Hi Tech Pharmacal (HITK) 10-Q 2010 Q3 Quarterly report

United States

Securities and Exchange Commission

Washington, D.C. 20549

Form 10-Q

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

For the quarterly period ended January 31, 2010

OR

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

For the transition period from            to            

Commission File Number 0-20424

Hi-Tech Pharmacal Co., Inc.

(Exact name of registrant as specified in its charter)

Delaware	11-2638720
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)

369 Bayview Avenue, Amityville, New York 11701

(Address of principal executive offices) (zip code)

631 789-8228

(Registrant’s telephone number including area code)

Not applicable

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

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

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: Common Stock, $.01 Par Value — 12,372,000 shares outstanding as March 9, 2010

INDEX

HI-TECH PHARMACAL CO., INC.

		Page
PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements	3
	Condensed consolidated balance sheets—January 31, 2010 (unaudited) and April 30, 2009	3
	Condensed consolidated statements of operations—Three months and nine months ended January 31, 2010 and 2009 (unaudited)	4
	Condensed consolidated statements of cash flows—Nine months ended January 31, 2010 and 2009 (unaudited)	5
	Notes to condensed consolidated financial statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	19
Item 4.	Controls and Procedures	19
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	20
Item 1A.	Risk Factors	20
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	20
Item 3.	Defaults Upon Senior Securities	20
Item 4.	Reserved	20
Item 5.	Other Information	21
Item 6.	Exhibits	21
	Signatures	22
	Certifications

PART I. ITEM 1.

HI-TECH PHARMACAL CO., INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

	January 31, 2010			April 30, 2009
	(unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents	$	39,552,000		$	17,891,000
Accounts receivable, less allowance for doubtful accounts		30,027,000			31,896,000
Inventory		21,632,000			17,183,000
Prepaid income taxes		1,154,000			942,000
Deferred income taxes		4,835,000			3,498,000
Other current assets		4,137,000			3,676,000
TOTAL CURRENT ASSETS	$	101,337,000		$	75,086,000
Property and equipment—net		19,889,000			19,210,000
Intangible assets—net		20,510,000			12,467,000
Investment in Neuro-Hitech		46,000			153,000
Other assets		513,000			439,000
TOTAL ASSETS	$	142,295,000		$	107,355,000
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES
Accounts payable	$	5,491,000		$	6,237,000
Accrued expenses		8,932,000			9,098,000
Current portion of obligation under capital lease		190,000			180,000
Notes payable		—			4,138,000
TOTAL CURRENT LIABILITIES	$	14,613,000		$	19,653,000
Obligation under capital lease		86,000			230,000
Deferred income taxes		1,101,000			1,117,000
TOTAL LIABILITIES	$	15,800,000		$	21,000,000
Commitments and Contingencies (Note 12)
STOCKHOLDERS’ EQUITY
Preferred stock, par value $.01 per share; authorized 3,000,000 shares, none issued
Common stock, par value $.01 per share; authorized 50,000,000 shares, issued 14,824,000 at January 31, 2010 and 13,603,000 at April 30, 2009, respectively		148,000			138,000
Additional paid-in capital		73,565,000			57,977,000
Retained earnings		75,916,000			51,304,000
Accumulated other comprehensive loss, net of tax		(134,000	)		(64,000	)
Treasury stock, 2,456,000 shares of common stock, at cost on January 31, 2010 and April 30, 2009		(23,000,000	)		(23,000,000	)
TOTAL STOCKHOLDERS’ EQUITY	$	126,495,000		$	86,355,000
LIABILITIES AND STOCKHOLDERS’ EQUITY	$	142,295,000		$	107,355,000

See notes to condensed consolidated financial statements

3

HI-TECH PHARMACAL CO., INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

	Three months ended January 31,						Nine months ended January 31,
	2010			2009			2010			2009
NET SALES	$	38,820,000		$	29,420,000		$	123,172,000		$	70,336,000
Cost of goods sold		16,269,000			15,604,000			51,673,000			38,570,000
GROSS PROFIT		22,551,000			13,816,000			71,499,000			31,766,000
Selling, general and administrative expenses		11,983,000			9,261,000			34,845,000			22,659,000
Research and product development costs		1,718,000			1,790,000			5,184,000			5,479,000
Royalty income		(1,596,000	)		(119,000	)		(2,539,000	)		(233,000	)
Contract research (income)		(581,000	)		(40,000	)		(894,000	)		(40,000	)
Interest expense		9,000			12,000			24,000			29,000
Other (income) expense		52,000			(548,000	)		(1,233,000	)		(4,234,000	)
TOTAL	$	11,585,000		$	10,356,000		$	35,387,000		$	23,660,000
Income before income tax expense		10,966,000			3,460,000			36,112,000			8,106,000
Income tax expense		2,426,000			1,389,000			11,500,000			3,411,000
NET INCOME	$	8,540,000		$	2,071,000		$	24,612,000		$	4,695,000
BASIC INCOME PER SHARE	$	0.70		$	0.19		$	2.10		$	0.41
DILUTED INCOME PER SHARE	$	0.67		$	0.18		$	2.01		$	0.40
Weighted average common shares outstanding—basic		12,179,000			11,180,000			11,732,000			11,328,000
Effect of potential common shares		521,000			330,000			533,000			432,000
Weighted average common shares outstanding—diluted		12,700,000			11,510,000			12,265,000			11,760,000

See notes to condensed consolidated financial statements

4

HI-TECH PHARMACAL CO., INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

	Nine months ended January 31,
	2010			2009
NET CASH FLOWS PROVIDED BY OPERATING ACTIVITIES	$	20,711,000		$	7,905,000
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment		(2,669,000	)		(2,201,000	)
Sale of marketable securities, net		—			3,045,000
Proceeds from the sale of intangible assets		2,187,000			3,235,000
Purchase of intangible assets		(7,180,000	)		(500,000	)
Purchase of ECR assets		(5,042,000	)		—
NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES	$	(12,704,000	)	$	3,579,000
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock and exercise of options		10,934,000			37,000
Payment under capital lease obligation		(134,000	)		(95,000	)
Tax benefit of stock incentives		2,854,000			—
Purchase of treasury stock		—			(1,649,000	)
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES	$	13,654,000		$	(1,707,000	)
NET INCREASE IN CASH AND CASH EQUIVALENTS		21,661,000			9,777,000
Cash and cash equivalents at beginning of the period		17,891,000			11,722,000
CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	39,552,000		$	21,499,000
Supplemental and non cash disclosures of cash flow information:
Interest paid	$	24,000		$	29,000
Income taxes paid	$	10,164,000		$	—
Loan for purchase of computer software	$	—		$	548,000
Other receivable from the sale of marketing rights	$	312,000		$	—
ECR contingent consideration accrual	$	1,045,000		$	—

See notes to condensed consolidated financial statements

5

HI-TECH PHARMACAL CO., INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

January 31, 2010

1. BASIS OF PRESENTATION:

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. The preparation of the Company’s financial statements in conformity with generally accepted accounting principles necessarily requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the balance sheet dates and the reported amounts of revenues and expense during the reporting periods. Actual results could differ from these estimates and assumptions. Operating results for the three and nine month periods ended January 31, 2010 are not necessarily indicative of the results that may be expected for the year ending April 30, 2010. For further information, refer to the financial statements and footnotes thereto for the year ended April 30, 2009 in the Company’s Annual Report on Form 10-K.

2. BUSINESS:

Hi-Tech is a specialty pharmaceutical company developing, manufacturing and marketing generic and branded prescription and OTC products. The Company specializes in the manufacture of liquid and semi-solid dosage forms and produces a range of sterile ophthalmic, otic and inhalation products. The Company’s Health Care Products Division is a developer and marketer of branded prescription and OTC products for the diabetes marketplace. Hi-Tech’s ECR Pharmaceuticals subsidiary markets branded prescription products. Hi-Tech’s Midlothian Laboratories division sources and markets generic prescription products.

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

	Nine months ended January 31, 2010		Nine months ended January 31, 2009
Hi-Tech Generics	$	99,146,000	$	56,588,000
Health Care Products		8,597,000		7,798,000
Midlothian Laboratories		3,192,000		5,950,000
ECR Pharmaceuticals		12,237,000		—
Total	$	123,172,000	$	70,336,000

3. REVENUE RECOGNITION:

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

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

4. NET INCOME PER SHARE:

Basic income per common share is computed based on the weighted average number of common shares outstanding and on the weighted average number of common shares and share equivalents (stock options) outstanding for diluted earnings per share. The weighted average number of shares outstanding used in the computation of basic and diluted net earnings per share does not include the effect of potentially outstanding common stock whose effect would have been antidilutive. Such outstanding potential shares consisted of options totaling 261,000 and 2,463,000 shares at January 31, 2010 and 2009, respectively.

6

HI-TECH PHARMACAL CO., INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

January 31, 2010

5. INVENTORY:

The components of inventory consist of the following:

	January 31, 2010		April 30, 2009
Raw materials	$	12,929,000	$	9,350,000
Work in process		639,000		772,000
Finished products		8,064,000		7,061,000
TOTAL INVENTORY	$	21,632,000	$	17,183,000

6. PROPERTY AND EQUIPMENT:

The components of property and equipment consist of the following:

	January 31, 2010		April 30, 2009
Land and building	$	15,423,000	$	13,867,000
Machinery and equipment		22,856,000		21,992,000
Transportation equipment		37,000		37,000
Computer equipment and systems		5,226,000		5,018,000
Furniture and fixtures		1,149,000		1,108,000
	$	44,691,000	$	42,022,000
Accumulated depreciation and amortization		24,802,000		22,812,000
TOTAL PROPERTY AND EQUIPMENT	$	19,889,000	$	19,210,000

The Company incurred depreciation expense of $1,990,000 and $1,665,000 for the nine months ended January 31, 2010 and January 31, 2009, respectively. Depreciation expense for the three months ended January 31, 2010 and January 31, 2009 was $625,000 and $542,000, respectively.

7. INTANGIBLE ASSETS:

The components of net intangible assets are as follows:

	January 31, 2010		April 30, 2009		Amortization Period
ECR intangible assets	$	4,977,000	$	3,278,000	10 years
Clobetasol intangible asset		4,000,000		—	10 years
Midlothian intangible asset		3,609,000		3,964,000	3-10 years
Zostrix® intangible assets		3,192,000		3,560,000	3-11.5 years
Zolpimist® intangible asset		3,000,000		—	10 years
Vosol® and Vosol® HC intangible assets		560,000		613,000	10 years
Other license agreements		1,172,000		1,052,000	10 years
TOTAL INTANGIBLE ASSETS	$	20,510,000	$	12,467,000

Intangible assets are stated at cost and amortized using the straight line method over the expected useful lives of the product rights. Amortization expense of the intangible assets for the nine months ended January 31, 2010 and January 31, 2009 was $1,087,000 and $844,000, respectively. Amortization expense for the three months ended January 31, 2010 and January 31, 2009 was $363,000 and $279,000, respectively. Amortization is included in selling, general and administrative expenses for all periods presented. The Company amortizes intangible assets when the related products begin to sell. The Company tests for impairment of intangible assets when events or circumstances indicate that the carrying value of the assets may not be recoverable.

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

7

HI-TECH PHARMACAL CO., INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

January 31, 2010

On November 13, 2009, Hi-Tech signed an exclusive licensing agreement between Hi-Tech’s ECR Pharmaceuticals subsidiary and NovaDel Pharma, Inc., a drug development company, through which ECR obtained the rights to market Zolpimist^® (Zolpidem Tartrate oral spray, 5mg per spray), in the United States and Canada. Under the terms of the agreement ECR paid NovaDel $3 million upon closing. In addition NovaDel will receive a royalty of up to 15% on net sales, and a one time $7.5 million milestone payment if net sales reach $100,000,000 in any calendar year throughout the life of the product.

During the nine months ending January 31, 2010, the Company incurred a liability of $1,950,000 relating to an earn-out provision of the ECR Pharmaceuticals asset purchase which was accounted for using the purchase method of accounting for business combinations. This amount is included in the ECR intangible assets. The Company purchased an additional $180,000 of intangible assets during the period.

8. FREIGHT EXPENSE:

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

9. STOCK-BASED COMPENSATION:

The Company follows the provisions of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 718, “Compensation — Stock Compensation” (“ASC 718”). ASC 718 requires the measurement and recognition of compensation expense for all share-based payment awards made to employees, non-employee directors, and consultants, including employee stock options. Stock compensation expense based on the grant date fair value estimated in accordance with the provisions of ASC 718 is recognized as an expense over the requisite service period.

For stock options granted as consideration for services rendered by non-employees, the Company recognizes compensation expense in accordance with the requirements of FASB ASC Topic 505-50, “Equity Based Payments to Non- Employees”.

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

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

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

	Nine months ended January 31, 2010		Nine months ended January 31, 2009
Cost of sales	$	350,000	$	418,000
Selling, general and administrative expenses		1,338,000		1,512,000
Research and product development costs		122,000		150,000
Stock-based compensation expense	$	1,810,000	$	2,080,000

Stock-based compensation expense resulted in a decrease of $0.15 in basic and diluted net income per share for the nine months ended January 31, 2010 and a decrease of $0.18 in basic and $0.17 in diluted net income per share for the nine months ended January 31, 2009.

	Three months ended January 31, 2010		Three months ended January 31, 2009
Cost of sales	$	144,000	$	147,000
Selling, general and administrative expenses		463,000		530,000
Research and product development costs		50,000		53,000
Stock-based compensation expense	$	657,000	$	730,000

8

HI-TECH PHARMACAL CO., INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

January 31, 2010

Stock-based compensation expense resulted in a decrease of $0.05 in basic and diluted net income per share for the three months ended January 31, 2010 and a decrease of $0.07 in basic and $0.06 in diluted net income per share for the three months ended January 31, 2009.

The following weighted average assumptions were used for stock option granted during the three and nine months ended January 31, 2010 and 2009:

	Three months ended January 31,						Nine months ended January 31,
	2010			2009			2010			2009
Dividend yield		None			None			None			None
Expected volatility		58	%		55	%		58	%		55	%
Risk-free interest rate		2.28	%		2.12	%		2.28	%		2.12	%
Expected term		5.0			5.0			5.0			5.0
Weighted average fair value per share at grant date	$	10.07		$	2.86		$	10.07		$	2.97

The Company has elected to use the Black-Scholes option-pricing model, which incorporates various assumptions including volatility, expected life, and interest rate. The expected volatility is based on the historical volatility of the Company’s common stock. The interest rates for periods within the contractual life of the award are based on the U.S. Treasury yield on the date of each option grant.

All options granted through January 31, 2010 had exercise prices equal to the fair market value of the stock on the date of grant, a contractual term of ten years and a vesting period of four years. The Company adjusts stock-based compensation on a quarterly basis for changes to the estimate of expected equity award forfeitures based on actual forfeiture experience. The effect of adjusting the forfeiture rate for all expense amortization after May 1, 2006 is recognized in the period the forfeiture estimate is changed. As of January 31, 2010, the weighted average forfeiture rate was 9% and the effect of forfeiture adjustments for the three and nine months ended January 31, 2010 was insignificant. The Company granted 318,000 options under the employee plan and 50,000 under the director plan at an exercise price of $19.59 during the three months ended January 31, 2010. The Company granted 304,000 options to employees and 60,000 to directors during the three months ended January 31, 2009.

The intrinsic value of options exercised for the 1992 Stock Option Plan and the 1994 Stock Option Plan was $12,111,000 and $102,000 for the nine month periods ended January 31, 2010 and January 31, 2009, respectively. As of January 31, 2010, $5,341,000 of total unrecognized compensation cost related to stock options for both plans is expected to be recognized over a weighted average period of 3.0 years.

10. PRODUCT DIVESTITURES:

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

On July 3, 2009 the Company entered into an agreement whereby the Company has granted the marketing rights to certain nutritional products previously marketed by Midlothian Laboratories, in exchange for a series of payments totaling $1,000,000 over the course of one year. In addition, the Company will receive a royalty on the sales of these products, not to exceed $1,500,000 per year for three years. These products contributed approximately $1,600,000 in sales for the Midlothian Laboratories division for the year ended April 30, 2009. These products contributed $600,000 and $1,800,000 in sales for the nine months ended January 31, 2010 and January 31, 2009, respectively. The Company recognized a gain of $1,000,000 from this agreement in the first quarter of fiscal 2010, recorded in other (income) expense on the Condensed Consolidated Statement of Operations.

11. INCOME TAXES:

The Company estimated its effective tax rate to be approximately 32% for the year ended April 30, 2010. On May 1, 2008, the Company adopted the provisions of ASC Topic 740-10, “Income Taxes” relating to recognition thresholds and measurement attributes for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Company has elected an accounting policy to classify interest and penalties related to unrecognized tax benefits as interest expense. At April 30, 2009, the Company had recorded a $427,000 liability for uncertain tax positions related to research and development credits taken by the Company. There was no change in the liability for uncertain tax positions during the period ended January 31, 2010.

9

HI-TECH PHARMACAL CO., INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

January 31, 2010

The Company is no longer subject to U.S. federal, state or local income tax examination for years ended prior to April 30, 2003. The Company is currently under examination by the Internal Revenue Service for the taxable years ending April 30, 2004, 2005, 2006, 2007, 2008 and 2009.

12. CONTINGENCIES AND OTHER MATTERS:

[1] Government Regulation:

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

In May 2009, the Company was contacted by the U. S. Department of Justice (“DOJ”), representing the Drug Enforcement Administration (“DEA”), concerning alleged regulatory violations of the Controlled Substances Act. DEA alleged that the Company failed to maintain and/or file certain required records and reports and that one of the Company’s facilities failed to maintain the appropriate DEA registration. The Company has agreed to pay a civil fine of $250,000 to settle, compromise and resolve this matter without the need for litigation. The Company has independently taken action to improve its DEA regulatory compliance program.

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

[2] Legal Proceedings:

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

Pursuant to the unsealing Order, a Revised Corrected Seventh Amended Complaint was filed by the relator and unsealed on February 10, 2010. The revised corrected Complaint does not name the Company as a defendant.

On February 9, 2010, the Court also unsealed the “United States’ Notice of Partial Declination” in which the government determined not to intervene against 68 named defendants, including the Company. The Notice stated that the relator has filed a Motion for Voluntary Dismissal of 55 of the 68 named defendants. The government’s declination Notice also stated that it had not yet made an election decision as to “certain other defendants.” These could include a subsidiary or affiliate of one of the pharmaceutical companies. Portions of the revised corrected Complaint contain “redactions” that block from view (i.e., remain under seal) statements or allegations that may relate to a subsidiary or affiliate of the Company. Other than the Unsealing Order, the United States’ Notice of Partial Declination, and the Revised Corrected Seventh Amended Complaint, to our knowledge no other documents have been unsealed at this time. If a subsidiary or affiliate of the Company were to be named in this Qui Tam action, the Company would vigorously defend against such allegations. The Company cannot predict the outcome of any such action.

On June 5, 2009, Allergan, Inc. (“Allergan”) filed a complaint against the Company in the United States District Court for the Eastern District of Texas, Civil Action No. 2:09-cv-182, in response to the Company’s Paragraph IV certifications in ANDA No. 91-086 (the “ANDA”) alleging noninfringement or invalidity of the United States patents identified in the Orange Book on Allergan’s product, Combigan®. In counts one and two of the complaint, Allergan alleges that the Company’s submission of the ANDA to the FDA under Section 505(j) of the Food, Drug & Cosmetic Act (“FDCA”) to obtain approval to engage in the commercial manufacture, use or sale of the Company’s generic Brimonidine Tartrate/Timolol Maleate Ophthalmic Solution 0.2%/0.5% product infringes U.S. Patents No. 7,030,149 and 7,320,976. The Company believes the complaint is without merit. On July 25, 2009, the Company filed a motion to dismiss the action based on lack of personal jurisdiction and improper venue. Allergan responded on September 8, 2009 opposing Hi-Tech’s motion to dismiss. The Company withdrew its motion to dismiss on November 19, 2009, and on November 20, 2009, Allergan filed an amended complaint adding a claim for infringement of U.S. Patent No. 7,323,463. The Company answered the amended complaint on December 10, 2009, asserting counterclaims of non-infringement and invalidity as to all asserted patents. Allergan replied to the Company’s counterclaims on January 4, 2010. Discovery will commence shortly. The Company cannot predict the outcome at this time.

10

HI-TECH PHARMACAL CO., INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

January 31, 2010

On September 28, 2007, Walmed Pharmaceuticals, Ltd., LLC filed a complaint against the Company, Case No. 1:07CV810, in the United States District Court, District of Ohio, Western Division, alleging that the Company breached its brokerage agreement with plaintiff. The Company filed an answer to the complaint denying all liability on December 7, 2007. Walmed filed a motion to amend its complaint on February 17, 2009, after the Company filed its motion for summary judgment, seeking to add a new claim asserting that the Company breached its brokerage agreements by understating its sales to Walgreens. The court granted plaintiff’s motion to amend on June 23, 2009 and rescheduled the trial date from July 20, 2009 to May 10, 2010. Walmed asserts that its damages under the new claim total nearly $3 million. The Company denies that it misstated its sales to Walgreens and intends to vigorously defend against Walmed’s amended complaint. Discovery is now complete. The Company filed its renewed motion for summary judgment on November 16, 2009. The motion remains pending. The Company believes it has meritorious defenses to the allegations of the amended complaint and has asked the Court to dismiss all claims for relief.

[3] Commitments and Contingencies:

The Company’s Midlothian division signed a lease for a 12,000 square foot facility in Montgomery, AL commencing on December 1, 2008 and terminating on November 30, 2013. The lease includes monthly payments of $7,645 for the term of the lease.

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

In connection with the acquisition of the assets of Midlothian Laboratories, LLC, the Company has a contingent liability of $500,000 if the Company is first to market with an ANDA that Midlothian had in development at the time of acquisition. To date, this product has not been approved, so the milestone has not yet been met.

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

In connection with the acquisition of the assets of ECR Pharmaceuticals, the Company has a contingent liability of up to $4,000,000 if certain sales and gross margin levels are achieved by ECR over a three year period. During the nine months ended January 31, 2010 the Company achieved minimum required sales and gross margin levels and incurred a liability of $1,950,000 of the $4,000,000 contingent liability. Additionally, during the period, the Company paid $905,000 of the liability incurred. Contingent earn-out in excess of the acquisition date fair value are recorded as goodwill.

On November 13, 2009, Hi-Tech signed an exclusive licensing agreement between Hi-Tech’s ECR Pharmaceuticals subsidiary and NovaDel Pharma, Inc., a drug development company, through which ECR obtained the rights to market Zolpimist^® (Zolpidem Tartrate oral spray, 5mg per spray), in the United States and Canada. Under the terms of the agreement ECR paid NovaDel $3 million upon closing. In addition NovaDel will receive a royalty of up to 15% on net sales, and a one time $7.5 million milestone payment if net sales reach $100,000,000 in any calendar year throughout the life of the product.

[4] Other Matters:

During the period ended January 31, 2010, the Company paid $2,100,000 to its royalty partner on the Dorzolamide with Timolol Ophthalmic Solution to buy out the future royalty stream. This payment is included in selling, general and administrative expense.

13. RECENT ACCOUNTING PRONOUNCEMENTS:

In June 2009, the Financial Accounting Standards Board (FASB) issued guidance which is included in the Codification in FASB Accounting Standards Codification (ASC) 105, “Generally Accepted Accounting Principles.” This guidance modifies the Generally Accepted Accounting Principles (GAAP) hierarchy by establishing only two levels of GAAP, authoritative and nonauthoritative accounting literature. Effective July 2009, the FASB ASC, also known collectively as the “Codification,” is considered the single source of authoritative U.S. accounting and reporting standards, except for additional authoritative rules and interpretive releases issued by the SEC. This guidance is effective for financial statements issued for reporting periods that end after September 15, 2009. Where possible, FASB references have been replaced with ASC references.

As of July 31, 2009, the Company implemented FASB ASC 825-10-65-1, “Financial Instruments” (ASC 825-10-65-1). ASC 825-10-65-1 provides disclosure about fair value of financial instruments in interim as well as in annual financial statements. This guidance is effective for periods ending after June 15, 2009.

11

HI-TECH PHARMACAL CO., INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

January 31, 2010

In December 2007, the FASB issued guidance which is included in the Codification in ASC 805, “Business Combination” (ASC 805). For the Company, the standard is applicable to new business combinations occurring on or after May 1, 2009. ASC 805 requires an acquiring entity to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. Most significantly, ASC 805 requires that acquisition costs generally be expensed as incurred, certain acquired contingent liabilities be recorded at fair value, and acquired in-process research and development be recorded at fair value as an indefinite-lived intangible asset at the acquisition date. The implementation of this standard did not have a material impact on the Company’s condensed consolidated financial statements, however, this standard may have an impact on the accounting for any future acquisitions.

In April 2009, the FASB issued updated guidance related to business combinations, which is included in the Codification in ASC 805-20, “Business Combinations — Identifiable Assets, Liabilities and Any Noncontrolling Interest” (ASC 805-20). ASC 805-20 amends the provisions in ASC 805 for the initial recognition and measurement, subsequent measurement and accounting, and disclosures for assets and liabilities arising from contingencies in business combinations. ASC 805-20 is effective for contingent assets or contingent liabilities acquired in business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The implementation of this standard did not have a material impact on the Company’s condensed consolidated financial statements.

In May 2009, the FASB issued guidance which is included in the Codification in ASC 855, “Subsequent Events” (ASC 855). This guidance establishes the accounting and disclosure of events that occur after the balance sheet date but before financial statements are issued. It requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date. This guidance is effective for interim or annual financial periods ending after June 15, 2009, and as such, became effective for the Company on July 31, 2009. The implementation of this standard did not have a material impact on the Company’s condensed consolidated financial statements.

In February 2010, FASB issued ASU 2010-09 Subsequent Event (Topic 855) Amendments to Certain Recognition and Disclosure Requirements. ASU 2010-09 removes the requirement for an SEC filer to disclose a date in both issued and revised financial statements. Revised financial statements include financial statements revised as a result of either correction of an error or retrospective application of GAAP. All of the amendments in ASU 2010-09 are effective upon issuance of the final ASU, except for the use of the issued date for conduit debt obligors. That amendment is effective for interim or annual periods ending after June 15, 2010. The Company adopted ASU 2010-09 in February 2010.

In August 2009, the FASB issued Accounting Standards Update (ASU) No. 2009-05, “Fair Value Measurements and Disclosures” (Topic 820) (ASU 2009-05). ASU 2009-05 provided amendments to ASC 820-10, “Fair Value Measurements and Disclosures — Overall,” for the fair value measurement of liabilities. ASU 2009-05 provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using certain techniques. ASU 2009-05 also clarifies that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of a liability. ASU 2009-05 also clarifies that both a quoted price in an active market for the identical liability at the measurement date and the quoted price for the identical liability when traded as an asset in an active market when no adjustments to the quoted price of the asset are required are Level 1 fair value measurements. The guidance if effective for the Company during the interim period ended October 31, 2009. The implementation of ASU 2009-05 did not have a material impact on the Company’s condensed consolidated financial statements.

14. COMPREHENSIVE INCOME:

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

The Company’s investment in Neuro-Hitech, Inc., a marketable security is classified as available for sale and measured at fair value with the adjustment to fair value and changes therein recorded in accumulated other comprehensive income. At January 31, 2010, the Company owned 1,526,922 shares of Neuro-Hitech with a market value of $0.03 per share.

	Three months ended January 31,					Nine months ended January 31,
	2010		2009			2010			2009
Net income	$	8,540,000	$	2,071,000		$	24,612,000		$	4,695,000
Other comprehensive gain (loss), net of tax		9,000		(10,000	)		(70,000	)		(98,000	)
Comprehensive income	$	8,549,000	$	2,061,000		$	24,542,000		$	4,597,000

12

HI-TECH PHARMACAL CO., INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(unaudited)

January 31, 2010

15. SIGNIFICANT CUSTOMERS AND CONCENTRATION OF CREDIT RISK:

For the nine months ended January 31, 2010, four customers, McKesson, AmerisourceBergen, Cardinal Health and Walgreen’s, accounted for net sales of approximately 24%, 19%, 17% and 11%, respectively. These customers represented approximately 69% of accounts receivable at January 31, 2010. For the nine months ended January 31, 2009, three customers, Cardinal Health, McKesson and AmerisourceBergen, accounted for net sales of approximately 14%, 14% and 13%, respectively. At January 31, 2009, trade receivables from these customers were approximately 50% of total receivables.

For the three months ended January 31, 2010, four customers, AmerisourceBergen, Cardinal Health, McKesson and Walgreen’s, accounted for net sales of approximately 24%, 22%, 17% and 11%, respectively. During the three months ended January 31, 2009, the Company’s significant customers were AmerisourceBergen with 16% of net sales and McKesson with 13% of net sales. At January 31, 2009 trade receivables from AmerisourceBergen and McKesson were approximately 32% of total receivables.

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

16. PRO FORMA FINANCIAL STATEMENTS:

The results of ECR Pharmaceuticals, acquired on February 27, 2009, have been included in the statements of operations since the date of acquisition. Unaudited pro forma results of operations for the nine and three months ended January 31, 2009 are included below. Such pro forma information assumes that the above acquisition had occurred as of May 1, 2008, and net sales is presented in accordance with our accounting policies. This summary is not necessarily indicative of what our result of operations would have been had ECR Pharmaceuticals been acquired on May 1, 2008, nor does it purport to represent results of operations for any future periods.

	Nine Months Ended January 31, 2009 (unaudited)		Three Months Ended January 31, 2009 (unaudited)
Net sales	$	79,590,000	$	33,000,000
Net income	$	5,508,000	$	2,497,000
Weighted average numbers of shares outstanding—Basic		11,328,000		11,180,000
Income per share—Basic	$	0.49	$	0.22
Weighted average numbers of shares outstanding—Diluted		11,760,000		11,510,000
Income per share—Diluted	$	0.47	$	0.22

17. OBLIGATION UNDER CAPITAL LEASE:

During the fiscal year ended April, 30, 2009, the Company entered into capital lease agreements to finance part of its enterprise resource management system. As of January 31, 2010, the Company was obligated to provide for aggregate monthly payments of approximately $17,000 and terms expiring from June through August 2011.

18. FAIR VALUE MEASUREMENTS:

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

The Company’s investment in Neuro-Hitech is valued at the unadjusted quoted price in the active market as of January 31, 2010 and April 30, 2009.

19. SUBSEQUENT EVENTS:

On March 1, 2010, the Company acquired the Mag-Ox® line of magnesium nutritional supplements from Blaine Company, Inc., a privately held company, for $4,100,000 in an all-cash transaction. The Company paid an additional $300,000 for inventory. Under the terms of the acquisition Hi-Tech received rights to Mag-Ox®, Maginex®, Uro-Mag® and Corban™. The products had net sales of approximately $3,400,000 in calendar year 2009. The brands will be sold through the Company’s Health Care Products OTC division.

13

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

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

RESULTS OF OPERATIONS FOR THREE MONTHS ENDED JANUARY 31, 2010 AND 2009

Revenue

	January 31, 2010		January 31, 2009		Change			% Change
Hi-Tech Generics	$	30,449,000	$	24,518,000	$	5,931,000		24	%
Health Care Products		2,894,000		2,639,000		255,000		10	%
Midlothian Laboratories		1,052,000		2,263,000		(1,211,000	)	(54	)%
ECR Pharmaceuticals		4,425,000		—		4,425,000		N/A
Total	$	38,820,000	$	29,420,000	$	9,400,000		32	%

Net sales of Hi-Tech generic pharmaceutical products, which includes some private label contract manufacturing, increased due to increased unit volume and higher pricing for Sulfamethoxazole with Trimethoprin, increased sales of Promethazine products, sales of Acetic Acid with Hydrocortizone, and increased sales of Hydrocodone Bitartrate and Homatropine Methylbromide Syrup. These increases were partially offset by decreases in sales of other unapproved cough and cold and topical products which the Company discontinued. Net sales of Dorzolamide with Timolol ophthalmic solution were approximately $5,700,000 in the current quarter compared with sales of approximately $6,300,000 in the three months ended January 31, 2009.

Sales for the Health Care Products division, which markets the Company’s branded OTC products, increased due to strong demand across multiple product lines.

Midlothian Laboratories’ sales declined due to the discontinuation of unapproved cough and cold products and the divestiture of certain nutritional products in July 2009, for which the Company is now receiving royalty income through December 2010.

In February 2009, the Company acquired the assets of ECR Pharmaceuticals which sells branded prescription products. Sales for the period included sales of the Lodrane^® line of antihistamines, the Dexpak^® line of corticosteroids, Bupap^®, an analgesic tablet and the newly launched VoSol^® HC, a product indicated for swimmer’s ear.

Cost of Sales

	January 31, 2010			January 31, 2009
	$	% of sales		$	% of sales
Cost of Sales	16,269,000	42	%	15,604,000	53	%

The ECR Pharmaceuticals subsidiary, included in this quarter’s results, sells higher margin branded products. The increase in gross profit is due to increased sales of higher margin products including Hydrocortisone with Acetic Acid.

14

Expense (Income) Items

	January 31, 2010			January 31, 2009			Change			% Change
Selling, general and administrative expense	$	11,983,000		$	9,261,000		$	2,722,000		29	%
Research and product development costs	$	1,718,000		$	1,790,000		$	(72,000	)	(4	)%
Royalty and contract research income	$	(2,177,000	)	$	(159,000	)	$	(2,018,000	)	1,269	%
Interest expense	$	9,000		$	12,000		$	(3,000	)	(25	)%
Other (income) expense	$	52,000		$	(548,000	)	$	600,000		(109	)%
Provision for income tax expense	$	2,426,000		$	1,389,000		$	1,037,000		75	%

Selling, general and administrative expenses for the period ended January 31, 2010 include expenses of the ECR Pharmaceuticals subsidiary. ECR Pharmaceuticals markets branded pharmaceuticals to doctors with a sales force of approximately fifty sales representatives, and therefore spends a higher proportion of its sales on selling, general and administrative expenses. ECR Pharmaceutical’s selling, general and administrative expenses totaled $2,355,000 for the three months ended January 31, 2010.

During the period ended January 31, 2010, the Company paid $2,100,000 to its royalty partner on the Dorzolamide with Timolol Ophthalmic Solution to buy out the future royalty stream. This payment is included in selling, general and administrative expense. The Company incurred a royalty expense during the three months ended January 31, 2009 of approximately $2,500,000 based on gross profits on sales of Dorzolamide with Timolol Ophthalmic Solution.

Additional increases in selling, general and administrative expenses in the current period included freight, compensation, and IT expenses related to the implementation of the SAP enterprise resource planning system. The Company accrued a $250,000 fine in selling, general and administrative expenses to settle an alleged DEA violation.

Expenditures for research and development declined slightly as the Company recently completed a clinical trail which had driven costs higher in prior periods.

Royalty income increased due to royalties on certain nutritional products divested by Midlothian Laboratories in July 2009. Royalty income also includes royalties relating to Brometane which the Company divested in July 2008 and a royalty on sales of the 500 mg strength Naprelan^®.

Contract research income increased for the period since the Company achieved several milestones in a contract research project.

The effective tax rate declined this period due to the benefit of stock option exercises and a domestic production credit.

Income Analysis

	January 31, 2010		January 31, 2009		Change		% Change
Net Income	$	8,540,000	$	2,071,000	$	6,469,000	312	%
Basic Earnings Per Share	$	0.70	$	0.19	$	0.51	268	%
Diluted Earnings Per Share	$	0.67	$	0.18	$	0.49	272	%
Weighted Average Common Shares Outstanding, Basic		12,179,000		11,180,000		999,000	9	%
Effect of Potential Common Shares		521,000		330,000		191,000	58	%
Weighted Average Common Shares Outstanding, Diluted		12,700,000		11,510,000		1,190,000	10	%

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

RESULTS OF OPERATIONS FOR NINE MONTHS ENDED JANUARY 31, 2010 AND 2009

Revenue

	January 31, 2010		January 31, 2009		Change			% Change
Hi-Tech Generics	$	99,146,000	$	56,588,000	$	42,558,000		75	%
Health Care Products		8,597,000		7,798,000		799,000		10	%
Midlothian Laboratories		3,192,000		5,950,000		(2,758,000	)	(46	)%
ECR Pharmaceuticals		12,237,000		—		12,237,000		N/A
Total	$	123,172,000	$	70,336,000	$	52,836,000		75	%

Net sales of Hi-Tech generic pharmaceutical products, which include some private label contract manufacturing, increased primarily due to new product launches in the previous year. Sales for Dorzolamide with Timolol Ophthalmic Solution totaled $22,600,000 in the period as the Company sold significantly more units, although at lower average prices. Sales of Dorzolamide with Timolol were approximately $11,700,000 in the nine months ended January 31, 2009. Additionally, the Company launched Hydrocortisone with Acetic Acid, a generic version of VoSol^® HC, which the Company acquired in fiscal 2007. Strong sales of Sulfamethoxazole with Trimethoprim and Fluticasone Propionate nasal spray also contributed to the strong results. The Company discontinued several unapproved cough and cold products in the period, which resulted in significantly lower sales of these products.

15

The Health Care Products division, which markets the Company’s branded OTC products, experienced higher sales of Diabetic Tussin^® and Multibetic^®.

Midlothian Laboratories’ sales declined due to the discontinuation of unapproved cough and cold products and the divestiture of certain nutritional products in July 2009, for which the Company is now receiving royalty income through December 31, 2010.

In February 2009, the Company acquired the assets of ECR Pharmaceuticals which sells branded prescription products. Sales for the period included sales of the Lodrane^® line of antihistamines, the Dexpak^® line of corticosteroids, Bupap^®, an analgesic tablet and the newly launched VoSol^® HC, a product indicated for swimmer’s ear.

Cost of Sales

	January 31, 2010			January 31, 2009
	$	% of sales		$	% of sales
Cost of Sales	51,673,000	42	%	38,570,000	55	%

The increase in gross profit is due to increased sales of higher margin products including Dorzolamide with Timolol ophthalmic solution, Dorzolamide ophthalmic solution and Hydrocortisone with Acetic Acid. As competitors enter the Dorzolamide products market, the Company has experienced a decline in the sales price and gross profit margin for these products. Sales of some products such as Sulfamethoxazole with Trimethoprim were at higher average prices due to a change in the mix of customers. The Company was able to negotiate lower raw material prices from some of its suppliers. Additionally, increases in units produced lowered overhead cost per unit. Sales from ECR Pharmaceuticals, which are higher margin branded products, contributed to this trend.

Expense (Income) Items

	January 31, 2010			January 31, 2009			Change			% Change
Selling, general and administrative expense	$	34,845,000		$	22,659,000		$	12,186,000		54	%
Research and product development costs	$	5,184,000		$	5,479,000		$	(295,000	)	(5	)%
Royalty and contract research income	$	(3,433,000	)	$	(273,000	)	$	(3,160,000	)	1,158	%
Interest expense	$	24,000		$	29,000		$	(5,000	)	(17	)%
Other (income) expense	$	(1,233,000	)	$	(4,234,000	)	$	3,001,000		(71	)%
Provision for income tax expense	$	11,500,000		$	3,411,000		$	8,089,000		237	%

Selling, general and administrative expenses for the period ended January 31, 2010 include expenses of the ECR Pharmaceuticals subsidiary. ECR Pharmaceuticals markets branded pharmaceuticals to doctors with a sales force of approximately fifty sales representatives, and therefore spends a higher proportion of its sales on selling, general and administrative expenses. ECR Pharmaceutical’s selling, general and administrative expenses totaled $6,065,000 for the nine months ended January 31, 2010.

During the period ended January 31, 2010, the Company paid $2,100,000 to its royalty partner on the Dorzolamide with Timolol Ophthalmic Solution to buy out the future royalty stream. This payment is included in selling, general and administrative expense. Prior to this buy-out, the Company incurred a $4,100,000 selling, general and administrative expense to this partner. For the nine months ended January 31, 2009, the Company incurred a $2,500,000 selling, general and administrative expense to this partner.

Additional increases in selling, general and administrative expenses in the current period included freight, legal, compensation, and IT expenses related to the implementation of the SAP enterprise resource planning system. The Company accrued a $250,000 fine in selling, general and administrative expenses to settle an alleged DEA violation.

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

Royalty income increased due to royalties on certain nutritional products divested by Midlothian Laboratories in July 2009. Royalty income also includes royalties relating to Brometane which the Company divested in July 2008 and a royalty on sales of the 500 mg strength Naprelan^®.

Other (income) expense includes the $1,000,000 gain on the sale of the related rights to certain nutritional products previously sold by Midlothian for the period ended January 31, 2010. Other (income) expense includes the $3,500,000 gain on the sale of Brometane for the nine months ended January 31, 2009.

The effective tax rate declined due to the benefit of stock option exercises and a domestic production credit.

16

Income Analysis

	January 31, 2010		January 31, 2009		Change		% Change
Net Income	$	24,612,000	$	4,695,000	$	19,917,000	424	%
Basic Earnings Per Share	$	2.10	$	0.41	$	1.69	412	%
Diluted Earnings Per Share	$	2.01	$	0.40	$	1.61	403	%
Weighted Average Common Shares Outstanding, Basic		11,732,000		11,328,000		404,000	4	%
Effect of Potential Common Shares		533,000		432,000		101,000	23	%
Weighted Average Common Shares Outstanding, Diluted		12,265,000		11,760,000		505,000	4	%

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

LIQUIDITY AND CAPITAL RESOURCES

The Company’s operations are historically financed principally by cash flow from operations. At January 31, 2010 and April 30, 2009, working capital was approximately $86,724,000 and $55,433,000, respectively, an increase of $31,291,000 during the nine months ended January 31, 2010.

Cash from operating activities was approximately $20,711,000 which is primarily due to earnings.

Cash flows used in investing activities were $12,704,000 and were principally the result of payments of notes payable and contingent consideration related to ECR Pharmaceuticals amounted to $5,042,0000, acquisition of product rights amounted to $7,180,000 and purchase of fixed assets amounted to $2,669,000 offset by proceeds from the divestiture of certain products amounted to $2,187,000.

Cash provided by financing activities of $13,654,000 was principally due to $10,934,000 of proceeds from the exercise of options and the related tax benefit of $2,854,000.

The Company believes that its financial resources consisting of current working capital and anticipated future operating revenue will be sufficient to enable it to meet its working capital requirements for at least the next 12 months.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 2009, the FASB issued ASC Topic 810, “Amendments to FASB Interpretation No. 46(R)” (“ASC 810”). ASC 810 amends certain requirements of FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities, to improve financial reporting by enterprises involved with variable interest entities and to provide more relevant and reliable information to users of financial statements. This guidance is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. The Company is currently assessing the impact of the adoption of ASC 810.

SEASONALITY

Historically, the months of September through March account for a greater portion of the Company’s sales than the other months of the fiscal year. However, this sales pattern is unlikely to continue as the Company sells fewer cough and cold products and more products without seasonal fluctuations. Period-to-period comparisons within the same fiscal year are not necessarily meaningful and should not be relied on as indicative of future results.

CRITICAL ACCOUNTING POLICIES

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

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

Revenue Recognition and Accounts Receivable: Revenue is recognized for product sales upon shipment and when risk is passed to the customer and when estimates of discounts, rebates, promotional adjustments, price adjustments, returns, chargebacks, and other potential adjustments are reasonably determinable, collection is reasonably assured and the Company has no further performance obligations. These estimates are presented in the financial statements as reductions to net revenues and accounts receivable. Estimated sales returns, allowances and discounts are provided for in determining net sales. Contract research income is recognized as work is completed and billable costs are incurred. In certain cases, contract research income is based on attainment of designated milestones.

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

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

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

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

• A change in retail customer mix

• A change in negotiated terms with retailers

• Product sales mix at the wholesaler

• Retail inventory levels

• Changes in Wholesale Acquisition Cost (WAC)

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

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

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

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

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

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

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

The following table presents the roll forward of each significant estimate as of January 31, 2010 and January 31, 2009 and for the nine months then ended, respectively.

For the nine months ended January 31, 2010	Beginning Balance May 1		Current Provision		Actual Credits in Current Period			Ending Balance January 31
Chargebacks	$	3,299,000	$	55,837,000	$	(53,260,000	)	$	5,876,000
Sales Discounts		786,000		4,204,000		(4,241,000	)		749,000
Sales Allowances & Returns		8,140,000		20,035,000		(18,470,000	)		9,705,000
Total Adjustment for Returns & Price Allowances	$	12,225,000	$	80,076,000	$	(75,971,000	)	$	16,330,000
For the nine months ended January 31, 2009
Chargebacks	$	2,668,000	$	24,987,000	$	(24,495,000	)	$	3,160,000
Sales Discounts		440,000		2,556,000		(2,423,000	)		573,000
Sales Allowances & Returns		5,357,000		22,059,000		(15,405,000	)		12,011,000
Total Adjustment for Returns & Price Allowances	$	8,465,000	$	49,602,000	$	(42,323,000	)	$	15,744,000

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

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

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

CONTRACTUAL OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS

As part of our ongoing business, we do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of January 31, 2010 we are not involved in any material unconsolidated transactions.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

ITEM 4. CONTROLS AND PROCEDURES

Under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures within 90 days of the filing date of this quarterly report, and, based on their evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures have a material weakness as disclosed in the Company’s Form 10-K for the year ended April 30, 2009.

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During the first quarter of 2010, we implemented a plan to remediate the material weaknesses identified and discussed in detail in our Annual Report on Form 10-K for the year ended April 30, 2009. The material weakness is related to the implementation of a new enterprise resource management system (“ERP System”).

The ERP system was not fully implemented at the “go-live” date and as a result certain internal controls surrounding the modification, processing, retrieving and monitoring of financial data were not fully operational. Additionally, certain financial reporting capabilities were not operational which resulted in some controls around the underlying financial data not being fully operational or performed on a timely basis.

The Company continues to take the necessary steps to monitor and maintain appropriate internal controls during the remaining phase of the implementation. These steps include the continued deployment of resources to mitigate internal control risks and performing additional verifications and testing to ensure ongoing data integrity.

The Company will continue to expand the financial reporting capabilities of the system and implement full functionality of the inventory costing and customer chargeback modules which will offer significant control improvements once implemented. Once fully implemented, in addition to the information technology control improvements, the Company will consider and apply the appropriate manual controls and procedures for the period-end financial close process to ensure timely completion.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The disclosure under Note 12, Contingencies and Other Matters, Legal Proceedings included in Part I of this report is incorporated in this Part II, Item 1 by reference.

ITEM 1A. RISK FACTORS

Not applicable

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

Period	Total Number of Shares Purchased	Average Price per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans	Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans (1)
11/01/09 – 11/30/09	0	$	0	0	$	0
12/01/09 – 12/31/09	0	$	0	0	$	0
1/01/10 – 1/31/10	0	$	0	0	$	0

(1) The Company’s Board of Directors has authorized $23,000,000 to repurchase the Company’s common stock. Pursuant to the terms of a Rule 10b5-1 stock repurchase plan, these repurchases may be made from time to time in the open market or in private transactions as market conditions dictate. To date the Company has purchased 2,456,000 shares for $23,000,000.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4. RESERVED

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ITEM 5. OTHER INFORMATION

None

ITEM 6. EXHIBITS

(a) Exhibits

31.1	Rule 13A-14(a)/15D-14(a) Certification
31.2	Rule 13A-14(a)/15D-14(a) Certification
32	Certification of Officers Pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2003

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SIGNATURES

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

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

by the undersigned thereunto duly authorized.

HI-TECH PHARMACAL CO., INC.

(Registrant)

Date: March 12, 2010

By:	/S/    DAVID S. SELTZER
	David S. Seltzer
	(President and Chief Executive Officer)

Date: March 12, 2010

By:	/S/    WILLIAM PETERS
	William Peters
	(Vice President and Chief Financial Officer)

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