1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K /x/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended August 31, 1995 OR / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___________________ to _______________________ Commission File Number 0-11488 PENWEST, LTD. (Exact name of registrant as specified in its charter) Washington 91-1221360 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 777-108th Avenue N.E., Suite 2390 Bellevue, Washington 98004-5193 (Address of principal Executive Offices) (Zip Code) Registrant's telephone number, including area code: (206) 462-6000 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: Title of each class Name of each exchange of which registered None None SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: Common Stock, $1.00 par value Common Stock Purchase Rights Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for at least the past 90 days. Yes X No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [x] 2 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (continued) The aggregate market value of the Registrant's Common Stock held by non-affiliates as of October 24, 1995 was approximately $171 million. The number of shares of the Registrant's Common Stock (the Registrant's only outstanding class of stock) outstanding (net of treasury stock) as of October 24, 1995 was 6,769,896. DOCUMENTS INCORPORATED BY REFERENCE The Registrant's definitive Proxy Statement relating to the 1996 Annual Meeting of Shareholders is incorporated by reference into Part III of this Form 10-K. Page 2 3 PART I ITEM 1: BUSINESS A) GENERAL: PENWEST, LTD. (PENWEST) was incorporated in September 1983 and commenced operations on March 1, 1984. PENWEST consists of the following business units: - Penford Products Co. (specialty carbohydrate chemicals for papermaking) - The history of Penford Products Co. can be traced to 1894. Penford Products Co. operates as a wholly-owned subsidiary of PENWEST. - Penwest Pharmaceutical Group (pharmaceutical excipients and controlled release technology) - In March 1991, PENWEST purchased the net assets of Edward Mendell Co., Inc. (Mendell) which manufactures and distributes pharmaceutical excipients. Mendell was founded in 1946 and is a wholly-owned subsidiary of PENWEST. The Company established TIMERx Technologies to focus on the development of controlled release technology. TIMERx Technologies is a division of PENWEST. - Penwest Foods Co. (specialty food ingredient products) - In September 1991, Penwest Foods Co. was organized to manufacture and market specialty carbohydrate-based food ingredients and agricultural nutrients formerly sold by Penford Products Co. Penwest Foods Co. is a division of PENWEST. - Pacific Cogeneration, Inc. - This entity was incorporated in 1981 and was a wholly-owned subsidiary of PENWEST. The Company sold the assets of Pacific Cogeneration to third parties during the second quarter of fiscal 1995. B) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS: PENWEST's single business segment is developing, manufacturing and marketing carbohydrate-based specialty chemicals. The Company operates in three market lines: carbohydrate-based specialty chemicals used in paper manufacturing, pharmaceutical excipients and controlled release technology, and food ingredient products. The Company's cogeneration business was not of sufficient size to constitute a separate reportable industry segment. C) DESCRIPTION OF BUSINESS: BUSINESS UNITS: 1. SPECIALTY CHEMICALS: PENFORD PRODUCTS CO. (PENFORD), the core business of PENWEST, develops, manufactures and markets carbohydrate-based specialty chemical starches for papermaking. These starches are principally ethylated (chemically modified with ethylene oxide) and cationic (carrying a positive electrical charge) starches. Ethylated starches are used in coatings and as binders, providing strength and printability to fine white, magazine and catalog paper. Cationic starches are used at the "wet-end" of the paper machine, providing strong internal bonding of paper fibers. In addition, starch copolymers, a patented combination of synthetic and natural carbohydrate chemistry, are used in coating and binder applications in various segments of the paper industry. Penford's products, in general, are designed to improve strength, quality and runnability of coated and uncoated paper. Page 3 4 Specialty chemicals, principally corn-based ethylated and cationic starches and starch copolymers, are produced at the Company's Cedar Rapids, Iowa facility. Potato-based cationic starches are produced at the Company's Idaho Falls, Idaho facility. Penford also sells specialty starch products to the domestic textile industry for warp sizing, which is a fiber bonding process for yarn and finished fabric, and for fabric sizing, which provides body and stiffness to textiles. Specialty chemical brand names of Penford for the paper industry include, among others, Penford(R) Gums, PENSIZE and the Apollo(R) series. Penford's specialty chemicals for the paper industry are manufactured by a process known as corn wet milling, which is the process by which the various parts of corn are separated, refined and modified. The corn, after it is removed from the cob and cleaned, is placed in warm steepwater treated with sulfur dioxide, which causes the corn to swell and soften. The softened kernels pass through a mill which separates the corn's germ from its endosperm. Water is added, producing a thick slurry. The germ is then separated from the slurry. After the germ has been washed and dried, the crude corn oil contained in the germ is removed and refined, yielding a fine quality salad and cooking oil, or a raw material for corn oil margarines. Germ meal is used in animal feed. The remaining mixture of hull and endosperm is then processed. Hull particles are screened out for animal feed, while the finer particles of gluten and starch pass through. The corn oil, germ meal and hull particles are all sold as by-products. The water slurry of starch and gluten is separated. The starch, which is more than 99 percent pure, is washed a third time to remove small quantities of solubles. Modified starches are created by adding chemical reagents and catalysts to the pure starch slurry. The modified starch is then filtered and dried and is ready for shipping. 2. PHARMACEUTICALS GROUP: MENDELL manufactures and supplies pharmaceutical excipients. Pharmaceutical excipients are the non-active ingredients in tablet and capsule prescription pharmaceuticals, over-the-counter drugs and vitamins. The products include binders, lubricants, fillers and disintegrants. The products provide bulk for concentrated medicines, ease of manufacture, product integrity and disintegration which aids release of the active drug in the body. Mendell's primary product, Emcocel(R), is made from wood pulp, a cellulosic carbohydrate. Mendell operates facilities at Patterson, New York, Nastola, Finland, and Cedar Rapids, Iowa. Pharmaceutical excipients' brand names include, among others, EMCOCEL(R), EXPLOTAB(R), EMCOMPRESS(R) and EMDEX(R). TIMERx TECHNOLOGIES is engaged in the development of controlled release technology for pharmaceuticals. Its principal product is currently included in several drug formulation development projects with licensees. These projects are in different phases of development. All development work is subject to FDA approval. There is no assurance that such trials will be successful or that such approval, if and when applied for, will be obtained. TIMERx Technologies operates at facilities in Patterson, New York. Page 4 5 3. SPECIALTY FOOD INGREDIENT PRODUCTS: PENWEST FOODS CO. develops, manufactures and markets specialty food ingredients to the food and confectionery industries. These ingredients include food grade potato starch products as well as dextrose based products such as specialty maltodextrins and specialty dried corn syrup solids. Penwest Foods Co., headquartered in Englewood, Colorado, maintains manufacturing facilities at Cedar Rapids, Iowa for the dextrose and agricultural nutrient based products and at Richland, Washington for the food grade potato starches. Penwest Foods Co.'s product brand names include, among others, CanTab(R), CarriDex(TM), and PenPlus. Sales were less than 10% of the Company's consolidated total sales for the fiscal year ended August 31, 1995. 4. COGENERATION: PACIFIC COGENERATION, INC. owned and operated a cogeneration facility adjacent to Canada Malting Co.'s malting plant at Vancouver, Washington. This cogeneration facility consisted of a natural gas fired turbine, an electric generator and boilers. The heat output of this cogeneration facility was sold to the malting plant and the electrical energy was sold to a local public utility district. The Company sold the assets of Pacific Cogeneration, Inc. to third parties during the second quarter of fiscal 1995. The Company recognized a pre-tax gain of $899,000 on the sale of these assets. Sales were less than 2% of the Company's consolidated total sales for the fiscal year ended August 31, 1995. RAW MATERIALS Corn: The Penford corn wet milling plant is located at Cedar Rapids, Iowa, in the middle of the U.S. corn belt. Accordingly, the plant has truck and rail-delivered corn available throughout the year from a large number of corn dealers and farmers at prices related to the principal U.S. grain markets. The cost of the corn to be purchased is generally hedged by entering into futures contracts. Cellulose Wood Pulp: Mendell's facilities at Nastola, Finland and Cedar Rapids, Iowa use high-grade dissolving wood pulp (cellulose) as their primary raw material to manufacture microcrystalline cellulose (EMCOCEL). Mendell's suppliers of cellulose are located in North America. Chemicals: The principal chemical used in modifying starch is ethylene oxide, a petrochemical derivative. Ethylene oxide is a commodity chemical, subject to price fluctuations due to market conditions. Corn, cellulose and ethylene oxide are not generally subject to availability constraints. About one-half of total manufacturing costs are the costs of corn, cellulose, and chemicals. The remaining portion consists primarily of utility and labor costs. PATENTS, TRADEMARKS AND TRADENAMES PENWEST owns several patents, trademarks and tradenames, none of which is considered material to current operations. RESEARCH AND DEVELOPMENT Company sponsored research and development costs of $6,773,000, $6,346,000 and $5,662,000 in fiscal 1995, 1994 and 1993, respectively, were charged to expense as incurred. Page 5 6 ENVIRONMENTAL MATTERS The Company has adopted a Policy on Environmental Matters and has implemented a comprehensive corporate-wide environmental management program. The program is managed by the Director of Environmental Health and Safety and is intended to carry out the policy's goal of conducting the Company's business in a safe and fiscally responsible manner that protects and preserves the health and safety of Company employees, the communities surrounding the Company's plants and the environment. The Company continues to monitor environmental legislation and regulations which may affect its operations. No material capital expenditures were incurred for environmental control in fiscal 1995, 1994 or 1993. WORKING CAPITAL Working capital requirements of PENWEST are financed through cash resources, operating cash flow and an unsecured revolving line of credit of $15 million with four participating banks. There were no borrowings outstanding under the revolving line of credit during fiscal year 1995. The Company did have overnight borrowings during the year under additional uncommitted lines of credit, but there were no related outstanding balances at fiscal year end. PRINCIPAL CUSTOMERS PENWEST sells to approximately ninety major customers. No single customer accounted for more than 10% of total sales. COMPETITION PENWEST competes with approximately eight other companies that manufacture corn wet milling products, none of which is dominant in the ethylated starch business. Although Penford is one of the smaller corn wet millers, it is one of the major producers of specialty ethylated starches. Quality, service and price are the major competitive factors for Penford. PENWEST competes with approximately five other companies that manufacture pharmaceutical excipients, three of whom have larger market shares. Mendell is one of the major producers of microcrystalline cellulose. Quality, service and price are the major competitive factors for Mendell. PENWEST competes with approximately four other companies which manufacture specialty food ingredients, all of whom have larger market shares. Application expertise, quality, service, and price are the major competitive factors for Penwest Foods Co. PENWEST competes with numerous other companies in developing controlled release drug delivery systems for the pharmaceutical industry, a few of whom have larger market shares. Development expertise and proprietary technology are the major competitive factors for TIMERx Technologies. EMPLOYEES At October 24, 1995, PENWEST and its subsidiaries had 514 employees. PENWEST's specialty chemical and food ingredient operations, pharmaceuticals group and executive office employed 400, 101 and 13 people, respectively. Approximately 40% of the employees are represented by unions. Management believes its employee relations are good. Page 6 7 METHODS OF DISTRIBUTION Penford, Penwest Foods Co. and Mendell use a direct sales force to market their products in North America. Mendell uses a combination of direct sales and distributors in Europe. Penford customers may purchase products through fixed-price contracts for periods covering three months to one year or on a spot basis. Sales are approximately equally divided between the two methods. Products are shipped in either a bulk or bagged format. D) FOREIGN OPERATIONS AND EXPORT SALES: Mendell has a facility in Nastola, Finland. This operation is not significant to the Company taken as a whole. Sales from this facility were less than 5% of the Company's total sales in fiscal 1995. Export sales have accounted for less than 10% of the Company's total sales during each of the last three fiscal years. Page 7 8 ITEM 2: PROPERTIES (MAJOR) Registrant's executive offices, which are leased, are located at Suite 2390, 777-108th Avenue N.E., Bellevue, Washington 98004- 5193. Other facilities are as follows: Bldg. Area Land Area Owned/ Function of (Sq. Ft.) (Acres) Leased Facility --------- ------- ------ -------- SPECIALTY CHEMICALS AND FOOD INGREDIENTS Cedar Rapids, Iowa 707,000 29 Owned Manufacture of corn starch products Englewood, Colorado 45,000 3 Leased -- Expires Offices and April 2000, with research renewal option laboratories Idaho Falls, Idaho 31,000 6 Owned Manufacture of potato starch products Richland, Washington 16,000 2 Leased -- Expires Manufacture of November 2014, potato starch with renewal option products The corn wet milling operation in Cedar Rapids, Iowa has operating capacity, measured in bushels ground, of 65,000 bushels per day. The grind operates continuously except for periodic maintenance. PHARMACEUTICAL EXCIPIENTS Patterson, New York 40,000 15 Owned Warehouse and offices Nastola, Finland 15,000 2 Leased -- Manufacture of 2 years notice pharmaceutical required. excipients Cedar Rapids, Iowa 35,000 1 Owned Manufacture of pharmaceutical excipients Page 8 9 All of the major properties are owned. Production facilities are well maintained and in good condition. The capacities of the plants are suitable and generally sufficient to meet current production requirements. PENWEST is continually undertaking a process of expanding and improving its property, plant and equipment. ITEM 3: LEGAL PROCEEDINGS There are no material legal actions pending either for or against PENWEST and its subsidiaries. ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of shareholders during the fourth quarter of fiscal 1995. Page 9 10 EXECUTIVE OFFICERS OF THE REGISTRANT (1) (2) (3) (4) Name Age Title ---- --- ----- Tod R. Hamachek 49 President and Chief Executive Officer of Registrant 1985 - current President and Chief Operating Officer of Registrant 1983 - 1985 Franklin E. Olsen, Jr. 62 Vice President-Employee Relations of Registrant 1984 - 1995 Jeffrey T. Cook 39 Vice President-Finance and Chief Financial Officer of Registrant 1991 - current Treasurer of Registrant 1988-1991 Robert G. Widmaier, Ph.D. 47 Vice President-Technical Director and Chief Innovation Officer of Registrant 1990 - current Vice President-Technical Director of Registrant 1988 -1990 H. Thomas Reed 60 Vice President of Registrant and President and General Manager, Penford Products Co., a wholly-owned subsidiary of Registrant 1985 - current John V. Talley, Jr. 39 Vice President of Registrant and President and General Manager, Edward Mendell Co., Inc., a wholly-owned subsidiary of Registrant 1993 - current Vice President of Marketing, Sanofi Winthrop Pharma- ceuticals 1992 - 1993 Vice President - Marketing, Hospital Products Division Sanofi Winthrop Pharma- ceuticals 1989 - 1992 Page 10 11 Gregory C. Horn 47 Vice President of Registrant and President and General Manager, Penwest Foods Co. 1995 - current Vice President of Marketing, Penford Products Co. 1993 - 1994 Vice President and General Manager, Sarah Lee Corporation 1992 - 1993 Vice President and General Manager, Churchill Industries 1990 - 1993 (1) As of October 25, 1995 (2) With the exception of Mr. Talley and Mr. Horn, all executive officers of the Registrant have held an executive position with the Registrant, or a subsidiary of the Registrant, for a period exceeding five years. (3) Officers are appointed annually by the Board of Directors of the Company to serve for a period of one year and serve at the discretion of the Board. No arrangement or understanding exists between any officer and any other person pursuant to which he was selected as an officer. (4) Mr. Olsen retired as an executive officer of the Company effective August 31, 1995. Page 11 12 PART II ITEM 5: MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS PENWEST common stock, $1.00 par value, trades on the Nasdaq Stock Market under the symbol "PENW". On October 25, 1995, there were 1,415 stockholders of record. The high and low closing bid prices of the Company's common shares during the last two fiscal years are set forth below. The quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily reflect actual transactions. MARKET PRICE HIGH LOW ---- --- 1994/95 Quarter Ended November 30 $25.50 $21.00 Quarter Ended February 28 $23.00 $17.50 Quarter Ended May 31 $23.25 $20.50 Quarter Ended August 31 $26.25 $21.25 1993/94 Quarter Ended November 30 $22.50 $19.75 Quarter Ended February 28 $23.50 $19.50 Quarter Ended May 31 $23.25 $17.75 Quarter Ended August 31 $25.75 $18.25 During each quarter in fiscal years 1995 and 1994, a $0.05 per share cash dividend was declared and paid. The Company anticipates that it will continue to pay such quarterly dividends in the foreseeable future. Page 12 13 ITEM 6: SELECTED FINANCIAL DATA Year Ended August 31 --------------------------------------------------------------------------------------- (Thousands of dollars except per share data) 1995 1994 1993 1992(1) 1991(2) - ----------------------------------------------------------------------------------------------------------------------------------- Operating Data: Net sales $174,200 $158,787 $135,517 $125,952 $110,910 Gross margin percentage 27.5% 25.9% 26.4% 26.8% 29.0% Income from operations 14,973 10,894 9,110 10,466 12,515 Net income 7,217 6,120 6,315 7,505 8,813 Earnings per share $1.03 $0.86 $0.88 $1.01 $1.17 Dividend declared per share $0.20 $0.20 $0.20 $0.15 -- Average shares outstanding 7,018,970 7,110,953 7,175,855 7,461,439 7,558,910 Balance Sheet Data: Property, plant and equipment (net) 111,440 99,973 96,250 73,742 61,223 Long-term debt 58,628 42,897 46,998 30,877 31,550 Shareholders' equity 71,982 67,165 62,490 61,447 60,081 Capital expenditures 23,019 13,259 31,266 19,450 14,006 Total assets 186,760 164,357 157,966 130,641 120,488 (1) During fiscal year 1992, the Company adopted FASB Statement No. 106 "Employer's Accounting for Post-Retirement Benefits Other Than Pensions." This change increased the annual pre-tax post-retirement benefit expense by $800,000 and decreased equity by $5,900,000 (net of tax). Also, during fiscal year 1992, the Company adopted FASB Statement No. 109 "Accounting for Income Taxes." This change resulted in a reduction of deferred taxes and an increase in equity of $1,560,000. (2) During fiscal year 1991, the Company purchased the net assets of Edward Mendell Co., Inc. for $8,090,000. Results of operations for six months have been included in the consolidated financial data. Page 13 14 ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Comparison of Fiscal 1995 to 1994 Results of Operations Sales increased $15.4 million, or 9.7 percent, during fiscal 1995. The increase reflects higher demand for hydroxyethylated (HES) corn starches from paper industry customers as new customers converted to Penford Gums. During the year, Penford converted the single largest customer in its history. As a result, Penford is near production capacity. The improvement in the paper industry has also benefited Penford. Also contributing to the increase were higher sales of industrial potato starches to the paper industry. The Company's Idaho Falls potato starch plant capacity was essentially sold out by year-end. Sales of microcrystalline cellulose (MCC) to pharmaceutical industry customers were up sharply as PENWEST's Cedar Rapids MCC plant's gained new customers and its operating results reached break-even. Specialty food-grade potato starches sold by Penwest Foods Co. (PFC) gained 107 percent, reflecting new product activity and the addition of major new customers. However, PFC was not profitable in 1995. Gross margins were 27.5% in 1995 compared with 25.9% in 1994. Higher gross margins reflected renegotiated sales contracts with key customers, a shift at Penford to higher margin products, the achievement of break-even at Mendell's Cedar Rapids MCC plant and reduced losses at Penwest Foods. Operating margins grew from 6.9% to 8.6%, a gain of 24.6%. The 1995 margins were depressed by power interruptions and higher corn costs at Penford Product Co.'s Cedar Rapids plant. High heat and humidity in Iowa placed exceptional demand on the local electrical utility, which interrupted service to some of its industrial customers, including Penford. The plant experienced ten blackouts during the fourth quarter. This resulted in fewer units being produced and therefore a higher per unit cost. Since Penford does not maintain much inventory, most of the impact was recorded during the fourth quarter. In December 1994 the Company sold the assets of its cogeneration facility, recording a pre-tax gain of $899,000 (8 cents per share after tax) in the second quarter. The gain effectively offset earnings the facility would have provided in fiscal 1995. The turbine from the facility was sold to IES Utilities, Inc. and in the fourth quarter of fiscal 1996, the Company expects to begin receiving a portion of its thermal needs in Cedar Rapids from that turbine under a thermal supply agreement with IES Utilities, Inc. This agreement should generate a savings that will approximate the earnings from the Company's cogeneration facility prior to the sale. Operating expenses increased $2.7 million, or 9.0%. Operating expenses in 1994 were reduced by $900,000 as the result of the curtailment of postretirement health benefits previously accrued. Research and development expenses increased $427,000, or 6.7%, as a result of greater development spending at Penwest Pharmaceuticals Group. The Company expects to continue R & D investments at approximately 3.5 to 4% of sales. Net interest expense increased $2.0 million reflecting a greater debt level, higher interest rates and a lower investment portfolio. The effective tax rate was 35.0% in fiscal 1995, compared with 24.3% in the prior year when PENWEST recorded a federal tax benefit relating to research and development expenditures. Page 14 15 Comparison of Fiscal 1994 to 1993 Results of Operations Sales increased $23.3 million, or 17.2%, during fiscal 1994. The gain was generated from additional volumes due to the specialty ethylated starch capacity expansion in late fiscal 1993 at Penford's Cedar Rapids plant, as well as greater utilization of existing oxidized starch capacity. Penford also had increased sales of its potato starch and corn cationic products. Mendell sales of microcrystalline cellulose (MCC) increased due to additional capacity that was brought on line in August 1993. Sales at Penwest Foods Co. (PFC) increased significantly during the year; however, PFC continued to record operating losses. Gross margins were 25.9% for fiscal 1994 compared to 26.4% for fiscal 1993. The gross margins in fiscal 1994 were affected by a change in the volume mix with an increase in the sales of oxidized starches, which yield lower margins. Margins at Penford in the prior year were negatively affected by approximately $425,000 of expenses related to flooding in the Midwest. Margins at Mendell declined during the year primarily due to increased expenses at the new MCC plant in Cedar Rapids. Operating expenses increased $3,537,000, or 13.3%, due to increased research and development, an increase in operating expenses at PFC, and higher expenses associated with a stock appreciation rights program. This increase at PFC was due to its growth and a continued investment in its business. Research and development expenses increased $684,000, or 12.1% in fiscal 1994 due to an increase at both Mendell and TIMERx Technologies. Net interest expense increased $1.3 million in fiscal 1994 due to lower capitalized interest in the current year, higher interest rates, and a lower investment portfolio. The effective tax rate was 24.3% in fiscal 1994 compared to 17.3% in fiscal 1993. The effective rate in 1994 is lower than the statutory rate primarily due to a federal tax benefit recorded during the first quarter related to research and development tax credits. The effective tax rate for 1993 was less than the statutory rate due to certain tax refunds and credits received by the Company. PENWEST's core business was strong in fiscal 1994. The specialty paper chemical products continued to grow at double-digit rates. Although there was some improvement in the Company's largest customer base, the paper industry, many of the large paper companies were still in the early stages of recovery which made the environment difficult to increase sales and prices. The starch copolymer family of products continued to make progress during fiscal 1994 and operated at break-even. Page 15 16 Liquidity and Capital Resources PENWEST has strong liquidity and capital resources. The Company had $5.3 million in cash and cash equivalents at year-end and working capital of $29.2 million. The Company has a $15 million revolving credit agreement. There were no borrowings under this agreement during the fiscal year. The Company also has several uncommitted lines with various banks that are used for overnight borrowings. These lines were used throughout the year, however, there were no outstanding balances at year-end. Operating cash flow was $16.3 million, $12.2 million, and $17.8 million in fiscal 1995, 1994, and 1993, respectively. The improvement in fiscal 1995 was primarily due to an improvement in operating income and by changes in working capital components. Capital expenditures amounted to $23.0 million in fiscal 1995 compared to $13.3 million in fiscal 1994 and were $31.3 million in fiscal 1993. Expenditures have been funded from operations, cash, a private placement of debt, and borrowings under uncommitted lines. The significant capital expenditures during fiscal 1995 were for the completion of expansion of the Penwest Foods facility in Richland, Washington, the completion of new laboratory facilities for Penwest Pharmaceuticals Group, and capacity expansion at Penford Products. The remainder of the expenditures was for various improvements to manufacturing facilities. Capital expenditures in fiscal 1996 should be lower than fiscal 1995. The only significant planned project is a $6 million capacity expansion project at Penford Products. The Company expects to fund these capital expenditures from operations and cash. The Company commenced paying a quarterly cash dividend of $0.05 per share with the quarter ended February 28, 1992, and has paid such dividend each quarter thereafter. The Board of Directors reviews the dividend policy on a periodic basis. In April 1994, the Board of Directors authorized a stock repurchase program for the purchase of up to 500,000 shares of the outstanding common stock of the Company. The Company repurchased 66,000 shares of its stock during fiscal 1995 for $1,310,000. Page 16 17 ITEM 8: PENWEST, LTD. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLIDATED BALANCE SHEETS August 31 (Thousands of dollars) 1995 1994 - ----------------------------------------------------------------------------------- Assets Current assets: Cash and cash equivalents $ 5,334 Trade accounts receivable 23,943 $ 20,748 Inventories 14,209 16,734 Prepaid expenses and other 5,447 4,593 --------- --------- Total current assets 48,933 42,075 Property, plant and equipment: Land 3,359 3,089 Plant and equipment 175,533 162,570 Construction in progress 3,371 6,611 Less accumulated depreciation (70,823) (72,297) --------- --------- Net property, plant and equipment 111,440 99,973 Deferred income taxes 9,927 9,545 Other assets 16,460 12,764 --------- --------- $ 186,760 $ 164,357 ========= ========= Liabilities and shareholders' equity Current liabilities: Bank overdraft, net $ 635 Accounts payable $ 8,749 8,131 Accrued liabilities 6,728 7,847 Current portion of long-term debt 4,270 4,100 --------- --------- Total current liabilities 19,747 20,713 Long-term debt 58,628 42,897 Other post retirement benefits 10,155 10,102 Deferred income taxes and other 26,248 23,480 Shareholders' equity: Common stock, par value $1.00 per share, authorized 29,000,000 shares, issued 8,591,027 shares in 1995 and 8,577,427 in 1994, including treasury shares 8,591 8,577 Additional paid-in capital 12,550 12,489 Retained earnings 84,949 79,128 Treasury stock, at cost, 1,832,752 shares in 1995 and 1,766,752 shares in 1994 (30,637) (29,327) Note receivable from PENWEST Savings and Stock Ownership Plan (2,978) (3,340) Cumulative translation adjustment (493) (362) --------- --------- Total shareholders' equity 71,982 67,165 --------- --------- $ 186,760 $ 164,357 ========= ========= The accompanying notes are an integral part of these statements. Page 17 18 CONSOLIDATED STATEMENTS OF INCOME Year Ended August 31 (Thousands of dollars except per share data) 1995 1994 1993 - ------------------------------------------------------------------------------------------------------- Sales $ 174,200 $ 158,787 $ 135,517 Cost of sales 126,341 117,734 99,785 ----------- ----------- ----------- Gross margin 47,859 41,053 35,732 Operating expenses 32,886 30,159 26,622 ----------- ----------- ----------- Income from operations 14,973 10,894 9,110 Other income 899 Investment income 418 636 1,016 Interest expense (5,183) (3,444) (2,489) ----------- ----------- ----------- Income before income taxes 11,107 8,086 7,637 Income taxes 3,890 1,966 1,322 ----------- ----------- ----------- Net income $ 7,217 $ 6,120 $ 6,315 =========== =========== =========== Weighted average common shares and equivalents outstanding 7,018,970 7,110,953 7,175,855 =========== =========== =========== Earnings per share $ 1.03 $ 0.86 $ 0.88 =========== =========== =========== Dividends declared per share $ 0.20 $ 0.20 $ 0.20 =========== =========== =========== The accompanying notes are an integral part of these statements. Page 18 19 CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended August 31 (Thousands of dollars) 1995 1994 1993 - ---------------------------------------------------------------------------------------------- Operating activities: Net income $ 7,217 $ 6,120 $ 6,315 Adjustments to reconcile net income to net cash from operating activities Depreciation and amortization 10,375 10,343 9,414 Deferred income taxes 1,504 2,676 2,891 Gain on sale of assets (899) Change in operating assets and liabilities Receivables (3,195) (4,743) (2,941) Inventories 2,525 (6,520) (367) Accounts payable and other (1,181) 4,349 2,523 -------- -------- -------- Net cash from operating activities 16,346 12,225 17,835 Investing activities: Additions to property, plant and equipment (23,019) (13,259) (31,266) Proceeds from sale of assets 2,500 Other (530) 1,594 (815) -------- -------- -------- Net cash used by investing activities (21,049) (11,665) (32,081) Financing activities: Proceeds from unsecured line of credit 41,305 30,605 Payments on unsecured line of credit (41,305) (30,605) Proceeds from long-term debt 20,000 20,000 Payments on long-term debt (4,100) (3,880) (673) Purchase of treasury stock (1,310) (1,277) (5,085) Purchase of life insurance for officers' benefit plans (2,501) (1,343) (1,343) Payment of dividends (1,360) (1,371) (1,394) Other (57) 1,199 489 -------- -------- -------- Net cash from (used by) financing activities 10,672 (6,672) 11,994 -------- -------- -------- Net increase (decrease) in cash 5,969 (6,112) (2,252) Cash, (bank overdrafts) and cash equivalents at beginning of year (635) 5,477 7,729 -------- -------- -------- Cash (bank overdrafts) and cash equivalents at end of year $ 5,334 $ (635) $ 5,477 ======== ======== ======== Supplemental disclosure of cash flow information Cash paid during the year for: Interest $ 4,976 $ 3,478 $ 2,341 Income taxes $ 2,052 $ 2,909 $ 3,005 The accompanying notes are an integral part of these statements. Page 19 20 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Note Receiv- able from PENWEST Total Additional Savings & Cumulative Share- Common Paid-In Retained Treasury Stock Own- Translation holders' (Thousands of dollars) Stock Capital Earnings Stock ership Plan Adjustment Equity - ----------------------------------------------------------------------------------------------------------------------------------- Balances, September 1, 1992 $ 8,540 $ 12,332 $ 68,994 $(22,965) $ (5,319) $ (135) $ 61,447 Net income 6,315 6,315 Exercise of stock options 23 71 94 Purchase of treasury stock (5,085) (5,085) Savings and Stock Ownership Plan activity 1,014 1,014 Pension plan minimum liability 450 450 Translation loss (361) (361) Dividends declared (1,384) (1,384) -------- -------- -------- -------- -------- -------- -------- Balances, August 31, 1993 8,563 12,403 74,375 (28,050) (4,305) (496) 62,490 Net income 6,120 6,120 Exercise of stock options 14 86 100 Purchase of treasury stock (1,277) (1,277) Savings and Stock Ownership Plan activity 965 965 Translation gain 134 134 Dividends declared (1,367) (1,367) -------- -------- -------- -------- -------- -------- -------- Balances, August 31, 1994 8,577 12,489 79,128 (29,327) (3,340) (362) 67,165 Net income 7,217 7,217 Exercise of stock options 14 61 75 Purchase of treasury stock (1,310) (1,310) Savings and Stock Ownership Plan activity 362 362 Translation loss (131) (131) Dividends declared (1,396) (1,396) -------- -------- -------- -------- -------- -------- -------- Balances, August 31, 1995 $ 8,591 $ 12,550 $ 84,949 $(30,637) $ (2,978) $ (493) $ 71,982 ======== ======== ======== ======== ======== ======== ======== The accompanying notes are an integral part of these statements. Page 20 21 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE A SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Business PENWEST's business is developing, manufacturing and marketing chemically modified carbohydrate-based specialty chemicals. No single customer accounts for more than 10% of sales. The consolidated financial statements include PENWEST and its wholly-owned subsidiaries. Material intercompany balances and transactions have been eliminated. Cash and Cash Equivalents The Company considers all highly liquid investments with a maturity of less than three months when purchased to be cash equivalents. Cash equivalents consist of money market funds, short-term deposits, and commercial paper. Amounts reported in the balance sheet represent cost which approximates market value. PENWEST's cash management system includes a cash overdraft feature for uncleared checks in the disbursing accounts. Cash in the accompanying balance sheets represents the net amounts available to the disbursing accounts. Uncleared checks in excess of $1,581,000 are netted against cash at August 31, 1995. Property, Plant and Equipment Property, plant and equipment are recorded at cost. Expenditures for maintenance and repairs are expensed as incurred. The Company uses the straight-line method to compute depreciation assuming average useful lives of three to forty years for financial reporting purposes. For income tax purposes, the Company generally uses accelerated depreciation methods. Interest is capitalized on major construction projects while in progress. Interest of $209,000, $51,000 and $985,000 was capitalized in 1995, 1994, and 1993, respectively. Foreign Currencies Monetary assets and liabilities of the Company's foreign operations are translated into U.S. dollars at year-end exchange rates and revenue and expenses are translated at average exchange rates. Non-monetary assets and liabilities are converted at historical rates. In each instance, the functional currency is the U.S. dollar. Realized gains and losses from foreign currency transactions are reflected in the income statement. Income Taxes Deferred income taxes are provided on temporary differences between financial and income tax reporting methods. Revenue Recognition Sales revenue is recorded upon shipment of product. Page 21 22 Earnings Per Share Earnings per common share were computed by dividing net income by the weighted average number of common shares and dilutive common share equivalents outstanding during the fiscal year. Outstanding stock options and stock appreciation rights are considered to be common share equivalents. Research and Development Research and development costs of $6,773,000, $6,346,000 and $5,662,000 in 1995, 1994, and 1993, respectively, were charged to expense as incurred. Reclassifications Certain prior year amounts have been reclassified to conform with current year presentation. NOTE B INVENTORIES Inventories are stated at the lower of cost or market. Cost, which includes material, labor and manufacturing overhead costs, is determined by the first-in, first-out (FIFO) method. The Company generally follows a policy of hedging corn purchases, related to fixed price sales contracts and certain anticipated corn purchases to minimize price risk due to market fluctuations and risk of crop failure. The instruments used are principally readily marketable exchange traded futures contracts which are designated as hedges. The changes in market value of such contracts have a high correlation to the price changes of the hedged commodity. Also, the underlying commodity can be delivered against such contracts. To obtain a proper matching of revenue and expense, gains or losses arising from open and closed hedging transactions are included in inventory as a cost of the commodities and reflected in the income statements when the product is sold. Components of inventory are as follows: August 31 (Thousands of dollars) 1995 1994 - -------------------------------------------------------------------------------- Raw materials, supplies and other $ 3,828 $ 6,074 Work in progress 483 622 Finished goods 9,898 10,038 ------- ------- Total inventories $14,209 $16,734 ======= ======= Page 22 23 NOTE C DEBT August 31 (Thousands of dollars) 1995 1994 - ------------------------------------------------------------------------------------------------------------ Unsecured term agreement, quarterly principal payments, final maturity in 2000, 6.50% interest rate at year-end $16,000 $19,000 Private placement, 7.93% interest rate, semiannual interest-only payments with principal payments beginning in 1996, final maturity in 2005 20,000 20,000 Private placement, 7.97% interest rate, semiannual interest-only payments with two equal principal payments, one in 1998 and one in 2006 20,000 Unsecured note, 9.4% interest rate, due in quarterly installments through 2000 3,780 4,450 Note payable, 8.49% interest rate, quarterly principal and interest payments through October 1997 3,118 3,547 ------- ------- 62,898 46,997 Less current portion 4,270 4,100 ------- ------- Net long-term debt $58,628 $42,897 ======= ======= Maturities of long-term debt for the fiscal years ending August 31, 1996 through 2000 are as follows (thousands of dollars): 1996 $4,270 1997 7,127 1998 8,955 1999 16,697 2000 6,277 The Company has an unsecured term loan agreement of $16 million with four banks which expires on November 30, 2000. Borrowing rates available to the Company under the term agreement are at prime rate or less depending on the selection of borrowing options. The Company has an unsecured revolving line of credit of $15 million with four banks which expires on April 15, 1997. Borrowing rates available to the Company under the revolver are at prime rate or less depending on the selection of borrowing options. Borrowings under the revolver can be converted, at the option of PENWEST, to term notes due on the expiration date of the revolving line of credit. At year-end, there were no outstanding borrowings under this agreement. The unsecured term agreement, the private placements, and the unsecured revolving line of credit include, among other terms, various limitations on long-term indebtedness, minimum net worth and working capital ratios, and restrictions on PENWEST's ability to purchase or redeem its own stock. The Company has uncommitted lines of credit aggregating $15 million, which provide for financing at various floating rates. Page 23 24 The Company enters into interest rate swap agreements to modify the interest characteristics of its outstanding debt. These agreements involve the exchange of interest payment streams without an exchange of the underlying principal amount. Net amounts paid or received are reflected as adjustments to interest expense. The fair values of the swap agreements are not recognized in the financial statements. In the event of default by a counterparty, the risk in these transactions is the cost of replacing the interest rate contract at current market rates. The Company continually monitors the credit ratings of its counterparties. Management believes the risk of incurring losses is remote, and that if incurred, such losses would be immaterial. At August 31, 1995, approximately $25 million of the Company's outstanding debt was subject to interest rate swap agreements. Of this amount, $15 million involves floating rate to fixed rate swaps which effectively fix rates at approximately 9% and $10 million involves fixed rate to floating rate swaps, with the floating rate approximating 6% at August 31, 1995. The Company has hedged the interest rate risk on $8.9 million of its long-term debt using Treasury note futures. The cost of the hedge has been deferred and will be recognized as a component of interest expense over the life of the debt. The hedge will result in an effective interest rate on the hedged portion of long-term debt of approximately 9.5%. NOTE D LEASES Certain of the Company's property, plant, and equipment is leased under operating leases ranging from one to fifteen years with renewal options. Rental expense under operating leases was $3,202,000, $2,787,000 and $2,066,000 for fiscal years ended August 31, 1995, 1994, and 1993, respectively. Future lease payments as of August 31, 1995 for noncancellable operating leases having initial lease terms of more than one year are as follows (thousands of dollars): Years ending August 31 Operating Leases - ---------------------- ---------------- 1996 $4,098 1997 2,814 1998 2,312 1999 1,951 2000 608 Thereafter 1,898 ------- Total minimum lease payments $13,681 ======= Page 24 25 NOTE E STOCK OPTIONS Under stock option plans, options have been granted to certain officers and key employees to purchase PENWEST common stock. Changes in stock options for the three years ended August 31 are as follows: 1995 Option 1995 1994 1993 Price Range - ---------------------------------------------------------------------------------------------------------- Outstanding at beginning of year 615,859 590,809 596,762 $ 3.313 - $27.50 Granted 271,000 59,000 27,000 20.750 - 22.75 Exercised (13,600) (13,950) (23,003) 3.313 - 22.6 Cancelled (25,800) (20,000) (9,950) 19.13 ------- ------- ------ Outstanding at end of year 847,459 615,859 590,809 3.313 - 27.50 ======= ======= ======= ===== ===== Exercisable at end of year 401,159 299,109 184,259 3.313 - 27.50 ======= ======= ======= ===== ===== At August 31, 1995, 62,232 stock appreciation rights (SARs) were outstanding to certain officers. The SARs were granted in December 1986 at the market price of PENWEST stock and are fully vested as of August 31, 1995. As a result of appreciation (depreciation) of PENWEST stock and vesting of the SARs, compensation expense was charged (credited) for $78,000, $342,000 and ($303,000) in 1995, 1994, and 1993 respectively. Page 25 26 NOTE F INCOME TAXES Income tax expense consists of the following: Year Ended August 31 (Thousands of dollars) 1995 1994 1993 - -------------------------------------------------------------------------------- Current Federal $ 2,102 $ (904) $(1,731) Foreign 4 138 213 State 232 56 (51) ------- ------- ------- 2,338 (710) (1,569) Deferred Federal 1,459 2,253 2,808 State 93 423 83 ------- ------- ------- 1,552 2,676 2,891 ------- ------- ------- Total provision $ 3,890 $ 1,966 $ 1,322 ======= ======= ======= A reconciliation of the statutory federal tax to the actual provision is as follows: Year Ended August 31 (Thousands of dollars) 1995 1994 1993 - -------------------------------------------------------------------------------- Statutory tax rate 34% 34% 34% Statutory tax $ 3,776 $ 2,749 $ 2,597 State taxes, net of federal benefit 215 164 77 Tax credits, including research and development credits (313) (1,095) (1,503) Tax advantaged investment income (47) Other 259 148 151 ------- ------- ------- Total provision $ 3,890 $ 1,966 $ 1,322 ======= ======= ======= The significant components of deferred tax assets and liabilities are as follows: August 31 (Thousands of dollars) 1995 1994 - -------------------------------------------------------------------------------- Deferred tax assets: Alternative minimum tax credit $ 2,725 $ 3,269 Research and development credit 622 300 Postretirement benefits 3,691 3,671 Provisions for accrued expenses 2,366 1,963 Other 523 342 ------------------------ Total deferred tax assets 9,927 9,545 Deferred tax liabilities: Depreciation 17,650 16,826 Other 2,143 926 ------------------------ Total deferred tax liabilities 19,793 17,752 ------------------------ Net deferred tax liabilities $ 9,866 $ 8,207 ======================== Page 26 27 NOTE G PENSION AND OTHER EMPLOYEE BENEFITS PENWEST maintains two noncontributory defined benefit pension plans that cover substantially all employees. Benefits under the plan for hourly employees are primarily related to years of service. Benefits for salaried employees are primarily related to years of credited service and final average five-year earnings. Employees generally become eligible to participate in the plans after attaining age 21 and benefits normally become vested after five years of credited service. The Company's funding policy is to contribute amounts to the plans sufficient to meet or exceed the minimum requirements of the Employee Retirement Income Security Act of 1974. Assumptions used in the measurement of the projected benefit obligation in 1995 and 1994 included a discount rate of 7.5% and 8.0%, respectively, and a rate of increase in compensation levels of 6.0% for the salaried employees. The change in the discount rate had the impact of increasing the projected benefit obligation by approximately $1.4 million. The expected long-term rate of return on plan assets is assumed to be 8.0%. Net periodic pension expense consisted of the following (in thousands): Year Ended August 31 1995 1994 1993 - --------------------------------------------------------------------------------------------- Service cost of benefits earned during the year $ 603 $ 591 $ 545 Interest cost on projected benefit obligation 1,363 1,256 1,245 Actual return on plan assets (2,599) (842) (2,449) Net amortization and deferral 1,480 (253) 1,676 ------- ------- ------- Net pension expense $ 847 $ 752 $ 1,017 ======= ======= ======= The following table sets forth the funded status of both pension plans as of August 31, 1995 and 1994 (in thousands): August 31 1995 1994 - ------------------------------------------------------------------------------------ Actuarial present value of projected obligation, based on service to date and current salary levels: Vested $ 17,081 $ 15,521 Nonvested 430 387 -------- -------- Accumulated benefit obligation 17,511 15,908 Effect of projected salary increases 2,052 1,663 -------- -------- Projected benefit obligation 19,563 17,571 Plan assets at fair market value 18,910 15,977 -------- -------- Projected benefit obligation greater than plan assets (653) (1,594) Unrecognized actuarial net loss 254 1,264 Balance of unrecognized net obligation at transition being amortized over 15 years 1,137 577 Unrecognized prior service cost 534 472 Adjustment to record minimum liability (1,987) -------- -------- Net pension asset (liability) $ 1,272 $ (1,268) ======== ======== Page 27 28 Assets of the pension plans are invested in units of common trust funds managed by Frank Russell Trust Company. The common trust funds own stocks, bonds and real estate. Penwest Savings And Stock Ownership Plan The Company has a savings investment plan. The savings component, available to all employees, matches 75% of the employee's contribution up to 6% of the employee's pay, in the form of PENWEST common stock. The plan held 113,271 unallocated shares of PENWEST common stock as of August 31, 1995, including shares earned but not yet allocated. During 1995, approximately 52,630 shares of stock were earned by plan participants. The savings component expense of the plan was $520,000, $599,900 and $519,000 for fiscal years 1995, 1994, and 1993, respectively. Compensation expense is recorded by the Company as the market value of shares released. The plan also includes an annual profit-sharing component that is awarded by the Board of Directors based on achievement of predetermined corporate goals. This feature of the plan is available to all employees who meet the eligibility requirements of the plan. The profit sharing expense, which reflects the cost basis of stock released by the plan to participants was $402,000, $285,000 and $420,000 for the fiscal years 1995, 1994 and 1993, respectively. The plan acquired the PENWEST common stock by issuing a note to the Company. The note is reflected as a reduction of shareholders' equity and is amortized ratably as stock is released to participants in the plan. The shares held by the plan are considered outstanding for puposes of calculating earnings per share. Supplemental Executive Retirement Plan The Company established a Supplemental Executive Retirement Plan (SERP), a nonqualified plan, which covers certain employees. For 1995, 1994, and 1993, the net pension expense accrued for the SERP was $856,000, $347,000 and $283,000 respectively. Health Care And Life Insurance Benefits The Company offers health care and life insurance benefits to most active employees. Costs incurred to provide these benefits are charged to expense when paid. Health care and life insurance expense was $2,501,000, $2,649,000 and $2,297,000 in 1995, 1994, and 1993, respectively. NOTE H OTHER POSTRETIREMENT BENEFITS PENWEST maintains two postretirement benefit plans that cover substantially all salaried and hourly retirees. Benefits under the plan for hourly employees include medical coverage, prescription drug coverage, and, to a certain grandfathered group, life insurance. Hourly participants contribute to the cost of the benefits based on a pension credit formula. Benefits under the plan for salaried employees includes medical coverage and vision coverage. Salaried participants contribute, for the most part, 100% of the premiums. Page 28 29 Postretirement benefit expense was $359,000, $834,000 and $1,088,000 for the years ended August 31, 1995, 1994, and 1993, respectively. Presently the Company funds the current benefits on a cash basis and therefore there are no plan assets. The following table sets forth the plan's funded status (in thousands of dollars): Accumulated postretirement benefit obligation: Year Ended August 31, 1995 August 31, 1994 --------------- --------------- Retirees $ 4,119 $ 5,020 Fully eligible active plan participants 311 297 Other active plan participants 2,190 2,365 ------- ------- Accumulated post-retirement benefit obligation 6,620 7,682 Unrecognized actuarial net gain 3,535 2,420 ------- ------- Accrued postretirement benefit obligation $10,155 $10,102 ======= ======= Net periodic postretirement benefit costs include the following components: Year Ended August 31 1995 1994 1993 ------- ------- ------- Service cost -- benefits earned during the period $ 186 $ 295 $ 288 Interest cost on accumulated postretirement benefit obligations 402 604 800 Net amortization and deferral (229) (65) ------- ------- ------- $ 359 $ 834 $ 1,088 ======= ======= ======= Future benefit costs were estimated assuming medical costs would increase at a 10% annual rate for fiscal 1996, then beginning in fiscal 1997, decreasing by one half of a percent ratably over the next nine years to a rate of 5.5%. A 1% increase in this annual trend rate would have increased the accumulated postretirement benefit obligation at August 31, 1995 by $954,000, with an increase of $105,000 in the annual 1995 postretirement benefit expense. The weighted average discount rate used to estimate the accumulated postretirement obligation was 7.5% in 1995 and 8.0% in 1994. The change in discount rate had the impact of increasing the accumulated post-retirement benefit obligation by $1.1 million. During the second quarter of fiscal 1994, the Company curtailed postretirement health benefits for salaried employees that had been previously accrued. The Company formerly paid a portion of the health insurance premiums for salaried retirees but no longer does so for eligible salaried employees retiring after May 15, 1994. As a result, in the second quarter of 1994, there was a $900,000 reduction of operating expenses recorded. Page 29 30 NOTE I SHAREHOLDERS' EQUITY UNISSUED PREFERRED STOCK There are 1,000,000 shares of $1.00 par value preferred stock authorized for issue; however, none are outstanding. Common Stock Purchase Rights On June 16, 1988, PENWEST distributed a dividend of one right (Right) for each outstanding share of PENWEST common stock. In addition, previously outstanding Rights were redeemed for $0.025 each. When exercisable, each Right will entitle its holder to buy one share of PENWEST's common stock at $44.00 per share. The Rights will become exercisable if a purchaser acquires 20% of PENWEST's common stock or makes an offer to acquire common stock. In the event that a purchaser acquires 20% of the common stock of PENWEST, each Right shall entitle the holder, other than the acquirer, to purchase one share of common stock of PENWEST for one half of the market price of the common stock. In the event that PENWEST is acquired in a merger or transfers 50% or more of its assets or earnings to any one entity, each Right entitles the holder to purchase common stock of the surviving or purchasing company having a market value of twice the exercise price of the Right. The Rights may be redeemed by PENWEST at a price of $.01 per Right, and they expire in June 1998. NOTE J PACIFIC COGENERATION, INC. In December of 1994 the Company sold the assets of its subsidiary Pacific Cogeneration, Inc. to third parties. The Company recognized a gain on the sale of $899,000 which is reflected as other income in 1995. NOTE K QUARTERLY FINANCIAL DATA (UNAUDITED) Fiscal 1995 First Second Third Fourth (Thousands of dollars except earnings per share data) Quarter Quarter Quarter Quarter Total - ----------------------------------------------------------------------------------------------------------------------------- Sales $ 42,771 $ 42,429 $ 43,618 $ 45,382 $174,200 Gross margin 11,244 11,912 12,465 12,238 47,859 Income from operations 3,716 3,504 4,225 3,528 14,973 Net income 1,757 2,153 2,000 1,307 7,217 Earnings per common share $ 0.25 $ 0.31 $ 0.29 $ 0.19 $ 1.03 Dividends declared $ 0.05 $ 0.05 $ 0.05 $ 0.05 $ 0.20 Fiscal 1994 First Second Third Fourth (Thousands of dollars except earnings per share data) Quarter Quarter Quarter Quarter Total - ----------------------------------------------------------------------------------------------------------------------------- Sales $ 37,817 $ 35,837 $ 41,347 $ 43,786 $158,787 Gross margin 9,987 8,724 11,050 11,292 41,053 Income from operations 2,599 1,678 3,267 3,350 10,894 Net income 1,761 863 1,774 1,722 6,120 Earnings per common share $ 0.25 $ 0.12 $ 0.25 $ 0.24 $ 0.86 Dividends declared $ 0.05 $ 0.05 $ 0.05 $ 0.05 $ 0.20 Page 30 31 Report of Ernst & Young LLP, Independent Auditors The Board of Directors and Shareholders PENWEST, LTD. We have audited the accompanying consolidated balance sheets of PENWEST, LTD. as of August 31, 1995 and 1994, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended August 31, 1995. 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 in accordance with generally accepted auditing standards. 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of PENWEST, LTD. at August 31, 1995 and 1994, and the consolidated results of its operations and its cash flows for each of the three years in the period ended August 31, 1995, in conformity with generally accepted accounting principles. Seattle, Washington October 12, 1995 Page 31 32 REPORT OF MANAGEMENT The management of PENWEST, LTD. has prepared and is responsible for the integrity and fairness of the financial statements and other financial information presented in this annual report. The statements have been prepared in accordance with generally accepted accounting principles and, to the extent appropriate, include amounts based on management's judgment and/or estimates. In order to fulfill its responsibilities for these financial statements and information, management maintains accounting systems and related internal controls. These controls are designed to provide reasonable assurance that transactions are properly authorized and recorded, that assets are safeguarded, and that financial records are reliably maintained. Ernst & Young LLP, independent auditors, is retained to audit the Company's consolidated financial statements. Their accompanying report is based on an audit conducted in accordance with generally accepted auditing standards, including a review of internal accounting controls and tests of accounting procedures and records to the extent necessary to support their audit. The Audit Committee of the Board of Directors, which is composed solely of outside directors, meets periodically with management and with the independent auditors to review the quality of financial reporting, the operation and development of the internal control systems, and the results of independent audits. The independent auditors regularly meet with the Audit Committee without the presence of any other parties. Tod R. Hamachek President and Chief Executive Officer Jeffrey T. Cook Vice President, Finance and Chief Financial Officer Jennifer L. Good Corporate Controller and Corporate Secretary Page 32 33 ITEM 9: CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT The information set forth under "Election of Directors" in the Company's definitive Proxy Statement for the 1996 Annual Meeting of Shareholders is incorporated herein by reference. Information regarding executive officers of the Company is set forth in Part I above and incorporated herein by reference. ITEM 11: EXECUTIVE COMPENSATION The information set forth under "Executive Compensation" in the Company's definitive Proxy Statement for the 1996 Annual Meeting of Shareholders is incorporated herein by reference. ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information set forth under "Security Ownership of Certain Beneficial Owners and Management" in the Company's definitive Proxy Statement for the 1996 Annual Meeting of Shareholders is incorporated herein by reference. ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information relating to certain relationships and related transactions of the Company set forth under "Change-in-Control Arrangements" in the Company's definitive Proxy Statement for the 1996 Annual Meeting of Shareholders is incorporated herein by reference. PART IV ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) (1) Financial Statements The consolidated balance sheets as of August 31, 1995 and 1994 and the related statements of income, cash flows and shareholders' equity for each of the three years in the period ended August 31, 1995 and the report of independent auditors are included in Part II, Item 8. Page 33 34 (a) (2) Financial Statement Schedules (a) Quarterly financial information is included in Part II, Item 8. All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted. (a) (3) Exhibits See list of Exhibits on page 36. This list includes a subset containing each management contract, compensatory plan, or arrangement required to be filed as an exhibit to this report. (b) Reports on Form 8-K No reports on Form 8-K were filed during the last quarter of the period covered by this report. Page 34 35 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. PENWEST, LTD. Date November 29, 1995 Tod R. Hamachek --------------------------------------------- Tod R. Hamachek, President and Chief Executive Officer Principal Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Date November 29, 1995 Tod R. Hamachek --------------------------------------------- Tod R. Hamachek, President and Chief Executive Officer (Principal Executive Officer) Date November 29, 1995 Jeffrey T. Cook --------------------------------------------- Jeffrey T. Cook, Chief Financial Officer (Principal Financial Officer) Date November 29, 1995 Jennifer L. Good --------------------------------------------- Jennifer L. Good, Corporate Controller (Principal Accounting Officer) Directors Richard E. Engebrecht Tod R. Hamachek By Tod R. Hamachek Paul H. Hatfield ------------------------------------------ C. Calvert Knudsen Harry L. Mullikin Attorney-in-Fact Sally G. Narodick Power of Attorney Dated William G. Parzybok, Jr. October 24, 1995 N. Stewart Rogers Date October 24, 1995 William K. Street James H. Wiborg Page 35 36 INDEX TO EXHIBITS Exhibits identified in parentheses below, on file with the Securities and Exchange Commission, are incorporated by reference. Exhibit No. Item (3.1) Restated Articles of Incorporation of Registrant (3.2) Bylaws of Registrant as amended and restated as of June 27, 1995 (4.1) PENWEST, LTD. Common Stock Purchase Rights, dated June 3, 1988 (filed on Form 8-A dated June 3, 1988) (10.1) Unsecured Term Agreement among PENWEST, LTD. and Penford Products Co. as Borrowers, and Seattle- First National Bank, Continental Bank N.A., U.S. Bank of Washington, National Association, and The Bank of Nova Scotia as Lenders, dated as of November 9, 1990 (filed as an Exhibit to Registrant's Form 10-Q for the quarter ended February 28, 1993) (10.2) Senior Note Agreement among PENWEST, LTD. as Borrower and Mutual of Omaha and Affiliates as lenders, dated November 1, 1992 (filed as an Exhibit to Registrant's Form 10-Q for the quarter ended February 28, 1993) (10.3) Term Loan Agreement among Penford Products Co., and PENWEST, LTD. as Borrowers, and First Interstate Bank of Washington, N.A. as Lender, dated September 27, 1990 (Registrant agrees to furnish a copy of this instrument to the Commission on request) (10.4) Loan Agreement among PENWEST, LTD. as Borrower and Seattle-First National Bank as Lender, dated December 1, 1989 (Registrant agrees to furnish a copy of this instrument to the Commission on request) Page 36 37 (10.5) PENWEST, LTD. Supplemental Executive Retirement Plan, dated March 19, 1990 (filed as an Exhibit to Registrant's Form 10-K for the fiscal year ended August 31, 1991) (10.6) PENWEST, LTD. Supplemental Survivor Benefit Plan, dated January 15, 1991 (filed as an Exhibit to Registrant's Form 10-K for the fiscal year ended August 31, 1991) (10.7) PENWEST, LTD. Deferred Compensation Plan, dated January 15, 1991 (filed as an Exhibit to Registrant's Form 10-K for the fiscal year ended August 31, 1991) (10.8) Change of Control Agreements with Messrs. Hamachek, Reed, Cook, Widmaier, Schmelzer, Talley, Horn and Rydzewski (a representative copy of these agreements is filed herewith) (10.9) PENWEST, LTD. 1993 Non-Employee Director Restricted Stock Plan (filed as an Exhibit to Registrant's Form 10-Q for the quarter ended November 30, 1993) (10.10) Note Agreement dated as of October 1, 1994 among PENWEST, Ltd., Principal Mutual Life Insurance Company and TMG Life Insurance Company (filed as an Exhibit to Registrant's Form 10-Q for the quarter ended February 28, 1995) (10.11) PENWEST, Ltd. 1994 Stock Option Plan (filed as an Exhibit to the Registration Statement dated April 25, 1995 on Form S-8, Commission File No. 33-58799) 11 Statement Regarding Computation of Per Share Earnings 21 Subsidiaries of the Registrant 23 Consent of Independent Auditors 24 Power of Attorney 27 Financial Data Schedule Page 37 38 SUBSET OF THE INDEX TO EXHIBITS Executive Compensation Plans and Arrangements. This subset of the index to exhibits includes a subset containing each management contract, compensatory plan, or arrangement required to be filed as an exhibit to this Report. Exhibit No. Item - ----------- ---- (10.5) PENWEST, LTD. Supplemental Executive Retirement Plan, dated March 19, 1990 (filed as an Exhibit to Registrant's Form 10-K for the fiscal year ended August 31, 1991, Commission File No. 0-11488) (10.6) PENWEST, LTD. Supplemental Survivor Benefit Plan, dated January 15, 1991 (filed as an Exhibit to Registrant's Form 10-K for the fiscal year ended August 31, 1991, Commission File No. 0-11488) (10.7) PENWEST, LTD. Deferred Compensation Plan, dated January 15, 1991 (filed as an Exhibit to Registrant's Form 10-K for the fiscal year ended August 31, 1991, Commission File No. 0-11488) (10.8) Change of Control Agreements with Messrs. Hamachek, Reed, Cook, Widmaier, Schmelzer, Talley, Horn and Rydzewski (a representative copy of these agreements is filed herewith) (10.9) PENWEST, LTD. 1993 Non-Employee Director Restricted Stock Plan. (Filed as an Exhibit to Registrant's Form 10-Q for the quarter ended November 30, 1993, Commission File Number 0-11488.) (10.11) PENWEST, LTD. 1994 Stock Option Plan (filed as an Exhibit to the Registration Statement dated April 25, 1995 on Form S-8, Commission File No. 33-58799) Page 38