Attached files

file filename
EX-31.2 - CERTIFICATION PURSUANT TO RULE 13A-14 OR 15D-14 - HI TECH PHARMACAL CO INCdex312.htm
EX-32.1 - CERTIFICATION OF CEO AND CFO PURSUANT TO 18 U.S.C. SECTION 1350 - HI TECH PHARMACAL CO INCdex321.htm
EX-21.1 - SUBSIDIARIES OF THE REGISTRANT - HI TECH PHARMACAL CO INCdex211.htm
EX-31.1 - CERTIFICATION PURSUANT TO RULE 13A-14 OR 15D-14 - HI TECH PHARMACAL CO INCdex311.htm
EX-23.1 - CONSENT OF EISNERAMPER LLP - HI TECH PHARMACAL CO INCdex231.htm
Table of Contents

 

 

U.S. Securities and Exchange Commission

Washington, D.C. 20549

 

 

Form 10-K

 

 

 

x ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For fiscal year ended April 30, 2011

 

¨ 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)

 

(I.R.S. Employer

Identification Number)

369 Bayview Avenue, Amityville, New York 11701

(Address of principal executive offices, including zip code)

Registrant’s telephone number, including area code: (631) 789-8228

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $.01 par value

(Title of Class)

 

 

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    ¨  Yes    x  No

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    ¨  Yes    x  No

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 of 1934 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  ¨    Accelerated filer  x    Non-accelerated filer  ¨    Smaller reporting company  ¨
      (Do not check if a smaller
reporting company)
  

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

The aggregate market value of the voting stock held by non-affiliates of the registrant as of October 31, 2010, the last business day of the registrant’s most recently completed second fiscal quarter, was $207,626,000, based upon the closing price of the common stock on that date, as reported by NASDAQ. Shares of common stock known to be owned by directors and executive officers of the Registrant subject to Section 16 of the Securities Exchange Act of 1934 are not included in the computation. No determination has been made that such persons are “affiliates” within the meaning of Rule 12b-2 under the Exchange Act.

The number of shares of common stock of the registrant outstanding as of July 8, 2011 was 12,738,000.

DOCUMENTS INCORPORATED BY REFERENCE: None

 

 

 


Table of Contents

HI-TECH PHARMACAL CO., INC.

INDEX TO FORM 10-K

FOR THE YEAR ENDED APRIL 30, 2011

 

  PART I   

ITEM 1.

  Business      2   

ITEM 1A.

  Risk Factors      10   

ITEM 1B.

  Unresolved Staff Comments      15   

ITEM 2.

  Properties      15   

ITEM 3.

  Legal Proceedings      15   

ITEM 4.

  Removed and Reserved      16   
  PART II   

ITEM 5.

  Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities      16   

ITEM 6.

  Selected Financial Data      19   

ITEM 7.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      20   

ITEM 7A.

  Quantitative and Qualitative Disclosures About Market Risk      28   

ITEM 8.

  Financial Statements and Supplementary Data      29   

ITEM 9.

  Changes In and Disagreements With Accountants on Accounting and Financial Disclosure      54   

ITEM 9A.

  Controls and Procedures      54   

ITEM 9B.

  Other Information      55   
  PART III   

ITEM 10.

  Directors, Executive Officers and Corporate Governance      55   

ITEM 11.

  Executive Compensation      59   

ITEM 12.

  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      72   

ITEM 13.

  Certain Relationships, Related Transactions and Director Independence      74   

ITEM 14.

  Principal Accountant Fees and Services      74   
  PART IV   

ITEM 15.

  Exhibits, Financial Statement Schedules      76   

SIGNATURES

     78   

CERTIFICATIONS

  

 

1


Table of Contents

FORWARD LOOKING STATEMENTS

This Annual Report on Form 10-K and certain information incorporated herein by reference contain certain future projections and forward-looking statements (statements which are not historical facts) with respect to the anticipated future performance of Hi-Tech made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such future projections and forward-looking statements are not assurances, promises or guarantees and investors are cautioned that all future projections and forward-looking statements involve significant business, economic and competitive risks and uncertainties, many of which are beyond Hi-Tech’s ability to control or estimate precisely, 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, loss of customers or employees, the possibility that legal proceedings may be instituted against Hi-Tech and other results and other risks detailed from time to time in Hi-Tech’s filings with the Securities and Exchange Commission. The actual results will vary from the projected results and such variations may be material. These statements are based on management’s current expectations and assumptions concerning the future performance of Hi-Tech and are naturally subject to uncertainty and changes in circumstances. No representations or warranties are made as to the accuracy or completeness of any of the information contained herein, including, but not limited to, any assumptions or projections contained herein or forward-looking statements based thereon. We caution you not to place undue reliance upon any such forward-looking statements which speak only as of the date made, except to the extent specifically dated as of an earlier date. Hi-Tech is under no obligation, and expressly disclaims any such obligation, to update, alter or correct any inaccuracies herein, whether as a result of new information, future events or otherwise.

PART I

 

ITEM 1. BUSINESS.

General

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 manufacturer and marketer of prescription, over-the-counter and nutritional products.

We develop, manufacture and market products in three categories – generics, prescription brands and over the counter (OTC) brands. We produce a wide range of products for various disease states, including glaucoma, asthma, bronchial disorders, dermatological disorders, allergies, pain, stomach, oral care and other conditions.

The Company’s generic products are primarily prescription items and include oral solutions and suspensions, topical creams and ointments as well as nasal sprays. We also specialize in the manufacture of products in our state of the art sterile facility capable of producing liquid ophthalmic, otic and inhalation products. The generic product category includes a small amount of contract manufacturing sales for both the prescription and OTC markets.

The Company’s Midlothian Laboratories division, a generic pharmaceutical company specializing in prescription vitamins, operated through a “virtual company” structure, outsourcing R&D and manufacturing, while concentrating on the marketing of generics, was divested in May 2011, subsequent to the fiscal year end.

Our ECR Pharmaceuticals (“ECR Pharmaceuticals” or “ECR”) subsidiary is engaged in the development and distribution of branded prescription pharmaceuticals. ECR’s products treat various disease states, including pain relief, sleep disorders, allergies, poison ivy and contact dermatitis, and swimmer’s ear. The Company does not manufacture any of ECR’s products except for the Vosol® line. Other products are sourced, at ECR’s direction, through contract manufacturers and packagers. Research and development is also conducted through contract organizations.

Our Health Care Products Division (“HCP”) markets a line of OTC branded products primarily for people with diabetes, including Diabetic Tussin® , DiabetiDerm®, Multi-betic®, Mag-Ox®, Choice® DM and DiabetiSweet®. The division also sells the Zostrix® brand of capsaicin products for pain management of conditions including arthritis and diabetic foot pain. In addition, HCP markets Nasal Ease homeopathic allergy reliever.

Our customers include chain drug stores, drug wholesalers, managed care purchasing organizations, certain Federal government agencies, generic distributors, mass merchandisers, and mail-order pharmacies. Some of our key customers include McKesson Corporation, Cardinal Health, Inc., AmeriSourceBergen Corporation, CVS, Walgreens and Medco.

For the fiscal year ended April 30, 2011 sales of generic pharmaceuticals represented 81% of total sales, sales of the Company’s ECR Pharmaceutical subsidiary were 12% and sales of the Health Care Products line of OTC products accounted for 7% of total sales.

 

2


Table of Contents

Generic Products

Our top 5 selling generic products in fiscal 2011 were:

 

   

Fluticasone propionate (the generic equivalent of Flonase® from GlaxoSmithKline)

 

   

Dorzolamide with Timolol and Dorzolamide (the generic equivalents of Cosopt® and Trusopt® from Merck)

 

   

Sulfamethoxazole with Trimethoprim (the generic equivalent of Bactrim® from Roche)

 

   

Hydrocodone with Homatropine (the generic equivalent of Endo’s Hycodan®)

 

   

Lactulose (the generic equivalent of Sanofi-Aventis’ Chronulac® and Cephulac®)

Generic Approvals and Product Launches

We have 51 prescription products approved for marketing by the Food and Drug Administration (“FDA”) and two products with tentative approval. In addition, we have 13 products submitted to the FDA pending approval, including one product, mesalamine, filed by another company in which the Company has a financial interest and approximately 20 products in various stages of development.

In our fiscal 2011, we received approvals for four products from the FDA:

 

   

Gabapentin Oral Solution (the generic equivalent of Pfizer’s Neurontin®), launched February 2011

 

   

Levofloxacin Ophthalmic Solution (the generic equivalent of Vistakon’s Quixin®), launched March 2011

 

   

Ranitidine Syrup (the generic equivalent of GlaxoSmithKline’s Zantac®), launched May 2011

 

   

Lidocaine HCL Jelly 2% (the generic equivalent of APP’s Xylocaine®), to be launched in fiscal 2012

The Company received tentative approvals for two products including:

 

   

Levofloxacin Oral Solution (the generic equivalent of McNeil’s Levaquin®), launched in June 2011

 

   

Brimonidine Tartrate and Timolol Maleate Ophthalmic Solution (the generic equivalent of Allergan’s Combigan®), to be launched pursuant to the terms of the Allergan settlement (See (Note L) [2] to the consolidated financial statements).

Additionally, the Company launched the following product for which a partner company received approval:

 

   

Buprenorphine (the generic equivalent of Reckitt Benckiser’s Subutex®), launched September 2010

ECR Pharmaceuticals

ECR’s products are branded and trademarked. The products, in order of sales, are:

 

   

Lodrane® 24/Lodrane® 24 D, an extended release antihistamine/ antihistamine with decongestant capsule

 

   

Bupap®, an analgesic tablet

 

   

DexPak® TaperPak, an oral corticosteroid tablet available in 13 day, 10 day and 6 day tapered packages

 

   

Zolpimist® Oral Spray, indicated for the treatment of insomnia

 

   

Tropazone™, a treatment for dermatitis

 

   

Vosol® HC, a treatment for swimmer’s ear

On March 2, 2011, the U.S. Food and Drug Administration “FDA” indicated in its MedWatch publication that the FDA intends to remove approximately 500 currently marketed cough/cold and allergy related products. Three of these are currently marketed by ECR Pharmaceuticals under the brand name Lodrane®. ECR Pharmaceuticals must stop shipping these products within 180 days after March 2, 2011. Sales of Lodrane® products amounted to approximately $16,600,000 and $13,100,000 for the year ended April 30, 2011 and April 30, 2010, respectively. The Company is pursuing a variety of options to obtain FDA approval for a Lodrane® product.

Health Care Products Division

Our Health Care Products Division (“HCP”) is a leading marketer of OTC branded products that include over-the-counter medications, nutritional products, cosmetics and medical devices, primarily for people with diabetes. HCP also has several lines that fall outside the diabetes area in pain management and allergy products. The Health Care Products Division is composed of several product lines which account for a majority of its sales.

 

3


Table of Contents

The top five product lines, in order of sales, are:

 

   

Diabetic Tussin® cough products

 

   

Mag-Ox® magnesium supplement

 

   

Zostrix® pain relief products

 

   

Multibetic® multi-vitamins

 

   

DiabetiDerm® dermatological and footcare products

The Diabetic Tussin® line accounted for over one third of Health Care Products sales.

Growth Strategy

Management believes that growth in the generic pharmaceutical industry is driven by several factors which should continue in the coming years. These factors include:

 

   

The increasing number of branded pharmaceutical products that have lost or will lose patent protection or exclusivity

 

   

Efforts by federal and state governments, employers, third-party payers and consumers to control health care costs

 

   

The aging of the U.S. population

 

   

Increased acceptance of generic products by physicians, pharmacists and consumers

Management intends to exploit these macroeconomic trends by making strategic decisions which will result in the Company’s growth. Our growth strategy is based on the following:

 

   

Increase the number of new product introductions by expanding our research and development efforts and increasing our ANDA submissions

 

   

Increase market share for our core prescription generic products by adding new customers and introducing additional products to existing customers

 

   

Continue to develop and license branded products with a focus on niche markets, such as diabetes care and related areas, including podiatry

 

   

Acquire products and businesses that management believes can contribute to the Company’s growth

 

   

Leverage our manufacturing capabilities by primarily focusing on the development of liquid and semi-solid dosage forms and products requiring sterile manufacturing

Product Development Strategy

Our product development strategy is determined by Hi-Tech’s strategic focus on liquid dosage forms with emphasis on ophthalmic products and nasal sprays. Our product selection process includes the following criteria:

 

   

Products that we believe will have limited competition due to smaller market size but can generate long term revenues

 

   

Products with significant volume and high annual sales

 

   

Products that are difficult to bring to market and more likely to face limited competition, enabling us to earn higher margins for a longer period of time. These opportunities include nasal sprays and sterile products, including ophthalmics and inhalation products. Some of these projects may include barriers to competition such as clinical trials.

 

   

Products with patents that we believe we can successfully challenge through the patent challenge process of the Hatch-Waxman Act

Current branded market for the dosage forms that present strategic interest to Hi-Tech

 

     In billions  

Ophthalmic

   $ 3.0   

Nasal Spray

   $ 1.9   

Solutions for Inhalation

   $ 1.2   

Oral Liquid (solutions and suspensions)

   $ 0.7   

Other targeted products

   $ 1.3   
        
   $ 8.1   
        

 

4


Table of Contents

Based on the outlined criteria and branded products market potential, the Company has identified specific products for our pipeline that either have patents or exclusivity which expire in the next five years or have patents which the Company believes that it can successfully challenge. We are currently developing drugs with total branded sales of approximately $4 billion and plan to take advantage of this opportunity.

In addition to the main strategic focus, the Company enters into partnerships with other pharmaceutical companies in the United States and overseas to develop other dosage forms, such as tablets, capsules and powders. Under such arrangements, the Company sponsors or co-sponsors product development. In return Hi-Tech will either have marketing rights for approved products in the United States and pay a royalty to its partner, or receive royalty payments on the sales of products manufactured and marketed by a partner. Such agreements potentially expand the Company’s product line offered to its customers and increase its revenue stream through royalty payments.

Research and Development

The Company obtains new generic pharmaceutical products primarily through internal product development. The Company currently employs 31 pharmaceutical scientists, ten of whom have Ph. D degrees. The group is led by Dr. Kamel Egbaria, the Company’s Executive Vice President and Chief Scientific Officer. The Company also enters into strategic arrangements with other pharmaceutical companies. These strategic arrangements include both development contracts where Hi-Tech pays a third party to develop a new product and licensing arrangements where Hi-Tech sells a product and pays a royalty to the owner of the ANDA or NDA.

For the fiscal years ended April 30, 2011, 2010 and 2009 total R&D expenditures were $9,350,000, $7,259,000 and $7,429,000 respectively. The increase over the past year is the result of expenditures on both internal and external development projects. The Company’s largest expenditure was on mesalamine 400 mg, a product that was jointly developed with two other generic drug companies. The Company spent $127,000, $713,000, and $2,978,000 in fiscal years ended April 30, 2011, 2010 and 2009 respectively, on this project including expenditures on a clinical trial. An ANDA was filed for the product in fiscal 2010.

During the fiscal year the Company began work on three ANDA projects that are expected to require multi-million dollar clinical trials. All of these projects were undertaken with different partners which will share in development costs and profits once the products are brought to the market.

We have 13 ANDA applications pending at the FDA that address over $1 billion in annual brand and generic product sales in the United States in 2010 according to IMS Health. Additionally, the Company has more than 20 products targeting over $4 billion in branded sales in development. The Company does not know when any of these products will be approved.

ECR Growth Strategy

Our ECR subsidiary launched Zolpimist®, a sleep aid which utilizes a unique oral spray delivery system, in the fourth quarter of fiscal year 2011 and established its presence in the substantial U.S. insomnia marketplace. ECR also launched Tropazone™ Cream, a line extension of its current franchise, during the fourth quarter of fiscal 2011. The Company anticipates launching an additional dermatologic wound care product in the second quarter of fiscal 2012. ECR’s business development efforts are focused on the evaluation of licensing and acquisition opportunities to expand ECR’s product line and introduce new products which offer patient enhancements, and take advantage of the expertise of the sales group.

The Company is currently evaluating several strategies to preserve its Lodrane® franchise. These opportunities include filing a 505(b)(2) filing with the FDA to receive approval for the current Lodrane® product or in-licensing a similar product. A filing with the FDA could lead to either a prescription or OTC product depending on the requested indication and data provided in the filing.

On June 27, 2011, the Company acquired marketing and distribution rights to several branded products for the treatment of pain from Atley Pharmaceuticals. Three of the products are approved and additional products are pending approval with the FDA.

Customers and Marketing

We market our products to chain drug stores, drug wholesalers, managed care purchasing organizations, certain Federal government agencies, generic distributors, mass merchandisers and mail order pharmacies. We sell our generic products to over 100 active accounts located throughout the United States. For the fiscal year ended April 30, 2011, McKesson

 

5


Table of Contents

Corporation, AmerisourceBergen and Cardinal Health accounted for net sales of approximately 15%, 13%, and 11%, respectively. These customers represented approximately 52% of the outstanding accounts receivable at April 30, 2011. Our top five customers accounted for approximately 54% and 66% of the Company’s total sales for the fiscal years ended April 30, 2011 and 2010, respectively. If any of our top five customers discontinues or substantially reduces its purchases from the Company, it may have a material adverse effect on our business and financial condition. We believe, however, that we have good relationships with our customers.

The Company has standard industry agreements made in the ordinary course of business with these customers which include prompt payment discount, and various standard fee or rebate arrangements. Purchases are made on a purchase order basis. The agreements generally do not bind the customers to meet any purchase agreements from the Company. The Company has a contract to supply Dorzolamide and Dorzolamide with Timolol to the U.S. government under the federal supply schedule.

We utilize our state of the art manufacturing facilities and laboratories to offer contract manufacturing services to our existing as well as potential customers.

We are focused on growth and will continue to develop new branded and generic products as well as devise new marketing strategies to penetrate our markets. We are seeking to complement this internal effort by acquiring products for future marketing, as well as licensing rights to proprietary products and technologies for development and commercialization. We will place increasing emphasis on establishing co-development agreements with strategic partners.

ECR currently markets nine different products primarily in the Mid-Atlantic and Southeastern United States. These products are detailed and sampled by ECR’s sales force primarily to physicians serving in general practice, family medicine and certain specialty areas. ECR sells its products to established drug wholesalers, with key customers including Cardinal Health, Inc., McKesson Corporation and AmerisourceBergen Corporation. ECR has arrangements with these wholesalers to stock our products in pharmacies in the areas in which we detail the products.

We market HCP brands using various marketing strategies which include professional and consumer sampling and educational programs, telemarketing, coupon promotions, contemporary packaging and national print media. We also tie in our efforts to retailer’s in-store promotions and circulars. We also plan to increase the use of the internet including social networking sites as a vehicle to promote our brands and emphasize our Company’s goal of helping people with diabetes live a healthier life. We view the internet as an effective vehicle to educate people with diabetes about making good decisions in helping manage their condition. Our websites are registered under the domain names diabeticproducts.com, Zostrix.com, Mag-Ox.com and nasalease.com, which are linked to most search engines and diabetic based websites.

We are focused on growth and will continue to develop new branded and generic products as well as devise new marketing strategies to penetrate our markets. We are seeking to complement this internal effort by acquiring products for future marketing, as well as licensing rights to proprietary products and technologies for development and commercialization. We will place increasing emphasis on establishing co-development and co-marketing agreements with strategic partners.

Facilities

Our manufacturing facilities are designed to be flexible in order to allow for the low cost production of a variety of products of different dosages, sizes, packaging and quantities while maintaining a high level of quality and customer service. This flexible production capability allows us to adjust on-line production in order to meet customer requirements.

We operate from six buildings owned by the Company on one site in Amityville, New York, totaling approximately 207,000 square feet.

Included in these building are two manufacturing facilities, one for sterile and the other for non-sterile products. Our sterile facility has process tanks and 3 filling lines including two liquid fillers and one tube filler. The non-sterile facility includes 23 process tanks at various capacities and 13 filling lines including 11 for liquids, one for semi-solids and one unit dose machine. Included in this list is Hi-Tech’s new high speed nasal spray filling and packing machine, installed in May 2011.

Additionally, the Company leases a 12,000 square feet building in Richmond, Virginia, which houses ECR’s administrative offices and warehouse and a parking lot in Amityville, NY.

Raw Materials/Active Pharmaceutical Ingredients

The active compounds for our products, also called active pharmaceutical ingredients or APIs, are purchased from specialized manufacturers and are essential to our business and success. API manufacturers are required to file a Drug Master File with the FDA. Each individual API must be approved by the FDA as part of the ANDA approval process. API manufacturers are also regularly inspected by the FDA.

 

6


Table of Contents

In some cases, the raw materials used to manufacture pharmaceutical products are only available from a single FDA-approved supplier. Even when more than one supplier exists, the Company may elect to list, and in most cases has only listed, one supplier in its applications with the FDA. Any change in a supplier not previously approved must then be submitted through a supplemental approval process with the FDA.

It is crucial for the business to select suppliers that meet Current Good Manufacturing Practices (“cGMP”) requirements and that are reliable and offer competitive prices. We are proactive in maintaining good relationships with our API suppliers because we believe that these relationships allow us to save crucial time and be cost competitive. For new products in development, the timely selection of the right API suppliers that have access to cutting-edge chemical and process technologies, and in some cases offer proprietary and patented methods for chemical synthesis and manufacturing processes, can potentially give us a significant advantage over our competitors.

We believe we have good, cooperative working relationships with our suppliers and are not experiencing any difficulty in obtaining raw materials. If a supplier were unable to supply us, we believe we could locate an alternative supplier. However, any change in suppliers of a raw material could cause significant delays and cost increases in the manufacture of products. To mitigate this risk and to lower costs, the Company is currently in the process of certifying alternative suppliers for several key APIs.

We have a non-exclusive supply agreement with Ragactives S.L.U. (“Ragactives”) dated July 18, 2008 to supply dorzolamide hydrochloride, the active ingredient in Dorzolamide with Timolol Ophthalmic Solution and Dorzolamide Ophthalmic Solution. These products accounted for approximately 14% of Hi-Tech’s sales for fiscal 2011. The agreement has a ten year term beginning in July 2008 and is automatically renewed for successive two year periods unless terminated by either party upon written notice not less than 180 days prior to the end of the current term. The agreement may be terminated by either party upon 90 days’ notice for material breach of the agreement in the event the breaching party fails to remedy the breach during such 90 day period or immediately in the event of bankruptcy. The agreement provides that the Company will consider Ragactives as its preferential supplier of the product and the Company will give Ragactives notice of any offer from a third party manufacturer of the product to enable Ragactives to meet the price of product from such manufacturer. There are no minimum purchase requirements under the agreement; however, the Company is obligated to purchase at least seventy-five (75%) percent of its annual requirements of the product from Ragactives as long as Ragactives’ price is not more than ten (10%) percent higher than other manufacturer’s price. The agreement has standard confidentiality and indemnification clauses. We have no other material agreements with suppliers and we utilize standard purchase orders when obtaining materials.

Our ECR Pharmaceuticals subsidiary uses contract manufacturers to manufacture their products.

Competition

The market for generic pharmaceuticals is highly competitive. Our direct competition consists of numerous generic drug manufacturers, many of which have greater financial and other resources than we do. If one or more other generic pharmaceutical manufacturers significantly reduce their prices in an effort to gain market share, our profitability or market position could be adversely affected. Such competitive pressures was one of the causes of our decline in sales and profitability for fiscal 2007 and 2008. Competition is based principally on price, quality of products, customer service levels, reputation and marketing support.

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, period-to-period comparisons within the same fiscal year are not necessarily meaningful and should not be relied on as indicative of future results.

Government Regulation

FDA Oversight

Our products and facilities are subject to regulation by a number of Federal and state governmental agencies. The FDA, in particular, maintains oversight of our manufacturing process as well as the distribution of our products. Facilities, procedures, operations and/or testing of products are subject to periodic inspection by the FDA, the Drug Enforcement Administration and other authorities. In addition, the FDA conducts pre-approval and post-approval reviews and plant inspections to determine whether our systems and processes are in compliance with cGMP and other FDA regulations. Certain of our suppliers are subject to similar regulations and periodic inspections. We have had several FDA inspections including our most recent which took place in the third quarter of fiscal 2011.

 

7


Table of Contents

A sponsor of a New Drug Application (“NDA”) is required to identify in its application any patent that claims the drug or a use of the drug, which is the subject of the application. Upon NDA approval, the FDA lists the approved drug product and these patents in the Orange Book. In addition to patent exclusivity, the holder of the NDA for the listed drug may be entitled to a period of non-patent, market exclusivity, during which the FDA cannot approve an application for a bioequivalent product. If the listed drug is a new chemical entity, the FDA may not accept an ANDA for a bioequivalent product for up to five years following approval of the NDA for the new chemical entity. If it is not a new chemical entity but the holder of the NDA conducted clinical trials essential to approval of the NDA or a supplement thereto, the FDA may not approve an ANDA for a bioequivalent product before expiration of three years. Certain other periods of exclusivity may be available if the listed drug is indicated for treatment of a rare disease or is studied for pediatric indications.

The FDA has extensive enforcement powers, including the power to seize noncomplying products, to seek court action to prohibit their sale and to seek criminal penalties for noncomplying manufacturers. Although it has no statutory power to force the recall of products, the FDA usually accomplishes a recall as a result of the threat of judicially imposed seizure, injunction and/or criminal penalties.

On June 30, 2010, the Company received a warning letter from the U.S. Food and Drug Administration (“FDA”) resulting from an FDA inspection, which occurred during November and December 2009. 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 responded to the warning letter and as a follow up Hi-Tech management met with FDA on August 3, 2010 to determine how best to resolve these issues. The Company decided to suspend the manufacturing and distribution of these products until the issue is resolved. Sales of these products totaled approximately $5,000,000 in fiscal year 2010. As a follow up to the management meeting with the agency, a follow up inspection was conducted by the FDA in November 2010 that resulted in several observations. Hi-Tech responded to the observations in December 2010. On February 18, 2011 Hi-Tech received its first ANDA approval which the Company believes indicates its compliance to be satisfactory. Hi-Tech received approval on additional five ANDA products between February and May 2011, indicating that the FDA appears satisfied with Hi-Tech’s actions and responses to the warning letter and subsequent observations.

ANDA Process

Most products we currently market and intend to market under our product development program require prior FDA approval using the ANDA procedure prior to being marketed. We currently have 51 approved products, 1 tentatively approved product, 13 products pending FDA approval including one product, mesalamine, in which we have a financial interest, but was filed by another company, and over 20 products in active development, which will require ANDA submissions or a 505(B)(2) submission.

The ANDA approval process is generally less time-consuming and complex than the NDA approval process. It generally does not require new pre-clinical and clinical studies because it relies on the studies establishing safety and efficacy conducted for the drug previously approved through the NDA process. The ANDA process does, however, occasionally, require one or more bioequivalency studies to show that the ANDA drug is bioequivalent to the previously approved drug. Bioequivalence compares the bioavailability of one drug product with that of the referenced product formulation containing the same active ingredient. When established, bioequivalency confirms that the rate of absorption and levels of concentration in the bloodstream of a formulation of the previously approved drug and the generic drug are equivalent. Bioavailability indicates the rate and extent of absorption and levels of concentration of a drug product in the bloodstream needed to produce the same therapeutic effect. Such studies are not generally required to be performed for solutions (oral, ophthalmic, or solutions for inhalation). Suspensions and certain types of topical products do require bioequivalency testing. Topical creams and ointments require clinical testing. Fluticasone propionate nasal spray required a large and expensive clinical trial. In certain cases, such as nasal spray suspensions, clinical studies are required in addition to bioequivalency studies to show efficacy compared to the branded product. Such studies, though not as extensive as corresponding studies conducted by innovator companies as part of their NDA process, will require substantial funding.

The completion of a prospective product’s formulation, testing and FDA approval generally takes several years. Development activities could begin several years in advance of the patent expiration date, and may include bioequivalency and clinical studies. Consequently, we are presently selecting and will continue to select and develop drugs we expect to market several years in the future.

The timing of final FDA approval of ANDA applications depends on a variety of factors, including whether the applicant challenges any listed patents for the drug and/or its use and whether the brand-name manufacturer is entitled to one or more statutory exclusivity periods. Pending the resolution of any such issues the FDA is prohibited from granting final approval to

 

8


Table of Contents

generic products. In certain circumstances, a regulatory exclusivity period can extend beyond the life of a patent, and thus block ANDAs from being approved on the patent expiration date. For example, the FDA may now extend the exclusivity of a product by six months past the date of patent expiry if the manufacturer undertakes studies on the effect of their product in children (“pediatric extension”). See “Patent Challenge Process.”

Before approving a product, the FDA also requires that a company’s procedures and operations conform to cGMP regulations, as defined in the U.S. Code of Federal Regulations. The Company must follow the cGMP regulations at all times during the manufacture of its products.

If the FDA concludes that all substantive ANDA requirements (chemistry, bioequivalency, labeling and manufacturing) have been satisfied, but a final ANDA approval cannot be granted because of patent or exclusivity-related considerations, the FDA may issue a tentative approval.

Patent Challenge Process

The Hatch-Waxman Act provides incentives for generic pharmaceutical manufacturers to challenge patents on branded pharmaceutical products, their methods of use and specific formulations, as well as to develop non-infringing forms of the patented subject matter. The purpose of the Hatch-Waxman Act is to stimulate competition by providing incentives to generic companies to introduce their products early, and at the same time to ensure that such suits are not frivolous.

If there is a patent listed in the FDA’s Orange Book at the time of filing an ANDA with the FDA and the generic drug company intends to market the generic equivalent prior to the expiration of that patent, the generic company files with its ANDA a certification asserting that the patent is invalid, unenforceable and/or not infringed (“Paragraph IV certification”). After receiving notice from the FDA that its application is acceptable for filing, the generic company sends the patent holder and the holder of the New Drug Application (“NDA”) for the brand-name drug a notice explaining why it believes that the patents in question are invalid, unenforceable and/or not infringed. Upon receipt of the notice from the generic company, the patent holder has 45 days during which to bring a patent infringement suit in federal district court against the generic company. Should the patent holder bring suit, the discovery, trial and appeals process in such suits can take several years and have high legal costs.

If a suit is commenced by the patent holder, the Hatch-Waxman Act provides for an automatic stay on the FDA’s ability to grant final approval of the ANDA for the generic product. The period during which the FDA may not approve the ANDA and the patent challenger therefore may not market the generic product is 30 months, or such shorter or longer period as may be ordered by the court. The 30-month period may or may not, and often does not, coincide with the timing of the resolution of the lawsuit or the expiration of a patent, but if the patent challenge is successful or the challenged patent expires during the 30-month period, the FDA may approve the generic drug for marketing, assuming there are no other obstacles to approval such as exclusivities given to the NDA holder.

Under the Hatch-Waxman Act, the developer of a proposed generic drug which is the first to have its ANDA accepted for filing by the FDA, and whose filing includes a Paragraph IV certification, may be eligible to receive a 180-day period of generic market exclusivity. This period of market exclusivity may provide the patent challenger with the opportunity to earn a return on the risks taken and its legal and development costs and to build its market share before competitors can enter the market.

Medicaid and Medicare

Medicaid, Medicare and other reimbursement legislation or programs govern reimbursement levels and require all pharmaceutical manufacturers to rebate a percentage of their revenues arising from Medicaid-reimbursed drug sales to individual states. Congress passed the Affordable Care Act in March 2010, which increased the rebate from 11% to 13% of the average manufacturer’s price for sales of Medicaid-reimbursed products marketed under ANDAs. We believe that Federal or state governments may continue to enact measures aimed at reducing the cost of drugs to the public.

DEA

Because the Company sells and develops products containing controlled substances, it must meet the requirements and regulations of the Controlled Substances Act which are administered by the Drug Enforcement Agency (“DEA”). These regulations include stringent requirements for manufacturing controls and security to prevent diversion of or unauthorized access to the drugs in each stage of the production and distribution process. We have the approval of the DEA to sell certain generic pharmaceutical products containing narcotics. We are currently manufacturing 7 preparations containing narcotics and are developing other products that contain narcotics. In order to manufacture and sell products containing narcotics, we have implemented stringent security precautions to insure that the narcotics are accounted for and properly stored and handled.

 

9


Table of Contents

Environment

We believe that our operations comply in all material respects with applicable laws and regulations concerning the environment. While it is impossible to predict accurately the future costs associated with environmental compliance and potential remediation activities, compliance with environmental laws is not expected to require significant capital expenditures and has not had, and is not expected to have, a material adverse effect on our earnings or competitive position.

Product Liability

The sale of pharmaceutical products can expose the manufacturer of such products to product liability claims by consumers. A product liability claim, if successful and in excess of our insurance coverage, could have a material adverse effect on our financial condition. We maintain product liability insurance policies which provide coverage in the amount $20,000,000 per claim and in the aggregate.

Order Backlog

Due to the relatively short lead-time required to fill orders for our products, the backlog of orders is not material to our business.

Employees

As of April 30, 2011, we employed 406 full-time persons and 2 part-time persons, of whom 48 full-time employees and 1 part-time employee were engaged in executive, financial and administrative capacities; 91 in marketing, sales and service; 166 full-time employees and 1 part-time employee in production, warehousing and distribution; and 101 in research and development and quality control functions. We are not a party to a collective bargaining agreement. The management of the Company considers its relations with its employees to be satisfactory.

Website Access to Filings with the Securities and Exchange Commission

Additional information about the Company is available on our website at www.hitechpharm.com. All of our electronic filings with the SEC including Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, are available on our website free of charge as soon as reasonably practicable after they are electronically filed with and furnished to the SEC. The SEC’s internet site contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. Our SEC filings are also available through the SEC’s website at http://www.sec.gov. You may read and copy any material we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.W., Washington, D.C. 20549. You may obtain information on the operation of the Public Room by calling the SEC at 1-800-SEC-0330. Information contained on our website is not incorporated by reference in the Annual Report on Form 10-K and shall not be deemed “filed” under the Securities Exchange Act of 1934.

 

ITEM 1A. Risk Factors.

The following risk factors could have a material adverse effect on the Company’s business, financial position or results of operations. These risk factors may not include all of the important factors that could affect our business or our industry or that could cause our future financial results to differ materially from historic or expected results or cause the market price of our common stock to fluctuate or decline.

Our pipeline of products in development may be subject to regulatory delays at the FDA. Delays in key products could have material adverse effects on our business, financial position and results of operations.

Our future revenue growth and profitability are dependent upon our ability to develop and introduce new products on a timely basis in relation to our competitors’ product introductions. Our failure to do so successfully could have a material adverse effect on our financial position and results of operations.

Many products require FDA approval prior to being marketed. The process of obtaining FDA approval to manufacture and market new and generic pharmaceutical products is rigorous, time-consuming, costly and largely unpredictable. We may be unable to obtain requisite FDA approvals on a timely basis for new generic products that we may develop. The Company has experienced delays on non-material products from time to time, and has on occasion withdrawn ANDAs when the Company determined that approval was not likely.

 

10


Table of Contents

The ANDA process often results in the FDA granting final approval to a number of ANDAs for a given product. We may face immediate competition when we introduce a generic product into the market. These circumstances could result in significantly lower prices, as well as reduced margins, for generic products compared to brand products. New generic market entrants generally cause continued price and margin erosion over the generic product life cycle.

From June 2010 to February 2011, the Company did not receive any approvals, because the Company was on a compliance hold related to a warning letter at the FDA.

The timing and cost of obtaining FDA approvals could adversely affect our product introduction plans, financial position and results of operations.

We have sold certain prescription items that the Company believes did not require FDA approval. The FDA has taken action to require formal approvals for many of these products.

During fiscal year 2011, Hi-Tech sold approximately 14 generic prescription products which the company believes do not currently require FDA approvals. These products were discontinued by the Company upon receipt of a warning letter by the FDA.

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 responded to the warning letter and met with the FDA to determine how best to resolve these issues. The Company suspended sales of these products until the issue is resolved. Sales of these products totaled approximately $5,000,000 in fiscal year 2010. In addition, the Company incurred an expense of $865,000 to write off the value of the inventory used in the manufacturing of these products.

Many of these products either fall under the grandfathered Drug Efficacy Study Implementation (“DESI”) or nutritional classifications. Grandfathered drugs are drugs that were on the market prior to the passage of the Food, Drug and Cosmetic Act of 1938. It was not until the passage of the Food, Drug and Cosmetic Act of 1938 that a New Drug Application (NDA) was required for marketing a drug product as the regulatory mechanism for insuring that all new drugs were cleared for safety prior to distribution. The requirement for pre-clearance for effectiveness was added by the 1962 amendment.

Following enactment of the 1938 law, drugs on the market prior to that time were exempted or “grandfathered” and manufacturers were not required to file an NDA. The premise was that all pre-1938 drugs were considered safe, and if the manufacturer did not change the product formulation or indication, then an NDA was not required. FDA has taken the position, however, that if manufacturing conditions or labeling for the pre-1938 drugs have changed then these drugs are no longer “grandfathered” and require formal FDA approval.

DESI drugs are drugs that were approved solely on the basis of their safety prior to 1962. Thereafter, Congress required drugs to be shown to be effective as well. The FDA initiated the DESI program to evaluate the effectiveness of those drugs that had been previously approved on safety grounds alone. These drugs, and those identical, related, and similar to them, may continue to be marketed until the administrative proceedings evaluating their effectiveness have been concluded, at which point continued marketing is only permitted if an NDA is approved for such drugs. The vast majority of the DESI proceedings have been concluded, but a few are still pending.

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 under the brand name Lodrane®. ECR Pharmaceuticals must stop shipping these products within 180 days after March 2, 2011. Sales of Lodrane® products amounted to approximately $16,600,000 and $13,100,000 for the year ended April 30, 2011 and April 30, 2010, respectively. The Company reserved $900,000 for the potential obsolescence of Lodrane® inventory held as of April 30, 2011. The Company is pursuing a variety of options to obtain FDA approval for a Lodrane® product.

The following table shows the sales contributions of these unapproved prescription products to each division and Hi-Tech’s total sales for fiscal 2011.

 

     % of Sales  

Hi-Tech Generics

     1

Health Care Products

     0

ECR Pharmaceuticals

     85

Hi-Tech (consolidated)

     9

 

11


Table of Contents

Continuing studies of the proper utilization, safety and efficacy of pharmaceutical products are being conducted by the industry, government agencies and others. Such studies, which increasingly employ sophisticated methods and techniques, can call into question the utilization, safety and efficacy of currently marketed products. In some cases, these studies have resulted, and may in the future result, in the discontinuance of product marketing. These situations, should they occur, could have a material adverse effect on our profitability, financial position and results of operations.

We are subject to government regulation from the FDA and the DEA. We face significant costs and uncertainties associated with our efforts to comply with applicable regulations. Should we fail to comply, we could experience material adverse effects on our business, financial position and results of operations.

The pharmaceutical industry is subject to regulation by various Federal and state governmental authorities. For instance, we must comply with FDA requirements with respect to the manufacture, labeling, sale, distribution, marketing, advertising, promotion and development of pharmaceutical products. Failure to comply with FDA and other governmental regulations can result in fines, disgorgement, unanticipated compliance expenditures, recall or seizure of products, total or partial suspension of production and/or distribution, suspension of FDA’s review of ANDAs, enforcement actions, injunctions and criminal prosecution. Under certain circumstances, the FDA also has the authority to revoke previously granted drug approvals. Although we have internal regulatory compliance programs and policies and have had a favorable compliance history, there is no guarantee that we may not be deemed to be deficient in some manner in the future. If we were deemed to be deficient in any significant way, it could have a material adverse effect on our business, financial position and results of operations.

In addition to the new drug approval process, the FDA also regulates the facilities and operational procedures that we use to manufacture our products. We must register our facilities with the FDA. All products manufactured in those facilities must be made in a manner consistent with current Good Manufacturing Practices (“cGMP”). Compliance with cGMP regulations requires substantial expenditures of time, money and effort in such areas as production and quality control to ensure full technical compliance. Failure to comply with cGMP regulations could result in an enforcement action brought by the FDA, which periodically inspects our manufacturing facilities for compliance, which could include withholding the approval of ANDAs or other product applications of a facility if deficiencies are found at that facility. FDA approval to manufacture a drug is site-specific. If the FDA would cause our manufacturing facilities to cease or limit production, our business could be adversely affected. Delay and cost in obtaining FDA approval to manufacture at a different facility also could have a material adverse effect on our business, financial position and results of operations.

The Drug Enforcement Administration (“DEA”) enforces the Controlled Substances Act and maintains oversight over the Company’s products that are considered controlled substances. The DEA requires the Company to comply with certain reporting and record keeping requirements and requires certification of the Company’s facilities for the manufacture and sale of these products.

We are subject, as are generally all manufacturers, to various Federal, state and local laws of general applicability, such as laws regulating working conditions, as well as environmental protection laws and regulations, including those governing the discharge of materials into the environment. Although we have not incurred significant costs associated with complying with such environmental provisions in the past, if changes to such environmental provisions are made in the future that require significant changes in our operations or if we engage in the development and manufacturing of new products requiring new or different environmental controls, we may be required to expend significant funds. Such changes could have a material adverse effect on our business, financial position and results of operations.

Once approved, our new products may not achieve the expected levels of market acceptance. Failure to capture market share on new products could have material adverse effects on our business, financial position and results of operations.

Our approved products may not achieve expected levels of market acceptance, which could have a material adverse effect on our profitability, financial position and results of operations. Even if we were able to obtain regulatory approvals of our new pharmaceutical products, generic or brand, the success of those products is dependent upon market acceptance. Levels of market acceptance for new products could be impacted by several factors, including:

 

   

the timing of our market entry

 

   

the availability of alternative products from our competitors

 

   

the price of our products relative to that of our competitors

 

   

the availability of authorized generics

 

   

the acceptance of our products by government and private formularies

Many of these factors are not within our control.

 

12


Table of Contents

Our industry is highly competitive. Competitors could cause pricing declines or loss of market share which could cause material adverse effects on our business, financial position and results of operations.

We face competition from other pharmaceutical manufacturers that potentially threatens the commercial acceptance and pricing of our products, which could have a material adverse effect on our business, financial position and results of operations. Competitors which compete with Hi-Tech on multiple products include Wockhardt, Qualitest, Actavis, Falcon, Bausch and Lomb, Fougera, Roxanne and Apotex. Each of these competitors is larger than Hi-Tech and may have the ability to price products more competitively than Hi-Tech. These competitors may reduce prices on products that we currently market which would force us to lower our price or could cause us to lose market share.

Our competitors may be able to develop products and processes competitive with or superior to our own for many reasons, because they may have:

 

   

proprietary processes or delivery systems

 

   

larger research and development staffs

 

   

larger sales and marketing staffs

 

   

larger production capabilities

 

   

more products

 

   

more experience in developing new drugs and greater financial resources

Each of these factors and others could have a material adverse effect on our business, financial position and results of operations.

We sell our products to a limited number of major customers. The number of customers in our industry has declined due to consolidations over the past several years. Any significant reduction in business with any of our top five customers could have a material adverse effect on our business, financial position and results of operations.

Our top 5 customers, based on sales, accounted for 54% of our total sales for fiscal 2011. The Company has standard industry agreements made in the ordinary course of business with these customers which include prompt payment discounts, and various standard fee or rebate arrangements. Purchases are made on a purchase order basis. Therefore, the agreements are not material since they do not bind the customers to purchase their requirements from the Company. Any significant reduction of business with any of our top 5 customers could have a material adverse effect on our business, financial position and results of operations.

Sales of our products may be adversely affected by the continuing consolidation of our customers.

Significant amounts of our sales are made to a relatively small number of drug wholesalers, retail drug chains, managed care purchasing organizations, mail order pharmacies and hospitals. These customers represent an essential part of the distribution chain of generic pharmaceutical products. These customers have undergone, and are continuing to undergo, significant consolidation. This consolidation may result in these groups gaining additional purchasing leverage and consequently increasing the product pricing pressures facing our business. Additionally, the existence of large buying groups representing independent retail pharmacies and the prevalence and influence of managed care organizations and similar institutions potentially enable those groups to attempt to extract price discounts on our products. The result of these developments may have a material adverse effect on our business, financial position and results of operations.

We are reliant on third party suppliers for the active ingredients for our products. A prolonged interruption in the supply of such products could have a material adverse effect on our business, financial position and results of operations.

Active pharmaceutical ingredients, packaging components, and other materials and supplies that we use in our pharmaceutical manufacturing operations, as well as certain finished products, are generally available and purchased from many different foreign and domestic suppliers. With the exception of a supply agreement for the active ingredient for the Company’s Dorzolamide Hydrochloride products, the Company does not have any written material agreements with any of its raw material suppliers. We attempt to maintain sufficient raw materials inventory, in some cases by carrying long term supplies. In certain cases we have listed only one supplier in our applications with the FDA, but we have applied to the FDA to receive approval to use alternative suppliers on several products. However, there is no guarantee that we will always have timely and sufficient access to a critical raw material or finished product. A prolonged interruption in the supply of a single-sourced active ingredient or finished product could cause our financial position and results of operations to be materially adversely affected.

 

13


Table of Contents

We manufacture a majority of our generic products and some of our over the counter brands at two facilities in one location. A significant disruption at this facility, even on a short term basis, could have a material adverse effect on our business, financial position and results of operations.

Our generic products and some of our branded products are produced at our two manufacturing facilities located at one site. The Company stores products at facilities in Amityville, NY and Richmond, VA. A significant disruption at the manufacturing facilities, even on a short-term basis, could impair our ability to produce and ship products to the market on a timely basis, which could have a material adverse effect on our business, financial position and results of operations.

The following table shows the sales contributions of products manufactured at Hi-Tech’s Amityville facility to each division and to the Company as a whole:

 

     % of Sales  

Hi-Tech Generics

     98

Health Care Products

     37

ECR Pharmaceuticals

     1

Hi-Tech (consolidated)

     82

The Company uses multiple contract manufacturers to supply products not made at Hi-Tech’s Amityville facility. Failure of one or more than one of these manufacturers to supply products to Hi-Tech could have material adverse effects on our business.

Approximately 99% of the products made for our ECR Pharmaceuticals are made at contract manufacturers. Additionally, both our Health Care Products division and our Hi-Tech Generic division utilize contract manufacturers. The Company usually holds higher levels of inventory of products made from outside suppliers to minimize supply disruptions. In the event that one or more of these contract manufactures were to experience manufacturing problems or FDA regulatory issues and were unable to deliver product on behalf of the Company, our financial position and results from operations could be adversely affected.

In the normal course of business, we periodically enter into employment agreements, legal settlements and other agreements which incorporate indemnification provisions. We maintain insurance coverage which we believe will effectively mitigate our obligations under these indemnification provisions. Should our obligation under an indemnification provision exceed our coverage or should coverage be denied, it could have a material adverse effect on our business, financial position and results of operations.

In the normal course of business, we periodically enter into employment agreements, legal settlements, and other agreements which incorporate indemnification provisions. We maintain insurance coverage which we believe will effectively mitigate our obligations under these indemnification provisions. However, should our obligation under an indemnification provision exceed our coverage or should coverage be denied, it could have a material adverse effect on our business, financial position and results of operations.

We use a variety of estimates and assumptions in preparing our financial statements. Estimates, judgments and assumptions are inherently subject to change in the future, and any such changes could result in corresponding changes to the amounts of assets, liabilities, revenues, expenses and income. Any such changes could have a material adverse effect on our business, financial position and results of operations.

There are inherent uncertainties involved in estimates, judgments and assumptions used in the preparation of financial statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Any changes in estimates, judgments and assumptions used could have a material adverse effect on our business, financial position and results of operations.

The financial statements included in the periodic reports we file with the Securities and Exchange Commission (“SEC”) are prepared in accordance with GAAP. The preparation of financial statements in accordance with GAAP involves making estimates of expenses and income. This includes, but is not limited to, estimates, judgments and assumptions used in the adoption of the provisions of ASC Topic 360-10-35,”Impairment or Disposal of Long-Lived Assets”, ASC Topic 605, “Revenue Recognition” and ASC Topic 718,”Compensation—Stock Compensation”. Estimates, judgments and assumptions are inherently subject to change in the future, and any such changes could result in corresponding changes to the amounts of assets, liabilities, revenues, expenses and income. Any such changes could have a material adverse effect on our business, financial position and results of operations.

 

14


Table of Contents

Our business and results of operations could be adversely affected by qui tam litigation.

In connection with the sale of pharmaceutical products, certain claims alleging the submission of false claims to the government can form the basis for qui tam complaints to be filed. The qui tam provisions of the federal civil False Claims Act and various state civil False Claims Acts authorize a private person, known as a “relator” (i.e. “whistleblower”), to file civil actions under the federal and state statutes on behalf of the federal and state governments. Under the federal civil False Claims Act and applicable state civil False Claims Acts, the filing of a qui tam complaint by a relator imposes obligations on federal or state government authorities to investigate the allegations and to determine whether or not to intervene in the action. Such cases typically revolve around the marketing, sale and/or purchase of pharmaceutical products and allege wrongdoing in the marketing, sale and/or purchase of such products. Such complaints are filed under seal and remain sealed until the applicable court orders otherwise.

Our business and results of operations could be adversely affected if it is determined that we are found liable under the qui tam complaint filed against us for false claims under the civil False Claims Act.

We are subject to changing rules and regulations of federal and state government as well as the stock exchange on which our common stock is listed.

We are subject to changing rules and regulations of federal and state government as well as the stock exchange on which our common stock is listed. These entities, including the Public Company Accounting Oversight Board, the SEC and the Nasdaq Global Market, have issued a significant number of new and increasingly complex requirements and regulations over the course of the last several years and continue to develop additional regulations and requirements in response to laws enacted by Congress. On July 21, 2010, the Dodd-Frank Wall Street Reform and Protection Act, or the Dodd-Frank Act, was enacted. There are significant corporate governance and executive compensation-related provisions in the Dodd-Frank Act that require the SEC to adopt additional rules and regulations in these areas such as “say on pay” and proxy access. Our efforts to comply with these requirements are likely to result in an increase in expenses which is difficult to quantify at this time.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS.

NONE

 

ITEM 2. PROPERTIES.

Our executive offices and manufacturing facilities are owned by the Company, are located in Amityville, New York, and are comprised of six buildings with approximately 207,000 square feet. These include:

 

   

A 42,000 square foot facility dedicated to liquid and semi-solid production

 

   

A 28,000 square foot facility housing a sterile manufacturing facility, DEA manufacturing, chemistry and microbiology laboratories

 

   

A 72,000 square foot facility used for the warehousing of finished goods which also houses our Health Care Products division

 

   

A 21,500 square foot facility with 3,500 square feet of research and development space and 18,000 square feet of warehouse space

 

   

A 8,000 square foot office building which is utilized for administrative functions

 

   

A 35,000 square foot facility with mixed office, laboratory and manufacturing space

Additionally, the Company’s ECR Pharmaceuticals subsidiary leases approximately 12,000 square feet in Richmond, Virginia. The lease on this facility expires August 31, 2014 and is renewable.

We believe that our properties are adequately covered by insurance and are suitable and adequate for our needs for several years.

 

ITEM 3. LEGAL PROCEEDINGS.

The disclosure under Note [L], Commitments, Contingencies and Other Matters, Legal Proceedings included in Part II Item 8 of this report is incorporated in this Part I Item 3 by reference.

 

15


Table of Contents
ITEM 4. REMOVED AND RESERVED.

PART II

 

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

Market Information

The Company’s common stock is traded on the National Global Market System of the National Association of Securities Dealers Automated Quotation System (“NASDAQ”) under the symbol HITK.

The following table sets forth the high and low closing sales prices per share of the Company’s common stock for the periods indicated on the NASDAQ National Global Market System. The quotations are inter-dealer prices, without retail mark-up, mark-down or commissions paid, and may not necessarily reflect actual transactions.

 

Quarter Ended

   High      Low  

Fiscal 2010

     

July 31, 2009

     17.73         7.37   

October 31, 2009

     25.38         13.49   

January 31, 2010

     29.09         18.27   

April 30, 2010

     26.65         20.00   

Fiscal 2011

     

July 31, 2010

     25.39         17.38   

October 31, 2010

     23.12         16.69   

January 31, 2011

     26.18         21.06   

April 30, 2011

     27.67         18.68   

As of July 8, 2011 the closing price of the Common Stock on the Nasdaq Global Market System was $30.35.

Performance Graph

This performance graph shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) or otherwise subject to the liabilities under that Section and shall not be deemed to be incorporated by reference into any filing of the Company under the Securities Act of 1933, as amended, or the Exchange Act.

The following graph compares, for the five year period ended April 30, 2011, the cumulative total stockholder return for our common stock, the Nasdaq Stock Market (U.S. companies) Index (the “Nasdaq Composite”) and the Nasdaq Pharmaceutical Index (the “Nasdaq Pharmaceutical”). The graph assumes that $100 was invested on April 30, 2006 in the common stock of the Company, and in the Nasdaq Composite and the Nasdaq Pharmaceutical and assumes reinvestment of any dividends. The stock price performance on the following graph is not necessarily indicative of future stock price performance.

 

16


Table of Contents

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*

Among Hi-Tech Pharmacal Co., Inc., the NASDAQ Composite Index

and the NASDAQ Pharmaceutical Index

LOGO

*$100 invested on 4/30/06 in stock or index, including reinvestment of dividends.

Fiscal year ending April 30.

Equity Compensation Plan Information

The table below sets forth, as of the end of the fiscal year ended April 30, 2011, for the Hi-Tech Pharmacal Co., Inc. Amended and Restated Stock Option Plan, 2009 Stock Option Plan and 1994 Director Stock Option Plan, as Amended (“Plans”) the number of securities to be issued upon the exercise of outstanding options, warrants and rights; the weighted-average exercise price of the outstanding options warrants and rights; and the number of securities remaining for future issuance under the Plans:

 

Plan Category

   Number of securities to
be issued upon exercise of
outstanding  options,
warrants and rights
     Weighted-average
exercise price of
outstanding options,
warrants and  rights
     Number of securities
remaining available
for future issuance
under  equity
compensation plans
(excluding securities
reflected in column
(a))
 
     (a)      (b)      (c)  

Equity compensation plans approved by security holders

     2,384,000       $ 15.24         754,000   

Equity compensation plans not approved by security holders

     —           —           —     
                          

Total

     2,384,000       $ 15.24         754,000   
                          

There are no Company equity compensation plans not approved by the Company’s stockholders.

 

17


Table of Contents

UNREGISTERED SALES OF EQUITY SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES

Recent Sales of Unregistered Shares

 

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)
 

02/01/11 – 02/28/11

     0       $ 0.00         0       $ 0   

03/01/11 – 03/31/11

     0       $ 0.00         0       $ 0   

04/01/11 – 04/30/11

     0       $ 0.00         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 spent the entire $23,000,000 and has repurchased 2,456,000 shares. There are no further repurchases planned at this time.

Common Stock Holders

The Company believes there are approximately 6,000 holders of Common Stock, not including shares held in street name by brokers and nominees, as of July 8, 2011.

Dividends

The Company has never declared or paid any cash dividends, and it does not anticipate that it will pay cash dividends in the foreseeable future. The declaration of dividends by the Company in the future is subject to the sole discretion of the Company’s Board of Directors and will depend upon the operating results, capital requirements and financial position of the Company, general economic conditions and other pertinent conditions or restrictions relating to any financing. The Company’s Revolving Credit Agreement with JPMorgan Chase prohibits the payment of cash dividends.

 

18


Table of Contents
ITEM 6. SELECTED FINANCIAL DATA

The selected financial data presented below as of and for the years, as indicated, is derived from the audited financial statements of the Company. This data is qualified in its entirety by reference to, and should be read in conjunction with, Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Company’s financial statements and related notes thereto for the years ended April 30, 2011, 2010 and 2009. The following results may not be indicative of our future results.

 

YEAR ENDED APRIL 30,

   2011     2010     2009     2008     2007  

Statement of operations data

          

Net sales

   $ 190,848,000      $ 159,339,000      $ 101,780,000      $ 57,636,000      $ 58,898,000   

Cost and expenses:

          

Cost of goods sold

     83,263,000        68,553,000        53,845,000        38,924,000        35,704,000   

Selling, general and administrative expense

     39,104,000        43,100,000        30,633,000        21,900,000        23,914,000   

Research and product development costs

     9,350,000        7,259,000        7,429,000        6,208,000        4,733,000   

Royalty income

     (4,607,000     (3,572,000     (547,000     —          —     

Contract research (income)

     (675,000     (894,000     (136,000     —          (123,000

Interest expense

     45,000        29,000        38,000        27,000        18,000   

Interest (income) and other

     (433,000     (1,193,000     (4,237,000     (480,000     (1,314,000
                                        

Total costs and expenses

   $ 126,047,000      $ 113,282,000      $ 87,025,000      $ 66,579,000      $ 62,932,000   
                                        

Income (loss) from continuing operations before provision for income taxes

     64,801,000        46,057,000        14,755,000        (8,943,000     (4,034,000

Provision for income tax expense/(benefit)

     21,082,000        14,471,000        5,660,000        (2,476,000     (1,998,000
                                        

Income (loss) from continuing operations

     43,719,000        31,586,000        9,095,000        (6,467,000     (2,036,000

Income (loss) from discontinued operations

     (2,265,000     (465,000     722,000        1,369,000        —     
                                        

Net income (loss)

   $ 41,454,000      $ 31,121,000      $ 9,817,000      $ (5,098,000   $ (2,036,000
                                        

Basic earnings (loss) per share:

          

Continuing operations

     3.47        2.65        0.80        (0.57     (0.17

Discontinued operations

     (0.18     (0.04     0.07        0.12        —     
                                        

Basic earnings (loss) per share

   $ 3.29      $ 2.61      $ 0.87      $ (0.45   $ (0.17
                                        

Diluted earnings (loss) per share:

          

Continuing operations

     3.36        2.54        0.78        (0.57     (0.17

Discontinued operations

     (0.17     (0.04     0.06        0.12        —     
                                        

Diluted earnings (loss) per share

   $ 3.19      $ 2.50      $ 0.84      $ (0.45   $ (0.17
                                        

Weighted average common shares outstanding, basic

     12,615,000        11,903,000        11,303,000        11,353,000        11,884,000   

Effect of potential common shares

     397,000        522,000        389,000        —          —     
                                        

Weighted average common shares outstanding, diluted

     13,012,000        12,425,000        11,692,000        11,353,000        11,884,000   
                                        

APRIL 30,

   2011     2010     2009     2008     2007  

Balance sheet data:

          

Working capital

   $ 132,135,000      $ 88,692,000      $ 55,433,000      $ 45,875,000      $ 55,540,000   

Total assets

   $ 203,240,000      $ 150,284,000      $ 107,355,000      $ 85,012,000      $ 97,742,000   

Long-term debt

   $ 621,000      $ 37,000      $ 230,000      $ 0      $ 0   

Stockholders’ equity

   $ 181,012,000      $ 134,766,000      $ 86,355,000      $ 75,165,000      $ 82,985,000   

 

19


Table of Contents
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

GENERAL

The following discussion and analysis should be read in conjunction with the Financial Statements and Notes thereto appearing elsewhere in this Report.

The following table sets forth, for all periods indicated, the percentage relationship that items in the Company’s Statements of Operations bear to net sales.

 

     YEAR ENDED APRIL 30,  
     2011     2010     2009  

Net sales

     100.0     100.0     100.0

Cost of sales

     43.6     43.0     52.9
                        

Gross profit

     56.4     57.0     47.1
                        

Selling, general & administrative expense

     20.5     27.0     30.1

Research and product development costs

     4.9     4.6     7.3

Royalty income

     -2.4     -2.2     -0.5

Contract research (income)

     -0.4     -0.6     -0.1

Interest expense

     0.0     0.0     0.0

Interest (income) and other

     -0.2     -0.7     -4.2
                        

Total expenses

     22.4     28.1     32.6
                        

Income before tax provision

     34.0     28.9     14.5

Income tax provision

     11.0     9.1     5.6
                        

Income from continuing operations

     23.0     19.8     8.9

Income (loss) from discontinued operations

     -1.3     -0.3     0.7
                        

Net income

     21.7     19.5     9.6
                        

RESULTS OF OPERATIONS FOR YEARS ENDED APRIL 30, 2011 AND 2010

Revenue

 

     2011      2010      Change      % Change  

Hi-Tech Generics

   $ 157,361,000       $ 129,359,000       $ 28,002,000         22

Health Care Products

     13,872,000         11,268,000         2,604,000         23

ECR Pharmaceuticals

     19,615,000         18,712,000         903,000         5
                                   

Total

   $ 190,848,000       $ 159,339,000       $ 31,509,000         20
                                   

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 $73,800,000 for the year versus $13,800,000 in the previous year. Sales of Dorzolamide with Timolol ophthalmic solution and Dorzolamide ophthalmic solution dropped to approximately $27,100,000 from approximately $49,600,000 in the previous year due to significantly lower pricing for the products. Sales of cold and flu items declined during the year, compared to a period of unusually strong demand during summer 2009. 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. Sales of these products totaled approximately $5,000,000 in 2010.

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.

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 due to competition.

 

20


Table of Contents

On March 2, 2011, the US Food and Drug Administration (FDA) indicated in its MedWatch publication that the Agency removed approximately 500 currently marketed cough/cold and allergy related products including Lodrane® products. Three of these are currently marketed by ECR Pharmaceuticals under the brand name Lodrane®. ECR Pharmaceuticals must stop shipping these products within 180 days after March 2, 2011. Sales of Lodrane® products amounted to approximately $16,600,000 and $13,100,000 for the year ended April 30, 2011 and April 30, 2010, respectively.

On May 9, 2011 the Company sold various assets of its Midlothian Laboratories division, and the sales from this business are included in discontinued operations.

Cost of Sales

 

     2011     2010  
     $      % of sales     $      % of sales  

Cost of Sales

   $ 83,263,000         44   $ 68,553,000         43

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. Pricing decreases and unit sales declines of the higher margin Acetic Acid with Hydrocortisone also contributed to this trend. Increased sales of Fluticasone Propionate nasal spray at higher average prices partially offset this effect as did increased sales of the MagOx® line of magnesium supplements and Lodrane®, 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 for certain generic products. Included in cost of sales is a reserve of $1,123,000 for potential obsolescence of Lodrane® and Zolpimist® inventory for the ECR subsidiary.

Expense Items

 

     2011     2010     Change     % Change  

Selling, general and administrative expense

   $ 39,104,000      $ 43,100,000      $ (3,996,000     (9 )% 

Research and product development costs

   $ 9,350,000      $ 7,259,000      $ 2,091,000        29

Royalty income

   $ (4,607,000   $ (3,572,000   $ (1,035,000     29

Contract research (income)

   $ (675,000   $ (894,000   $ 219,000        (24 )% 

Interest expense

   $ 45,000      $ 29,000      $ 16,000        55

Interest (income) and other

   $ (433,000   $ (1,193,000   $ 760,000        (64 )% 

Provision for income tax expense

   $ 21,082,000      $ 14,471,000      $ 6,611,000        46

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 for $2,100,000 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, including an increase in the internal R&D staff 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, for which the Company received royalties through December 2010, a royalty on sales of certain Naprelan® strengths and on nutritional products divested by the Company’s Midlothian division. Hi-Tech kept the royalty stream generated by these nutritional products when it sold off other assets of the Midlothian division. Royalties of these nutritional products were the primary driver of the increase in royalty income, because the Company received four quarters of income this fiscal year versus only three quarters in fiscal 2010.

Interest (income) and other includes the $1,000,000 gain on the sale of the related rights to certain nutritional products previously sold by Midlothian for the year ended April 30, 2010. Other (income) expense also 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 33% in fiscal year 2011 from 31% in fiscal year 2010 due to a larger benefit from stock option exercises in the prior year.

 

21


Table of Contents

Income Analysis

 

     2011     2010     Change     % Change  

Income from continuing operations

   $ 43,719,000      $ 31,586,000      $ 12,133,000        38

Income (loss) from discontinued operations, net of tax

     (2,265,000     (465,000     (1,800,000     387
                                

Net Income

   $ 41,454,000      $ 31,121,000      $ 10,333,000        33
                                

Basic Earnings Per Share:

        

Continuing Operations

     3.47        2.65        0.82        31

Discontinued Operations

     (0.18     (0.04     (0.14     350
                                

Basic Earnings Per Share

   $ 3.29      $ 2.61      $ 0.68        26
                                

Diluted Earnings Per Share:

        

Continuing Operations

     3.36        2.54        0.82        32

Discontinued Operations

     (0.17     (0.04     (0.13     325
                                

Diluted Earnings Per Share

   $ 3.19      $ 2.50      $ 0.69        28
                                

Weighted Average Common Shares Outstanding, Basic

     12,615,000        11,903,000        712,000        6

Effect of Potential Common Shares

     397,000        522,000        (125,000     (24 )% 

Weighted Average Common Shares Outstanding, Diluted

     13,012,000        12,425,000        587,000        5

Shares outstanding increased due to the exercise of options.

RESULTS OF OPERATIONS FOR YEARS ENDED APRIL 30, 2010 AND 2009

Revenue

 

     2010      2009      Change      % Change  

Hi-Tech Generics

   $ 129,359,000       $ 88,848,000       $ 40,511,000         46

Health Care Products

     11,268,000         10,125,000         1,143,000         11

ECR Pharmaceuticals

     18,712,000         2,807,000         15,905,000         567
                                   

Total

   $ 159,339,000       $ 101,780,000       $ 57,559,000         57
                                   

Net sales of Hi-Tech generic pharmaceutical products, which include some private label contract manufacturing, increased primarily due to new product launches in the previous year. Sales for Dorzolamide with Timolol Ophthalmic Solution and Dorzolamide Ophthalmic solution totaled $49,600,000 in the year as the Company sold significantly more units, although at lower average prices than the previous year in which sales totaled $23,500,000 for the six months in which the product was sold in the previous year. The Company launched Hydrocortisone with Acetic Acid, a generic version of VoSol® HC, which the Company acquired in fiscal 2007, and sales of this product were the second largest driver of Hi-Tech’s generic sales increase. Strong sales of Sulfamethoxazole with Trimethoprim and Fluticasone Propionate nasal spray also contributed to the strong results. Sales of Dorzolamide and Fluticasone products surged in the Company’s fourth quarter as a competitor was unable to supply these products. The Company discontinued several unapproved cough and cold products, salicylic acid products and some strengths of urea products during the year, which resulted in significantly lower sales of these products.

The Health Care Products division, which markets the Company’s branded OTC products, experienced higher sales of Diabetic Tussin® and Multibetic®. Additionally, the Company acquired the Mag-Ox® line of Magnesium supplements from Blaine Pharmaceuticals in March 2010, and benefited from two months of sales of these products.

In February 2009, the Company acquired the assets of ECR Pharmaceuticals which sells branded prescription products. Sales for the period included sales of the Lodrane® line of antihistamines, the Dexpak® line of corticosteroids, Bupap®, an analgesic tablet and VoSol® HC, a product indicated for swimmer’s ear. In February 2010, ECR launched Tropazone TM , a treatment for dermatitis. Sales of Lodrane® accounted for approximately 75% of the sales of this subsidiary, and the Company implemented a pricing increase in January 2010 for its Lodrane® line.

On May 9, 2011 the Company sold various assets of its Midlothian Laboratories division, and the sales from this business are included in discontinued operations.

 

22


Table of Contents

Cost of Sales

 

     2010     2009  
     $      % of sales     $      % of sales  

Cost of Sales

   $ 68,553,000         43   $ 53,845,000         53

The primary factor for an increase in gross profit is a full year of sales from our ECR Pharmaceuticals subsidiary, which sells higher margin branded products. Gross margins declined in our Midlothian Laboratories’ business with a change in product mix, and this business now has the lowest margins among our businesses. A full year of sales of higher margin generic products, including Dorzolamide with Timolol ophthalmic solution, Dorzolamide ophthalmic solution and Hydrocortisone with Acetic Acid, also contributed to higher gross margins. As competitors entered the Dorzolamide products market, the Company experienced a decline in the sales price and gross profit margin for these products. Sales of some products, such as Sulfamethoxazole with Trimethoprim, were at higher average prices than the previous year due to a price increase and a change in the mix of customers. The Company was able to negotiate lower raw material prices from some of its suppliers, helping decrease costs. Subsequent to year end, due to a warning letter from the FDA the Company suspended sales of Paregoric, Urea 40% and vitamins containing fluoride. As a consequence of the withdrawal of these products, the Company wrote off the value of inventory at year end by approximately $865,000. In fiscal 2010 these products contributed approximately $5,000,000 in sales and approximately $2,000,000 in gross margin.

Expense Items

 

     2010     2009     Change     % Change  

Selling, general and administrative expense

   $ 43,100,000      $ 30,633,000      $ 12,467,000        41

Research and product development costs

   $ 7,259,000      $ 7,429,000      $ (170,000     (2 )% 

Royalty income

   $ (3,572,000   $ (547,000   $ (3,025,000     553

Contract research (income)

   $ (894,000   $ (136,000   $ (758,000     557

Interest expense

   $ 29,000      $ 38,000      $ (9,000     (24 )% 

Interest (income) and other

   $ (1,193,000   $ (4,237,000   $ 3,044,000        (72 )% 

Provision for income tax expense/(benefit)

   $ 14,471,000      $ 5,660,000      $ 8,811,000        156

Selling, general and administrative expenses for the period ended April 30, 2010 include expenses of the ECR Pharmaceuticals subsidiary. ECR Pharmaceuticals markets branded pharmaceuticals to doctors and therefore, spends a higher proportion of its sales on selling, general and administrative expenses. ECR Pharmaceuticals’ sales force increased during the year from fifty to over sixty sales representatives. ECR Pharmaceutical’s selling, general and administrative expenses totaled $8,570,000 for the year ended April 30, 2010. ECR’s selling, general and administrative expenses for fiscal year 2009 were only $623,000, as it was acquired in February 2009.

During the fiscal year ended April 30, 2010, the Company paid $6,200,000 to its royalty partner on the Dorzolamide with Timolol Ophthalmic Solution including a $2,100,000 payment to buy out the future royalty stream. These payments are included in selling, general and administrative expense. For the year ended April 30, 2009 the Company paid $5,000,000 in royalties to its partner.

Additional increases in selling, general and administrative expenses in the current fiscal year included freight, legal, compensation, and IT expenses related to the implementation of the SAP enterprise resource planning system.

Expenditures for research and development were driven by the end of clinical trials for an externally developed project offset by increased expenditures on other external projects.

Royalty income increased due to royalties on certain nutritional products divested by Midlothian Laboratories in July 2009. Hi-Tech kept the royalty stream generated by these nutritional products when it sold off other assets of the Midlothian division. Royalty income also includes royalties relating to Brometane which the Company divested in July 2008 and a royalty on sales of the 500 mg strength Naprelan®.

Contract research income was primarily for work completed on a product for a company in the branded prescription product market. The Company plans to manufacture this product once it is approved the FDA.

Interest (income) and other includes the $1,000,000 gain on the sale of the related rights to certain nutritional products previously sold by Midlothian for the fiscal year ended April 30, 2010. Interest (income) and other includes the $3,500,000 gain on the sale of Brometane for the fiscal year ended April 30, 2009.

 

23


Table of Contents

The effective tax rate declined in fiscal year 2010 from fiscal year 2009 due to the benefit from the exercises of options in a disqualifying disposition, and the reduction of the accrual for uncertain tax positions in the current year, compared to an increase in the prior year.

Income Analysis

 

     2010     2009      Change     % Change  

Income from continuing operations

   $ 31,586,000      $ 9,095,000       $ 22,491,000        247

Income from discontinued operations, net of tax

     (465,000     722,000         (1,187,000     (164 )% 
                                 

Net Income

   $ 31,121,000      $ 9,817,000       $ 21,304,000        217
                                 

Basic Earnings Per Share:

         

Continuing Operations

     2.65        0.80         1.85        231

Discontinued Operations

     (0.04     0.07         (0.11     (157 )% 
                                 

Basic Earnings Per Share

   $ 2.61      $ 0.87       $ 1.74        200
                                 

Diluted Earnings Per Share:

         

Continuing Operations

     2.54        0.78         1.76        226

Discontinued Operations

     (0.04     0.06         (0.10     (167 )% 
                                 

Diluted Earnings Per Share

   $ 2.50      $ 0.84       $ 1.66        198
                                 

Weighted Average Common Shares Outstanding, Basic

     11,903,000        11,303,000         600,000        5

Effect of Potential Common Shares

     522,000        389,000         133,000        34

Weighted Average Common Shares Outstanding, Diluted

     12,425,000        11,692,000         733,000        6

Shares outstanding increased due to the exercise of options, and the effect of potential common shares increased due to a higher stock price which resulted in a higher number of “in the money” outstanding options.

LIQUIDITY AND CAPITAL RESOURCES

The Company’s operations are historically financed principally by cash flows generated from operations. At April 30, 2011 and April 30, 2010, working capital was approximately $132,135,000 and $88,692,000, respectively. The increase of $43,443,000 was primarily due to operating income earned during the fiscal year and cash received as a result of the exercise of stock options.

Cash flows provided by operating activities were approximately $33,086,000 which was primarily the result of net income of $41,454,000 plus non-cash expenses for depreciation and amortization of $5,099,000 and stock based compensation of $2,552,000. These inflows were offset by an increase of accounts receivables of $18,128,000 and various other changes in working capital accounts. The receivables for the Company increased primarily due to the increase in sales of $17,825,000 in the fourth quarter. A surge in orders in March and April for Fluticasone led to higher receivables levels and lower inventory levels than the Company would consider typical at year end.

Cash flows used in investing activities for the year ended April 30, 2011 were approximately $9,765,000. Intangible asset acquisitions are detailed on the following table:

 

Acquisition

   Amount  

ECR earn-out

   $ 1,440,000   

Nystatin oral suspension acquisition

   $ 150,000   

Other

   $ 65,000   

Capital expenditures of $8,266,000 in the fiscal year included an expansion of the production area in our non-sterile manufacturing facility and the purchase of a new high speed filler for nasal and oral sprays.

Cash flows provided by financing activities were $2,754,000 and primarily resulted from the proceeds and the tax benefit resulting from the exercise of stock options. The Company drew down $621,000 on its equipment financing line with JP Morgan Chase as described below.

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

 

24


Table of Contents

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.

The Company believes that its financial resources consisting of current working capital, anticipated future operating revenue and its credit line will be sufficient to enable it to meet its working capital requirements for at least the next twelve months.

RECENT ACCOUNTING PRONOUNCEMENTS

The Financial Accounting Standards Board (“FASB”) has issued Accounting Standard Update (“ASU”) No. 2010-27, Other Expenses (Topic 720): Fees Paid to the Federal Government by Pharmaceutical Manufacturers. This ASU provides guidance on how pharmaceutical manufacturers should recognize and classify in their income statements fees mandated by the Patient Protection and Affordable Care Act (PPACA) and the Health Care and Education Reconciliation Act, both enacted in March 2010, referred to as the “Acts.” The Acts impose an annual fee on the pharmaceutical manufacturing industry for each calendar year beginning on or after January 1, 2011. An entity’s portion of the annual fee is payable no later than September 30 of the applicable calendar year and is not tax deductible. A portion of the annual fee will be allocated to individual entities on the basis of the amount of their brand prescription drug sales (including authorized generic product sales) for the preceding year as a percentage of the industry’s brand prescription drug sales (including authorized generic product sales) for the same period. An entity’s portion of the annual fee becomes payable to the U.S. Treasury once a pharmaceutical manufacturing entity has a gross receipt from branded prescription drug sales to any specified government program or in accordance with coverage under any government program for each calendar year beginning on or after January 1, 2011. The amendments in this ASU specify that the liability for the fee should be estimated and recorded in full upon the first qualifying sale with a corresponding deferred cost that is amortized to expense using a straight-line method of allocation unless another method better allocates the fee over the calendar year that it is payable. The annual fee is classified as an operating expense in the income statement. The amendments in this ASU were effective for calendar years beginning after December 31, 2010, when the fee initially became effective. The annual impact of this fee on us will be highly variable depending on the volume of our sales of authorized generics and brand products. There was no material impact of the adoption of this guidance on the consolidated financial statements of the Company at April 30, 2011.

The FASB has issued ASU 2010-29, Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations. The amendments in this ASU affect any public entity as defined by Topic 805, Business Combinations, that enters into business combinations that are material on an individual or aggregate basis. The amendments in this ASU specify 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(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand 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 amendments are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010.

In December 2010, the FASB updated the accounting guidance relating to the annual goodwill impairment test. The updated guidance requires companies to perform the second step of the impairment test to measure the amount of impairment loss, if any, when it is more likely than not that goodwill impairment exists when the carrying amount of a reporting unit is zero or negative. In considering whether it is more likely than not that goodwill impairment exists, an entity shall evaluate whether there are adverse qualitative factors. The updated guidance is effective for the Company beginning in the first quarter of fiscal 2012. The adoption of this guidance is not expected to have a material impact on the Company’s consolidated financial statements.

 

25


Table of Contents

In June 2011, the FASB updated the disclosure requirements for comprehensive income. The updated guidance requires companies to disclose the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The updated guidance does not affect how earnings per share is calculated or presented. The updated guidance is effective for the Company beginning in the first quarter of fiscal year 2013. The Company is currently evaluating the impact of adoption of this accounting guidance on its consolidated financial statements.

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. Our significant accounting policies are more fully described in Note A to our financial statements.

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.

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 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.

 

26


Table of Contents

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 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.

The following table presents the roll forward of each significant estimate, which balances are reflected as deductions from accounts receivable as of April 30, 2011, 2010 and 2009 and for the years then ended, respectively.

 

     Beginning
Balance
May 1
     Current
Provision
     Actual Credits
in Current
Period
    Ending
Balance
April 30
 

For the year ended April 30, 2011

          

Chargebacks

   $ 6,509,000       $ 113,922,000       $ (111,843,000   $ 8,588,000   

Sales Discounts

     1,391,000         7,483,000         (6,521,000     2,353,000   

Sales Allowances & Returns

     6,470,000         34,995,000         (35,306,000     6,159,000   
                                  

Total Adjustment for Returns & Price Allowances

   $ 14,370,000       $ 156,400,000       $ (153,670,000   $ 17,100,000   
                                  

For the year ended April 30, 2010

          

Chargebacks

   $ 2,904,000       $ 73,676,000       $ (70,071,000   $ 6,509,000   

Sales Discounts

     786,000         5,767,000         (5,162,000     1,391,000   

Sales Allowances & Returns

     7,794,000         26,117,000         (27,441,000     6,470,000   
                                  

Total Adjustment for Returns & Price Allowances

   $ 11,484,000       $ 105,560,000       $ (102,674,000   $ 14,370,000   
                                  

For the year ended April 30, 2009

          

Chargebacks

   $ 2,668,000       $ 35,783,000       $ (35,547,000   $ 2,904,000   

Sales Discounts

     440,000         3,744,000         (3,398,000     786,000   

Sales Allowances & Returns

     5,357,000         23,311,000         (20,874,000     7,794,000   
                                  

Total Adjustment for Returns & Price Allowances

   $ 8,465,000       $ 62,838,000       $ (59,819,000   $ 11,484,000   
                                  

 

27


Table of Contents

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 cost or market, with cost being determined based upon standard costing. In evaluating the inventory, 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.

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 April 30, 2011 we are not involved in any material unconsolidated transactions.

The Company’s ECR Pharmaceuticals subsidiary signed a lease for approximately 12,000 square feet in Richmond, VA commencing September 1, 2009 and terminating August 31, 2014. The lease includes monthly payments of $6,941 which increase by 2% each year for the term of the lease.

The Company entered into two lease obligations to partially finance a new computer system.

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 connection with the acquisition of the assets of ECR Pharmaceuticals, the Company incurred $2,062,000 and $1,938,000 for fiscal 2010 and 2011, respectively, for an earn-out of which $498,000 was unpaid at April 30, 2011. The Company paid the final earn-out of $498,000 in May, 2011. No additional obligation exists with respect to the earn-out.

Subject to the information and qualifications included in the above paragraphs, the table below sets forth the Company’s enforceable and legally binding future commitments and obligations relating to all contracts that we are likely to continue regardless of the fact that the contracts may be terminated.

 

     Payments due by April 30,  

Contractual Obligations

   2012      2013      2014      2015      2016  

Richmond, VA lease

   $ 85,000       $ 87,000       $ 88,000       $ 30,000       $ —     

Software lease (principal and interest)

     37,000               

Amityville, NY lease

     17,000         17,000         18,000         19,000         3,000   
                                            

Total

   $ 139,000       $ 104,000       $ 106,000       $ 49,000       $ 3,000   
                                            

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

We are exposed to market risk for changes in the market values of our investments (Investment Risk) and the impact of interest rate changes (Interest Rate Risk). We have not used derivative financial instruments in our investment portfolio.

We maintain our portfolio of cash equivalents and short-term investments primarily in money market funds, but sometimes invest in a variety of securities, including both government and government agency obligations with ratings of A or better. Our investments seek to preserve the value of our principal, provide liquidity and maximize return on the Company’s investment against minimal interest rate risk. Consequently, our interest rate and principal risk are minimal. The quantitative and qualitative disclosures about market risk are set forth below.

 

28


Table of Contents

Investment Risk

We regularly review the carrying value of our investments and identify and recognize losses, for income statement purposes, when events and circumstances indicate that any declines in the fair values of such investments below our accounting basis are other than temporary.

Interest Rate Risk

Our exposure to interest rate risk relates primarily to our cash equivalents and our floating interest rate on our new revolving credit and equipment financing facilities with JPMorgan Chase. Our cash is invested in bank deposits and A-rated money market mutual funds.

We do not operate and transact business in foreign countries and are, therefore, not subject to the risk of foreign currency exchange rate fluctuations.

At this time, we have no material commodity price risks.

We do not believe that inflation has had a significant impact on our revenues or operations.

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

 

INDEX

  

PAGE NUMBER

Reports of Independent Registered Public Accounting Firm

   30

Consolidated Balance Sheets

   32

Consolidated Statements of Operations

   33

Consolidated Statements of Changes in Stockholders’ Equity

   34

Consolidated Statements of Cash Flows

   35

Notes to Consolidated Financial Statements

   36

 

29


Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders

Hi-Tech Pharmacal Co., Inc.

We have audited the accompanying consolidated balance sheets of Hi-Tech Pharmacal Co., Inc. (the “Company”) as of April 30, 2011 and 2010, and the related consolidated statements of operations, changes in stockholders’ equity and cash flows for each of the years in the three-year period ended April 30, 2011. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Hi-Tech Pharmacal Co., Inc. as of April 30, 2011 and 2010, and the consolidated results of their operations and their cash flows for each of the years in the three-year period ended April 30, 2011, in conformity with accounting principles generally accepted in the United States of America.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Hi-Tech Pharmacal Co., Inc.’s internal control over financial reporting as of April 30, 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated July 8, 2011 expressed an unqualified opinion on the Company’s internal control over financial reporting.

EisnerAmper LLP

New York, New York

July 8, 2011

 

30


Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders of

Hi-Tech Pharmacal Co., Inc.

We have audited Hi-Tech Pharmacal Co., Inc.’s (the “Company”) internal control over financial reporting as of April 30, 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of April 30, 2011, based on criteria established in Internal Control Integrated Framework issued by COSO.

We have also audited in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Hi-Tech Pharmacal Co., Inc. as of April 30, 2011 and 2010 and the related consolidated statements of operations, changes in stockholders’ equity and cash flows for each of the years in the three-year period ended April 30, 2011 and our report dated July 8, 2011 expressed an unqualified opinion on those financial statements.

EisnerAmper LLP

New York, New York

July 8, 2011

 

31


Table of Contents

HI-TECH PHARMACAL CO., INC.

CONSOLIDATED BALANCE SHEETS

 

     April 30,  
     2011     2010  
ASSETS     

CURRENT ASSETS:

    

Cash and cash equivalents

   $ 62,304,000      $ 36,018,000   

Accounts receivable (less allowances for doubtful accounts of $500,000 and $400,000 at April 30, 2011 and 2010, respectively)

     57,632,000        39,604,000   

Inventory

     23,784,000        19,604,000   

Deferred income taxes

     5,546,000        4,219,000   

Prepaid income taxes

     661,000        —     

Other current assets

     3,041,000        3,055,000   

Current assets of discontinued operations

     774,000        1,673,000   
                

TOTAL CURRENT ASSETS

   $ 153,742,000      $ 104,173,000   

Property and equipment, net

     25,866,000        20,321,000   

Deferred income taxes

     1,084,000        883,000   

Other assets

     300,000        479,000   

Intangible assets, net

     21,231,000        21,686,000   

Non-current assets of discontinued operations

     1,017,000        2,742,000   
                

TOTAL ASSETS

   $ 203,240,000      $ 150,284,000   
                
LIABILITIES     

CURRENT LIABILITIES:

    

Accounts payable

   $ 7,806,000      $ 5,388,000   

Accrued expenses

     13,658,000        8,757,000   

Current portion of obligation under capital lease

     37,000        193,000   

Income taxes payable

     —          880,000   

Current liabilities of discontinued operations

     106,000        263,000   
                

TOTAL CURRENT LIABILITIES

   $ 21,607,000      $ 15,481,000   

Obligation under capital lease

     621,000        37,000   
                

TOTAL LIABILITIES

   $ 22,228,000      $ 15,518,000   
                

COMMITMENTS AND CONTINGENCIES (Note L)

    

STOCKHOLDERS’ EQUITY

    

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

    

Common stock, par value $.01; authorized 50,000,000 shares, 15,163,000 and 15,017,000 shares issued at April 30, 2011 and 2010, respectively

     152,000        150,000   

Additional paid-in capital

     79,981,000        75,345,000   

Retained earnings

     123,879,000        82,425,000   

Accumulated other comprehensive (loss), net of tax

     —          (154,000

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

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

TOTAL STOCKHOLDERS’ EQUITY

   $ 181,012,000      $ 134,766,000   
                

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

   $ 203,240,000      $ 150,284,000   
                

See notes to Consolidated Financial Statements

 

32


Table of Contents

HI-TECH PHARMACAL CO., INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

 

     Year Ended April 30,  
     2011     2010     2009  

NET SALES

   $ 190,848,000      $ 159,339,000      $ 101,780,000   

Cost of goods sold

     83,263,000        68,553,000        53,845,000   
                        

GROSS PROFIT

     107,585,000        90,786,000        47,935,000   

COST AND EXPENSES:

      

Selling, general and administrative expense

     39,104,000        43,100,000        30,633,000   

Research and product development costs

     9,350,000        7,259,000        7,429,000   

Royalty income

     (4,607,000     (3,572,000     (547,000

Contract research (income)

     (675,000     (894,000     (136,000

Interest expense

     45,000        29,000        38,000   

Interest (income) and other

     (433,000     (1,193,000     (4,237,000
                        

TOTAL

   $ 42,784,000      $ 44,729,000      $ 33,180,000   
                        

Income from continuing operations before provision for income taxes

     64,801,000        46,057,000        14,755,000   

Provision for income tax expense

     21,082,000        14,471,000        5,660,000   
                        

Income from continuing operations

   $ 43,719,000      $ 31,586,000      $ 9,095,000   

Income (loss) from discontinued operations, net of tax

     (2,265,000     (465,000     722,000   
                        

NET INCOME

   $ 41,454,000      $ 31,121,000      $ 9,817,000   
                        

BASIC EARNINGS (LOSS) PER SHARE:

      

Continuing operations

     3.47        2.65        0.80   

Discontinued operations

     (0.18     (0.04     0.07   
                        

BASIC EARNINGS (LOSS) PER SHARE

   $ 3.29      $ 2.61      $ 0.87   
                        

DILUTED EARNINGS (LOSS) PER SHARE:

      

Continuing operations

     3.36        2.54        0.78   

Discontinued operations

     (0.17     (0.04     0.06   
                        

DILUTED EARNINGS (LOSS) PER SHARE

   $ 3.19      $ 2.50      $ 0.84   
                        

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING, BASIC

     12,615,000        11,903,000        11,303,000   

EFFECT OF POTENTIAL COMMON SHARES

     397,000        522,000        389,000   
                        

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING, DILUTED

     13,012,000        12,425,000        11,692,000   
                        

See notes to Consolidated Financial Statements

 

33


Table of Contents

HI-TECH PHARMACAL CO., INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

 

    Common Stock     Additional
Paid in
Capital
    Retained
Earnings
    Accumulated
Other
Comprehensive
Income (Loss)
    Treasury
Stock at
Cost
    Total
Stockholders’
Equity
    Comprehensive
Income (Loss)
 
    Shares     Amount              

BALANCE—APRIL 30, 2008

    13,603,000      $ 136,000      $ 54,829,000      $ 41,487,000      $ 64,000      $ (21,351,000   $ 75,165,000     

Net income

          9,817,000            9,817,000        9,817,000   

Exercise of options

    183,000        2,000        312,000              314,000     

Purchase of Treasury Stock

              (1,649,000     (1,649,000  

Stock-based compensation expense

        2,532,000              2,532,000     

Tax benefit from exercise of options

        304,000              304,000     

Other comprehensive income (loss), net of tax

            (128,000       (128,000     (128,000
                                                               

Total Comprehensive Income

                $ 9,689,000   
                     

BALANCE—APRIL 30, 2009

    13,786,000      $ 138,000      $ 57,977,000      $ 51,304,000      $ (64,000   $ (23,000,000   $ 86,355,000     

Net income

          31,121,000            31,121,000        31,121,000   

Exercise of options

    1,231,000        12,000        12,017,000              12,029,000     

Stock-based compensation expense

        2,459,000              2,459,000     

Tax benefit from exercise of options

        2,892,000              2,892,000     

Other comprehensive income (loss), net of tax

            (90,000       (90,000     (90,000
                                                               

Total Comprehensive Income

                $ 31,031,000   
                     

BALANCE—APRIL 30, 2010

    15,017,000      $ 150,000      $ 75,345,000      $ 82,425,000      $ (154,000   $ (23,000,000   $ 134,766,000     

Net income

          41,454,000            41,454,000        41,454,000   

Exercise of options

    146,000        2,000        1,670,000              1,672,000     

Stock-based compensation expense

        2,552,000              2,552,000     

Tax benefit from exercise of options

        414,000              414,000     

Other comprehensive income (loss), net of tax

            154,000          154,000        154,000   
                                                               

Total Comprehensive Income

                $ 41,608,000   
                     

BALANCE—APRIL 30, 2011

    15,163,000      $ 152,000      $ 79,981,000      $ 123,879,000      $ —        $ (23,000,000   $ 181,012,000     
                                                         

See notes to Consolidated Financial Statements

 

34


Table of Contents

HI-TECH PHARMACAL CO., INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

     Year ended April 30,  
     2011     2010     2009  

CASH FLOWS FROM OPERATING ACTIVITIES:

      

Net income

   $ 41,454,000      $ 31,121,000      $ 9,817,000   

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

      

Loss (income) from discontinued operations

     2,265,000        465,000        (722,000

Depreciation and amortization

     5,099,000        3,819,000        3,180,000   

Deferred income taxes

     (1,528,000     (2,721,000     (375,000

Stock based compensation expense

     2,552,000        2,459,000        2,532,000   

(Gain) loss on sale of intangible asset and divestiture of products

     —          (1,000,000     (3,500,000

Impairment of intangible assets

     221,000        —          —     

Increase in bad debt allowance

     100,000        —          —     

Loss on investment

     250,000        —          —     

(Reversal) other than temporary write down of marketable securities

     —          —          (500,000

CHANGES IN OPERATING ASSETS AND LIABILITIES:

      

Accounts receivable

     (18,128,000     (8,897,000     (13,779,000

Inventory

     (4,180,000     (3,224,000     2,177,000   

Prepaid taxes / taxes payable

     (1,862,000     415,000        1,624,000   

Other current assets

     (142,000     (871,000     (731,000

Other assets

     164,000        23,000        (20,000

Accounts payable

     2,418,000        (406,000     1,087,000   

Accrued expenses

     4,403,000        (260,000     4,263,000   
                        

NET CASH PROVIDED BY OPERATING ACTIVITIES OF CONTINUING OPERATIONS

   $ 33,086,000      $ 20,923,000      $ 5,053,000   
                        

CASH FLOWS FROM INVESTING ACTIVITIES:

      

Proceeds from sale of investment in marketable securities, net

   $ —        $ —        $ 3,045,000   

Purchase of property and equipment

     (8,266,000     (3,907,000     (3,895,000

Purchase of intangible assets

     (215,000     (11,380,000     (650,000

Proceeds from sale of intangible assets, net and from divestiture of products

     156,000        2,343,000        3,235,000   

Investment in Neuro-HiTech

     —          —          (100,000

Purchase of ECR Pharmaceuticals assets

     (1,440,000     (6,200,000     (1,115,000
                        

NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES OF CONTINUING OPERATIONS

   $ (9,765,000   $ (19,144,000   $ 520,000   
                        

CASH FLOWS FROM FINANCING ACTIVITIES:

      

Proceeds from the exercise of options

   $ 1,672,000      $ 12,029,000      $ 314,000   

Tax benefit of stock incentives

     654,000        4,299,000        304,000   

Purchase of treasury stock

     —          —          (1,649,000

Payments under capital lease obligation

     (193,000     (180,000     (138,000

Proceeds from draw down of equipment loan

     621,000        —          —     
                        

NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES OF CONTINUING OPERATIONS

   $ 2,754,000      $ 16,148,000      $ (1,169,000
                        

NET INCREASE IN CASH AND CASH EQUIVALENTS OF CONTINUING OPERATIONS

     26,075,000        17,927,000        4,404,000   

NET INCREASE IN CASH AND CASH EQUIVALENTS OF DISCONTINUED OPERATIONS

     211,000        200,000        1,765,000   

Cash and cash equivalents at beginning of year

     36,018,000        17,891,000        11,722,000   
                        

CASH AND CASH EQUIVALENTS AT END OF YEAR

   $ 62,304,000      $ 36,018,000      $ 17,891,000   
                        

Supplemental disclosure of cash flow information

      

Cash paid for: Interest

   $ 75,000      $ 29,000      $ 38,000   

Income taxes

     21,000,000        12,219,000        6,797,000   

Non-cash investing transactions:

      

Other receivable from divestiture of products

     —          156,000        —     

Notes receivable from the sale of intangible asset

     —          —          1,500,000   

Assets subject to capital leases

     —          —          506,000   

See notes to Consolidated Financial Statements

 

35


Table of Contents

HI-TECH PHARMACAL CO., INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(NOTE A) The Company and Summary of Significant Accounting Policies:

[1] 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.

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

 

Revenue

   2011      2010      2009  

Hi-Tech Generics

   $ 157,361,000       $ 129,359,000       $ 88,848,000   

Health Care Products

     13,872,000         11,268,000         10,125,000   

ECR Pharmaceuticals

     19,615,000         18,712,000         2,807,000   
                          

Total

   $ 190,848,000       $ 159,339,000       $ 101,780,000   
                          

[2] Basis of Accounting and Principles of Consolidation:

The accompanying consolidated financial statements of the Company are prepared on the accrual basis of accounting in accordance with accounting principles generally accepted in the United States of America (“U.S.”). All intercompany accounts and transactions are eliminated in consolidation.

[3] Inventory:

Inventories are valued at the lower of cost (first-in first-out or average cost) or market.

[4] Property and equipment:

Property and equipment is stated at cost less accumulated depreciation and amortization. Estimated depreciation and amortization of the respective assets is computed using the straight line method over their estimated useful lives.

[5] Income taxes:

The Company uses the liability method to account for deferred income taxes in accordance with ASC Topic 740-10 “Income Taxes”. The liability method measures deferred income taxes by applying enacted statutory rates in effect at the balance sheet date to the differences between the tax bases of assets and liabilities and their reported amounts in the financial statements. The resulting asset or liability is adjusted to reflect changes in the tax law as they occur.

The Company follows the provision of ASC Topic 740-10, “Income Taxes”, relating to recognition thresholds and measurement attributes for the financial statements recognition and measurement of a tax position taken or expected to be taken in a tax return. It also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and requires increased disclosures.

This guidance provides that the tax effects from an uncertain tax position can be recognized in our financial statements, only if the position is more likely than not of being sustained on audit, based on the technical merits of the position. The Company has elected an accounting policy to classify interest and penalties related to unrecognized tax benefits as interest expense.

 

36


Table of Contents

[6] 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 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.

[7] Advertising Expense:

Advertising costs are expensed when incurred. Advertising expense for the years ended April 30, 2011, 2010 and 2009 amounted to $3,968,000, $3,791,000 and $3,217,000, respectively.

[8] Freight Expense:

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

[9] Research and Development Costs:

Research and product development costs are charged to expense as incurred.

[10] Cash and cash equivalents:

The Company considers U.S. Treasury bills and government agency obligations with a maturity of three months or less when purchased to be cash equivalents.

[11] Earnings (loss) per share:

Basic earnings (loss) from continuing operations per common share is computed based on the weighted average number of common shares outstanding. Diluted earnings from continuing operations per common share gives effect to all dilutive potential common shares outstanding during the year. The dilutive effect of the outstanding options and warrants was computed using the treasury stock method. The number of potentially dilutive securities excluded from the computation of diluted income per share was approximately 303,000, 299,000 and 2,116,000 for the years ended April 30, 2011, 2010 and 2009, respectively. These securities were excluded since their effect would have been antidilutive.

[12] Long-lived assets:

The Company evaluates and records impairment losses on long-lived assets used in operations, including intangible assets, when events and circumstances indicate that the assets might be impaired using the undiscounted cash flows estimated to be generated by those assets. Long-lived assets to be disposed of are reported at the lower of their carrying amounts or fair values less disposal costs. The Company incurred an impairment loss of $1,296,000 in connection with the sale of certain assets of the Midlothian division which is included in the loss from discontinued operations and $221,000 in connection with the discontinuation of Tanafed products for the year ended April 30, 2011.

[13] Fair Value of Financial Instruments:

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

[14] Use of estimates:

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Company makes significant estimates in many areas of its accounting, including but not limited to the following: sales returns, chargebacks, allowances and discounts, inventory obsolescence, the useful lives of property and equipment and its impairment, stock-based compensation, accruals, impact of legal matters and the realization of deferred tax assets. Actual results may differ from those estimates.

 

37


Table of Contents

[15] Comprehensive Income:

The Company follows ASC Topic 220-10, “Comprehensive Income,” which requires companies to report as comprehensive income 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.

[16] Stock-Based Compensation:

The Company follows the provisions of ASC Topic 718, “Compensation – Stock Compensation”, which 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-based compensation is measured at the grant date, based on the calculated fair value of the award, and is recognized as an expense over the requisite employee service period (generally the vesting period of the grant).

The Company recognized stock-based compensation for awards issued under the Company’s Stock Option Plans in the following line items in the Statement of Operations:

 

     Year ended
April 30, 2011
     Year ended
April 30, 2010
     Year ended
April 30, 2009
 

Cost of sales

   $ 318,000       $ 488,000       $ 495,000   

Selling, general and administrative expenses

     1,930,000         1,801,000         1,861,000   

Research and development expenses

     304,000         170,000         176,000   
                          

Stock-based compensation expense before income tax benefit

   $ 2,552,000       $ 2,459,000       $ 2,532,000   
                          

The Company amortizes the fair value of all awards on a straight-line basis over the requisite service period. Cumulative compensation expense recognized at any date will at least equal the grant date fair value of the vested portion of the award at that time.

ASC Topic 718 requires the use of a valuation model to calculate the fair value of stock-based awards. 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 expected life of an award is based on the expected life pursuant to Staff Accounting Bulletin No. 107, “Share Based Payments”, as amended by Staff Accounting Bulletin No. 110. 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.

The following weighted average assumptions were used for stock options granted during the years ended April 30, 2011, 2010 and 2009:

 

     Year Ended April 30,  
     2011     2010     2009  

Dividend yield

     None        None        None   

Expected volatility

     58     58     49

Risk-free interest rate

     2.60     2.31     2.37

Expected term

     5.0        5.0        5.0   

Weighted average fair value per share at grant date

   $ 11.70      $ 10.26      $ 2.55   

All options granted through April 30, 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 generally a vesting period of four years. In accordance with ASC Topic 718, 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 is recognized in the period the forfeiture estimate is changed. As of April 30, 2011, the forfeiture rate was 9% and the effect of forfeiture adjustments in the year ended April 30, 2011 was insignificant.

 

38


Table of Contents

ASC Topic 718 requires the cash flows resulting from tax deductions in excess of compensation cost recognized for those options (excess tax benefits) to be classified as financing cash flows. The actual income tax benefits realized for tax deductions related to option exercises of share-based payments was $654,000, $4,299,000 and $304,000 for the year ended April 30, 2011, 2010 and 2009, respectively.

STOCK OPTION PLAN ACTIVITY

Employee Stock Option Plan:

A summary of the stock options activity and related information for the Amended and Restated Stock Option Plan and the 2009 Stock Option Plan (“Employee Plan”) for the years ended April 30, 2011 and April 30, 2010 is as follows:

 

Amended and Restated Stock Option Plan

   Shares     Weighted-Average
Exercise Price
     Weighted-Average
Remaining
Contractual Term
     Aggregate Intrinsic
Value
 

Outstanding at May 1, 2010

     1,662,000      $ 13.26         

Grants

     454,000        22.69         

Exercised

     (132,000     11.75         

Forfeitures or expirations

     (28,000     12.87         
                

Outstanding at April 30, 2011

     1,956,000      $ 15.40         6.4       $ 23,982,000   
                

Vested and expected to vest at April 30, 2011

     1,869,000      $ 15.27         6.3       $ 23,161,000   

Exercisable at April 30, 2011

     997,000      $ 12.76         4.1       $ 14,863,000   
                

 

Amended and Restated Stock Option Plan

   Shares     Weighted-Average
Exercise Price
     Weighted-Average
Remaining
Contractual Term
     Aggregate Intrinsic
Value
 

Outstanding at May 1, 2009

     2,447,000      $ 10.83         

Grants

     358,000        19.98         

Exercised

     (1,090,000     10.02         

Forfeitures or expirations

     (53,000     13.02         
                

Outstanding at April 30, 2010

     1,662,000      $ 13.26         6.6       $ 18,615,000   
                

Vested and expected to vest at April 30, 2010

     1,603,000      $ 13.23         6.4       $ 17,811,000   

Exercisable at April 30, 2010

     860,000      $ 13.08         4.4       $ 9,682,000   
                

Directors Stock Option Plan

A summary of the stock option activity and related information for the 1994 Director Stock Option Plan, as Amended, for the years ended April 30, 2011 and April 30, 2010 is as follows:

 

1994 Directors Stock Option Plan, as Amended

   Shares     Weighted-Average
Exercise Price
     Weighted-Average
Remaining
Contractual Term
     Aggregate Intrinsic
Value
 

Outstanding at May 1, 2010

     415,000      $ 13.72         

Grants

     50,000        22.25         

Exercised

     (14,000     8.36         

Forfeitures or expirations

     (23,000     20.68         
                

Outstanding at April 30, 2011

     428,000      $ 14.54         5.7       $ 5,622,000   
                

Vested and expected to vest at April 30, 2011

     428,000      $ 14.54         5.7       $ 5,622,000   

Exercisable at April 30, 2011

     294,000      $ 13.90         4.4       $ 4,079,000   
                

 

1994 Directors Stock Option Plan, as Amended

   Shares     Weighted-Average
Exercise Price
     Weighted-Average
Remaining
Contractual Term
     Aggregate Intrinsic
Value
 

Outstanding at May 1, 2009

     518,000      $ 11.61         

Grants

     50,000        19.59         

Exercised

     (141,000     8.29         

Forfeitures or expirations

     (12,000     10.99         
                

Outstanding at April 30, 2010

     415,000      $ 13.72         6.0       $ 4,439,000   
                

Vested and expected to vest at April 30, 2010

     415,000      $ 13.72         6.0       $ 4,439,000   

Exercisable at April 30, 2010

     266,000      $ 14.40         4.8       $ 2,689,000   
                

The aggregate intrinsic values in the preceding tables represent the total pretax intrinsic value, based on options with an exercise price less than the Company’s closing stock price of $27.66 as of April 29, 2011, which would have been received by the option holders had those option holders exercised their options as of that date.

Total intrinsic values of options exercised for the Employee Plan and the 1994 Directors Stock Option Plan, as Amended, were $1,885,000, $15,584,000 and $880,000 for the years ended April 30, 2011, 2010 and 2009, respectively. The total fair value of stock options vested during the years ended April 30, 2011, 2010 and 2009 amounted to $2,259,000, $2,341,000 and $2,090,000, respectively. As of April 30, 2011, $8,065,000 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.

On November 10, 2010, a majority of the holders of the outstanding shares of common stock of the Company approved an increase by 1,000,000 the number of shares reserved under the 2009 Stock Option Plan, under which the Company can issue up to 1,500,000 shares. As of April 30, 2011 there were 768,000 shares available for grant under the 2009 Stock Option Plan and the 1994 Directors Stock Option Plan. There were no shares available under the Amended and Restated Option Plan. An aggregate of 504,000 stock options were awarded under both the employees’ plans and the director plan for the year ended April 30, 2011.

 

39


Table of Contents

[17] Recent Accounting Pronouncements:

The Financial Accounting Standards Board (“FASB”) has issued Accounting Standard Update (“ASU”) No. 2010-27, Other Expenses (Topic 720): Fees Paid to the Federal Government by Pharmaceutical Manufacturers. This ASU provides guidance on how pharmaceutical manufacturers should recognize and classify in their income statements fees mandated by the Patient Protection and Affordable Care Act (PPACA) and the Health Care and Education Reconciliation Act, both enacted in March 2010, referred to as the “Acts.” The Acts impose an annual fee on the pharmaceutical manufacturing industry for each calendar year beginning on or after January 1, 2011. An entity’s portion of the annual fee is payable no later than September 30 of the applicable calendar year and is not tax deductible. A portion of the annual fee will be allocated to individual entities on the basis of the amount of their brand prescription drug sales (including authorized generic product sales) for the preceding year as a percentage of the industry’s brand prescription drug sales (including authorized generic product sales) for the same period. An entity’s portion of the annual fee becomes payable to the U.S. Treasury once a pharmaceutical manufacturing entity has a gross receipt from branded prescription drug sales to any specified government program or in accordance with coverage under any government program for each calendar year beginning on or after January 1, 2011. The amendments in this ASU specify that the liability for the fee should be estimated and recorded in full upon the first qualifying sale with a corresponding deferred cost that is amortized to expense using a straight-line method of allocation unless another method better allocates the fee over the calendar year that it is payable. The annual fee is classified as an operating expense in the income statement. The amendments in this ASU were effective for calendar years beginning after December 31, 2010, when the fee initially became effective. The annual impact of this fee on the Company will be highly variable depending on the volume of our sales of authorized generics and brand products. There was no material impact of the adoption of this guidance on the consolidated financial statements of the Company at April 30, 2011.

The FASB has issued ASU 2010-29, Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations. The amendments in this ASU affect any public entity as defined by Topic 805, Business Combinations, that enters into business combinations that are material on an individual or aggregate basis. The amendments in this ASU specify 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(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand 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 amendments are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010.

In December 2010, the FASB updated the accounting guidance relating to the annual goodwill impairment test. The updated guidance requires companies to perform the second step of the impairment test to measure the amount of impairment loss, if any, when it is more likely than not that goodwill impairment exists when the carrying amount of a reporting unit is zero or negative. In considering whether it is more likely than not that goodwill impairment exists, an entity shall evaluate whether there are adverse qualitative factors. The updated guidance is effective for the Company beginning in the first quarter of fiscal 2012. The adoption of this guidance is not expected to have a material impact on the Company’s consolidated financial statements.

In June 2011, the FASB updated the disclosure requirements for comprehensive income. The updated guidance requires companies to disclose the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The updated guidance does not affect how earnings per share is calculated or presented. The updated guidance is effective for the Company beginning in the first quarter of fiscal year 2013. The Company is currently evaluating the impact of adoption of this accounting guidance on its consolidated financial statements.

(NOTE B) Marketable Securities:

The Company invested in auction rate securities (ARS) consisting primarily of municipal securities that were held as investments available-for-sale. During January and February of 2008, two of the auction rate securities failed to auction due to sell orders exceeding buy orders. Liquidity for these auction-rate securities is typically provided by an auction process that resets the applicable interest rate at pre-determined intervals. The Company sold one of these securities at a loss of approximately $500,000 in July 2008. This decrease in the value of the security was fully reserved for at April 30, 2008, and the corresponding expense was included in interest income and other on the statement of operations. The remaining securities were liquidated in September 2008 at their par value. In December 2008, the Company received a reimbursement from the dealer of the security, Bank of America, of approximately $500,000 for the ARS sold by the Company at a loss. This amount is included in interest income and other in the Company’s consolidated statement of operations for the year ended April 30, 2009.

 

40


Table of Contents

On May 1, 2008, the Company adopted Statement of ASC Topic 820, “Fair Value Measurements and Disclosures”. The adoption of the standard did not have a material impact on the Company’s financial position and the results of operations.

ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. This standard is now the single source in generally accepted accounting principles for the definition of fair value, except for the fair value of leased property. It establishes a fair value hierarchy that distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs), (2) assumptions that are other than quoted prices which are either directly or indirectly observable for the asset or liability through correlation with market data and (3) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3).

The three levels of the fair value hierarchy under ASC Topic 820 are described below:

 

   

Level 1—Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

 

   

Level 2—Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, including quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates); and inputs that are derived principally from or corroborated by observable market data by correlation or other means.

 

   

Level 3—Inputs that are both significant to the fair value measurement and unobservable.

At April 30, 2011 and 2010, the Company had no marketable securities except Neuro-HiTech described in Note F.

(NOTE C) Accounts Receivable:

At April 30, 2011 and 2010, accounts receivable balances net of returns and allowances and allowance for doubtful accounts are as follows:

 

     April 30,  
     2011     2010  

Accounts receivable, gross

   $ 75,232,000      $ 54,374,000   

Adjustment for returns and price allowances (a)

     (17,100,000     (14,370,000

Allowance for doubtful accounts

     (500,000     (400,000
                

Accounts receivable, net

   $ 57,632,000      $ 39,604,000   
                

 

(a) directly reduces gross revenue

(NOTE D) Inventory:

The components of inventory consist of the following:

 

     April 30,  
     2011      2010  

Finished goods

   $ 8,124,000       $ 7,306,000   

Work in process

     935,000         740,000   

Raw materials

     14,725,000         11,558,000   
                 

Total

   $ 23,784,000       $ 19,604,000   
                 

 

41


Table of Contents

Work in process included raw materials and components staged for use in production as well as raw materials and components for our ECR Pharmaceuticals division which are held at a contract manufacturer for manufacturing prior to completion.

During fiscal 2011 and 2010 the Company incurred an expense of $534,000 and $865,000 to write off the value of inventory for products for which the company suspended sales subsequent to year end due to receipt of a warning letter from the FDA. Additionally, the Company reserved $900,000 and $223,000 on ECR’s Lodrane® and Zolpimist® inventory, respectively, for the year ended April 30, 2011.

(NOTE E) Property and Equipment:

The components of property and equipment consist of the following:

 

     April 30,         
     2011      2010      Useful Lives  

Land and building and improvements

   $ 17,453,000       $ 15,741,000         27.5 Yrs.   

Machinery and equipment

     26,916,000         21,172,000         7 and 10 Yrs.   

Transportation equipment

     55,000         37,000         7 Yrs.   

Computer equipment and systems

     5,679,000         4,982,000         3 and 7 Yrs.   

Furniture and fixtures

     1,145,000         1,057,000         7 Yrs.   
                    
     51,248,000         42,989,000      

Accumulated depreciation and amortization

     25,382,000         22,668,000      
                    

Total property and equipment—net

   $ 25,866,000       $ 20,321,000      
                    

The Company incurred depreciation expense of $2,722,000, $2,647,000 and $2,456,000 for the years ended April 30, 2011, 2010, and 2009, respectively. No depreciation is taken on land with a carrying value of $1,754,000 at April 30, 2011 and 2010.

(NOTE F) Other Assets:

Included in other assets is the Company’s investment in a limited liability company for the marketing, development and distribution of nutritional supplements, Marco Hi-Tech JV LLC (“Marco Hi-Tech”). The investment in Marco Hi-Tech is recorded using the equity method. During fiscal year ended April 30, 2011 a loss of $174,000 attributable to the investment in Marco Hi-Tech is included in interest (income) and other on the statement of operations. At April 30, 2011 the carrying value of this investment was $213,000.

During fiscal year ended April 30, 2010 income of $28,000 attributable to the investment in Marco Hi-Tech is included in interest (income) and other on the statement of operations. At April 30, 2010 the carrying value of this investment was $387,000.

The valuation of our investment in Neuro-Hitech, Inc., a marketable security to be retained by the Company valued pursuant to ASC Topic 320, “Investments – Debt and Equity Securities”, is classified as available for sale and measured at fair value with the adjustment to fair value and changes therein recorded in accumulated other comprehensive income. The Company wrote off the investment in Neuro-Hitech, Inc. during the year ended April 30, 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.

At April 30, 2010, the Company owned 1,526,922 shares of Neuro-Hitech with a fair value of $0.01 per share, with a total value of $15,000 which resulted in an unrealized loss of $90,000, net of deferred tax of $48,000, being included in accumulated other comprehensive income (loss) as of such date.

 

42


Table of Contents

(NOTE G) Intangible Assets:

Acquired intangible assets consist of:

 

     April 30, 2011     April 30, 2010        
     Gross Carrying
Amount
     Accumulated
Amortization
    Gross Carrying
Amount
     Accumulated
Amortization
    Amortization Period  

ECR intangible assets

   $ 7,334,000       $ (1,102,000   $ 5,396,000       $ (459,000     9-10 years   

MagOx® intangible assets

     4,100,000         (478,000     4,100,000         (68,000     10 years   

Clobetasol intangible asset

     4,000,000         (400,000     4,000,000         —          10 years   

Zolpimist® intangible assets

     3,000,000         (94,000     3,000,000         —          10 years   

Zostrix ® intangible assets

     5,354,000         (2,738,000     5,354,000         (2,285,000     3-11.5 years   

Midlothian intangible assets

     1,011,000         (224,000     1,011,000         (157,000     3-10 years   

Vosol® and Vosol® HC intangible assets

     700,000         (227,000     700,000         (157,000     10 years   

Other intangible assets

     1,528,000         (533,000     1,534,000         (283,000     2-10 years   
                                          
   $ 27,027,000       $ (5,796,000   $ 25,095,000       $ (3,409,000  
                                    

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 years ended April 30, 2011, 2010 and 2009 was $2,387,000, $1,172,000 and $762,000, 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. As of April 30, 2011, the Company had approximately $245,000 of intangibles, for which the amortization period had not started yet. 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.

Business acquisitions:

On December 28, 2007, the Company acquired the assets of Midlothian Laboratories, LLC for $5,900,000 in an all-cash transaction, including inventory. Under the terms of the acquisition Hi-Tech received rights to Midlothian’s current product line, consisting of prescription nutritional supplements including pre-natal vitamins and several cough and cold formulations, and future ANDA and non-ANDA products that were in development. Subsequent to April 30, 2011, on May 9, 2011 the Company sold certain assets of the Midlothian Laboratories division (See Discontinued Operations). The Company incurred amortization expense of $67,000 for the years ended April 30, 2011, 2010 and 2009 related to assets retained by Hi-Tech after the divestiture of the Midlothian Laboratories division.

On February 27, 2009 the Company entered into an asset purchase agreement with E. Claiborne Robins Company, Inc. d/b/a ECR Pharmaceuticals, a Virginia corporation (“ECR”) to purchase substantially all of the assets and business of ECR for a purchase price of $5,138,000 plus an earn-out. Based on the purchase agreement, $1,000,000 was paid at closing and $4,138,000 was paid within eight months after closing. To date, the Company recorded $4,000,000 of an earn-out based on sales and gross margins. These payments increased the ECR intangible asset balance, including $545,000 of goodwill. The Company has $498,000 accrued at April 30, 2011 related to the earn-out, which the Company paid in May, 2011. No additional obligation exists with respect to the earn-out.

Intangible assets with an estimated fair value of $7,334,000, including $4,000,000 from the earn-out payment, were recognized in the acquisition of certain assets of ECR. These intangible assets, consisting of certain brand name products and intellectual property, have estimated useful lives of 10 years. The Company incurred amortization expense of $643,000 and $403,000 for the years ended April 30, 2011 and April 30, 2010, respectively.

Assets acquired in connection with the purchase of the assets and the business of ECR are:

 

Brand name and intellectual property

   $ 7,334,000   

Accounts receivable, net

     1,263,000   

Inventory

     1,035,000   

Property and equipment

     104,000   

Other assets

     73,000   
        
     9,809,000   

Assumed liabilities

     (322,000
        

Net asset acquired

   $ 9,487,000   
        

 

43


Table of Contents

Product Acquisitions:

On July 12, 2005, the Company acquired an interest in Zostrix® brand products for $5,054,000 including $491,000 of closing costs. $4,000,000 was paid at the closing and $400,000 was payable in four equal quarterly installments commencing October 1, 2005. Such amount was paid by the fiscal year ended April 30, 2008. The Company incurred amortization expense of $423,000, $461,000 and $468,000 for the years ended April 30, 2011, 2010 and 2009, respectively, in connection with the purchase of Zostrix® brand.

On February 19, 2007, the Company purchased the rights to a new Zostrix® foot care product from Rodlen Laboratories, Inc. The purchase price for the formula was $300,000, of which $150,000 was paid upon signing and $150,000 was paid on June 19, 2007. The Company incurred amortization expense of $30,000, $30,000 and $30,000 for the years ended April 30, 2011, 2010 and 2009, respectively.

In May 2008, the Company purchased an ANDA for $200,000 from a development company. This amount is included in other intangibles, and the intangible is being amortized over a ten year life.

In December 2008, the Company signed a supply and distribution agreement with a foreign company to be the sole U.S. distributor of an ANDA that this company had filed with the FDA. Hi-Tech paid an upfront payment of $300,000 which is being amortized over the life of the five year agreement. This amount is included in other intangibles.

In March 2009, the Company licensed the technology for a patented over the counter product for an upfront payment of $150,000 and an additional payment of $150,000 paid 180 days after the agreement date. The license agreement is included in other intangibles and is being amortized over the life of the product’s patents.

On July 16, 2009, the Company entered into an agreement with DFB Pharmaceuticals Inc. (“DFB”), the plaintiff in a lawsuit against the Company, whereby in exchange for the payment of $2,000,000 upon signing the term sheet of the settlement agreement, the Company obtained the right to purchase five ANDAs and/or a manufacturing facility from DFB for consideration agreed to in the agreement. The Company signed the settlement agreement and paid $2,000,000 on July 17, 2009. On August 31, 2009 the Company paid an additional $2,000,000 in order to obtain five ANDAs of various dosage forms of Clobetasol Propionate 0.05% including the ointment, solution, cream, emoltion cream and gel. The Company markets and plans to subsequently manufacture these products at its facility. The Company did not exercise the option to purchase a manufacturing facility from DFB. The Company incurred amortization expense of $400,000 for the year ended April 30, 2011.

On November 13, 2009, Hi-Tech signed an exclusive licensing agreement between Hi-Tech’s ECR Pharmaceuticals subsidiary and NovaDel Pharma, Inc., a drug development company, through which ECR obtained the rights to market Zolpimist® (Zolpidem Tartrate oral spray, 5mg per spray), in the United States and Canada. Under the terms of the agreement ECR paid NovaDel $3,000,000 upon closing. In addition NovaDel will receive a royalty of up to 15% on net sales, and a one time $7,500,000 milestone payment if net sales reach $100,000,000 in any calendar year throughout the life of the product. The Company incurred amortization expense of $94,000 for the year ended April 30, 2011.

On March 1, 2010, the Company acquired the Mag-Ox® line of magnesium nutritional supplements from Blaine Company, Inc., a privately held company, for $4,100,000 in an all-cash transaction. The Company paid an additional $300,000 for inventory. Under the terms of the acquisition Hi-Tech received rights to Mag-Ox®, Maginex®, Uro-Mag® and Corban™. The brands are being sold through the Company’s Health Care Products division. The Company incurred amortization expense of $410,000 and $68,000 for the years ended April 30, 2011 and April 30, 2010, respectively.

The Company purchased an additional $215,000 of intangible assets during the period including a payment of $150,000 for the Nystatin Oral Suspension ANDA.

 

Estimated Amortization Expense

For the year ending April 30,

      

2012

   $ 2,882,000   

2013

     2,653,000   

2014

     2,653,000   

2015

     2,653,000   

2016

     2,618,000   

Thereafter

     7,227,000   
        

Total

   $ 20,686,000   
        

Discontinued Operations:

The Company divested the Midlothian Laboratories division in exchange for a cash payment of $1,700,000 in May 2011. The Company retained marketing and distribution rights to generic buprenorphine sublingual tablets, an ANDA that is filed with the FDA,

 

44


Table of Contents

an ANDA that is in development and a royalty stream from products previously divested. Metrics, Inc, a drug development company located in North Carolina, acquired Midlothian Laboratories from the Company.

At April 30, 2011, the Company recorded an impairment charge of $1,296,000 in connection with the sale of the Midlothian Laboratories division, which is included in the loss from discontinued operations. Intangible assets in the amount of $953,000 are included in Non-current assets of discontinued operations at April 30, 2011.

The operations of the Midlothian Laboratories division have been segregated from continuing operations and are reflected as discontinued operations in each period’s consolidated statement of operations as follows:

 

     April 30,  
     2011     2010     2009  

Sales

   $ 2,136,000      $ 4,352,000      $ 6,871,000   

(Loss) income from discontinued operations, net of tax

     (2,265,000     (465,000     722,000   

Diluted (loss) earnings per common share from discontinued operations

   $ (0.17   $ (0.04   $ 0.06   

(NOTE H) Accrued Expenses and Other Current Liabilities:

The following summarizes accrued expenses and other current liabilities:

 

     April 30,  
     2011      2010  

Accrued rebates and advertising

   $ 5,274,000       $ 3,159,000   

Accrued commissions and royalty payments

     1,748,000         1,653,000   

Accrued compensation and benefits

     3,826,000         2,312,000   

Accrued professional and legal fees

     1,237,000         717,000   

Accrued earnout payable

     498,000         —     

Other

     1,075,000         916,000   
                 
   $ 13,658,000       $ 8,757,000   
                 

(NOTE I) Debt

Obligation under Capital Lease:

 

During year ended April, 30, 2009, the Company entered into capital lease agreements to finance part of its enterprise resource management system. As of April 30, 2011, the Company was obligated to provide for aggregate monthly payments of approximately $17,000 and terms expiring from June through August 2011.

The carrying value of assets under capital leases included in property and equipment are as follows:

 

     April 30,
2011
 

Equipment and software

   $ 506,000   

Less accumulated amortization and depreciation

     (180,000
        
   $ 326,000   
        

Depreciation expense for equipment under capital lease for the years ended April 30, 2011 and April 30, 2010 were $72,000 and $72,000, respectively.

Future minimum lease payments under the terms of the capital lease agreements are as follows at April 30, 2011:

 

Year Ending April 30,

      

2012

   $ 37,000   

2013

     —     
        

Future minimum lease payments

     37,000   

Less interest

     —     
        

Future principal payments

     37,000   

Less current portion

     37,000   
        

Long-term obligations under capital leases

   $ 0   
        

 

45


Table of Contents

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 has not drawn down on this credit facility and has no balance due at April 30, 2011.

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. The Company has a balance of $621,000 under this loan at April 30, 2011.

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.

(NOTE J) Product Divestures:

On July 11, 2008, the Company sold the related rights to Brometane, a cough and cold product, for $3,500,000. The Company has received royalties on net sales of the product through December 2010. The Company recognized a gain of $3,500,000 on this transaction in the first quarter of fiscal 2009. The gain was included in Interest (income) and other on the Consolidated Statement of Operations.

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 division, in exchange for a series of payments totaling $1,000,000 over the course of one year. In addition, the Company receives a royalty on the sales of these products, not to exceed $1,500,000 per year for three years ending June 30, 2012. These products contributed approximately $600,000 and $1,600,000 in sales for the Midlothian Laboratories division for the year ended April 30, 2010 and 2009, 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 Consolidated Statement of Operations.

(NOTE K) Related Party Transactions:

On May 1, 2010, the Company entered into an amended and restated executive employment agreement with David S. Seltzer pursuant to which Mr. Seltzer is to serve as President and Chief Executive Officer, effective May 1, 2010 through April 30, 2013. Mr. Seltzer is to receive an annual base salary of $464,565 for the period May 1, 2010 through April 30, 2011 (“Base Salary”) and for each fiscal year thereafter during the term of the employment agreement, Mr. Seltzer will be paid a base salary equal to the sum of (a) the Base Salary for the immediately preceding fiscal year and (b) an amount determined by multiplying the Base Salary in effect for the immediately preceding fiscal year by five percent (5%). Mr. Seltzer may also receive a bonus during each year of employment which shall be approved by the Company’s Compensation Committee. Such bonus may be based on the Company meeting certain fiscal goals and also taking into account, among other things, progress towards strategic objectives not fully measured by pre-tax net income, the Company’s acquisitions, strategic alliances, submissions to the FDA, operational efficiencies and approval of ANDAs by the FDA. During the term of the agreement Mr. Seltzer shall be eligible to annually receive options to purchase a minimum amount of 50,000 shares of the Company’s common stock. Compensation paid under the agreement for the years ended April 30, 2011, 2010, and 2009 was $465,000, $451,000 and $442,000, respectively. Annual bonuses under the agreement were $300,000, $225,000, and $0 paid in the years ended April 30, 2011, 2010 and 2009, respectively.

 

46


Table of Contents

Mr. Reuben Seltzer, an attorney, stockholder, director, and brother of the President, has been employed by the Company in corporate development activities since January 1, 2009. For each of the fiscal years 2011, 2010 and 2009, he received compensation of $378,000, $306,000, and $95,000, respectively. Annual bonuses under the agreement were $275,000, $100,000 and $0. Mr. Reuben Seltzer was previously the CEO of Neuro-Hitech and also has an interest in the joint venture of Marco Hi-Tech as described in Note F.

In addition, in fiscal year 2011 the Company granted Mr. Reuben Seltzer an option to purchase 95,000 shares of the Company’s common stock at an exercise price of $22.25, which vest at 25% per annum and are exercisable through 2020. The Company valued these options at $1,097,000, which is being charged to operations over a four year term. In fiscal year 2010, the Company granted Mr. Reuben Seltzer an option to purchase 25,000 shares of the Company’s common stock at an exercise price of $19.59, which vest at 25% per annum and are exercisable through 2019. The Company valued these options at $252,000, which is being charged to operations over a four year term.

The Company is jointly developing a generic product outside of its area of expertise with EMET Pharmaceuticals, LLC (“EMET”), previously known as XCell Pharmaceuticals, and another entity. Reuben Seltzer is a principal of EMET. During the fiscal years 2011, 2010 and 2009, the Company spent approximately $127,000, $713,000 and $2,978,000, respectively, on this project, which was included in research and development expense.

Tashlik, Kreutzer, Goldwyn and Crandell P.C. received $397,000, $422,000, and $297,000 in legal fees in each of the years ended April 30, 2011, 2010 and 2009, respectively, for services performed for the Company. Mr. Martin M. Goldwyn, a member of such firm, is a director of the Company.

(NOTE L) Commitments, 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 these products as a result of the warning letter. Sales of these products totaled approximately $5,000,000 in fiscal year 2010. In addition, the Company incurred an expense of $534,000 and $865,000 to write off the value of the inventory used in the manufacturing of these products in fiscal year 2011 and fiscal year 2010, respectively. 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 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.

On March 2, 2011, the US Food and Drug Administration (FDA) indicated in its MedWatch publication that the Agency removed approximately 500 currently marketed cough/cold and allergy related products including Lodrane® products. Three of these are currently marketed by ECR Pharmaceuticals under the brand name Lodrane®. 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 $16,600,000 and $13,100,000 for the year ended April 30, 2011 and April 30, 2010, respectively.

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.

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

 

47


Table of Contents

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 renewed its motion to dismiss or stay the action on April 14, 2011. The motion is pending. The Company intends to defend against such allegations and believes it has meritorious defenses. The Company is in settlement discussions with the plaintiff. The Company believes that any potential settlement payment will not be material.

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. The Company settled with Allergan on May 20, 2011 without incurring a liability and the case was dismissed with prejudice on May 31, 2011.

[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.

The Company entered into two software lease obligations to partially finance a new computer system, see note I.

 

48


Table of Contents

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 acquisition of the assets of ECR Pharmaceuticals, the Company paid $2,062,000 and $1,938,000 for fiscal 2010 and 2011, respectively, for an earn-out. At April 30, 2011 $498,000 was included in accrued expenses for the ECR earn-out. No additional obligation exists with respect to the earn-out.

 

     Payments due by April 30,  

Contractual Obligations

   2012      2013      2014      2015      2016  

Richmond, VA lease

   $ 85,000       $ 87,000       $ 88,000       $ 30,000       $ —     

Software lease (principal and interest)

     37,000               

Amityville, NY lease

     17,000         17,000         18,000         19,000         3,000   
                                            

Total

   $ 139,000       $ 104,000       $ 106,000       $ 49,000       $ 3,000   
                                            

For the years ended April 30, 2011, 2010 and 2009, the rent expense amounted to approximately $112,000, $107,000 and $93,000, respectively.

(NOTE M) Income Taxes:

[1] The provision (benefit) for income taxes from continued operations is comprised of the following:

 

     Year Ended April 30,  
     2011     2010     2009  

Current:

      

Federal

   $ 22,433,000      $ 17,093,000      $ 5,974,000   

State

     122,000        26,000        60,000   

Foreign

     55,000        73,000        0   

Deferred:

      

Federal

     (1,504,000     (2,682,000     (368,000

State

     (24,000     (39,000     (6,000
                        

Total

   $ 21,082,000      $ 14,471,000      $ 5,660,000   
                        

[2] Expected tax expense based on the statutory rate is reconciled with actual tax expense from continued operations as follows:

 

     Year Ended April 30,  
     2011     2010     2009  

Statutory rate

     35.0     35.0     35.0

State income tax, net of federal income tax benefit

     0.2     0.1     0.4

Research and development tax credit

     (0.5 )%      (0.8 )%      (1.1 )% 

IRS Section 199 tax benefit

     (3.0 )%      (1.7 )%      (1.9 )% 

Share-based compensation expense

     1.0     1.2     3.5

Other

     (0.2 )%      (2.4 )%      2.5
                        

Effective tax rate

     32.5     31.4     38.4
                        

For the years ended April 30, 2011, April 30, 2010, and April 30, 2009, the Company’s state effective tax rate was reduced due to the utilization of state investment tax credits, the utilization of net operating losses carry forwards and change in New York law. Future effective state income tax rates may be affected by the availability of state investment tax credits.

 

49


Table of Contents

During the year ended April 30, 2011, the Company earned tax deductions from the exercise of non-qualified options and of options in a disqualifying disposition of approximately $1,884. As a result, the Company recorded tax benefits amounting to $414,000 as additional paid in capital and $240,000 as a credit to income tax expense.

[3] Current and non-current deferred tax assets are composed of the following:

 

     April 30,  
     2011     2010  

Current deferred tax assets:

    

Allowances and write-offs not currently deductible for accounts receivable and inventory

   $ 5,493,000      $ 3,144,000   

Expenses not currently deductible

     53,000        1,075,000   
                
     5,546,000        4,219,000   
                

Non-current deferred tax assets (liabilities):

    

Expenses not currently deductible

     1,861,000        1,637,000   

Tax credits

     1,409,000        984,000   

Depreciation, amortization and unrealized gain on investments

     (802,000     (779,000

Valuation allowance

     (1,384,000     (959,000
                
   $ 1,084,000      $ 883,000   
                

The Company recorded a liability for uncertain tax positions related to research and development credits taken by the Company in the net amount of $0 and $163,000 as of April 30, 2011 and 2010, respectively.

The reconciliation of the beginning and ending amount of unrecognized tax benefit is as follows:

 

Balance at April 30, 2010

   $ 163,000   

Decrease in tax positions for prior years

     (163,000
        

Balance at April 30, 2011

   $ 0   
        

All tax years prior to April 30, 2008 are closed to IRS and state tax authorities audit.

At April 30, 2011 the Company has New York State investment tax credits in the amount of $1,384,000, of which $242,000 are expiring through April 30, 2023. The Company is accounting for the investment tax credit using the flow-through method. The Company provided a full valuation allowance on its New York State credits due to the unlikely utilization of the credits as the New York state allocation continues to decrease. The allowance increased by approximately $425,000 during the year ended April 30, 2011.

(NOTE N) Significant Customers and Concentration of Credit Risk:

For the year ended April 30, 2011, three customers, accounted for net sales of approximately 15%, 13%, and 11%, respectively. These customers represented approximately 52% of the accounts receivable at April 30, 2011. For the year ended April 30, 2010, these three customers accounted for net sales of approximately 22%, 16%, and 16%, respectively. These customers represented approximately 65% of the accounts receivable at April 30, 2010.

Cash in excess of Federal Deposit Insurance Company limitations is held in certain banks.

(NOTE O) Savings Plan:

The Company has a defined contribution plan that qualifies under Section 401(k) of the Internal Revenue Code for the benefit of substantially all full time eligible employees. Employees may contribute between 1% and 15% of their salary up to the dollar maximum allowed by the Internal Revenue Service. Company contributions are voluntary and are made at the discretion of the Board of Directors. The Company contributed $397,000, $366,000 and $284,000, for fiscal years 2011, 2010, and 2009, respectively.

 

50


Table of Contents

(NOTE P) Quarterly Financial Results (unaudited):

 

     Quarter     Year  
     1     2     3     4    

Fiscal 2011

          

Net sales

   $ 39,309,000      $ 44,656,000      $ 49,700,000      $ 57,183,000      $ 190,848,000   

Gross profit

   $ 22,543,000      $ 25,131,000      $ 28,632,000      $ 31,279,000      $ 107,585,000   

Income from continuing operations

   $ 8,525,000      $ 10,423,000      $ 10,796,000      $ 13,975,000      $ 43,719,000   

Income (loss) from discontinued operations, net of tax

   $ 150,000      $ (447,000   $ (658,000   $ (1,310,000   $ (2,265,000
                                        

Net income

   $ 8,675,000      $ 9,976,000      $ 10,138,000      $ 12,665,000      $ 41,454,000   
                                        

Basic earnings (loss) per share:

          

Continuing operations

   $ 0.68      $ 0.83      $ 0.85      $ 1.10      $ 3.47   

Discontinued operations

   $ 0.01      $ (0.04   $ (0.05   $ (0.10   $ (0.18
                                        

Basic earnings per share

   $ 0.69      $