Table of Contents

				Page No.
PART I. FINANCIAL INFORMATION

	ITEM 1.	FINANCIAL STATEMENTS

		Consolidated Balance Sheets as of ~~December 31, 2016~~September 30, 2017 (unaudited) and June 30, ~~2016~~2017	3

		Consolidated Statements of Operations (unaudited) for the three ~~and six~~ months ended ~~December 31,~~September 30, 2017 and 2016 ~~and 2015~~	4

		Consolidated Statements of Comprehensive ~~Income~~Income/Loss (unaudited) for the three ~~and six~~ months ended ~~December 31,~~September 30, 2017 and 2016 ~~and 2015~~	5

		Consolidated Statements of Changes in Stockholders’ Equity (unaudited) for the ~~six~~three months ended ~~December 31, 2016~~September 30, 2017	6

		Consolidated Statements of Cash Flows (unaudited) for the ~~six~~three months ended ~~December 31,~~September 30, 2017 and 2016 ~~and 2015~~	7

		Notes to Consolidated Financial Statements (unaudited)	8

	ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	3026

	ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	4833

	ITEM 4.	CONTROLS AND PROCEDURES	4834

PART II. OTHER INFORMATION

	ITEM 1.	LEGAL PROCEEDINGS	4935

	ITEM 1A.	RISK FACTORS	4935

	ITEM 6.	EXHIBITS	4935

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

LANNETT COMPANY, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

	(Unaudited)						(Unaudited)
	December 31, 2016			June 30, 2016			September 30, 2017			June 30, 2017
ASSETS
Current assets:
Cash and cash equivalents	$	247,253		$	224,769		$	92,461		$	117,737
Investment securities	11,870			14,094			23,973			27,091
Accounts receivable, net	222,986			211,722			243,326			204,066
Inventories	130,238			114,904			125,390			122,604
Deferred tax assets	45,375			40,892
Prepaid income taxes							13,494			16,703
Other current assets	7,886			6,434			9,325			6,592
Total current assets	665,608			612,815			507,969			494,793
Property, plant and equipment, net	227,053			216,638			249,276			243,148
Intangible assets, net	470,065			575,503			447,797			453,861
Goodwill	339,566			333,611			339,566			339,566
Deferred tax assets	31,782			11,556			48,592			52,753
Other assets	18,848			13,895			22,587			19,191
TOTAL ASSETS	$	1,752,922		$	1,764,018		$	1,615,787		$	1,603,312

LIABILITIES
Current liabilities:
Accounts payable	$	43,772		$	34,720		$	49,229		$	44,720
Accrued expenses	11,662			9,247			13,042			12,499
Accrued payroll and payroll-related expenses	8,910			10,572			6,706			4,833
Rebates payable	36,785			21,894			47,336			44,593
Royalties payable	3,550			5,127			2,480			3,015
Restructuring liability	5,347			4,130			4,498			5,431
Settlement liability	8,000			7,000			14,500			17,000
Income taxes payable	1,483			743
Acquisition-related contingent consideration	35,000			35,000
Short-term borrowings and current portion of long-term debt	178,239			178,236			63,556			60,117
Total current liabilities	332,748			306,669			201,347			192,208
Long-term debt, net	867,221			883,612			831,665			843,530
Settlement liability	9,167			12,526
Other liabilities	7,136			6,754			6,504			6,452
TOTAL LIABILITIES	1,216,272			1,209,561			1,039,516			1,042,190
Commitments and Contingencies (Note 13 and 14)
Commitments and contingencies (Note 12 and 13)

STOCKHOLDERS’ EQUITY
Common stock ($0.001 par value, 100,000,000 shares authorized; 37,443,721 and 37,150,165 shares issued; 36,838,519 and 36,604,202 shares outstanding at December 31, 2016 and June 30, 2016, respectively)	37			37
Common stock ($0.001 par value, 100,000,000 shares authorized; 37,672,233 and 37,528,450 shares issued; 37,034,055 and 36,919,296 shares outstanding at September 30, 2017 and June 30, 2017, respectively)							38			37
Additional paid-in capital	288,906			283,301			295,282			292,780
Retained earnings	257,119			278,355			291,031			277,774
Accumulated other comprehensive loss	(257		)	(295		)	(221		)	(222		)
Treasury stock (605,202 and 545,963 shares at December 31, 2016 and June 30, 2016, respectively)	(9,155		)	(7,349		)
Total Lannett Company, Inc. stockholders’ equity	536,650			554,049
Noncontrolling interest	—			408
Treasury stock (638,178 and 609,154 shares at September 30, 2017 and June 30, 2017, respectively)							(9,859		)	(9,247		)
Total stockholders’ equity	536,650			554,457			576,271			561,122
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	1,752,922		$	1,764,018		$	1,615,787		$	1,603,312

The accompanying notes are an integral part of the consolidated financial statements.

LANNETT COMPANY, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

(In thousands, except share and per share data)

	Three months ended						Six months ended
	December 31,						December 31,						Three Months Ended September 30,
	2016			2015			2016			2015			2017			2016

Net sales	$	170,944		$	127,059		$	332,503		$	233,492		$	154,961		$	161,559
Cost of sales	75,154			51,800			145,974			80,619			79,553			70,820
Amortization of intangibles	7,737			3,614			16,624			3,801			7,737			8,887
Gross profit	88,053			71,645			169,905			149,072			67,671			81,852
Operating expenses:
Research and development expenses	9,939			9,069			22,310			15,597			7,409			12,371
Selling, general and administrative expenses	18,069			14,666			39,329			30,202			19,038			21,260
Acquisition and integration-related expenses	1,027			17,585			2,418			21,527			18			1,391
Restructuring expenses	1,712			—			3,764			—			527			2,052
Intangible asset impairment charges	23,000			—			88,084			—
Intangible asset impairment charge													—			65,084
Total operating expenses	53,747			41,320			155,905			67,326			26,992			102,158
Operating income	34,306			30,325			14,000			81,746
Operating income (loss)													40,679			(20,306		)
Other income (loss):
Investment income (loss)	1,021			975			2,048			(135		)
Investment income													1,164			1,027
Interest expense	(23,333		)	(11,772		)	(46,327		)	(11,832		)	(20,912		)	(22,994		)
Other	(266		)	(30		)	(263		)	(30		)	(251		)	3
Total other loss	(22,578		)	(10,827		)	(44,542		)	(11,997		)
Total other income (loss)													(19,999		)	(21,964		)
Income (loss) before income tax	11,728			19,498			(30,542		)	69,749			20,680			(42,270		)
Income tax expense (benefit)	3,542			5,958			(9,340		)	23,013			7,423			(12,882		)
Net income (loss)	8,186			13,540			(21,202		)	46,736			13,257			(29,388		)
Less: Net income attributable to noncontrolling interest	14			20			34			35			—			20
Net income (loss) attributable to Lannett Company, Inc.	$	8,172		$	13,520		$	(21,236	)	$	46,701		$	13,257		$	(29,408	)

Earnings (loss) per common share attributable to Lannett Company, Inc.:
Basic	$	0.22		$	0.37		$	(0.58	)	$	1.28		$	0.36		$	(0.80	)
Diluted	$	0.22		$	0.36		$	(0.58	)	$	1.25		$	0.35		$	(0.80	)

Weighted average common shares outstanding:
Basic	36,810,388			36,388,542			36,754,828			36,349,597			36,992,064			36,699,267
Diluted	37,676,370			37,388,450			36,754,828			37,401,878			37,730,656			36,699,267

The accompanying notes are an integral part of the consolidated financial statements.

LANNETT COMPANY, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(UNAUDITED)

(In thousands)

Three months ended

Six months ended

December 31,

December 31,

2016

2015

2016

2015

Net income (loss)

$
8,186

$
13,540

$
(21,202
)
$
46,736

Other comprehensive income, before tax:

Foreign currency translation gain

41

42

38

26

Total other comprehensive income, before tax

41

42

38

26

Income tax related to items of other comprehensive income

—

—

—

—

Total other comprehensive income, net of tax

41

42

38

26

Comprehensive income (loss)

8,227

13,582

(21,164
)
46,762

Less: Total comprehensive income attributable to noncontrolling interest

14

20

34

35

Comprehensive income (loss) attributable to Lannett Company Inc.

$
8,213

$
13,562

$
(21,198
)
$
46,727

	Three Months Ended September 30,
	2017		2016

Net income (loss)	$	13,257	$	(29,388	)
Other comprehensive income (loss), before tax:
Foreign currency translation gain (loss)	1		(3		)
Total other comprehensive income (loss), before tax	1		(3		)
Income tax related to items of other comprehensive income	—		—
Total other comprehensive income (loss), net of tax	1		(3		)
Comprehensive income (loss)	13,258		(29,391		)
Less: Total comprehensive income attributable to noncontrolling interest	—		20
Comprehensive income (loss) attributable to Lannett Company, Inc.	$	13,258	$	(29,411	)

The accompanying notes are an integral part of the consolidated financial statements.

LANNETT COMPANY, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(UNAUDITED)

(In thousands)

Stockholders’ Equity Attributable to Lannett Company Inc.

Common Stock

Additional

Accumulated
Other

Stockholders’
Equity

Total

Shares
Issued

Amount

Paid-In
Capital

Retained
Earnings

Comprehensive
Loss

Treasury
Stock

Attributable to
Lannett Co., Inc.

Noncontrolling
Interest

Stockholders’
Equity

Balance, June 30, 2016

37,150

$
37

$
283,301

$
278,355

$
(295
)
$
(7,349
)
$
554,049

$
408

$
554,457

Shares issued in connection with share-based compensation plans

294

—

1,785

—

—

—

1,785

—

1,785

Share-based compensation

—

—

4,173

—

—

—

4,173

—

4,173

Excess tax benefits on share-based compensation awards

—

—

705

—

—

—

705

—

705

Purchase of noncontrolling interest

—

—

(1,058
)
—

—

—

(1,058
)
(442
)
(1,500
)
Purchase of treasury stock

—

—

—

—

—

(1,806
)
(1,806
)
—

(1,806
)
Other comprehensive income, net of income tax

—

—

—

—

38

—

38

—

38

Net income (loss)

—

—

—

(21,236
)
—

—

(21,236
)
34

(21,202
)

Balance, December 31, 2016

37,444

$
37

$
288,906

$
257,119

$
(257
)
$
(9,155
)
$
536,650

$
—

$
536,650

	Common Stock			Additional				Accumulated Other						Total
	Shares Issued	Amount		Paid-In Capital		Retained Earnings		Comprehensive Loss			Treasury Stock			Stockholders’ Equity

Balance, June 30, 2017	37,528	$	37	$	292,780	$	277,774	$	(222	)	$	(9,247	)	$	561,122

Shares issued in connection with share-based compensation plans	144	1		313		—		—			—			314
Share-based compensation	—	—		2,189		—		—			—			2,189
Purchase of treasury stock	—	—		—		—		—			(612		)	(612		)
Other comprehensive income, net of tax	—	—		—		—		1			—			1
Net income	—	—		—		13,257		—			—			13,257

Balance, September 30, 2017	37,672	$	38	$	295,282	$	291,031	$	(221	)	$	(9,859	)	$	576,271

The accompanying notes are an integral part of the consolidated financial statements.

LANNETT COMPANY, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(In thousands)

	Six Months Ended December 31,						Three Months Ended September 30,
	2016			2015			2017			2016
OPERATING ACTIVITIES:
Net income (loss)	$	(21,202	)	$	46,736		$	13,257		$	(29,388	)
Adjustments to reconcile net income to net cash provided by operating activities:
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization	27,963			8,119			13,778			14,317
Deferred income tax expense (benefit)	(24,709		)	1,743			4,161			(3,432		)
Share-based compensation	4,173			6,398			2,189			2,456
Excess tax benefits on share-based compensation awards	(705		)	(1,034		)	—			(644		)
Intangible assets impairment charges	88,084			—
Intangible asset impairment charge							—			65,084
Loss on sale of assets	267			26			234			2
Loss (gain) on investment securities	(1,697		)	334
(Gain) on investment securities							(864		)	(808		)
Amortization of debt discount and other debt issuance costs	10,509			2,662			5,017			5,288
Other noncash expenses	1,056			—			—			474
Changes in assets and liabilities which provided (used) cash, net of acquisition:
Changes in assets and liabilities which provided (used) cash:
Accounts receivable, net	(17,219		)	5,306			(39,260		)	15,241
Inventories	(15,334		)	5,996			(2,786		)	(12,847		)
Prepaid income taxes/Income taxes payable	1,827			(13,652		)
Prepaid income taxes							3,261			(22,252		)
Other assets	(7,099		)	(2,459		)	(6,262		)	(1,640		)
Rebates payable	14,891			5,184			2,743			(1,791		)
Royalties payable	(1,577		)	2,684			(535		)	(969		)
Restructuring liability	1,217			—			(933		)	637
Settlement liability	(3,000		)	—
Accounts payable	9,052			(4,937		)	2,009			9,267
Accrued expenses	2,415			5,636			543			(958		)
Accrued payroll and payroll-related expenses	(1,662		)	(7,117		)	1,873			(1,625		)
Net cash provided by operating activities	67,250			61,625
Net cash provided by (used in) operating activities							(1,575		)	36,412
INVESTING ACTIVITIES:
Purchases of property, plant and equipment	(21,324		)	(10,629		)	(12,053		)	(9,945		)
Proceeds from sale of property, plant and equipment	33			10			15			33
Acquisition, net of cash acquired	—			(929,581		)
Purchase of intangible asset							(2,038		)	—
Proceeds from sale of investment securities	31,019			21,374			27,822			15,703
Purchase of investment securities	(27,098		)	(22,227		)	(23,840		)	(12,182		)
Net cash used in investing activities	(17,370		)	(941,053		)	(10,094		)	(6,391		)
FINANCING ACTIVITIES:
Proceeds from issuance of debt	—			910,610
Repayments of long-term debt	(26,618		)	(22,817		)	(13,310		)	(13,308		)
Purchase of noncontrolling interest	(1,500		)	—
Proceeds from issuance of stock	1,785			2,689			314			1,355
Payment of debt issuance costs	—			(32,716		)
Excess tax benefits on share-based compensation awards	705			1,034			—			644
Purchase of treasury stock	(1,806		)	(908		)	(612		)	(1,798		)
Net cash provided by (used in) financing activities	(27,434		)	857,892
Net cash used in financing activities							(13,608		)	(13,107		)
Effect on cash and cash equivalents of changes in foreign exchange rates	38			26			1			(3		)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS	22,484			(21,510		)
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS							(25,276		)	16,911
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD	224,769			200,340			117,737			224,769
CASH AND CASH EQUIVALENTS, END OF PERIOD	$	247,253		$	178,830		$	92,461		$	241,680
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid (net of amounts capitalized)	$	34,986		$	5,569
Income taxes paid	$	13,553		$	34,950
Interest paid (net of capitalized interest of $457 thousand and $751 thousand for the three months ended September 30, 2017 and 2016, respectively)							$	15,714		$	17,373
Income taxes paid, net							$	231		$	12,802
Credits issued pursuant to a Settlement Agreement							$	2,500		$	—

The accompanying notes are an integral part of the consolidated financial statements.

LANNETT COMPANY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Note 1. Interim Financial Information

The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) for the presentation of interim financial statements and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, the unaudited financial statements do not include all the information and footnotes necessary for a comprehensive presentation of the financial position, results of operations and cash flows for the periods presented. In the opinion of management, the unaudited financial statements include all the normal recurring adjustments that are necessary for a fair presentation of the financial position, results of operations and cash flows for the periods presented. Operating results for the three ~~and six~~ months ended ~~December 31, 2016~~September 30, 2017 are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, ~~2017.~~2018. These unaudited financial statements should be read in combination with the other Notes in this section; “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing in Item 2; and the Consolidated Financial Statements, including the Notes to the Consolidated Financial Statements, included in our Annual Report on Form 10-K for the fiscal year ended June 30, ~~2016.~~2017. The Consolidated Financial Statements for the fiscal year ended June 30, ~~2016~~2017 were derived from audited financial statements.

Note 2. The Business And Nature of Operations

Lannett Company, Inc. (a Delaware corporation) and its subsidiaries (collectively, the “Company” or “Lannett”) develop, manufacture, package, market and distribute solid oral and extended release (tablets and capsules), topical, nasal and oral solution finished dosage forms of drugs, that address a wide range of therapeutic areas. Certain of these products are manufactured by others and distributed by the Company, most notably under the Jerome Stevens Distribution Agreement. The Company also manufactures active pharmaceutical ingredients through its Cody Laboratories, Inc. (“Cody Labs”) subsidiary, providing a vertical integration benefit.

On November 25, 2015, the Company completed the acquisition of Kremers Urban Pharmaceuticals, Inc. (“KUPI”), the former U.S. specialty generic pharmaceuticals subsidiary of global biopharmaceuticals company UCB ~~S.A.~~S.A (“UCB”). KUPI is a specialty pharmaceuticals manufacturer focused on the development of products that are difficult to formulate or utilize specialized delivery technologies. Strategic benefits of the acquisition include expanded manufacturing capacity, a diversified product portfolio and pipeline and complementary research and development expertise.

The Company operates pharmaceutical manufacturing plants in Philadelphia, Pennsylvania; Cody, Wyoming; Carmel, New York and Seymour, Indiana. The Company’s customers include generic pharmaceutical distributors, drug wholesalers, chain drug stores, private label distributors, mail-order pharmacies, other pharmaceutical manufacturers, managed care organizations, hospital buying groups, governmental entities and health maintenance organizations.

Note 3. Summary of Significant Accounting Policies

Basis of Presentation

The Consolidated Financial Statements have been prepared in conformity with ~~U.S. GAAP.~~United States generally accepted accounting principles (U.S. GAAP).

Principles of consolidation

The Consolidated Financial Statements include the accounts of Lannett Company, Inc. and its ~~wholly owned~~wholly-owned subsidiaries, as well as Cody LCI Realty, LLC (“Realty”), a variable interest entity (“VIE”) in which the Company had a 50% ownership interest until November 30, 2016, when the Company acquired the remaining 50% interest. Noncontrolling interest in Realty was recorded net of tax as net income attributable to the noncontrolling interest. Additionally, all intercompany accounts and transactions have been eliminated.

Business Combinations

benefit of the asset, the various characteristics of the asset and projected future cash flows. Significant judgment is employed in determining the assumptions utilized as of the acquisition date and for each subsequent measurement period. Accordingly, changes in assumptions described above could have a material impact on our consolidated results of operations.

Reclassifications

Certain prior year amounts have been reclassified to conform to the current year financial statement presentation.

Use of estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates and assumptions are required in the determination of revenue recognition and sales deductions for estimated chargebacks, rebates, returns and other adjustments including a provision for the Company’s liability under the Medicare Part D program. Additionally, significant estimates and assumptions are required when determining the fair value of long-lived assets, including goodwill and intangible assets, income taxes, contingencies, share-based compensation and contingent consideration. Because of the inherent subjectivity and complexity involved in these estimates and assumptions, actual results could differ from those estimates.

Foreign currency translation

The Consolidated Financial Statements are presented in U.S. Dollars, the reporting currency of the Company. The financial statements of the Company’s foreign subsidiary are maintained in local currency and translated into U.S. dollars at the end of each reporting period. Assets and liabilities are translated at period-end exchange rates, while revenues and expenses are translated at average exchange rates during the period. The adjustments resulting from the use of differing exchange rates are recorded as part of stockholders’ equity in accumulated other comprehensive income (loss). Gains and losses resulting from transactions denominated in foreign currencies are recognized in the Consolidated Statements of Operations under Other income (loss). Amounts recorded due to foreign currency fluctuations are immaterial to the Consolidated Financial Statements.

Cash and cash equivalents

The Company considers all highly liquid investments with original maturities less than or equal to three months at the date of purchase to be cash and cash equivalents. Cash and cash equivalents are stated at cost, which approximates fair value, and consist of bank deposits and certificates of deposit that are readily convertible into cash. The Company maintains its cash deposits and cash equivalents at well-known, stable financial institutions. Such amounts frequently exceed insured limits.

Investment securities

The Company’s investment securities consist of publicly-traded equity securities which are classified as trading investments. Investment securities are recorded at fair value based on quoted market prices from broker or dealer quotations or transparent pricing sources at each reporting date. ~~Gains~~Realized and unrealized gains and losses are included in the Consolidated Statements of Operations under Other income (loss).

Allowance for doubtful accounts

The Company continuously monitors collections and payments from its customers and maintains a provision for estimated credit losses. The Company determines its allowance for doubtful accounts by considering a number of factors, including the length of time balances are past due, the Company’s previous loss history, the customer’s current ability to pay its obligations to the Company and the condition of the general economy and the industry as a whole. The Company writes off accounts receivable when they are determined to be uncollectible.

Inventories

Inventories are stated at the lower of cost ~~or market determined~~and net realizable value by the first-in, first-out method. Inventories are regularly reviewed and provisions for excess and obsolete inventory are recorded based primarily on current inventory levels and estimated sales forecasts.

Property, Plant and Equipment

Property, plant and equipment are stated at cost less accumulated depreciation. Depreciation is computed on a straight-line basis over the assets’ estimated useful lives. Depreciation expense for each of the three months ended December 31, 2016 and 2015 was $5.5 million and $2.4 million, respectively. Depreciation expense for each of the six months ended December 31, 2016 and 2015 was $10.6 million and $4.2 million, respectively.

Intangible Assets

Definite-lived intangible assets are stated at cost less accumulated amortization. Amortization of definite-lived intangible assets is computed on a straight-line basis over the assets’ estimated useful lives, generally for periods ranging from 10 to 15 years. The Company continually evaluates the reasonableness of the useful lives of these assets. Indefinite-lived intangible assets are not amortized, but instead are tested at least annually for impairment. Costs to renew or extend the term of a recognized intangible asset are expensed as incurred.

Valuation of Long-Lived Assets, including Intangible Assets

The Company’s long-lived assets primarily consist of property, plant and equipment and definite and indefinite-lived intangible assets. Property, plant and equipment and definite-lived intangible assets are reviewed for impairment whenever events or changes in circumstances (“triggering events”) indicate that the carrying amount of the asset may not be recoverable. If a triggering event is determined to have occurred, the asset’s carrying value is compared to the future undiscounted cash flows expected to be generated by the asset. If the carrying value exceeds the undiscounted cash flow of the asset, then impairment exists. Indefinite-lived intangible assets are tested for impairment at least annually during the fourth quarter of each fiscal year or more frequently if events or changes in circumstances indicate that the asset might be impaired. An impairment loss is measured as the excess of the asset’s carrying value over its fair value, which in most cases is calculated using a discounted cash flow model. Discounted cash flow models are highly reliant on various assumptions which are considered Level 3 inputs, including estimates of future cash flows (including long-term growth rates), discount rates and the probability of achieving the estimated cash flows.

In-Process Research and Development

Amounts allocated to in-process research and development (“IPR&D”) in connection with a business combination are recorded at fair value and are considered indefinite-lived intangible assets subject to impairment testing in accordance with the Company’s impairment testing policy for indefinite-lived intangible assets. As products in development are approved for sale, amounts will be allocated to product rights and will be amortized over their estimated useful lives. Definite-lived intangible assets are amortized over the expected ~~life~~lives of the ~~asset.~~related assets. The judgments made in determining the estimated fair value of in-process research and development, as well as asset lives, can materially impact our results of operations. The Company’s fair value assessments are highly reliant on various assumptions which are considered Level 3 inputs, including estimates of future cash flows (including long-term growth rates), discount rates and the probability of achieving the estimated cash flows.

Goodwill

Goodwill, which represents the excess of purchase price over the fair value of net assets acquired, is carried at cost. Goodwill is tested for impairment on an annual basis on the first day of the fourth quarter of each fiscal year or more frequently if events or changes in circumstances indicate that the asset might be impaired. The Company first performs a qualitative assessment to determine if the quantitative impairment test is required. If changes in circumstances indicate an asset may be impaired, the Company performs the quantitative impairment test. ~~In accordance with accounting standards, a two-step quantitative method is used for determining goodwill impairment. In the~~The Company first ~~step, the Company~~ determines the fair value of our reporting unit (generic pharmaceuticals). If the net book value of our reporting unit exceeds its fair value, the ~~second step~~difference will be recorded as a goodwill impairment, not to exceed the carrying amount of the impairment test which requires the hypothetical allocation of our reporting unit’s fair value to all of its assets and liabilities using the acquisition method prescribed under authoritative guidance for business combinations would then be performed. Any residual fair value is allocated to goodwill. An impairment charge is recognized to the extent that the estimated fair value of our reporting unit’s goodwill is less than its carrying amount. The judgments made in determining the estimated fair value of goodwill can materially impact our results of operations. The Company’s fair value assessments are highly reliant on various assumptions which are considered Level 3 inputs, including estimates of future cash flows (including long-term growth rates), discount rates and the probability of achieving the estimated cash flows. The judgments made in determining the estimated fair value of goodwill can materially impact our results of operations.

Segment Information

The Company operates in one reportable segment, generic pharmaceuticals. As such, the Company aggregates its financial information for all products. The following table identifies the Company’s net sales by medical indication for the three ~~and six~~ months ended ~~December 31, 2016~~September 30, 2017 and ~~2015:~~2016:

(In thousands)

For the Three Months Ended
December 31,

For the Six Months Ended
December 31,

Medical Indication

2016

2015

2016

2015

Antibiotic

$
4,792

$
2,828

$
8,572

$
5,556

Anti Psychosis

15,365

730

32,685

3,472

Cardiovascular

11,975

13,082

24,669

21,385

Central Nervous System

10,555

6,077

20,904

6,077

Gallstone

13,425

18,719

26,308

38,691

Gastrointestinal

18,977

8,617

37,029

8,693

Glaucoma

5,311

6,543

11,095

13,365

Migraine

7,863

5,705

15,023

11,247

Muscle Relaxant

3,004

1,393

6,536

3,054

Obesity

960

851

1,795

1,830

Pain Management

7,439

8,074

14,047

16,207

Respiratory

2,957

1,396

5,170

1,396

Thyroid Deficiency

45,431

37,432

85,269

78,534

Urinary

4,693

3,378

9,794

3,593

Other

10,173

9,963

20,519

18,121

Contract manufacturing revenue

8,024

2,271

13,088

2,271

Total

$
170,944

$
127,059

$
332,503

$
233,492

(In thousands)	Three Months Ended September 30,
Medical Indication	2017		2016
Antibiotic	$	3,349	$	3,780
Anti-Psychosis	14,991		17,320
Cardiovascular	11,306		12,694
Central Nervous System	8,818		10,350
Gallstone	6,564		12,883
Gastrointestinal	14,553		18,052
Glaucoma	2,668		5,783
Migraine	15,015		7,160
Muscle Relaxant	3,791		3,532
Pain Management	5,761		6,608
Respiratory	1,647		2,213
Thyroid Deficiency	47,214		39,838
Urinary	2,997		5,101
Other	12,696		11,182
Contract manufacturing revenue	3,591		5,063
Total	$	154,961	$	161,559

Customer, Supplier and Product Concentration

The following table presents the percentage of total net sales, for the three ~~and six~~ months ended ~~December 31,~~September 30, 2017 and 2016, ~~and 2015,~~ for ~~certain~~one of the Company’s products, defined as products containing the same active ingredient or combination of ingredients, which accounted for at least 10% of net sales in any of those periods:

For the Three Months Ended
December 31,

For the Six Months Ended
December 31,

2016

2015

2016

2015

Product 1

27
%
29
%
26
%
34
%
Product 2

8
%
15
%
8
%
17
%

	2017		2016

Product 1	30	%	25	%

The following table presents the percentage of total net sales, for the three ~~and six~~ months ended ~~December 31,~~September 30, 2017 and 2016, ~~and 2015,~~ for certain of the Company’s customers which accounted for at least 10% of net sales in any of those periods:

	For the Three Months Ended December 31,				For the Six Months Ended December 31,
	2016		2015		2016		2015		2017		2016

Customer A	28	%	27	%	28	%	27	%	27	%	28	%
Customer B	20	%	18	%	20	%	15	%	20	%	20	%

The Company’s primary finished goods inventory supplier is Jerome Stevens Pharmaceuticals, Inc. (“JSP”), in Bohemia, New York. Purchases of finished goods inventory from JSP accounted for approximately ~~39%~~33% and ~~59%~~37% of the Company’s inventory purchases during the three months ended ~~December 31,~~September 30, 2017 and 2016, and 2015, respectively. Purchases of finished goods inventory from JSP accounted for approximately 38% and 62% of the Company’s inventory purchases during the six months ended December 31, 2016 and 2015, respectively. See Note 2221 “Material Contracts with Suppliers” for more information.

Revenue Recognition

The Company recognizes revenue when title and risk of loss have transferred to the customer and provisions for rebates, promotional adjustments, price adjustments, returns, chargebacks and other potential adjustments are reasonably ~~determinable.~~determinable and collection is reasonably assured. The Company also considers all other relevant criteria specified in Securities and Exchange Commission Staff Accounting Bulletin No. 104, Topic No. 13, “Revenue Recognition”, in determining when to recognize revenue.

Net Sales Adjustments

When revenue is recognized a simultaneous adjustment to gross sales is made for estimated chargebacks, rebates, returns, promotional adjustments and other potential adjustments. These provisions are primarily estimated based on historical experience, future expectations, contractual arrangements with wholesalers and indirect customers and other factors known to management at the time of accrual. Accruals for provisions are presented in the Consolidated Financial Statements as a reduction to gross sales with the corresponding reserve presented as a reduction of accounts receivable or included as rebates payable, depending on the nature of the reserve. The reserves, presented as a reduction of accounts receivable, totaled ~~$179.3~~$184.1 million and ~~$176.1~~$175.8 million at ~~December 31, 2016~~September 30, 2017 and June 30, ~~2016,~~2017, respectively. Rebates payable at ~~December 31, 2016~~September 30, 2017 and June 30, ~~2016 were $36.8~~2017 totaled $47.3 million and ~~$21.9~~$44.6 million, respectively, for certain rebate programs, primarily related to Medicare Part D and Medicaid and certain sales allowances and other adjustments paid to indirect customers.

Cost of Sales, including Amortization of Intangibles

Cost of sales includes all costs related to bringing products to their final selling destination, which includes direct and indirect costs, such as direct material, labor and overhead expenses. Additionally, cost of sales includes product royalties, depreciation, amortization and costs to renew or extend recognized intangible assets, freight charges and other shipping and handling expenses.

Research and Development

Research and development costs are expensed as incurred, including all production costs until a drug candidate is approved by the Food and Drug Administration (“FDA”). Research and development expenses include costs associated with internal projects as well as costs associated with third-party research and development contracts.

Contingencies

Loss contingencies, including litigation-related contingencies, are included in the Consolidated Statements of Operations when the Company concludes that a loss is both probable and reasonably estimable. Legal fees related to litigation-related matters are expensed as incurred and ~~are~~ included in the Consolidated Statements of Operations under the Selling, general and administrative line item.

~~Contingent Consideration~~

Contingent consideration resulting from the KUPI acquisition was recorded at its estimated fair value on the acquisition date. The Company has agreed to a 50/50 split of the additional tax liabilities UCB will incur associated with the IRS Section 338(H)(10) tax election, up to $35.0 million. This election is expected to result in additional tax benefits to the Company of approximately $100.0 million. These fair value measurements represent Level 3 measurements, as they are based on significant inputs not observable in the market.

Restructuring Costs

The Company records charges associated with approved restructuring plans to remove duplicative headcount and infrastructure associated with business acquisitions or to simplify business processes. Restructuring charges can include severance costs to eliminate a specified number of employees, infrastructure charges to vacate facilities and consolidate operations and contract cancellation costs. The Company records restructuring charges based on estimated employee terminations, site closure and consolidation plans. The Company accrues severance and other employee separation costs under these actions when it is probable that a liability exists and the amount is reasonably estimable.

Share-based Compensation

Share-based compensation costs are recognized over the vesting period, using a straight-line method, based on the fair value of the instrument on the date of grant less an estimate for expected forfeitures. The Company uses the Black-Scholes valuation model to determine the fair value of stock options, ~~and~~ the stock price on the grant date to value restricted ~~stock.~~stock and the Monte-Carlo simulation model to determine the fair value of performance-based shares. The Black-Scholes valuation ~~model includes~~and Monte-Carlo simulation models include various assumptions, including the expected volatility, the expected life of the award, dividend yield and the risk-free interest ~~rate.~~rate as well as performance assumptions of peer companies. These assumptions involve inherent uncertainties based on market conditions which are generally outside the Company’s control. Changes in these assumptions could have a material impact on share-based compensation costs recognized in the financial statements.

Self-Insurance

Effective January 1, 2017, the Company self-insures for certain employee medical and prescription benefits. The Company also maintains stop loss coverage with third party insurers to limit its total liability exposure. The liability for self-insured risks is primarily calculated using independent third party actuarial valuations which take into account actual claims, claims growth and claims incurred but not yet reported. Actual experience, including claim frequency and severity as well as health-care inflation, could result in different liabilities than the amounts currently recorded. The liability for self-insured risks under this plan as of September 30, 2017 totaled $2.1 million and was not material to the financial position of the Company as of June 30, 2017.

Income Taxes

The Company uses the liability method to account for income taxes as prescribed by Accounting Standards Codification (“ASC”) 740, Income Taxes. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities as measured by the enacted tax rates which will be in effect when these differences reverse. Deferred tax expense (benefit) is the result of changes in deferred tax assets and liabilities. Deferred income tax assets and liabilities are adjusted to recognize the effects of changes in tax laws or enacted tax rates in the period during which they are signed into law. The factors used to assess the likelihood of realization are the Company’s forecast of future taxable income and available tax planning strategies that could be implemented to realize the net deferred tax assets. Under ASC 740, Income Taxes, a valuation allowance is required when it is more likely than not that all or some portion of the deferred tax assets will not be realized through generating sufficient future taxable income. Failure to achieve forecasted taxable income in applicable tax jurisdictions could affect the ultimate realization of deferred tax assets and could result in an increase in the Company’s effective tax rate on future earnings.

The Company may recognize the tax benefit from an uncertain tax position claimed on a tax return only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. The authoritative accounting standards also provide guidance on de-recognition, classification, interest and penalties on income taxes, accounting in interim periods and requires increased disclosures.

Earnings (Loss) Per Common Share

Basic earnings per common share attributable to Lannett Company, Inc. is computed by dividing net income attributable to Lannett Company, Inc. common stockholders by the weighted average number of shares outstanding during the period. Diluted earnings per common share attributable to Lannett Company, Inc. is computed by dividing net income attributable to Lannett Company, Inc. common stockholders by the weighted average number of shares outstanding during the period including additional shares that would have been outstanding related to potentially dilutive securities. These potentially dilutive securities ~~primarily~~ consist of stock options, unvested restricted stock and performance-based shares and an outstanding warrant. Anti-dilutive securities are excluded from the calculation. Dilutive shares are also excluded in the calculation in periods of net loss because the effect of including such securities would be anti-dilutive.

Comprehensive Income (Loss)

Comprehensive income (loss) includes all changes in equity during a period except those that resulted from investments by or distributions to the Company’s stockholders. Other comprehensive income (loss) refers to gains and losses that are included in comprehensive income (loss), but excluded from net income as these amounts are recorded directly as an adjustment to stockholders’ equity.

Recent Accounting Pronouncements

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with ~~Customers~~.Customers. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The authoritative guidance is effective for annual reporting periods beginning after December 15, 2017. ~~The Company is continuing to assess~~Based on a preliminary review of the ~~impact this guidance will have on~~contracts representing a substantial portion of our revenues, the ~~consolidated financial statements.~~

~~In July 2015, the FASB issued ASU 2015-11,~~ ~~Inventory — Simplifying the Measurement of Inventory~~. ASU 2015-11 requires inventory to be subsequently measured using the lower of cost and net realizable value, thereby eliminating the market value approach. Net realizable value is defined as the “estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation.” ASU 2015-11 is effective for reporting periods beginning after December 15, 2016 and is applied prospectively. Early adoption is permitted. The Company does not ~~believe this~~expect the guidance ~~will~~to have a material impact on our disclosures or the ~~consolidated financial statements.~~timing and recognition of our revenues. The Company intends to use the modified retrospective approach upon implementation.

~~In September 2015, the FASB issued ASU 2015-16,~~ ~~Business Combinations — Simplifying the Accounting for Measurement-Period Adjustments~~. ASU 2015-16 requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. ASU 2015-16 also requires that the acquirer record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. ASU 2015-16 is effective for reporting periods beginning after December 15, 2015 and is applied prospectively. Early adoption is permitted. The Company elected to early adopt ASU 2015-16 as of March 31, 2016.

In November 2015, the FASB issued ASU 2015-17, Income Taxes — Balance Sheet Classification of Deferred Taxes. ASU 2015-17 requires all deferred tax assets and liabilities to be classified as noncurrent on the balance sheet. The guidance may be applied either prospectively or retrospectively. ~~ASU 2015-17 is~~The guidance became effective for ~~fiscal years~~the Company in the first quarter of Fiscal 2018. Accordingly, the Company currently presents all deferred tax assets and ~~interim periods within those fiscal years beginning after December 15, 2016. Early adoption is permitted. The Company does not believe this guidance will have a material impact~~liabilities as noncurrent on the ~~consolidated financial statements.~~balance sheet. All prior period amounts have also been reclassified to conform with the current year presentation.

In February 2016, the FASB issued ASU 2016-02, Leases. ASU 2016-02 requires an entity to recognize right-of-use assets and liabilities on its balance sheet for all leases with terms longer than 12 months. Lessees and lessors are required to disclose quantitative and qualitative information about leasing arrangements to enable a user of the financial statements to assess the amount, timing and uncertainty of cash flows arising from leases. ASU 2016-02 is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period and requires a modified retrospective application, with early adoption permitted. The Company is currently in the process of assessing the impact this guidance will have on the consolidated financial statements.

~~In March 2016, the FASB issued ASU 2016-09,~~ ~~Compensation — Stock Compensation: Improvements to Employee Share-Based Payment Accounting~~. ASU 2016-09 clarifies several aspects of accounting for share-based compensation including the accounting for excess tax benefits and deficiencies, accounting for forfeitures and the classification of excess tax benefits on the cash flow statement. ASU 2016-09 is effective for fiscal years beginning after December 15, 2016 and in interim periods within those fiscal years, with early adoption permitted. The Company is currently in the process of assessing the impact this guidance will have on the consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows — Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 addresses how certain cash receipts and cash payments are presented and classified in the statement of cash flows. ASU 2016-15 is effective for annual reporting periods, and interim periods therein, beginning after December 15, 2017. The Company is currently in the process of assessing the impact this guidance will have on the consolidated financial statements.

~~Note 4. Acquisitions~~

~~Kremers Urban Pharmaceuticals Inc.~~

On November 25, 2015, the Company completed the acquisition of KUPI, the former U.S. specialty generic pharmaceuticals subsidiary of global biopharmaceuticals company UCB S.A., pursuant to the terms and conditions of a Stock Purchase Agreement. KUPI is a specialty pharmaceuticals manufacturer focused on the development of products that are difficult to formulate or utilize specialized delivery technologies. Strategic benefits of the acquisition include expanded manufacturing capacity, a diversified product portfolio and pipeline and complementary research and development expertise.

~~Pursuant to the terms of the Stock Purchase Agreement, Lannett purchased 100% of the outstanding equity interests of KUPI for total consideration of approximately $1.2 billion.~~

~~The following table summarizes the fair value of total consideration transferred to KUPI shareholders at the acquisition date of November 25, 2015:~~

(In thousands)

Cash purchase price paid to KUPI shareholders

$
1,030,000

Working capital adjustment

(41,605
)
Certain amounts reimbursable by UCB

(37,340
)
Total cash consideration transferred to KUPI shareholders

951,055

12.0% Senior Notes issued to UCB

200,000

Acquisition-related contingent consideration

35,000

Warrant issued to UCB

29,920

Total consideration to KUPI shareholders

$
1,215,975

The Company funded the acquisition and transaction expenses with proceeds from the issuance of the $910.0 million of term loans, $22.8 million borrowings from a revolving credit facility, the issuance of $250.0 million Senior Notes (see Note 12 “Long-term Debt”) and cash on hand of $94.6 million. Lannett also issued a warrant with an estimated fair value of $29.9 million.

As part of the acquisition, the Company and UCB have agreed to jointly make an election under Section 338(h)(10) of the Internal Revenue Code of 1986, as amended and under the corresponding provisions of state law, to treat the acquisition as a deemed purchase and sale of assets for income tax purposes. The Company has agreed to reimburse UCB for 50% of the incremental tax cost of making such election, subject to a reimbursement cap of $35.0 million. This liability has been recorded as acquisition-related contingent consideration on the Consolidated Balance Sheet. This election is expected to result in additional tax benefits to the Company of approximately $100.0 million.

The Company also agreed to contingent payments related to Methylphenidate Hydrochloride Extended Release tablets (“Methylphenidate ER”) provided the FDA reinstates the AB-rating for such product and certain sales thresholds are met. On October 18, 2016, the Company received notice from the FDA that it will seek to withdraw approval of the Company’s ANDA for Methylphenidate ER. See Note 11 “Goodwill and Intangible Assets” for more information.

The Company used the acquisition method of accounting to account for this transaction. Under the acquisition method of accounting, the assets acquired and liabilities assumed in the transaction were recorded at the date of acquisition at their respective fair values.

~~The purchase price has been allocated to the assets acquired and liabilities assumed for the KUPI business as follows:~~

(In thousands)

Purchase
Price Allocation

Cash and cash equivalents

$
16,877

Accounts receivable, net of revenue-related reserves

129,408

Inventories

84,009

Other current assets

11,238

Property, plant and equipment

111,849

Product rights

427,000

Trade name

2,920

Other intangible assets

19,000

In-process research and development

125,000

Goodwill

339,425

Deferred tax assets

4,186

Other assets

10,218

Total assets acquired

1,281,130

Accounts payable

(19,249
)
Accrued expenses

(6,079
)
Accrued payroll and payroll-related expenses

(21,040
)
Rebates payable

(9,816
)
Royalties payable

(3,602
)
Other liabilities

(5,369
)
Total net assets acquired

$
1,215,975

~~In the first quarter of Fiscal 2017, the Company recorded a $6.0 million measurement period adjustment to the Returns reserve.~~

Included in the purchase price allocation above are indemnification assets totaling approximately $20.7 million, of which $10.4 million relates to compensation-related payments, $4.9 million relates to unrecognized tax benefits and $5.4 million for chargeback and rebate-related items. The inventory balance above includes $19.1 million to reflect fair value step-up adjustments. KUPI’s intangible assets primarily consist of product rights and in-process research and development. See Note 11 “Goodwill and Intangible Assets.”

Amounts allocated to acquired in-process research and development represent the fair value of purchased in-process technology for research projects that, as of the closing date of the acquisition, had not yet reached technological feasibility and had no alternative future use. The fair value of in-process research and development was based on the excess earnings method, which utilizes forecasts of expected cash inflows (including estimates for ongoing costs) and other contributory charges, on a project-by-project basis at the appropriate discount rate for the inherent risk in each project and will be tested for impairment in accordance with the Company’s policy for testing indefinite-lived intangible assets.

Goodwill of $339.4 million arising from the acquisition consists primarily of the value of the employee workforce and the value of products to be developed in the future. The goodwill was assigned to the Company’s only reporting unit. Goodwill recognized is expected to be fully deductible for income tax purposes.

~~Unaudited Pro Forma financial results~~

The following supplemental unaudited pro forma information presents the financial results as if the acquisition of KUPI had occurred on July 1, 2014 for the three and six months ended December 31, 2015. This supplemental pro forma information has been prepared for comparative purposes and does not purport to be indicative of what would have occurred had the acquisition been made on July 1, 2014, nor are they indicative of any future results.

For the Three Months Ended
December 31,

For the Six Months Ended
December 31,

(In thousands, except per share data)

2015

2015

Revenues

$
173,189

$
357,155

Net income attributable to Lannett Company, Inc.

28,810

55,129

Earnings per common share attributable to Lannett Company, Inc.:

Basic

$
0.79

$
1.52

Diluted

$
0.77

$
1.47

The supplemental pro forma earnings for the three months ended December 31, 2015 were adjusted to exclude $23.3 million of acquisition-related costs, of which $17.6 million was incurred by Lannett and $5.7 million was incurred by KUPI, and to include $5.8 million of expense related to the amortization of fair value step-up adjustments to acquisition-date inventory.

The supplemental pro forma earnings for the six months ended December 31, 2015 were adjusted to exclude $28.9 million of acquisition-related costs, of which $21.5 million was incurred by Lannett and $7.4 million was incurred by KUPI, and to include $5.8 million of expense related to the amortization of fair value adjustments to acquisition-date inventory.

Note 5.4. Restructuring Charges

2016 Restructuring Program

On February 1, 2016, in connection with the acquisition of KUPI, the Company announced a plan related to the future integration of KUPI and the Company’s operations. The plan focuses on the closure of KUPI’s corporate functions and the consolidation of manufacturing, sales, research and development and distribution functions. The Company estimates that it will incur an aggregate of up to approximately ~~$21.0~~$20.0 million in restructuring charges for actions that have been announced or communicated since the 2016 Restructuring Program began. Of this amount, approximately ~~$12.0~~$11.0 million relates to employee separation costs, approximately $1.0 million relates to contract termination costs and approximately $8.0 million relates to facility closure costs and other actions. The 2016 Restructuring Program is expected to be completed by the end of Fiscal 2019. The expenses associated with the restructuring program included in restructuring expenses during the three ~~and six~~ months ended ~~December 31,~~September 30, 2017 and 2016 were as follows:

					Three			Three
					Months Ended			Months Ended
(In thousands)	Three Months Ended December 31, 2016		Six Months Ended December 31, 2016		September 30, 2017			September 30, 2016
Employee separation costs	$	1,004	$	2,161	$	(590	)	$	1,157
Contract termination costs					—			—
Facility closure costs	708		1,603		1,117			895
Total	$	1,712	$	3,764	$	527		$	2,052

In the first quarter of Fiscal 2018, the Company decided to retain certain employees who were previously included in the 2016 Restructuring Program. As a result, the Company reversed all previous charges incurred related to these employees.

A reconciliation of the changes in restructuring liabilities associated with the 2016 Restructuring Program from June 30, ~~2016~~2017 through ~~December 31, 2016~~September 30, 2017 is set forth in the following table:

(In thousands)

Employee
Separation Costs

Contract
Termination
Costs

Facility Closure
Costs

Total

Balance at June 30, 2016

$
3,833

$
297

$
—

$
4,130

Restructuring Charges

2,161

—

1,603

3,764

Payments

(808
)
(136
)
(1,603
)
(2,547
)
Balance at December 31, 2016

$
5,186

$
161

$
—

$
5,347

(In thousands)	Employee Separation Costs			Contract Termination Costs		Facility Closure Costs			Total
Balance at June 30, 2017	$	5,431		$	—	$	—		$	5,431
Restructuring Charges (Credits)	(590		)	—		1,117			527
Payments	(343		)	—		(1,117		)	(1,460		)
Balance at September 30, 2017	$	4,498		$	—	$	—		$	4,498

Note 6.5. Accounts Receivable

Accounts receivable consisted of the following components at ~~December 31, 2016~~September 30, 2017 and June 30, ~~2016:~~2017:

(In thousands)	December 31, 2016			June 30, 2016			September 30, 2017			June 30, 2017
Gross accounts receivable	$	402,901		$	388,460		$	428,681		$	380,653
Less Chargebacks reserve	(82,285		)	(86,495		)	(79,274		)	(79,537		)
Less Rebates reserve	(39,062		)	(32,189		)	(45,312		)	(43,023		)
Less Returns reserve	(44,608		)	(40,593		)	(45,421		)	(42,135		)
Less Other deductions	(13,329		)	(16,851		)	(14,057		)	(11,096		)
Less Allowance for doubtful accounts	(631		)	(610		)	(1,291		)	(796		)
Accounts receivable, net	$	222,986		$	211,722		$	243,326		$	204,066

For the three months ended ~~December 31,~~September 30, 2017, the Company recorded a provision for chargebacks, rebates (including rebates presented as rebates payable), returns and other deductions of $254.7 million, $78.5 million, $10.4 million and $12.4 million, respectively. For the three months ended September 30, 2016, the Company recorded a provision for chargebacks, rebates (including rebates presented as rebates payable), returns and other deductions of ~~$217.7~~$198.5 million, ~~$73.5~~$69.5 million, ~~$7.9~~$6.8 million and ~~$13.9~~$15.5 million, respectively. For the three months ended December 31, 2015, the Company recorded a provision for chargebacks, rebates (including rebates presented as rebates payable), returns and other deductions of $151.0 million, $42.4 million, $7.1 million, and $8.9 million, respectively.

For the six months ended December 31, 2016, the Company recorded a provision for chargebacks, rebates (including rebates presented as rebates payable), returns, and other deductions of $416.2 million, $143.0 million, $14.7 million, and $29.3 million, respectively. For the six months ended December 31, 2015, the Company recorded a provision for chargebacks, rebates (including rebates presented as rebates payable), returns, and other deductions of $239.6 million, $70.2 million, $10.8 million, and $15.3 million, respectively.

Note 7.6. Inventories

Inventories at ~~December 31, 2016~~September 30, 2017 and June 30, ~~2016~~2017 consisted of the following:

(In thousands)	December 31, 2016		June 30, 2016		September 30, 2017		June 30, 2017
Raw materials	$	52,270	$	47,881
Raw Materials					$	59,128	$	57,442
Work-in-process	18,600		20,207		19,286		15,676
Finished goods	59,368		46,816
Finished Goods					46,976		49,486
Total	$	130,238	$	114,904	$	125,390	$	122,604

~~The reserve~~Inventories were reduced by $5.3 million and $4.5 million at September 30, 2017 and June 30, 2017, respectively for excess and obsolete inventory ~~was $6.1~~amounts. During the three months ended September 30, 2017 and 2016, the Company recorded provisions for excess and obsolete inventory of $2.2 million and ~~$6.9~~$3.3 million, ~~at December 31, 2016 and June 30, 2016,~~ respectively.

Note 8.7. Property, Plant and Equipment

Property, plant and equipment at ~~December 31, 2016~~September 30, 2017 and June 30, ~~2016~~2017 consisted of the following:

(In thousands)	Useful Lives	December 31, 2016			June 30, 2016			Useful Lives	September 30, 2017			June 30, 2017
Land	—	$	6,191		$	6,191		—	$	6,191		$	6,191
Building and improvements	10 - 39 years	105,637			103,496			10 - 39 years	108,740			108,730
Machinery and equipment	5 - 10 years	134,239			120,272			5 - 10 years	142,885			142,086
Furniture and fixtures	5 - 7 years	2,673			2,904			5 - 7 years	2,987			2,953
Less accumulated depreciation		(64,049		)	(53,598		)		(76,809		)	(71,461		)
		184,691			179,265				183,994			188,499
Construction in progress		42,362			37,373				65,282			54,649
Property, plant and equipment, net		$	227,053		$	216,638			$	249,276		$	243,148

Depreciation expense for the three months ended September 30, 2017 and 2016 was $5.7 million and $5.1 million, respectively.

During the three ~~and six~~ months ended ~~December 31,~~September 30, 2017 and 2016, ~~and 2015,~~ the Company had no impairment charges related to property, plant and equipment. Property, plant and equipment, net included amounts held in foreign countries in the amount of ~~$924 thousand and~~ $1.0 million at ~~December 31, 2016~~September 30, 2017 and June 30, ~~2016, respectively.~~2017.

Note 9.8. Fair Value Measurements

The Company’s financial instruments recorded in the Consolidated Balance Sheets include cash and cash equivalents, accounts receivable, investment securities, accounts payable, accrued expenses and debt obligations. Included in cash and cash equivalents are certificates of deposit with maturities less than or equal to three months at the date of purchase and money market funds. The carrying value of certain financial instruments, primarily cash and cash equivalents, accounts receivable, accounts payable and accrued expenses, approximate their estimated fair values based upon the short-term nature of their maturity dates. The carrying amount of the Company’s debt obligations approximates fair value based on current interest rates available to the Company on similar debt obligations.

The Company follows the authoritative guidance of ASC Topic 820 “Fair Value Measurements and Disclosures.” Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The authoritative guidance also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The Company’s financial assets and liabilities measured at fair value are entirely within Level 1 of the hierarchy as defined below:

Level 1 — Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity can access at the measurement date.

Level 2 — Directly or indirectly observable inputs, other than quoted prices, such as quoted prices for similar assets or liabilities; quoted prices for identical or similar instruments in markets that are not active; or model-derived valuations whose inputs are observable or whose significant value drivers are observable.

Level 3 — Unobservable inputs that are supported by little or no market activity and that are material to the fair value of the asset or liability. Financial instruments whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant judgment or estimation are examples of Level 3 assets and liabilities.

If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.

The Company’s ~~recurring and nonrecurring~~financial assets and liabilities measured at fair value at ~~December 31, 2016~~September 30, 2017 and June 30, ~~2016,~~2017, were as follows:

	December 31, 2016								September 30, 2017
(In thousands)	Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3		Total
Assets
Equity securities	$	11,870	$	—	$	—	$	11,870	$	23,973	$	—	$	—	$	23,973
Intangible Assets - KUPI IPR&D (a)	—		—		18,000		18,000
Total Assets	$	11,870	$	—	$	18,000	$	29,870	$	23,973	$	—	$	—	$	23,973

Liabilities
Acquisition-related contingent consideration	$	—	$	—	$	35,000	$	35,000
Total Liabilities	$	—	$	—	$	35,000	$	35,000

June 30, 2016

(In thousands)

Level 1

Level 2

Level 3

Total

Assets

Equity securities

$
14,094

$
—

$
—

$
14,094

Total Assets

$
14,094

$
—

$
—

$
14,094

Liabilities

Acquisition-related contingent consideration

$
—

$
—

$
35,000

$
35,000

Total Liabilities

$
—

$
—

$
35,000

$
35,000

(a) Intangible assets related to KUPI’s IPR&D with a carrying amount of $41.0 million were written down to a fair value of $18.0 million due to an impairment charge of $23.0 million recorded in the second quarter of Fiscal 2017.

	June 30, 2017
(In thousands)	Level 1		Level 2		Level 3		Total
Assets
Equity securities	$	27,091	$	—	$	—	$	27,091
Total Assets	$	27,091	$	—	$	—	$	27,091

Note ~~10.~~9. Investment Securities

The Company uses the specific identification method to determine the cost of securities sold, which consisted entirely of securities classified as trading.

The Company had a net gain on investment securities of ~~$888~~$864 thousand during the three months ended ~~December 31, 2016, which primarily consisted of realized gains. The Company had a net gain on investment securities of $862 thousand during the three months ended December 31, 2015,~~September 30, 2017, which included an unrealized gain related to securities still held at ~~December 31, 2015~~September 30, 2017 of ~~$838~~$37 thousand.

The Company had a net gain on investment securities of ~~$1.7 million~~$808 thousand during the ~~six~~three months ended ~~December 31,~~September 30, 2016, which included an unrealized gain related to securities still held at ~~December 31,~~September 30, 2016 of $557 thousand. The Company had a net loss on investment securities of $334 thousand during the six months ended December 31, 2015, which included an unrealized loss related to securities still held at December 31, 2015 of $405 thousand.

Note ~~11.~~10. Goodwill and Intangible Assets

The changes in the carrying amount of goodwill for the ~~six~~three months ended ~~December 31, 2016~~September 30, 2017 are as follows:

(In thousands)

Generic
Pharmaceuticals

Balance at June 30, 2016

$
333,611

Measurement-period adjustments

5,955

Balance at December 31, 2016

$
339,566

~~In the first quarter of Fiscal 2017, the Company recorded a $6.0 million measurement-period adjustment to the Returns reserve.~~

(In thousands)	Generic Pharmaceuticals
Balance at June 30, 2017	$	339,566
Goodwill acquired	—
Impairments	—
Balance at September 30, 2017	$	339,566

Intangible assets, net as of ~~December 31, 2016~~September 30, 2017 and June 30, ~~2016,~~2017, consisted of the following:

	Weighted	Gross Carrying Amount				Accumulated Amortization						Intangible Assets, Net				Weighted	Gross Carrying Amount				Accumulated Amortization						Intangible Assets, Net
(In thousands)	Avg. Life (Yrs.)	December 31, 2016		June 30, 2016		December 31, 2016			June 30, 2016			December 31, 2016		June 30, 2016		Avg. Life (Yrs.)	September 30, 2017		June 30, 2017		September 30, 2017			June 30, 2017			September 30, 2017		June 30, 2017

Definite-lived:
Cody Labs import license	15	$	582	$	582	$	(328	)	$	(309	)	$	254	$	273	15	$	582	$	582	$	(357	)	$	(347	)	$	225	$	235
KUPI product rights	15	434,000		427,000		(28,819		)	(17,119		)	405,181		409,881		15	434,000		434,000		(50,519		)	(43,286		)	383,481		390,714
KUPI trade name	2	2,920		2,920		(1,608		)	(878		)	1,312		2,042		2	2,920		2,920		(2,703		)	(2,338		)	217		582
KUPI other intangible assets	15	19,000		19,000		(1,395		)	(762		)	17,605		18,238		15	19,000		19,000		(2,345		)	(2,028		)	16,655		16,972
Silarx product rights	15	10,000		10,000		(1,056		)	(722		)	8,944		9,278		15	10,000		10,000		(1,556		)	(1,389		)	8,444		8,611
Other product rights	14	653		653		(333		)	(311		)	320		342		15	2,691		653		(365		)	(355		)	2,326		298
Total definite-lived		$	467,155	$	460,155	$	(33,539	)	$	(20,101	)	$	433,616	$	440,054		$	469,193	$	467,155	$	(57,845	)	$	(49,743	)	$	411,348	$	417,412

Indefinite-lived:
KUPI in-process research and development	—	$	18,000	$	117,000	$	—		$	—		$	18,000	$	117,000	—	$	18,000	$	18,000	$	—		$	—		$	18,000	$	18,000
Silarx in-process research and development	—	18,000		18,000		—			—			18,000		18,000		—	18,000		18,000		—			—			18,000		18,000
Other product rights	—	449		449		—			—			449		449		—	449		449		—			—			449		449
Total indefinite-lived		36,449		135,449		—			—			36,449		135,449			36,449		36,449		—			—			36,449		36,449
Total intangible assets, net		$	503,604	$	595,604	$	(33,539	)	$	(20,101	)	$	470,065	$	575,503		$	505,642	$	503,604	$	(57,845	)	$	(49,743	)	$	447,797	$	453,861

For the three months ended ~~December 31,~~September 30, 2017 and 2016, ~~and 2015,~~ the Company recorded amortization expense of $8.1 million and ~~$3.8 million, respectively. For the six months ended December 31, 2016 and 2015, the Company recorded amortization expense of $17.4 million and $3.9~~$9.3 million, respectively.

On October 18, 2016, the Company received a notice from the FDA indicating that the FDA will seek to withdraw approval of the Company’s Methylphenidate ER ANDA. As a result of the notice, the Company performed an impairment analysis including a review of revised net sales projections for Methylphenidate ER. This analysis resulted in the Company recording a $65.1 million impairment charge inIn the first quarter of Fiscal ~~2017.~~

~~In the second quarter of Fiscal 2017,~~2018, the Company ~~abandoned~~filed a ~~project within KUPI’s in-process research and development portfolio.~~505(b)(2) New Drug Application with the FDA for Cocaine Hydrochloride Topical Solution. The ~~value assigned~~Company paid a $2.0 million filing fee to the ~~project~~FDA along with the application, which was ~~$23.0 million. Accordingly, the Company recorded~~capitalized as an intangible asset that will be amortized over a ~~$23.0 million impairment charge in the second quarter.~~15-year useful life period.

Future annual amortization expense consisted of the following as of ~~December 31, 2016:~~September 30, 2017:

(In thousands)
Fiscal Year Ending June 30,

Annual Amortization Expense

2017

$
16,204

2018

31,530

2019

30,946

2020

30,938

2021

30,938

Thereafter

293,060

$
433,616

(In thousands) Fiscal Year Ending June 30,	Amortization Expense
2018	$	23,530
2019	31,082
2020	31,074
2021	31,074
2022	31,074
Thereafter	263,514
	$	411,348

Note ~~12.~~11. Long-Term Debt

~~Amended Senior Secured Credit Facility~~

The Senior Secured Credit Facility consisted of a Term Loan A facility in an aggregate principal amount of $275.0 million, a Term Loan B facility in an aggregate principal amount of $635.0 million and a revolving credit facility providing for revolving loans in an aggregate principal amount of up to $125.0 million. On April 8, 2016, the Company drew down the full $125.0 million Revolving Credit Facility for working capital and other general purposes. The entire balance of the Revolving Credit Facility loan is outstanding as of December 31, 2016.

On June 17, 2016, Lannett amended the Senior Secured Credit Facility and the Credit and Guaranty Agreement to raise an incremental term loan in the principal amount of $150.0 million (the “Incremental Term Loan”) and amended certain sections of the agreement (the “Amended Senior Secured Credit Facility”). The terms of this Incremental Term Loan are substantially the same as those applicable to the Term Loan B facility. The Company used the proceeds of the Incremental Term Loan and cash on hand to repurchase the outstanding $250.0 million aggregate principal amount of Lannett’s 12.0% Senior Notes due 2023 (the “Senior Notes”) issued in connection with the KUPI acquisition.

The Term Loan A Facility will mature on November 25, 2020. The Term Loan A Facility amortizes in quarterly installments (a) through December 31, 2017 in amounts equal to 1.25% of the original principal amount of the Term Loan A Facility and (b) from January 1, 2018 through September 30, 2020 in amounts equal to 2.50% of the original principal amount of the Term Loan A Facility, with the balance payable on November 25, 2020. The Term Loan B Facility will mature on November 25, 2022. The Term Loan B Facility amortizes in equal quarterly installments in amounts equal to 1.25% of the original principal amount of the Term Loan B Facility with the balance payable on November 25, 2022. Any outstanding Revolving Loans will mature on November 25, 2020.

The Amended Senior Secured Credit Facility is guaranteed by all of Lannett’s significant wholly-owned domestic subsidiaries (the “Subsidiary Guarantors”) and is collateralized by substantially all present and future assets of Lannett and the Subsidiary Guarantors.

The interest rates applicable to the Amended Term Loan Facility are based on a fluctuating rate of interest of the greater of an adjusted LIBOR and 1.00%, plus a borrowing margin of 4.75% (for Term Loan A Facility) or 5.375% (for Term Loan B Facility). The interest rate applicable to the Revolving Credit Facility is based on a fluctuating rate of interest of an adjusted LIBOR plus a borrowing margin of 4.75%. The interest rate applicable to the unused commitment for the Revolving Credit Facility was initially 0.50%. Beginning March 2016, the interest margins and unused commitment fee on the Revolving Credit Facility are subject to a leveraged based pricing grid.

The Amended Senior Secured Credit Facility contains a number of covenants that, among other things, limit the ability of Lannett and its restricted subsidiaries to: incur more indebtedness; pay dividends; redeem stock or make other distributions of equity; make investments; create restrictions on the ability of Lannett’s restricted subsidiaries that are not Subsidiary Guarantors to pay dividends to Lannett or make intercompany transfers; create negative pledges; create liens; transfer or sell assets; merge or consolidate; enter into sale leasebacks; enter into certain transactions with Lannett’s affiliates; and prepay or amend the terms of certain indebtedness.

The Amended Senior Secured Credit Facility contains a financial performance covenant that is triggered when the aggregate principal amount of outstanding Revolving Credit Facility and outstanding letters of credit as of the last day of the most recent fiscal quarter is greater than 30% of the aggregate commitments under the Revolving Credit Facility. The covenant provides that Lannett shall not permit its first lien net senior secured leverage ratio as of the last day of any four consecutive fiscal quarters (i) from and after December 31, 2015, to be greater than 4.25:1.00 (ii) from and after December 31, 2017 to be greater than 3.75:1.00 and (iii) from and after December 31, 2019 to be greater than 3.25:1.00.

The Amended Senior Secured Credit Facility also contains a financial performance covenant for the benefit of the Term Loan A Facility lenders which provides that Lannett shall not permit its net senior secured leverage ratio as of the last day of any four consecutive fiscal quarters (i) prior to December 31, 2017, to be greater than 4.25:1.00, (ii) as of December 31, 2017 and prior to December 31, 2019 to be greater than 3.75:1.00 and (iii) as of December 31, 2019 and thereafter to be greater than 3.25:1.00.

~~The Amended Senior Secured Credit Facility also contains certain affirmative covenants, including financial and other reporting requirements.~~

In connection with the Senior Secured Credit Facility and the Senior Notes, the Company incurred an initial purchaser’s discount of $72.1 million and debt issuance costs of $32.7 million. These costs are recorded as a reduction of long-term debt in the Consolidated Balance Sheet. In connection with the amendment to the Senior Secured Credit Facility and raising the Incremental Term Loan, the Company capitalized $14.0 million of initial purchaser’s discount and other fees and expensed $2.2 million of legal and other expenses.

Long-term debt, net consisted of the following:

	December 31,			June 30,			September 30,			June 30,
(In thousands)	2016			2016			2017			2017
Term Loan A due 2020	$	261,250		$	268,125		$	250,938		$	254,375
Unamortized discount and other debt issuance costs	(19,109		)	(22,104		)	(14,808		)	(16,238		)
Term Loan A, net	242,141			246,021			236,130			238,137
Term Loan B due 2022	747,554			767,226			718,045			727,881
Unamortized discount and other debt issuance costs	(70,039		)	(77,273		)	(59,653		)	(63,106		)
Term Loan B, net	677,515			689,953			658,392			664,775
Revolving Credit Facility due 2020	125,000			125,000			—			—
Other	804			874			699			735
Total debt, net	1,045,460			1,061,848			895,221			903,647
Less short-term borrowings and current portion of long-term debt	(178,239		)	(178,236		)	(63,556		)	(60,117		)
Total long-term debt, net	$	867,221		$	883,612		$	831,665		$	843,530

~~Debt~~Long-term debt amounts due, for the twelve month periods ending ~~December 31~~September 30 are as follows:

Amounts Payable

(In thousands)

to Institutions

2017

$
178,239

2018

66,996

2019

67,003

2020

232,010

2021

39,518

Thereafter

550,842

Total

$
1,134,608

	Amounts Payable
(In thousands)	to Institutions
2018	$	63,556
2019	67,000
2020	67,008
2021	211,390
2022	39,407
Thereafter	521,321
Total	$	969,682

Note ~~13.~~12. Legal, Regulatory Matters and Contingencies

~~Richard Asherman~~

On April 16, 2013, Richard Asherman (“Asherman”), the former President of and a member in Realty, filed a complaint (“Complaint”) in Wyoming state court against the Company and Cody Labs. At the same time, he also filed an application for a temporary restraining order to enjoin certain operations at Cody Labs, claiming, among other things, that Cody Labs was in violation of certain zoning laws and that Cody Labs was required to increase the level of its property insurance and to secure performance bonds for work being performed at Cody Labs. Mr. Asherman claimed Cody Labs was in breach of his employment agreement and was required to pay him severance under his employment agreement, including 18 months of base salary, vesting of unvested stock options and continuation of benefits. Mr. Asherman also asserted that the Company was in breach of the Realty Operating Agreement and, among other requested remedies, he sought to have the Company (i) pay him 50% of the value of 1.66 acres of land that Realty previously agreed to donate to an economic development entity associated with the City of Cody, Wyoming, which contemplated transaction has since been avoided and cancelled. Although Mr. Asherman originally sought to require that Lannett acquire his interest in Realty for an unspecified price and/or to dissolve Realty, those claims have been dismissed. In October 2016, the Company and Mr. Asherman reached a tentative agreement in principle to resolve their disputes. On November 30, 2016, the parties agreed to a settlement payment in full and final satisfaction of the claims filed by Asherman without an admission of liability by either party. As part of this settlement, the Company purchased the remaining noncontrolling interest in Realty, free and clear of all liens, claims and encumbrances.

Connecticut Attorney General Inquiry

In July 2014, the Company received interrogatories and subpoena from the State of Connecticut Office of the Attorney General concerning its investigation into the pricing of digoxin. According to the subpoena, the Connecticut Attorney General is investigating whether anyone engaged in any activities that resulted in (a) fixing, maintaining or controlling prices of digoxin or (b) allocating and dividing customers or territories relating to the sale of digoxin in violation of Connecticut antitrust law. In June 2016, the Connecticut Attorney General issued interrogatories and a subpoena to an employee of the Company in order to gain access to documents and responses previously supplied to the Department of Justice. In December 2016, the Connecticut Attorney General, joined by numerous other State Attorneys General, filed a civil complaint alleging that six pharmaceutical companies engaged in anti-competitive behavior related to Doxycycline Hyclate and Gliburide. The Company was not named in the action and does not compete on the products that formed the basis of the complaint. On October 31, 2017, the state Attorneys General filed a motion for leave to amend their complaint to add numerous additional defendants, including the Company, and claims relating to 13 additional drugs. The claim relating to Lannett involves alleged price-fixing for one drug, doxycycline monohydrate, but did not involve the pricing for digoxin. The state Attorneys General also allege that all defendants were part of an overarching, industry-wide conspiracy to allocate markets and fix prices generally. None of the defendants, including the Company, has responded yet to the motion of the state Attorneys General.

The Company maintains that it acted in compliance with all applicable laws and regulations and continues to cooperate with the Connecticut Attorney General’s investigation.

Federal Investigation into the Generic Pharmaceutical Industry

In fiscal ~~year~~years 2015 and 2016, the Company and certain affiliated individuals each were served with a grand jury subpoena relating to a federal investigation of the generic pharmaceutical industry into possible violations of the Sherman Act. The subpoenas request corporate documents of the Company relating to corporate, financial and employee information, communications or correspondence with competitors regarding the sale of generic prescription medications and the marketing, sale, or pricing of certain products, generally for the period of 2005 through the dates of the subpoenas.

Based on reviews performed to date by outside counsel, the Company currently believes that it has acted in compliance with all applicable laws and regulations and continues to cooperate with the federal investigation.

Texas Medicaid Investigation

In August 2015, KUPI received a letter from the Texas Office of the Attorney General alleging that ~~they~~it had inaccurately reported certain price information in violation of the Texas Medicaid Fraud Prevention Act. UCB, KUPI’s previous parent company is handling the defense and is evaluating the allegations and cooperating with the Texas Attorney General’s Office. Per the terms of the Stock Purchase Agreement between the Company and UCB (“Stock Purchase Agreement”) dated September 2, 2015, the Company is fully indemnified for any pre-acquisition amounts. ~~In conjunction with information received from UCB’s legal counsel, the~~The Company is currently unable to estimate the timing or the outcome of this matter.

Government Pricing

During the quarter ended December 31, 2016, the Company completed a contract compliance review, for the period January 1, 2012 through June 30, 2016, for one of KUPI’s government-entity customers. As a result of the review, the Company identified certain commercial customer prices and other terms that were not properly disclosed to the government-entity resulting in potential overcharges. As of ~~December 31, 2016,~~September 30, 2017 and June 30, 2017, the Company’s best estimate of the ~~total~~ liability for potential overcharges iswas approximately $9.3 million. For the period January 1, 2012 through November 24, 2015 (“the pre-acquisition period”), the Company is fully indemnified per the Stock Purchase Agreement. Accordingly, the Company has recorded an indemnification asset and related liability of $8.3 million related to the pre-acquisition period. The Company does not believe that the ultimate resolution of this matter will have a significant impact on our financial position, results of operations or cash flows.

AWP Litigation

The Company and some of our competitors have been named as defendants in two lawsuits filed in 2016 alleging that the Company and a number of other generic pharmaceutical manufacturers caused the Average Wholesale Prices (AWPs) of our and their products to be inflated, thereby injuring government programs, entities and persons who reimbursed prescription drugs based on AWPs. The Company stopped using AWP as a basis for establishing prices in or around 2002 and the bulk of prescription drugs manufactured by the Company was sold under private label. The first lawsuit, filed in the United States District Court for the Eastern of Pennsylvania, was dismissed on September 25, 2017 (the “Federal Action”). It is unknown at this time whether the plaintiffs will seek to appeal the dismissal of the Federal Action. The second lawsuit, pending in the Philadelphia (Pennsylvania) County Court of Common Pleas, was stayed pending the final resolution of the Federal Action. The Company disputes these allegations and does not believe that the ultimate resolution of these lawsuits will have a significant impact on our financial position, results of operations or cash flows.

EPA Violation Notice

On July 13, 2017, the United States Department of Environmental Protection Agency (“EPA”) sent a Finding of Violation to KUPI alleging several violations of national emissions standards for hazardous air pollutants at KUPI’s Seymour, Indiana facility. The EPA is giving the company the opportunity to discuss the matter with the agency before filing a formal complaint or assessing fines with respect to the alleged violations. The Company is conducting an investigation into the matter and cannot reasonably predict the outcome of any potential EPA action at this time.

Private Antitrust and Consumer Protection Litigation

The Company and certain competitors have been named as defendants in 22a number of lawsuits filed in 2016 and 2017 alleging that the Company and certain generic pharmaceutical manufacturers have conspired to fix prices of generic digoxin, levothyroxine, ursodiol and ~~doxycycline.~~baclofen. These cases ~~have been consolidated in the United States District Court for the Eastern District~~are part of ~~Pennsylvania. In January 2017, the Court granted the United States leave to intervene in the consolidated case.~~

~~In December 2016, four purported class action~~a larger group of more than 100 lawsuits ~~were filed in the United States District Court for the Southern District of New York against the Company and other manufacturers and distributors of~~generally alleging that over 30 generic ~~levothyroxine on behalf of direct and indirect purchasers. The cases generally allege that the Company and other~~pharmaceutical manufacturers and distributors conspired to fix prices for at least 18 different generic ~~levothyroxine products~~drugs in violation of the federal Sherman Act, various state antitrust laws, and various state consumer protection statutes. ~~In December 2016 and January~~The United States also has been granted leave to intervene in the cases. On April 6, 2017, ~~three additional purported class action lawsuits~~the Judicial Panel on Multidistrict Litigation (the “JPML”) ordered that all of the cases alleging price-fixing for generic drugs be consolidated for pretrial proceedings in the United States District Court for the Eastern District of Pennsylvania ~~against~~under the ~~Company~~caption In re: Generic Pharmaceuticals Pricing Antitrust Litigation. The various plaintiffs are grouped into three categories — Direct Purchaser Plaintiffs, End Payer Plaintiffs, and ~~other manufacturers~~Indirect Reseller Purchasers — and ~~distributors of generic levothyroxine on behalf of direct purchasers, asserting substantially similar claims for violation of the federal Sherman Act and claims for damages as the suits~~ filed ~~in the Southern District of New York.~~

On January 30, 2017, the Company and two other sellers of generic ursodiol were named as defendants in a purported class action lawsuit filed in the District of New Jersey on behalf of indirect purchasers of ursodiol. The case generally alleges thatConsolidated Amended Complaints (“CACs”) against the Company and the other defendants ~~conspired~~on August 15, 2017. The CACs naming the Company as a defendant involve generic digoxin, levothyroxine, ursodiol and baclofen. Pursuant to a court-ordered schedule grouping the 18 different drug cases into three separate tranches, the Company and other generic pharmaceutical manufacturer defendants on October 6, 2017 filed joint and individual motions to dismiss the CACs involving the six drugs in the first tranche, including digoxin.

In addition to the lawsuits brought by private plaintiffs, the Attorneys General of 45 states, the District of Columbia and Puerto Rico have filed parens patriae lawsuits alleging price-fixing conspiracies by various generic pharmaceutical manufacturers, but not involving the Company. The JPML has consolidated the suits by the state Attorneys General in the Eastern District of Pennsylvania as part of the multidistrict litigation. The original lawsuits did not name the Company, but the state Attorneys General on October 31, 2017 filed a motion with the District Court for leave to amend their complaint to add numerous additional defendants, including the Company, and claims relating to 13 additional drugs. The claim relating to Lannett involves alleged price-fixing for one drug, doxycycline monohydrate, although the state Attorneys General allege that all defendants were part of an overarching, industry-wide conspiracy to allocate markets and fix prices ~~for generic ursodiol products in violation~~generally. None of the ~~federal Sherman Act, various~~defendants, including the Company, has responded yet to the motion of the state ~~antitrust laws and various state consumer protection statutes.~~Attorneys General.

The Company believes that it acted in compliance with all applicable laws and regulations. Accordingly, the Company disputes the allegations set forth in these class actions. ~~The Company does not believe that the ultimate resolution of these lawsuits will have a significant impact on our financial position, results of operations or cash flows.~~

Shareholder Litigation

In November 2016, a ~~suit~~putative class action lawsuit was filed in the United States District Court for the Eastern District of Pennsylvania against the Company and two of its officers claiming that the Company damaged the purported class by including in its securities filings ~~made~~ false and misleading statements ~~in connection with its~~regarding the Company’s drug pricing methodologies and internal ~~controls with respect to drug pricing methodologies causing damage to the plaintiff. The~~controls. An amended complaint ~~has not yet been served, but based upon the allegations as pleaded,~~was filed in May 2017, and the Company ~~will be filing~~filed a motion to ~~dismiss.~~dismiss the amended complaint in September 2017. The response to the motion to dismiss is due to be filed in November 2017. The Company cannot reasonably predict the outcome of the suit at this time.

Patent Infringement (Paragraph IV Certification)

There is substantial litigation in the pharmaceutical industry with respect to the manufacture, use and sale of new products which are the subject of conflicting patent and intellectual property claims. Certain of these claims relate to paragraph IV certifications, which allege that an innovator patent is invalid or would not be infringed upon by the manufacture, use, or sale of the new drug.

Zomig®

The Company filed with the Food and Drug Administration an ANDA No. 206350, along with a paragraph IV certification, alleging that the two patents associated with the Zomig® nasal spray product (U.S. Patent No. 6,750,237 and U.S. Patent No. 67,220,767) are invalid.

In July 2014, AstraZeneca AB, AstraZeneca UK Limited and Impax Laboratories, Inc. filed two patent infringement lawsuits in the United States District Court for the District of Delaware, alleging that the Company’s filing of ANDA No. 206350 constitutes an act of patent infringement and seeking a declaration that the two patents at issue are valid and infringed.

In September 2014, the Company filed a motion to dismiss one patent infringement lawsuit for lack of standing and responded to the second lawsuit by denying that any valid patent claim would be infringed. In the second lawsuit, the Company also counterclaimed for a declaratory judgment that the patent claims are invalid and not infringed. The Court has consolidated the two actions and denied the motion to dismiss the first action without prejudice.

In July 2015, the Company filed with the United States Patent and Trademark Office (“USPTO”) a Petition for Inter Partes Review of each of the patents in suit seeking to reject as invalid all claims of the patents in suit. The USPTO has issued a decision denying initiation of the Inter Partes Review.

A trial was conducted in September 2016. ~~Post-trial~~The Court issued its decision on March 29, 2017, finding that Lannett did not prove that the patents at issue are invalid. The Company has appealed the decision. All briefing to the appellate court has been ~~completed~~submitted, and the parties are waiting for the appellate court to set a date for oral argument before the court. A final decision of the appellate court is expected ~~to issue its decision~~ in ~~the next few months.~~late 2017 or early 2018.

Thalomid®

The Company filed with the Food and Drug Administration an ANDA No. 206601, along with a paragraph IV certification, alleging that the fifteen patents associated with the Thalomid drug product (U.S. Patent Nos. 6,045,501; 6,315,720; 6,561,976; 6,561,977; 6,755,784; 6,869,399; 6,908,432; 7,141,018; 7,230,012; 7,435,745; 7,874,984; 7,959,566; 8,204,763; 8,315,886; 8,589,188 and 8,626,53) are invalid, unenforceable and/or not infringed. On January 30, 2015, Celgene Corporation and Children’s Medical Center

Corporation filed a patent infringement lawsuit in the United States District Court for the District of New Jersey, alleging that the Company’s filing of ANDA No. 206601 constitutes an act of patent infringement and seeking a declaration that the patents at issue are valid and infringed. The Company filed an answer and affirmative defenses, and an amended answer to the complaint.

A ~~mediation before~~settlement agreement was reached and the Court dismissed the lawsuit in October 2017. Pursuant to the settlement agreement, the Company entered into a ~~magistrate judge was held on January 6, 2017 but a settlement was not reached. Discovery on~~license agreement that permits Lannett to manufacture and market in the ~~merits is underway.~~U.S. its generic thalidomide product as of August 1, 2019 or earlier under certain circumstances.

~~Dilaudid®~~SUPREP®

The Company filed ANDA No. 209941 with the Food and Drug Administration ~~an ANDA No. 207108,~~seeking approval to sell a bowel preparation oral solution (the “Company’s Oral Solution”), along with a paragraph IV certification, alleging that US Patent ~~6,589,960~~6,946,149 associated with the ~~Dilaudid® (hydromorphone oral solution)~~Suprep® bowel preparation kit would not be infringed by the Company’s ~~proposed hydromorphone oral solution product~~Oral Solution and/or that the patent is invalid. ~~On August 8, 2015, Purdue Pharmaceutical Products L.P, Purdue Pharma L.P and Purdue Pharma Technologies~~

In March 2017, Braintree Laboratories, Inc. (“~~Purdue”~~Braintree”) filed a patent infringement lawsuit in the United States District Court for the District of ~~New Jersey,~~Delaware (C.A. No. 1:17-cv-00293-GMS), alleging that the Company’s filing of ANDA No. ~~207108~~209941 constitutes an act of patent infringement and seeking a declaration that the patent at issue was infringed by the submission of ANDA ~~No, 207108.~~No. 209941. The Company answered the complaint denying infringement and ~~Purdue have reached~~raising invalidity as a ~~settlement~~defense, and has filed counterclaims seeking a declaration of non-infringement and invalidity. The matter is currently scheduled for a 4-day bench trial beginning on January 22, 2019. On July 28, 2017, the ~~case was dismissed with prejudice in October 2016.~~Company filed a motion for judgment on the pleadings, seeking a ruling that its ANDA product does not infringe the Braintree patent and seeking judgment as a matter of law. Braintree has opposed the motion and has alternatively requested that the Court delay its decision on the motion until discover is taken. The Company has opposed Braintree’s request to delay the decision. All motions remain pending at this time.

Although the Company cannot currently predict the length or outcome of paragraph IV litigation, legal expenses associated with these lawsuits could have a significant impact on the financial position, results of operations and cash flows of the Company.

Other Litigation Matters

The Company is also subject to various legal proceedings arising out of the normal course of its business including, but not limited to, product liability, intellectual property, patent infringement claims and antitrust matters. It is not possible to predict the outcome of these various proceedings. An adverse determination in any of these proceedings in the future could have a significant impact on the financial position, results of operations and cash flows of the Company.

Note ~~14.~~13. Commitments

Leases

The Company leases certain manufacturing and office equipment, in the ordinary course of business. These leases are typically renewed annually. Rental and lease expense was not material for all periods presented.

Future minimum lease payments under noncancelable operating leases (with initial or remaining lease terms in excess of one year) for the remainder of Fiscal ~~2017~~2018 and the twelve month periods ending June 30 thereafter are as follows:

(In thousands)	Amounts Due		Amounts Due
Remainder of 2017	$	796
2018	1,142
Remainder of 2018			$	1,185
2019	1,080		1,805
2020	1,080		1,853
2021	1,080		1,472
2022			1,080
Thereafter	6,318		5,238
Total	$	11,496	$	12,633

Other Commitment

During the third quarter of Fiscal 2017, the Company signed an agreement with a company operating in the pharmaceutical business, under which the Company agreed to provide up to $15.0 million in revolving loans for the purpose of expansion and other business needs. The decision to provide any portion of the revolving loan is at the Company’s sole discretion. At any time after the outstanding revolving loan balance is equal to or greater than $7.5 million, the Company has the option to convert the first $7.5

million into a 50% ownership interest in the entity. As of September 30, 2017, $3.5 million was outstanding under the revolving loan. The board of the entity is comprised of five members, two of which are employees of the Company. Based on the guidance set forth in ASC 810-10 Consolidation, the Company has concluded that it has a variable interest in the entity. However, the Company is not the primary beneficiary to the entity and as such, is not required to consolidate the entity’s results of operations.

Note ~~15.~~14. Accumulated Other Comprehensive Loss

The Company’s Accumulated Other Comprehensive Loss was comprised of the following components as of ~~December 31, 2016~~September 30, 2017 and ~~2015:~~2016:

(In thousands)	December 31, 2016			December 31, 2015				September 30, 2017			September 30, 2016
Foreign Currency Translation
Beginning Balance, June 30	$	(295	)	$		(295	)	$	(222	)	$	(295	)
Net gain (loss) on foreign currency translation (net of tax of $0 and $0)	38			26				1			(3		)
Reclassifications to net income (net of tax of $0 and $0)	—			—				—			—
Other comprehensive income (loss), net of tax	38			26				1			(3		)
Ending Balance, December 31	(257		)	(269			)
Ending Balance, September 30								(221		)	(298		)
Total Accumulated Other Comprehensive Loss	$	(257	)	$	(269		)	$	(221	)	$	(298	)

Note ~~16.~~15. Earnings (Loss) Per Common Share

A dual presentation of basic and diluted earnings per common share is required on the face of the Company’s Consolidated Statement of Operations as well as a reconciliation of the computation of basic earnings per common share to diluted earnings per common share. Basic earnings per common share excludes the dilutive impact of potentially dilutive securities and is computed by dividing net income (loss) attributable to Lannett Company, Inc. by the weighted average number of common shares outstanding for the period. Diluted earnings per common share is computed using the treasury stock method and includes the effect of potential dilution from the exercise of outstanding stock options, ~~and~~ a warrant and treats unvested restricted stock and performance-based shares as if it were vested. Potentially dilutive securities have been excluded in the weighted average number of common shares used for the calculation of earnings per share in periods of net loss because the effect of including such securities would be anti-dilutive. A reconciliation of the Company’s basic and diluted earnings per common share was as follows:

Three Months Ended
December 31,

(In thousands, except share and per share data)

2016

2015

Net income attributable to Lannett Company, Inc.

$
8,172

$
13,520

Basic weighted average common shares outstanding

36,810,388

36,388,542

Effect of potentially dilutive stock options, warrants and restricted stock awards

865,982

999,908

Diluted weighted average common shares outstanding

37,676,370

37,388,450

Earnings per common share attributable to Lannett Company, Inc.:

Basic

$
0.22

$
0.37

Diluted

$
0.22

$
0.36

	Six Months Ended December 31,					Three Months Ended September 30,
(In thousands, except share and per share data)	2016			2015		2017		2016

Net income (loss) attributable to Lannett Company, Inc.	$	(21,236	)	$	46,701	$	13,257	$	(29,408	)

Basic weighted average common shares outstanding	36,754,828			36,349,597		36,992,064		36,699,267
Effect of potentially dilutive stock options, warrants and restricted stock awards	—			1,052,281
Effect of potentially dilutive options and restricted stock awards						738,592		—
Diluted weighted average common shares outstanding	36,754,828			37,401,878		37,730,656		36,699,267

Earnings (loss) per common share attributable to Lannett Company, Inc.:
Basic	$	(0.58	)	$	1.28	$	0.36	$	(0.80	)
Diluted	$	(0.58	)	$	1.25	$	0.35	$	(0.80	)

The number of anti-dilutive shares that have been excluded in the computation of diluted earnings per share for the three months ended ~~December 31,~~September 30, 2017 and 2016 ~~and 2015 were~~was 3.0 million and ~~2.6~~4.3 million, respectively. The number of anti-dilutive shares that have been excluded in the computation of diluted earnings per share for the six months ended December 31, 2016 and 2015 were 4.4 million and 2.6 million, respectively.

Note ~~17.~~16. Warrant

In connection with the KUPI acquisition, Lannett issued to UCB Manufacturing a warrant to purchase up to a total of 2.5 million shares of Lannett’s common stock (the “Warrant”).

The Warrant has a term of three years (expiring November 25, 2018) and an exercise price of $48.90 per share, subject to customary adjustments, including for stock splits, dividends and combinations. The Warrant also has a “weighted average” anti-dilution adjustment provision. The fair value included as part of the total consideration transferred to UCB at the acquisition date was $29.9 million. The fair value assigned to the Warrant was determined using the Black-Scholes valuation model. The Company concluded that the warrant was indexed to its own stock and therefore the Warrant has been classified as an equity instrument.

Note ~~18.~~17. Share-based Compensation

At ~~December 31, 2016,~~September 30, 2017, the Company had two share-based employee compensation plans (the 2011 Long-Term Incentive Plan “LTIP” and the 2014 “LTIP”). Together these plans authorized an aggregate total of 4.5 million shares to be issued. The plans have a total of ~~2.1~~1.7 million shares available for future issuances.

The Company issues share-based compensation awards with a vesting period ranging up to 3 years and a maximum contractual term of 10 years. The Company issues new shares of stock when stock options are exercised. As of ~~December 31, 2016,~~September 30, 2017, there was ~~$9.8~~$11.3 million of total unrecognized compensation cost related to non-vested share-based compensation awards. That cost is expected to be recognized over a weighted average period of ~~2.0~~2.4 years.

Stock Options

The Company measures share-based compensation cost for options using the Black-Scholes option pricing model. The following table presents the weighted average assumptions used to estimate fair values of the stock options granted during the ~~six~~three months ended ~~December 31,~~September 30, 2017 and 2016, ~~and 2015,~~ the estimated annual forfeiture rates used to recognize the associated compensation expense and the weighted average fair value of the options granted:

	Six Months Ended
	December 31, 2016			December 31, 2015			September 30, 2017			September 30, 2016
Risk-free interest rate	1.1		%	1.7		%	1.9		%	1.1		%
Expected volatility	55.6		%	48.3		%	57.4		%	55.6		%
Expected dividend yield	0.0		%	0.0		%	—			—
Forfeiture rate	6.5		%	6.5		%	6.5		%	6.5		%
Expected term (in years)	5.2 years			5.2 years			5.4 years			5.2 years
Weighted average fair value	$	15.33		$	26.24		$	9.06		$	15.33

Expected volatility is based on the historical volatility of the price of our common shares during the historical period equal to the expected term of the option. The Company uses historical information to estimate the expected term, which represents the period of time that options granted are expected to be outstanding. The risk-free rate for the period equal to the expected life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The forfeiture rate assumption is the estimated annual rate at which unvested awards are expected to be forfeited during the vesting period. This assumption is based on our actual forfeiture rate on historical awards. Periodically, management will assess whether it is necessary to adjust the estimated rate to reflect changes in actual forfeitures or changes in expectations. Additionally, the expected dividend yield is equal to zero, as the Company has not historically issued and has no immediate plans to issue, a dividend.

A stock option roll-forward as of ~~December 31, 2016~~September 30, 2017 and changes during the ~~six~~three months then ended, is presented below:

														Weighted
										Weighted-				Average
										Average		Aggregate		Remaining
										Exercise		Intrinsic		Contractual
(In thousands, except for weighted average price and life data)	Awards		Weighted- Average Exercise Price		Aggregate Intrinsic Value		Weighted Average Remaining Contractual Life (yrs.)	Awards		Price		Value		Life (yrs.)

Outstanding at June 30, 2016	1,730		$	16.77	$	19,524	6.3
Outstanding at June 30, 2017								1,475		$	18.02	$	12,212	5.7
Granted	11		$	31.30				18		$	17.40
Exercised	(190	)	$	6.54	$	4,325		(14	)	$	6.53	$	150
Forfeited, expired or repurchased	(19	)	$	31.40				(6	)	$	26.55
Outstanding at December 31, 2016	1,532		$	17.96	$	14,370	6.2
Outstanding at September 30, 2017								1,473		$	18.09	$	10,075	5.5

Vested and expected to vest at December 31, 2016	1,525		$	17.85	$	14,370	6.2
Exercisable at December 31, 2016	1,379		$	15.64	$	14,370	6.0
Vested and expected to vest at September 30, 2017								1,470		$	18.07	$	10,073	5.5
Exercisable at September 30, 2017								1,436		$	17.66	$	10,057	5.4

Restricted Stock

The Company measures restricted stock compensation costs based on the stock price at the grant date less an estimate for expected forfeitures. The annual forfeiture rate used to calculate compensation expense was 6.5% for the ~~six~~three months ended ~~December 31, 2016~~September 30, 2017 and ~~2015.~~2016.

A summary of restricted stock awards as of ~~December 31, 2016~~September 30, 2017 and changes during the ~~six~~three months then ended, is presented below:

(In thousands)	Awards		Weighted Average Grant - date Fair Value		Aggregate Intrinsic Value
(In thousands, except for weighted average price data)							Awards		Weighted Average Grant - date Fair Value		Aggregate Intrinsic Value

Non-vested at June 30, 2016	167		$	48.22
Non-vested at June 30, 2017							334		$	30.71
Granted	275		$	25.03			460		17.16
Vested	(76	)	$	43.80	$	2,326	(116	)	35.35		$	2,452
Forfeited	(18	)	$	37.13			(17	)	24.13
Non-vested at December 31, 2016	348		$	31.38
Non-vested at September 30, 2017							661		$	39.72

Performance-Based Shares

On September 22, 2017, the Company approved and granted performance-based awards to certain key executives. The stock-settled awards will vest based on relative Total Shareholder Return (“TSR”) over a three year period. The Company measures share-based compensation cost for TSR awards using a Monte-Carlo simulation model. The impact of the grant was not material to the consolidated financial statements during the first quarter of Fiscal 2018.

Employee Stock Purchase Plan

In February 2003, the Company’s stockholders approved an Employee Stock Purchase Plan (“ESPP”). Employees eligible to participate in the ESPP may purchase shares of the Company’s stock at 85% of the lower of the fair market value of the common stock on the first day of the calendar quarter, or the last day of the calendar quarter. Under the ESPP, employees can authorize the Company to withhold up to 10% of their compensation during any quarterly offering period, subject to certain limitations. The ESPP was implemented on April 1, 2003 and is qualified under Section 423 of the Internal Revenue Code. The Board of Directors authorized an aggregate total of 1.1 million shares of the Company’s common stock for issuance under the ESPP. During the ~~six~~three months ended ~~December 31,~~September 30, 2017 and 2016, ~~and 2015, 27~~14 thousand shares and 1113 thousand shares were issued under the ESPP, respectively. As of ~~December 31, 2016, 512~~September 30, 2017, 557 thousand total cumulative shares have been issued under the ESPP.

The following table presents the allocation of share-based compensation costs recognized in the Consolidated Statements of Operations by financial statement line item:

Three Months Ended

Six Months Ended

December 31,

December 31,

(In thousands)

2016

2015

2016

2015

Selling, general and administrative expenses

$
1,251

$
1,494

$
3,223

$
5,380

Research and development expenses

152

201

325

389

Cost of sales

314

329

625

629

Total

$
1,717

$
2,024

$
4,173

$
6,398

Tax benefit at statutory rate

$
627

$
729

$
1,523

$
2,303

	Three Months Ended September 30,
(In thousands)	2017		2016
Selling, general and administrative	$	1,787	$	1,972
Research and development	151		173
Cost of sales	251		311
Total	$	2,189	$	2,456

Tax benefit at statutory rate	$	799	$	897

Note ~~19.~~18. Employee Benefit Plan

The Company has a 401k defined contribution plan (the “Plan”) covering substantially all employees. Pursuant to the Plan provisions, the Company is required to make matching contributions equal to 50% of each employee’s contribution, not to exceed 4% of the employee’s compensation for the Plan ~~year~~.year. Contributions to the Plan during the three months ended ~~December 31,~~September 30, 2017 and 2016 ~~and 2015~~ were ~~$492~~$562 thousand and ~~$188 thousand, respectively. Contributions to the Plan during the six months ended December 31, 2016 and 2015 were $1.1 million and $437~~$579 thousand, respectively.

Note ~~20.~~19. Income Taxes

The Company uses the liability method to account for income taxes. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities as measured by the enacted tax rates which will be in effect when these differences reverse. Deferred tax expense (benefit) is the result of changes in deferred tax assets and liabilities.

The federal, state and local income tax expense for the three months ended ~~December 31, 2016 and 2015~~September 30, 2017 was ~~$3.5~~$7.4 million ~~and $6.0~~compared to an income tax benefit of $12.9 million ~~respectively.~~for the three months ended September 30, 2016. The effective tax rates for the three months ended ~~December 31,~~September 30, 2017 and 2016 were 35.9% and 2015 were 30.2% and 30.6%, respectively. The federal, state and local income tax benefit for the six months ended December 31, 2016 was $9.3 million compared to income tax expense of $23.0 million for the six months ended December 31, 2015. The effective tax rates were 30.6% and 33.0%30.5%, respectively. The effective tax rate for the ~~six~~three months ended ~~December 31, 2016~~

September 30, 2017 was ~~lower~~higher compared to the ~~six~~three months ended ~~December 31, 2015~~September 30, 2016 primarily due to ~~higher~~ lower domestic manufacturing deductions ~~and research and experimentation credits~~ relative to expected ~~annual~~ pre-tax income ~~partially offset by~~as well as the ~~effect~~impact of ~~changes in the Company’s state~~excess tax ~~profile as result of the KUPI~~ ~~acquisition.~~shortfalls related to stock compensation.

As of ~~December 31, 2016~~September 30, 2017 and June 30, ~~2016,~~ 2017, the Company ~~reported~~has total unrecognized tax benefits of ~~$6.6~~$6.0 million and ~~$6.2~~$5.9 million respectively, ~~in other liabilities.~~of which $4.2 million would impact the Company’s effective tax rate if recognized. As a result of the positions taken during the period, the Company has not recorded any interest and penalties for the period ended ~~December 31, 2016~~September 30, 2017 in the statement of operations and no cumulative interest and penalties have been recorded either in the Company’s statement of financial position as of ~~December 31, 2016~~September 30, 2017 and June 30, ~~2016.~~2017. The Company will recognize interest accrued on unrecognized tax benefits in interest expense and any related penalties in operating expenses. The ~~Company does not believe that the total~~cumulative amount of unrecognized tax benefits ~~will significantly increase or decrease~~as of September 30, 2017 includes approximately $3.0 million of state reserves related to the acquisition of KUPI, which are expected to be recognized in ~~the next twelve months.~~Fiscal 2018 due to a lapse of statute of limitations.

The Company files income tax returns in the United States federal jurisdiction and various states. The Company’s tax returns for Fiscal Year ~~2012~~2013 and prior generally are no longer subject to review as such years generally are closed. The Company’s Fiscal Year 2016 federal return is currently under examination by the IRS. The Company ~~believes that an unfavorable resolution for open tax years would not be material to~~cannot reasonably predict the ~~financial position~~outcome of the ~~Company.~~examination at this time.

Note ~~21.~~20. Related Party Transactions

The Company had sales of ~~$1.1 million~~$834 thousand and ~~$529~~$856 thousand during the three months ended ~~December 31,~~September 30, 2017 and 2016, ~~and 2015,~~ respectively, to a generic distributor, Auburn Pharmaceutical Company (“Auburn”). ~~Sales to Auburn for the six months ended December 31, 2016 and 2015 were $2.0 million and $866 thousand, respectively.~~ Jeffrey Farber, Chairman of the Board, is the owner of Auburn. Accounts receivable includes amounts due from Auburn of ~~$754~~$716 thousand and ~~$682~~$751 thousand at ~~December 31, 2016~~September 30, 2017 and June 30, 2017, respectively.

The Company also had sales of $467 thousand and $67 thousand during the three months ended September 30, 2017 and 2016, respectively, to a generic distributor, KeySource. Albert Paonessa, a current board member, was appointed the CEO of KeySource in May 2017. Accounts receivable includes amounts due from KeySource of $491 thousand and $606 thousand as of September 30, 2017 and June 30, 2017, respectively.

Note ~~22.~~21. Material Contracts with Suppliers

Jerome Stevens Pharmaceuticals Distribution Agreement:

The Company’s primary finished goods inventory supplier is JSP, in Bohemia, New York. Purchases of finished goods inventory from JSP accounted for ~~approximately 39~~%33% and ~~59%~~37% of the Company’s inventory purchases in the three months ended ~~December 31,~~September 30, 2017 and 2016, ~~and 2015,~~ respectively. ~~Purchases of finished goods inventory from JSP accounted for 38% and 62% of the Company’s inventory purchases in the six months ended December 31, 2016 and 2015, respectively.~~

On August 19, 2013, the Company entered into an agreement with JSP to extend its initial contract to continue as the exclusive distributor in the United States of three JSP products: Butalbital, Aspirin, Caffeine with Codeine Phosphate Capsules USP; Digoxin Tablets USP; and Levothyroxine Sodium Tablets USP. The amendment to the original agreement extends the initial contract, which was due to expire on March 22, 2014, for five years through March 2019. In connection with the amendment, the Company issued a total of 1.5 million shares of the Company’s common stock to JSP and JSP’s designees. In accordance with its policy related to renewal and extension costs for recognized intangible assets, the Company recorded a $20.1 million expense in cost of sales, which represents the fair value of the shares on August 19, 2013. If the parties agree to a second five year extension from March 23, 2019 to March 23, 2024, the Company is required to issue to JSP or its designees an additional 1.5 million shares of the Company’s common stock. Both Lannett and JSP have the right to terminate the contract if one of the parties does not cure a material breach of the contract within thirty (30) days of notice from the non-breaching party.

During the renewal term of the JSP Distribution Agreement, the Company is required to use commercially reasonable efforts to purchase minimum dollar quantities of JSP products. There is no guarantee that the Company will be able to meet the minimum purchase requirement for Fiscal ~~2017~~2018 and in the future. If the Company does not meet the minimum purchase requirements, JSP’s sole remedy is to terminate the JSP Distribution Agreement.

~~Note 23. Subsequent Events~~

On January 23, 2017, the Company voluntarily made a $75.0 million payment against its outstanding revolving credit facility balance. As of January 31, 2017, the balance outstanding was $50.0 million.

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

Cautionary Statement About Forward-Looking Statements

This Report on Form 10-Q and certain information incorporated herein by reference contains forward-looking statements which are not historical facts made pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not promises or guarantees and investors are cautioned that all forward-looking statements involve risks and uncertainties, including but not limited to the impact of competitive products and pricing, product demand and market acceptance, new product development, acquisition-related challenges, the regulatory environment, interest rate fluctuations, reliance on key strategic alliances, availability of raw materials, fluctuations in operating results and other risks detailed from time to time in our filings with the Securities and Exchange Commission (the “SEC”). These statements are based on management’s current expectations and are naturally subject to uncertainty and changes in circumstances. We caution you not to place undue reliance upon any such forward-looking statements which speak only as of the date made. Lannett is under no obligation to, and expressly disclaims any such obligation to, update or alter its forward-looking statements, whether as a result of new information, future events or otherwise.

The following information should be read in conjunction with the consolidated financial statements and notes in Part I, Item 1 of this Quarterly Report and with Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, ~~2016.~~2017. All references to “Fiscal 2018” or “Fiscal Year 2018” shall mean the fiscal year ended June 30, 2018 and all references to “Fiscal 2017” or “Fiscal Year 2017” shall mean the fiscal year ended June 30, ~~2017 and all references to “Fiscal 2016” or “Fiscal Year 2016” shall mean the fiscal year ended June 30, 2016.~~2017.

Company Overview

Lannett Company, Inc. (a Delaware corporation) and its subsidiaries (collectively, the “Company”, “Lannett”, “we” or “us”) develop, manufacture, package, market and distribute solid oral and extended release (tablets and capsules), topical, nasal and oral solution finished dosage forms of drugs, that address a wide range of therapeutic areas. Certain of these products are manufactured by others and distributed by the Company. The Company also manufactures active pharmaceutical ingredients through its Cody Labs subsidiary, providing a vertical integration benefit. Additionally, the Company is pursuing partnerships, research contracts and internal expansion for the development and production of other dosage forms including: ophthalmic, nasal, patch, foam, buccal, sublingual, soft gel, injectable and oral dosages.

On November 25, 2015, the Company completed the acquisition of Kremers Urban Pharmaceutical, Inc. (“KUPI”), the former subsidiary of global biopharmaceuticals company UCB S.A. KUPI is a specialty pharmaceuticals manufacturer focused on the development of products that are difficult to formulate or utilize specialized delivery technologies. Strategic benefits of the acquisition include expanded manufacturing capacity, a diversified product portfolio and pipeline and complementary research and development expertise.

2016 Restructuring Plan

On February 1, 2016, in connection with the acquisition of KUPI, the Company announced a plan related to the future integration of KUPI and the Company’s operations (the “2016 Restructuring Program”). The plan focuses on the closure of KUPI’s corporate functions and the consolidation of manufacturing, sales, research and development and distribution functions. The Company estimates that it will incur an aggregate of up to approximately ~~$21.0~~$20.0 million in restructuring charges for actions that have been announced or communicated since the 2016 Restructuring Program began. Of this amount, approximately ~~$12.0~~$11.0 million relates to employee separation costs, approximately $1.0 million relates to contract termination costs and approximately $8.0 million relates to facility closures costs and other actions.

The plan is currently estimated to generate annualized synergies of approximately $50.0 million by the end of Fiscal 2018 and is expected to achieve an ultimate annual run rate of synergies totaling approximately $65.0 million by the end of Fiscal 2020.

These amounts are ~~preliminary~~ estimates based on the information currently available to management. It is possible that additional charges and future cash payments could occur in relation to the restructuring actions.

Financial Summary

For the ~~second~~first quarter of Fiscal Year ~~2017,~~2018, net sales ~~increased~~decreased 4% to ~~$170.9~~$155.0 million as compared to ~~$127.1 million in~~ the same prior-year period. Gross profit ~~increased~~decreased to ~~$88.1~~$67.7 million compared to ~~$71.6~~$81.9 million in the prior-year period and gross profit percentage decreased to ~~52%~~44% compared to ~~56%~~51% in the prior-year period. R&D expenses ~~increased 10%~~decreased 40% to ~~$9.9~~$7.4 million compared to ~~$9.1~~$12.4 million in the ~~second~~first quarter of Fiscal Year ~~2016~~2017 while SG&A expenses ~~increased 23%~~decreased 10% to ~~$18.1~~$19.0 million from ~~$14.7~~$21.3 million. Acquisition and integration-related expenses decreased to ~~$1.0 million~~$18 thousand from ~~$17.6~~$1.4 million in the prior-year period. Restructuring expenses ~~increased~~decreased 74% to ~~$1.7 million as a result of implementing the 2016 Restructuring Program.~~$527 thousand from $2.1 million. Operating income for the ~~second~~first quarter of Fiscal Year 2018 was $40.7 million compared to an operating loss of $20.3 million in the first quarter of Fiscal Year 2017, which included a ~~$23.0~~$65.1 million intangible asset impairment ~~charge, was $34.3 million compared to $30.3 million in the second quarter of Fiscal Year 2016.~~charge. Net income attributable to Lannett Company, Inc. for the ~~second~~first quarter of Fiscal Year ~~2017~~2018 was ~~$8.2~~$13.3 million, or ~~$0.22~~$0.35 per diluted share compared to ~~$13.5 million or $0.36 per diluted share in the second quarter of Fiscal Year 2016.~~

~~For the first six months of Fiscal 2017,~~ net sales increased to $332.5 million compared to $233.5 million in the same prior-year period. Gross profit increased $20.8 million to $169.9 million, compared to $149.1 million in the prior-year period. Gross profit percentage decreased to 51% compared to 64% in the prior-year period. R&D expenses increased 43% to $22.3 million compared to $15.6 million in the first six months of Fiscal 2016 while SG&A expenses increased 30% to $39.3 million from $30.2 million. Acquisition and integration-related expenses decreased to $2.4 million from $21.5 million in the prior-year period. Restructuring expenses increased to $3.8 million as a result of implementing the 2016 Restructuring Program. Operating income for the first six months of Fiscal 2017, which included an $88.1 million intangible assets impairment charge, was $14.0 million compared to $81.7 million in the prior-year period. Net loss attributable to Lannett Company, Inc. ~~for the first six months~~ of ~~Fiscal 2017 was $21.2~~$29.4 million or ~~$0.58 per diluted share compared to net income attributable to Lannett Company, Inc. of $46.7 million or $1.25~~$0.80 per diluted share in the ~~prior-year period.~~first quarter of Fiscal Year 2017.

A more detailed discussion of the Company’s financial results can be found below.

Results of Operations - Three months ended ~~December 31, 2016~~September 30, 2017 compared with the three months ended ~~December 31, 2015~~September 30, 2016

Net sales ~~increased 35%~~decreased 4% to ~~$170.9~~$155.0 million for the three months ended ~~December 31, 2016.~~September 30, 2017. The following table identifies the Company’s net product sales by medical indication for the three months ended ~~December 31, 2016~~September 30, 2017 and ~~2015:~~2016:

(In thousands)	Three Months Ended December 31,				Three Months Ended September 30,
Medical Indication	2016		2015		2017		2016
Antibiotic	$	4,792	$	2,828	$	3,349	$	3,780
Anti Psychosis	15,365		730		14,991		17,320
Cardiovascular	11,975		13,082		11,306		12,694
Central Nervous System	10,555		6,077		8,818		10,350
Gallstone	13,425		18,719		6,564		12,883
Gastrointestinal	18,977		8,617		14,553		18,052
Glaucoma	5,311		6,543		2,668		5,783
Migraine	7,863		5,705		15,015		7,160
Muscle Relaxant	3,004		1,393		3,791		3,532
Obesity	960		851
Pain Management	7,439		8,074		5,761		6,608
Respiratory	2,957		1,396		1,647		2,213
Thyroid Deficiency	45,431		37,432		47,214		39,838
Urinary	4,693		3,378		2,997		5,101
Other	10,173		9,963		12,696		11,182
Contract manufacturing revenue	8,024		2,271		3,591		5,063
Total	$	170,944	$	127,059	$	154,961	$	161,559

The ~~increase~~decrease in net sales was ~~primarily~~ driven by ~~additional sales~~decreased average selling price of ~~KUPI~~ products of ~~$38.1~~$31.8 million, ~~due to the timing of the acquisition as well as~~partially offset by increased volumes of ~~$5.0 million~~$25.2 million. Average selling prices were impacted by competitive pricing pressure across a number of products, product mix and ~~increased product prices of $842 thousand.~~ changes within distribution channels.Although the Company has benefited in the past from favorable pricing trends, ~~the~~these trends ~~are stabilizing and in, many instances, beginning to reverse.~~have reversed. The level of competition in the marketplace is constantly changing and the Company cannot predict with certainty that these trends will continue.

~~Beginning in~~

In January 2017, a provision in the Bipartisan Budget Act of 2015 ~~will require~~required drug manufacturers to pay additional rebates to ~~State~~state Medicaid programs if the prices of their generic drugs rise at a rate faster than inflation. ~~Based on our forecasted product~~The provision negatively impacted the Company’s net sales ~~mix, we expect~~by $5.4 million during the ~~new provision~~three months ended September 30, 2017, which contributed to ~~lower our future Medicaid-related net sales.~~the overall decreased average selling price.

The following chart details price and volume changes by medical indication:

Medical indication

Sales volume
change %

Sales price
change %

Acquisition
change %

Antibiotic

64
%
6
%
—
%
Anti Psychosis

54
%
1950
%
—
%
Cardiovascular

(22
)%
(32
)%
45
%
Central Nervous System

(26
)%
(23
)%
122
%
Gallstone

(21
)%
(8
)%
—
%
Gastrointestinal

(8
)%
(32
)%
160
%
Glaucoma

(5
)%
(13
)%
—
%
Migraine

52
%
(14
)%
—
%
Muscle Relaxant

349
%
(233
)%
—
%
Obesity

76
%
(63
)%
—
%
Pain Management

(4
)%
(4
)%
—
%
Respiratory

59
%
(76
)%
129
%
Thyroid Deficiency

15
%
6
%
—
%
Urinary

(30
)%
(42
)%
111
%

~~Anti Psychosis.~~ Net sales of drugs used for the treatment of anti psychosis increased by $14.6 million. The increase in net sales was primarily attributable to product price increases on key products, and to a lesser extent, increased volumes.

~~Cardiovascular.~~ Net sales of drugs used for cardiovascular treatment decreased by $1.1 million. The decrease was primarily the result of decreased volumes due to competition in the market for products used to treat congestive heart failure and price decreases on several key products. The decreases were partially offset by additional sales of KUPI products due to the timing of the acquisition.

Medical indication	Sales volume change %		Sales price change %
Antibiotic	3	%	(14	)%
Anti Psychosis	(23	)%	10	%
Cardiovascular	48	%	(59	)%
Central Nervous System	13	%	(28	)%
Gallstone	(16	)%	(33	)%
Gastrointestinal	14	%	(33	)%
Glaucoma	(3	)%	(51	)%
Migraine	129	%	(19	)%
Muscle Relaxant	159	%	(152	)%
Pain Management	(13	)%	—	%
Respiratory	5	%	(31	)%
Thyroid Deficiency	15	%	4	%
Urinary	12	%	(53	)%

Central Nervous System. Net sales of central nervous system products increased by $4.5 million. The increase was primarily attributable to additional sales of Methylphenidate Hydrochloride Extended Release tablets in the three months ended December 31, 2016 as compared to the same prior-year period due to the timing of the KUPI acquisition. The increase was partially offset by decreased volumes and product price decreases. Sales of Methylphenidate Hydrochloride Extended Release tablets could continue to be affected by the changing regulatory environment as discussed below.

Methylphenidate Hydrochloride Extended Release Tablets (“Methylphenidate ER”)

During a teleconference in November 2014, the FDA informed KUPI that it had concerns about whether generic versions of Concerta (methylphenidate hydrochloride extended release tablets), including KUPI’s Methylphenidate ER product, are therapeutically equivalent to Concerta. The FDA indicated that its concerns were based in part on adverse event reports concerning lack of effect and its analyses of pharmacokinetic data. The FDA informed KUPI that it was changing the therapeutic equivalence rating of its product from “AB” (therapeutically equivalent) to “BX.” A BX-rated drug is a product for which data are insufficient to determine therapeutic equivalence; it is still approved and can be prescribed, but the FDA does not recommend it as automatically substitutable for the brand-name drug at the pharmacy.

During the November 2014 teleconference, the FDA also asked KUPI to either voluntarily withdraw its product or to conduct new bioequivalence (“BE”) testing in accordance with the recommendations for demonstrating bioequivalence to Concerta proposed in a new draft BE guidance that the FDA issued earlier that November. The FDA had approved the KUPI product (and originally granted it an AB rating) in 2013, on the basis of KUPI data showing its product met BE criteria set forth in draft BE guidance that the FDA had issued in 2012. The FDA’s position concerning the KUPI product was the subject of a public announcement by the agency. The Company agreed to conduct new BE studies per the new draft BE guidance. KUPI submitted the data from those studies to the FDA in June 2015. The Company continues to pursue the FDA to obtain its decision on the submitted study as well as its response on whether it will restore the AB-rating for our product.

On October 18, 2016, the Company received notice from the FDA that it will seek to withdraw approval of the Company’s ANDA for Methylphenidate ER. The FDA’s notice includes an opportunity for the Company to request a hearing on this matter. The Company initially had until November 17, 2016 to request the hearing and until December 19, 2016 to submit all data, information and analyses upon which the request for a hearing relies. As a result of the notice, the Company performed an impairment analysis including a review of revised net sales projections for Methylphenidate ER. This analysis resulted in the Company recording a $65.1 million impairment charge in the first quarter of Fiscal 2017.

On November 30, 2016, the Company announced that the FDA granted a 90-day extension to submit documentation related to the hearing request. ~~The new~~On February 22, 2017, the Company announced that the FDA suspended indefinitely the deadline ~~for submitting the~~to submit supporting documentation ~~is March 20, 2017.~~related to the hearing request in order to give the FDA additional time to retrieve documents requested by the Company.

The Company intends to continue working to submit data to the FDA to regain the “AB” rating, or to maintain the drug on the U.S. market with a B-level rating, however, there can be no assurance as to when or if the Company will be permitted to remain on the market. If the Company were to receive the “AB” rating, net sales of the product could increase subject to market factors existing at that time. The Company also agreed to potential acquisition-related contingent payments to UCB related to Methylphenidate ER if the FDA reinstates the AB-rating and certain sales thresholds are met.

~~Gallstone.~~ ~~Net sales of drugs used for gallstones decreased by $5.3 million. The decrease in net sales was primarily attributable~~ Such potential contingent payments are set to ~~decreased volumes as well as a decrease in the average selling price of key products.~~

~~Gastrointestinal.~~ ~~Net sales of gastrointestinal products increased by $10.4 million. The increase in net sales was primarily attributable to additional sales of KUPI products in the three months ended~~expire after December 31, ~~2016 as compared to the same prior-year period due to the timing of the KUPI acquisition. The increase was partially offset by product price decreases on certain key products and decreased volumes.~~2020.

~~Glaucoma.~~ Net sales of drugs used for the treatment of glaucoma decreased by $1.2 million. The decrease in net sales was primarily attributable to a decrease in the average selling price of key products as well as decreased volumes.

~~Pain Management.~~ Net sales of pain management products decreased $635 thousand. The decrease in net sales was mainly attributable to decreases on the average selling price of key products and, to a lesser extent, decreased volumes.

~~Respiratory.~~ Net sales of respiratory products increased by $1.6 million. The increase in net sales was primarily attributable to additional sales of KUPI products in the three months ended December 31, 2016 as compared to the same prior-year period due to the timing of the KUPI acquisition. Excluding the impact of the additional sales of KUPI products in the current period, net sales of respiratory products decreased slightly as a result of product price decreases, partially offset by increased volumes.

~~Thyroid Deficiency.~~ Net sales of drugs used for the treatment of thyroid deficiency increased by $8.0 million, primarily as a result of increased volumes and, to a lesser extent, increases in the average selling price of Levothyroxine.

~~Urinary.~~ Net sales of urinary products increased by $1.3 million. The increase in net sales was primarily attributable to additional sales of KUPI products in the three months ended December 31, 2016 as compared to the same prior-year period due to the timing of the KUPI acquisition. The increase was partially offset by product price decreases and decreased volumes due to increased competition.

~~Contract manufacturing revenue.~~ ~~Contract manufacturing revenue for the second quarter of Fiscal 2017 increased by $5.8 million, which was primarily attributable to the timing of the KUPI acquisition.~~

The Company sells its products to customers in various distribution channels. The table below presents the Company’s net sales to each distribution channel for the three months ended ~~December 31:~~September 30:

(In thousands) Customer Distribution Channel	December 31, 2016		December 31, 2015		September 30, 2017		September 30, 2016
Wholesaler/Distributor	$	129,585	$	92,704	$	120,801	$	124,925
Retail Chain	19,457		21,604		18,768		20,094
Mail-Order Pharmacy	13,878		10,480		11,801		11,477
Contract manufacturing revenue	8,024		2,271		3,591		5,063
Total	$	170,944	$	127,059	$	154,961	$	161,559

Net sales to wholesaler/distributor and ~~mail-order pharmacies increased primarily as a result of additional net sales of KUPI products due to the timing of the KUPI acquisition. Net sales to~~ retail chains decreased as a result of ~~strategic partnerships~~the overall decrease in net sales. Net sales within the ~~industry,~~various distribution channels remained consistent in ~~which retailers submit orders through~~ the ~~wholesalers.~~first quarter of Fiscal 2018 as compared to the prior-year period.

Cost of Sales, including amortization of intangibles. Cost of sales, including amortization of intangibles for the ~~second~~first quarter of Fiscal ~~2017~~Year 2018 increased ~~$27.5~~10% to $87.3 million ~~to $82.9 million.~~from $79.7 million in the same prior-year period. The increase was primarily attributable to ~~additional cost of~~changes in our product sales ~~from KUPI due to the timing of the acquisition.~~mix and increased product royalties, partially offset by lower amortization expense. Product royalties expense included in cost of sales totaled ~~$5.1~~$6.7 million for the ~~second~~first quarter of Fiscal Year ~~2017~~2018 and ~~$3.1~~$4.8 million for the ~~second~~first quarter of Fiscal Year ~~2016.~~2017. Amortization expense included in cost of sales totaled $7.7 million for the ~~second~~first quarter of Fiscal Year ~~2017~~2018 and ~~$3.6~~$8.9 million for the ~~second~~first quarter of Fiscal Year ~~2016.~~2017. The ~~increase~~decrease was primarily ~~reflected additional amortization~~due to a lower intangible assets base in the first quarter of ~~the acquired intangibles from the acquisition~~Fiscal 2018 as a result of ~~KUPI.~~impairment charges in Fiscal 2017.

Gross Profit. Gross profit for the ~~second~~first quarter of Fiscal ~~2017 increased 23%~~2018 decreased 17% to ~~$88.1~~$67.7 million or ~~52%~~44% of net sales. In comparison, gross profit for the ~~second~~first quarter of Fiscal ~~2016~~2017 was ~~$71.6~~$81.9 million or ~~56%~~51% of net sales. The decrease in gross profit percentage was primarily attributable to ~~the dilutive impact~~lower average selling price of ~~KUPI~~key products ~~additional amortization of intangibles,~~ as well as ~~depreciation of property, plant and equipment related to the acquisition of KUPI.~~additional product royalties.

Research and Development Expenses. Research and development expenses for the ~~second~~first quarter ~~increased 10%~~decreased 40% to ~~$9.9~~$7.4 million in Fiscal ~~2017~~Year 2018 from ~~$9.1~~$12.4 million in Fiscal ~~2016.~~Year 2017. The ~~increase was~~decrease is primarily due to ~~the timing of the KUPI acquisition, which resulted in additional research and development expenses. The increase was partially offset by~~ lower product development ~~expenses.~~expenses as well as decreased spend related to the C-Topical clinical trials.

Selling, General and Administrative Expenses. Selling, general and administrative expenses ~~increased 23%~~decreased 10% to ~~$18.1~~$19.0 million in the ~~second~~first quarter of Fiscal ~~2017~~Year 2018 compared with ~~$14.7~~$21.3 million in Fiscal ~~2016.~~Year 2017. The ~~increase was~~decrease is primarily ~~due to the timing of the KUPI acquisition, which resulted in additional selling, general and administrative expenses. Additional legal expenses also contributed to the increase.~~driven by lower incentive compensation-related costs.

The Company is focused on controlling operating expenses and has implemented its 2016 Restructuring Plan as noted above, however increases in personnel and other costs to facilitate enhancements in the Company’s infrastructure and expansion may continue to impact operating expenses in future periods.

Acquisition and Integration-related Expenses. Acquisition and integration-related expenses decreased ~~$16.6~~$1.4 million to $18 thousand for the first quarter of Fiscal Year 2018 as compared to the prior-year period. The decrease was due to ~~higher costs during~~ the ~~second quarter~~timing of ~~Fiscal 2016 associated with~~ the acquisition of ~~KUPI.~~Kremers Urban Pharmaceuticals Inc.

Restructuring Expenses. Restructuring expenses ~~increased $1.7~~decreased $1.5 million to $527 thousand for the first quarter of Fiscal Year 2018 compared to the prior-year period ~~as a result of implementing~~primarily due to higher employee separation costs incurred in connection with the 2016 Restructuring Program ~~on February 1,~~during the three months ended September 30, 2016.

~~Intangible Asset Impairment Charge.~~ In the second quarter of Fiscal 2017, the Company abandoned a project within KUPI’s in-process research and development portfolio. The value assigned to the project was $23.0 million. Accordingly, the Company recorded a $23.0 million impairment charge in the second quarter.

Other Income (Loss). Interest expense for the three months ended ~~December 31, 2016~~September 30, 2017 totaled ~~$23.3~~$20.9 million compared to ~~$11.8~~$23.0 million for the three months ended ~~December 31, 2015. Interest expense for~~September 30, 2016. The decrease was due to a lower weighted-average debt balance in the first quarter ~~ended December 31, 2015 included approximately one month~~ of ~~interest on the debt obligation used to finance the KUPI acquisition~~Fiscal 2018 as compared to the ~~three months ended December 31, 2016, which included a full quarter of interest expense.~~prior-year period. The weighted average interest rate for the ~~second~~first quarter of Fiscal 2018 and 2017 was ~~8.0%.~~8.3% and 7.8%, respectively. Investment income totaled $1.2 million in the first quarter of Fiscal 2018 compared with investment income of $1.0 million in the ~~second~~first quarter of Fiscal ~~2017 compared with $975 thousand in the second quarter of Fiscal 2016.~~2017.

Income Tax. The Company recorded income tax expense of $7.4 million in the ~~second~~first quarter of Fiscal ~~2017 of $3.5 million~~Year 2018 as compared to ~~$6.0~~an income tax benefit of $12.9 million in the ~~second~~first quarter of Fiscal Year 2017. The effective tax rate for the three months ended September 30, 2017 was 35.9%, compared to 30.5% for the three months ended September 30, 2016. The effective tax rate for the three months ended ~~December 31, 2016~~September 30, 2017 was ~~30.2%,~~higher compared to ~~30.6% for~~ the three months ended ~~December 31, 2015.~~September 30, 2016 primarily due to lower domestic manufacturing deductions relative to expected pre-tax income as well as the impact of excess tax shortfalls related to stock compensation.

Net ~~Income.~~Income (Loss). For the three months ended ~~December 31, 2016,~~September 30, 2017, the Company reported net income attributable to Lannett Company, Inc. of ~~$8.2~~$13.3 million, or ~~$0.22~~$0.35 per diluted share. Comparatively, net ~~income~~loss attributable to Lannett Company, Inc. in the corresponding prior-year period was ~~$13.5~~$29.4 million, or ~~$0.36 per diluted share.~~

~~Results of Operations - Six months ended December 31, 2016 compared with the six months ended December 31, 2015~~

Net sales increased 42% to $332.5 million for the six months ended December 31, 2016. The following table identifies the Company’s net product sales by medical indication for the six months ended December 31, 2016 and 2015:

(In thousands)

Six Months Ended December 31,

Medical Indication

2016

2015

Antibiotic

$
8,572

$
5,556

Anti Psychosis

32,685

3,472

Cardiovascular

24,669

21,385

Central Nervous System

20,904

6,077

Gallstone

26,308

38,691

Gastrointestinal

37,029

8,693

Glaucoma

11,095

13,365

Migraine

15,023

11,247

Muscle Relaxant

6,536

3,054

Obesity

1,795

1,830

Pain Management

14,047

16,207

Respiratory

5,170

1,396

Thyroid Deficiency

85,269

78,534

Urinary

9,794

3,593

Other

20,519

18,121

Contract manufacturing revenue

13,088

2,271

Total

$
332,503

$
233,492

The increase in net sales was primarily driven by additional sales of KUPI products of $87.9 million due to the timing of the acquisition as well as increased volumes of $7.6 million and increased product prices of $3.5 million. Although the Company has benefited in the past from favorable pricing trends, the trends are stabilizing and in, many instances, beginning to reverse. The level of competition in the marketplace is constantly changing and the Company cannot predict with certainty that these trends will continue.

Beginning in January 2017, a provision in the Bipartisan Budget Act of 2015 will require drug manufacturers to pay additional rebates to State Medicaid programs if the prices of their generic drugs rise at a rate faster than inflation. Based on our forecasted product sales mix, we expect the new provision to lower our future Medicaid-related net sales.

~~The following chart details price and volume changes by medical indication:~~

Medical indication

Sales volume
change %

Sales price
change %

Acquisition
change %

Antibiotic

53
%
2
%
—
%
Anti Psychosis

9
%
832
%
—
%
Cardiovascular

(20
)%
(29
)%
64
%
Central Nervous System

(26
)%
(23
)%
292
%
Gallstone

(21
)%
(11
)%
—
%
Gastrointestinal

(3
)%
(35
)%
365
%
Glaucoma

(5
)%
(12
)%
—
%
Migraine

48
%
(14
)%
—
%
Muscle Relaxant

251
%
(137
)%
—
%
Obesity

30
%
(32
)%
—
%
Pain Management

(4
)%
(9
)%
—
%
Respiratory

59
%
(76
)%
288
%
Thyroid Deficiency

10
%
(1
)%
—
%
Urinary

(27
)%
(41
)%
241
%

~~Anti Psychosis.~~ Net sales of drugs used for the treatment of anti psychosis increased by $29.2 million. The increase in net sales was primarily attributable to product price increases on key products, and to a lesser extent, increased volumes.

~~Cardiovascular.~~ Net sales of drugs used for cardiovascular treatment increased by $3.3 million. The increase was primarily due to additional sales of KUPI products due to the timing of the acquisition. The increase was partially offset by decreased volumes due to competition in the market for products used to treat congestive heart failure and price decreases on several key products.

~~Central Nervous System.~~ Net sales of central nervous system products increased by $14.8 million. The increase was primarily attributable to additional sales of Methylphenidate Hydrochloride Extended Release tablets in the six months ended December 31, 2016 as compared to the same prior-year period due to the timing of the KUPI acquisition. The increase was partially offset by decreased volumes and product price decreases.

~~Gallstone.~~ Net sales of drugs used for gallstones decreased by $12.4 million. The decrease in net sales was primarily attributable to decreased volumes as well as a decrease in the average selling price of key products.

~~Gastrointestinal.~~ Net sales of gastrointestinal products increased by $28.3 million. The increase in net sales was primarily attributable to additional sales of KUPI products in the six months ended December 31, 2016 as compared to the same prior-year period due to the timing of the KUPI acquisition. The increase was partially offset by product price decreases and decreased volumes.

~~Glaucoma.~~ Net sales of drugs used for the treatment of glaucoma decreased by $2.3 million. The decrease in net sales was primarily attributable to a decrease in the average selling price of key products as well as decreased volumes.

~~Pain Management.~~ Net sales of pain management products decreased $2.2 million. The decrease in net sales was mainly attributable to decreases on the average selling price of key products and, to a lesser extent, decreased volumes.

~~Respiratory.~~ Net sales of respiratory products increased by $3.8 million. The increase in net sales was primarily attributable to additional sales of KUPI products in the six months ended December 31, 2016 as compared to the same prior-year period due to the timing of the KUPI acquisition. Excluding the impact of the additional sales of KUPI products in the current period, net sales of respiratory products decreased slightly as a result of product price decreases, partially offset by increased volumes.

~~Thyroid Deficiency.~~ Net sales of drugs used for the treatment of thyroid deficiency increased by $6.7 million, primarily as a result of increased volumes, partially offset by a decrease in the average selling price of Levothyroxine.

~~Urinary.~~ Net sales of urinary products increased by $6.2 million. The increase in net sales was primarily attributable to additional sales of KUPI products in the six months ended December 31, 2016 as compared to the same prior-year period due to the timing of the KUPI acquisition. The increase was partially offset by product price decreases and decreased volumes due to increased competition.

~~Contract manufacturing revenue.~~ ~~Contract manufacturing revenue for the first six months of Fiscal 2017 increased by $10.8 million, which was primarily attributable to the timing of the KUPI acquisition.~~

The Company sells its products to customers in various distribution channels. The table below presents the Company’s net sales to each distribution channel for the six months ended December 31, 2016 and 2015:

(In thousands)
Customer Distribution Channel

December 31,
2016

December 31,
2015

Wholesaler/Distributor

$
254,510

$
173,168

Retail Chain

39,551

39,138

Mail-Order Pharmacy

25,355

18,915

Contract manufacturing revenue

13,087

2,271

Total

$
332,503

$
233,492

~~Net sales to wholesaler/distributor, retail chains and mail-order pharmacies increased primarily as a result of additional net sales related to the KUPI acquisition.~~

~~Cost of Sales, including amortization of intangibles.~~ Cost of sales, including amortization of intangibles for the first six months of Fiscal 2017 increased 93% to $162.6 million from $84.4 million in the same prior-year period. The increase was primarily attributable to additional cost of sales from KUPI due to the timing of the acquisition. Product royalties expense included in cost of sales totaled $9.9 million for the first six months of Fiscal Year 2017 and $4.3 million for the first six months of Fiscal Year 2016. Amortization expense included in cost of sales totaled $16.6 million for the first six months of Fiscal Year 2017 and $3.8 million for the first six months of Fiscal Year 2016. The increase primarily reflected additional amortization of the acquired intangibles from the acquisition of KUPI.

~~Gross Profit.~~ Gross profit for the first six months of Fiscal 2017 increased 14% to $169.9 million or 51% of net sales. In comparison, gross profit for the first six months of Fiscal 2016 was $149.1 million or 64% of net sales. The decrease in gross profit percentage was attributable to dilutive impact of KUPI products, additional amortization of intangibles, as well as amortization of inventory step-up and depreciation of property, plant and equipment related to the acquisition of KUPI.

~~Research and Development Expenses.~~ Research and development expenses for the first six months increased 43% to $22.3 million in Fiscal 2017 from $15.6 million in Fiscal 2016. The increase was primarily due to the timing of the KUPI acquisition, which resulted

~~in additional research and development expenses. Increased spending related to C-Topical clinical trials also contributed to the increase.~~

~~Selling, General and Administrative Expenses.~~ Selling, general and administrative expenses increased 30% to $39.3 million in the first six months of Fiscal 2017 compared with $30.2 million in Fiscal 2016. The increase was primarily due to the timing of the KUPI acquisition, which resulted in additional selling, general and administrative expenses. Increased headcount as well as additional legal and consulting costs also contributed to the increase.

~~Acquisition and Integration-related Expenses.~~ Acquisition and integration-related expenses decreased $19.1 million compared to the prior-year period. The decrease was due to higher costs during the first six months of Fiscal 2016 associated with the acquisition of KUPI.

~~Restructuring Expenses.~~ ~~Restructuring expenses increased $3.8 million compared to the prior-year period as a result of implementing the 2016 Restructuring Program on February 1, 2016.~~

~~Intangible Asset Impairment Charges.~~ On October 18, 2016, the Company received notice from the FDA that it will seek to withdraw approval of the Company’s ANDA for Methylphenidate ER. As a result of the notice, the Company performed an impairment analysis including a review of revised net sales projections for Methylphenidate ER. This analysis resulted in the Company recording a $65.1 million impairment charge in the first quarter of Fiscal 2017. Additionally, in the second quarter of Fiscal 2017, the Company abandoned a project within KUPI’s in-process research and development portfolio. The value assigned to the project was $23.0 million. Accordingly, the Company recorded a $23.0 million impairment charge in the second quarter.

~~Other Income (Loss).~~ Interest expense in the first six months of Fiscal 2017 totaled $46.3 million compared to $11.8 million in Fiscal 2016. Interest expense during the six months ended December 31, 2015 included approximately one month of interest on the debt obligation used to finance the KUPI acquisition as compared to the six months ended December 31, 2016, which included six months of interest expense. The weighted average interest rate for the first six months of Fiscal 2017 was 7.9%. Investment income in the first six months of Fiscal 2017 totaled $2.0 million compared to investment losses of $135 thousand in Fiscal 2016.

~~Income Tax.~~ The Company recorded an income tax benefit in the first six months of Fiscal 2017 of $9.3 million compared to income tax expense of $23.0 million in the first six months of Fiscal 2016. The effective tax rate for the six months ended December 31, 2016 was 30.6% compared to 33.0% for the six months ended December 31, 2015. The effective tax rate for the six months ended December 31, 2016 was lower compared to the six months ended December 31, 2015 primarily due to higher domestic manufacturing deductions and research and experimentation credits relative to expected annual pre-tax income, partially offset by the effect of changes in the Company’s state tax profile as result of the KUPI acquisition.

~~Net Income (Loss).~~ For the six months ended December 31, 2016, the Company reported net loss attributable to Lannett Company, Inc. of $21.2 million, or $0.58 per diluted share. Comparatively, net income attributable to Lannett Company, Inc. in the corresponding prior-year period was $46.7 million, or $1.25$0.80 per diluted share.

Liquidity and Capital Resources

Cash Flow

Until November 25, 2015, the date of the KUPI acquisition, the Company had historically financed its operations with cash flow generated from operations supplemented with borrowings from various government agencies and financial institutions. At ~~December 31, 2016,~~September 30, 2017, working capital was ~~$332.9~~$306.6 million as compared to ~~$306.1~~$302.6 million at June 30, ~~2016,~~2017, an increase of ~~$26.8~~$4.0 million. Current product portfolio sales as well as sales related to future product approvals are anticipated ~~to continue~~ to generate positive cash flow from operations, which we expect will be sufficient to service our outstanding debt.

Net cash ~~provided by~~used in operating activities of ~~$67.3~~$1.6 million for the ~~six~~three months ended ~~December 31, 2016~~September 30, 2017 reflected net ~~loss~~income of ~~$21.2~~$13.3 million, adjustments for non-cash items of ~~$104.9~~$24.5 million, as well as cash used by changes in operating assets and liabilities of ~~$16.4~~$39.4 million. In comparison, net cash provided by operating activities of ~~$61.6~~$36.4 million for the ~~six~~three months ended ~~December 31, 2015~~September 30, 2016 reflected net ~~income~~loss of ~~$46.7~~$29.4 million, adjustments for non-cash items of ~~$18.3~~$82.7 million, as well as cash used by changes in operating assets and liabilities of ~~$3.4~~$16.9 million.

Significant changes in operating assets and liabilities from June 30, ~~2016~~2017 to ~~December 31, 2016~~September 30, 2017 were comprised of:

· An increase in accounts receivable of ~~$17.2~~$39.3 million mainly due to increased sales as well as the timing of ~~collections during the quarter ended December 31, 2016 compared to the quarter ended June 30, 2016.~~collections. The Company’s days sales outstanding (“DSO”) at December 31, 2016, based on gross sales for the six months ended December 31, 2016 and gross accounts receivable at December 31, 2016 was 75 days. The level of DSO at December 31, 2016 was comparable to the Company’s expectations that DSO will be in the 70 to 80 day range based on customer payment terms.

· ~~An increase in inventories totaling $15.3 million primarily due to a decision to increase our inventory supply of certain key products in order to meet customer demands.~~

· ~~An increase in rebates payable of $14.9 million due to an increase in rebate-eligible sales to government programs as well as the timing of processed rebates~~

· ~~An increase in accounts payable totaling $9.1 million due to the timing of vendor payments.~~

~~Significant changes in operating assets and liabilities from June~~September 30, ~~2015 to December 31, 2015 were comprised of:~~

· A decrease in accounts receivable of $5.3 million mainly due to the timing of collections during the quarter ended December 31, 2015 compared to the quarter ended June 30, 2015. The Company’s days sales outstanding (“DSO”) at December 31, 2015,2017, based on gross sales for the three months ended ~~December 31, 2015~~September 30, 2017 and gross accounts receivable at ~~December 31, 2015,~~September 30, 2017, was 7276 days. The level of DSO at ~~December 31, 2014~~September 30, 2017 was comparable to the Company’s expectation that DSO will be in the 70 to 80 day range based on customer payment terms.

· An increase in ~~rebates payable of $5.2~~other assets totaling $6.3 million primarily due to anprepaid FDA user fees as well as additional loans issued to a company operating in the pharmaceutical business. See Note 13 “Commitments” for more information.

· An increase in ~~rebate eligible sales~~inventories totaling $2.8 million primarily due to ~~wholesalers as well an increase~~the timing of customer order fulfillment.

Significant changes in ~~Medicaid rebates.~~operating assets and liabilities from June 30, 2016 to September 30, 2016 were comprised of:

· A decrease in accounts receivable of $15.2 million mainly due to the timing of collections and a decrease in gross accounts receivable resulting from decreased sales partially offset by decreases in total revenue-related reserves. The Company’s days sales outstanding (“DSO”) at September 30, 2016, based on gross sales for the three months ended September 30, 2016 and gross accounts receivable at September 30, 2016, was 71 days. The level of DSO at September 30, 2016 was comparable to the Company’s expectation that DSO will be in the 70 to 80 day range based on customer payment terms.

· An increase in inventories totaling $12.8 million primarily due to the timing of customer order fulfillment.

· An increase in accounts payable ~~totaling $4.9~~of $9.3 million due to the timing of payments.

· An increase in prepaid income taxes ~~totaling $13.7 million. The amount was mainly~~of $22.3 million primarily due to estimated tax payments ~~partially offset by~~and current period tax ~~liabilities~~benefits associated with pre-tax ~~income~~losses for the ~~six~~three months ended ~~December 31, 2015.~~

· ~~A decrease in accrued payroll and payroll related costs of $7.1 million primarily related to payments made in August 2015 in connection with incentive compensation accrued in Fiscal Year 2015.~~September 30, 2016.

Net cash used in investing activities of ~~$17.4~~$10.1 million for the ~~six~~three months ended ~~December 31, 2016 is~~September 30, 2017, was mainly the result of purchases of investment securities ~~of $27.1~~totaling $23.8 million, ~~and~~ purchases of property, plant and equipment of ~~$21.3~~$12.1 million and the purchase of an intangible asset of $2.0 million, partially offset by proceeds from the sale of investment securities of ~~$31.0~~$27.8 million. Net cash used in investing activities of ~~$941.0~~$6.4 million for the ~~six~~three months ended ~~December 31, 2015 is~~September 30, 2016, was mainly the result of ~~the acquisition of KUPI totaling $929.6 million (net of cash acquired),~~ purchases of investment securities ~~of $22.2~~totaling $12.2 million and purchases of property, plant and equipment of ~~$10.6~~$9.9 million, partially offset by proceeds from the sale of investment securities of ~~$21.4~~$15.7 million.

Net cash used in financing activities of ~~$27.4~~$13.6 million for the ~~six~~three months ended ~~December 31,~~September 30, 2017 was primarily due to debt repayments of $13.3 million and purchases of treasury stock totaling $612 thousand, partially offset by proceeds from issuance of stock pursuant to stock compensation plans of $314 thousand. Net cash used in financing activities of $13.1 million for the three months ended September 30, 2016 was primarily due to debt repayments of ~~$26.6~~$13.3 million and purchases of treasury stock totaling $1.8 ~~million and purchase of the noncontrolling interest in Realty of $1.5~~ million, partially offset by proceeds from issuance of stock pursuant to stock compensation plans of ~~$1.8~~$1.4 million and excess tax benefits on share-based compensation awards of ~~$705~~$644 thousand. Net cash provided by financing activities of $857.9 million for the six months ended December 31, 2015 was primarily due to proceeds from the issuance of debt totaling $910.6 million, proceeds from issuance of stock pursuant to stock compensation plans of $2.7 million and excess tax benefits on stock option exercises of $1.0 million, partially offset by payments of debt issuance costs totaling $32.7 million, debt repayments of $22.8 million and purchases of treasury stock totaling $908 thousand.

Credit Facility and Other Indebtedness

The Company has previously entered into and may enter future agreements with various government agencies and financial institutions to provide additional cash to help finance the Company’s acquisitions, various capital investments and potential strategic opportunities. These borrowing arrangements as of ~~December 31, 2016~~September 30, 2017 are as follows:

Amended Senior Secured Credit Facility

On November 25, 2015, in connection with its acquisition of KUPI, Lannett entered into a credit and guaranty agreement (the “Credit and Guaranty Agreement”) among certain of its wholly-owned domestic subsidiaries, as guarantors, Morgan Stanley Senior Funding, Inc., as administrative agent and collateral agent and other lenders providing for a senior secured credit facility (the “Senior Secured Credit Facility”). The Senior Secured Credit Facility consisted of Term Loan A in an aggregate principal amount of $275.0 million, Term Loan B in an aggregate principal amount of $635.0 million and a revolving credit facility providing for revolving loans in an aggregate principal amount of up to $125.0 million. On April 8, 2016, the Company drew down the full $125.0 million Revolving Credit Facility for working capital and other general purposes. The entire balance of the Revolving Credit Facility loan is outstanding as of December 31, 2016.

On June 17, 2016, Lannett amended the Senior Secured Credit Facility and the Credit and Guaranty Agreement to raise an incremental term loan in the principal amount of $150.0 million (the “Incremental Term Loan”) and amended certain sections of the agreement (the “Amended Senior Secured Credit Facility”). The terms of this Incremental Term Loan are substantially the same as those applicable to the Term Loan B. The Company used the proceeds of the Incremental Term Loan and cash on hand to repurchase the outstanding $250.0 million aggregate principal amount of Lannett’s 12.0% Senior Notes due 2023 (the “Senior Notes”) issued in connection with the KUPI acquisition.

~~The Term Loan A Facility will mature~~Refer to the Company’s Form 10-K for the fiscal year ended June 30, 2017 for further details on ~~November 25, 2020. The Term Loan A Facility amortizes in quarterly installments (a) through December 31, 2017 in amounts equal to 1.25% of~~ the original principal amount of the Term Loan A Facility and (b) from January 1, 2018 through September 30, 2020 in amounts equal to 2.50% of the original principal amount of the Term Loan A Facility, with the balance payable on November 25, 2020. The Term Loan B Facility will mature on November 25, 2022. The Term Loan B Facility amortizes in equal quarterly installments in amounts equal to 1.25% of the original principal amount of the Term Loan B Facility with the balance payable on November 25, 2022. Any outstanding Revolving Loans will mature on November 25, 2020.

~~The~~ Amended Senior Secured Credit Facility is guaranteed by all of Lannett’s significant wholly-owned domestic subsidiaries (the “Subsidiary Guarantors”) and is collateralized by substantially all present and future assets of Lannett and the Subsidiary Guarantors. The interest rates applicable to the Amended Term Loan Facility are based on a fluctuating rate of interest of the greater of an adjusted LIBOR and 1.00%, plus a borrowing margin of 4.75% (for Term Loan A Facility) or 5.375% (for Term Loan B Facility). The interest rates applicable to the Revolving Credit Facility is based on a fluctuating rate of interest of an adjusted LIBOR plus a borrowing margin of 4.75%. The interest rate applicable to the unused commitment for the Revolving Credit Facility was initially 0.50%. Beginning March 2016, the interest margins and unused commitment fee on the Revolving Credit Facility are subject to a leveraged based pricing grid.Facility.

~~The Amended Senior Secured Credit Facility also contains certain affirmative covenants, including financial and other reporting requirements.~~

Cody Mortgage

Realty owns land and a building which is being leased to Cody Labs. ARealty has a mortgage loan with the First National Bank of Cody ~~has been consolidated in the Company’s financial statements, along with the~~ related to its land and building. As of ~~December 31, 2016~~September 30, 2017 and June 30, ~~2016,~~2017, the effective rate was 4.5% per annum. The mortgage is collateralized by the land and building with a net book value of $1.4 million. As of ~~December 31, 2016, $804~~September 30, 2017, $699 thousand is outstanding under the mortgage loan, of which ~~$144~~$149 thousand is classified as currently due.

Other Liquidity Matters

Material Suppliers

During the renewal term of the JSP Distribution Agreement, the Company is required to use commercially reasonable efforts to purchase minimum dollar quantities of JSP products. There is no guarantee that the Company will continue to meet the minimum purchase requirement for Fiscal ~~2017~~2018 and thereafter. If the Company does not meet the minimum purchase requirements, JSP’s sole remedy is to terminate the agreement.

Cody Expansion

OnIn January ~~26,~~ 2017, the Company announced ~~that it will launch~~ a ~~$50.0~~$50 million expansion plan in conjunction with Forward Cody to expand operations in Cody, WY. The project is expected to be completed by the middle of ~~its Cody Labs facilities.~~Fiscal 2020.

Future Acquisitions

We are continuously evaluating the potential for product and company acquisitions as a part of our future growth strategy. In conjunction with a potential acquisition, the Company may utilize current resources or seek additional sources of capital to finance any such acquisition, which could have an impact on future liquidity.

We may also from time to time depending on market conditions and prices, contractual restrictions, our financial liquidity and other factors, seek to prepay outstanding debt or repurchase our outstanding debt through open market purchases, privately negotiated purchases, or otherwise. The amounts involved in any such transactions, individually or in the aggregate, may be material and may be funded from available cash or from additional borrowings.

Research and Development Arrangements

In the normal course of business, the Company has entered into certain research and development and other arrangements. As part of these arrangements, the Company has agreed to certain contingent payments which generally become due and payable only upon the achievement of certain developmental, regulatory, commercial and/or other milestones. In addition, under certain arrangements, we may be required to make royalty payments based on a percentage of future sales, or other metric, for products currently in development in the event that the Company begins to market and sell the product. Due to the inherent uncertainty related to these developmental, regulatory, commercial and/or other milestones, it is unclear if the Company will ever be required to make such payments.

~~Prospects for the Future~~

Over the last several years, we have grown to be a formidable generic drug company. We have earned the respect of our customers by our continuous growth in product offerings and our extraordinary service as a reliable supplier. The Company’s strong regulatory record and the ability to respond to our customers’ needs make our Company a desirable supplier. In 2016, we once again won the prestigious Diana Award for Best Generic Manufacturer from the Healthcare Distribution Alliance.

Over the past several years, Lannett continued to experience substantial improvement in many important financial metrics. Each year, our knowledge, staffs’ skills and talent increase. The Company is strengthening and building momentum to grow within the generic pharmaceutical industry organically and through mergers and acquisitions. The recently completed acquisitions of Silarx and KUPI demonstrates our ability to grow through M&A.

One initiative at the core of the Company’s long term strategy is our plan to vertically integrate our supply chain. Acquired in 2007 we continue leveraging Cody Labs. In July 2008, the DEA granted Cody Labs a license to directly import concentrated poppy straw for extraction into opioid-based active pharmaceutical ingredients (“APIs”) such as Morphine Base, Hydromorphone, Hydrocodone and Oxycodone, for use in various dosage forms for pain management. The value of this license comes from the successful development of patentable processes. Cody Labs has filed and received numerous patents using their expertise in API development and manufacture. Our technical skills allow the Company to perform in a market with high barriers to entry and limited foreign and domestic competition.

Because of this vertical integration, the Company has direct control of those APIs manufactured by Cody. In this fashion we can avoid increased costs, add to the Company’s overall margins and avoid supply chain interruptions associated with buying APIs from third-party manufacturers. The Company can also leverage this vertical integration not only for direct supply of opioid-based APIs, but also for the manufacture of non-opioid-based controlled drugs such as Cocaine HCl.

The Company believes that demand for controlled substances and pain management drugs, having grown from $3 billion in 2005 to over $31 billion today, will continue based upon the “Baby Boomer” demographics. By concentrating additional resources in the development of opioid-based APIs and dosage forms, the Company is well-positioned to take advantage of this opportunity. The Company is currently vertically integrated on three products, with several others in various stages of development.

One product that the Company manufactures is a brand drug for use in surgery. Our C-Topical® Solution brand of cocaine hydrochloride involves the successful patented synthetic process developed by Cody. This product is being manufactured and marketed under the product name C-Topical® Solution. This product is an analgesic topical solution, with vasoconstriction as a side effect, for use primarily by ear, nose and throat physicians during surgical procedures. This product represents the Company’s first foray into the brand market. Currently, we have completed the Phase III study and our CRO is assembling the data for our New Drug Application. As the Company continues to invest in and focus on process and manufacturing optimization, Cody Labs will continue to be an important part of our future growth plan.

Selling brand versus generic products require a dedicated sales force to detail and educate physicians on the product. The Company strongly believes that C-Topical®, once FDA has granted approval, will be an important contributor to total revenue, with higher than average profit margins as a result of vertical integration. The Company’s strategic goal is to continue investing in controlled substance product development. Revenues from manufactured products derived from controlled substances carry higher-than-average gross margins.

In addition to focusing on the development and manufacture of opioid-based APIs and dosage forms, the Company has made a decision to develop products which require a paragraph four (“P-IV”) certification when filing the ANDA. A P-IV certification is required when an ANDA is submitted for a product for which the innovator’s patent has not yet expired. The certification must state whether the patent on the reference listed drug (“RLD”) is being challenged on grounds of it being invalid, or if the patent is being circumvented. This path to product approval represents an opportunity for our Company, because we do not have to wait until a particular patent expires to potentially enter the market. Secondly, if our Company is the first-to-file a P-IV certification on a product and we successfully invalidate or circumvent the patent, the FDA may grant 180 days of market exclusivity. This allows us to be the sole competitor to the brand currently on the market for six months unless the innovator company sells an authorized generic. During this market exclusivity period, we could capture a significant portion of the market from the brand company at reasonably higher prices than our older products.

The Company filed its first ANDA with a P-IV certification in Fiscal 2013. As of December 31, 2016, we have 11 P-IV certifications pending with the FDA. Two of the P-IV certifications are currently being challenged. In response to our P-IV certification with respect to the Zomig® nasal spray product, AstraZeneca AB, AstraZeneca UK Limited and Impax Laboratories, Inc. filed two patent infringement complaints against the Company in July 2014. In response to our P-IV certification with respect to Thalomid®, Celgene Corporation and Children’s Medical Center Corporation filed a patent infringement lawsuit against the Company in January 2015. Refer to Note 13 “Legal, Regulatory Matters and Contingencies” for additional information.

The Company has a business development group focused on mergers, acquisitions and other strategic alliances. The Company is party to supply and development agreements with JSP, Summit Bioscience LLC, HEC Pharm Group, Pharma Pass II LLC and various other international and domestic companies. The Company is currently in negotiations of similar agreements with other companies and is actively seeking additional strategic partnerships, through which it will market and distribute products manufactured in-house or by third parties. The Company plans to continue evaluating potential merger and acquisition opportunities as well as product acquisitions that are a strategic fit and accretive to the business.

After we closed upon the KUPI acquisition, we established a very aggressive integration plan. We are pleased to say that our integration plans are moving swiftly and we will be benefitting from the synergies created through integration.

We are pleased to announce that the FDA inspected our overseas pharmacokinetic subsidiary Darmantest Laboratory as well as Firmplace, a joint venture stability lab this fall. Both Darmantest and Firmplace passed inspection. These operations may affect lower cost benefits for stability and bioequivalency studies in the future.

Critical Accounting Policies

The preparation of our consolidated financial statements in accordance with accounting principles generally accepted in the United States and the rules and regulations of the U.S. Securities & Exchange Commission requires the use of estimates and assumptions. A listing of the Company’s significant accounting policies are detailed in Note 3 “Summary of Significant Accounting Policies.” A subsection of these accounting policies have been identified by management as “Critical Accounting Policies.” Critical accounting policies are those which require management to make estimates using assumptions that were uncertain at the time the estimates were made and for which the use of different assumptions, which reasonably could have been used, could have a material impact on the financial condition or results of operations.

Management has identified the following as “Critical Accounting Policies”: Revenue Recognition, Inventories, Income Taxes, Valuation of Long-Lived Assets, including Goodwill and Intangible Assets, In-Process Research and Development and Share-based Compensation.

Revenue Recognition

The Company recognizes revenue when title and risk of loss have transferred to the customer and provisions for estimates, including rebates, promotional adjustments, price adjustments, returns, chargebacks and other potential adjustments are reasonably determinable. The Company also considers all other relevant criteria specified in Securities and Exchange Commission Staff Accounting Bulletin No. 104, Topic No. 13, “Revenue Recognition,” in determining when to recognize revenue.

When revenue is recognized, a simultaneous adjustment to gross sales is made for chargebacks, rebates, returns, promotional adjustments and other potential adjustments. These provisions are primarily estimated based on historical experience, future expectations, contractual arrangements with wholesalers and indirect customers and other factors known to management at the time of accrual. Accruals for provisions are presented in the Consolidated Financial Statements as a reduction to gross sales with the corresponding reserve presented as a reduction of accounts receivable or included as rebates payable. The reserves presented as a reduction of accounts receivable totaled ~~$179.3~~$184.1 million and ~~$176.1~~$175.8 million at ~~December 31, 2016~~September 30, 2017 and June 30, ~~2016,~~2017, respectively. Rebates payable at ~~December 31, 2016~~September 30, 2017 and June 30, ~~2016 were $36.8~~2017 totaled $47.3 million and ~~$21.9~~$44.6 million, respectively, for certain rebate programs, primarily related to Medicare Part D, Medicaid and certain sales allowances and other adjustments paid to indirect customers.

The following table identifies the activity and ending balances of each major category of ~~revenue~~revenue-related reserve for the ~~six~~three months ended ~~December 31, 2016~~September 30, 2017 and ~~2015:~~2016:

Reserve Category (In thousands)	Chargebacks			Rebates			Returns			Other			Total			Chargebacks			Rebates			Returns			Other			Total
Balance at June 30, 2016	$	86,495		$	54,084		$	40,593		$	16,851		$	198,023
Additions related to an acquisition	—			8,329			5,955			—			14,284
Balance at June 30, 2017																$	79,537		$	87,616		$	42,135		$	11,096		$	220,384
Current period provision	416,212			143,016			14,728			29,307			603,263			254,689			78,455			10,437			12,364			355,945
Credits issued during the period	(420,422		)	(129,583		)	(16,668		)	(32,829		)	(599,502		)	(254,952		)	(73,422		)	(7,151		)	(9,403		)	(344,928		)
Balance at December 31, 2016	$	82,285		$	75,846		$	44,608		$	13,329		$	216,068
Balance at September 30, 2017																$	79,274		$	92,649		$	45,421		$	14,057		$	231,401

Reserve Category
(In thousands)

Chargebacks

Rebates

Returns

Other

Total

Balance at June 30, 2015

$
35,801

$
20,498

$
19,209

$
1,528

$
77,036

Additions related to an acquisition

44,366

34,474

15,691

7,386

101,917

Current period provision

239,637

70,179

10,844

15,257

335,917

Credits issued during the period

(233,846
)
(66,500
)
(7,572
)
(14,606
)
(322,524
)
Balance at December 31, 2015

$
85,958

$
58,651

$
38,172

$
9,565

$
192,346

Reserve Category (In thousands)	Chargebacks			Rebates			Returns			Other			Total
Balance at June 30, 2016	$	86,495		$	54,084		$	40,593		$	16,851		$	198,023
Measurement-period adjustments	—			—			5,955			—			5,955
Current period provision	198,500			69,486			6,847			15,454			290,287
Credits issued during the period	(212,649		)	(69,028		)	(5,531		)	(20,773		)	(307,981		)
Balance at September 30, 2016	$	72,346		$	54,542		$	47,864		$	11,532		$	186,284

For the three months ending ~~December 31,~~September 30, 2017 and 2016, ~~and 2015,~~ as a percentage of gross sales the provision for chargebacks was ~~45.7%~~50.2% and ~~45.2%~~44.4%, the provision for rebates was 15.5% and ~~12.7%~~15.6%, the provision for returns was ~~1.7%~~2.1% and ~~2.1%,~~1.5% and the provision for other adjustments was ~~2.9%~~2.4% and ~~2.7%, respectively.~~

For the six months ending December 31, 2016 and 2015, as a percentage of gross sales the provision for chargebacks was 45.1% and 42.3%, the provision for rebates was 15.5% and 12.4%, the provision for returns was 1.6% and 1.9%, and the provision for other adjustments was 3.2% and 2.7%3.5%, respectively.

The increase in total reserves from June 30, ~~2016~~2017 to ~~December 31, 2016~~September 30, 2017 was ~~mainly~~primarily due to ~~an increase~~increased net sales in ~~rebates reserve for potential liabilities for overcharges~~the first quarter of Fiscal 2018 as compared to ~~a government entity as well as additional sales incentives.~~the fourth quarter of Fiscal 2017. The activity in the “Other” category for the ~~six~~three months ended ~~December 31,~~September 30, 2017 and 2016 ~~and 2015~~ includes, shelf-stock, shipping and other sales adjustments including prompt payment discounts. ~~In the first quarter of Fiscal 2017, the Company recorded a $6.0 million measurement-period adjustment to the Returns reserve acquired in the KUPI acquisition.~~ In the second quarter of Fiscal 2017, the Company recorded a $8.3 million adjustment to the Rebates reserve for potential overcharges to a government entity related to the KUPI acquisition. The amount is fully indemnified per the Stock Purchase Agreement as discussed in Note 13. “Legal, Regulatory Matters and Contingencies.” Historically, we have not recorded any material amounts in the current period related to reversals or additions of prior period reserves. If the Company were to record a material reversal or addition of any prior period reserve amount, it would be separately disclosed.

Provisions for chargebacks, rebates, returns and other adjustments require varying degrees of subjectivity. While rebates generally are based on contractual terms and require minimal estimation, chargebacks and returns require management to make more subjective assumptions. Each major category is discussed in detail below:

~~Chargebacks~~

The provision for chargebacks is the most significant and complex estimate used in the recognition of revenue. The Company sells its products directly to wholesale distributors, generic distributors, retail pharmacy chains and mail-order pharmacies. The Company also sells its products indirectly to independent pharmacies, managed care organizations, hospitals, nursing homes and group purchasing organizations, collectively referred to as “indirect customers.” The Company enters into agreements with its indirect customers to establish pricing for certain products. The indirect customers then independently select a wholesaler from which to purchase the products. If the price paid by the indirect customers is lower than the price paid by the wholesaler, the Company will provide a credit, called a chargeback, to the wholesaler for the difference between the contractual price with the indirect customers and the wholesaler purchase price. The provision for chargebacks is based on expected sell-through levels by the Company’s wholesale customers to the indirect customers and estimated wholesaler inventory levels. As sales to the large wholesale customers, such as Cardinal Health, AmerisourceBergen and McKesson increase (decrease), the reserve for chargebacks will also generally increase (decrease). However, the size of the increase (decrease) depends on product mix and the amount of sales made to indirect customers with which the Company has specific chargeback agreements. The Company continually monitors the reserve for chargebacks and makes adjustments when management believes that expected chargebacks may differ from the actual chargeback reserve.

~~Rebates~~

~~Rebates are offered~~Refer to the Company’s key chain drug store, distributor and wholesaler customers to promote customer loyalty and increase product sales. These rebate programs provide customers with credits upon attainment of pre-established volumes or attainment of net sales milestonesForm 10-K for the fiscal year ended June 30, 2017 for a specified period. Other promotional programs are incentive programs offered to the customers. Additionally, as a result of the Patient Protection and Affordable Care Act (“PPACA”) enacted in the U.S. in March 2010, the Company participates in a new cost-sharing program for certain Medicare Part D beneficiaries designed primarily for the sale of brand drugs and certain generic drugs if their FDA approval was granted under a New Drug Application (“NDA”) or 505(b) NDA versus an ANDA. Because our drugs used for the treatment of thyroid deficiency and our Morphine Sulfate Oral Solution product were both approved by the FDA as 505(b)(2) NDAs, they are considered “brand” drugs for purposes of the PPACA. Drugs purchased within the Medicare Part D coverage gap (commonly referred to as the “donut hole”) result in additional rebates. The Company estimates the reserve for rebates and other promotional credit programs based on the specific terms in each agreement when revenue is recognized. The reserve for rebates increases (decreases) as sales to certain wholesale and retail customers increase (decrease). However, since these rebate programs are not identical for all customers, the size of the reserve will depend on the mix of sales to customers that are eligible to receive rebates.

~~Returns~~

Consistent with industry practice, the Company has a product returns policy that allows customers to return product within a specified time period prior to and subsequent to the product’s expiration date in exchange for a credit to be applied to future purchases. The Company’s policy requires that the customer obtain pre-approval from the Company for any qualifying return. The Company estimates its provision for returns based on historical experience, changes to business practices, credit terms and any extenuating circumstances known to management. While historical experience has allowed for reasonable estimations in the past, future returns may or may not follow historical trends. The Company continually monitors the reserve for returns and makes adjustments when management believes that actual product returns may differ from the established reserve. Generally, the reserve for returns increases as net sales increase.

~~Other Adjustments~~

Other adjustments consist primarily of price adjustments, also known as “shelf-stock adjustments” and “price protections,” which are both credits issued to reflect increases or decreases in the invoice or contract prices of the Company’s products. In the case of a price decrease, a credit is given for product remaining in customer’s inventories at the time of the price reduction. Contractual price protection results in a similar credit when the invoice or contract prices of the Company’s products increase, effectively allowing customers to purchase products at previous prices for a specified period of time. Amounts recorded for estimated shelf-stock adjustments and price protections are based upon specified terms with direct customers, estimated changes in market prices and estimates of inventory held by customers. The Company regularly monitors these and other factors and evaluates the reserve as additional information becomes available. Other adjustments also include prompt payment discounts.

~~Inventories~~

Inventories are stated at the lower of cost or market determined by the first-in, first-out method. Inventories are regularly reviewed and provisions for excess and obsolete inventory are recorded based primarily on current inventory levels and estimated sales forecasts. During the three months ended December 31, 2016 and 2015, the Company recorded provisions for excess and obsolete inventory of $2.1 million and $1.6 million, respectively. During the six months ended December 31, 2016 and 2015, the Company recorded provisions for excess and obsolete inventory of $5.4 million and $2.8 million, respectively.

~~Income Taxes~~

The Company uses an asset and liability approach to account for income taxes as prescribed by ASC 740, Income Taxes. Deferred taxes are recorded to reflect the tax consequences on future years of events that the Company has already recognized in the financial statement or tax returns. Deferred income tax assets and liabilities are adjusted to recognize the effect of changes in tax law or tax rates in the period during which the new law is enacted. Under ASC 740, Income Taxes, a valuation allowance is required when it is more likely than not that all or some portion of the deferred tax assets will not be realized through generating sufficient future taxable income. Failure to achieve forecasted taxable income in applicable tax jurisdictions could affect the ultimate realization of deferred tax assets and could result in an increase in the Company’s effective tax rate on future earnings.

The Company may recognize the tax benefit from an uncertain tax position claimed on a tax return only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. The benefit from uncertain tax positions recorded in the financial statements was immaterial for all period presented.

The Company’s future effective income tax rate is highly reliant on future projections of taxable income, tax legislation, and potential tax planning strategies. A change in any of these factors could materially affect the effective income tax rate of the Company in future periods.

~~Business Combinations~~

Acquired businesses are accounted for using the acquisition method of accounting, which requires that the assets acquired and liabilities assumed be recorded at the date of acquisition at their respective estimated fair values. The fair values and useful lives assigned to each class of assets acquired and liabilities assumed are based on, among other factors, the expected future period of benefit of the asset, the various characteristics of the asset and projected future cash flows. Significant judgment is employed in determining the assumptions utilized as of the acquisition date and for each subsequent measurement period. Accordingly, changes in assumptions described above, could have a material impact on our consolidated results of operations.

~~Valuation of Long-Lived Assets, including Goodwill and Intangible Assets~~

~~The Company’s long-lived assets primarily consist of property, plant and equipment, definite and indefinite-lived intangible assets and goodwill .~~

Property, plant and equipment are stated at cost less accumulated depreciation. Depreciation is computed on a straight-line basis over the assets’ estimated useful lives, generally for periods ranging from 5 to 39 years. Definite-lived intangible assets are stated at cost less accumulated amortization and are amortized on a straight-line basis over the assets’ estimated useful lives, generally for periods ranging from 10 to 15 years. The Company continually evaluates the reasonableness of the useful lives of these assets.

Property, plant and equipment and definite-lived intangible assets are reviewed for impairment whenever events or changes in circumstances (“triggering events”) indicate that the carrying amount of the asset may not be recoverable. The nature and timing of triggering events by their very nature are unpredictable; however, management regularly considers the performance of an asset as compared to its expectations, industry events, industry and economic trends, as well as any other relevant information known to management when determining if a triggering event occurred. If a triggering event is determined to have occurred, the first step in the impairment test is to compare the asset’s carrying value to the undiscounted cash flows expected to be generated by the asset. If the carrying value exceeds the undiscounted cash flow of the asset, then an impairment exists. An impairment loss is measured as the excess of the asset’s carrying value over its fair value, which in most cases is calculated using a discounted cash flow model. Discounted cash flow models are highly reliant on various assumptions which are considered Level 3 inputs, including estimates of future cash flows (including long-term growth rates), discount rates and the probability of achieving the estimated cash flows. The judgments made in determining the estimated fair value can materially impact our results of operations. There can be no assurances as to when, or if, future impairments may occur.

Goodwill and indefinite-lived intangible assets, including in-process research and development, are not amortized. Instead, goodwill and indefinite-lived intangible assets are tested for impairment annually during the fourth quarter of each fiscal year, or more frequently whenever events or changes in circumstances (“triggering events”) indicate that the asset might be impaired. The Company first performs a qualitative assessment to determine if the quantitative impairment test is required. If changes in circumstances indicate an asset may be impaired, the Company performs the quantitative test. The quantitative impairment test consists of a Step I analysis that requires a comparison between the reporting unit’s fair value and carrying amount. If the fair value of the reporting unit exceeds its carrying amount, impairment does not exist and no further analysis is required. A Step II analysis would be required if the fair value of the reporting unit is lower than its carrying amount. If the carrying amount of a reporting unit exceeds the fair value, Step II of the quantitative impairment test requires the allocation of the reporting unit fair value to all of its assets and liabilities using the acquisition method prescribed under authoritative guidance for business combinations with any residual fair value being allocated to goodwill or indefinite-lived intangibles. An impairment charge is recognized only when the implied fair value of the reporting unit’s goodwill or indefinite-lived intangible is less than its carrying amount. The Company’s fair value assessments are highly reliant on various assumptions which are considered Level 3 inputs, including estimates of future cash flows (including long-term growth rates), discount rates and the probability of achieving the estimated cash flows. The judgments made in determining the estimated fair value of goodwill and indefinite-lived intangible asset can materially impact our results of operations. There can be no assurances as to when, or if, future impairments may occur. The Company has one reportable segment and one reporting unit, generic pharmaceuticals.

~~In-Process Research and Development~~

Acquired businesses are accounted for using the acquisition method of accounting. The acquisition purchase price is allocated to the net assets of the acquired business at their respective fair values. Amounts allocated to in-process research and development are recorded at fair value and are considered indefinite-lived intangible assets subject to the impairment testing in accordance with the Company’s impairment testing policy for indefinite-lived intangible assets as described above. As products in development are approved for sale, amounts will be allocated to product rights and will be amortized over their estimated useful lives. Definite-lived intangible assets are amortized over the expected life of the asset. The Company’s fair value assessments are highly reliant on various assumptions which are considered Level 3 inputs, including estimates of future cash flows (including long-term growth rates), discount rates and the probability of achieving the estimated cash flows. The judgments made in determining the estimated fair value of in-process research and development, as well as asset lives, can materially impact our results of operations. There can be no assurances as to when, or if, future impairments may occur.

~~Share-~~~~based Compensation~~

Share-based compensation costs are recognized over the vesting period, using a straight-line method, based on the fair value of the instrument on the date of grant less an estimate for expected forfeitures. The Company uses the Black-Scholes valuation model to determine the fair value of stock options and the market price on the grant date to value restricted stock. The Black-Scholes valuation model includes various assumptions, including the expected volatility, the expected life of the award, dividend yield and the risk-free interest rate. These assumptions involve inherent uncertainties based on market conditions which are generally outside the Company’s control. Changes in these assumptions could have a material impact on share-based compensation costs recognized in the financial statements.

The following table presents the weighted average assumptions used to estimate fair values of the stock options granted during the six months ended December 31, 2016 and 2015 and the estimated annual forfeiture rates used to recognize the associated compensation expense:

Six Months Ended

December 31,
2016

December 31,
2015

Risk-free interest rate

1.1
%
1.7
%
Expected volatility

55.6
%
48.3
%
Expected dividend yield

0.0
%
0.0
%
Forfeiture rate

6.5
%
6.5
%
Expected term

5.2 years

5.2 years

~~Expected volatility is based on the historical volatility of the price~~description of our common shares during the historical period equal to the expected term of the option. The Company uses historical information to estimate the expected term, which represents the period of time that options granted are expected to be outstanding. The risk-free rate for the period equal to the expected life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The forfeiture rate assumption is the estimated annual rate at which unvested awards are expected to be forfeited during the vesting period. This assumption is based on our actual forfeiture rate on historical awards. Periodically, management will assess whether it is necessary to adjust the estimated rate to reflect changes in actual forfeitures or changes in expectations. Additionally, the expected dividend yield is equal to zero, as the Company has not historically issued and has no immediate plans to issue, a dividend.

~~Recent~~remaining Critical Accounting ~~Pronouncements~~Policies.

~~In May 2014, the FASB issued ASU 2014-09,~~ ~~Revenue from Contracts with Customers~~. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The authoritative guidance is effective for annual reporting periods beginning after December 15, 2017. The Company is continuing to assess the impact this guidance will have on the consolidated financial statements.

~~In July 2015, the FASB issued ASU 2015-11,~~ ~~Inventory — Simplifying the Measurement of Inventory~~. ASU 2015-11 requires inventory to be subsequently measured using the lower of cost and net realizable value, thereby eliminating the market value approach. Net realizable value is defined as the “estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation.” ASU 2015-11 is effective for reporting periods beginning after December 15, 2016 and is applied prospectively. Early adoption is permitted. The Company does not believe this guidance will have a material impact on the consolidated financial statements.

~~In November 2015, the FASB issued ASU 2015-17,~~ ~~Income Taxes — Balance Sheet Classification of Deferred Taxes.~~ ASU 2015-17 requires all deferred tax assets and liabilities to be classified as noncurrent on the balance sheet. The guidance may be applied either prospectively or retrospectively. ASU 2015-17 is effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2016. Early adoption is permitted. The Company does not believe this guidance will have a material impact on the consolidated financial statements.

~~In February 2016, the FASB issued ASU 2016-02,~~ ~~Leases.~~ ASU 2016-02 requires an entity to recognize right-of-use assets and liabilities on its balance sheet for all leases with terms longer than 12 months. Lessees and lessors are required to disclose quantitative and qualitative information about leasing arrangements to enable a user of the financial statements to assess the amount, timing and uncertainty of cash flows arising from leases. ASU 2016-02 is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period and requires a modified retrospective application, with early adoption permitted. The Company is currently in the process of assessing the impact this guidance will have on the consolidated financial statements.

~~In August 2016, the FASB issued ASU 2016-15,~~ ~~Statement of Cash Flows — Classification of Certain Cash Receipts and Cash Payments.~~ ASU 2016-15 addresses how certain cash receipts and cash payments are presented and classified in the statement of cash flows. ASU 2016-15 is effective for annual reporting periods, and interim periods therein, beginning after December 15, 2017. The Company is currently in the process of assessing the impact this guidance will have on the consolidated financial statements.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

On November 25, 2015, in connection with the acquisition of KUPI, the Company entered into a Senior Secured Credit Facility, which was subsequently amended in June 2016. Based on the variable-rate debt outstanding at ~~December 31, 2016,~~September 30, 2017, each 1/8% increase in interest rates would yield ~~$1.4~~$1.2 million of incremental annual interest expense.

A mortgage loan with First National Bank of Cody has been consolidated in the Company’s financial statements, along with the related land and building. The mortgage requires monthly principal and interest payments of $15 thousand. As of ~~December 31, 2016~~September 30, 2017 and June 30, ~~2016,~~2017, the effective interest rate was 4.5% per annum. The mortgage is collateralized by the land and building with a net book value of $1.4 million. As of ~~December 31, 2016, $804~~September 30, 2017, $699 thousand is outstanding under the mortgage loan.

The Company invests in equity securities, U.S. government agency securities and corporate bonds, which are exposed to market and interest rate fluctuations. The market value, interest and dividends earned on these investments may vary based on fluctuations in interest rate and market conditions.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this Form 10-Q, management performed, with the participation of our Chief Executive Officer and Chief Financial Officer, an evaluation of the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Our disclosure controls and procedures are designed to provide reasonable assurance that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures.

Based upon the evaluation, the Chief Executive Officer and Chief Financial Officer concluded that Lannett’s disclosure controls and procedures were effective as of the end of the period covered by this report.

Change in Internal Control Over Financial Reporting

During the third quarter of Fiscal 2017, the Company completed the carve-out of data and software systems supporting the operations of KUPI from the hosted environment of UCB. The integration of the Company’s entities into a single consolidated system is planned in phases and is expected to be completed in Fiscal 2018. As such, internal controls have and will continue to change in various functional areas within the Company. However, management has taken steps to ensure that any changes to the design and implementation of internal controls continue to function appropriately. There ~~has~~have been no ~~change~~other changes in Lannett’s internal control over financial reporting during the three ~~and six~~ months ended ~~December 31, 2016~~September 30, 2017, that ~~has~~have materially affected, or isare reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Information pertaining to legal proceedings can be found in Note ~~13.~~12 “Legal, Regulatory Matters and Contingencies” of the Consolidated Financial Statements included in Part I, Item 1.1 of this Quarterly Report on Form 10-Q and is incorporated by reference herein.

ITEM 1A. RISK FACTORS

Lannett Company, ~~Inc.’s~~Inc’s Annual Report on Form 10-K for the fiscal year ended June 30, ~~2016~~2017 includes a detailed description of its risk factors.

ITEM 6. EXHIBITS

(a) A list of the exhibits required by Item 601 of Regulation S-K to be filed as a part of this Form 10-Q is shown on the Exhibit Index filed herewith.

~~SIGNATURES~~

~~In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.~~

		~~LANNETT COMPANY, INC.~~

~~Dated: February 3, 2017~~	~~By:~~	~~/s/ Arthur P. Bedrosian~~
		~~Arthur P. Bedrosian~~
		~~Chief Executive Officer~~


~~Dated: February 3, 2017~~	~~By:~~	~~/s/ Martin P. Galvan~~
		~~Martin P. Galvan~~
		~~Vice President of Finance,~~ ~~Chief Financial Officer and Treasurer~~


~~Dated: February 3, 2017~~	~~By:~~	~~/s/ G. Michael Landis~~
		~~G. Michael Landis~~
		~~Director of Finance and Principal Accounting Officer~~

Exhibit Index

31.1	Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	Filed Herewith

31.2	Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	Filed Herewith

32	Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	Filed Herewith

101.INS	XBRL Instance Document

101.SCH	XBRL Extension Schema Document

101.CAL	XBRL Calculation Linkbase Document

101.DEF	XBRL Definition Linkbase Document

101.LAB	XBRL Label Linkbase Document

101.PRE	XBRL Presentation Linkbase Document

SIGNATURES

51In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

		LANNETT COMPANY, INC.

Dated: November 8, 2017	By:	/s/ Arthur P. Bedrosian
		Arthur P. Bedrosian
		Chief Executive Officer


Dated: November 8, 2017	By:	/s/ Martin P. Galvan
		Martin P. Galvan
		Vice President of Finance, Chief Financial Officer and Treasurer


Dated: November 8, 2017	By:	/s/ G. Michael Landis
		G. Michael Landis
		Director of Finance and Principal Accounting Officer

State of Delaware		23-0787699
(State of Incorporation)		(I.R.S. Employer I.D. No.)

Large accelerated filer x		Accelerated filer o

Non-accelerated filer o		Smaller reporting company o
(Do not check if a smaller reporting company)		Emerging growth company o

Class		Outstanding as of ~~January~~October 31, 2017
Common stock, par value $0.001 per share		~~37,189,492~~37,667,411

(In thousands)
Cash purchase price paid to KUPI shareholders	$	1,030,000
Working capital adjustment	(41,605		)
Certain amounts reimbursable by UCB	(37,340		)
Total cash consideration transferred to KUPI shareholders	951,055
12.0% Senior Notes issued to UCB	200,000
Acquisition-related contingent consideration	35,000
Warrant issued to UCB	29,920
Total consideration to KUPI shareholders	$	1,215,975

(In thousands)	Purchase Price Allocation
Cash and cash equivalents	$	16,877
Accounts receivable, net of revenue-related reserves	129,408
Inventories	84,009
Other current assets	11,238
Property, plant and equipment	111,849
Product rights	427,000
Trade name	2,920
Other intangible assets	19,000
In-process research and development	125,000
Goodwill	339,425
Deferred tax assets	4,186
Other assets	10,218
Total assets acquired	1,281,130
Accounts payable	(19,249		)
Accrued expenses	(6,079		)
Accrued payroll and payroll-related expenses	(21,040		)
Rebates payable	(9,816		)
Royalties payable	(3,602		)
Other liabilities	(5,369		)
Total net assets acquired	$	1,215,975

	For the Three Months Ended December 31,		For the Six Months Ended December 31,
(In thousands, except per share data)	2015		2015
Revenues	$	173,189	$	357,155
Net income attributable to Lannett Company, Inc.	28,810		55,129
Earnings per common share attributable to Lannett Company, Inc.:
Basic	$	0.79	$	1.52
Diluted	$	0.77	$	1.47

(In thousands) Fiscal Year Ending June 30,	Annual Amortization Expense
2017	$	16,204
2018	31,530
2019	30,946
2020	30,938
2021	30,938
Thereafter	293,060
	$	433,616

	Three Months Ended December 31,
(In thousands, except share and per share data)	2016		2015

Net income attributable to Lannett Company, Inc.	$	8,172	$	13,520

Basic weighted average common shares outstanding	36,810,388		36,388,542
Effect of potentially dilutive stock options, warrants and restricted stock awards	865,982		999,908
Diluted weighted average common shares outstanding	37,676,370		37,388,450

Earnings per common share attributable to Lannett Company, Inc.:
Basic	$	0.22	$	0.37
Diluted	$	0.22	$	0.36

(In thousands)	Six Months Ended December 31,
Medical Indication	2016		2015
Antibiotic	$	8,572	$	5,556
Anti Psychosis	32,685		3,472
Cardiovascular	24,669		21,385
Central Nervous System	20,904		6,077
Gallstone	26,308		38,691
Gastrointestinal	37,029		8,693
Glaucoma	11,095		13,365
Migraine	15,023		11,247
Muscle Relaxant	6,536		3,054
Obesity	1,795		1,830
Pain Management	14,047		16,207
Respiratory	5,170		1,396
Thyroid Deficiency	85,269		78,534
Urinary	9,794		3,593
Other	20,519		18,121
Contract manufacturing revenue	13,088		2,271
Total	$	332,503	$	233,492