UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
ACETO CORPORATION
(Exact name of registrant as specified in its charter)
New York 11-1720520
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(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)
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Securities registered pursuant to Section 12 (b) of the Act:
Common Stock, Par Value $.01 Per Share The NASDAQ Global Select Market
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(Title of Class) (Name of each exchange on
which registered)
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Securities registered pursuant to Section 12 (g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act.
Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 of Section 15(d) of the Act.
Yes [ ] No [X]
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]
Indicate by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer" and "large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
Indicate by check mark whether the Registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
The aggregate market value of the voting stock of the Company held by non-affiliates of the Company as of December 31, 2006 was approximately $207,307,261.
The Registrant has 24,333,503 shares of common stock outstanding as of September 4, 2007.
Documents incorporated by reference: The information required in response to Part III of this Annual Report on Form 10-K is hereby incorporated by reference to the specified portions of the Registrant's definitive proxy statement for the annual meeting of shareholders to be held on December 6, 2007.
ACETO CORPORATION AND SUBSIDIARIES
FORM 10-K
FOR THE FISCAL YEAR ENDED JUNE 30, 2007
TABLE OF CONTENTS
PART I. 4
Item 1. Business 4
Item 1A. Risk Factors 6
Item 1B. Unresolved Staff Comments 11
Item 2. Properties 11
Item 3. Legal Proceedings 11
Item 4. Submission of Matters to a Vote of Security Holders 12
PART II. 13
Item 5. Market for the Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of
Equity Securities 13
Item 6. Selected Financial Data 15
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 15
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk 27
Item 8. Financial Statements and Supplementary Data 28
Item 9. Changes In and Disagreements With Accountants on
Accounting and Financial Disclosure 28
Item 9A. Controls and Procedures 28
Item 9B. Other Information 31
PART III. 31
Item 10. Directors, Executive Officers and Corporate Governance 31
Item 11. Executive Compensation 31
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters 31
Item 13. Certain Relationships and Related Transactions and
Director Independence 31
Item 14. Principal Accountant Fees and Services 31
PART IV. 31
Item 15. Exhibits and Financial Statement Schedules 31
Signatures 64
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PART I
CAUTIONARY STATEMENT RELATING TO THE SAFE HARBOR PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995
This Annual Report on Form 10-K and the information incorporated by reference includes "forward-looking statements" within the meaning of section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. We intend those forward looking-statements to be covered by the safe harbor provisions for forward-looking statements. All statements regarding our expected financial position and operating results, our business strategy, our financing plans and the outcome of any contingencies are forward-looking statements. Any such forward-looking statements are based on current expectations, estimates, and projections about our industry and our business. Words such as "anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates," or variations of those words and similar expressions are intended to identify such forward-looking statements. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those stated in or implied by any forward-looking statements. Factors that could cause actual results to differ materially from forward-looking statements include, but are not limited to, unforeseen environmental liabilities, international military conflicts, the mix of products sold and their profit margins, order cancellation or a reduction in orders from customers, competitive product offerings and pricing actions, an inability to continue to license technology needed to sell certain of our crop protection products, the availability and pricing of key raw materials, dependence on key members of management, risks of entering into new European markets, and economic and political conditions in the United States and abroad.
NOTE REGARDING DOLLAR AMOUNTS
In this Annual Report, all dollar amounts are expressed in thousands, except share prices and per-share amounts.
ITEM 1. BUSINESS
GENERAL
Aceto Corporation, together with its consolidated subsidiaries, are referred to herein collectively as "Aceto", "Company", "we", "us", and "our" unless the content indicates otherwise. Aceto was incorporated in 1947 in the State of New York. We are a global leader in the sourcing, regulatory support, marketing and distribution of chemically derived pharmaceuticals, biopharmaceuticals, specialty chemicals and crop protection products. Our business is organized along product lines into three principal segments: Health Sciences, Chemicals & Colorants and Crop Protection.
The Health Sciences segment is our largest segment in terms of both sales and gross profits. Products that fall within this segment include active pharmaceutical ingredients (API's), pharmaceutical intermediates, nutritionals and biopharmaceuticals. In fiscal 2007, we entered the market for finished dosage form generic drugs when we received orders for our first Aceto branded product, Isoflurane.
We typically partner with both customers and suppliers years in advance of a drug coming off patent to provide the generic equivalent. We believe we have a pipeline of new API's poised to reach commercial levels over the coming years as the patents on existing drugs expire, both in the United States and Europe. In addition, we continue to explore opportunities to provide a second-source option for existing generic drugs with approved abbreviated new drug applications (ANDA's). The opportunities that we are looking for are to supply the API's for the more mature generic drugs where pricing has stabilized following the dramatic decreases in price that these drugs experienced after coming off patent. As is the case in the generic industry, the entrance into the market of other generic competition generally has a negative impact on the pricing of the affected products.
By leveraging our worldwide sourcing and regulatory capabilities, we believe we can be an alternative lower cost, second-source provider of existing API's to generic drug companies.
Looking at worldwide pharmaceutical sales, and using that as a proxy for our Health Sciences business segment, in calendar 2006, the industry experienced total market growth of $42 billion, or a 7% increase. About one half of this growth originated from the US market where the growth rate of 8.3% reflected the impact of the first year of the Medicare Part D benefit.
The Chemicals & Colorants segment is a major supplier to the many different industries that require outstanding performance from chemical raw materials and additives. Products that fall within this segment include intermediates for dyes, pigments and agrochemicals. We provide chemicals used to make plastics, surface coatings, textiles, lubricants, flavors and fragrances.
Many of Aceto's raw materials are also used in high-tech products like high-end electronic parts (circuit boards and computer chips) and binders for specialized rocket fuels. Aceto is currently responding to the changing needs of our customers in the color producing industry by taking our resources and knowledge downstream as a supplier of select organic pigments. We expect that continued global Gross Domestic Product growth will drive higher demand for the chemical industry, especially in China and other emerging regions of the world. With supply growth limited, we expect that industry supply/demand balances will remain favorable. However, continued volatility in energy costs will add uncertainty to our profit outlook.
According to the American Chemistry Council, the global chemical industry still appears to be in an expansionary mode although leading indicators of global industrial production suggest that the current growth cycle may have peaked. Overall, on a year-over-year basis, global chemical industry production increased by 4.4%.
The Crop Protection segment sells herbicides, pesticides, and other agricultural chemicals to customers, primarily located in the United States and Western Europe. Our joint venture with Nufarm, which markets Butoxone(R), increased our market share of the peanut, soybean and alfalfa herbicide markets. In fiscal 2007, we entered into a multi-year contract with a major agricultural chemical distributor and launched generic Asulam, an herbicide for sugar cane and the first generic registration that Aceto has received. Our plan is to develop over time a pipeline of additional products in a similar manner. The Crop Protection segment was formerly reported as the Agrochemical segment with the name change effected on December 31, 2006.
According to the US Department of Agriculture, total acreage planted in 2007 increased by 1.3% to slightly more than 320 million acres. The number of peanut acres planted in 2007 was down 4.5% from 2006 levels, sugarcane acreage was down 0.7% from 2006 and potato acres planted in 2007 were down 3.6% from 2006 levels.
Our main business strengths are sourcing, regulatory support, quality control, marketing and distribution. With a physical presence in ten countries, we distribute over 1000 chemicals and pharmaceuticals used principally as raw materials in the pharmaceutical, agricultural, color, surface coating/ink and general chemical consuming industries. We believe that we are currently the largest buyer of pharmaceutical and specialty chemicals for export from China, purchasing from over 500 different manufacturers.
Our presence in China, Germany, France, the Netherlands, Singapore, India, Poland, Hong Kong, the United Kingdom and the United States, along with strategically located warehouses worldwide, enable us to respond quickly to demands from customers worldwide, assuring that a consistent, high-quality supply of pharmaceutical, biopharmaceutical, specialty chemicals and crop protection products are readily accessible. We are able to offer our customers competitive pricing, continuity of supply, and quality control. We believe our 60 years of experience, our reputation for reliability and stability, and our long-term relationships with suppliers have fostered loyalty among our customers.
We remain confident about our business prospects. We anticipate continued organic growth which will be enhanced through our plans to enter the market for companion animal vaccines, the market for finished dosage form generic drugs, the Japanese pharmaceutical market, the continued globalization of our Chemicals & Colorants business, the further expansion of our crop protection segment by acquisition of product lines and intellectual property, the continued enhancement of our sourcing operations in China and India, and the steady improvement of our regulatory capabilities.
We believe our track record of continuous product introductions demonstrates that Aceto has come to be recognized by the worldwide generic pharmaceutical industry as an important, reliable supplier. Our plans involve seeking strategic acquisitions that enhance our earnings and forming alliances with partners that add to our capabilities, when possible.
Information concerning revenue and gross profit attributable to each of our reportable segments is found in Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations", and in Note 19 to the Consolidated Financial Statements, Part II, Item 8, "Financial Statements and Supplementary Data."
PRODUCTS AND CUSTOMERS
During the fiscal years ended June 30, 2007 and 2006, approximately 65% and 67%, respectively, of our purchases were from Asia and approximately 21% were from Europe.
Our customers are primarily located throughout the United States, Europe and Asia. They include a wide range of companies in the industrial chemical, agricultural, and health science industries, and range from small trading companies to Fortune 500 companies. During fiscal years 2007 and 2006, sales made to customers in the United States totaled $153,147 and $157,527,
respectively. Sales made to customers outside the United States during fiscal years 2007 and 2006 totaled $160,326 and $139,801, respectively, of which, approximately 58% and 53%, respectively, were to customers located in Europe.
The chemical industry is highly competitive. We compete by offering high-quality products produced around the world by both large and small manufacturers at attractive prices. Because of our long standing relationships with many suppliers as well as our sourcing operations in both China and India, we are able to ensure that any given product is manufactured at a facility that is appropriate for that product. For the most part, we store our inventory of chemicals in public warehouses strategically located throughout the United States, Europe, and Asia, and we can therefore fill orders rapidly from inventory. We have developed ready access to key purchasing, research, and technical executives of our customers and suppliers. This allows us to ensure that when necessary, sourcing decisions can be made quickly.
No single product or customer accounted for as much as 10% of net sales in fiscal years 2007, 2006 or 2005. No single supplier accounted for as much as 10% of purchases in fiscal 2007 and 2006. Two suppliers accounted for approximately 13% and 12% of purchases in fiscal year 2005.
We hold no patents, licenses, franchises or concessions that we consider material to our operations.
Our subsidiary Aceto Agricultural Chemicals Corp. ("Aceto Agricultural") markets, and contracts for the manufacture of, certain crop protection products that are subject to the Federal Insecticide, Fungicide and Rodenticide Act ("FIFRA"). Under FIFRA, companies that wish to market pesticides must provide test data to the Environmental Protection Agency ("EPA") to register, obtain and maintain approved labels for those pesticides. The EPA requires that follow-on registrants of these products, on a basis prescribed in the FIFRA regulations, compensate the initial registrant for the cost of producing the necessary test data. Follow-on registrants do not themselves generate or contract for the data. However, when FIFRA requirements mandate that new test data be generated to enable all registrants to continue marketing a pesticide product, often both the initial and follow-on registrants establish a task force to jointly undertake, and pay for, the testing effort. We are currently a member of three such task force groups and historically, our payments have been in the range of $250 - $500 per year. We may be required to make such additional payments in the future.
EMPLOYEES
At June 30, 2007, we had 224 employees, none of whom were covered by a collective bargaining agreement.
ITEM 1A. RISK FACTORS
You should carefully consider the following risk factors and other information included in this Annual Report. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not currently known to us or that we currently deem immaterial may also impair our business operations. If any of the following risk factors occur, our business, financial condition, operating results and cash flows could be materially adversely affected.
IF WE ARE UNABLE TO COMPETE EFFECTIVELY WITH OUR COMPETITORS, MANY OF WHICH HAVE GREATER MARKET PRESENCE AND RESOURCES THAN US, OUR PROFITABILITY AND FINANCIAL CONDITION WILL BE ADVERSELY AFFECTED.
Our financial condition and operating results are directly related to our ability to compete in the intensely competitive worldwide chemical market. We face intense competition from global and regional distributors of chemical products, many of which are large chemical manufacturers as well as distributors. Many of these companies have substantially greater resources than us, including greater financial, marketing and distribution resources. We cannot assure you that we will be able to compete successfully with any of these companies. In addition, increased competition could result in price reductions, reduced margins and loss of market share for our services, all of which would adversely affect our business, results of operations and financial condition.
WE MAY INCUR SIGNIFICANT UNINSURED ENVIRONMENTAL AND OTHER LIABILITIES INHERENT IN THE CHEMICAL DISTRIBUTION INDUSTRY THAT WOULD HAVE A NEGATIVE EFFECT ON OUR FINANCIAL CONDITION.
The business of distributing chemicals is subject to regulation by numerous federal, state, local, and foreign governmental authorities. These regulations impose liability for loss of life, damage to property and equipment, pollution and other environmental damage that may occur in our business. Many of these regulations provide for substantial fines and remediation costs in the event of chemical spills, explosions and pollution. While we believe that we are in substantial compliance with all current laws and regulations, we can give no assurance that we will not incur material liabilities that exceed our insurance coverage or that such insurance will remain available on terms and at rates acceptable to us.
Additionally, if existing environmental and other regulations are changed, or additional laws or regulations are passed, the cost of complying with those laws may be substantial, thereby adversely affecting our financial performance.
In May 2007, February 2007 and September 2006, the Company received letters from the Pulvair Site Group, a group of potentially responsible parties ("PRP Group") who are working with the State of Tennessee (the "State") to remediate a contaminated property in Tennessee called the Pulvair site. The PRP Group has alleged that one of Aceto's subsidiaries shipped hazardous substances to the site which were released into the environment. The State had begun administrative proceedings against the members of the PRP group and Aceto with respect to the cleanup of the Pulvair site and the group has begun to undertake cleanup. The PRP Group is seeking a settlement of approximately $2,100 from the Company for its share to remediate the site contamination. Although the Company acknowledges that its subsidiary shipped materials to the site for formulation over twenty years ago, the Company believes that the evidence does not show that the hazardous materials sent by Aceto's subsidiary to the site have significantly contributed to the contamination of the environment. Accordingly, the Company believes that the settlement offer is unreasonable. Alternatively, counsel to the PRP Group has proposed that Aceto's subsidiary join it as a participating member and pay 3.16% of the PRP Group's cost. The Company believes that this percentage is high because it is based on the total volume of materials that Aceto's subsidiary sent to the site, most of which were non-hazardous substances and as such, believes that its subsidiary is a very minor contributor to the site contamination. The impact of the resolution of this matter on the Company's results of operations in a particular reporting period is not known. However, management believes that the ultimate outcome of this matter will not have a material adverse effect on the Company's financial condition or liquidity.
Our subsidiary, Arsynco, has environmental remediation obligations in connection with its former manufacturing facility in Carlstadt, New Jersey. Estimates of how much it would cost to remediate environmental contamination at this site have increased since the facility was closed in 1993. If the actual costs are significantly greater than estimated, it could have a material adverse effect on our financial condition, operating results and cash flows.
In March 2006, also related to its former manufacturing facility in Carlstadt, New Jersey, Arsynco received notice from the EPA of its status as a potentially responsible party ("PRP") under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) for a site described as the Berry's Creek Study Area. Arsynco is one of over 150 PRP's which have potential liability for the required investigation and remediation of the site. The estimate of the potential liability is not quantifiable for a number of reasons, including the difficulty in determining the extent of contamination and the length of time remediation may require. In addition, any estimate of liability must also consider the number of other potentially responsible parties and their financial strength. Since an amount of the liability can not be reasonably estimated at this time, no accrual is recorded for these potential future costs. The impact of the resolution of this matter on the Company's results of operations in a particular reporting period is not known. However, management believes that the ultimate outcome of this matter will not have a material adverse effect on the Company's financial condition or liquidity.
THE DISTRIBUTION AND SALE OF OUR PRODUCTS ARE SUBJECT TO PRIOR GOVERNMENTAL APPROVALS AND THEREAFTER ONGOING GOVERNMENTAL REGULATION.
Our products are subject to laws administered by federal, state and foreign governments, including regulations requiring registration and approval of many of our products. More stringent restrictions could make our products less desirable, which would adversely affect our revenues and profitability. Some of our products are subject to the EPA registration and re-registration requirements, and are registered in accordance with FIFRA. Such registration requirements are based, among other things, on data demonstrating that the product will not cause unreasonable adverse effects on human health or the environment when used according to approved label directions. Governmental regulatory authorities have required, and may require in the future, that certain scientific data requirements be performed on our products and this may require us on our behalf or in joint efforts with other registrants to perform additional testing. Responding to such requirements may cause delays in or the cessation of the sales of one or more of our products which would adversely affect our profitability. We can provide no assurance that any testing approvals or registrations will be granted on a timely basis, if at all, or that our resources will be adequate to meet the costs of regulatory compliance or that the economic benefit of complying with the requirement will exceed our cost.
ASSESSMENTS BY VARIOUS TAX AUTHORITIES MAY BE MATERIALLY DIFFERENT THAN THE AMOUNTS WE HAVE PROVIDED FOR IN OUR CONSOLIDATED FINANCIAL STATEMENTS.
We are regularly audited by federal, state, and foreign tax authorities. From time to time, these audits may result in proposed assessments. While we believe that we have adequately provided for any such assessments, future settlements may be materially different than we have provided for and thereby adversely affect our earnings and cash flows.
We operate in various tax jurisdictions, and although we believe that we have provided for income and other taxes in accordance with the relevant regulations, if the applicable regulations were ultimately interpreted differently by a taxing authority, we may be exposed to additional tax liabilities.
IF WE ARE UNABLE TO CONTINUE TO USE LICENSED TECHNOLOGY THAT WE RELY ON TO CONDUCT OUR CROP PROTECTION BUSINESS, OUR PROFITABILITY AND FINANCIAL CONDITION WILL BE ADVERSELY AFFECTED.
We cannot assure you that we will be able to continue to license the technology that we currently rely on in order to sell certain of our crop protection products. An inability to license this technology could prevent us from continuing to sell the products and, in turn, materially adversely affect our profitability and financial condition. We may also incur substantial costs in seeking enforcement of our rights related to our licensed technologies.
One of the Company's crop protection products is subject to certain licensed technology, which expired in August 2007. The Company has commenced a lawsuit against the owner of the patent license bringing claims based on antitrust and breach of contract and related claims. The Company intends to pursue these claims vigorously in order to continue to license the technology and sell the particular crop protection product.
OUR ACQUISITION STRATEGY IS SUBJECT TO A NUMBER OF INHERENT RISKS, INCLUDING THE RISK THAT OUR ACQUISITIONS MAY NOT BE SUCCESSFUL.
We continually seek to expand our business through acquisitions of other companies that complement our own and through joint ventures, licensing agreements and other arrangements. Any decision regarding strategic alternatives would be subject to inherent risks, and we cannot guarantee that we will be able to identify the appropriate opportunities, successfully negotiate economically beneficial terms, successfully integrate any acquired business, retain key employees, or achieve the anticipated synergies or benefits of the strategic alternative selected. Acquisitions can require significant capital resources and divert our management's attention from our existing business. Additionally, we may issue additional shares in connection with a strategic transaction, thereby diluting the holdings of our existing common shareholders, incur debt or assume liabilities, become subject to litigation, or consume cash, thereby reducing the amount of cash available for other purposes.
ANY ACQUISITION THAT WE MAKE COULD RESULT IN A SUBSTANTIAL CHARGE TO OUR EARNINGS.
We have previously incurred charges to our earnings in connection with acquisitions, and may continue to experience charges to our earnings for any acquisitions that we make, including large and immediate write-offs of acquired assets, or impairment charges. These costs may also include substantial severance and other closure costs associated with eliminating duplicate or discontinued products, employees, operations and facilities. These charges could have a material adverse effect on our results of operations for particular quarterly periods and they could possibly have an adverse impact on the market price of our common stock.
OUR REVENUE STREAM IS DIFFICULT TO PREDICT.
Our revenue stream is difficult to predict because it is primarily generated as customers place orders and customers can change their requirements or cancel orders. Many of our sales orders are short-term and may be cancelled at any time. As a result, much of our revenue is not recurring from period to period, which contributes to the variability of our results from period to period. We believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance.
OUR OPERATING RESULTS MAY FLUCTUATE IN FUTURE QUARTERS, WHICH MAY ADVERSELY AFFECT THE TRADING PRICE OF OUR COMMON STOCK.
Our operating results will fluctuate on a quarterly basis as a result of a number of factors, including the timing of contracts, the delay or cancellation of a contract, and changes in government regulations. Any one of these factors could have a significant impact on our quarterly results. In some quarters, our revenue and operating results may fall below the expectations of securities analysts and investors, which would likely cause the trading price of our common stock to decline.
FAILURE TO OBTAIN PRODUCTS FROM OUTSIDE MANUFACTURERS COULD ADVERSELY AFFECT OUR ABILITY TO FULFILL SALES ORDERS TO OUR CUSTOMERS.
We rely on outside manufacturers to supply products for resale to our customers. Manufacturing problems may occur with these and other outside sources. If such problems occur, we cannot ensure that we will be able to deliver our products to our customers profitably or on time.
OUR POTENTIAL LIABILITY ARISING FROM OUR COMMITMENT TO INDEMNIFY OUR DIRECTORS, OFFICERS AND EMPLOYEES COULD ADVERSELY AFFECT OUR EARNINGS AND FINANCIAL CONDITION.
We have committed in our bylaws to indemnify our directors, officers and employees against the reasonable expenses incurred by these persons in connection with an action brought against him or her in such capacity, except in matters as to which he or she is adjudged to have breached a duty to us. The maximum potential amount of future payments we could be required to make under this provision is unlimited. While we have"directors and officers" insurance policies that covers a portion of this potential exposure, we may be adversely affected if we are required to pay damages or incur legal costs in connection with a claim above our insurance limits.
OUR BUSINESS MAY GIVE RISE TO PRODUCT LIABILITY CLAIMS NOT COVERED BY INSURANCE OR INDEMNITY AGREEMENTS.
The marketing, distribution and use of chemical products involves substantial risk of product liability claims. A successful product liability claim that we have not insured against, that exceeds our levels of insurance or that we are not indemnified for may require us to pay a substantial amount of damages. In the event that we are forced to pay such damages, this payment may have a material adverse effect on our financial and operating results.
OUR BUSINESS MAY BE ADVERSELY AFFECTED BY TERRORIST ACTIVITIES.
Our business depends on the free flow of products and services through the channels of commerce. Instability due to military, terrorist, political and economic actions in other countries could materially disrupt our overseas operations and export sales. In fiscal years 2007 and 2006, approximately 53% and 47%, respectively, of our revenues were attributable to operations conducted abroad and to sales generated from the United States to foreign countries. In addition, in fiscal year 2007, approximately 65% and 21% of our purchases came from Asia and Europe, respectively. In addition, in certain countries where we currently operate or export, intend to operate or export, or intend to expand our operations, we could be subject to other political, military and economic uncertainties, including labor unrest, restrictions on transfers of funds and unexpected changes in regulatory environments.
FLUCTUATIONS IN FOREIGN CURRENCY EXCHANGE RATES MAY ADVERSELY AFFECT OUR RESULTS OF OPERATIONS AND FINANCIAL CONDITION.
A substantial portion of our revenue is denominated in currencies other than the U.S. dollar because certain of our foreign subsidiaries operate in their local currencies. Our results of operations and financial condition may therefore be adversely affected by fluctuations in the exchange rate between foreign currencies and the U.S. dollar.
WE RELY HEAVILY ON KEY EXECUTIVES FOR OUR FINANCIAL PERFORMANCE.
Our financial performance is highly dependent upon the efforts and abilities of our key executives. The loss of the services of any of our key executives could therefore have a material adverse effect upon our financial position and operating results. None of our key executives has an employment agreement with us and we do not maintain "key-man" insurance on any of our key executives.
VIOLATIONS OF CGMP AND OTHER GOVERNMENT REGULATIONS COULD HAVE A MATERIAL ADVERSE AFFECT ON OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
All facilities and manufacturing techniques used to manufacture products for clinical use or for commercial sale in the United States must be operated in conformity with current Good Manufacturing Practices ("cGMP") regulations as required by the FDA. Our suppliers' facilities are subject to scheduled periodic regulatory and customer inspections to ensure compliance with cGMP and other requirements applicable to such products. A finding that we had materially violated these requirements could result in one or more regulatory sanctions, loss of a customer contract, disqualification of data for client submissions to regulatory authorities and a mandated closing of our suppliers' facilities, which in turn could have a material adverse effect on our business, financial condition and results of operations.
LITIGATION MAY HARM OUR BUSINESS AND OUR MANAGEMENT AND FINANCIAL RESOURCES.
Substantial, complex or extended litigation could cause us to incur large expenditures and could distract our management. For example, lawsuits by employees, stockholders, collaborators, distributors, customers, or end-users of our products or services could be very costly and substantially disrupt our business. Disputes from time to time with such companies or
individuals are not uncommon, and we cannot assure you that we will always be able to resolve such disputes out of court or on favorable terms.
THE MARKET PRICE OF OUR STOCK COULD BE VOLATILE.
The market price of our common stock has been subject to volatility and may continue to be volatile in the future, due to a variety of factors, including:
o quarterly fluctuations in our operating income and earnings per
share results
o technological innovations or new product introductions by us or
our competitors
o economic conditions
o disputes concerning patents or proprietary rights
o changes in earnings estimates and market growth rate projections
by market research analysts
o sales of common stock by existing security holders
o loss of key personnel
o securities class actions or other litigation
The market price for our common stock may also be affected by our ability to meet analysts' expectations. Any failure to meet such expectations, even slightly, could have an adverse effect on the market price of our common stock. In addition, the stock market is subject to extreme price and volume fluctuations. This volatility has had a significant effect on the market prices of securities issued by many companies for reasons unrelated to the operating performance of these companies.
INCIDENTS RELATED TO HAZARDOUS MATERIALS COULD ADVERSELY AFFECT OUR BUSINESS.
Portions of our operations require the controlled use of hazardous materials. Although we are diligent in designing and implementing safety procedures to comply with the standards prescribed by federal, state, and local regulations, the risk of accidental contamination of property or injury to individuals from these materials cannot be completely eliminated. In the event of such an incident, we could be liable for any damages that result, which could adversely affect our business.
THERE ARE INHERENT UNCERTAINTIES INVOLVED IN ESTIMATES, JUDGMENTS AND ASSUMPTIONS USED IN PREPARING FINANCIAL STATEMENTS IN ACCORDANCE WITH U.S. GENERALLY ACCEPTED ACCOUNTING PRINCIPLES. ANY CHANGES IN THE ESTIMATES, JUDGMENTS AND ASSUMPTIONS WE USE COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR FINANCIAL POSITION AND RESULTS OF OPERATIONS.
The consolidated financial statements included in the periodic reports we file with the SEC are prepared in accordance with U.S. generally accepted accounting principles ("GAAP"). Preparing financial statements in accordance with GAAP involves making estimates, judgments and assumptions that affect reported amounts of assets, liabilities, revenues, expenses and income. Estimates, judgments and assumptions are inherently subject to change, and any such changes could result in corresponding changes to the reported amounts.
FAILURE TO MAINTAIN EFFECTIVE INTERNAL CONTROLS IN ACCORDANCE WITH SECTION 404 OF THE SARBANES-OXLEY ACT COULD HAVE AN ADVERSE EFFECT ON OUR BUSINESS AND STOCK PRICE.
Section 404 of the Sarbanes-Oxley Act requires us to evaluate annually the effectiveness of our internal controls over financial reporting as of the end of each fiscal year and to include a management report assessing the effectiveness of our internal controls over financial reporting in our annual report. Section 404 also requires our independent registered public accounting firm to report on our internal controls over financial reporting. If we fail to maintain the adequacy of our internal controls, we cannot assure you that we will be able to conclude in the future that we have effective internal controls over financial reporting. If we fail to maintain effective internal controls, we might be subject to sanctions or investigation by regulatory authorities, such as the Securities and Exchange Commission or NASDAQ. Any such action could adversely affect our financial results and the market price of our common stock and may also result in delayed filings with the Securities and Exchange Commission.
AVAILABLE INFORMATION
We file annual, quarterly, and current reports, proxy statements, and other information with the U.S. Securities and Exchange Commission. You may read and copy any document we file at the SEC's public reference room at Room 1024, 450 Fifth Street, NW, Washington, D.C. 20549. You may call the SEC at 1-800-SEC-0330 for information on the public reference
room. The SEC maintains a website that contains annual, quarterly, and current reports, proxy statements, and other information that issuers (including Aceto) file electronically with the SEC. The SEC's website is WWW.SEC.GOV.
Our website is WWW.ACETO.COM. We make available free of charge through our Internet site, via a link to the SEC's website at WWW.SEC.GOV, our annual reports on Form 10-K; quarterly reports on Form 10-Q; current reports on Form 8-K; Forms 3, 4 and 5 filed on behalf of our directors and executive officers; and any amendments to those reports and forms. We make these filings available as soon as reasonably practicable after they are electronically filed with, or furnished to, the SEC. The information on our website is not incorporated by reference into this Annual Report.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
Our general headquarters and main sales office occupy approximately 26,000 gross square feet of leased space in an office building in Lake Success, New York. The lease expires in April 2011.
Arsynco's former manufacturing facility is located on a 12-acre parcel in Carlstadt, New Jersey, that it owns. This parcel contains one building with approximately 5,000 gross square feet of office space.
In November 2004, we purchased approximately 1,300 gross square meters of office space located in Shanghai, China for our sales offices and investment purposes.
We also lease office space in Hamburg, Germany; Dusseldorf, Germany; Heemskerk, the Netherlands; Paris, France; Lyon, France; Singapore; Warsaw, Poland and Mumbai, India. These offices are used for sales and administrative purposes.
We believe that our properties are generally well maintained, in good condition and adequate for our present needs.
ITEM 3. LEGAL PROCEEDINGS.
We are subject to various claims that have arisen in the normal course of business. We do not know what impact the final resolution of these matters will have on our results of operations in a particular reporting period. We believe, however, that the ultimate outcome of such matters will not have a material adverse effect on our financial condition or liquidity.
In May 2007, February 2007 and September 2006, the Company received letters from the Pulvair Site Group, a group of potentially responsible parties ("PRP Group") who are working with the State of Tennessee (the "State") to remediate a contaminated property in Tennessee called the Pulvair site. The PRP Group has alleged that one of Aceto's subsidiaries shipped hazardous substances to the site which were released into the environment. The State had begun administrative proceedings against the members of the PRP group and Aceto with respect to the cleanup of the Pulvair site and the group has begun to undertake cleanup. The PRP Group is seeking a settlement of approximately $2,100 from the Company for its share to remediate the site contamination. Although the Company acknowledges that its subsidiary shipped materials to the site for formulation over twenty years ago, the Company believes that the evidence does not show that the hazardous materials sent by Aceto's subsidiary to the site have significantly contributed to the contamination of the environment. Accordingly, the Company believes that the settlement offer is unreasonable. Alternatively, counsel to the PRP Group has proposed that Aceto's subsidiary join it as a participating member and pay 3.16% of the PRP Group's cost. The Company believes that this percentage is high because it is based on the total volume of materials that Aceto's subsidiary sent to the site, most of which were non-hazardous substances and as such, believes that its subsidiary is a very minor contributor to the site contamination. The impact of the resolution of this matter on the Company's results of operations in a particular reporting period is not known. However, management believes that the ultimate outcome of this matter will not have a material adverse effect on the Company's financial condition or liquidity.
In March 2006, Arsynco received notice from the EPA of its status as a PRP under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) for a site described as the Berry's Creek Study Area. Arsynco is one of over 150 PRP's which have potential liability for the required investigation and remediation of the site. The estimate of the potential liability is not quantifiable for a number of reasons, including the difficulty in determining the extent of contamination and the length of time remediation may require. In addition, any estimate of liability must also consider the number of other potentially responsible parties and their financial strength. Since an amount of the liability can not be reasonably estimated at this time, no accrual is recorded for these potential future costs. The impact of the resolution of this
matter on the Company's results of operations in a particular reporting period is not known. However, management currently believes that the ultimate outcome of this matter will not have a material adverse effect on the Company's financial condition or liquidity.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matter was submitted to a vote of our security holders during the fourth quarter of the fiscal year covered by this Annual Report.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Our common stock is traded on the NASDAQ Global Select Market using the symbol "ACET." The following table states the fiscal year 2007 and 2006 high and low sales prices of our common stock as reported by the NASDAQ Global Market for the periods indicated.
HIGH LOW
FISCAL YEAR 2007
First Quarter $ 7.63 $ 6.54
Second Quarter 9.25 6.82
Third Quarter 9.98 7.22
Fourth Quarter 9.48 7.60
FISCAL YEAR 2006
First Quarter $ 8.20 $ 5.49
Second Quarter 6.96 5.64
Third Quarter 7.70 6.44
Fourth Quarter 8.36 6.33
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Cash dividends of $0.075 per common share were paid in January 2007 and cash dividends of $0.10 per common share were paid in June of 2007. Cash dividends of $0.075 per common share were paid in January and June of fiscal years 2006 and 2005. Our revolving credit facility restricts the payment of cash dividends to $4,500 per year.
As of September 4, 2007, there were 520 holders of record of our common stock.
22,172 shares of our common stock were held by the nominee of the Depository Trust Company, the country's principal central depository. For purposes of determining the number of owners of our common stock, those shares are considered to be owned by one holder. Additional individual holdings in street name result in a sizable number of beneficial owners being represented on our records as owned by various banks and stockbrokers.
The following table states certain information with respect to our equity compensation plans at June 30, 2007:
Number of securities
Number of securities to Weighted-average remaining available for
be issued upon exercise exercise price of future issuance under
Plan category of outstanding options outstanding options equity compensation plans
Equity compensation plans approved
by security holders 2,700 $7.58 161
Equity compensation plans not
approved by security holders - - -
-----------------------------------------------------------------------
Total 2,700 $7.58 161
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PERFORMANCE GRAPH
The following graph compares on a cumulative basis the yearly percentage change, assuming dividend reinvestment, over the last five fiscal years in (a) the total shareholder return on our common stock with (b) the total return on the Standard & Poor's 500 Index and (c) the total return on a published line-of-business index - the Dow Jones U.S. Chemicals Index (the "Peer Group").
The following graph assumes that $100 had been invested in each of the Company, the Standard & Poor's 500 Index and the Peer Group on June 30, 2002. The stock price performance included in this graph is not necessarily indicative of future stock price performance.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN
AMONG ACETO CORPORATION, THE S&P 500 INDEX
And The Dow Jones US Chemicals Index
$400 - -[-]
- - ----
$350 - - - ---
- - --[-]
$300 - - - --
[-]- - --
$250 - -- -[-] --
-- - [-]
$200 - - ------------
- .[.].
[_]__
$150 - - [_]_________
[-] _______[_][.].________..........[.]..
[_][.].......
$100 - [_]_________[_]_________...
[.]......... ......
[.]..
$ 50 -
$ 0 -
-----------------------------------------------------------------
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6/02 6/03 6/04 6/05 6/06 6/07
-[-]- Aceto Corporation _[_]_ = S&P 500 Index .[.]. = Dow Jones U.S. Chemicals
ASSUMES $100 INVESTED ON JUNE 30, 2002
ASSUMES DIVIDEND REINVESTMENT
FISCAL YEAR ENDING JUNE 30, 2007
DOW JONES U.S.
ACETO CORPORATION S&P 500 INDEX CHEMICALS
----------------- ------------- --------------
June 30, 2002 100 100 100
June 30, 2003 264 100 91
June 30, 2004 380 119 115
June 30, 2005 246 127 126
June 30, 2006 232 138 134
June 30, 2007 317 166 177
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ITEM 6. SELECTED FINANCIAL DATA
(In thousands, except per-share amounts)
Fiscal Years Ended June 30, 2007 2006 2005 2004(1) 2003 --------------------------- ---- ---- ---- ---- ---- Net sales (2) $313,473 $297,328 $313,431 $296,646 $270,116 Operating income (2) 15,064 12,429 11,590 16,405 13,182 Income from continuing operations 10,212 9,264 10,625 13,111 9,522 Net income(3) 10,212 9,237 10,015 13,067 7,595 At Year End ----------- Working capital $112,930 $104,707 $ 94,249 $ 86,420 $ 72,208 Total assets 188,478 166,592 149,028 149,697 123,519 Long-term liabilities 15,548 15,140 3,982 2,877 1,043 Shareholders' equity 124,827 115,053 107,655 100,266 84,569 Per Diluted Common Share(4) --------------------------- Income from continuing operations $ 0.41 $ 0.38 $ 0.43 $ 0.53 $ 0.40 Net income $ 0.41 $ 0.38 $ 0.41 $ 0.53 $ 0.32 Cash dividends $ 0.175 $ 0.15 $ 0.15 $ 0.11 $ 0.10 |
(1) Includes the acquisition of Pharma Waldhof on December 31, 2003.
(2) Certain reclassifications have been made to fiscal 2006 and prior year
amounts included in the previously filed Form 10-K to conform to the
current year presentation.
(3) Fiscal 2003 net income includes a $1,873 charge ($0.08 per diluted
common share) for a cumulative effect of an accounting change resulting
from an impairment of goodwill.
(4) Adjusted for stock splits, effected in the form of dividends, as
appropriate.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
EXECUTIVE SUMMARY
The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to provide the readers of our financial statements with a narrative discussion about our business. The MD&A is provided as a supplement to and should be read in conjunction with our financial statements and the accompanying notes.
We are reporting a $2,635 increase in operating profit to $15,064 for the year ended June 30, 2007 as compared to $12,429 for the prior year. This increase in operating profit was achieved, despite a highly competitive environment, primarily through maintaining our profit margin and our successful management of selling, general and administrative costs. Net sales for fiscal 2007 were $313,473, an increase of $16,145 from fiscal 2006. This increase in net sales also impacted our gross profit, which increased $3,535 to $54,493 for fiscal 2007. Our net income increased to $10,212, or $0.41 per diluted share, an increase of $975 or 10.6% compared to fiscal year 2006.
Our financial position as of June 30, 2007, remains strong, as we had cash and short-term investments of $35,356, working capital of $112,930, no long-term debt and shareholders' equity of $124,827.
Our business is separated into three principal segments: Health Sciences, Chemicals & Colorants and Crop Protection.
The Health Sciences segment is our largest segment in terms of both sales and gross profits. Products that fall within this segment include API's, pharmaceutical intermediates, nutritionals and biopharmaceuticals. In fiscal 2007, we entered the market for finished dosage form generic drugs when we received orders for our first Aceto branded product, Isoflurane.
We typically partner with both customers and suppliers years in advance of a drug coming off patent to provide the generic equivalent. We believe we have a pipeline of new API's poised to reach commercial levels over the coming years as the patents on existing drugs expire, both in the United States and Europe. In addition, we continue to explore opportunities to
provide a second-source option for existing generic drugs with approved ANDA's. The opportunities that we are looking for are to supply the API's for the more mature generic drugs where pricing has stabilized following the dramatic decreases in price that these drugs experienced after coming off patent. As is the case in the generic industry, the entrance into the market of other generic competition generally has a negative impact on the pricing of the affected products.
By leveraging our worldwide sourcing and regulatory capabilities, we believe we can be an alternative lower cost, second-source provider of existing API's to generic drug companies.
The Chemicals & Colorants segment is a major supplier to the many different industries that require outstanding performance from chemical raw materials and additives. Products that fall within this segment include intermediates for dyes, pigments and agrochemicals. We provide chemicals used to make plastics, surface coatings, textiles, lubricants, flavors and fragrances. Many of Aceto's raw materials are also used in high-tech products like high-end electronic parts (circuit boards and computer chips) and binders for specialized rocket fuels. Aceto is currently responding to the changing needs of our customers in the color producing industry by taking our resources and knowledge downstream as a supplier of select organic pigments. We expect that continued global Gross Domestic Product growth will drive higher demand for the chemical industry, especially in China and other emerging regions of the world. With supply growth limited, we expect that industry supply/demand balances will remain favorable. However, continued volatility in energy costs will add uncertainty to our profit outlook.
The Crop Protection segment sells herbicides, pesticides, and other agricultural chemicals to customers, primarily located in the United States and Western Europe. Our joint venture with Nufarm, which markets Butoxone(R), increased our market share of the peanut, soybean and alfalfa herbicide markets. In fiscal 2007, we entered into a multi-year contract with a major agricultural chemical distributor and launched generic Asulam, an herbicide for sugar cane and the first generic registration that Aceto has received. Our plan is to develop over time a pipeline of additional products in a similar manner. The Crop Protection segment was formerly reported as the Agrochemical segment with the name change effected on December 31, 2006.
We formerly also reported under the Institutional Sanitary Supplies segment, which included cleaning solutions, fragrances and deodorants for commercial and industrial customers. This former segment was successfully divested from our ongoing business during fiscal 2006.
Our main business strengths are sourcing, regulatory support, quality control, marketing and distribution. With a physical presence in ten countries, we distribute over 1,000 chemicals and pharmaceuticals used principally as raw materials in the pharmaceutical, agricultural, color, surface coating/ink and general chemical consuming industries. We believe that we are currently the largest buyer of pharmaceutical and specialty chemicals for export from China, purchasing from over 500 different manufacturers.
In this MD&A, we explain our general financial condition and results of operations, including the following:
o factors that affect our business
o our earnings and costs in the periods presented
o changes in earnings and costs between periods
o sources of earnings
o the impact of these factors on our overall financial condition
As you read this MD&A, refer to the accompanying consolidated statements of income, which present the results of our operations for the three years ended June 30, 2007. We analyze and explain the differences between periods in the specific line items of the consolidated statements of income.
CRITICAL ACCOUNTING ESTIMATES AND POLICIES
This discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. In preparing these financial statements, we were required to make estimates and assumptions that affect the amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We regularly evaluate our estimates including those related to allowances for bad debts, inventories, goodwill and indefinite-life intangible assets, long-lived assets, environmental and other contingencies, income taxes and stock-based compensation. We base our estimates on various factors, including historical experience, advice from outside subject-matter experts, and various assumptions that we believe to be reasonable under the circumstances, which together form the basis for our making judgments about the
carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.
We believe the following critical accounting policies affected our more significant judgments and estimates used in preparing these consolidated financial statements.
REVENUE RECOGNITION
We recognize revenue from sales of any product when it is shipped and title and risk of loss pass to the customer. We have no acceptance or other post-shipment obligations and we do not offer product warranties or services to our customers.
Sales are recorded net of returns of damaged goods from customers, which historically have been immaterial, and sales incentives offered to customers. Sales incentives consist primarily of volume incentive rebates. We record volume incentive rebates as the underlying revenue transactions that result in progress by the customer in earning the rebate are recorded, in accordance with Emerging Issues Task Force ("EITF") 01-09, "Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor's Products)."
ALLOWANCE FOR DOUBTFUL ACCOUNTS
We maintain allowances for doubtful accounts relating to estimated losses resulting from customers being unable to make required payments. Allowances for doubtful accounts are based on historical experience and known factors regarding specific customers and the industries in which those customers operate. If the financial condition of our customers were to deteriorate, resulting in their ability to make payments being impaired, additional allowances would be required.
INVENTORIES
Inventories, which consist principally of finished goods, are stated at the lower of cost (first-in first-out method) or market. We write down our inventories for estimated excess and obsolete goods by an amount equal to the difference between the carrying cost of the inventory and the estimated market value based upon assumptions about future demand and market conditions. A significant sudden increase in demand for our products could result in a short-term increase in the cost of inventory purchases, while a significant decrease in demand could result in an increase in the excess inventory quantities on-hand. Additionally, we may overestimate or underestimate the demand for our products which would result in our understating or overstating, respectively, the write-down required for excess and obsolete inventory. Although we make every effort to ensure the accuracy of our forecasts of future product demand, any significant unanticipated changes in demand could have a significant impact on the value of our inventory and reported operating results.
GOODWILL AND OTHER INDEFINITE-LIVED INTANGIBLE ASSETS
Goodwill is calculated as the excess of the cost of purchased businesses over the value of their underlying net assets. Other indefinite-lived intangible assets principally consist of trademarks. Goodwill and other indefinite-lived intangible assets are not amortized.
In accordance with Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets," we test goodwill and other indefinite-lived intangible assets for impairment on at least an annual basis. To determine the fair value of these intangible assets, we use many assumptions and estimates that directly impact the results of the testing. In making these assumptions and estimates, we use industry-accepted valuation models and set criteria that are reviewed and approved by various levels of management. If our estimates or our related assumptions change in the future, we may be required to record impairment charges for these assets.
LONG-LIVED ASSETS
In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," long-lived assets and certain identifiable intangibles are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Identifiable intangible assets principally consist of customer relationships, customer lists, EPA registrations and related data, patent license and covenants not to compete. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. Recoverability of assets held for sale is measured by comparing the carrying amount of the assets to their estimated fair value. If such assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount of the assets exceed the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.
ENVIRONMENTAL AND OTHER CONTINGENCIES
We establish accrued liabilities for environmental matters and other contingencies when it is probable that a liability has been incurred and the amount of the liability can reasonably be estimated. If the contingency is resolved for an amount greater or less than the accrual, or our share of the contingency increases or decreases, or other assumptions relevant to the development of the estimate were to change, we would recognize an additional expense or benefit in income in the period that the determination was made.
TAXES
We account for income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes." SFAS No. 109 establishes financial accounting and reporting standards for the effects of income taxes that result from an enterprise's activities during the current and preceding years. It requires an asset-and-liability approach to financial accounting and reporting of income taxes.
As of June 30, 2007, we had current net deferred tax assets of $1,656 and non-current net deferred tax assets of $3,212. These net deferred tax assets have been recorded based on our projecting that we will have sufficient future earnings to realize these assets, and the net deferred tax assets have been provided for at currently enacted income tax rates. If we determine that we will not be able to realize a deferred tax asset, an adjustment to the deferred tax asset will result in a reduction of net income at that time.
Deferred taxes have not been provided on undistributed earnings of foreign subsidiaries since substantially all of these earnings are expected to be permanently reinvested in our foreign operations. A deferred tax liability will be recognized when we expect that we will recover those undistributed earnings in a taxable manner, such as through receipt of dividends or sale of the investments. Determination of the amount of the unrecognized U.S. income tax liability is not practical because of the complexities of the hypothetical calculation. In addition, unrecognized foreign tax credit carryforwards would be available to reduce a portion of such U.S. tax liability.
Tax reform has taken place in Germany whereby an income tax law was passed in July 2007, awaiting approval into the Federal Gazette. The enacted tax rate in Germany will potentially change from 40% to 30%. As a result, the deferred tax balance could decrease by $1,600 in 2008.
STOCK-BASED COMPENSATION
With the adoption of SFAS No. 123(R) on July 1, 2005, we are required to record the fair value of stock-based compensation awards as an expense. In order to determine the fair value of stock options on the date of grant, we apply the Black-Scholes option-pricing model, including an estimate of forfeitures. Inherent in this model are assumptions related to expected stock-price volatility, option term, risk-free interest rate and dividend yield. While the risk-free interest rate and dividend yield are less subjective assumptions that are based on factual data derived from public sources, the expected stock-price volatility and option term assumptions require a greater level of judgment which makes them critical accounting estimates.
We use an expected stock-price volatility assumption that is based on the historical daily price changes of the underlying stock which are obtained from public data sources. For stock option grants issued during fiscal 2007, we used an expected stock-price volatility of 57% based upon the historical volatility at the time of issuance. With regard to the weighted-average option term assumption, for stock option grants issued during fiscal 2007, we used an expected option term assumption of 5.5 years as determined under the "simplified" method prescribed in SEC Staff Accounting Bulletin ("SAB") No. 107.
RESULTS OF OPERATIONS
FISCAL YEAR ENDED JUNE 30, 2007 COMPARED TO FISCAL YEAR ENDED JUNE 30, 2006
NET SALES BY SEGMENT
Year ended June 30,
Comparison 2007
2007 2006 Over/(Under) 2006
-------------------- -------------------- --------------------
% of % of $ %
Segment Net Sales Total Net Sales Total Change Change
------- -------- -------- -------- -------- -------- --------
Health Sciences $170,691 54.5% $166,725 56.1% $ 3,966 2.4%
Chemicals & Colorants 123,299 39.3 110,869 37.3 12,430 11.2
Crop Protection 19,483 6.2 19,734 6.6 (251) (1.3)
-------- -------- -------- -------- -------- --------
Net sales $313,473 100.0% $297,328 100.0% $ 16,145 5.4%
======== ======== ======== ======== ======== ========
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GROSS PROFIT BY SEGMENT
Year ended June 30,
Comparison 2007
2007 2006 Over/(Under) 2006
-------------------- -------------------- --------------------
Gross % of Gross % of $ %
Segment Profit Sales Profit Sales Change Change
------- -------- -------- -------- -------- -------- --------
Health Sciences $ 33,007 19.3% $ 32,313 19.4% $ 694 2.1%
Chemicals & Colorants 16,556 13.4 17,144 15.5 (588) (3.4)
Crop Protection 4,930 25.3 4,760 24.1 170 3.6
-------- -------- -------- -------- -------- --------
Segment gross profit 54,493 17.4 54,217 18.2 276 0.5
Freight and storage
costs (1) - - (3,259) (1.1) 3,259 100.0
-------- -------- -------- -------- -------- --------
Gross profit $ 54,493 17.4% $ 50,958 17.1% $ 3,535 6.9%
======== ======== ======== ======== ======== ========
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(1) Prior to July 2006, certain freight and storage costs were not able to be allocated to the segments. Effective July 2006, as a result of certain system improvements, all freight and storage costs are allocated to a particular segment. Therefore, the unallocated portion of certain freight and storage costs for the year ended June 30, 2007 have now been identified to the segments as presented above. Total Company gross profit and margin were not affected by this change in allocation of costs. However, the comparison of gross profit by segment will be affected by the change in allocation of these costs.
NET SALES
Net sales increased $16,145, or 5.4%, to $313,473 for the year ended June 30, 2007, compared with $297,328 for the prior year. We reported sales increases in our Health Sciences and Chemicals & Colorants segments, which were partially offset by a slight sales decrease in our Crop Protection segment.
HEALTH SCIENCES
Net sales for the Health Sciences segment increased by $3,966 for the year ended June 30, 2007, to $170,691, which represents a 2.4% increase over net sales of $166,725 for the prior year. The sales increase from the prior period is primarily related to increased sales from our foreign operations of $9,229, specifically our Germany and Singapore operations, and increased sales from the pharmaceutical intermediates and diagnostics products of $4,365. These increases were partially offset by a decrease from one specific generic product of $9,906 due to its normal selling pattern.
CHEMICALS & COLORANTS
Net sales for the Chemicals & Colorants segment were $123,299 for the year ended June 30, 2007, compared to $110,869 for the prior year. This increase of $12,430 or 11.2%, over the prior period is attributable to an increase in the number of products being offered by our foreign subsidiaries, namely Germany and Singapore. Sales of Chemicals & Colorants by our foreign subsidiaries for the year ended June 30, 2007 increased by $6,920 over the comparable prior year period. The increase in sales for this segment also resulted from the increase in sales in the coatings product group of $7,350. The increase in Chemicals and Colorant sales is partially offset by one customer within our color-pigment and pigment-intermediate business, whose contract expired in fiscal 2006 and purchased $3,118 during 2006 as compared to zero in 2007. Our chemical business is diverse in terms of products, customers and consuming markets.
CROP PROTECTION
Net sales for the Crop Protection segment decreased to $19,483 for the year ended June 30, 2007, a decrease of $251, or 1.3%, over net sales of $19,734 for the prior year. The overall decrease in net sales was mainly attributable to decreases in three products of $2,955 due to the unseasonable dry weather conditions, particularly in the southern U.S. region and the 10-20% reduction of peanut acreage in favor of corn due to the increased demand for ethanol. These decreases were partially offset by the launch of our Asulam product in the first quarter of 2007 which resulted in sales of $2,802.
GROSS PROFIT
Gross profit by segment increased $3,535 to $54,493 (17.4% of net sales) for the year ended June 30, 2007, as compared to $50,958 (17.1% of net sales) for the prior year. The gross profit of each segment was negatively affected by the direct allocation of certain freight and storage costs in 2007 that had been reported as unallocated in prior years. The Company's overall gross profit and margin were not affected but the segmental comparisons to last year have been affected.
HEALTH SCIENCES
Health Sciences' gross profit of $33,007 for the year ended June 30, 2007, was $694 or 2.1% higher than the prior year. This increase in gross profit was directly attributable to the increase in the sales volume. The gross margin declined to 19.3% in fiscal 2007 compared to a gross margin of 19.4% for the prior fiscal year which is directly attributed to the direct allocation of certain freight and storage charges that are not included in last year's comparable period.
CHEMICALS & COLORANTS
Gross profit for the year ended June 30, 2007, decreased by $588, or 3.4%, over the prior year due to the direct allocation of certain freight and storage charges not included in last year's comparable period as well as settlement of an anti-dumping claim of $330. Gross margin decreased from 15.5% in fiscal 2006 to 13.7% in fiscal 2007. The foreign subsidiaries, primarily Germany and Singapore, contributed $625 or 19% more gross profit in 2007 as compared to 2006. Additionally, the coatings product group reported an increase of $723 due to the sales increase previously mentioned above over the prior year.
CROP PROTECTION
Gross profit for the Crop Protection segment increased to $4,930 for the year ended June 30, 2007, versus $4,760 for the prior year, an increase of $170 or 3.6%. The primary reason for the increase in gross profit was due to the launch of the Asulam product. The gross profit was negatively affected by $1,028 related to the sales decline in the three products discussed earlier, which was partially offset by lower costs to maintain our EPA registered products of $338.
UNALLOCATED FREIGHT AND STORAGE COSTS
Unallocated cost of sales was $0 for fiscal 2007 compared to $3,259 in 2006. As a result of certain system improvements, certain freight and storage costs which were not able to be identified to a particular segment in the prior fiscal years, have now been included within the segments. Therefore, there are no unallocated freight and storage costs in the current year. Total Company gross profit and margin were not affected by this allocation. This revision will affect the comparison of the segments' gross profits, however.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses ("SG&A") increased $900, or 2.3%, to $39,429 for the year ended June 30, 2007 compared to $38,529 for the prior year. As a percentage of sales, SG&A decreased to 12.6% for fiscal 2007 versus 13.0% for fiscal 2006. The increase in SG&A is primarily attributable to the increase of $1,244 in personnel costs including increased bonus expenses and additional employees, $415 increase in sales and marketing expenses, and $259 increased legal costs, partially offset by lower operating expenses of $952 resulting from the sale of one of our subsidiaries in August 2005 and a $537 charge for settlement of legal claims against one of our subsidiaries in 2006.
OPERATING INCOME
Fiscal 2007 operating income was $15,064 compared to $12,429 in the prior year, an increase of $2,635 or 21.2%. This increase was due to the $3,535 increase in gross profit, which was partially offset by the overall increase in SG&A expenses of $900.
INTEREST AND OTHER INCOME, NET
Interest and other income was $532 for fiscal 2007, which represents a 44.4% decrease from $956 in fiscal 2006. The decrease is primarily attributable to a decrease of $409 in a government subsidy paid annually for doing business in a free trade zone in Shanghai, China and net loss on foreign currency of $770, partially offset by an increase in interest income of $455 due to increased investments during the year and increased interest rates.
PROVISION FOR INCOME TAXES
The effective tax rate for fiscal 2007 increased to 33.8% from 30.1% for fiscal 2006. The increase in the effective tax rate relates primarily to increased earnings in foreign tax jurisdictions with higher tax rates, primarily Germany.
RESULTS OF OPERATIONS
FISCAL YEAR ENDED JUNE 30, 2006 COMPARED TO FISCAL YEAR ENDED JUNE 30, 2005
NET SALES BY SEGMENT
Year ended June 30,
Comparison 2006
2006 2005 Over/(Under) 2005
-------------------- -------------------- --------------------
% of % of $ %
Segment Net Sales Total Net Sales Total Change Change
------- -------- -------- -------- -------- -------- --------
Health Sciences $166,725 56.1% $184,577 58.9% $(17,852) (9.7)
Chemicals & Colorants 110,869 37.3 104,777 33.4 6,092 5.8
Crop Protection 19,734 6.6 20,031 6.4 (297) (1.5)
Institutional Sanitary
Supplies - 4,046 1.3 (4,046) (100.0)
-------- -------- -------- -------- -------- --------
Net sales $297,328 100.0% $313,431 100.0% $(16,103) (5.1%)
======== ======== ======== ======== ======== ========
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GROSS PROFIT BY SEGMENT
Year ended June 30,
Comparison 2006
2006 2005 Over/(Under) 2005
-------------------- -------------------- --------------------
Gross % of Gross % of $ %
Segment Profit Sales Profit Sales Change Change
------- -------- -------- -------- -------- -------- --------
Health Sciences $ 32,313 19.4% $ 32,886 17.8% $ (573) (1.7)%
Chemicals & Colorants 17,144 15.5 17,257 16.5 (113) (0.6)
Crop Protection 4,760 24.1 6,719 33.5 (1,959) (29.2)
Institutional Sanitary
Supplies - - 696 17.2 (696) (100.0)
-------- -------- -------- -------- -------- --------
Segment gross profit 54,217 18.2 57,558 18.4 (3,341) (5.8)
Freight and storage
costs (1) (3,259) (1.1) (4,407) (1.4) 1,148 26.0
-------- -------- -------- -------- -------- --------
Gross profit $ 50,958 17.1% $ 53,151 17.0% $ (2,193) (4.1)%
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(1) Represents certain freight and storage costs that are not allocated to a segment.
NET SALES
Net sales decreased $16,103, or 5.1%, to $297,328 for the year ended June 30, 2006, compared with $313,431 for the prior year. We reported sales decreases in our Health Sciences and Crop Protection segments, which were partially offset by a sales increase in our Chemicals & Colorants segment.
HEALTH SCIENCES
Net sales for the Health Sciences segment decreased by $17,852 for the year ended June 30, 2006, to $166,725, which represents a 9.7% decrease over net sales of $184,577 for the prior year. The sales decrease from the prior period is directly attributable to the loss of foreign business of $16,716 from two previously launched APIs due to increased competition. The fiscal 2006 results, net of the two lost APIs, include a sales reduction of $2,243 from our foreign operations which was partially offset by a sales increase of $1,162 from our domestic operations over the prior fiscal year.
CHEMICALS & COLORANTS
Net sales for the Chemicals & Colorants segment were $110,869 for the year ended June 30, 2006, compared to $104,777 for the prior year. This increase of $6,092, or 5.8%, over the prior period is primarily attributable to an increase in the agricultural intermediate, food, beverage and cosmetics and coatings product groups of $7,650 as compared to fiscal 2005. Our chemical business is diverse in terms of products, customers and consuming markets. One customer within our color-pigment and pigment-intermediate business purchased $3,515 less product during fiscal 2006 as their contract had expired. This reduction was more than offset by an increase over the prior period in domestic sales of our diverse chemical and colorants offerings. In addition, net sales include a $1,783 increase relating to our former CDC business, primarily from sales of the Anti-Clog product we retained.
CROP PROTECTION
Net sales for the Crop Protection segment decreased to $19,734 for the year ended June 30, 2006, a decrease of $297, or 1.5%, over net sales of $20,031 for the prior year. This decline over the prior year was primarily due to dry weather conditions shortening the agricultural selling season, for our second largest product.
GROSS PROFIT
Gross profit by segment before unallocated cost of sales (primarily storage and certain freight costs) decreased $3,341 to $54,217 (18.2% of net sales) for the year ended June 30, 2006, as compared to $57,558 (18.4% of net sales) for the prior year.
HEALTH SCIENCES
Health Sciences' gross profit of $32,313 for the year ended June 30, 2006, was $573 or 1.7% lower than the prior year. This decrease in gross profit was directly attributable to the loss of business on two larger previously-launched APIs in Asia of $2,373 due to significant competitive pressures as well as a decrease in our foreign business, net of the two APIs, of $499. This lost gross profit was partially offset by an increase in gross profit from sales increases from our domestic business of $1,087 over the prior fiscal year. The gross margin increased to 19.4% in fiscal 2006 compared to a gross margin of 17.8% for the prior fiscal year due primarily to a shift in the product mix of net sales to higher margin products during the 2006 fiscal year.
CHEMICALS & COLORANTS
Gross profit for the year ended June 30, 2006, decreased by $113, or 0.6%, over the prior year. Gross margin decreased from 16.5% in fiscal 2005 to 15.5% in fiscal 2006. Decreases in categories such as organic chemicals and chemical intermediates in terms of both volume and margins were the primary reasons for these decreases. In addition, the decrease in gross margin percentage was partly attributable to an increased allocation of certain freight and storage costs.
CROP PROTECTION
Gross profit for the Crop Protection segment decreased to $4,760 for the year ended June 30, 2006, versus $6,719 for the prior year, a decrease of $1,959 or 29.2%. Gross margin decreased from 33.5% in fiscal 2005 to 24.1% in fiscal 2006. The
primary cause of the decrease was lower royalty payments from our foreign customers of $652 and lower gross margins on our second highest volume product compared to the prior fiscal year of $416. The gross profits and margins were also negatively affected by higher costs associated with maintaining our EPA registered products and increased rebate expenses of $339.
UNALLOCATED FREIGHT AND STORAGE COSTS
Unallocated cost of sales decreased $1,148, to $3,259 in fiscal 2006, compared to $4,407 in the prior year, representing a 26.0% decrease. The lower costs were mainly a result of decreased sales and shipments to customers. In addition, certain system improvements allow previously unallocated costs to be identifiable and included in a particular segment.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses ("SG&A") decreased $3,032, or 7.3%, to $38,529 for the year ended June 30, 2006 compared to $41,561 for the prior year. As a percentage of sales, SG&A remained stable at 13.0% for fiscal 2006 versus 13.3% for fiscal 2005. The decrease in SG&A was primarily due to a $1,405 decrease in expenses for our former CDC business, reduced legal fees of $878, a reduction in audit and Sarbanes-Oxley compliance costs of $428 and reduced sales and marketing related expenses of $638. These expense reductions were partially offset by a $537 charge for a settlement of legal claims against one of our subsidiaries.
OPERATING INCOME
Fiscal 2006 operating income was $12,429 compared to $11,590 in the prior year, an increase of $839 or 7.2%. This increase was due to the $3,032 decrease in SG&A expenses, which was partially offset by the overall decrease in gross profit of $2,193.
INTEREST AND OTHER INCOME
Interest and other income was $956 for fiscal 2006, which represents a 24.8% decrease from $1,271 in fiscal 2005. The decrease is primarily attributable to a net loss on foreign currency of $537 offset in part by an increase of $208 in interest income.
PROVISION FOR INCOME TAXES
The effective tax rate for fiscal 2006 increased to 30.1% from 16.9% for fiscal 2005. The effective tax rate for fiscal 2005 included the recognition of certain deferred tax assets for foreign net operating loss carryforwards, which previously were fully offset by a valuation allowance in the amount of $1,263. Excluding the recognition of the deferred tax assets, the effective tax rate for fiscal 2005 would have been 26.8%. The increase in the effective tax rate relates primarily to increased earnings in foreign tax jurisdictions with higher tax rates, primarily Germany.
DISCONTINUED OPERATIONS
In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-lived Assets," the results of operations for one of the subsidiaries forming part of the Institutional Sanitary Supplies segment have been recorded as discontinued operations in the accompanying consolidated statements of income. The net loss from discontinued operations was $27 and $610 the fiscal years ended 2006 and 2005, respectively. The net loss from discontinued operations for the fiscal year ended 2005 includes a non-cash write-down of goodwill, net of an income tax benefit, of $570.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOWS
At June 30, 2007, we had $32,320 in cash, $3,026 in short-term investments and only $25 in short-term bank loans.
Our cash position at June 30, 2007 decreased $1,412 from the amount at June 30, 2006. Operating activities for the year ended June 30, 2007 provided cash of $4,163 as compared to cash provided by operations of $16,028 for the comparable 2006 period. The $4,163 was comprised of $10,212 in net income and $3,878 derived from adjustments for non-cash items, offset by a net $9,927 decrease from changes in operating assets and liabilities. The non-cash items included $1,791 in depreciation and amortization expense and $1,692 for the deferred income taxes provision. Accounts receivable increased $6,973 during the year ended June 30, 2007, due to increased sales during the fourth quarter of 2007 as compared to the
fourth quarter of 2006. Inventories increased by approximately $12,565 and accounts payable increased by $7,884 as a result of a ramp-up in orders for products to be shipped in the first quarter of 2008 and an increase in products in which we have decided to carry stock. Accrued expenses and other liabilities increased $4,185 during the year ended June 30, 2007, due primarily to an increase in accrued expenses related to a joint venture, an increase in accrued expenses for our foreign subsidiaries related to increased sales and profitability overseas, as well as increase in accrued compensation related to increased performance payments, which are anticipated to be paid in the first quarter of 2008. Other receivables increased $1,726 due to an increase in VAT taxes receivables in our European subsidiaries, related to increased sales in that region. Our cash position at June 30, 2006, increased $13,782 from the amount at June 30, 2005. Operating activities provided cash of $16,028, primarily from net income of $9,237 and a decrease in inventory of $4,909. Our cash position at June 30, 2005, decreased $3,380 from the amount at June 30, 2004. Operating activities used cash of $771, primarily due to inventories having been increased by $10,188 in order to take advantage of current prices in an environment of rising prices and the anticipated revaluation of the Chinese currency which may increase future product costs. This was partially offset by net income of $10,015.
Investing activities for the year ended June 30, 2007 used cash of $2,591 primarily related to purchases of investments of $6,274 and purchases of property and equipment and intangibles of $704 and $2,468, respectively, including $2,000 for the Asulam product registration and related data filed with the United States Environmental Protection Agency and state regulatory agencies to support such registrations and other supporting data. The amount of cash used for investing activities is offset in part by $6,779 of maturities of available for sale investments. We expect capital expenditures will be between $1,000 and $1,500 during fiscal 2008, including approximately $600 for the opening of a facility in India. Investing activities for the year ended June 30, 2006 provided cash of $1,387, primarily as a result of proceeds from the sale of investments of $1,799. This was partially offset by $485 of expenditures for property and equipment. Investing activities for the year end June 30, 2005 provided cash of $486, primarily as a result of net proceeds from investments of $4,537. This was partially offset by $4,195 of expenditures for property and equipment, including the purchase of office space located in Shanghai, China in the amount of $3,015.
Financing activities for the year ended June 30, 2007 used cash of $3,991 primarily from the payments of dividends of $4,257. Financing activities for the year ended June 30, 2006 used cash of $4,009 primarily as a result of payments of cash dividends of $3,637 and payments for purchases of treasury stock of $581. Financing activities for the year end June 30, 2005 used cash of $3,069 primarily as a result of payments of cash dividends of $3,641 and payment of a related party note of $500, which were partially offset by proceeds from the exercise of stock options of $946.
CREDIT FACILITIES
We have available credit facilities with certain foreign financial institutions. These facilities provide us with a line of credit of $19,472, as of June 30, 2007. We are not subject to any financial covenants under these arrangements.
In June 2007, we amended our revolving credit agreement with a financial institution that expires June 30, 2010, and provides for available credit of $10,000. At June 30, 2007, we had utilized $702 in letters of credit, leaving $9,298 of this facility unused. Under the credit agreement, we may obtain credit through direct borrowings and letters of credit. Our obligations under the credit agreement are guaranteed by certain of our subsidiaries and are secured by 65% of the capital of certain of our non-domestic subsidiaries. There is no borrowing base on the credit agreement. Interest under the credit agreement is at LIBOR plus 1.50%. The credit agreement contains several covenants requiring, among other things, minimum levels of debt service and tangible net worth. We are also subject to certain restrictive debt covenants, including covenants governing liens, limitations on indebtedness, limitations on cash dividends, guarantees, sale of assets, sales of receivables, and loans and investments. We were in compliance with all covenants at June 30, 2007.
WORKING CAPITAL OUTLOOK
Working capital was $112,930 at June 30, 2007, versus $104,707 at June 30, 2006. The increase in working capital was primarily attributable to net income during the year. We continually evaluate possible acquisitions of or investments in businesses that are complementary to our own, and such transactions may require the use of cash. The Company is considering forming a joint venture in connection with their crop protection business. The joint venture will require us to acquire product registration costs and related data filed with the United States Environmental Protection Agency, which could approximate $2,000 in fiscal 2008. We believe that our cash, other liquid assets, operating cash flows, borrowing capacity and access to the equity capital markets, taken together, provide adequate resources to fund ongoing operating expenditures and the anticipated continuation of semi-annual cash dividends for the next twelve months. We may obtain additional credit facilities to enhance our liquidity.
OFF-BALANCE SHEET ARRANGEMENTS AND COMMITMENTS AND CONTINGENCIES
We have no material financial commitments other than those under operating lease agreements, letters of credit and unconditional purchase obligations. We have certain contractual cash obligations and other commercial commitments that will affect our short and long-term liquidity. At June 30, 2007, we had no significant obligations for capital expenditures. At June 30, 2007, contractual cash obligations and other commercial commitments were as follows:
Payments Due and/or
Amount of Commitment
(Expiration Per Period)
-----------------------
Less than 1-3 4-5 After
Total 1 Year Years Years 5 Years
------- ------- ------- ------- -------
Operating leases $ 5,074 $ 1,543 $ 2,544 $ 913 $ 74
Commercial letters of credit
702 702 - - -
Standby letters of credit 225 225 - - -
Unconditional purchase
obligations 71,891 67,611 4,280 - -
------- ------- ------- ------- -------
Total $77,892 $70,081 $ 6,824 $ 913 $ 74
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Other significant commitments and contingencies include the following:
1. One of our subsidiaries markets certain crop protection products which are subject to the Federal Insecticide, Fungicide and Rodenticide Act ("FIFRA"). FIFRA requires that test data be provided to the EPA to register, obtain and maintain approved labels for pesticide products. The EPA requires that follow-on registrants of these products compensate the initial registrant for the cost of producing the necessary test data on a basis prescribed in the FIFRA regulations. Follow-on registrants do not themselves generate or contract for the data. However, when FIFRA requirements mandate that new test data be generated to enable all registrants to continue marketing a pesticide product, often both the initial and follow-on registrants establish a task force to jointly undertake the testing effort. We are presently a member of three such task force groups and historically, our payments have been in the range of $250 - $500 per year. We may be required to make additional payments in the future.
2. We, together with our subsidiaries, are subject to pending and threatened legal proceedings that have arisen in the normal course of business. We do not know how the final resolution of these matters will affect our results of operations in a particular reporting period. Our management is of the opinion, however, that the ultimate outcome of such matters will not have a material adverse effect upon our financial condition or liquidity.
3. In March 2006, Arsynco received notice from the EPA of its status as a PRP under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) for a site described as the Berry's Creek Study Area. Arsynco is one of over 150 PRP's which have potential liability for the required investigation and remediation of the site. The estimate of the potential liability is not quantifiable for a number of reasons, including the difficulty in determining the extent of contamination and the length of time remediation may require. In addition, any estimate of liability must also consider the number of other potentially responsible parties and their financial strength. Since an amount of the liability can not be reasonably estimated at this time, no accrual is recorded for these potential future costs. The impact of the resolution of this matter on the Company's results of operations in a particular reporting period is not known. However, management currently believes that the ultimate outcome of this matter will not have a material adverse effect on the Company's financial condition or liquidity.
RELATED PARTY TRANSACTIONS
Certain of our directors are affiliated with law firms that serve as our legal counsel on various corporate matters. During fiscal years 2007, 2006 and 2005, we incurred legal fees of $329, $315 and $215, respectively, for services rendered to the Company by those law firms. We believe that the fees charged by those firms were at rates comparable to rates obtainable from other firms for similar services.
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
In June 2006, the Financial Accounting Standards Board's ("FASB") EITF issued EITF 06-3, "How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation)." The Task Force determined that the presentation of certain taxes on either a gross basis (included in revenues and expenses) or a net basis (excluded from revenues) is an accounting policy decision that should be disclosed. An entity is not required to re-evaluate its existing policies related to taxes assessed by a governmental authority. However, an entity is required to disclose the amounts of such taxes reported on a gross basis. The Company has adopted EITF 06-3 and reports these taxes on a net basis.
In June 2006, the FASB issued FASB Interpretation ("FIN") No. 48 "Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement 109". FIN 48 prescribes a comprehensive model for recognizing, measuring, presenting and disclosing in the financial statements tax positions taken or expected to be taken on a tax return. FIN 48 is effective for fiscal years beginning after December 15, 2006. Management is currently assessing the impact of FIN 48 on the consolidated financial position and results of operations.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" ("SFAS No. 157"). SFAS No. 157 establishes a common definition for fair value to be applied to US GAAP guidance requiring use of fair value, establishes a framework for measuring fair value, and expands disclosure about such fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. Management is currently assessing the impact of SFAS No. 157 on the consolidated financial position and results of operations.
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans" ("SFAS No. 158"). SFAS No. 158 requires that employers recognize on a prospective basis the funded status of their defined benefit pension and other postretirement plans on their consolidated balance sheet and recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost. SFAS No. 158 also requires additional disclosures in the notes to financial statements. The Company adopted the recognition and disclosure provisions of this statement for the year ended June 30, 2007. The adoption of this statement did not have a material impact on the Company's consolidated financial position.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities--including an Amendment of FASB Statement No. 115" (" SFAS No. 159"). SFAS No. 159 allows companies the choice to measure many financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected will be recognized in earnings at each subsequent reporting date. The provisions of SFAS No. 159 will be effective for fiscal years beginning after November 15, 2007. Management is currently evaluating the impact of SFAS No. 159 on the consolidated financial position and results of operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK SENSITIVE INSTRUMENTS
The market risk inherent in our market-risk-sensitive instruments and positions is the potential loss arising from adverse changes in investment market prices, foreign currency exchange-rates and interest rates.
INVESTMENT MARKET PRICE RISK
We had short-term investments of $3,036 at June 30, 2007. Those short-term investments consisted of government and agency securities, corporate bonds and corporate equity securities, and they were recorded at fair value and had exposure to price risk. If this risk is estimated as the potential loss in fair value resulting from a hypothetical 10% adverse change in prices quoted by stock exchanges, the effect of that risk would be $304 as of June 30, 2007. Actual results may differ.
FOREIGN CURRENCY EXCHANGE RISK
In order to reduce the risk of foreign currency exchange rate fluctuations, we hedge some of our transactions denominated in a currency other than the functional currencies applicable to each of our various entities. The instruments used for hedging are short-term foreign currency contracts (futures). The changes in market value of such contracts have a high correlation to price changes in the currency of the related hedged transactions. At June 30, 2007, we had foreign currency contracts outstanding that had a notional amount of $13,793. The difference between the fair market value of the foreign currency contracts and the related commitments at inception and the fair market value of the contracts and the related commitments at June 30, 2007, was not material.
In addition, we enter into cross currency interest rate swaps to reduce foreign currency exposure on inter-company transactions. In June 2004 we entered into a one-year cross currency interest rate swap transaction, which expired in June 2005 when the underlying inter-company loan was repaid, and in May 2003 we entered into a five-year cross currency interest rate swap transaction, both for the purpose of hedging fixed-interest-rate, foreign-currency-denominated cash flows under inter-company loans. Under the terms of these derivative financial instruments, U.S. dollar fixed principal and interest payments to be received under inter-company loans will be swapped for Euro denominated fixed principal and interest payments. The change in fair value of the swaps from date of purchase to June 30, 2007, was $(75). The gains or losses on the inter-company loans due to changes in foreign currency rates will be offset by the gains or losses on the swap in the accompanying consolidated statements of income. Since our interest rate swaps qualify as hedging activities, the change in their fair value, amounting to $161 and $42 in fiscal 2007 and 2006, respectively, is recorded in accumulated other comprehensive income included in the accompanying consolidated balance sheets.
We are subject to risk from changes in foreign exchange rates for our
subsidiaries that use a foreign currency as their functional currency and are
translated into U.S. dollars. These changes result in cumulative translation
adjustments, which are included in accumulated other comprehensive income
(loss). On June 30, 2007, we had translation exposure to various foreign
currencies, with the most significant being the Euro and the Chinese Renminbi.
The potential loss as of June 30, 2007, resulting from a hypothetical 10%
adverse change in quoted foreign currency exchange rates amounted to $5,791.
Actual results may differ.
INTEREST RATE RISK
Due to our financing, investing and cash-management activities, we are subject to market risk from exposure to changes in interest rates. We utilize a balanced mix of debt maturities along with both fixed-rate and variable-rate debt to manage our exposure to changes in interest rates. Our financial instrument holdings at year-end were analyzed to determine their sensitivity to interest rate changes. In this sensitivity analysis, we used the same change in interest rate for all maturities. All other factors were held constant. If there were an adverse change in interest rates of 10%, the expected effect on net income related to our financial instruments would be immaterial. However, there can be no assurances that interest rates will not significantly affect our results of operations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements and supplementary data required by this Item 8 are set forth later in this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
As previously reported on Form 8-K dated November 29, 2005, the Company decided to change accountants. There were no disagreements with predecessor accountants.
ITEM 9A. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Our disclosure controls and procedures are also designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officer, to allow timely decisions regarding required disclosure. Our chief executive offi