

   $ 50,032,000       $ 38,820,000       $ 11,212,000        29
                                  

Net sales of Hi-Tech generic pharmaceutical products, which include some private label contract manufacturing, increased due to an increase in sales of Fluticasone Propionate nasal spray. Strong unit sales at higher average prices helped increase sales of Fluticasone Propionate nasal spray to approximately $17,900,000 in the quarter versus approximately $2,700,000 in the comparable quarter. Sales of Dorzolamide with Timolol ophthalmic solution and Dorzolamide ophthalmic solution decreased to approximately $5,200,000 from approximately $8,500,000 in the comparable quarter as the Company sold more units but at lower average prices. The Company is expanding its capacity to meet demand for Fluticasone Propionate. Lower pricing and unit volumes of Acetic Acid with Hydrocortisone also contributed to the decline in sales of other generic products. The Company temporarily halted sales of several unapproved products in late June 2010, which resulted in lower sales of these products. The Company has not resumed shipments of these products.

 

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Sales for the Health Care Products division, which markets the Company’s branded OTC products, rose due to sales of the MagOx® line of magnesium supplements the Company acquired from Blaine Pharmaceuticals in March 2010.

Midlothian Laboratories’ sales declined due to lower pricing and decreased volumes.

ECR Pharmaceuticals, which sells branded prescription products, experienced increased sales of the Lodrane® line of antihistamines, which were partially offset by lower sales of the Dexpak® line of corticosteroids.

On March 2, 2011, the US Food and Drug Administration (FDA) indicated in its MedWatch publication that the Agency intends to remove approximately 500 currently marketed cough/cold and allergy related products. Three of these are currently marketed by ECR Pharmaceuticals. According to the FDA press release, ECR Pharmaceuticals must stop shipping these products within 180 days after March 2, 2011. Sales of Lodrane® products amounted to approximately $4,900,000 and $3,500,000 for the three months ended January 31, 2011 and January 31, 2010, respectively.

Cost of Sales

 

     January 31, 2011     January 31, 2010  
   $      % of sales     $      % of sales  

Cost of Sales

     21,761,000         43     16,269,000         42

The increase in cost of sales as a percentage of net sales is primarily due to significant pricing declines for Dorzolamide with Timolol ophthalmic solution and Dorzolamide ophthalmic solution. Increased sales of Fluticasone Propionate nasal spray at higher average prices partially offset this effect as did sales of the MagOx® line of magnesium supplements, which sell at margins above the Company’s average. The Company experienced an increase in prices on certain raw materials and components which increased cost of sales. Included in cost of sales is a reserve of $400,000 for potential obsolescence of Lodrane® inventory for the ECR subsidiary.

Expense (Income) Items

 

     January 31, 2011     January 31, 2010     Change     % Change  

Selling, general and administrative expense

   $ 11,267,000      $ 11,983,000      $ (716,000     (6 )% 

Research and product development costs

   $ 2,742,000      $ 1,718,000      $ 1,024,000        60

Royalty income

   $ (1,557,000   $ (1,596,000   $ 39,000        (2 )% 

Contract research (income)

   $ (50,000   $ (581,000   $ 531,000        (91 )% 

Interest expense

   $ 12,000      $ 9,000      $ 3,000        33

Other (income) expense

   $ 227,000      $ 52,000      $ 175,000        337

Provision for income tax expense

   $ 5,492,000      $ 2,426,000      $ 3,066,000        126

The decline in selling, general and administrative expenses was primarily due to absence of the royalty payment on profits of Dorzolamide with Timolol ophthalmic solution which was $2,500,000 in the prior period. The Company bought out its partner on the product in January 2010 and no longer incurs this expense.

Offsetting the decline in selling, general and administrative expenses were increased legal expenses, including legal work related to complying with the warning letter the Company received from the FDA. Amortization expense also increased when compared to the prior year.

Selling, general and administrative expenses for the ECR Pharmaceuticals subsidiary rose as the sales force increased.

The increase in Research and Development expenditures is due to increased spending on internal projects for the generic division and expenditures at the Company’s ECR Pharmaceuticals subsidiary.

Royalty income includes royalties relating to Brometane, a cough and cold product which the Company divested in July 2008, a royalty on sales of certain Naprelan® strengths and on nutritional products divested by the Company’s Midlothian division.

Other (income) expense includes a $250,000 write-off of the Company’s investment in Neuro-Hitech based on the decline in the stock price and the limited trading activity.

The effective tax rate increased to 34% in the three months ended January 31, 2011 from 22% for the three months ended January 31, 2010. The prior year rate was lower due to larger benefit of stock option exercises.

Income Analysis

 

     January 31, 2011      January 31, 2010      Change      % Change  

Net Income

   $ 10,138,000       $ 8,540,000       $ 1,598,000         19

Basic Earnings Per Share

   $ 0.80       $ 0.70       $ 0.10         14

Diluted Earnings Per Share

   $ 0.79       $ 0.67       $ 0.12         18

Weighted Average Common Shares Outstanding, Basic

     12,632,000         12,179,000         453,000         4

 

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     January 31, 2011      January 31, 2010      Change     % Change  

Effect of Potential Common Shares

     242,000         521,000         (279,000     (54 )% 

Weighted Average Common Shares Outstanding, Diluted

     12,874,000         12,700,000         174,000        1

The increased share count in period to period shares outstanding reflects option exercises and new option grants.

RESULTS OF OPERATIONS FOR NINE MONTHS ENDED JANUARY 31, 2011 AND 2010

Revenue

 

     January 31, 2011      January 31, 2010      Change     % Change  

Hi-Tech Generics

   $ 109,392,000       $ 99,146,000       $ 10,246,000        10

Health Care Products

     10,553,000         8,597,000         1,956,000        23

Midlothian Laboratories

     1,657,000         3,192,000         (1,535,000     (48 )% 

ECR Pharmaceuticals

     13,720,000         12,237,000         1,483,000        12
                                  

TOTAL

   $ 135,322,000       $ 123,172,000       $ 12,150,000        10
                                  

Net sales of Hi-Tech generic pharmaceutical products, which include some private label contract manufacturing, increased due to an increase in sales of Fluticasone Propionate nasal spray and a decrease in sales of Dorzolamide with Timolol ophthalmic solution and Dorzolamide ophthalmic solution. Strong unit sales at higher average prices helped increase sales of Fluticasone Propionate nasal spray to $46,900,000 in the period versus $7,400,000 in the comparable period. Sales of Dorzolamide with Timolol ophthalmic solution and Dorzolamide ophthalmic solution dropped to approximately $21,200,000 from approximately $27,200,000 in the comparable period as the Company sold more units but at lower average prices. Sales of cold and flu items declined in the current period, compared to a period of unusually strong demand last summer. Lower pricing and unit volumes of Acetic Acid with Hydrocortisone also contributed to the decline in sales of other generic products. The Company temporarily halted sales of several unapproved products in late June 2010, which resulted in lower sales of these products. As of today, the Company has not resumed shipments of these products.

The Health Care Products division, which markets the Company’s branded OTC products, experienced higher sales due to the Company’s acquisition of the MagOx® line of magnesium supplements from Blaine Pharmaceuticals in March 2010.

Midlothian Laboratories’ sales declined due to the divestiture of certain nutritional products in July 2010, for which the Company is now receiving royalty income through July 31, 2012 and due to lower pricing on other products.

ECR Pharmaceuticals, which sells branded prescription products, saw increased sales of the Lodrane® line of antihistamines, which were partially offset by lower sales of the Dexpak® line of corticosteroids.

On March 2, 2011, the US Food and Drug Administration (FDA) indicated in its MedWatch publication that the Agency intends to remove approximately 500 currently marketed cough/cold and allergy related products. Three of these are currently marketed by ECR Pharmaceuticals. According to the FDA press release, ECR Pharmaceuticals must stop shipping these products within 180 days after March 2, 2011. Sales of Lodrane® products amounted to approximately $11,800,000 and $8,500,000 for the nine months ended January 31, 2011 and January 31, 2010, respectively.

Cost of Sales

 

     January 31, 2011     January 31, 2010  
     $      % of sales     $      % of sales  

Cost of Sales

     58,855,000         43     51,673,000         42

The increase in cost of sales as a percentage of net sales is primarily due to significant pricing declines for Dorzolamide with Timolol ophthalmic solution and Dorzolamide ophthalmic solution. Increased sales of Fluticasone Propionate nasal spray at higher average prices partially offset this effect as did sales of the MagOx® line of magnesium supplements, which sell at margins above the Company’s average. The Company experienced an increase in prices on certain raw materials and components which increased cost of sales. Included in cost of sales is a reserve of $400,000 for potential obsolescence of Lodrane® inventory for the ECR subsidiary.

Expense (Income) Items

 

     January 31, 2011     January 31, 2010     Change     % Change  

Selling, general and administrative expense

   $ 29,871,000      $ 34,845,000      $ (4,974,000     (14 )% 

Research and product development costs

   $ 7,207,000      $ 5,184,000      $ 2,023,000        39

Royalty income

   $ (3,778,000   $ (2,539,000   $ (1,239,000     49

 

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     January 31, 2011     January 31, 2010     Change      % Change  

Contract research income

   $ (667,000   $ (894,000   $ 227,000         (25 )% 

Interest expense

   $ 34,000      $ 24,000      $ 10,000         42

Other (income) expense

   $ (89,000   $ (1,233,000   $ 1,144,000         (93 )% 

Provision for income tax expense

   $ 15,100,000      $ 11,500,000      $ 3,600,000         31

The decline in selling, general and administrative expenses was primarily due to absence of the royalty payment on profits of Dorzolamide with Timolol ophthalmic solution which was $4,100,000 in the prior period. The Company bought out its partner on the product in January 2010 and no longer incurs this expense.

Selling, general and administrative expenses for the ECR Pharmaceuticals subsidiary rose as the sales force increased.

The increase in Research and Development expenditures is due to increased spending on internal projects for the generic division and expenditures at the Company’s ECR Pharmaceuticals subsidiary.

Royalty income includes royalties relating to Brometane, a cough and cold product which the Company divested in July 2008, a royalty on sales of certain Naprelan® strengths and on nutritional products divested by the Company’s Midlothian division.

Other (income) expense includes the $1,000,000 gain on the sale of the related rights to certain nutritional products previously sold by Midlothian for the nine months ended January 31, 2010. Other (income) expense also includes the $250,000 write-off of the Company’s investment in Neuro-Hitech based on the decline in the stock price and the limited trading activity.

The effective tax rate increased to 34% in the nine months ended January 31, 2011 from 32% in the nine months ended January 31, 2010 due to a larger benefit from stock option exercises in the prior period.

Income Analysis

 

     January 31, 2011      January 31, 2010      Change     % Change  

Net Income

   $ 28,789,000       $ 24,612,000       $ 4,177,000        17

Basic Earnings Per Share

   $ 2.29       $ 2.10       $ 0.19        9

Diluted Earnings Per Share

   $ 2.22       $ 2.01       $ 0.21        10

Weighted Average Common Shares Outstanding, Basic

     12,595,000         11,732,000         863,000        7

Effect of Potential Common Shares

     399,000         533,000         (134,000     (25 )% 

Weighted Average Common Shares Outstanding, Diluted

     12,994,0000         12,265,000         729,000        6

The increased share count in period to period shares outstanding reflects option exercises and new option grants.

LIQUIDITY AND CAPITAL RESOURCES

The Company’s operations are historically financed principally by cash flow from operations. At January 31, 2011 and April 30, 2010, working capital was approximately $119,016,000 and $88,692,000, respectively, an increase of $30,324,000 during the nine months ended January 31, 2011.

Cash flows provided by operating activities were approximately $26,592,000 which is primarily due to net income in the period offset by the increase in accounts receivable and an increase in inventory. Part of the increase in inventory is due to a buildup of components for Fluticasone Propionate nasal spray and finished product for the planned Zolpimist® oral spray launch.

Cash flows used in investing activities were $5,563,000 and were mostly for capital expenditures which were primarily made for capacity expansion at the Company’s Amityville facilities and earnout payments related to ECR.

Cash flows provided by financing activities of $1,974,000 include the proceeds from the exercise of stock options of $1,197,000 and the draw down on an equipment financing line from JP Morgan Chase of $621,000.

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. The Company does not believe that the suspension of sales of Lodrane® products will have a material impact on the Company’s liquidity over the next twelve months. Additionally, the Company has a $10,000,000 revolving line of credit with JP Morgan Chase which remains undrawn, and an additional

 

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$4,379,000 of the equipment financing line from JP Morgan Chase. Both of these financing agreements have terms which expire no earlier than May 27, 2013.

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 rate, or for a LIBOR Loan, at a rate equal to the Adjusted LIBOR rate 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.

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, and anticipates drawing down an additional $1,379,000 to finance the remaining payments for the equipment.

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 January 2010, the FASB amended the existing disclosure guidance on fair value measurements, which is effective for the Company on May 1, 2010, except for disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements, which is effective May 1, 2011. Among other things, the updated guidance requires additional disclosure for the amounts of significant transfers in and out of Level 1 and Level 2 measurements and requires certain Level 3 disclosures on a gross basis. Additionally, the updates amend existing guidance to require a greater level of disaggregated information and more robust disclosures about valuation techniques and inputs to fair value measurements. Since the amended guidance requires only additional disclosures, the adoption of the provisions effective May 1, 2011 will not impact the Company’s financial position or results of operations. The implementation of this guidance, for the provisions effective May 1, 2010, did not have a material impact on the Company’s consolidated financial statements.

SEASONALITY

Historically, the months of September through March account for a greater portion of the Company’s sales than the other months of the fiscal year. However, this sales pattern is unlikely to continue as the Company sells fewer cough and cold products, more allergy products and more products without seasonal fluctuations. Even with these changes in product mix, 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

 

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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 risk 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 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 by utilizing historical sales data to calculate an average estimated chargeback percentage by product by customer. The percentage is applied to all wholesale invoices that have been billed to the customer within a reasonable time frame determined by the Company. The Company currently obtains wholesaler inventory data for the wholesalers which represent approximately 95% of our chargeback activity. This data is used to verify the information calculated in the chargeback accrual.

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

 

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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 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.

The following table presents the roll forward of each significant estimate as of January 31, 2011 and January 31, 2010 and for the nine months then ended, respectively.

 

For the nine months ended January 31, 2011

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

Chargebacks

   $ 6,685,000       $ 86,842,000       $ (85,171,000   $ 8,356,000   

Sales Discounts

     1,405,000         5,366,000         (5,205,000     1,566,000   

Sales Allowances & Returns

     6,766,000         25,657,000         (26,976,000     5,447,000   
                                  

TOTAL ADJUSTMENT FOR RETURNS & PRICE ALLOWANCES

   $ 14,856,000       $ 117,865,000       $ (117,352,000   $ 15,369,000   
                                  

For the nine months ended January 31, 2010

                          

Chargebacks

   $ 3,299,000       $ 55,837,000       $ (53,260,000   $ 5,876,000   

Sales Discounts

     786,000         4,204,000         (4,241,000     749,000   

Sales Allowances & Returns

     8,140,000         20,035,000         (18,470,000     9,705,000   
                                  

TOTAL ADJUSTMENT FOR RETURNS & PRICE ALLOWANCES

   $ 12,225,000       $ 80,076,000       $ (75,971,000   $ 16,330,000   
                                  

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 or 60 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.

 

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CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS

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 January 31, 2011 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.

Interest Rate Risks

As of January 31, 2011, the Company had $621,000 in long-term debt outstanding under an equipment financing agreement. This borrowing and any future borrowings will bear interest at negotiated rates and would be subject to interest rate risk. The agreement includes interest rates at the option of the Company that are based on: (i) the Prime Rate; (ii) Adjusted LIBOR plus the Applicable Margin. The effective interest rate was 1.82% for the nine months ended January 31, 2011.

Assuming no changes in the Company’s financial structure as it stood at January 31, 2011, if market interest rates average an increase of 100 basis points over the final three months period for Fiscal 2011 compared to the interest rates incurred for the nine month period ended January 31, 2011, there would be an immaterial change in interest expense. This amount was determined by calculating the effect of the average hypothetical interest rate increase on the Company’s variable rate under the equipment financing agreement.

 

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.

 

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PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

The disclosure under Note 13, 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

 

Period

   Total Number of
Shares  Purchased
     Average Price  per
Share
     Total Number of  Shares
Purchased as Part of Publicly
Announced Plans
     Approximate Dollar
Value  of Shares that
May Yet Be Purchased
Under the Plans (1)
 

11/01/10 – 11/30/10

     0       $ 0         0       $ 0   

12/01/10 – 12/31/10

     0       $ 0         0       $ 0   

1/01/11 – 1/31/11

     0       $ 0         0       $ 0   

 

(1) The Company’s Board of Directors has authorized $23,000,000 to repurchase the Company’s common stock. To date the Company has purchased 2,456,000 shares for the full $23,000,000 authorization. There are no further repurchases planned at this time.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

 

ITEM 4. (REMOVED AND RESERVED)

None

 

ITEM 5. OTHER INFORMATION

None

 

ITEM 6. EXHIBITS

(a) Exhibits

 

  3.1    Certificate of Incorporation
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 2002

 

 

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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)

 

By:  

/S/    DAVID S. SELTZER

    Date: March 14, 2011
  David S. Seltzer    
  (President and Chief Executive Officer)    
By:  

/s/    William Peters

    Date: March 14, 2011
  William Peters    
  (Vice President and Chief Financial Officer)    

 

 

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