Although Lannett Company (LCI) remains a shell of its former self, investors are increasingly optimistic about the direction of the company. Shares doubled in the last month after the business reported fiscal full-year 2019 operating results and inked two potentially lucrative agreements at the end of August.
The current market cap of $550 million is well off the five-year peak of $2.5 billion, and revenue in fiscal 2020 will be lower than the level achieved in the year-ago period, but the turnaround certainly has momentum. Can management continue to execute and prove that Lannett Company is a turnaround stock worth buying?
What caused the turnaround in the first place?
The most visible catalyst driving the company's recent demise came in August 2018. That's when Lannett Company announced that an important supply agreement with Jerome Stevens Pharmaceuticals (JSP) would expire in March 2019. The contract generated $253 million in revenue in fiscal 2018, which represented 37% of Lannett Company's total revenue that year.
The expiring contract not only highlighted the risks of becoming too dependent on a single customer, but also the risks of relying too much on a single product. While JSP tapped Lannett Company for a handful of generic drugs, levothyroxine sodium tablets were responsible for $245.9 million of the contract's total sales value in fiscal 2018. That marked significant growth from the $174 million the tablets generated in fiscal 2017, and was responsible for all of the company's total revenue growth in that span.
That explains why investors soured on the pharmaceutical stock so quickly when the JSP news broke. But renewing the contract may turn out to be the best thing that never happened to Lannett Company. Management received the wake-up call loud and clear, and has been furiously replacing lost revenue with a more diverse product portfolio.
Swift progress so far
The generic drug supplier has acquired or in-licensed more than 40 products since the beginning of calendar year 2018. CEO Timothy Crew told investors on the fiscal full-year 2019 earnings conference call that Lannett Company exited June having launched 25 of those, boasting 110 total drug products on the market and a pipeline of roughly 60 product candidates. A new supply deal for levothyroxine sodium tablets can be counted among the projects in the pipeline.
As a result of that swift progress, quarterly revenue grew from $101 million in fiscal Q1 2019 to $134 million in fiscal Q4 of the same year. And the upward trend should continue for the foreseeable future. Lannett Company landed a supply deal from Sinotherapeutics for generic posaconazole tablets (an antifungal medication). The innovator brand, Noxafil from Merck, generated $325 million in U.S. sales in the 12-month period ending June 30, although the generic drug will only generate a fraction of that.
Nonetheless, investors are suddenly optimistic about the company's future. Lannett Company reported $655 million in revenue in fiscal 2019, besting the top end of its guidance range by $10 million. Management expects fiscal full-year 2020 revenue of $535 million at the midpoint, which reflects the first full year without the JSP contract. But that's markedly better than the average Wall Street expectation of just $506 million, according to Yahoo! Finance.
On a promising path, but obstacles remain
There's no denying that the pace of the turnaround is exceeding expectations. However, investors shouldn't forget that the business faces more headwinds than replacing its former top customer. Lannett Company had seen its market cap tumble from $2.5 billion in early 2015 to below $500 million, all before announcing in August 2018 that JSP was walking away. That news actually pushed the company's valuation below $200 million.
The generic drug industry remains under constant pressure. Manufacturers and suppliers are grappling with an avalanche of competition, shifts in distribution networks and consumer behaviors, and accusations that many of the industry's largest players were involved in a price-fixing conspiracy. The latter issue, which includes 44 attorneys general, unfortunately includes Lannett Company.
The worst-case scenario would include a fine or settlement. The balance sheet should be better equipped to handle that scenario now that the balance of goodwill and intangible assets has been reduced by 46% in the last year. And if there's any silver lining for Lannett Company compared to its peers, it's the fact that the business hasn't (yet) been implicated in lawsuits stemming from the opioid crisis.
That said, the turnaround will take time to complete. In fiscal Q4 2019, the first without the JSP contract, the business generated a healthy $9.4 million in operating income, but paid more than twice that amount in interest expense. The result: a significant net loss. That trend is unlikely to reverse itself anytime soon without refinancing or significant debt reduction efforts. Knowing that, investors might be better off waiting a few quarters and confirming that Lannett Company can keep its momentum going before buying shares, especially after the stock's triple-digit gain in the last month.