| The following table sets forth certain elements of our Consolidated Statements of Cash Flows (in thousands): | |
| | | |
| | Fiscal Year Ended | |
| | July 31, | July 31, | July 31, | |
| | | 2006 | 2005 | 2004 | |
| Net cash provided by operating activities | $ 10,635 | $ 12,985 | $ 18,577 | |
| | Net cash used in investing activities | (14,979) | (3,575) | (10,428) | |
| Net cash provided by (used in) financing activities | 5,560 | (9,638) | (6,262) | |
| | Effect of exchange rate changes on cash and cash equivalents | (554) | (175) | (292) | |
| Net increase (decrease) in cash and cash equivalents | 662 | (403) | 1,595 | |
Net cash provided by operating activities
Net cash provided by operations decreased by $2,350,000 to $10,635,000 in fiscal 2006. The decrease was due primarily to a decrease in net income during fiscal 2006, a decrease in depreciation and amortization and other non-cash charges, and an increase in working capital. Net cash provided by operations decreased by $5,592,000 to $12,985,000 in fiscal 2005. The decrease was due primarily to a decrease in depreciation and other non-cash charges and a decrease in current liabilities. For fiscal years 2006 and 2005, the primary components of working capital that impacted operating cash flows were as follows:
Accounts receivable, less allowance for doubtful accounts, increased by $2,631,000 compared to fiscal year end 2005. The increase was due to sales in the fourth quarter of fiscal 2006 of $51,694,000 versus sales for the fourth quarter of fiscal 2005 of $46,017,000. Accounts receivable in 2005 decreased $531,000 as compared to 2004 due to bad debt recovery and a focused effort to improve accounts receivable processes.
Inventories increased in 2006 compared to fiscal 2005 by $3,011,000 due to higher cost of materials and increased tons in ending inventory. Inventories in 2005 increased only $287,000 as compared to fiscal 2004.
Prepaid overburden removal expense in fiscal 2006 increased $316,000 compared to fiscal 2005. During fiscal 2005, prepaid overburden removal expense decreased $1,037,000. Year to year fluctuations are the result of different amounts of non-usable material that need to be removed from the various sites.
Accounts payable and other accrued expenses increased $3,775,000 in fiscal 2006 compared to fiscal 2005 due to increased energy and packaging costs. During fiscal 2005, accounts payable and accrued expenses decreased $3,101,000 due to a $1,250,000 accrual for a patent infringement lawsuit settlement at July 31, 2004 and lower accruals for trade promotions, advertising and bonus at July 31, 2005.
Net cash used in investing activities
Cash used in investing activities increased $11,404,000 compared to fiscal 2005 to $14,979,000 during fiscal 2006. In fiscal 2006, cash used for capital expenditures was $10,827,000, a $3,516,000 increase compared to fiscal 2005. During fiscal 2006 cash available from new long-term debt financing was used to purchase debt and investment securities of $5,158,000 (net of dispositions), compared to net dispositions of debt and investment securities of $3,699,000 in fiscal 2005. Cash proceeds from the sale of property, plant and equipment were $1,006,000 in fiscal 2006 versus $37,000 in fiscal 2005.
Cash used in investing activities decreased $6,853,000 compared to fiscal 2004 to $3,575,000 during fiscal 2005. In fiscal 2004, more cash was available for investing due to $2,241,000 received from the termination of two split-dollar life insurance plans and reduced capital spending as compared to fiscal 2003. In fiscal 2003, $6,000,000 cash was spent to purchase assets related to the Jonny Cat brand of cat litter. During fiscal 2004 cash was used to purchase debt and investment securities of $4,997,000 (net of dispositions). In fiscal 2005, many of these investments matured and the cash was used for the purchase of treasury stock. During fiscal 2005, cash was provided by dispositions of debt and investment securities of $3,699,000 (net of purchases). Conversely, cash used for capital expenditures in fiscal 2005 increased $1,244,000 compared to fiscal 2004.
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Net cash provided by (used in) financing activities
Cash was provided by financing activities during fiscal 2006 of $5,560,000 compared to cash used by financing activities during fiscal 2005 of $9,638,000. During fiscal 2006 cash was provided primarily from proceeds from issuance of long-term debt of $15,000,000. Principal payments on long-term debt were also $1,000,000 less in fiscal 2006 versus 2005 and net purchases of treasury stock were $585,000 lower in fiscal 2006 versus 2005. In contrast, proceeds from issuance of common stock, primarily related to stock option exercises, were $1,687,000 lower in fiscal 2006 versus 2005.
Cash used by financing activities increased $3,376,000 compared to fiscal 2004 to $9,638,000 during fiscal 2005. During fiscal 2005 net purchases of treasury stock were $5,941,000 higher compared to fiscal 2004. In contrast, proceeds from issuance of common stock, primarily related to stock option exercises, were $2,810,000 higher in fiscal 2005 versus 2004.
Other
Total cash and investment balances held by our foreign subsidiaries at July 31, 2006, 2005 and 2004 were $477,000, $3,427,000 and $3,633,000, respectively. Certain investments held by our foreign subsidiaries were liquidated in fiscal 2006 to facilitate the repatriation of previously untaxed foreign earnings and profits. See Note 5 of the Notes to the Consolidated Financial Statements.
We received cash grants of approximately $590,000 in fiscal 2006 and $1,200,000 in fiscal 2005 from the State of Illinois. The money from these grants was used to enhance processing capabilities at our Mounds, Illinois production facility. These funds were accounted for on a “net” grant accounting basis; therefore they were not shown as a cash in-flow or a capital expenditure outflow. As of July 31, 2006 and 2005, the grant funds received in the respective fiscal years were completely utilized.
As part of the normal course of business, we guarantee certain debts and trade payables of our wholly owned subsidiaries. These arrangements are made at the request of the subsidiaries’ creditors, as separate financial statements are not distributed for the wholly owned subsidiaries. As of July 31, 2006, the value of these guarantees was $500,000 of short-term liabilities, $359,000 of lease liabilities and $2,500,000 of long-term debt.
Our capital requirements are subject to change as business conditions warrant and opportunities arise. The tables in the following subsection summarize our contractual obligations and commercial commitments at July 31, 2006 for the timeframes indicated.
We entered into an unsecured revolving credit agreement with Harris N.A on January 27, 2006, pursuant to which we may borrow up to $15,000,000 from time to time. Our payment obligations under this credit agreement are guaranteed by certain of our subsidiaries. The credit agreement contains restrictive covenants that, among other things and under various conditions (including a limitation on capital expenditures), limit our ability to incur additional indebtedness or to acquire or dispose of assets. The agreement also requires us to maintain a minimum fixed coverage ratio and a minimum consolidated net worth. As of July 31, 2006, we had $15,000,000 available under this credit facility and were in compliance with our covenants.
We believe that cash flow from operations, availability under our revolving credit facility and current cash and investment balances will provide adequate cash funds for foreseeable working capital needs, capital expenditures at existing facilities and debt service obligations for at least the next 12 months. Our ability to fund operations, to make planned capital expenditures, to make scheduled debt payments and to remain in compliance with all of the financial covenants under debt agreements, including, but not limited to, the credit agreement, depends on our future operating performance, which, in turn, is subject to prevailing economic conditions and to financial, business and other factors.
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CONTRACTUAL OBLIGATIONS AND OTHER COMMERCIAL COMMITMENTS
The following table summarizes our significant contractual obligations at July 31, 2006, and the effect such obligations are expected to have on liquidity and cash flows in future periods:
| | | Payments Due by Period |
| | | | | Less Than 1 | | | | | | |
| Contractual Obligations | | Total | | Year | | 1 – 3 Years | | 4 – 5 Years | | After 5 Years |
| Long-Term Debt | | $35,240,000 | | $14,080,000 | | $19,660,000 | | $16,700,000 | | $14,800,000 |
| Interest on Long-Term Debt | | 9,959,000 | | 2,147,000 | | 3,380,000 | | 2,384,000 | | 2,048,000 |
| Operating Leases | | 11,878,000 | | 2,760,000 | | 2,373,000 | | 1,770,000 | | 4,975,000 |
| Unconditional Purchase Obligations | | 7,595,000 | | 7,595,000 | | -- | | -- | | -- |
| Total Contractual Cash Obligations | | $64,672,000 | | $ 16,582,000 | | $15,413,000 | | $10,854,000 | | $21,823,000 |
We are not required to make a contribution to our defined benefit pension plan in fiscal 2007. We have not presented this obligation for future years in the table above because the funding requirement can vary from year to year based on changes in the fair value of plan assets and actuarial assumptions.
| | | Amount of Commitment Expiration Per Period |
| | | Total | | | | | | | | | | | |
| Other Commercial | | Amounts | | Less Than 1 | | | | | | | | | |
| Commitments | | Committed | | Year | | 1 – 3 Years | | 4 – 5 Years | | After 5 Years |
| Standby Letters of Credit | | $ | 500,000 | | $ | 500,000 | | $ -- | | | $ -- | | | $ -- | |
| Other Commercial Commitments | | 10,964,000 | | 10,964,000 | | -- | | | -- | | | | |
| Total Commercial Commitments | | $ | 11,964,000 | | $ | 11,964,000 | | $ -- | | | $ -- | | | $ -- | |
The expected timing of payments of the obligations above is estimated based on current information. Timing of payments and actual amounts paid may be different, depending on the time of receipt of goods or services, or changes to agreed-upon amounts for some obligations.
OFFBALANCESHEETARRANGEMENTS
We do not have any unconsolidated special purpose entities. As of July 31, 2006, we do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors. The term “off-balance sheet arrangement” generally means any transaction, agreement or other contractual arrangement to which an entity unconsolidated with us is a party, under which we have: (i) any obligation arising under a guarantee contract, derivative instrument or variable interest; or (ii) a retained or contingent interest in assets transferred to such entity or similar arrangement that serves as credit, liquidity or market risk support for such assets.
CRITICALACCOUNTING POLICIES AND ESTIMATES
Management’s discussion and analysis of the financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with the generally accepted accounting principles of the United States. Annually we review our financial reporting and disclosure practices and accounting policies to ensure that our financial reporting and disclosures provide accurate and transparent information relative to current economic and business environment. We believe that of our significant accounting policies stated in Note 1 of the Notes to the Consolidated Financial Statements, the policies listed below involve a higher degree of judgment and/or complexity. The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities, as well as the reported amounts of revenues and expenses during the reporting period. Significant estimatesinclude promotional programs, allowance for doubtful accounts, prepaid overburden, pension accounting and income taxes. Actual results could differ from these estimates.
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Stock Split Effected by a Stock Dividend.If a stock split is effected after the close of the fiscal year, but before the release of the financial statements, generally accepted accounting principles require per share data to be based on the new shares outstanding including the effect of the stock split transaction. In addition, if the par value of the underlying stock is not reduced for a stock dividend, a credit to the common stock account and a charge to paid-in-capital are necessary to adjust the aggregate par value. Our Board announced the stock dividend on June 6, 2006. The stock dividend was paid on September 8, 2006 to shareholders of record at the close of business on August 4, 2006. Accordingly, shares outstanding, income (loss) per share and balance sheet values for all years presented have been restated to reflect the five-for-four stock split effected by a stock dividend of one-quarter share for each outstanding share of Common Stock and Class B Stock and the adjustment to aggregate par value has been made.
Revenue Recognition.Under the terms of our sales agreements with customers, we recognize revenue when title is transferred. Upon shipment an invoice is generated that sets the fixed and determinable price. Sales returns and allowances have historically not been material.
Trade Promotions and Advertising. We routinely commit to one-time or on-going trade promotion programs in our Retail and Wholesale Products Group. Promotional reserves are provided for sales incentives made directly to consumers, such as coupons, and sales incentives made to customers, such as slotting, discounts based on sales volume, cooperative marketing programs and other arrangements. All such trade promotion costs are netted against sales. Advertising costs are part of selling, general and administrative expenses.
We have accrued liabilities at the end of each period for the estimated expenses incurred, but unpaid for trade spending and advertising programs. The determination of the trade spending liabilities requires us to use judgment for estimates which include our historical experience with trade spending patterns and that of the industry, current trends and forecasted data. While management believes our promotional reserves are reasonable and that appropriate judgments have been made, estimated amounts could differ from future obligations. We recorded reserves of $3,522,000 and $3,362,000 for these trade promotions and advertising liabilities at July 31, 2006 and 2005, respectively.
Cost of Sales.Cost of sales includes all manufacturing costs, inbound and outbound freight, inspection costs, purchasing costs associated with materials and packaging used in the production processes and warehouse and distribution costs.
Selling, General and Administrative Expenses.Selling, general and administrative expenses include salaries, wages and benefits associated with the staff outside the manufacturing and distribution functions, all marketing related costs, any miscellaneous trade spending expenses not required to be included in net sales, research and development costs and all other non-manufacturing and non-distribution expenses.
Cash Equivalents and Investments in Securities.Cash equivalents are highly liquid investments with maturities of three months or less when purchased. Investments in treasury securities are carried at cost, plus accrued interest, which approximates market. We occasionally purchase as investments certain debt securities of highly rated United States corporations. These securities are reported as current or long-term depending on the maturity of the instrument. We classify these investments as held-to-maturity and measure them on an amortized cost basis because we have both the intention and the ability to hold these investments to maturity.
Trade Receivables.Trade receivables are recognized when the risk of loss and title pass to the customer consistent with the Revenue Recognition policy. We provide for an allowance for doubtful accounts based on our historical experience and a periodic review of our accounts receivable, including a review of the overall aging of accounts and analysis of specific accounts. While management believes our allowance for doubtful accounts is reasonable, the unanticipated default by a customer with material trade receivable could occur. We recorded an allowance for doubtful accounts of $567,000 and $609,000 at July 31, 2006 and 2005, respectively.
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Inventories. Inventories are valued at the lower of cost (first-in, first-out) or market. Inventory costs include the cost of raw materials, packaging supplies, labor and other overhead costs. We perform a detailed review of our inventory items to determine if an obsolescence reserve adjustment is necessary. The review surveys all of our operating facilities and sales divisions to ensure that both historical issues and new market trends are considered. The allowance not only considers specific items, but also takes into consideration the overall value of the inventory as of the balance sheet date. The inventory obsolescence reserve values at July 31, 2006 and 2005 were $307,000 and $301,000, respectively.
Prepaid Overburden Removal and Mining Costs.We mine sorbent materials on property that we either own or lease as part of our overall operations. A significant part of our mining cost is incurred during the process of removing the overburden (non-usable material) from the mine site, thus exposing the sorbent material that is then used in a majority of our production processes. The cost of the overburden removal is recorded in a prepaid expense account and, as the usable sorbent material is mined, the prepaid overburden removal expense is amortized over the estimated available material. We had $1,686,000 and $1,370,000 of prepaid expense recorded on our consolidated balance sheet, as of July 31, 2006 and 2005, respectively. We amortized to current expense approximately $2,134,000 of previously recorded prepaid expense in fiscal 2006, $2,637,000 in fiscal 2005 and $2,895,000 in fiscal 2004. See the discussion in Note 1 of the Notes to the Consolidated Financial Statements regarding EITF Issue No. 04-06, “Accounting for Stripping Costs in the Mining Industry”, which will change our reporting of post-production stripping costs beginning in the first quarter of fiscal year 2007.
To determine the value of prepaid overburden, our mining personnel survey the individual mining areas. The estimation work is conducted utilizing a combination of manual and computerized survey tools. Once the survey data is recorded it is charted on numerous topographical maps of the mining areas. Finally, based on the survey data, maps and professional judgment of the mining engineers’ estimates are developed.
During the normal course of our overburden removal activities we perform on-going reclamation activities. As overburden is removed from a pit, it is hauled to a previously mined pit and used to refill the older site. This process allows us to continuously reclaim older pits and dispose of overburden simultaneously, therefore minimizing the liability for the reclamation function.
Additionally, it is our policy to capitalize the purchase cost of land and mineral rights, including associated legal fees, survey fees and real estate fees. The costs of obtaining mineral patents, including legal fees and drilling expenses, are also capitalized. Pre-production development costs on new mines and any prepaid royalties that are offset against future royalties due upon extraction of the mineral are also capitalized. All exploration related costs are expensed as incurred.
Impairment of goodwill, trademarks and other intangible assets.Carrying values of goodwill, trademarks and other indefinite lived intangible assets are reviewed periodically for possible impairment in accordance with Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets”. Our impairment review is based on a discounted cash flow approach that requires significant judgment with respect to volume, revenue, expense growth rates and the selection of an appropriate discount rate. Impairment occurs when the carrying value exceeds the fair value. Our impairment analysis is performed in the first quarter of the fiscal year and we use judgment in assessing whether assets may have become impaired between annual valuations. Indicators such as unexpected adverse economic factors, unanticipated technological changes, competitive activities and acts by governments and courts may indicate that an asset has become impaired. Our analysis in the first quarter of fiscal 2006 did not indicate any impairment. We continue to monitor events, circumstances or changes in the business that might imply a reduction in value and might lead to impairment.
Stock Based Compensation.On August 1, 2005 we adopted Financial Accounting Standards (“FAS”) No. 123-R “Share-Based Payments” (“FAS 123-R”). This statement is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation” and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. FAS 123-R establishes fair value as the measurement objective in accounting for share-based payment arrangements and requires all companies to apply a fair-value-based measurement method in accounting for generally all share-based payment transactions with employees. The fair value is estimated on the grant date using the Black-Scholes Option Pricing Method. FAS 123-R requires that the costs resulting from all share-based payment transactions be recognized in the financial statements. The amount of share-based compensation expense recognized in fiscal 2006 was $330,000, net of related tax effect. This includes expense related to stock option grants and amortization of restricted stock. We adopted the pronouncement using a modified prospective application. Under this application, we are required to record compensation expense for all awards granted after the date of adoption and for the unvested portion of previously granted awards that remain outstanding at the date of adoption. Accordingly, prior period amounts have not been restated.
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Prior to the adoption of FAS 123-R, we had applied Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees”, and related other interpretations to account for our stock option plans. Under APB 25, we applied the intrinsic value method. All of the outstanding options issued under the plans had exercise prices equal to the market value on the day of issue. Accordingly, we did not record any compensation expense associated with our issuance of stock options. Had we accounted for stock-based compensation in accordance with SFAS No. 123-R, we would have reported in fiscal years 2005 and 2004 additional employee compensation expense (net of related tax effect) of approximately $325,000 and $301,000, respectively. See Note 7 to the Notes of the Consolidated Financial Statements for further discussion.
Pension Accounting. Pension benefit obligations and the related effects on results of operations are calculated using actuarial models. Two critical assumptions, discount rate and expected return on assets, are important elements of plan expense and asset/liability measurement. We evaluate these critical assumptions at least annually. Other assumptions involving demographic factors, such as retirement age, mortality and turnover, are evaluated periodically and are updated to reflect actual experience. Actual results in any given year will often differ from actuarial assumptions because of economic and other factors.
Our expected rate of return on plan assets is determined based on asset allocations and historical experience. The expected long-term rate of inflation and risk premiums for the various asset categories are based on general historical returns and inflation rates. The target allocation of assets is used to develop a composite rate of return assumption.
The discount rate is based on a market benchmark rate that is of comparable duration to the plan’s liabilities. Specifically, at July 31, 2006, the discount rate was based on the Citigroup Pension Liability Index and at July 31, 2005 the discount rate was based on Moody’s Aa Corporate Bond Yield adjusted to be based on annual compounding. The rate was rounded to the nearest 25 basis points.
Income Taxes.Our effective tax rate is based on expected income, statutory tax rates and tax planning opportunities available to us in various jurisdictions in which we operate. Significant judgment is required in determining our effective tax rate and in evaluating our tax positions.
We determine our current and deferred taxes in accordance with SFAS No. 109, “Accounting for Income Taxes”. The tax effect of the reversal of tax differences is recorded at rates currently enacted for each jurisdiction in which we operate. To the extent that temporary differences will result in future tax benefit, we must estimate the timing of their reversal and whether taxable operating income in future periods will be sufficient to fully recognize any deferred tax assets. We maintain valuation allowances where it is likely that all or a portion of a deferred tax asset will not be realized. Changes in valuation allowances from period to period are included in the income tax provision in the period of change. In determining whether a valuation allowance is warranted, we take into account such factors as prior earnings history, expected future earnings and other factors that could effect the realization of deferred tax assets. We recorded valuation allowances for income taxes of $1,831,000 and $1,784,000 at July 31, 2006 and 2005, respectively.
RECENTLYISSUEDACCOUNTINGSTANDARDS
In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 158, “Employers’ Accounting for Defined Pension and Other Postretirement Plans”. This Statement requires recognition of the funded status of a single-employer defined benefit postretirement plan as an asset or liability in its statement of financial position. Funded status is determined as the difference between the fair value of plan assets and the benefit obligation. Changes in that funded status should be recognized in other comprehensive income. This recognition provision and the related disclosures are effective as of the end of the fiscal year ending after December 15, 2006. The Statement also requires the measurement of plan assets and benefit obligations as of the date of the fiscal year-end statement of financial position. This measurement provision is effective for fiscal years ending after December 15, 2008. We are currently reviewing this pronouncement, but we believe it could have a material impact on our financial statements.
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In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurement”, effective for fiscal years beginning after November 15, 2007. This Statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This Statement does not require any new fair value measurements, but simplifies and codifies related guidance within generally accepted accounting principles (GAAP). This Statement applies under other accounting pronouncements that require or permit fair value measurements. We are currently reviewing this pronouncement, but we believe it will not have a material impact on our financial statements.
In June 2006, the FASB issued Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes”, effective for fiscal years beginning after December 15, 2006. This interpretation clarifies the accounting for uncertainty in income taxes in accordance with FASB Statement No. 109, “Accounting for Income Taxes”. The pronouncement provides a recognition threshold and measurement guidance for the financial statement recognition of a tax position taken or expected to be taken in a tax return. We are currently reviewing this pronouncement, but we believe it will not have a material impact on our financial statements.
In May 2005, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 154, “Accounting Changes and Error Corrections,” effective for the first fiscal period in the fiscal year beginning after December 15, 2005. This statement replaces APB Opinion No. 20, “Accounting Changes” and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements”. This statement applies to all voluntary changes in accounting principle and requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable. We would only be impacted by this statement if it made a voluntary change in accounting principle after the effective date.
In March 2005, the Financial Accounting Standards Board ratified the consensus reached in EITF Issue No. 04-06 (“EITF Issue 04-06”), “Accounting for Stripping Costs in the Mining Industry”. The consensus will be effective for the first fiscal period in the fiscal year beginning after December 15, 2005. The consensus on EITF Issue 04-06 calls for post-production stripping costs to be treated as a variable inventory production cost. As a result, such costs are subject to inventory costing procedures in the period they are incurred.
Once EITF Issue 04-06 becomes effective in the first quarter of fiscal 2007, we will be required to write off the amount of our prepaid overburden removal expense account at August 1, 2006 as a cumulative effect adjustment to our opening balance of retained earnings. Although the write-off adjusts the opening balance of retained earnings, it will also reduce our earnings per share in the first quarter of fiscal 2007. The value of the prepaid overburden removal expense account at July 31, 2006 was $1,686,000. Also, on an ongoing basis we expect not to defer and amortize the vast majority of our overburden removal expenses. Post-production overburden removal costs will be considered variable production expenses and will be included in cost of sales in the period they are incurred; however, in accordance with EITF Issue 04-06, we will continue to defer and amortize the pre-production overburden removal costs associated with opening a new mine. We expect these changes to result in increased earnings volatility on a quarterly, but not an annual, basis.
ITEM 7A – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to interest rate risk and employ policies and procedures to manage our exposure to changes in the market risk of our cash equivalents and short-term investments. We had two interest rate swap agreements outstanding as of July 31, 2006. We believe that the market risk arising from holdings of our financial instruments is not material.
We are exposed to currency risk as it relates to certain accounts receivables and our foreign operations. We believe that the currency risk is immaterial to the overall presentation of the financial statements.
We are exposed to regulatory risk in the fluid purification and agricultural markets, principally as a result of the risk of increasing regulation of the food chain in the United States and Europe. We actively monitor developments in this area, both directly and through trade organizations of which we are a member.
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We are exposed to commodity price risk with respect to fuel. We plan to contract for 41% of our fuel needs for fiscal 2007 using forward purchase contracts to manage the volatility in fuel prices related to this exposure. All contracts are related to the normal course of business and no contracts are entered into for speculative purposes. The weighted average cost of our natural gas contracts has been estimated to be approximately 15.1% higher than the contracts for fiscal 2006.
The following table provides information about our natural gas future contracts, which are sensitive to changes in commodity prices, specifically natural gas prices. For the future contracts the table presents the notional amounts in MMBtu’s, the weighted average contract prices, and the total dollar contract amount, which will mature by July 31, 2007. The Fair Value was determined using the “Most Recent Settle” price for the “Henry Hub Natural Gas” option contract prices as listed by the New York Mercantile Exchange on October 2, 2006.
| Commodity Price Sensitivity |
| Natural Gas Future Contracts |
| For the Year Ending July 31, 2007 |
| | Expected 2007 Maturity | Fair Value |
| Natural Gas Future Volumes (MMBtu) | 880,000 | | |
| |
| Weighted Average Price (Per MMBtu) | $8.63 | | |
| |
| Contract Amount ($ U.S., in thousands) | $7,595.0 | | $6,249.8 |
Factors that could influence the fair value of the natural gas contracts, include, but are not limited to, the creditworthiness of our natural gas suppliers, the overall general economy, developments in world events, and the general demand for natural gas by the manufacturing sector, seasonality and the weather patterns throughout the United States and the world. Some of these same events have allowed us to mitigate the impact of the natural gas contracts by the continued, and in some cases expanded, use of recycled oil in our manufacturing processes. Accurate estimates of the impact that these contracts may have on our fiscal 2007 financial results are difficult to make due to the inherent uncertainty of future fluctuations in option contract prices in the natural gas options market.
Please also see Item 1A above, “Risk Factors”, for a discussion of these and other risks and uncertainties we face in our business.
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ITEM 8 – FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONSOLIDATED BALANCE SHEETS
| | | July 31, |
| ASSETS | | 2006 | | 2005 |
| | | | (in thousands of dollars) | |
| Current Assets | | | | | | | | |
| Cash and cash equivalents | | $ | 6,607 | | | $ | 5,945 | |
| Investment in treasury securities | | | 19,248 | | | | 13,098 | |
| Investment in debt securities | | | -- | | | | 392 | |
| Accounts receivable, less allowance of $567 and $609 in 2006 and2005, respectively | | | 26,115 | | | | 23,611 | |
| Inventories | | | 15,697 | | | | 12,686 | |
| Prepaid overburden removal expense | | | 1,686 | | | | 1,370 | |
| Deferred income taxes | | | 1,722 | | | | 1,647 | |
| Prepaid expenses and other assets | | | 4,627 | | | | 4,347 | |
| Total Current Assets | | | 75,702 | | | | 63,096 | |
| | |
| Property, Plant and Equipment, at Cost | | | | | | | | |
| Buildings and leasehold improvements | | | 23,727 | | | | 22,667 | |
| Machinery and equipment | | | 101,001 | | | | 95,335 | |
| Office furniture and equipment | | | 11,578 | | | | 11,130 | |
| Vehicles | | | 5,976 | | | | 5,292 | |
| | | | 142,282 | | | | 134,424 | |
| Less accumulated depreciation and amortization | | | (107,496 | ) | | | (101,573 | ) |
| | | | 34,786 | | | | 32,851 | |
| Construction in progress | | | 5,713 | | | | 4,769 | |
| Land | | | 10,794 | | | | 10,278 | |
| Total Property, Plant and Equipment, Net | | | 51,293 | | | | 47,898 | |
| | |
| Other Assets | | | | | | | | |
| Goodwill | | | 5,162 | | | | 5,162 | |
| Trademarks and patents (Net of accumulated amortizationof $308 and $305 in 2006 and 2005, respectively) | | | 780 | | | | 778 | |
| Debt issuance costs (Net of accumulated amortizationof $393 and $356 in 2006 and 2005, respectively) | | | 444 | | | | 107 | |
| Licensing agreements (Net of accumulated amortization of$2,558 and $2,359 in 2006 and 2005, respectively) | | | 881 | | | | 1,080 | |
| Deferred income taxes | | | 1,151 | | | | 1,287 | |
| Other | | | 4,134 | | | | 4,163 | |
| Total Other Assets | | | 12,552 | | | | 12,577 | |
| Total Assets | | $ | 139,547 | | | $ | 123,571 | |
The accompanying notes are an integral part of the consolidated financial statements.
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| | | July 31, |
| | | 2006 | | 2005 |
| | | | (in thousands of dollars) | |
| LIABILITIES AND STOCKHOLDERS' EQUITY | | | | | | | | |
| Current Liabilities | | | | | | | | |
| Current maturities of notes payable | | $ | 4,080 | | | $ | 3,080 | |
| Accounts payable | | | 7,596 | | | | 5,228 | |
| Dividends payable | | | 754 | | | | 559 | |
| Accrued expenses | | | | | | | | |
| Salaries, wages and commissions | | | 3,492 | | | | 3,741 | |
| Trade promotions and advertising | | | 3,522 | | | | 3,362 | |
| Freight | | | 1,377 | | | | 1,386 | |
| Other | | | 6,292 | | | | 5,178 | |
| Total Current Liabilities | | | 27,113 | | | | 22,534 | |
| | |
| Noncurrent Liabilities | | | | | | | | |
| Notes payable | | | 31,160 | | | | 20,240 | |
| Deferred compensation | | | 4,093 | | | | 3,650 | |
| Other | | | 3,945 | | | | 3,293 | |
| Total Noncurrent Liabilities | | | 39,198 | | | | 27,183 | |
| Total Liabilities | | | 66,311 | | | | 49,717 | |
| | |
| Stockholders’ Equity | | | | | | | | |
| Common Stock, par value $.10 per share, issued 7,158,158shares in 2006 and 6,968,613 in 2005 | | | 716 | | | | 697 | |
| Class B Stock, par value $.10 per share, issued 2,234,544shares in 2006 and 2,164,544 in 2005 | | | 223 | | | | 216 | |
| Unrealized gain on marketable securities | | | 46 | | | | 38 | |
| Additional paid-in capital | | | 18,072 | | | | 13,735 | |
| Retained earnings | | | 97,390 | | | | 94,891 | |
| Restricted unearned stock compensation | | | (1,308 | ) | | | (75 | ) |
| Cumulative translation adjustment | | | 179 | | | | (282 | ) |
| | | | 115,318 | | | | 109,220 | |
| Less treasury stock, at cost (2,304,103 Common and324,741 Class B shares at July 31, 2006 and | | | | | | | | |
| 1,953,350Common and 342,241 Class B shares at July 31, 2005) | | | (42,082 | ) | | | (35,366 | ) |
| Total Stockholders’ Equity | | | 73,236 | | | | 73,854 | |
| Total Liabilities and Stockholders' Equity | | $ | 139,547 | | | $ | 123,571 | |
The accompanying notes are an integral part of the consolidated financial statements.
38
CONSOLIDATED STATEMENTS OF OPERATIONS
| | | Year Ended July 31, |
| | | 2006 | | 2005 | | 2004 |
| | | (in thousands, except for per share data) |
| Net Sales | | $ | 205,210 | | | $ | 187,868 | | | $ | 185,511 | |
| Cost of Sales | | | 167,136 | | | | 147,513 | | | | 142,263 | |
| Gross Profit | | | 38,074 | | | | 40,355 | | | | 43,248 | |
| Other Contractual Charge | | | -- | | | | -- | | | | (1,250 | ) |
| Loss on Impaired Long-Lived Assets | | | -- | | | | -- | | | | (464 | ) |
| Gain on Sale of Long-Lived Assets | | | 415 | | | | -- | | | | -- | |
| Selling, General and Administrative Expenses | | | (29,735 | ) | | | (30,470 | ) | | | (32,975 | ) |
| Income from Operations | | | 8,754 | | | | 9,885 | | | | 8,559 | |
| Other Income (Expense) | | | | | | | | | | | | |
| Interest income | | | 1,106 | | | | 464 | | | | 222 | |
| Interest expense | | | (2,255 | ) | | | (1,758 | ) | | | (2,079 | ) |
| Foreign exchange losses | | | (95 | ) | | | (244 | ) | | | (26 | ) |
| Other, net | | | 386 | | | | 585 | | | | 255 | |
| Total Other Expense, Net | | | (858 | ) | | | (953 | ) | | | (1,628 | ) |
| Income Before Income Taxes | | | 7,896 | | | | 8,932 | | | | 6,931 | |
| Income Taxes | | | 2,637 | | | | 2,392 | | | | 1,898 | |
| Net Income | | $ | 5,259 | | | $ | 6,540 | | | $ | 5,033 | |
| | |
| Net Income Per Share | | | | | | | | | | | | |
| Basic Common | | $ | 0.83 | | | $ | 1.02 | | | $ | 0.79 | |
| Basic Class B Common | | $ | 0.61 | | | $ | 0.76 | | | $ | 0.59 | |
| Diluted | | $ | 0.73 | | | $ | 0.88 | | | $ | 0.68 | |
| | |
| Average Shares Outstanding | | | | | | | | | | | | |
| Basic Common | | | 5,005 | | | | 5,047 | | | | 5,050 | |
| Basic Class B Common | | | 1,822 | | | | 1,818 | | | | 1,796 | |
| Diluted | | | 7,219 | | | | 7,455 | | | | 7,452 | |
The accompanying notes are an integral part of the consolidated financial statements.
39
| CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY | |
| | | Number of Shares | | $ Amounts ( in thousands) |
| | |
| | | | | | | | | | | | | | | | | Restricted | | | | | Accumulated | | | | |
| | | Common | | | | | Common | | | Additional�� | | | | | Unearned | | | | | Other | | Total |
| | | & ClassB | | Treasury | | & Class B | | | Paid-In | | Retained | | Stock | | Treasury | | Comprehensive | | Stockholders' |
| | | Stock | | Stock | | Stock | | | Capital | | Earnings | | Compensation | | Stock | | Income/(Loss) | | Equity |
| Balance,July 31,2003 | | 8,607,197 | | (1,761,306 | ) | | | 861 | | | 7,509 | | 88,002 | | | | (37 | ) | | (26,239 | ) | | | (1,082 | ) | | | 69,014 | | |
| | |
| NetIncome | | | | | | | | -- | | | -- | | 5,033 | | | | -- | | | -- | | | | -- | | | | 5,033 | |
| Cumulative Translation | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Adjustments | | | | | | | | -- | | | -- | | -- | | | | -- | | | -- | | | | 388 | | | | 388 | |
| Total ComprehensiveIncome | | | | | | | | | | | | | | | | | | | | | | | | | | | | 5,421 | |
| DividendsDeclared | | | | | | | | -- | | | -- | | (2,050 | ) | | | -- | | | -- | | | | -- | | | | (2,050 | ) |
| Purchases of TreasuryStock | | | | (119,506 | ) | | | -- | | | -- | | -- | | | | -- | | | (1,824 | ) | | | -- | | | | (1,824 | ) |
| Issuance of Stock Under1995 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Long-Term IncentivePlan | | 143,280 | | | | | | 14 | | | 1,655 | | -- | | | | -- | | | -- | | | | -- | | | | 1,669 | |
| Amortization of RestrictedStock | | | | | | | | -- | | | -- | | -- | | | | 28 | | | -- | | | | -- | | | | 28 | |
| Balance, July 31,2004 | | 8,750,477 | | (1,880,812 | ) | | | 875 | | | 9,164 | | 90,985 | | | | (9 | ) | | (28,063 | ) | | | (694 | ) | | | 72,258 | |
| | |
| NetIncome | | | | | | | | -- | | | -- | | 6,540 | | | | -- | | | -- | | | | -- | | | | 6,540 | |
| CumulativeTranslation | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Adjustments | | | | | | | | -- | | | -- | | -- | | | | -- | | | -- | | | | 412 | | | | 412 | |
| Unrealized gain onmarketable | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| securities | | | | | | | | -- | | | -- | | -- | | | | -- | | | -- | | | | 38 | | | | 38 | |
| Total ComprehensiveIncome | | | | | | | | | | | | | | | | | | | | | | | | | | | | 6,990 | |
| DividendsDeclared | | | | | | | | -- | | | -- | | (2,251 | ) | | | -- | | | -- | | | | -- | | | | (2,251 | ) |
| Purchases of TreasuryStock | | | | (463,500 | ) | | | -- | | | -- | | -- | | | | -- | | | (8,066 | ) | | | -- | | | | (8,066 | ) |
| Issuance of Stock Under1995 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Long-Term IncentivePlan | | 382,680 | | 48,721 | | | | 38 | | | 4,571 | | (383 | ) | | | (93 | ) | | 763 | | | | -- | | | | 4,896 | |
| Amortization of RestrictedStock | | | | | | | | -- | | | -- | | -- | | | | 27 | | | -- | | | | -- | | | | 27 | |
| Balance, July 31,2005 | | 9,133,157 | | (2,295,591 | ) | | $ | 913 | | | $13,735 | | $94,891 | | | $ | (75 | ) | | $ (35,366 | ) | | $ | (244 | ) | | $ | 73,854 | |
| NetIncome | | | | | | | | -- | | | -- | | 5,259 | | | | -- | | | -- | | | | -- | | | | 5,259 | |
| CumulativeTranslation | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Adjustments | | | | | | | | -- | | | -- | | -- | | | | -- | | | -- | | | | 461 | | | | 461 | |
| Unrealized gainon | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| marketablesecurities | | | | | | | | -- | | | -- | | -- | | | | -- | | | -- | | | | 8 | | | | 8 | |
| Total ComprehensiveIncome | | | | | | | | | | | | | | | | | | | | | | | | | | | | 5,728 | |
| DividendsDeclared | | | | | | | | -- | | | -- | | (2,598 | ) | | | -- | | | -- | | | | -- | | | | (2,598 | ) |
| Purchases of TreasuryStock | | | | (382,045 | ) | | | -- | | | -- | | -- | | | | -- | | | (7,811 | ) | | | -- | | | | (7,811 | ) |
| Issuance of Stock Under2006 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Long-Term IncentivePlan | | 259,545 | | 48,792 | | | | 26 | | | 3,517 | | (162 | ) | | | (1,386 | ) | | 1,095 | | | | -- | | | | 3,090 | |
| Share-based StockCompensation | | | | | | | | | | | 820 | | | | | | | | | | | | | | | | | 820 | |
| Amortization of RestrictedStock | | | | | | | | -- | | | -- | | -- | | | | 153 | | | -- | | | | -- | | | | 153 | |
| Balance, July 31,2006 | | 9,392,702 | | (2,628,844 | ) | | $ | 939 | | | $18,072 | | $97,390 | | | $ | (1,308 | ) | | $ (42,082 | ) | | $ | 225 | | | $ | 73,236 | |
| | |
| | |
| The accompanying statements are an integral part of the consolidated financial statements. | |
40
| CONSOLIDATED STATEMENTS OF CASH FLOWS | |
| | | Year Ended July 31, |
| | | 2006 | | 2005 | | 2004 |
| Cash Flows from Operating Activities | | (in thousands of dollars) |
| Net Income | | $ | 5,259 | | | $ | 6,540 | | | $ | 5,033 | |
| Adjustments to reconcile net income to netcash provided by operating activities: | | | | | | | | | | | | |
| Depreciation and amortization | | | 7,212 | | | | 7,429 | | | | 8,057 | |
| Amortization of investment discounts | | | (600 | ) | | | (226 | ) | | | (51 | ) |
| Stock compensation expense | | | 451 | | | | -- | | | | -- | |
| Excess tax benefits for share-based payments | | | (516 | ) | | | -- | | | | -- | |
| Deferred income taxes | | | 192 | | | | 952 | | | | 204 | |
| Provision for bad debts | | | 127 | | | | 27 | | | | 201 | |
| Loss on impaired assets | | | -- | | | | -- | | | | 464 | |
| (Gain) loss on the sale of property, plant and equipment | | | (309 | ) | | | 370 | | | | 398 | |
| (Increase) decrease in: | | | | | | | | | | | | |
| Accounts receivable | | | (2,631 | ) | | | 531 | | | | (615 | ) |
| Inventories | | | (3,011 | ) | | | (287 | ) | | | 108 | |
| Prepaid overburden removal expense | | | (316 | ) | | | 1,037 | | | | 85 | |
| Prepaid expenses | | | (280 | ) | | | (740 | ) | | | (199 | ) |
| Other assets | | | 345 | | | | (144 | ) | | | 2,175 | |
| Increase (decrease) in: | | | | | | | | | | | | |
| Accounts payable | | | 2,759 | | | | (26 | ) | | | (823 | ) |
| Accrued expenses | | | 1,016 | | | | (3,075 | ) | | | 2,825 | |
| Deferred compensation | | | 443 | | | | 195 | | | | 243 | |
| Other liabilities | | | 494 | | | | 402 | | | | 472 | |
| Total Adjustments | | | 5,376 | | | | 6,445 | | | | 13,544 | |
| Net Cash Provided by Operating Activities | | | 10,635 | | | | 12,985 | | | | 18,577 | |
| | |
| Cash Flows from Investing Activities | | | | | | | | | | | | |
| Capital expenditures | | | (10,827 | ) | | | (7,311 | ) | | | (6,067 | ) |
| Proceeds from the sale of Phoebe Products Co. | | | -- | | | | -- | | | | 325 | |
| Proceeds from sale of property, plant and equipment | | | 1,006 | | | | 37 | | | | 311 | |
| Purchases of investments in debt securities | | | (3,287 | ) | | | (250 | ) | | | (5,217 | ) |
| Maturities of investments in debt securities | | | 3,679 | | | | 2,834 | | | | 2,156 | |
| Purchases of investment in treasury securities | | | (65,336 | ) | | | (28,057 | ) | | | (43,608 | ) |
| Dispositions of investment in treasury securities | | | 59,786 | | | | 29,172 | | | | 41,672 | |
| Net Cash Used in Investing Activities | | | (14,979 | ) | | | (3,575 | ) | | | (10,428 | ) |
| | |
| Cash Flows from Financing Activities | | | | | | | | | | | | |
| Principal payments on long-term debt | | | (3,080 | ) | | | (4,080 | ) | | | (4,000 | ) |
| Proceeds from issuance of long-term debt | | | 15,000 | | | | -- | | | | -- | |
| Dividends paid | | | (2,403 | ) | | | (2,206 | ) | | | (1,998 | ) |
| Purchase of treasury stock | | | (7,811 | ) | | | (8,214 | ) | | | (1,824 | ) |
| Proceeds from issuance of treasury stock | | | 631 | | | | 449 | | | | -- | |
| Proceeds from issuance of common stock | | | 2,460 | | | | 4,147 | | | | 1,337 | |
| Excess tax benefits for share-based payments | | | 516 | | | | -- | | | | -- | |
| Other, net | | | 247 | | | | 266 | | | | 223 | |
| Net Cash Provided by (Used in) Financing Activities | | | 5,560 | | | | (9,638 | ) | | | (6,262 | ) |
| Effect of exchange rate changes on cash and cash equivalents | | | (554 | ) | | | (175 | ) | | | (292 | ) |
| Net Increase (Decrease) in Cash and Cash Equivalents | | | 662 | | | | (403 | ) | | | 1,595 | |
| Cash and Cash Equivalents, Beginning of Year | | | 5,945 | | | | 6,348 | | | | 4,753 | |
| Cash and Cash Equivalents, End of Year | | $ | 6,607 | | | $ | 5,945 | | | $ | 6,348 | |
The accompanying notes are an integral part of the consolidated financial statements.
41
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OFCONSOLIDATION
The consolidated financial statements include the accounts of Oil-Dri Corporation of America and its subsidiaries, all of which are wholly owned. All significant intercompany balances and transactions have been eliminated from the consolidated financial statements.
MANAGEMENTUSE OFESTIMATES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
REVENUERECOGNITION
Under the terms of our sales agreements with customers, we recognize revenue when title is transferred. At the time of shipment an invoice is generated which sets the fixed and determinable price. Sales returns and allowances are not material.
TRADEPROMOTIONS
In our Retail and Wholesale Products Group, we routinely commit to one-time or on-going trade promotion programs. All such costs are netted against sales. We have accrued liabilities at the end of each period for the estimated expenses incurred, but not paid for these programs. The determination of the trade spending liabilities requires us to use judgment for estimates which include our historical experience with trade spending patterns and that of the industry, current trends and forecasted data.
COST OF SALES
Cost of sales includes all manufacturing costs, inbound and outbound freight, inspection costs, purchasing costs associated with materials and packaging used in the production processes and warehouse and distribution costs.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses include salaries, wages and benefits associated with the staff outside the manufacturing and distribution functions, all marketing related costs, any miscellaneous trade spending expenses not required to be included in net sales, research and development costs and all other non-manufacturing and non-distribution expenses.
TRADERECEIVABLES
Trade receivables are recognized when the risk of loss and title pass to the customer consistent with the Revenue Recognition policy. We provide for an allowance for doubtful accounts based on our historical experience and a periodic review of our accounts receivable, including a review of the overall aging of accounts and analysis of specific accounts. A customer is determined to be uncollectible when we have completed our internal collection procedures, including termination of shipments, direct customer contact and formal demand of payment. We retain outside collection agencies to facilitate our collection efforts. Past due status is determined based on contractual terms and customer payment history.
42
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES
Deferred income tax assets and liabilities are recorded for the impact of temporary differences between the tax basis of assets and liabilities and the amounts recognized for financial reporting purposes. Deferred tax assets are reviewed and a valuation allowance is established if management believes that it is more likely than not that some portion of our deferred tax assets will not be realized. Changes in valuation allowances from period to period are included in the tax provision in the period of change.
U.S. income tax expense and foreign withholding taxes are provided on remittances of foreign earnings and on unremitted foreign earnings that are not indefinitely reinvested. Where unremitted foreign earnings are indefinitely reinvested, no provision for federal or state tax expense is recorded. When circumstances change and we determine that some or all of the undistributed earnings will be remitted in the foreseeable future, such as with the repatriation of earnings and profits under the American Jobs Creation Act described in Note 5 of the Notes to the Consolidated Financial Statements, a corresponding expense is accrued in the current period.
TRANSLATION OFFOREIGNCURRENCIES
Assets and liabilities of foreign subsidiaries, where the local currency is the functional currency, are translated at the exchange rates in effect at period end. Income statement items are translated at the average exchange rate on a monthly basis. Resulting translation adjustments are recorded as a separate component of stockholders’ equity.
CASHEQUIVALENTS ANDINVESTMENTS INSECURITIES
Cash equivalents are highly liquid investments with maturities of three months or less when purchased. Investments in treasury securities are carried at cost, plus accrued interest, which approximates market. We occasionally purchase as investments certain debt securities of highly rated United States corporations. These securities are reported as current or long-term depending on the maturity of the instrument. We classify these investments as held-to-maturity and measure them on an amortized cost basis because we have both the intention and the ability to hold these investments to maturity.
INVENTORIES
Inventories are valued at the lower of cost (first-in, first-out) or market. We recorded inventory obsolescence reserves of approximately $307,000 and $301,000 or the fiscal years ended July 31, 2006 and 2005, respectively. The composition of inventories as of July 31, 2006 and 2005 are as follows:
| | | 2006 | | 2005 |
| | | (in thousands) |
| Finished goods | | $ | 8,408 | | $ | 7,257 |
| Packaging | | | 3,688 | | | 3,310 |
| Other | | | 3,601 | | | 2,119 |
| | | $ | 15,697 | | $ | 12,686 |
43
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PREPAIDOVERBURDENREMOVAL ANDMININGCOSTS
As part of our overall operations, we mine sorbent materials on property that we either own or lease. A significant part of our overall mining cost is incurred during the process of removing the overburden (non-usable material) from the mine site, thus exposing the sorbent material that is then used in a majority of our production processes. The cost of the overburden removal is recorded in a prepaid expense account and, as the usable sorbent material is mined, the prepaid overburden removal expense is amortized over the estimated available material. We had $1,686,000 and $1,370,000 of prepaid overburden removal expense recorded on our Consolidated Balance Sheets as of July 31, 2006 and 2005, respectively. We amortized to current expense approximately $2,134,000 of previously recorded prepaid expense in fiscal 2006, $2,637,000 in fiscal 2005 and $2,895,000 in fiscal 2004. See the discussion in New Accounting Standards regarding EITF Issue No. 04-06, “Accounting for Stripping Costs in the Mining Industry”, which will change our reporting of post-production stripping costs beginning in the first quarter of fiscal year 2007.
We perform ongoing reclamation activities during the normal course of our overburden removal activities. As overburden is removed from a pit, it is hauled to a previously mined pit and used to refill the older site. This process allows us to continuously reclaim older pits and dispose of overburden simultaneously, therefore minimizing the liability for the reclamation function.
Additionally, it is our policy to capitalize the purchase cost of land and mineral rights, including associated legal fees, survey fees and real estate fees. The costs of obtaining mineral patents, including legal fees and drilling expenses, are also capitalized. Development costs of determining the nature and amount of mineral reserves and any prepaid royalties that are offset against future royalties due upon extraction of the mineral are also capitalized. All exploration related costs are expensed as incurred.
CONCENTRATION OFCREDITRISK
Financial instruments, which potentially subject us to concentrations of credit risk, consist principally of cash investments and accounts receivable. We place our cash investments in government-backed instruments, both foreign and domestic, and with other quality institutions. Concentrations of credit risk with respect to accounts receivable are subject to the financial condition of certain major customers, principally the customer referred to in Note 3 of the Notes to the Consolidated Financial Statements. We generally do not require collateral to secure customer receivables.
PROPERTY,PLANT ANDEQUIPMENT
Property, plant and equipment expenditures are generally depreciated using the straight-line method over their estimated useful lives which are listed below. Major improvements and betterments are capitalized while maintenance and repairs that do not extend the useful life of the applicable assets are expensed as incurred.
| | Years |
| Buildings and leasehold improvements | 5-30 |
| Machinery and equipment | 2-20 |
| Office furniture and equipment | 2-10 |
| Vehicles | 2-8 |
Property, plant and equipment are reviewed periodically for possible impairment on an annual basis. We review for idle and underutilized equipment and review business plans for possible impairment. When impairment is indicated, an impairment charge is recorded for the difference between the carrying value of the asset and its fair market value.
SHIPPING ANDHANDLINGCOSTS
Shipping and handling costs are included in cost of sales and were $33,011,000, $30,192,000 and $28,732,000 for the years ended July 31, 2006, 2005 and 2004, respectively.
44
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RESEARCH ANDDEVELOPMENT
Research and development costs of $1,808,000, $2,429,000 and $2,459,000 were charged to expense as incurred for the years ended July 31, 2006, 2005 and 2004, respectively.
INTANGIBLES ANDGOODWILL
Intangibles are amortized on a straight-line basis over periods ranging from seven to twenty years. We periodically review intangibles and goodwill to assess recoverability from projected discounted cash flows of the related operating entities. Our review is based on a discounted cash flow approach that requires significant judgment with respect to volume, revenue, expense growth rates and the selection of an appropriate discount rate. Impairment occurs when the carrying value exceeds the fair value. Our impairment analysis is performed in the first quarter of the fiscal year and we use judgment in assessing whether assets may have become impaired between annual valuations. Indicators such as unexpected adverse economic factors, unanticipated technological changes, competitive activities and acts by governments and courts may indicate that an asset has become impaired.
ADVERTISINGCOSTS
We defer recognition of advertising production costs until the first time the advertising takes place; other advertising costs are expensed as incurred. Advertising expenses were $1,273,000, $1,429,000 and $2,852,000 for the years ended July 31, 2006, 2005 and 2004, respectively.
RECLAMATIONOBLIGATIONS
We evaluated our potential reclamation liability at the end of fiscal 2006 in accordance with SFAS No. 143, “Accounting for Asset Retirement Obligations” and with FASB Interpretation No. 47 (as amended), “Accounting for Conditional Asset Retirement Obligations”. We recorded estimated reclamation assets of approximately $263,000 and corresponding reclamation liabilities in the same amount at the end of fiscal 2004. The value represents the discounted present value of the estimated future mining reclamation costs at the production plants. The assets will be depreciated over the estimated useful lives of the various mines. The liabilities will be increased based on a yearly accretion charge, once again over the estimated useful lives of the mines. We re-examined the assumptions used to establish the fiscal 2004 reclamation liability and determined them to be satisfactory for fiscal 2006.
FAIRVALUE OFFINANCIALINSTRUMENTS
Non-derivative financial instruments included in the Consolidated Balance Sheets are cash and cash equivalents, investment securities and notes payable. These instruments, except for notes payable, were carried at amounts approximating fair value as of July 31, 2006 and 2005. The fair value of notes payable was estimated based on future cash flows discounted at current interest rates available to us for debt with similar maturities and characteristics. The fair value of notes payable as of July 31, 2006 was less than its carrying value by approximately $306,000 and greater than its carrying value by approximately $438,000 as of July 31, 2005.
STOCKBASEDCOMPENSATION
In fiscal year 2006, we began accounting for stock based compensation in accordance with FAS No. 123 (revised 2004), Share-Based Payment (“FAS 123-R”). FAS 123-R requires the determination of the fair value of stock based compensation at the grant date and the recognition of the related compensation expense over the appropriate vesting period. Under FAS 123-R, we now recognize expense for stock options and restricted stock issued under our long term incentive plans. We adopted FAS 123-R using a modified prospective application. Accordingly, prior period amounts have not been restated.
45
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Prior to adoption of FAS 123-R, we applied Accounting Principles Board Opinion (“APB”) No. 25, Accounting for Stock Issued to Employees (“APB 25”) to account for our stock-based awards. Under APB 25, all options had exercise prices equal to the market value on the day of issue. Accordingly, we did not record any compensation expense associated with the issuance of stock options.
STOCKSPLITEFFECTED BY ASTOCKDIVIDEND
If a stock split is effected after the close of the fiscal year, but before the release of the financial statements, generally accepted accounting principles require per share data to be based on the new number shares. In addition, if the par value of the underlying stock is not reduced for a stock dividend, a credit to the common stock account and a charge to paid-in-capital are necessary to adjust the aggregate par value. Our Board announced the stock dividend on June 6, 2006. The stock dividend was paid on September 8, 2006 to shareholders of record at the close of business on August 4, 2006. Accordingly, shares outstanding, income (loss) per share and balance sheet values for all years presented have been restated to reflect the five-for-four stock split effected by a stock dividend of one-quarter share for each outstanding share of Common Stock and Class B Stock and the adjustment to aggregate par value has been made.
NEWACCOUNTINGSTANDARDS
In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 158, “Employers’ Accounting for Defined Pension and Other Postretirement Plans”. This Statement requires recognition of the funded status of a single-employer defined benefit postretirement plan as an asset or liability in the statement of financial position. Funded status is determined as the difference between the fair value of plan assets and the benefit obligation. Changes in the funded status should be recognized in other comprehensive income. This recognition provision and the related disclosures are effective as of the end of the fiscal year ending after December 15, 2006. The Statement also requires the measurement of plan assets and benefit obligations as of the date of the fiscal year-end statement of financial position. This measurement provision is effective for fiscal years ending after December 15, 2008. We are currently reviewing this pronouncement, but we believe it could have a material impact on our financial statements.
In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurement”, effective for fiscal years beginning after November 15, 2007. This Statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This Statement does not require any new fair value measurements, but simplifies and codifies related guidance within generally accepted accounting principles (GAAP). This Statement applies under other accounting pronouncements that require or permit fair value measurements. We are currently reviewing this pronouncement, but we believe it will not have a material impact on our financial statements.
In June 2006, the FASB issued Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes”, effective for fiscal years beginning after December 15, 2006. This interpretation clarifies the accounting for uncertainty in income taxes in accordance with FASB Statement No. 109, “Accounting for Income Taxes”. The pronouncement provides a recognition threshold and measurement guidance for the financial statement recognition of a tax position taken or expected to be taken in a tax return. We are currently reviewing this pronouncement, but we believe it will not have a material impact on our financial statements.
In May 2005, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 154, “Accounting Changes and Error Corrections,” effective for the first fiscal period in the fiscal year beginning after December 15, 2005. This statement replaces APB Opinion No. 20, “Accounting Changes” and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements”. This statement applies to all voluntary changes in accounting principle and requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable. We would only be impacted by this statement if it made a voluntary change in accounting principle after the effective date.
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NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
In March 2005, the Financial Accounting Standards Board ratified the consensus reached in EITF Issue No. 04-06 (“EITF Issue 04-06”), “Accounting for Stripping Costs in the Mining Industry”. The consensus will be effective for the first fiscal period in the fiscal year beginning after December 15, 2005. The consensus on EITF Issue 04-06 calls for post-production stripping costs to be treated as a variable inventory production cost. As a result, such costs are subject to inventory costing procedures in the period they are incurred.
Once EIFT Issue 04-06 becomes effective in the first quarter of fiscal 2007, we will be required to write off the amount of our prepaid overburden removal expense account at August 1, 2006 as a cumulative effect adjustment to our opening balance of retained earnings. Although the write-off adjusts the opening balance of retained earnings, it will also reduce our earnings per share in the first quarter of fiscal 2007. The value of the prepaid overburden removal expense account at July 31, 2006 was $1,686,000. Also, on an ongoing basis we expect not to defer and amortize the vast majority of our overburden removal expenses. Post-production overburden removal costs will be considered variable production expenses and will be included in cost of sales in the period they are incurred; however, in accordance with EITF Issue 04-06, we will continue to defer and amortize the pre-production overburden removal costs associated with opening a new mine. We expect these changes to result in increased earnings volatility on a quarterly, but not an annual, basis. The overburden removal expense recorded each fiscal year is not directly dependent on the tons of clay removed from the mining operation.
NOTE 2 – SPECIAL CHARGES, FEES AND CHANGES IN ACCOUNTING ESTIMATES
OTHERCONTRACTUALCHARGE–PATENTINFRINGEMENTLAWSUIT
We were named as a defendant in an action captionedPSN Illinois LLC v. Oil-Dri Corporation of America filed February 5, 2004 in the United States District Court for the Northern District of Illinois. The lawsuit alleged that most of our scoopable cat litter products infringed two patents owned by the plaintiff. The plaintiff was seeking monetary damages in an unspecified amount, treble damages if the alleged infringement was found to be willful, as well as injunctive relief. We settled the plaintiff’s claims on August 12, 2004. Under terms of the settlement, we paid the plaintiff $1,250,000 and the plaintiff granted us paid-up licenses of the two patents involved in the litigation as well as a third patent owned by the plaintiff. The $1,250,000 pre-tax charge was reflected as Other Contractual Income & Charges on the Consolidated Statement of Operations for the fiscal year ended July 31, 2004.
LOSS ONIMPAIREDLONG-LIVEDASSETS
We recorded a loss on impaired assets of $464,000 during the second quarter of fiscal 2004. This loss was related to the write-off of a scoopable “box” product line located at our Georgia facility plus the write-off of the remaining estimated held-for-sale value of a similar box line at one of our Mississippi facilities. The impairments were the result of our decision to change from boxed products to jug products. Both lines were previously used exclusively by the Retail and Wholesale Products Group.
GAIN ONSALE OFLONG-LIVEDASSETS
On September 16, 2005, in the first quarter of fiscal 2006, we recorded a $415,000 pre-tax gain from the sale of certain water rights in Nevada. These water rights were geographically located in an area that we were not actively planning to develop.
47
NOTE 3 – OPERATING SEGMENTS
SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information” establishes standards for reporting information about operating segments. Under this standard, we have two reportable operating segments: Retail and Wholesale Products and Business to Business Products. These segments are managed separately because each business has different customer characteristics. Net sales and operating income for each segment are provided below. Revenues by product line are not provided because it would be impracticable to do so.
The accounting policies of the segments are the same as those described in the summary of significant accounting policies. Historically, we had divided our business by product lines; however, we recognized that due to the various products manufacturing interdependencies and marketing synergies, the most appropriate segmentation is generally based upon the type of end-customer. To support this new operating structure we reorganized the management of the product groups. The Vice President of the former Consumer Products Group was promoted to President of the Retail and Wholesale Products Group. The Business to Business Products Group is currently being managed directly by Daniel Jaffee, President and CEO.
Management does not rely on any segment asset allocations and does not consider them meaningful because of the shared nature of our production facilities. However we have estimated the segment asset allocations as follows:
| | | July 31, |
| | | Assets |
| | | 2006 | | 2005 | | 2004 |
| | | (in thousands) |
| Business to Business Products | | $ | 36,358 | | | $ | 31,376 | | | $ | 31,801 | |
| Retail and Wholesale Products | | | 59,836 | | | | 57,393 | | | | 66,207 | |
| Unallocated Assets | | | 43,353 | | | | 34,802 | | | | 30,867 | |
| Total Assets | | $ | 139,547 | | | $ | 123,571 | | | $ | 128,875 | |
| | | Year Ended July 31 |
| | | Net Sales | | Income |
| | | 2006 | | 2005 | | 2004 | | 2006 | | 2005 | | 2004 |
| | | (in thousands) |
| Business to Business Products | | 70,349 | | 62,798 | | 62,040 | | 14,181 | | 13,340 | | 14,366 |
| Retail and Wholesale Products | | 134,861 | | 125,070 | | 123,471 | | 8,486 | | 11,547 | | 11,864 |
| Total Sales/Operating Income | | $ 205,210 | | $ 187,868 | | $ 185,511 | | 22,667 | | 24,887 | | 26,230 |
| Gain on Sale of Long-Lived Assets1 | | | | | | | | 415 | | -- | | -- |
| Less: | | | | | | | | | | | | |
| Other Contractual Charge2 | | | | | | | | -- | | -- | | 1,250 |
| Loss on Impaired Long-Lived Assets3 | | | | | | | | -- | | -- | | 464 |
| Corporate Expenses | | | | | | | | 14,037 | | 14,660 | | 15,727 |
| Interest Expense, Net of InterestIncome | | | | | | | | 1,149 | | 1,295 | | 1,858 |
| Income before Income Taxes | | | | | | | | 7,896 | | 8,932 | | 6,931 |
| Income Taxes Provision | | | | | | | | 2,637 | | 2,392 | | 1,898 |
| Net Income | | | | | | | | $ 5,259 | | $ 6,540 | | $ 5,033 |
1See Note 2 for a discussion of the gain on the sale of long-lived assets
2See Note 2 for a discussion of other contractual charge.
3See Note 2 for a discussion of the loss on impaired long-lived assets.
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NOTE 3 – OPERATING SEGMENTS (CONTINUED)
The following is a summary of financial information by geographic region for the years ended July 31:
| | | 2006 | | 2005 | | 2004 |
| | | (in thousands) |
| Sales to unaffiliated customers: | | | | | | | | | | | |
| Domestic | | $ | 188,823 | | | $ | 173,413 | | | $ | 172,114 | |
| Foreign subsidiaries | | $ | 16,387 | | | $ | 14,455 | | | $ | 13,397 | |
| Sales or transfers between geographic areas: | | | | | | | | | | | |
| Domestic | | $ | 7,224 | | | $ | 5,956 | | | $ | 6,035 | |
| Income before income taxes: | | | | | | | | | | | |
| Domestic | | $ | 7,478 | | | $ | 8,370 | | | $ | 5,968 | |
| Foreign subsidiaries | | $ | 418 | | | $ | 562 | | | $ | 963 | |
| Net Income: | | | | | | | | | | | |
| Domestic | | $ | 4,992 | | | $ | 6,195 | | | $ | 4,418 | |
| Foreign subsidiaries | | $ | 267 | | | $ | 345 | | | $ | 615 | |
| Identifiable assets: | | | | | | | | | | | |
| Domestic | | $ | 130,143 | | | $ | 111,992 | | | $ | 117,604 | |
| Foreign subsidiaries | | $ | 9,404 | | | $ | 11,579 | | | $ | 11,271 | |
Our largest customer accounted for the following percentage of consolidated net sales and net accounts receivable:
| | | 2006 | | 2005 | | 2004 |
| Net sales for the years ended July 31 | | 19% | | 18% | | 18% |
| Net accounts receivable as of July 31 | | 27% | | 25% | | 27% |
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NOTE 4 – NOTES PAYABLE
The composition of notes payable at July 31 is as follows:
| | 2006 | | 2005 |
| | (in thousands) | |
| Town of Blue Mountain, Mississippi | | | | | | |
| Principal payable on October 1, 2008. Interest payable monthly | | | | | | |
| at a variable interest rate reset weekly based on market conditions | | | | | | |
| for similar instruments. The average annual rate was 3.28% and 2.15% | | | | | | |
| in fiscal 2006 and 2005, respectively. Payment of these bonds | | | | | | |
| by the Company is guaranteed by a letter of credit issued by | | | | | | |
| Harris Trust and Savings Bank | $ | 2,500 | | $ | 2,500 | |
| | |
| Teachers Insurance and Annuity Association of America and | | | | | | |
| Prudential Financial | | | | | | |
| Payable in annual principal installments on April 15: | | | | | | |
| $4,000,000 in fiscal 2007 and 2008; $1,500,000 in fiscal 2009; | | | | | | |
| $3,000,000 in fiscal 2010; $2,000,000 in fiscal 2011; and | | | | | | |
| $1,500,000 in fiscal 2012 and 2013. Interest is payable | | | | | | |
| semiannually at an annual rate of 6.55% | | 17,500 | | | 20,500 | |
| | |
| The Prudential Insurance Company of America and Prudential | | | | | | |
| Retirement Insurance and Annuity Company | | | | | | |
| Payable in annual principal installments on October 15: | | | | | | |
| $1,500,000 in fiscal 2009; $200,000 in fiscal 2010; | | | | | | |
| $1,500,000 in fiscal 2011; $2,100,000 in fiscal 2012; | | | | | | |
| $2,300,000 in fiscal 2013; $3,500,000 in fiscal 2014; | | | | | | |
| $3,500,000 in fiscal 2015; $400,000 in fiscal 2016. | | | | | | |
| Interest is payable semiannually at an annual rate | | | | | | |
| of 5.89% | | 15,000 | | | -- | |
| | |
| Other | | 240 | | | 320 | |
| | $ | 35,240 | | $ | 23,320 | |
| | |
| Less current maturities of notes payable | | (4,080 | ) | | (3,080 | ) |
| | $ | 31,160 | | $ | 20,240 | |
We sold at face value $15,000,000 in senior promissory notes to The Prudential Insurance Company of America and to Prudential Retirement Insurance and Annuity Company pursuant to a Note Agreement dated December 16, 2005. The notes bear interest at 5.89% per annum and mature on October 15, 2015. The proceeds of the sale may be used to fund future principal payments on debt, acquisitions, stock repurchases, capital expenditures and for working capital purposes. The Note Agreement contains certain covenants that restrict our ability to, among other things, incur additional indebtedness, dispose of assets and merge or consolidate. The Note Agreement also requires a minimum fixed coverage ratio and a minimum consolidated net worth to be maintained.
On January 29, 1999, we entered into a Credit Agreement with Harris Trust and Savings Bank. The agreement, as amended, provided for up to $7,500,000 in committed unsecured revolving credit loans and/or letters of credit (not to exceed $5,000,000). This agreement provided three possible interest rates based on either an applicable margin plus a LIBOR-based rate, an applicable margin plus a prime-based rate or a negotiated bank rate. This agreement ended in January 2006 and we did not have any outstanding borrowings.
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NOTE 4 – NOTES PAYABLE (CONTINUED)
On January 27, 2006, we entered into a new unsecured revolving credit agreement with Harris N.A. that is effective until January 27, 2009. The credit agreement provides that we may select a variable rate based on either Harris’ prime rate or a LIBOR-based rate, plus a margin which varies depending on our debt to earnings ratio, or a fixed rate as agreed to with Harris N.A. At July 31, 2006, the variable rates would have been 8.3% for the Harris’ prime rate or 6.0% for the LIBOR-based rate. As of July 31, 2006, $15,000,000 was available under this credit facility. The credit agreement contains restrictive covenants that, among other things and under various conditions (including a limitation on capital expenditures), limit our ability to incur additional indebtedness or to dispose of assets. The agreement also requires a minimum fixed coverage ratio and a minimum consolidated net worth to be maintained. As of July 31, 2006, there were no outstanding borrowings against this agreement.
On July 12, 2006, Favorite Products Company, Ltd., a wholly owned subsidiary, entered into a credit agreement with the National Bank of Canada. The agreement provides up to $1,500,000 (Canadian dollars) in committed unsecured revolving credit loans. The interest rate on any outstanding borrowings would be based on the Canadian prime rate. The agreement also contains restrictive covenants that require Favorite Products to maintain a minimum working capital ratio and a maximum debt to equity ratio. As of July 31, 2006, there were no outstanding borrowings against this agreement.
The 1998 note agreement with Teachers Insurance and Annuity Association of America and Prudential Insurance for the $25,000,000 private debt placement was been amended to modify the fixed charges ratio covenant contained therein from the original ratio to ratio values that varied over different periods of time. The currently applicable fixed charges ratio was set forth in the July 2002 amendment and sets the ratio for the period November 1, 2003 and thereafter at 1.50 to 1.00. Also currently applicable is an additional interest charge of 0.25% for any fiscal quarter ending on or after July 31, 2002 if the fixed charge coverage ratio is less than 1.50 to 1.00.
The agreements with Teachers Insurance and Annuity Association of America, Prudential Insurance Company of America and Harris N.A. impose working capital requirements, dividend and financing limitations, minimum tangible net worth requirements and other restrictions. Our credit agreement with Harris N.A. indirectly restricts dividends by requiring us to maintain consolidated net worth, as defined, of about $56,760,000 plus 25% of cumulative quarterly earnings from January 31, 2006.
In prior years, the Town of Blue Mountain, Mississippi issued long-term bonds to finance the purchase of substantially all of the assets of certain plant expansion projects, and leased the projects to us and various of our subsidiaries (with the Company and various of its wholly owned subsidiaries as guarantors) at rentals sufficient to pay the debt service on the bonds.
Our debt agreements also contain provisions such that if we default on one debt agreement, the others will automatically default. If we default on any guaranteed debt with a balance greater than $1,000,000, our unsecured revolving credit agreement with Harris N.A. will be considered in default. If we default on any debt with a balance greater than $5,000,000, we will also be considered in default on the note agreement with Teachers Insurance and Annuity Association of America and Prudential Insurance and with the promissory notes to The Prudential Insurance Company of America and Prudential Retirement Insurance and Annuity Company.
We were in compliance with all restrictive covenants and limitations at July 31, 2006.
The following is a schedule by year of future maturities of notes payable as of July 31, 2006:
| | (in thousands) |
| 2007 | $4,080 | |
| 2008 | 4,080 | |
| 2009 | 5,580 | |
| 2010 | 3,200 | |
| Later years | | 18,300 | |
| | | $35,240 | |
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NOTE 5 – INCOME TAXES
| The provision (benefit) for income tax expense consists of the following: | | | | | | | | | |
| | 2006 | | 2005 | | 2004 |
| | (in thousands) |
| Current | | | | | | | | | | | |
| Federal | $ | 2,148 | | | $ | 1,178 | | | $ | 1,220 | |
| Foreign | | 68 | | | | 254 | | | | 297 | |
| State | | 360 | | | | 396 | | | | 177 | |
| | | 2,576 | | | | 1,828 | | | | 1,694 | |
| Deferred | | | | | | | | | | | |
| Federal | | (57 | ) | | | 507 | | | | 57 | |
| Foreign | | 82 | | | | (37 | ) | | | 51 | |
| State | | 36 | | | | 94 | | | | 96 | |
| | | 61 | | | | 564 | | | | 204 | |
| Total Income Tax Provision | $ | 2,637 | | | $ | 2,392 | | | $ | 1,898 | |
Principal reasons for variations between the statutory federal rate and the effective rates for the years ended July 31 were as follows:
| | | 2006 | | 2005 | | 2004 |
| U.S. federal income tax rate | | 34.0 | % | | 34.0 | % | | 34.0 | % |
| Depletion deductions allowed for mining | | (13.6 | ) | | (11.7 | ) | | (16.2 | ) |
| State income tax expense, net of federal tax expense | | 3.3 | | | 3.6 | | | 2.6 | |
| AMT | | 1.1 | | | -- | | | 4.0 | |
| Difference in effective tax rate of foreign subsidiaries | | 0.1 | | | 0.6 | | | 0.3 | |
| Empowerment zone credits | | (0.5 | ) | | (0.9 | ) | | (1.1 | ) |
| Remitted foreign earnings | | 6.6 | | | -- | | | 3.0 | |
| Other | | 2.4 | | | 1.2 | | | 0.8 | |
| | | 33.4 | % | | 26.8 | % | | 27.4 | % |
The Consolidated Balance Sheets as of July 31 included the following tax effects of cumulative temporary differences:
| | 2006 | | 2005 |
| | Assets | | Liabilities | | Assets | �� | Liabilities |
| | (in thousands) |
| Depreciation | $ | -- | | | $ | 1,026 | | | $ | -- | | | $ | 851 | |
| Deferred compensation | | 1,742 | | | | -- | | | | 1,623 | | | | -- | |
| Postretirement benefits | | 269 | | | | -- | | | | 214 | | | | -- | |
| Allowance for doubtful accounts | | 386 | | | | -- | | | | 363 | | | | -- | |
| Other assets | | 317 | | | | -- | | | | 454 | | | | -- | |
| Accrued expenses | | 1,223 | | | | -- | | | | 1,172 | | | | -- | |
| Tax credits | | 2,654 | | | | -- | | | | 2,470 | | | | -- | |
| Amortization | | -- | | | | 360 | | | | 206 | | | | -- | |
| Inventories | | 113 | | | | -- | | | | 112 | | | | -- | |
| Depletion | | -- | | | | 382 | | | | -- | | | | 763 | |
| Stock compensation expense | | 132 | | | | -- | | | | -- | | | | -- | |
| Unremitted earnings of foreign subsidiaries | | -- | | | | 210 | | | | -- | | | | 210 | |
| Other assets – foreign | | -- | | | | 154 | | | | -- | | | | 72 | |
| | | 6,836 | | | | 2,132 | | | | 6,614 | | | | 1,896 | |
| Valuation allowance | | (1,831 | ) | | | -- | | | | (1,784 | ) | | | -- | |
| Total deferred taxes | $ | 5,005 | | | $ | 2,132 | | | $ | 4,830 | | | $ | 1,896 | |
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NOTE 5 – INCOME TAXES (CONTINUED)
As of July 31, 2006, for federal income tax purposes there were alternative minimum tax credit carryforwards of approximately $2,346,000. A valuation allowance has been established for $1,831,000 of the deferred tax benefit related to the AMT tax credits since it is more likely than not that the benefit will not be realized. The alternative minimum tax credit carryforwards of $2,346,000 can be carried forward indefinitely or until utilized.
Historically no provision had been made for possible income taxes which may be paid on the distribution of untaxed earnings of foreign subsidiaries of approximately $3,700,000, $8,000,000 and $7,500,000 as of July 31, 2006, 2005 and 2004, respectively. No provision was required as substantially all such amounts were intended to be indefinitely invested in the subsidiaries or to be handled in such a way that no additional income taxes would be incurred when such earnings are distributed. In 2004, a $210,000 tax expense was recorded on certain unremitted earnings of the foreign subsidiary in Switzerland. This charge was taken to reflect the estimated potential impact of repatriating certain cash balances held by that subsidiary.
On October 22, 2004, the President signed the American Jobs Creation Act of 2004 (the “Act”). The Act provides a deduction for income from qualified domestic production activities, which will be phased in from 2005 through 2010. In return, the Act also provides for a two-year phase-out of the existing extra-territorial income exclusion (ETI) for foreign sales that was viewed to be inconsistent with international trade protocols by the European Union. We have implemented this provision effective July 31, 2006.
Also, the Act creates a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85% dividends received deduction for certain dividends from controlled foreign corporations. During fiscal 2006, we had a plan to repatriate untaxed earnings from our foreign subsidiaries. During the year we repatriated approximately $4,600,000 from our Swiss subsidiary. We recorded total additional tax expense relating to the repatriation of $735,000 (net of foreign tax credits), of which $525,000 was recorded in fiscal 2006 and $210,000 was recorded in fiscal 2004. This additional tax increased our effective tax rate in fiscal 2006 to 33.4% of pre-tax income versus 26.8% in fiscal 2005.
NOTE 6 – STOCKHOLDERS’ EQUITY
Our authorized capital stock at July 31, 2006 and 2005 consisted of 15,000,000 shares of Common Stock, 7,000,000 shares of Class B Stock and 30,000,000 shares of Class A Common Stock, each with a par value of $.10 per share. There are no Class A shares currently outstanding.
On June 6, 2006, the Board announced a five-for-four stock split, to be effected by a stock dividend of one-quarter share for each outstanding share of Common Stock and Class B Stock. The stock dividend was paid on September 8, 2006 to stockholders of record at the close of business on August 4, 2006. Except where otherwise noted, all share, per share and balance sheet values for all years presented have been restated to reflect the stock split.
The Common Stock and Class B Stock are equal, on a per share basis, in all respects except as to voting rights, conversion rights, cash dividends and stock splits or stock dividends. The Class A Common Stock is equal, on a per share basis, in all respects, to the Common Stock except as to voting rights and stock splits or stock dividends. In the case of voting rights, Common Stock is entitled to one vote per share and Class B Stock is entitled to ten votes per share, while Class A Common Stock generally has no voting rights. Common Stock and Class A Common Stock have no conversion rights. Class B Stock is convertible on a share-for-share basis into Common Stock at any time and is subject to mandatory conversion under certain circumstances.
Common Stock is entitled to cash dividends, as and when declared or paid, equal to at least 133 1/3% on a per share basis of the cash dividend paid on Class B Stock. Class A Common Stock is entitled to cash dividends on a per share basis equal to the cash dividend on Common Stock. Additionally, while shares of Common Stock, Class A Common Stock and Class B Stock are outstanding, the sum of the per share cash dividend paid on shares of Common Stock and Class A Common Stock, must be equal to at least 133 1/3% of the sum of the per share cash dividend paid on Class B Stock and Class A Common Stock. See Note 4 of the Notes to the Consolidated Financial Statements regarding dividend restrictions.
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NOTE 6 – STOCKHOLDERS’ EQUITY (CONTINUED)
Shares of Common Stock, Class A Common Stock and Class B Stock are equal in respect of all rights to dividends (other than cash) and distributions in the form of stock or other property (including stock dividends and split-ups) in each case in the same ratio except in the case of a Special Stock Dividend. The Special Stock Dividend, which can be issued only once, is either a dividend of one share of Class A Common Stock for each share of Common Stock and Class B Stock outstanding or a recapitalization, in which half of each outstanding share of Common Stock and Class B Stock would be converted into a half share of Class A Common Stock.
Our Board of Directors has authorized the repurchase of 2,916,771 shares of the Company stock. As of July 31, 2006, 2,158,058 shares of Common Stock and 342,241 shares of Class B stock have been repurchased under the Board approved repurchase authorizations and 146,545 shares of Common Stock by other transactions authorized by management prior to the adoption of this plan. The number of shares to be repurchased under Board authorization is not affected by the stock split described below; therefore, the number of shares has not been restated.
The number of holders of record of Common Stock and Class B stock on September 29, 2006 were 747 and 33, respectively, as reported by our transfer agent. Our Common Stock is traded on the New York Stock Exchange. There is no established trading market for the Class B Stock.
NOTE 7 – STOCK BASED COMPENSATION
In December 2004, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-Based Payments” (“FAS 123-R”), effective for the first reporting period which begins after June 15, 2005. This statement is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation” and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. This revised statement eliminates the alternative to use the intrinsic value method of accounting that was provided in SFAS 123, which generally resulted in no compensation expense recorded in the financial statements related to the issuance of stock option awards to employees. FAS 123-R requires all companies to apply a fair-value-based measurement method in accounting for generally all share-based payment transactions with employees and requires the resulting cost to be recognized in the financial statements.
On August 1, 2005 we adopted FAS 123-R using a modified prospective application. Accordingly, prior period amounts have not been restated. Under this application, we are required to record compensation expense for all awards granted after the date of adoption and for the unvested portion of previously granted awards that remain outstanding at the date of adoption.
Prior to the adoption of FAS 123-R, we applied APB 25 to account for stock-based awards. Under APB 25, we only recorded stock-based compensation expense for restricted stock. Under the provisions of APB 25, we were not required to recognize compensation expense for the cost of stock options. Beginning with the 2006 fiscal year, with the adoption of FAS 123-R, we recorded stock-based compensation expense for the cost of stock options and restricted stock (together, “Employee Stock-Based Awards”). Stock-based compensation expense for fiscal 2006 was $451,000 ($330,000 after tax). The effect on basic and diluted earnings per share was approximately $0.05 per share.
FAS 123-R requires that stock based compensation be recognized over the period from the date of grant to the date when the award is no longer contingent on the employee providing additional service to the company. Certain employees are eligible for accelerated vesting in accordance with the terms of our plans if they retire with 17 years of continuous service and are at least 55 years old and their age plus years of service equals 80. Any unamortized expense would be recognized immediately when the employee meets these criteria.
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NOTE 7 – STOCK BASED COMPENSATION (CONTINUED)
The following table details the effect on net income and earnings per share if compensation expense for the stock plans had been recorded based on the fair value method under FAS 123-R for all years presented. The reported and pro forma net income and earnings per share for fiscal 2006 in the table below are the same since stock-based compensation expense is calculated under the provisions of FAS 123-R. These amounts are included only for a basis of comparison to prior years.
| | Year Ended |
| (in thousands, | | | | | | | | |
| except per share data) | 2006 | | 2005 | | 2004 |
| Reported net income | $5,259 | | | $6,540 | | | $5,033 | |
| Add: Total stock-based | 330 | | | 16 | | | 20 | |
| employee compensation expense | | | | | | | | |
| included in reported net income, | | | | | | | | |
| net of related tax effects | | | | | | | | |
| Deduct: Total stock-based | (330 | ) | | (341 | ) | | (321 | ) |
| employee compensation expense | | | | | | | | |
| determined under fair value | | | | | | | | |
| method for all awards | | | | | | | | |
| net of related tax effects | | | | | | | | |
| Pro forma net income | $5,259 | | | $6,215 | | | $4,732 | |
| Earnings per share: | | | | | | | | |
| Basic Common – as reported | $0.83 | | | $1.02 | | | $0.79 | |
| Basic Common – pro forma | $0.83 | | | $0.97 | | | $0.74 | |
| Basic Class B Common – as reported | $0.61 | | | $0.76 | | | $0.59 | |
| Basic Class B Common – pro forma | $0.61 | | | $0.73 | | | $0.56 | |
| Diluted – as reported | $0.73 | | | $0.88 | | | $0.68 | |
| Diluted – pro forma | $0.73 | | | $0.83 | | | $0.63 | |
Stock Options
Our 1995 Long Term Incentive Plan (“1995 Plan”) provided for grants of both incentive and non-qualified stock options at an option price per share of 100% of the fair market value of our Class A Common Stock or, if no Class A Common Stock is outstanding, our Common Stock (“Stock”) on the date of grant. Stock options were generally granted with a five-year vesting period and a 10-year term. The stock options vest 25% two years after the grant date and 25% in each of the three following anniversaries of the grant date. This plan expired for purposes of issuing new grants on August 5, 2005. All stock issued from option exercises under this plan were from authorized but unissued stock. All restricted stock issued was from treasury stock.
On March 14, 2006, our Board of Directors unanimously approved adoption of the Oil-Dri Corporation of America 2006 Long Term Incentive Plan (“2006 Plan”), subject to approval by our stockholders. We expect to present the plan to stockholders for approval at the December 2006 annual meeting of stockholders. The 2006 Plan permits the grant of stock options, stock appreciation rights, restricted stock, restricted stock units, performance awards and other stock-based and cash-based awards. Our employees and non-employee directors are eligible to receive grants under the 2006 Plan. The total number of shares of Stock subject to grants under the 2006 Plan may not exceed 937,500. Option grants covering 25,000 shares were issued to our outside directors with a vesting period of one year and an option grant covering 12,500 shares was issued to an employee with vesting similar to the vesting described above under the 1995 Plan. 90,000 shares of restricted stock were issued under the 2006 Plan. Because our executive officers, directors and their affiliates control a majority of the aggregate voting power of Oil-Dri Corporation of America, the awards are expected to be approved and have met the grant date criteria established by FAS 123-R. However, no grants issued under the 2006 Plan will be exercisable or payable to a participant prior to approval of the 2006 Plan by our stockholders.
55
NOTE 7 – STOCK BASED COMPENSATION (CONTINUED)
The Oil-Dri Corporation of America Outside Director Stock Plan (the “Directors’ Plan”) provides for grants of stock options to its directors at an option price per share of 100% of the fair market value of Common Stock on the date of grant. Our directors are considered employees under the provisions of FAS 123-R. Stock options have been granted to our directors for a 10-year term with a one year vesting period. There are 100,000 shares outstanding and no shares available for future grants under this plan. All stock issued under this plan were from treasury stock.
| EQUITY COMPENSATION PLAN INFORMATION AS OF JULY 31, 2006 |
| | | | Number of |
| | | | securities |
| | | | remaining |
| | | | available for |
| | Number of | | further issuance |
| | securities to be | | under equity |
| | issued upon | | compensation |
| | exercise of | Weighted-average | plans (excluding |
| | outstanding | exercise price of | securities reflected |
| | options | outstanding | in column (a)) |
| | (in thousands) | options | (in thousands) |
| Plan category | (a) | (b) | (c) |
| Equity compensation plans approved by stockholders | 763 | | $8.30 | | -- | |
| Equity compensation plans expected to be approved by stockholders | 38 | | $15.00 | | 810 | |
| Equity compensation plans not approved by stockholders | 125 | | $8.50 | | -- | |
A summary of option transactions under the plans is shown below. The number of shares transacted is shown subsequent to the five-for-four stock split effected by a stock dividend paid on September 8, 2006.
| | Number of | | Weighted |
| | Shares | | Average |
| | (in thousands) | | Exercise Price |
| Options outstanding at July 31, 2003 | | 1,841 | | | $ | 8.33 | |
| Granted | | 245 | | | $ | 9.73 | |
| Exercised | | (174 | ) | | $ | 7.72 | |
| Expired | | (19 | ) | | $ | 10.90 | |
| Forfeited | | (49 | ) | | $ | 9.52 | |
| Options outstanding at July 31, 2004 | | 1,844 | | | $ | 8.50 | |
| Options vested at July 31, 2004 | | 1,159 | | | $ | 8.90 | |
| Options unvested at July 31, 2004 | | 685 | | | $ | 7.82 | |
| Granted | | 88 | | | $ | 12.94 | |
| Exercised | | (549 | ) | | $ | 8.38 | |
| Expired | | (72 | ) | | $ | 15.42 | |
| Forfeited | | (48 | ) | | $ | 6.56 | |
| Options outstanding at July 31, 2005 | | 1,263 | | | $ | 8.48 | |
| Options vested at July 31, 2005 | | 652 | | | $ | 8.42 | |
| Options unvested at July 31, 2005 | | 611 | | | $ | 8.54 | |
| Granted | | 37 | | | $ | 15.01 | |
| Exercised | | (340 | ) | | $ | 9.05 | |
| Forfeited | | (34 | ) | | $ | 6.54 | |
| Options outstanding at July 31, 2006 | | 926 | | | $ | 8.60 | |
| Options vested at July 31, 2006 | | 480 | | | $ | 8.27 | |
| Options unvested at July 31, 2006 | | 446 | | | $ | 8.96 | |
56
NOTE 7 – STOCK BASED COMPENSATION (CONTINUED)
As of July 31, 2006, 2005, and 2004, the weighted average remaining contractual term of all outstanding options was 5.5 years, 5.9 years and 5.9 years, respectively, and 4.1 years, 4.3 years and 4.7 years for options exercisable on those dates.
The total intrinsic value (the excess of the market price over the exercise price) was approximately $6,800,000 for all outstanding options at July 31, 2006, $3,700,000 for options exercisable at July 31, 2006 and $2,100,000 for options exercised during the fiscal year ended July 31, 2006. The total intrinsic value was approximately $7,500,000 for all outstanding options at July 31, 2005, $3,900,000 for options exercisable at July 31, 2005 and $2,900,000 for options exercised during the fiscal year ended July 31, 2005. The total intrinsic value was approximately $8,700,000 for all outstanding options at July 31, 2004, $5,100,000 for options exercisable at July 31, 2004 and $1,000,000 for options exercised during the fiscal year ended July 31, 2004.
| OPTIONS OUTSTANDING AND EXERCISABLE |
| BY PRICE RANGE AS OF 7/31/2006 |
| Options Outstanding | | Options Exercisable |
| | | | | | Weighted | | | | | | | | | | | |
| | | Outstanding as | | Average | | Weighted | | | | | Weighted |
| Range of | | of 7/31/2006 | | Remaining | | Average | | Shares | | Average |
| Exercise Prices | | (in thousands) | | Contractual Life | | Exercise Price | | (in thousands) | | Exercise Price |
| $4.96 - $6.00 | | 240 | | | 5.36 | | $ | 5.08 | | | 99 | | | $ | 5.10 | |
| $6.01 - $8.00 | | 104 | | | 4.13 | | $ | 6.72 | | | 104 | | | $ | 6.72 | |
| $8.01 - $10.00 | | 402 | | | 5.41 | | $ | 9.22 | | | 196 | | | $ | 9.09 | |
| $10.01 - $12.00 | | 86 | | | 4.62 | | $ | 11.80 | | | 54 | | | $ | 11.69 | |
| $12.01 - $14.00 | | 44 | | | 8.15 | | $ | 13.18 | | | 27 | | | $ | 13.11 | |
| $14.01 - $16.00 | | 50 | | | 9.46 | | $ | 14.94 | | | -- | | | $ | -- | |
| $4.96 - $16.00 | | 926 | | | 5.53 | | $ | 8.60 | | | 480 | | | $ | 8.27 | |
The amount of cash received from the exercise of options during the fiscal year ended July 31, 2006 was approximately $3,100,000 and the related tax benefit was approximately $550,000. The amount of cash received from the exercise of options during the fiscal year ended July 31, 2005 was approximately $4,600,000 and the related tax benefit was approximately $770,000. The amount of cash received from the exercise of options during the fiscal year ended July 31, 2004 was approximately $1,300,000 and the related tax benefit was approximately $270,000.
A five-for-four stock split was announced by our Board on June 6, 2006. In keeping with historical practices, we have adjusted the number of shares and the option prices to equitably adjust all outstanding stock options. Under FAS 123-R, the equitable adjustment of outstanding options to reflect a change in capitalization (such as a stock split) may require the recognition of incremental compensation expense if the adjustment is not determined to have been required by the actual terms of the equity incentive plan. The Oil-Dri Corporation of America Outside Director Stock Plan and the Oil-Dri Corporation of America 1995 Long Term Incentive Plan may be deemed to have been discretionary, rather than required by the actual terms of these plans. We will therefore recognize approximately $500,000 additional stock based compensation expense relating to the modification in fiscal 2007 and approximately $500,000 expense in subsequent years. As of July 31, 2006, we had a total of approximately $1,700,000 in unamortized expense associated with all outstanding stock options, including the additional compensation expense resulting from the stock split. The weighted average period over which this expense is expected to be amortized is 2.4 years. As of July 31, 2005 and July 31, 2004, we had a total of approximately $840,000 and $1,100,000, respectively, in unamortized compensation expense. The weighted average period over which this expense was expected to be amortized was 3.3 years and 3.9 years at July 31, 2005 and July 31, 2004, respectively.
57
NOTE 7 – STOCK BASED COMPENSATION (CONTINUED)
The fair value of the stock options granted was estimated on the date of the grant using a Black-Scholes option valuation model that uses the assumptions noted in the following table. The components of the table are weighted averages of the assumptions for each fiscal year. The assumptions are determined on the date of the grant. Grants issued on a given date are valued as a group. The risk free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant. The expected life (estimated period of time outstanding) of a grant is determined by reference to the vesting schedule, past exercise behavior and comparison with other reporting companies. We use the dividend rate at the date of grant as the best estimate of future dividends. Expected volatility is determined by calculating the standard deviation of our stock price for the 5 years immediately prior to the grant date. This period of time closely resembles the expected term. All of the options currently outstanding have a term of 10 years. All stock options issued under our plans have been issued at the closing market price on the date of grant.
| | 2006 | | 2005 | | 2004 |
| Dividend Yields | 2.5 | % | | 2.5 | % | | 3.0 | % |
| Volatility | 23.5 | % | | 35.1 | % | | 36.0 | % |
| Risk-free Interest Rate | 4.9 | % | | 4.1 | % | | 3.1 | % |
| Expected Life (Years) | 5.4 | | | 5.4 | | | 5.4 | |
| Weighted Average Fair Value | $3.48 | | $3.99 | | $2.6 | 4 |
| (restated for five-for-four stock split paid on September 8, 2006) | | | | | | | | |
Restricted Stock
Our 1995 Plan and 2006 Plan both provide for grants of restricted stock. The vesting schedule under the 1995 Plan has varied but has been three years or less. Under the 2006 Plan the grants issued so far have vesting periods between three and five years.
A summary of option transactions under the plans is shown below. The number of shares transacted reflects the five-for-four stock split effected by a stock dividend paid on September 8, 2006.
| | | Number of | | Weighted | |
| | | Shares | | Average | |
| | | (in | | Grant Date | |
| | | thousands) | | Fair Value | |
| Unvested restricted stock outstanding atJuly 31, 2003 | | 9 | | $ | 6.43 | | |
| Unvested restricted stock outstanding atJuly 31, 2004 | | 9 | | $ | 6.43 | | |
| Granted | | 6 | | $ | 14.86 | | |
| Vested | | (9) | | $ | 6.43 | | |
| Unvested restricted stock outstanding atJuly 31, 2005 | | 6 | | $ | 14.86 | | |
| Granted | | 90 | | $ | 15.40 | | |
| Vested | | (1) | | $ | 14.86 | | |
| Unvested restricted stock outstanding at July 31, 2006 | | 95 | | $ | 15.37 | | |
As of July 31, 2006, we had a total of $1,308,000 in unamortized expense associated with restricted stock. The weighted average period over which this expense is expected to be amortized is 4.2 years at July 31, 2006. As of July 31, 2005 and July 31, 2004, we had a total of approximately $75,000 and $10,000, respectively, in unamortized compensation expense. The weighted average period over which this expense was expected to be amortized was 2.8 years and 0.5 years at July 31, 2005 and July 31, 2004, respectively
58
NOTE 8 – EMPLOYEE BENEFIT PLANS
We have a defined benefit pension plan for eligible salaried and hourly employees. Benefits are based on a formula of years of credited service and levels of compensation or stated amounts for each year of credited service.
Pension benefit obligations and the related effects on operations are calculated using actuarial models. Two critical assumptions, discount rate and expected return on assets, are important elements of plan expense and asset/liability measurement. We evaluate these critical assumptions at least annually. Other assumptions involving demographic factors such as retirement age, mortality and turnover are evaluated periodically and are updated to reflect our experience. Actual results in any given year will often differ from actuarial assumptions because of economic and other factors.
The discount rate utilized for determining future pension obligations of the U.S. qualified plans is based on a market benchmark rate that is of comparable duration to the plan’s liabilities. Specifically, at July 31, 2006, the discount rate was based on the Citigroup Pension Liability Index and at July 31, 2005, the discount rate was based on the Moody’s Aa corporate rate. The rate was rounded to the nearest 25 basis point. The resulting discount rate increased from 5.25% at July 31, 2005 to 6.25% at July 31, 2006.
A one-percentage point change in the discount rate and the expected return on assets on key costs and accruals is shown below:
| | | (in thousands) |
| | | One-Percentage Point Increase | | One-Percentage Point Decrease |
| Effect on total service cost and | | ($192) | | $236 |
| interest cost components of | | | | |
| expense for a 1% change in the | | | | |
| discount rate | | | | |
| Effect on projected benefit | | ($2,541) | | $3,212 |
| obligation for a 1% change in | | | | |
| the discount rate | | | | |
| Effect on the return on | | ($137) | | $137 |
| investments component of | | | | |
| expense by a 1% change in the | | | | |
| return on investment | | | | |
Our expected rate of return on plan assets is determined by our asset allocation, our historical long-term investment performance, our estimate of future long-term returns by asset class (using input from our actuaries, investment services and investment managers), and long-term inflation assumptions. The long-term rate of return assumption used for determining net periodic pension expense for the fiscal year ended July 31, 2006 was 8%. This assumption is maintained at 8% for determining fiscal 2006 net periodic pension expense. Our historical actual return averaged 10.9% for the ten-year period ending July 31, 2006. The actual rate of return in fiscal 2006 was 10.3%. Future actual pension expense will depend on future investment performance, changes in future discount rates and various other factors related to the population of participants in our pension plans. The investment objective for the pension plan is to secure the benefit obligations to participants at a reasonable cost. The goal is to optimize the long-term return on plan assets at a moderate level of risk.
We review the allocation of plan assets quarterly. The allocation of plan assets at July 31, 2006 was 54% fixed income, 44% equity and 2% cash and accrued income. The allocation of plan assets at July 31, 2005 was 45% fixed income, 54% equity and 1% cash and accrued income. We are currently targeting a 50% fixed income and 50% equity funds allocation for fiscal 2007. There is no Oil-Dri common stock in the pension trust fund.
59
NOTE 8 – EMPLOYEE BENEFIT PLANS (CONTINUED)
The net periodic pension cost for the years ended July 31 consists of the following:
| 2006 | | 2005 | | 2004 |
| (in thousands) |
| Service cost | $ | 976 | | | $ | 786 | | | $ | 775 | |
| Interest cost on projected benefit obligations | | 1,018 | | | | 950 | | | | 906 | |
| Expected return on plan assets | | (1,094 | ) | | | (942 | ) | | | (814 | ) |
| Amortization of: | | | | | | | | | | | |
| Net transition asset | | (27 | ) | | | (27 | ) | | | (27 | ) |
| Prior service costs | | 50 | | | | 50 | | | | 50 | |
| Other actuarial loss | | 107 | | | | 18 | | | | 60 | |
| Net pension cost | $ | 1,030 | | | $ | 835 | | | $ | 950 | |
The measurement dates used to calculate the net periodic pension cost were August 1, 2005, 2004 and 2003, respectively.
The funded status of the plans at July 31 is as follows:
| | 2006 | | 2005 |
| (in thousands) |
| Fair Value of Plan Assets Less Than Projected Benefit Obligations | $ | (2,552 | ) | | $ (5,745 | ) |
| Unrecognized Net Loss | | 4 | | | 3,703 | |
| Unrecognized Prior Service Cost | | 282 | | | 331 | |
| Unrecognized Net Asset at Transition | | (51 | ) | | (78 | ) |
| Additional Minimum Liability | | -- | | | (216 | ) |
| Accrued Pension Included in Noncurrent Liabilities--Other | $ | (2,317 | ) | | $ (2,005 | ) |
Reconciliation of the assets and liabilities of the plans at July 31 is as follows:
| 2006 | | 2005 |
| (in thousands) |
| Change in Plan Assets: | | | | | | | |
| Plan assets at fair value, beginning of year | $ | 13,952 | | | $ | 11,843 | |
| Actual return on plan assets | | 1,434 | | | | 2,060 | |
| Contributions | | 500 | | | | 560 | |
| Benefits paid | | (534 | ) | | | (511 | ) |
| Plan assets at fair value, end of year | $ | 15,352 | | | $ | 13,952 | |
| |
| Change in Projected Benefit Obligation: | | | | | | | |
| Projected benefit obligation, beginning of year | $ | 19,697 | | | $ | 15,548 | |
| Service cost | | 976 | | | | 786 | |
| Interest cost | | 1,018 | | | | 950 | |
| Actuarial (gain) loss | | (3,253 | ) | | | 2,924 | |
| Benefits paid | | (534 | ) | | | (511 | ) |
| Projected benefit obligation, end of year | $ | 17,904 | | | $ | 19,697 | |
Assumptions used in the previous calculations are as follows:
| | 2006 | | 2005 |
| Discount rate for net pension cost | | 5.25% | | 6.25% |
| Discount rate for year-end obligations | | 6.25% | | 5.25% |
| Rate of increase in compensation levels | | 4.00% | | 4.00% |
| Long-term expected rate of return on assets | | 8.00% | | 8.00% |
60
NOTE 8 – EMPLOYEE BENEFIT PLANS (CONTINUED)
We have funded the plans based upon actuarially determined contributions that take into account the amount deductible for income tax purposes, the normal cost and the minimum contribution required and the maximum contribution allowed under the Employee Retirement Income Security Act of 1974 (ERISA), as amended.
We contributed $500,000 and $560,000 to the pension during the fiscal years ended July 31, 2006 and July 31, 2005, respectively. We are not required to make a contribution to the plan in fiscal 2007; however, we expect to make a contribution to the plan sufficient to fund the annual cost. We expect to contribute about $546,000 in fiscal 2007.
The accumulated benefit obligation for the pension plan was $14,830,000 as of July 31, 2006 and $15,957,000 as of July 31, 2005. The decrease in the accumulated benefit obligation is primarily due to the higher discount rate used at July 31, 2006. The measurement dates for determining the accumulated benefit obligation at July 31 are July 31, 2006 and 2005, respectively. The measurement dates for determining the net periodic pension cost for fiscal years ended July 31, 2006 and 2005 are August 1, 2005 and 2004, respectively.
Our estimated future benefit payments are as follows:
| Year ended July 31, | 2007 | | 2008 | | 2009 | | 2010 | | 2011 | | 2012-16 |
| (in thousands) |
| | | | | | | | | | | | |
| Estimated benefit payments | $605 | | $640 | | $665 | | $680 | | $721 | | $5,173 |
For the years ended July 31, 2006, 2005 and 2004, we maintained a 401(k) savings plan under which we match a portion of employee contributions. The plan is available to essentially all domestic employees following thirty or sixty days of employment. Our contributions to this plan, and to similar plans maintained by our foreign subsidiaries, were $562,000, $554,000 and $533,000 for fiscal years 2006, 2005 and 2004, respectively.
NOTE 9 – DEFERRED COMPENSATION
Effective April 1, 2003, we adopted the Oil-Dri Corporation of America Supplemental Executive Retirement Plan (“SERP”). The purpose of the Plan is to provide certain retired participants in the Oil-Dri Corporation of America Pension Plan (“Retirement Plan”) with the amount of benefits that would have been provided under the Retirement Plan but for: (1) the limitations on benefits imposed by Section 415 of the Internal Revenue Code (“Code”), and/or (2) the limitation on compensation for purposes of calculating benefits under the Retirement Plan imposed by Section 401(a)(17) of the Code. We recorded $27,000 in expense associated with this plan in the fiscal year ended July 31, 2006. The plan is unfunded and we will fund benefits when payments are made. The total liability recorded for the SERP is $98,000 at July 31, 2006.
In December 1995, we adopted the Oil-Dri Corporation of America Deferred Compensation Plan. This plan has permitted Directors and certain management employees to defer portions of their compensation and to earn interest on the deferred amounts. During the period January 1, 1999 through September 30, 2000, participants' returns were tied to the performance of various investment elections. After September 30, 2000 the participants’ returns have been set at our long-term cost of borrowing plus 1%. Compensation deferred since the inception of the plan has been accrued as well as earnings thereon. Participants have deferred $304,000, $292,000 and $360,000 into these plans in fiscal years 2006, 2005 and 2004, respectively. Payments to participants were $25,000.
We have segregated deferrals made since January 1, 2005, and the associated earnings, pending adoption of a new plan compliant with the provisions of Section 409(A) of the Internal Revenue Code. That plan will have earnings provisions identical to the Oil-Dri Corporation of America Deferred Compensation Plan.
61
NOTE 10 – COMMITMENTS AND CONTINGENCIES
We are party to various legal actions from time to time that are ordinary in nature and incidental to the operation of our business. While it is not possible at this time to determine with certainty the ultimate outcome of these or other lawsuits, management believes that none of the pending proceedings will have a material adverse effect on our business or financial condition.
NOTE 11 – LEASES
Our mining operations are conducted on leased or owned property. These leases generally provide us with the right to mine as long as we continue to pay a minimum monthly rental, which is applied against the per ton royalty when the property is mined.
We lease certain offices and production facilities. Please see Item 2. “Properties”, for further details.
In addition, we lease vehicles, railcars, mining property and equipment, warehouse space, data processing equipment, and office equipment. In most cases, we expect that, in the normal course of business, leases will be renewed or replaced by other leases.
The following is a schedule by year of future minimum rental requirements under operating leases that have initial or remaining noncancelable lease terms in excess of one year as of July 31, 2006:
| (in thousands) |
| 2007 | | $ | 2,760 | |
| 2008 | | | 1,307 | |
| 2009 | | | 1,066 | |
| 2010 | | | 988 | |
| 2011 | | | 782 | |
| Later years | | | 4,975 | |
| | $ | 11,878 | |
The following schedule shows the composition of total rental expense for all operating leases, including those with terms of one month or less which were not renewed, as of the years ended July 31:
| 2006 | | 2005 | | 2004 |
| (in thousands) |
| Vehicles and Railcars | | $ | 994 | | | | $ | 988 | | | $ | 878 | |
| Office facilities | | | 673 | | | | | 618 | | | | 516 | |
| Warehouse facilities | | | 142 | | | | | 132 | | | | 253 | |
| Mining properties | | | | | | | | | | | | | |
| Minimum | | | 104 | | | | | 94 | | | | 91 | |
| Contingent | | | 620 | | | | | 703 | | | | 678 | |
| Other | | | 760 | | | | | 844 | | | | 902 | |
| | $ | 3,293 | | | | $ | 3,379 | | | $ | 3,318 | |
Contingent mining royalty payments are determined based on the tons of raw clay mined.
62
NOTE 12 – OTHER CASH FLOW INFORMATION
Cash payments for interest and income taxes were as follows:
| 2006 | | 2005 | | 2004 |
| (in thousands) |
| Interest | | $ | 1,756 | | | | $ | 1,723 | | | $ | 1,859 | |
| Income taxes | | $ | 1,250 | | | | $ | 1,669 | | | $ | 1,034 | |
NOTE 13 – POST-RETIREMENT HEALTH BENEFITS
Domestic salaried employees who retire prior to reaching age 65 and have at least 17 years of continuous service and whose age is at least 55 and whose age plus years of service equals at least 80 may elect to continue their health care coverage under the Oil-Dri Corporation of America Employee Benefits Plan until they reach the age of 65. We accrue the costs of such benefits during the employees’ active years of service.
Net periodic post-retirement costs for the years ended July 31, were as follows:
| | | | 2006 | | 2005 | | 2004 |
| | | (in thousands) |
| Components of net periodic post- | | | | | | | | | | | | | | |
| | retirement cost | | | | | | | | | | | | | | |
| Service cost | | | $ | 73 | | | | $ | 54 | | | $ | 56 | |
| Interest cost | | | | 55 | | | | | 47 | | | | 45 | |
| Amortization of net transition obligation | | | | 16 | | | | | 16 | | | | 16 | |
| Amortization of losses | | | | 15 | | | | | 1 | | | | 5 | |
| Net periodic post-retirement benefit cost | | | $ | 159 | | | | $ | 118 | | | $ | 122 | |
The accumulated post-retirement benefit obligation assumptions were as follows:
| | 2006 | | 2005 |
| Discount rate for net periodic post- | | 5.25% | | 6.25% |
| retirement costs | | | | |
| Discount rate for year-end obligations | | 6.25% | | 5.25% |
| Medical trend | | 6.00% | | 6.00% |
A flat medical trend assumption of 6% per year has been used in the valuation. Although using a graded trend assumption would also be a reasonable approach, a graded trend assumption implies greater precision in the ability to predict future medical costs than is the case. A graded trend assumption also generally needs to be reset every few years. The flat trend of 6% is approximately equivalent to a graded trend schedule of 10% decreasing to 4.5% over six years.
A one-percentage point change in assumed health care cost trend would have had the following effects in the fiscal year ended July 31, 2006:
| | (in thousands) |
| | One-Percentage | | One-Percentage |
| | Point Increase | | Point Decrease |
| Effect on total service and interest costs | | $24 | | ($19) |
| for fiscal year ended July 31, 2006 | | | | |
| Effect on accumulated post-retirement | | $153 | | ($130) |
| benefit obligation as of July 31, 2006 | | | | |
63
NOTE 13 – POST-RETIREMENT HEALTH BENEFITS (CONTINUED)
Our estimated future benefit payments are as follows:
| (in thousands) |
| Year ended July 31, | 2007 | | 2008 | | 2009 | | 2010 | | 2011 | | 2012-16 |
| Estimated benefit payments | $ 16 | | $ 20 | | $ 26 | | $ 41 | | $ 65 | | $379 |
Our policy is to pay insurance premiums and claims under the above-mentioned plan from our assets.
The accrued post-retirement benefit liability and the change in benefit obligation as of July 31, 2006 andJuly 31, 2005 were as follows:
| July 31, |
| 2006 | | 2005 |
| (in thousands) |
| Change in benefit obligation: | | | | | | | | | | | |
| Benefit obligation at beginning of year | | $ | 1,066 | | | | | $ | 777 | | |
| Service cost | | | 73 | | | | | | 54 | | |
| Interest cost | | | 55 | | | | | | 47 | | |
| Actuarial (gain) loss | | | (150 | ) | | | | | 265 | | |
| Benefits paid | | | (15 | ) | | | | | (77 | ) | |
| Benefit obligation at end of year | | $ | 1,029 | | | | | $ | 1,066 | | |
| | | |
| Change in plan assets: | | | | | | | | | | | |
| Employer contribution | | $ | 15 | | | | | $ | 77 | | |
| Benefits paid | | | (15 | ) | | | | | (77 | ) | |
| Fair value of plan assets at end of year | | $ | -- | | | | | $ | -- | | |
| | | |
| Reconciliation of funded status: | | | | | | | | | | | |
| Funded status | | $ | (1,029 | ) | | | | $ | (1,066 | ) | |
| Unrecognized net transition obligation | | | 126 | | | | | | 141 | | |
| Unrecognized actuarial loss | | | 193 | | | | | | 358 | | |
| Net amount recognized at end of year | | $ | (710 | ) | | | | $ | (567 | ) | |
The Medicare Prescription Drug, Improvement and Modernization Act of 2003 has a minimal effect on the accumulated post-retirement benefit liability or on the periodic post-retirement benefit cost.
NOTE 14 – DERIVATIVE INSTRUMENTS
In 1998, we entered into two interest rate swap agreements. The notional amount of these agreements is $22,000,000 at July 31, 2006 and July 31, 2005. The swap agreements terminate on May 1, 2013. Changes in the fair value of the derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. These derivatives do not qualify for hedge accounting and accordingly, we have recorded these derivative instruments and the associated assets or liabilities at their fair values with the related gains or losses recorded as other income or expense in the Consolidated Statements of Operations. We recognized additional interest expense of $13,000, $18,000 and $14,000 in fiscal years 2006, 2005 and 2004, respectively, as a result of these contracts.
We have contracted for a portion of our fuel needs for fiscal 2007 using forward purchase contracts. These contracts were entered into during the normal course of business and no contracts were entered into for speculative purposes; therefore, these contracts are not required to be accounted for as derivative instruments.
64
NOTE 15 – SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
A summary of selected information for 2006 and 2005 is as follows:
| Fiscal 2006 Quarter Ended |
| October 31 | | January 31 | | April 30 | | July 31 | | | Total |
| (in thousands except per share amounts) |
| Net Sales | $ | 47,789 | | $ | 53,963 | | $ | 51,764 | | $ | 51,694 | | $ | 205,210 |
| Gross Profit | $ | 8,427 | | $ | 10,568 | | $ | 10,022 | | $ | 9,057 | | $ | 38,074 |
| Net Income | $ | 1,028 | | $ | 1,867 | | $ | 1,223 | | $ | 1,141 | | $ | 5,259 |
| Net Income Per Share | | | | | | | | | | | | | | |
| Basic Common | $ | 0.16 | | $ | 0.30 | | $ | 0.19 | | $ | 0.18 | | $ | 0.83 |
| Basic Class B Common | $ | 0.12 | | $ | 0.22 | | $ | 0.14 | | $ | 0.13 | | $ | 0.61 |
| Diluted | $ | 0.14 | | $ | 0.26 | | $ | 0.17 | | $ | 0.16 | | $ | 0.73 |
| Dividends Per Share | | | | | | | | | | | | | | |
| Common | $ | 0.10 | | $ | 0.10 | | $ | 0.10 | | $ | 0.10 | | $ | 0.40 |
| Class B | $ | 0.07 | | $ | 0.07 | | $ | 0.07 | | $ | 0.07 | | $ | 0.28 |
| Common Stock Price Range: | | | | | | | | | | | | | | |
| High | $ | 14.64 | | $ | 14.48 | | $ | 18.04 | | $ | 17.76 | | | |
| Low | $ | 13.52 | | $ | 13.76 | | $ | 14.00 | | $ | 14.32 | | | |
| |
| Fiscal 2005 Quarter Ended |
| October 31 | | January 31 | | April 30 | | July 31 | | Total |
| (in thousands except per share amounts) |
| Net Sales | $ | 44,121 | | $ | 49,481 | | $ | 48,249 | | $ | 46,017 | | $ | 187,868 |
| Gross Profit | $ | 9,668 | | $ | 11,579 | | $ | 9,759 | | $ | 9,349 | | $ | 40,355 |
| Net Income | $ | 1,280 | | $ | 2,146 | | $ | 1,972 | | $ | 1,142 | | $ | 6,540 |
| Net Income Per Share | | | | | | | | | | | | | | |
| Basic Common | $ | 0.20 | | $ | 0.34 | | $ | 0.30 | | $ | 0.18 | | $ | 1.02 |
| Basic Class B Common | $ | 0.15 | | $ | 0.25 | | $ | 0.23 | | $ | 0.14 | | $ | 0.76 |
| Diluted | $ | 0.18 | | $ | 0.29 | | $ | 0.26 | | $ | 0.16 | | $ | 0.88 |
| Dividends Per Share | | | | | | | | | | | | | | |
| Common | $ | 0.08 | | $ | 0.09 | | $ | 0.09 | | $ | 0.09 | | $ | 0.34 |
| Class B | $ | 0.06 | | $ | 0.06 | | $ | 0.06 | | $ | 0.06 | | $ | 0.26 |
| Common Stock Price Range: | | | | | | | | | | | | | | |
| High | $ | 13.20 | | $ | 14.87 | | $ | 15.29 | | $ | 14.55 | | | |
| Low | $ | 10.09 | | $ | 12.16 | | $ | 13.92 | | $ | 13.12 | | | |
65
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
of Oil-Dri Corporation of America:
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, stockholders’ equity, and cash flows present fairly, in all material respects, the financial position of Oil-Dri Corporation of America at July 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended July 31, 2006 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Chicago, Illinois
October 13, 2006
ITEM 9 – CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
66
PART III
ITEM 9A – CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Management conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this Form 10-K. The controls evaluation was conducted under the supervision and with the participation of management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO). Based upon the controls evaluation, our CEO and CFO have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified by the SEC, and that material information relating to us and our consolidated subsidiaries is made known to management, including the CEO and CFO, during the period when our periodic reports are being prepared.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during our most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Inherent Limitations on Effectiveness of Controls
Our management, including the CEO and CFO, do not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.
ITEM 9B – OTHER INFORMATION
None.
67
ITEM 10 – DIRECTORS AND EXECUTIVE OFFICERS OF OIL-DRI
The information called for by Item 401 of Regulation S-K relating to the Executive Officers is furnished in Part I of this Form 10-K under the caption “Executive Officers of the Registrant” and is incorporated herein by reference. The other information required by this Item (except as set forth below) is contained in Oil-Dri’s Proxy Statement for its 2006 annual meeting of stockholders (“Proxy Statement”) under the captions “1. Election of Directors”, “Section 16(a) Beneficial Ownership Reporting Compliance” and “Corporate Governance Matters” and is incorporated herein by this reference.
The Company has adopted a Code of Ethics and Business Conduct (the “Code”) which applies to all of its directors, officers (including the Company’s Chief Executive Officer and senior financial officers) and employees. The Code imposes significant responsibilities on the Chief Executive Officer and the senior financial officers of the Company. The Code, the Company’s Corporate Governance Guidelines and the charter of its Audit Committee may be viewed on the Company’s website,www.oildri.com and are available in print to any person upon request to Investor Relations, Oil-Dri Corporation of America, 410 North Michigan Avenue, Suite 400, Chicago, Illinois 60611-4213, telephone (312) 706-3232. Any amendment to, or waiver of, a provision of the Code which applies to the Company’s Chief Executive Officer or senior financial officers and relates to the elements of a “code of ethics” as defined by the Securities and Exchange Commission will also be posted on the Company’s website. As allowed by the controlled company exemption to certain New York Stock Exchange rules, the Company does not have a nominating/corporate governance committee and its compensation committee does not have a charter.
On January 3, 2006, we filed with the New York Stock Exchange, or NYSE, the Annual CEO Certification regarding our compliance with the NYSE's corporate governance listing standards as required by Section 303A.12(a) of the NYSE Listed Company Manual. In addition, we have filed as exhibits to this annual report the applicable certifications of our Chief Executive Officer and our Chief Financial Officer required under Section 302 of the Sarbanes-Oxley Act of 2002, regarding the quality of our public disclosures.
ITEM 11 – EXECUTIVE COMPENSATION
The information required by this Item is contained in Oil-Dri’s Proxy Statement under the captions “Executive Compensation,” “Report of the Compensation and the Stock Option Committees of Oil-Dri Corporation of America on Executive Compensation,” “Compensation Committee Interlocks and Insider Participation” and “Performance Graph” and is incorporated herein by this reference.
ITEM 12 – SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this Item is contained in Oil-Dri’s Proxy Statement under the captions “General-Principal Stockholders” and “Security Ownership of Management” and is incorporated herein by this reference.
ITEM 13 – CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is contained in Oil-Dri’s Proxy Statement under the caption “Compensation Committee Interlocks and Insider Participation” and is incorporated herein by this reference.
ITEM 14 – PRINCIPAL ACCOUNTANTS FEES AND SERVICES
The information required by this Item is contained in Oil-Dri’s Proxy Statement under the caption “Audit Fees” and is incorporated herein by this reference.
68
PART IV
ITEM 15 – EXHIBITS AND FINANCIAL STATEMENT SCHEDULE
| | (a)(1) | The following consolidated financial statements are contained herein.
|
| | Consolidated Balance Sheets as of July 31, 2006 and July 31, 2005.
|
| | Consolidated Statements of Operations for the fiscal years ended July 31, 2006, July 31, 2005 and July31, 2004.
|
| | Consolidated Statements of Stockholders' Equity for the fiscal years ended July 31, 2006, July 31, 2005 and July 31, 2004.
|
| | Consolidated Statements of Cash Flows for the fiscal years ended July 31, 2006, July 31, 2005 and July31, 2004.
|
| | Notes to Consolidated Financial Statements.
|
| | Report of Independent Registered Public Accounting Firm.
|
| (a)(2) | The following financial statement schedule is contained herein: |
| | |
| | Schedule to Financial Statements, as follows:
|
| | | Schedule II--Valuation and Qualifying Accounts, years ended July 31, 2006, July 31, 2005 andJuly 31, 2004. |
| | | |
| (a)(3) | The following documents are exhibits to this Report: |
Exhibit
No. | | Description | | SEC Document Reference |
| 3.1 | | Certificate of Incorporation of Oil-Dri, as amended. | | Incorporated by reference to Exhibit 4.1 to Oil Dri’s Registration Statement on Form S-8 (Registration No. 333-57625), filed on June 24, 1998. |
| | | | | |
| 3.2 | | Bylaws of Oil-Dri, as amended June 16, 1995. | | Incorporated by reference to Exhibit 3(b) to Oil Dri’s (File No. 001-12622) Annual Report on Form 10-K for the fiscal year ended July 31, 1995. |
| | | | | |
| 4.1 | | Letter of Credit Agreement, dated as of October 1, 1988 between Harris Trust and Savings Bank and Blue Mountain Production Company in the amount of $2,634,590 in connection with the issuance by Town of Blue Mountain, Mississippi of Variable/Fixed Rate Industrial Development Revenue Bonds, Series 1988 B (Blue Mountain Production Company Project) in the aggregate principal amount of $2,500,000 and related Indenture of Trust, Lease Agreement, Remarketing Agreement and Guaranties. | | Debt instruments under which the total amount authorized does not exceed 10 percent of our total consolidated assets. Pursuant to paragraph 4(iii)(A) of Item 601(b) of Regulation S-K, Oil-Dri agrees to furnish these agreements upon the request of the Commission.
|
69
Exhibit
No. | | Description | | SEC Document Reference |
| 10.1 | | Memorandum of Agreement #1450 “Fresh Step”™, dated as of March 12, 2001 between A&M Products Manufacturing Company and Oil-Dri (confidential treatment of certain portions of this exhibit has been granted). | | Incorporated by reference to Exhibit 10(s) to Oil-Dri’s (File No. 001-12622) Current Report on Form 8-K filed on May 1, 2001. |
| | | | | |
| 10.2 | | Exclusive Supply Agreement dated May 19, 1999 between Church & Dwight Co., Inc. and Oil-Dri (confidential treatment of certain portions of this exhibit has been granted). | | Incorporated by reference to Exhibit (10)(r) to Oil-Dri’s (File No. 001-12622) Annual Report on Form 10-K for the fiscal year ended July 31, 1999. |
| | | | | |
| 10.3 | | $25,000,000 Note Purchase Agreement dated as of April 15, 1998 between Oil-Dri and Teachers Insurance and Annuity Association of America and Cigna Investments, Inc. | | Incorporated by reference to Exhibit (10)(m) to Oil-Dri’s (File No. 001-12622) Quarterly Report on Form 10-Q for the quarter ended April 30, 1998. |
| | | | | |
| 10.4 | | First Amendment, dated as of January 15, 2001 to the Note Purchase Agreement dated as of April 15, 1998. | | Incorporated by reference to Exhibit (10)(m)(5) to Oil-Dri’s (File No. 001-12622) Quarterly Report on Form 10-Q for the quarter ended January 31, 2001. |
| | | | | |
| 10.5 | | Second Amendment, dated as of July 15, 2002 to Note Purchase Agreement dated as of April 15, 1998. | | Incorporated by reference to Exhibit 10(m)(6) to Oil-Dri’s (File No. 001-12622) Annual Report on Form 10-K for the fiscal year ended July 31, 2002. |
| | | | | |
| 10.6 | | Third Amendment, dated as of January 27, 2006 to Note Purchase Agreement dated as of April 15, 1998. | | Incorporated by reference to Exhibit 10.2 to Oil-Dri’s (File No. 001-12622) Current Report on Form 8-K filed on February 1, 2006. |
| | | | | |
| 10.7 | | $15,000,000 Credit Agreement, dated January 27, 2006 among the Company, certain subsidiaries of the Company and Harris N.A. | | Incorporated by reference to Exhibit 10.1 to Oil-Dri’s (File No. 001-12622) Current Report on Form 8-K filed on February 1, 2006. |
| | | | | |
| 10.8 | | $15,000,000 Note Agreement dated as of December 16, 2005 among the Company, The Prudential Insurance Company of America and Prudential Retirement Insurance and Annuity Company. | | Incorporated by reference to Exhibit 10.1 to Oil-Dri’s (File No. 001-12622) Current Report on Form 8-K filed on December 22, 2005. |
| | | | | |
| 10.9 | | First Amendment, dated as of July 12, 2006 to Note Agreement dated as of December 16, 2005. | | Filed herewith. |
| | | | | |
| 10.10 | | Description of 1987 Executive Deferred Compensation Program.* | | Incorporated by reference to Exhibit (10)(f) to Oil-Dri’s (File No. 001-12622) Annual Report on Form 10-K for the fiscal year ended July 31, 1988. |
| | | | | |
| 10.11 | | Salary Continuation Agreement dated August 1, l989 between Richard M. Jaffee and Oil-Dri (“1989 Agreement”).* | | Incorporated by reference to Exhibit (10)(g) to Oil-Dri’s (File No. 001-12622) Annual Report on Form 10-K for the fiscal year ended July 31, 1989. |
| | | | | |
| 10.12 | | Extension and Amendment, dated October 9, 1998, to the 1989 Agreement.* | | Filed herewith. |
70
Exhibit
No. | | Description | | SEC Document Reference |
| 10. | 13 | | Second Amendment, effective October 31, 2000, to the 1989 Agreement.* | | Incorporated by reference to Exhibit 99.1 to Oil-Dri’s (File No. 001-12622) Current Report on Form 8-K filed on November 13, 2000. |
| | | | | |
| 10. | 14 | | Third Amendment, dated as of January 31, 2006, to the 1989 Agreement.* | | Incorporated by reference to Exhibit 10.1 to Oil-Dri’s (File No. 001-12622) Current Report on Form 8-K filed on February 13, 2006. |
| | | | | |
| 10. | 15 | | Oil-Dri Corporation of America Deferred Compensation Plan, as amended and restated effective April 1, 2003.* | | Incorporated by reference to Exhibit (10)(j)(1) to Oil-Dri’s (File No. 001-12622) Quarterly Report on Form 10-Q for the quarter ended April 30, 2003. |
| | | | | |
| 10. | 16 | | Oil-Dri Corporation of America 1995 Long Term Incentive Plan as amended and restated effective June 9, 2000.* | | Incorporated by reference to Exhibit (10)(k) to Oil-Dri’s (File No. 001-12622) Annual Report on Form 10-K for the fiscal year ended July 31, 2000. |
| | | | | |
| 10. | 17 | | Supplemental Executive Retirement Plan dated April 1, 2003.* | | Incorporated by reference to Exhibit (10)(1) to Oil-Dri’s (File No. 001-12622) Quarterly Report on Form 10-Q for the quarter ended April 30, 2003. |
| | | | | |
| 10. | 18 | | Oil-Dri Corporation of America Outside Director Stock Plan as amended and restated effective October 16, 1999.* | | Incorporated by reference to Exhibit (10)(n) to Oil-Dri’s (File No. 001-12622) Annual Report on Form 10-K for the fiscal year ended July 31, 2000. |
| | | | | |
| 10. | 19 | | Oil-Dri Corporation of America Annual Incentive Plan (as amended and restated effective August 1, 2006).* | | Incorporated by reference to Exhibit 10.1 to Oil-Dri’s (File No. 001-12622) Current Report on Form 8-K filed on October 13, 2006. |
| | | | | |
| 10. | 20 | | Restricted Stock Agreement, dated as of March 14, 2006, between Oil-Dri Corporation of America and Daniel S. Jaffee.* | | Incorporated by reference to Exhibit 10.3 to Oil-Dri’s (File No. 001-12622) Current Report on Form 8-K filed on March 20, 2006. |
| | | | | |
| 10. | 21 | | Oil-Dri Corporation of America 2006 Long-Term Incentive Plan.* | | Incorporated by reference to Exhibit 10.2 to Oil-Dri’s (File No. 001-12622) Current Report on Form 8-K filed on March 20, 2006. |
| | | | | |
| 11. | 1 | | Statement re: Computation of Income per Share. | | Filed herewith. |
| | | | | |
| 14. | 1 | | Code of Ethics | | Available at Oil-Dri’s websitewww.oildri.com or in print upon request to Investor Relations, Oil-Dri Corporation of America, 410 North Michigan Avenue, Suite 400, Chicago, IL 60611-4213, telephone (312) 706-3232. |
| | | | | |
| 21. | 1 | | Subsidiaries of Oil-Dri. | | Filed herewith. |
| | | | | |
| 23. | 1 | | Consent of PricewaterhouseCoopers LLP. | | Filed herewith. |
| | | | | |
| 31. | 1 | | Certifications pursuant to Rule 13a – 14(a). | | Filed herewith. |
| | | | | |
| 32. | 1 | | Certifications pursuant to Section 1350 of the Sarbanes-Oxley Act of 2002. | | Furnished herewith. |
| ____________________ | | |
| * | | Management contract or compensatory plan or arrangement. | | |
71
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Oil-Dri has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| | OIL-DRI CORPORATION OF AMERICA |
| (Registrant) |
| | |
| | By | /s/ Daniel S. Jaffee | |
| | Daniel S. Jaffee |
| | President and Chief Executive Officer, Director |
Dated: October 20, 2006
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of Oil-Dri and in the capacities and on the dates indicated:
| | /s/ Richard M. Jaffee | | October 20, 2006 |
| Richard M. Jaffee | | |
| Chairman of the Board of Directors | | |
| |
| | /s/ Daniel S. Jaffee | | October 20, 2006 |
| Daniel S. Jaffee | | |
| President and Chief Executive Officer, Director | | |
| (Principal Executive Officer) | | |
| |
| | /s/ Andrew N. Peterson | | October 20, 2006 |
| Andrew N. Peterson | | |
| Vice President and Chief Financial Officer | | |
| (Principal Financial Officer) | | |
| |
| | /s/ Daniel T. Smith | | October 20, 2006 |
| Daniel T. Smith | | |
| Vice President and Controller | | |
| (Principal Accounting Officer) | | |
| |
| | /s/ J. Steven Cole | | October 20, 2006 |
| J. Steven Cole | | |
| Director | | |
| |
| | /s/ Arnold W. Donald | | October 20, 2006 |
| Arnold W. Donald | | |
| Director | | |
| |
| | /s/ Ronald B. Gordon | | October 20, 2006 |
| Ronald B. Gordon | | |
| Director | | |
| |
| | /s/ Joseph C. Miller | | October 20, 2006 |
| Joseph C. Miller | | |
| Vice Chairman of the Board of Directors | | |
| |
| | /s/ Michael A. Nemeroff | | October 20, 2006 |
| Michael A. Nemeroff | | |
| Director | | |
72
| | /s/ Allan H. Selig | | October 20, 2006 |
| Allan H. Selig | | |
| Director | | |
| |
| | /s/ Paul Suckow | | October 20, 2006 |
| Paul Suckow | | |
| Director | | |
73
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON FINANCIAL STATEMENT SCHEDULE
To the Board of Directors
of Oil-Dri Corporation of America:
Our audits of the consolidated financial statements referred to in our report dated October 13, 2006 appearing in the 2006 Annual Report to Shareholders of Oil-Dri Corporation of America (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the financial statement schedule listed in Item 15(a)(2) of this Form 10-K. In our opinion, this financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Chicago, Illinois
October 13, 2006
74
SCHEDULE II
OIL-DRI CORPORATION OF AMERICA AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
| | | Year Ended July 31 |
| | | 2006 | | 2005 | | 2004 |
| | | (in thousands) |
| | Allowance for doubtful accounts: | | | | | | | | |
| | Beginning balance | $ | 609 | | $ | 608 | | $ | 441 |
| | Additions charged to expense | | 127 | | | 30 | | | 201 |
| | Deductions* | | 169 | | | 29 | | | 34 |
| | Balance at end of year | $ | 567 | | $ | 609 | | $ | 608 |
| | | | | | | | | |
| * | Net of recoveries. | | | | | | | | |
| | | | | | | | | |
| | Valuation reserve for income taxes: | | | | | | | | |
| | Beginning balance | $ | 1,784 | | $ | 1,273 | | $ | 357 |
| | Additions (Deductions) charged to expense | | 47 | | | 511 | | | 916 |
| | Balance at end of year | $ | 1,831 | | $ | 1,784 | | $ | 1,273 |
75
| EXHIBITS |
| |
| EXHIBIT | | |
| NUMBER | | |
| | | |
| 10.9 | | First Amendment, dated as of July 12, 2006 to Note Agreement dated as of December 16, 2005. |
| | | |
| 10.12 | | Extension and Amendment, dated October 9, 1998, to the 1989 Agreement. |
| | | |
| 11.1 | | Statement Re: Computation of per share earnings |
| | | |
| 21.1 | | Subsidiaries of Oil-Dri |
| | | |
| 23.1 | | Consent of PricewaterhouseCoopers LLP |
| | | |
| 31.1 | | Certifications by Daniel S. Jaffee, President and Chief Executive Officer, and Andrew N. Peterson, Chief Financial Officer, required by Rule 13a-14(a) |
| | | |
| 32.1 | | Certifications pursuant to Section 1350 of the Sarbanes-Oxley Act of 2002 |
| |
| Note: | | Stockholders may receive copies of the above listed exhibits, without fee, by written request to Investor Relations, Oil-Dri Corporation of America, 410 North Michigan Avenue, Suite 400, Chicago, Illinois 60611-4213. |
76
