UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006
Commission file number 000-04217
ACETO CORPORATION
(Exact name of registrant as specified in its charter)
NEW YORK 11-1720520
-------- ----------
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)
ONE HOLLOW LANE, LAKE SUCCESS, NY 11042
(Address of principal executive offices
(516) 627-6000
(Registrant's telephone number, including area code)
WWW.ACETO.COM
(Registrant's website address)
Name of each exchange on which registered: The Nasdaq National Market.
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
Indicate by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer" and "large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer ___ Accelerated filer X Non-accelerated filer ___
Indicate by check mark whether the Registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes No X
----- ----
The Registrant has 24,264,948 shares of common stock outstanding as of May 3,
2006.
ACETO CORPORATION AND SUBSIDIARIES
QUARTERLY REPORT FOR THE PERIOD ENDED MARCH 31, 2006
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets - March 31, 2006 (unaudited) and
June 30, 2005
Consolidated Statements of Income - Nine Months
Ended March 31, 2006 and 2005 (unaudited)
Consolidated Statements of Income - Three Months
Ended March 31, 2006 and 2005 (unaudited)
Consolidated Statements of Cash Flows - Nine Months
Ended March 31, 2006 and 2005 (unaudited)
Notes to Consolidated Financial Statements (unaudited)
Report of Independent Registered Public Accounting Firm
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About
Market Risk
Item 4. Controls and Procedures
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 6. Exhibits
Signatures
Exhibits
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ACETO CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except per-share amounts)
March 31, June 30,
2006 2005
--------- ---------
(unaudited)
ASSETS
Current assets:
Cash in banks $ 21,875 $ 19,950
Investments 3,276 5,068
Trade receivables, less allowance for doubtful
accounts (March, $512, June $427) 62,156 49,636
Other receivables 1,316 1,421
Inventory 47,540 51,722
Prepaid expenses and other current assets 1,460 821
Assets held for sale -- 242
Deferred income tax benefit, net 2,799 2,780
--------- ---------
Total current assets 140,422 131,640
Long-term notes receivable 574 624
Property and equipment, net 5,237 5,543
Goodwill 1,721 1,720
Intangible assets, net 3,698 3,153
Deferred income tax benefit, net 1,650 3,626
Other assets 2,695 2,722
--------- ---------
TOTAL ASSETS $ 155,997 $ 149,028
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Drafts and acceptances payable $ 1,795 $ 2,462
Short term bank loans 17 126
Accounts payable 24,086 24,783
Note payable - related party 500 500
Accrued expenses 12,184 9,474
Liabilities relating to assets held for sale -- 46
--------- ---------
Total current liabilities 38,582 37,391
Long-term liabilities 4,876 3,811
Minority interest 175 171
--------- ---------
Total liabilities 43,633 41,373
Commitments and contingencies (Note 13)
Shareholders' equity:
Common stock, $.01 par value, 40,000 shares authorized; 25,644 shares issued;
24,257 and 24,282 shares outstanding at March 31, 2006 and
June 30, 2005, respectively 256 256
Capital in excess of par value 56,669 56,903
Retained earnings 67,320 62,864
Treasury stock, at cost, 1,387 and 1,362 shares at March 31, 2006 and June
30, 2005, respectively (13,403) (13,505)
Accumulated other comprehensive income 1,522 1,137
--------- ---------
Total shareholders' equity 112,364 107,655
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 155,997 $ 149,028
========= =========
See accompanying notes to consolidated financial statements and accountants'
review report.
3
ACETO CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(unaudited and in thousands, except per-share amounts)
Nine Months Ended
March 31,
2006 2005
--------- ---------
Net sales $ 225,306 $ 239,699
Cost of sales 187,891 198,653
--------- ---------
Gross profit 37,415 41,046
Selling, general and administrative expenses 29,380 31,005
--------- ---------
Operating income 8,035 10,041
Other income (expense):
Interest expense (76) (115)
Interest and other income, net 1,170 948
--------- ---------
1,094 833
--------- ---------
Income from continuing operations before income taxes 9,129 10,874
Provision for income taxes 2,830 3,086
--------- ---------
Income from continuing operations 6,299 7,788
Loss from discontinued operations, net of income taxes (Note 3) (27) (565)
--------- ---------
Net income $ 6,272 $ 7,223
========= =========
Basic income per common share:
Income from continuing operations $ 0.26 $ 0.32
Loss from discontinued operations $ -- $ (0.02)
Net income $ 0.26 $ 0.30
Diluted income per common share:
Income from continuing operations $ 0.26 $ 0.31
Loss from discontinued operations $ -- $ (0.02)
Net income $ 0.26 $ 0.29
Weighted average shares outstanding:
Basic 24,265 24,193
Diluted 24,586 24,708
See accompanying notes to consolidated financial statements and accountants'
review report.
4
ACETO CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(unaudited and in thousands, except per-share amounts)
Three Months Ended
March 31,
2006 2005
-------- --------
Net sales $ 80,846 $ 82,512
Cost of sales 67,402 68,263
-------- --------
Gross profit 13,444 14,249
Selling, general and administrative expenses 9,361 11,386
-------- --------
Operating income 4,083 2,863
Other income (expense):
Interest expense (15) (75)
Interest and other income, net (8) 93
-------- --------
(23) 18
-------- --------
Income from continuing operations before income taxes 4,060 2,881
Provision for income taxes 1,309 853
-------- --------
Income from continuing operations 2,751 2,028
Loss from discontinued operations, net of income taxes (Note 3) -- (133)
-------- --------
Net income $ 2,751 $ 1,895
======== ========
Basic income per common share:
Income from continuing operations $ 0.11 $ 0.09
Loss from discontinued operations $ -- $ (0.01)
Net income $ 0.11 $ 0.08
Diluted income per common share:
Income from continuing operations $ 0.11 $ 0.09
Loss from discontinued operations $ -- $ (0.01)
Net income $ 0.11 $ 0.08
Weighted average shares outstanding:
Basic 24,237 24,235
Diluted 24,569 24,690
See accompanying notes to consolidated financial statements and accountants'
review report.
5
ACETO CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited and in thousands)
Nine Months Ended
March 31,
2006 2005
-------- --------
(Revised - Note 1)
Operating activities:t
Net income $ 6,272 $ 7,223
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 1,083 999
Provision for doubtful accounts 94 342
Non-cash stock compensation 165 183
Deferred income taxes 1,957 1,851
Income tax benefit on exercise of stock options -- 266
Impairment charges -- 1,453
Changes in assets and liabilities:
Investments - trading securities 53 (4)
Trade accounts receivable (12,573) (1,933)
Other receivables 243 121
Inventory 4,225 (6,484)
Prepaid expenses and other current assets (636) (943)
Other assets (400) (818)
Drafts and acceptances payable (705) (56)
Accounts payable (881) (6,234)
Accrued compensation 60 (599)
Accrued environmental remediation -- (86)
Income taxes receivable -- 926
Other accrued expenses and long-term liabilities 3,734 1,384
-------- --------
Net cash provided by (used in) operating activities 2,691 (2,409)
-------- --------
Investing activities:
Purchases of investments -- (4,465)
Sales of investments 1,739 9,348
Payments received on notes receivable 49 70
Purchases of property and equipment (321) (3,899)
-------- --------
Net cash provided by investing activities 1,467 1,054
-------- --------
Financing activities:
Purchases of treasury stock (581) --
Proceeds from exercise of stock options 190 927
Payment of short-term bank loan (109) --
Excess income tax benefit on exercise of stock options 66 --
Payment of note payable - related party -- (500)
Payment of cash dividends (1,816) (1,820)
-------- --------
Net cash used in financing activities (2,250) (1,393)
-------- --------
Effect of exchange rate changes on cash 17 273
-------- --------
Net increase (decrease) in cash 1,925 (2,475)
Cash at beginning of period 19,950 23,330
-------- --------
Cash at end of period $ 21,875 $ 20,855
======== ========
See accompanying notes to consolidated financial statements and accountants'
review report.
6
ACETO CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited and in thousands, except per-share amounts)
(1) BASIS OF PRESENTATION
The consolidated financial statements of Aceto Corporation and subsidiaries (the
"Company") included herein have been prepared by the Company and reflect all
adjustments (consisting solely of normal recurring adjustments) necessary to
present fairly the financial position, results of operations and cash flows for
all periods presented. Interim results are not necessarily indicative of results
that may be achieved for the full year.
The preparation of financial statements in conformity with U.S. generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenues
and expenses reported in those financial statements. These judgments can be
subjective and complex, and consequently actual results could differ from those
estimates and assumptions. The Company's most critical accounting policies
relate to revenue recognition; allowance for doubtful accounts; inventory;
goodwill and other intangible assets; environmental matters and other
contingencies; and income taxes.
These consolidated financial statements do not include all disclosures
associated with consolidated financial statements prepared in accordance with
U.S. generally accepted accounting principles. Accordingly, these statements
should be read in conjunction with the Company's consolidated financial
statements and notes thereto contained in the Company's Form 10-K for the year
ended June 30, 2005.
Certain reclassifications have been made to the prior consolidated financial
statements to conform to the current presentation. In addition, we have revised
our statement of cash flows for the nine months ended March 31, 2005 to combine
cash flows from discontinued operations with cash flows from continuing
operations within each major category. We had previously reported cash flows
from discontinued operations as a single line item in the statement of cash
flows.
(2) STOCK-BASED COMPENSATION
Prior to July 1, 2005, the Company accounted for stock-based employee
compensation under the intrinsic value method as outlined in the provisions of
APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations while disclosing pro-forma net income and net income per share
as if the fair value method had been applied in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation." Under the intrinsic value method, no compensation expense was
recognized if the exercise price of the Company's employee stock options equaled
or exceeded the market price of the underlying stock on the date of grant. Since
the Company had issued all stock option grants with exercise prices equal to, or
greater than, the market value of the common stock on the date of grant, through
June 30, 2005 no compensation cost was recognized in the consolidated statements
of income.
Effective July 1, 2005, the Company adopted SFAS No. 123(R), "Share-based
Payment." SFAS No. 123(R) replaces SFAS No. 123 and supersedes APB Opinion No.
25. SFAS 123(R) requires that all stock-based compensation be recognized as an
expense in the financial statements and that such costs be measured at the fair
value of the award. This statement was adopted using the modified prospective
method, which requires the Company to recognize compensation expense on a
prospective basis. Therefore, prior period financial statements have not been
restated. Under this method, in addition to reflecting compensation expense for
new share-based payment awards, expense is also recognized to reflect the
remaining vesting period of awards that had been included in pro-forma
disclosures in prior periods. Since all options outstanding as of June 30, 2005
were fully vested, there was no compensation expense recognized for those
options in the consolidated statements of income for the three and nine month
periods ended March 31, 2006.
SFAS 123(R) also requires that excess tax benefits related to stock option
exercises be reflected as financing cash inflows instead of operating cash
inflows. Prior to the adoption of SFAS 123(R), the Company presented all tax
benefits related to stock-based compensation as an operating cash inflow. The
Company's policy is to satisfy stock-based compensation awards with treasury
shares.
7
ACETO CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited and in thousands, except per-share amounts)
The following table illustrates the effect on net income per common share for
the three and nine month periods ended March 31, 2005 as if the Company had
consistently measured the compensation cost for the Company's stock option
programs under the fair value method adopted in fiscal 2006:
Nine months ended Three months ended
March 31, March 31,
2005 2005
--------- ---------
Net income - as reported $ 7,223 $ 1,895
Add: Stock-based compensation
included in reported net income 183 93
Deduct: Total stock-based
employee compensation
expense determined under fair
value method for all awards,
net of related tax effects (4,484) (115)
--------- ---------
Net income - pro forma $ 2,922 $ 1,873
Net income per share:
Basic - as reported $ 0.30 $ 0.08
Basic - pro forma $ 0.12 $ 0.08
Diluted - as reported $ 0.29 $ 0.08
Diluted - pro forma $ 0.12 $ 0.08
Stock-based employee compensation expense under the fair value method for the
nine months ended March 31, 2005 includes $6,046, which represents the entire
fair value of 1,322 options granted to employees and 61 options granted to
directors in September 2004, all of which had an exercise price equal to or
greater than the market value of the common stock on the date of grant, as those
options were fully vested as of their date of grant.
In January 2006, the Company granted 131 options to certain employees and
directors at an exercise price equal to the market value of the common stock on
the date of grant. These options vest over one year and expire ten years from
the date of grant. In accordance with SFAS 123(R), compensation expense, which
is included in selling general and administrative expenses, of $376 will be
charged over the vesting period. For the three months ended March 31, 2006, $94
was charged to compensation expense. The Company estimates the fair value of
stock options using the Black-Scholes option pricing model, including an
estimate of forfeiture rates.
In addition to the exercise price and grant date price of the awards, certain
weighted average assumptions used in determining the Black-Scholes option
pricing fair value were as follows: expected volatility of 50%, expected term of
5.5 years, risk free interest rate of 4.36% and dividend yield of 2.2%. The
Company estimates expected volatility based on historical daily price changes of
the Company's common stock. The expected term is the number of years that the
Company estimates that options will be outstanding prior to exercise. The
expected term was determined using the "simplified" method prescribed in SEC
Staff Accounting Bulletin ("SAB") No. 107. The risk free interest rate is based
on the United States treasury yield curve in effect at the time of grant.
In September 2002, the Company adopted the Aceto Corporation 2002 Stock Option
Plan (2002 Plan), which was ratified by the Company's shareholders in December
2002. Under the 2002 Plan, options or restricted stock to purchase up to 1,688
shares of the Company's common stock may be granted by the Company to officers,
directors, employees and agents of the Company. The exercise price per share
shall not be less than the market value of Aceto common stock on the date of
grant and each option may not become exercisable less than six months from the
date it is granted. Restricted stock may be granted to an eligible participant
in lieu of a portion of any annual cash bonus earned by such participant. Such
award may include additional shares of restricted stock (premium shares) greater
than the portion of bonus paid in restricted stock. The restricted stock award
is vested at issuance and the
8
ACETO CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited and in thousands, except per-share amounts)
restrictions lapse ratably over a period of years as determined by the Board of
Directors, generally three years. The premium shares vest when all the
restrictions lapse, provided that the participant remains employed by the
Company at that time. As of March 31, 2006, there were 143 shares of common
stock available for grant as either options or restricted stock under the 2002
Plan.
In December 1998, the Company adopted the Aceto Corporation 1998 Omnibus Equity
Award Plan (1998 Plan). In accordance with the 1998 Plan the Company's Board of
Directors (Board) may grant up to 1,688 shares of common stock in the form of
stock options or restricted stock to eligible participants. The exercise price
per share, determined by the Board, for options granted cannot be less than the
market value of the stock on the date of grant. The options vest as determined
by the Board and expire no later than ten years from the date of grant.
Restricted stock may be granted to an eligible participant in lieu of a portion
of any annual cash bonus earned by such participant. Such restricted stock award
may include premium shares greater than the portion of bonus paid in restricted
stock. The restricted stock award is vested at issuance and the restrictions
lapse ratably over a period of years as determined by the Board. The premium
shares vest when the restrictions lapse, provided that the participant remains
employed by the Company at that time. Under the 1998 Plan, there were 85 shares
of common stock available for grant as either options or restricted stock at
March 31, 2006.
Under the terms of the Company's 1980 Stock Option Plan, as amended (1980 Plan),
options may be issued to officers and key employees. The exercise price per
share can be greater or less than the market value of the stock on the date of
grant. The options vest either immediately or over a period of years as
determined by the Board of Directors and expire no later than five or ten years
from the original date they are fully vested. The 1980 Plan expired in September
2005. Outstanding options survive the expiration of the 1980 Plan.
The following summarizes the shares of common stock under option for all plans
at March 31, 2006 and June 30, 2005, and the activity with respect to options
for the nine months ended March 31, 2006:
Weighted
Shares average Aggregate
subject to exercise price intrinsic
option per share value
------------- ---------------- ----------
Outstanding at June 30, 2005 2,764 $ 7.65
Granted 131 6.82
Exercised (57) 3.81
Forfeited (63) 10.90
------------- ---------------- ----------
Outstanding at March 31, 2006 2,775 7.62 $21,146
The weighted average fair value of stock options granted during the nine months
ended March 31, 2006 was $2.87. The aggregate intrinsic value of stock options
exercised during the nine months ended March 31, 2006 was $217. The aggregate
intrinsic value of the 2,644 exercisable stock options at March 31, 2006 was
$20,253 with a weighted-average remaining contractual life, in years, of 7.78.
Summarized information about stock options outstanding and exercisable at March
31, 2006, is as follows:
Number of Number of
Exercise Price Range Options Average Life Average Options Average
Outstanding (1) Price (2) Excercisable Price (2)
- ------------------------- ---------------- -------------- -------------- --------------- --------------
$2.67 - 4.28 1,056 7.11 $3.56 1,056 $3.56
6.87 131 9.75 6.87 - -
8.21 - 10.81 347 7.43 8.39 347 8.39
10.95 1,241 8.45 10.95 1,241 10.95
----- ---- ----- ----- -----
2,775 7.87 7.62 2,644 7.66
===== =====
(1) Weighted-average contractual life remaining, in years.
(2) Weighted-average exercise price.
9
ACETO CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited and in thousands, except per-share amounts)
The following summarizes the non-vested stock options at March 31, 2006 and the
activity with respect to non-vested options for the nine months ended March 31,
2006:
Shares Weighted
subject to average grant
option date fair value
--------------- ----------------
Non-vested at June 30, 2005 - -
Granted 131 2.87
Vested - -
Forfeited - -
--------------- ----------------
Non-vested at March 31, 2006 131 2.87
(3) SALE OF INSTITUTIONAL SANITARY SUPPLIES SEGMENT
During June 2005, the Company entered into an agreement to sell the majority of
the product lines formulated and marketed by CDC Products Corp. ("CDC"), which
is one of the two subsidiaries forming the Institutional Sanitary Supplies
segment. The sale of certain product lines of CDC was completed on August 24,
2005 for $75 and a note receivable of $44 due in April 2006, which resulted in a
pre-tax gain of $66, included in other income in the statement of income for the
nine months ended March 31, 2006. Excluded from the sale of CDC's product lines
was Anti-Clog, an EPA-registered biocide that has a unique delivery system and
is used in commercial air-conditioning systems. As a result of management's
decision to retain the Anti-Clog product, the Company has reclassified all of
CDC's operating results previously reported as "discontinued operations" for the
period ended March 31, 2005 to "continuing operations" in the consolidated
statements of income for the three and nine month periods ended March 31, 2005.
On September 6, 2005, the Company completed the sale of certain assets of Magnum
Research Corp. for $81, the remaining subsidiary of the Institutional Sanitary
Supplies segment, the operating results of which are included in discontinued
operations in the consolidated statements of income. In December 2005, the
Company exited the leased space previously occupied by CDC and Magnum Research
Corp. As a result, the Company recorded a pre-tax charge of $378, which was
further increased by $92 in March 2006. This charge was included in selling,
general and administrative expenses, representing the present value of the
remaining lease obligation, reduced by estimated sub-lease rental income over
the remaining lease term, which expires in December 2009.
Assets held for sale of the disposal group included in the accompanying
consolidated balance sheet as of June 30, 2005, consist of current assets
(primarily accounts receivable and inventory) of $217, and goodwill of $25.
Liabilities related to the assets held for sale reported in the accompanying
consolidated balance sheet as of June 30, 2005, consist of accounts payable and
accrued expenses of $46.
Operating results of discontinued operations were as follows:
Nine months ended Three months ended
March 31, March 31,
2006 2005 2006 2005
----- ----- ----- -----
Net sales $ 154 $ 986 - $ 260
----- ----- ----- -----
Income (loss) from operations of
discontinued business 44 (79) - (105)
(Provision) benefit for income taxes (17) 30 - 40
Non-cash impairment charge -- (833) - (110)
Benefit for income taxes -- 317 - 42
----- ----- ----- -----
Loss from discontinued operations $ (27) $(565) - $(133)
===== ===== ===== =====
10
ACETO CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited and in thousands, except per-share amounts)
(4) INVESTMENTS
A summary of short-term investments were as follows:
March 31, 2006 June 30, 2005
---------------- -----------------
Fair Cost Fair Cost
Value Basis Value Basis
----- ----- ----- -----
TRADING SECURITIES
Corporate equity securities $ 653 $ 152 $ 657 $ 152
AVAILABLE FOR SALE SECURITIES
Corporate bonds 1,172 $1,207 1,194 $1,210
Government and agency securities 1,451 $1,501 3,217 $3,253
----- ------
$3,276 $5,068
====== ======
(5) GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill of $1,721 and $1,720 as of March 31, 2006 and June 30, 2005,
respectively, relates to the Health Sciences segment.
Intangible assets subject to amortization as of March 31, 2006 and June 30, 2005
were as follows:
Gross Carrying Accumulated Net Book
Value Amortization Value
----- ------------ -----
March 31, 2006
--------------
Customer relationships $2,651 $ 852 $1,799
Customer lists 600 600 --
Non-compete agreements 641 520 121
EPA Registration 150 -- 150
Patent License 838 38 800
------ ------ ------
$4,880 $2,010 $2,870
====== ====== ======
June 30, 2005
-------------
Customer relationships $2,648 $ 567 $2,081
Customer lists 600 510 90
Non-compete agreements 641 486 155
------ ------ ------
$3,889 $1,563 $2,326
====== ====== ======
Amortization expense for intangible assets subject to amortization amounted to
$446 and $444 for the nine months ended March 31, 2006 and 2005, respectively.
The estimated aggregate amortization expense for intangible assets subject to
amortization for each of the succeeding years ended March 31 are as follows:
2007: $513; 2008: $513; 2009: $498; 2010: $473; 2011: $328 and thereafter: $545.
As of March 31, 2006 and June 30, 2005, the Company also had $828 and $827,
respectively, of intangible assets pertaining to trademarks which are not
subject to amortization.
Changes in goodwill and the gross carrying value of certain intangible assets
are attributable to foreign currency exchange rates used to translate the
financial statements of foreign subsidiaries.
11
ACETO CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited and in thousands, except per-share amounts)
(6) ACCRUED EXPENSES
The components of accrued expenses as of March 31, 2006 and June 30, 2005 were
as follows:
March 31, June 30,
2006 2005
------- -------
Accrued compensation $ 2,596 2,566
Accrued environmental remediation costs 1,195 1,195
Other accrued expenses 8,393 5,713
------- -------
$12,184 $ 9,474
======= =======
(7) COMMON STOCK
On May 4, 2006, the Company's board of directors declared a semi-annual cash
dividend of $0.075 per share to be distributed on June 29, 2006 to shareholders
of record as of June 19, 2006.
On December 2, 2005, the Company's board of directors declared a regular
semi-annual cash dividend of $0.075 per share or $1,816 in the aggregate which
was paid on January 11, 2006 to shareholders of record on December 23, 2005.
(8) NET INCOME PER COMMON SHARE
Basic income per common share is based on the weighted average number of common
shares outstanding during the period. Diluted income per common share includes
the dilutive effect of potential common shares outstanding. The Company's only
potential common shares outstanding are stock options, which resulted in a
dilutive effect of 332 and 455 shares for the three months ended March 31, 2006,
and 2005, respectively. There were 1,718 and 1,344 stock options outstanding as
of March 31, 2006 and 2005, respectively, that were not included in the
calculation of diluted income per common share for the three months ended March
31, 2006 and 2005, respectively, because their effect would have been
anti-dilutive.
(9) COMPREHENSIVE INCOME
Comprehensive income consists of net income and other gains and losses affecting
shareholders' equity that, under generally accepted accounting principles, are
excluded from net income.
The components of comprehensive income were as follows:
Nine months ended Three months ended
March 31, March 31,
2006 2005 2006 2005
---- ---- ---- ----
Comprehensive income:
Netincome $ 6,272 $ 7,223 $ 2,751 $ 1,895
Foreign currency translation
adjustment 375 1,708 503 (1,320)
Unrealized gain (loss) on available for
sale securities (33) (63) 13 24
Change in fair value of cross
currency interest rate swaps 43 (675) (11) 437
------- ------- ------- -------
Total $ 6,657 $ 8,193 $ 3,256 $ 1,036
======= ======= ======= =======
The financial statements of the Company's foreign subsidiaries are measured
using the local currency as the functional currency. Exchange gains or losses
resulting from the translation of financial statements of foreign
12
ACETO CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited and in thousands, except per-share amounts)
operations are accumulated in other comprehensive income. The currency
translation adjustments are not adjusted for income taxes as they relate to
indefinite investments in non-US subsidiaries.
(10) DEFERRED INCOME TAXES
The decrease in the deferred income tax assets of $1,957 and $1,299 during the
nine months ended March 31, 2006 and 2005, respectively, related to the
reduction of taxes payable due to the utilization of foreign net operating loss
carryforwards. During the nine months ended March 31, 2005, the reduction of
taxes payable of $1,851 was partially offset by a $552 deferred tax asset
established for the write-down of goodwill and certain long-lived assets.
(11) SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest and income taxes for the nine months ended March 31, 2006
and 2005 were as follows:
2006 2005
------ ------
Interest $ 62 $ 87
Income taxes, net of refunds 656 1,344
(12) RELATED PARTY TRANSACTIONS
Certain directors of the Company are affiliated with law firms that serve as
counsel to the Company on various corporate matters. During the nine months
ended March 31, 2006 and 2005, the Company incurred legal fees of $246 and $133,
respectively, for services rendered to the Company by these law firms.
(13) COMMITMENTS AND CONTINGENCIES
As of March 31, 2006, the Company had outstanding purchase obligations totaling
$53,887 with suppliers to acquire certain products for resale to third party
customers.
The Company and its subsidiaries are subject to various claims that have arisen
in the normal course of business. The impact of the final resolution of these
matters on the Company's results of operations or liquidity in a particular
reporting period is not known. Management is of the opinion, however, that the
ultimate outcome of these matters will not have a material adverse effect upon
the Company's financial condition or liquidity.
In March 2006, one of the Company's subsidiaries received notice from the
Environmental Protection Agency (EPA) of its status as a potentially responsible
party ("PRP") under the Comprehensive Environmental Response, Compensation and
Liability Act (CERCLA) for a site described as the Berry's Creek Study Area. The
subsidiary is one of over 150 PRP's which have potential liability for the
required investigation and remediation of the site. The estimate of the
subsidiary's potential liability is difficult to quantify for a number of
reasons, including the difficulty in determining the extent of contamination and
the length of time remediation may require. In addition, any estimate of
liability must also consider the number of other potentially responsible parties
and their financial strength. Since an amount of the subsidiary's liability can
not be reasonably estimated at this time, no accrual is recorded for these
future costs. The impact of the resolution of this matter on the Company's
results of operations in a particular reporting period is not known. However,
management believes that the ultimate outcome of this matter will not have a
material adverse effect on the Company's financial condition or liquidity.
One of the Company's subsidiaries was a defendant in a legal action alleging
patent infringement. The patent in question covered a particular method of
applying one of the products in the Company's Agrochemicals segment. In
September 2005, shortly before a trial was expected to begin, the parties agreed
to a settlement. Under the terms of the settlement agreement, the Company was
obligated to pay $1,375, of which $625 was paid in December 2005 and the
remaining $750 will be paid in equal installments over the next five years. As a
result of the settlement, the company recorded an intangible asset of $838 for
the patent license, which will be amortized over its remaining life of 11 years,
and a charge of $537, included in SG&A expense, for the nine months ended March
31, 2006.
13
ACETO CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited and in thousands, except per-share amounts)
Commercial letters of credit are issued by the Company during the ordinary
course of business through major domestic banks as requested by certain
suppliers. The Company had open letters of credit of approximately $1,005 and
$1,783 as of March 31, 2006 and June 30, 2005, respectively. The terms of these
letters of credit are all less than one year. No material loss is anticipated
due to non-performance by the counterparties to these agreements.
(14) RECENT ACCOUNTING PRONOUNCEMENTS
In June 2005, the Financial Accounting Standards Board ("FASB") issued SFAS No.
154, "Accounting Changes and Error Corrections," a replacement of APB Opinion
No. 20, "Accounting Changes", and FASB SFAS No. 3, "Reporting Accounting Changes
in Interim Financial Statements." SFAS No. 154 applies to all voluntary changes
in accounting principles, and changes the requirements for accounting for and
reporting of a change in accounting principle. SFAS No. 154 requires
retrospective application to prior periods' financial statements of a voluntary
change in accounting principle unless it is impracticable. SFAS No. 154 also
requires that a change in method of depreciation, amortization, or depletion for
long-lived, non-financial assets be accounted for as a change in accounting
estimate that is affected by a change in accounting principle. SFAS No. 154 is
effective for accounting changes and corrections of errors made in fiscal years
beginning after December 15, 2005. Earlier application is permitted for
accounting changes and corrections of errors occurring in fiscal years beginning
after June 1, 2005. SFAS No. 154 does not change the transition provisions of
any existing accounting pronouncements, including those that are in a transition
phase as of the date of SFAS No. 154. The Company does not believe that adoption
of SFAS No. 154 will have a material impact on its financial statements.
In March 2005, the FASB issued FASB Interpretation (FIN) No. 47, Accounting for
Conditional Asset Retirement Obligations - An Interpretation of SFAS No. 143.
The FASB issued FIN 47 to address diverse accounting practices that developed
with respect to the timing of liability recognition for legal obligations
associated with the retirement of a tangible long-lived asset when the timing
and (or ) method of settlement of the obligation are conditional on a future
event. FIN 47 concludes that an entity is required to recognize a liability for
the fair value of a conditional asset retirement obligation when incurred if the
liability's fair value can be reasonably estimated. FIN 47 is effective for the
Company no later than June 30, 2006. The Company is in the process of evaluating
what impact, if any, the adoption of FIN 47 will have on its financial
statements.
On October 22, 2004, the President of the United States signed the American Jobs
Creation Act of 2004. This law 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. The deduction is subject to a number of limitations, and the FASB
issued two Staff Positions to provide guidance on how companies should account
for the effects of the American Jobs Creation Act. The Company is currently
evaluating whether to repatriate any extraordinary dividends.
(15) SEGMENT INFORMATION
The Company's three continuing reportable segments, organized by product, are as
follows:
o Health Sciences - includes the active ingredients for generic
pharmaceuticals, vitamins, and nutritional supplements, as well
as products used in preparing pharmaceuticals, primarily by
major innovative drug companies, and biopharmaceuticals.
o Chemicals & Colorants - products include a variety of specialty
chemicals used in plastics, resins, adhesives, coatings, food,
flavor additives, fragrances, cosmetics, metal finishing,
electronics, air-conditioning systems and many other areas; dye
and pigment intermediates used in the color-producing industries
like textiles, inks, paper, and coatings; intermediates used in
the production of agrochemicals.
o Agrochemicals - products include herbicides, fungicides and
insecticides, as well as a sprout inhibitor for potatoes.
14
ACETO CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited and in thousands, except per-share amounts)
The Institutional Sanitary Supplies segment reported in prior years, which
included cleaning solutions, fragrances and deodorants for commercial and
industrial customers, was successfully divested from the Company's ongoing
business. During June 2005, the Company entered into an agreement to sell the
majority of the product lines formulated and marketed by CDC, which was one of
the two subsidiaries forming the Institutional Sanitary Supplies segment. The
sale of certain product lines of CDC was completed on August 24, 2005. Excluded
from the sale of CDC's product lines was Anti-Clog, an EPA-registered biocide
that has a unique delivery system and is used in commercial air-conditioning
systems. As a result of management's decision to retain the Anti-Clog product,
the Company has reclassified all of CDC's operating results previously reported
as "discontinued operations" for the period ended March 31, 2005 to "continuing
operations" in the consolidated statements of income for the three and nine
month periods ended March 31, 2006 and 2005. Commencing July 1, 2005, the
operating results of CDC, which consist primarily of Anti-Clog sales, are
included in the Chemicals & Colorants segment. On September 6, 2005, the Company
completed the sale of certain assets of Magnum Research Corp., the remaining
subsidiary of the former Institutional Sanitary Supplies segment, the operating
results of which are included in discontinued operations in the consolidated
statements of income.
Nine months ended March 31, 2006 and 2005:
INSTITUTIONAL
HEALTH CHEMICALS & SANITARY CONSOLIDATED
SCIENCES COLORANTS AGROCHEMICALS SUPPLIES TOTALS
-------- --------- ------------- -------- ------
2006
- ----
Net sales $ 127,451 $ 83,140 $ 14,715 -- $ 225,306
Gross profit 24,431 12,610 3,453 -- 40,494
Unallocated cost of sales (1) (3,079)
---------
Net gross profit $ 37,415
2005
- ----
Net sales $ 146,545 $ 75,285 $ 14,915 $ 2,954 $ 239,699
Gross profit 26,385 12,313 5,056 346 44,100
Unallocated cost of sales (1) (3,054)
---------
Net gross profit $ 41,046
Three months ended March 31, 2006 and 2005:
INSTITUTIONAL
HEALTH CHEMICALS & SANITARY CONSOLIDATED
SCIENCES COLORANTS AGROCHEMICALS SUPPLIES TOTALS
-------- --------- ------------- -------- ------
2006
- ----
Net sales $ 44,719 $ 31,261 $ 4,866 -- $ 80,846
Gross profit 8,166 4,517 1,515 -- 14,198
Unallocated cost of sales (1) (754)
---------
Net gross profit $ 13,444
2005
- ----
Net sales $ 48,923 $ 26,737 $ 5,918 $ 934 $ 82,512
Gross profit 8,712 4,396 2,265 13 15,386
Unallocated cost of sales (1) (1,137)
---------
Net gross profit $ 14,249
(1) Certain freight and storage costs are not allocated to the segments as such
costs are managed on an entity-wide basis, and the information to reasonably
allocate such costs is not readily available.
15
ACETO CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited and in thousands, except per-share amounts)
The Company does not allocate assets by segment. The Company's chief operating
decision maker evaluates performance of the segments based on net sales and
gross profit. The Company does not allocate assets by segment because the chief
operating decision maker does not review the assets by segment to assess the
segments' performance, as the assets are managed on an entity-wide basis.
Net sales and gross profit by location for the nine months ended March 31, 2006
and 2005 and long-lived assets by location as of March 31, 2006 and June 30,
2005 were as follows:
NET SALES GROSS PROFIT LONG-LIVED ASSETS
--------- ------------ -----------------
Nine months ended Nine months ended As of
March 31, March 31, March 31, June30,
2006 2005 2006 2005 2006 2005
-------- -------- -------- -------- -------- --------
United States $140,339 $135,910 $ 21,442 $ 21,666 $ 1,454 $ 1,469
Germany 42,784 49,381 9,796 10,201 421 509
Netherlands 7,760 6,194 1,350 1,383 220 285
France 11,743 9,291 1,369 1,318 87 90
Asia-Pacific 22,680 38,923 3,458 6,478 3,055 3,190
-------- -------- -------- -------- -------- --------
Total $225,306 $239,699 $ 37,415 $ 41,046 $ 5,237 $ 5,543
======== ======== ======== ======== ======== ========
16
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Aceto Corporation
We have reviewed the consolidated balance sheet of Aceto Corporation and
subsidiaries as of March 31, 2006, and the related consolidated statements of
income for the three-month and nine-month periods ended March 31, 2006, and the
related consolidated statement of cash flows for the nine-month period ended
March 31, 2006 included in the accompanying Securities and Exchange Commission
Form 10-Q for the period ended March 31, 2006. These interim financial
statements are the responsibility of the Company's management.
We conducted our review in accordance with the standards of the Public Company
Accounting Oversight Board (United States). A review of interim financial
information consists principally of applying analytical procedures and making
inquiries of persons responsible for financial and accounting matters. It is
substantially less in scope than an audit conducted in accordance with the
standards of the Public Company Accounting Oversight Board, the objective of
which is the expression of an opinion regarding the financial statements taken
as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the consolidated financial statements referred to above for them to
be in conformity with accounting principles generally accepted in the United
States of America.
The consolidated balance sheet of Aceto Corporation and subsidiaries as of June
30, 2005, and the related consolidated statements of income, shareholders'
equity and comprehensive income (loss), and cash flows for the year then ended
(not presented herein) have been previously audited by other independent public
accountants, in accordance with the standards of the Public Company Accounting
Oversight Board; and in their report dated September 8, 2005, they expressed an
unqualified opinion on those consolidated financial statements.
/s/ BDO Seidman, LLP
Melville, New York
May 3, 2006
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CAUTIONARY STATEMENT RELATING TO THE SAFE HARBOR PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995
This Quarterly Report on Form 10-Q and the information incorporated by reference
includes "forward-looking statements" within the meaning of section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
We intend those forward looking-statements to be covered by the safe harbor
provisions for forward-looking statements. All statements regarding our expected
financial position and operating results, our business strategy, our financing
plans and the outcome of any contingencies are forward-looking statements. Any
such forward-looking statements are based on current expectations, estimates and
projections about our industry and our business. Words such as "anticipates,"
"expects," "intends," "plans," "believes," "seeks," "estimates," or variations
of those words and similar expressions are intended to identify such
forward-looking statements. Forward-looking statements are subject to risks and
uncertainties that could cause actual results to differ materially from those
set forth or implied by any forward-looking statements. Factors that could cause
actual results to differ materially from forward-looking statements include, but
are not limited to, unforeseen environmental liabilities, uncertain military
actions in the world, the mix of products sold and their profit margins, order
cancellation or a reduction in orders from customers, the nature and pricing of
competing products, the availability and pricing of key raw materials,
dependence on key members of management, risks of entering into new European
markets, continued successful integration of acquisitions, and economic and
political conditions in the United States and abroad.
NOTE REGARDING DOLLAR AMOUNTS
In this quarterly report, all dollar amounts are expressed in thousands, except
for share prices and per-share amounts.
EXECUTIVE SUMMARY
We are reporting net sales of $225,306 for the nine months ended March 31, 2006,
which represents a 6.0% decrease from the $239,699 reported in the comparable
prior period. Our income from continuing operations of $6,299, or $0.26 per
diluted share was $1,489 lower than the comparable prior period. As discussed in
prior quarterly and annual reports, this decrease is directly attributable to
the loss of business on two previously launched API's.
Our financial position as of March 31, 2006 remains strong, as we had cash of
$21,875, working capital of $101,840, no long-term debt, and shareholders'
equity of $112,364.
Our business is separated into three principal segments: Health Sciences,
Chemicals & Colorants and Agrochemicals.
The Health Sciences segment is our largest segment in terms of both sales and
gross profits. This segment is comprised of APIs, pharmaceutical intermediates,
diagnostic chemicals and nutritional supplements. APIs comprise about 65% of
this segment's revenues.
We have a pipeline of new generic products that we expect will reach commercial
levels over the coming years as the patents on existing drugs expire, both in
the United States and Europe. We typically partner with both customers and
suppliers years in advance of a drug coming off patent to provide the generic
equivalent. In addition, as new members join the European Union, primarily from
Eastern Europe, they become subject to the same regulatory standards as their
Western Europe counterparts. Given our regulatory experience, we believe this
represents an opportunity for us, and we believe we are well positioned to take
advantage of that opportunity.
The Chemicals & Colorants segment supplies chemicals used in the color-producing
industries such as textiles, ink, paper and coatings, as well as chemicals used
in plastic, resins, adhesives, coatings, food, flavor additives,
air-conditioning systems and the production of agrochemicals. Our sales of these
products are predominantly in the United States and purchases are primarily from
China and Western Europe.
18
The Agrochemicals segment sells herbicides, pesticides, and other agrochemicals,
primarily in the United States and Western Europe. We expect that our joint
venture with Nufarm, which markets Butoxone(R) will increase our market share of
the peanut, soybean and alfalfa herbicide markets.
We formerly also reported under the Institutional Sanitary Supplies segment,
which included cleaning solutions, fragrances and deodorants for commercial and
industrial customers. This segment was successfully divested from our ongoing
business. Specifically, during June 2005, we entered into an agreement to sell
the majority of the product lines formulated and marketed by CDC Products Corp.
("CDC"), which was one of the two subsidiaries forming the Institutional
Sanitary Supplies segment. The sale of certain product lines of CDC was
completed on August 24, 2005. Excluded from the sale of CDC's product lines was
Anti-Clog, an EPA-registered biocide that has a unique delivery system and is
used in commercial air-conditioning systems. As a result of management's
decision to retain the Anti-Clog product, the Company has reclassified all of
CDC's operating results previously reported as "discontinued operations" for the
period ended December 31, 2004 to "continuing operations" in the consolidated
statements of income for the three and six month periods ended December 31, 2005
and 2004. Commencing July 1, 2005, the operating results of CDC, which consist
primarily of Anti-Clog sales, are included in the Chemicals & Colorants segment.
On September 6, 2005, we completed the sale of certain assets of Magnum Research
Corp., the remaining subsidiary forming part of the Institutional Sanitary
Supplies segment, the operating results of which are included in discontinued
operations in the consolidated statements of income. In December 2005, the
Company exited the leased space previously occupied by CDC and Magnum Research
Corp. As a result, the Company recorded a pre-tax charge of $378, which was
further increased by $92 in March 2006 and included in selling, general and
administrative expenses, representing the present value of the remaining lease
obligation reduced by estimated sub-lease rental income over the remaining lease
term, which expires in December 2009.
Our main business strengths are sourcing, regulatory support and quality
control. We believe that we are currently the largest buyer of pharmaceutical
and specialty chemicals for export from China, purchasing from over 500
different factories.
In this Management's Discussion and Analysis section, we explain our general
financial condition and results of operations, including the following:
o factors that affect our business
o our earnings and costs in the periods presented
o changes in earnings and costs between periods
o sources of earnings
o the impact of these factors on our overall financial condition
When you read this Management's Discussion and Analysis section, you should
refer to the accompanying consolidated statements of income, which present the
results of our operations for the three and nine month periods ended March 31,
2006 and 2005. We analyze and explain the differences between periods in the
specific line items of the consolidated statements of income.
CRITICAL ACCOUNTING ESTIMATES AND POLICIES
As disclosed in our Form 10-K for the year ended June 30, 2005, the discussion
and analysis of our financial condition and results of operations is based on
our consolidated financial statements, which have been prepared in accordance
with U.S. generally accepted accounting principles. In preparing these financial
statements, we were required to make estimates and assumptions that affect the
amounts of assets, liabilities, revenues and expenses, and related disclosure of
contingent assets and liabilities. We regularly evaluate our estimates including
those related to allowances for bad debts, inventories, goodwill and intangible
assets, environmental and other contingencies, and income taxes. We base our
estimates on various factors, including historical experience, advice from
outside subject-matter experts, and various assumptions that we believe to be
reasonable under the circumstances, which together form the basis for our making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates.
Since June 30, 2005, there have been no significant changes to the assumptions
and estimates related to those critical accounting estimates and policies.
19
RESULTS OF OPERATIONS
NINE MONTHS ENDED MARCH 31, 2006 COMPARED TO NINE MONTHS ENDED MARCH 31, 2005
NET SALES BY SEGMENT
Nine months ended March 31,
Comparison 2006
2006 2005 Over/(under) 2005
---------------- --------------------- -----------------
% of % of $ %
Segment Net Sales Total Net Sales Total Change Change
- ------ -------- ----- --------- ----- ------ ------
Health Sciences $127,451 56.6% $146,545 61.1% $(19,094) (13.0)%
Chemicals & Colorants 83,140 36.9 75,285 31.4 7,855 10.4
Agrochemicals 14,715 6.5 14,915 6.2 (200) (1.3)
Institutional Sanitary
Supplies -- -- 2,954 1.3 (2,954) (100.0)
-------- ----- -------- ---- -------- -----
Net sales $225,306 100.0% $239,699 100.0% $(14,393) (6.0)%
======== ===== ======== ===== ======== =====
GROSS PROFIT BY SEGMENT
Nine months ended March 31,
Comparison 2006
2006 2005 Over/(under) 2005
---------------- --------------------- -----------------------
Gross % of Gross % of $ %
Segment Profit Sales Profit Sales Change Change
- ------- ------ ----- ------ ----- -------- -------
Health Sciences $ 24,431 19.2 $ 26,385 18.0% $ (1,954) (7.4)%
Chemicals & Colorants 12,610 15.2 12,313 16.4 297 2.4
Agrochemicals 3,453 23.5 5,056 33.9 (1,603) (31.7)
Institutional Sanitary
Supplies -- -- 346 11.7 (346) (100.0)
-------- ----- -------- ---- -------- -----
Segment gross profit 40,494 18.0 44,100 18.4 (3,606) (8.2)
Freight and storage costs (1) (3,079) (1.4) (3,054) (1.3) (25) (0.8)
Gross profit $ 37,415 16.6% $ 41,046 17.1% $ (3,631) (8.8)%
======== ====== ======== ===== ======== =====
(1) Represents certain freight and storage costs that are not allocated to
a segment.
20
NET SALES
Net sales decreased $14,393, or 6.0%, to $225,306 for the nine months ended
March 31, 2006, compared with $239,699 for the comparable prior period. We
reported sales decreases in our Health Sciences and Agrochemicals segments
during this period, which was partially offset by a sales increase in our
Chemicals & Colorants segment.
HEALTH SCIENCES
Net sales for the Health Sciences segment decreased by $19,094 for the nine
months ended March 31, 2006, to $127,451, which represents a 13.0% decrease from
net sales of $146,545 for the prior period. The sales decrease from the prior
period is directly attributable to the loss of foreign business of $16,426 from
two previously launched APIs due to increased competition. The nine month
results, net of the two lost APIs, include a sales reduction of $4,040 from our
foreign operations which was partially offset by a sales increase of $1,369 from
our domestic operations over the prior comparable period.
CHEMICALS & COLORANTS
Net sales for the Chemicals & Colorants segment were $83,140 for the nine months
ended March 31, 2006, compared to $75,285 for the prior period. This increase of
$7,855, or 10.4%, over the prior period is primarily attributable to an increase
in the agricultural intermediate, food, beverage and cosmetics and coatings
product groups of $7,581 over the comparable period last year. Our chemical
business is diverse in terms of products, customers and consuming markets. One
customer within our color-pigment and pigment-intermediate business purchased
$2,679 less product during the nine months ended March 31, 2006 as their
contract had expired. This reduction was more than offset by an increase over
the prior period in domestic sales of our diverse chemical and colorants
offerings. In addition, the segment net sales includes a $1,375 increase
relating to our former CDC business, primarily from sales of the Anti-Clog
product we retained.
AGROCHEMICALS
Net sales for the Agrochemical segment remained relatively consistent at $14,715
for the nine months ended March 31, 2006, as compared to $14,915 for the prior
period, or a slight decrease of $200 or 1.3%.
GROSS PROFIT
Gross profit by segment before unallocated cost of sales (primarily storage and
certain freight costs) decreased $3,606 to $40,494 (18.0% of net sales) for the
nine months ended March 31, 2006, as compared to $44,100 (18.4% of net sales)
for the prior period.
HEALTH SCIENCES
Health Sciences' gross profit of $24,431 for the nine months ended March 31,
2006, was $1,954 or 7.4% lower than the prior period. This decrease in gross
profit was directly attributable to the loss of business on two larger
previously-launched APIs in Asia of $2,293 due to significant competitive
pressures. This lost gross profit was partially offset by an increase in gross
profit from sales increases from our domestic business of $836 over the prior
period. The gross margin increased to 19.2% compared to a gross margin of 18.0%
for the prior period due primarily to a shift in the product mix of net sales to
higher margin products during the nine months ended March 31, 2006.
CHEMICALS & COLORANTS
Gross profit for the nine months ended March 31, 2006, increased by $297, or
2.4%, over the prior period. The gross margin percentage was 15.2% for the
period compared to 16.4% for the prior period due to a shift in product mix to
slightly lower margin products.
21
AGROCHEMICALS
Gross profit for the Agrochemicals segment decreased to $3,453 for the nine
months ended March 31, 2006, versus $5,056 for the prior period, a decrease of
$1,603 or 31.7%. Gross margin for the period was 23.5% compared to the prior
period gross margin of 33.9%. The decrease in gross profit was primarily due to
lower royalty payments from our foreign customers of $495 compared to last year,
higher costs associated with maintaining our EPA registered products of $196 and
increased rebate expenses of $227. In addition, we experienced higher costs of
goods for our largest selling products of $139. We believe our gross margin for
the balance of the fiscal year will be more in line with historical levels.
Unallocated cost of sales remained stable at $3,079 for the nine months ended
March 31, 2006 compared to $3,054 in the prior period, a slight increase of $25
which represents a less than 1% increase.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses ("SG&A") decreased $1,625, or 5.2%
to $29,380 for the nine months ended March 31, 2006 compared to $31,005 for the
prior period. As a percentage of sales, SG&A was basically stable at 13.0% for
the nine months ended March 31, 2006 versus 12.9% for the prior period. The
decrease in SG&A expenses was primarily due to an $823 decrease in expenses for
our former CDC business, reduced legal fees of $396, a reduction in audit and
Sarbanes-Oxley compliance costs of $386 and reduced sales and marketing related
expenses of $457. These expense reductions were partially offset by a $537
charge for a settlement of legal claims against one of our subsidiaries.
OPERATING INCOME
For the nine months ended March 31, 2006, operating income was $8,035 compared
to $10,041 in the prior period, a decrease of $2,006 or 20.0%. This decrease was
due to the overall decrease in gross profit of $3,631 partially offset by the
$1,625 decrease in SG&A expenses.
INTEREST AND OTHER INCOME (EXPENSE)
Interest and other income (expense) was $1,170 for the nine months ended March
31, 2006, which represents an increase of $222 over the prior period. The
increase is primarily attributable to an increase of $103 regarding a government
subsidy paid annually for doing business in a free trade zone in Shanghai,
China, proceeds from credit insurance of $211, sale of distribution rights for a
particular product in certain European countries of $133 and proceeds from the
sale of certain task force data of $55, partially offset by a net loss on
foreign currency of $224.
PROVISION FOR INCOME TAXES
The effective tax rate for the nine months ended March 31, 2006 increased to
31.0% from 28.4% for the prior period. The increase in the effective tax rate
was primarily due to increased earnings in foreign tax jurisdictions with higher
tax rates, primarily Germany, and reduced earnings in foreign tax jurisdictions
with lower tax rates, primarily Shanghai.
DISCONTINUED OPERATIONS
The net loss from discontinued operations was $27 and $565 for the nine months
ended March 31, 2006 and 2005, respectively. The net loss from discontinued
operations for the nine months ended March 31, 2005 includes a non-cash
write-down of goodwill of $516, net of taxes of $317.
22
THREE MONTHS ENDED MARCH 31, 2006 COMPARED TO THREE MONTHS ENDED MARCH 31, 2005
NET SALES BY SEGMENT
Three months ended March 31,
Comparison 2006
2006 2005 Over/(under) 2005
---------------------- ----------------------- ------------------------
% of % of $ %
Segment Net Sales Total Net Sales Total Change Change
- ------- --------- ----- --------- ----- ------ ------
Health Sciences $44,719 55.3% $48,923 59.3% $(4,204) (8.6)%
Chemicals & Colorants 31,261 38.7 26,737 32.4 4,524 16.9
Agrochemicals 4,866 6.0 5,918 7.2 (1,052) (17.8)
Institutional Sanitary
Supplies -- -- 934 1.1 (934) (100.0)
------- ------- ------- ------- ------- -----
Net sales $80,846 100.0% $82,512 100.0% $(1,666) (2.0)%
======= ======= ======= ======= ======= =====
GROSS PROFIT BY SEGMENT
Three months ended March 31,
Comparison 2006
2006 2005 Over/(under) 2005
-------------------- -------------------- ----------------------
Gross % of Gross % of $ %
Segment Profit Sales Profit Sales Change Change
- ------- ------ ----- ------ ----- ------ ------
Health Sciences $ 8,166 18.3% $ 8,712 17.8% $ (546) (6.3)%
Chemicals & Colorants 4,517 14.4 4,396 16.4 121 2.8
Agrochemicals 1,515 31.1 2,265 38.3 (750) (33.1)
Institutional Sanitary
Supplies -- -- 13 1.4 (13) (100.0)
------- ------- ------- ------- ------- ------
Segment gross profit 14,198 17.6 15,386 18.7 (1,188) (7.7)%
Freight and storage costs (1) (754) (1.0) (1,137) (1.4) 383 (33.7)%
------- ------- ------- ------- ------- ------
Gross profit $13,444 16.6% $14,249 17.3% $ (805) (5.6)%
======= ======= ======= ======= ======= =====
(1) Represents certain freight and storage costs that are not allocated to
a segment.
23
NET SALES
Net sales decreased $1,666 or 2.0%, to $80,846 for the three months ended March
31, 2006, compared with $82,512 for the comparable prior period. We reported
sales decreases in our Health Sciences and Agrochemicals segments partially
offset by a sales increase in our Chemicals & Colorants, as explained below.
HEALTH SCIENCES
Net sales for the Health Sciences segment decreased by $4,204 for the three
months ended March 31, 2006, to $44,719, which represents an 8.6% decrease from
net sales of $48,923 for the prior period. The sales decrease from the prior
period is primarily attributable to the loss of foreign business of $3,738 due
principally to increased competition in the API business. Additionally, net
sales from our domestic operations decreased $466 from the prior period.
CHEMICALS & COLORANTS
Net sales for the Chemicals & Colorants segment were $31,261 for the three
months ended March 31, 2006, compared to $26,737 for the prior period. This
increase of $4,524, or 16.9%, over the prior period is primarily attributable to
an increase in the agricultural intermediate, food, beverage and cosmetics and
coatings product groups of $3,961. Sales of Chemicals & Colorants products by
our foreign subsidiaries for the three months ended March 31, 2006, showed an
increase of $1,384 over the prior period. Our chemical business is diverse in
terms of products, customers and consuming markets. One customer within our
color-pigment and pigment-intermediate business purchased $957 less product
during the three months ended March 31, 2006 due to the expiration of their
contract. This reduction was more than offset by the increase over the prior
period in domestic sales of our chemical and colorants offerings. In addition,
net sales includes a $288 increase due to the inclusion of Anti-Clog sales in
this segment.
AGROCHEMICALS
Net sales for the Agrochemicals segment decreased to $4,866 for the three months
ended March 31, 2006, a decrease of $1,052, or 17.8%, from net sales of $5,918
for the prior period. The decrease in net sales was primarily attributable to
lower royalty income from our foreign customers. In addition, our domestic sales
for the quarter declined over the prior period due to dry weather conditions
causing the agricultural selling season, for our second largest product, to
start later than last year.
GROSS PROFIT
Gross profit by segment before unallocated cost of sales (primarily storage and
certain freight costs) decreased $1,188 to $14,198 (17.6% of net sales) for the
three months ended March 31, 2006, as compared to $15,386 (18.7% of net sales)
for the prior period.
HEALTH SCIENCES
Health Sciences' gross profit of $8,166 for the three months ended March 31,
2006, was $546 or 6.3% lower than the prior period. This decrease in gross
profit was primarily attributed to the loss of foreign business of $808 due
principally to significant competitive pressures. This lost gross profit was
partially offset by an increase in gross profit from our domestic operations of
$262.
CHEMICALS & COLORANTS
Gross profit for the three months ended March 31, 2006 increased $121, or 2.8%,
over the prior period. The gross margin percentage was 14.4% for the period
compared to 16.4% for the prior period. This decrease was due to increasing
costs and a shift in product mix to slightly lower margin products.
24
AGROCHEMICALS
Gross profit for the Agrochemicals segment decreased to $1,515 for the three
months ended March 31, 2006, versus $2,265 for the prior period, a decrease of
$750 or 33.1%. Gross margin for the period was 31.1% compared to the prior
period gross margin of 38.3%. The primary cause of the decrease in gross profit
was lower royalty payments from our foreign customers of $217 and lower gross
margins on our second highest volume product compared to the prior period of
$145. The gross profits and margins were also negatively affected by higher
costs associated with maintaining our EPA registered products and increased
rebate expenses.
Unallocated cost of sales decreased $383, to $754 for the three months ended
March 31, 2006 compared to $1,137 in the prior period, representing a $383 or
33.7% decrease.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses ("SG&A") decreased $2,025, or
17.8%, to $9,361 for the three months ended March 31, 2006 compared to $11,386
for the prior period. As a percentage of sales, SG&A was 11.6% for the three
months ended March 31, 2006 versus 13.8% for the prior period. The decrease in
SG&A expenses was primarily due to a $1,003 decrease in expenses for our former
CDC business, reduced legal fees of $333, and a reduction in audit and
Sarbanes-Oxley compliance costs of $520.
OPERATING INCOME
For the three months ended March 31, 2006, operating income was $4,083 compared
to $2,863 in the prior period, an increase of $1,220 or 42.6%. This increase was
due to the overall decrease in SG&A expenses of $2,025 partially offset by an
$805 decrease in gross profit.
PROVISION FOR INCOME TAXES
The effective tax rate for the three months ended March 31, 2006 was 32.2% as
compared to 29.6% for the prior period.
DISCONTINUED OPERATIONS
The net loss from discontinued operations was $133 for the three months ended
March 31, 2005. The net loss from discontinued operations for the three months
ended March 31, 2005 includes a non-cash write-down of goodwill of $68, net of
taxes of $42.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOWS
At March 31, 2006, we had $21,875 in cash, $3,276 in short-term investments and
no long-term debt.
Our cash position at March 31, 2006 increased $1,925 from the June 30, 2005
level. Operating activities provided cash of $2,691, primarily from net income
of $6,272, partially offset by a net decrease caused by changes in assets and
liabilities.
Investing activities for the nine months ended March 31, 2006 provided cash of
$1,467 primarily related to the sale of certain short term investments.
Financing activities for the nine months ended March 31, 2006 used cash of
$2,250 primarily as a result of payments of dividends of $1,816 and treasury
stock purchases of $581.
25
CREDIT FACILITIES
We have credit facilities with certain foreign financial institutions. These
facilities provide us with a line of credit of $17,819, which was not utilized
as of March 31, 2006. We are not subject to any financial covenants under these
arrangements.
We have a revolving credit facility with a domestic financial institution which
expires June 30, 2007 and provides for available credit of $10,000. At March 31,
2006, we had utilized $821 in letters of credit, leaving $9,179 of this facility
unused. Under the credit agreement, we may obtain credit through direct
borrowings and letters of credit. Our obligations under the credit agreement are
guaranteed by certain of our subsidiaries and are secured by 65% of the capital
of certain of our non-domestic subsidiaries. There is no borrowing base on the
credit agreement. Interest under the credit agreement is at LIBOR plus 1.50%.
The credit agreement contains several covenants requiring, among other things,
minimum levels of debt service and tangible net worth. We are also subject to
certain restrictive debt covenants, including covenants governing liens,
limitations on indebtedness, limitations on cash dividends, guarantees, sale of
assets, sales of receivables, and loans and investments. We were in compliance
with all covenants at March 31, 2006.
WORKING CAPITAL OUTLOOK
Working capital was $101,840 at March 31, 2006 versus $94,249 at June 30, 2005.
The increase in working capital was attributable to various factors including
net income during the period. We continually evaluate possible acquisitions of
or investments in businesses that are complementary to our own, and such
transactions may require the use of cash. We believe that our cash, other liquid
assets, operating cash flows, borrowing capacity and access to the equity
capital markets, taken together, provide adequate resources to fund ongoing
operating expenditures and the anticipated continuation of semi-annual cash
dividends. Further, we may obtain additional credit facilities to enhance our
liquidity.
26
OFF-BALANCE SHEET ARRANGEMENTS AND COMMITMENTS AND CONTINGENCIES
We have no material financial commitments other than those under operating lease
agreements, letters of credit and unconditional purchase obligations. We have
certain contractual cash obligations and other commercial commitments which will
impact our short-term and long-term liquidity. At March 31, 2006, we had no
significant obligations for capital expenditures. At March 31, 2006, contractual
cash obligations and other commercial commitments were as follows:
PAYMENTS DUE AND/OR
AMOUNT OF COMMITMENT
EXPIRATION PER PERIOD
Less Than 1-3 4-5 After 5
Total 1 Year Years Years Years
------- ------- ------- ------- -------
Operating leases $ 7,382 $ 1,743 $ 3,168 $ 2,324 $ 147
Commercial letters of credit 821 821
Standby letters of credit 184 184
Unconditional purchase
obligations 53,887 53,350 537 -- --
------- ------- ------- ------- -------
Total $62,274 $56,098 $ 3,705 $ 2,324 $ 147
======= ======= ======= ======= =======
Other significant commitments and contingencies included the following:
1. Our non-qualified deferred compensation plans are intended to provide
certain executives with supplemental retirement benefits beyond our
401(k) plan, as well as to permit additional deferral of a portion of
their compensation. All compensation deferred under the plans is held
by us in a grantor trust, which is considered our asset. We had a
liability under the plan, included in long-term liabilities, of $2,720,
and the assets held by the grantor trust, included in other assets,
amounted to $2,410 as of March 31, 2006.
2. One of our subsidiaries markets certain agricultural chemicals which
are subject to the Federal Insecticide, Fungicide and Rodenticide Act
("FIFRA"). FIFRA requires that test data be provided to the
Environmental Protection Agency ("EPA") to register, obtain and
maintain approved labels for pesticide products. The EPA requires that
follow-on registrants of these products compensate the initial
registrant for the cost of producing the necessary test data on a basis
prescribed in the FIFRA regulations. Follow-on registrants do not
themselves generate or contract for the data. However, when FIFRA
requirements mandate that new test data be generated to enable all
registrants to continue marketing a pesticide product, often both the
initial and follow-on registrants establish a task force to jointly
undertake the testing effort. We are presently a member of two such
task force groups and historically, our payments have been in the range
of $250 - $500 per year. We may be required to make additional payments
in the future.
3. We, together with our subsidiaries, are subject to pending and
threatened legal proceedings that have arisen in the normal course of
business. We do not know how the final resolution of these matters will
affect our results of operations in a particular reporting period. Our
management is of the opinion, however, that the ultimate outcome of
such matters will not have a material adverse effect upon our financial
condition or liquidity.
One of our subsidiaries was a defendant in a legal action alleging
patent infringement. The patent in question covered a particular method
of applying one of the products in our Agrochemicals segment. In
September 2005, shortly before a trial was expected to begin, the
parties agreed to a settlement.
27
Under the terms of the settlement agreement, we are required to make
payments totaling $750 over the next five years.
RELATED PARTY TRANSACTIONS
Certain of our directors are affiliated with law firms which serve as our
counsel on various corporate matters. During the three months ended March 31,
2006 and 2005, we incurred legal fees of $89 and $76, respectively, for services
rendered to us by these law firms. The fees charged by such firms were at rates
comparable to rates obtainable from other firms for similar services.
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
In June 2005, the Financial Accounting Standards Board ("FASB") issued SFAS No.
154, "Accounting Changes and Error Corrections", a replacement of APB Opinion
No. 20, Accounting Changes, and FASB SFAS No. 3, Reporting Accounting Changes in
Interim Financial Statements. SFAS No. 154 applies to all voluntary changes in
accounting principles and changes the requirements for accounting for and
reporting of a change in accounting principle. SFAS No. 154 requires
retrospective application to prior periods' financial statements of a voluntary
change in accounting principle unless it is impracticable. SFAS No. 154 also
requires that a change in method of depreciation, amortization, or depletion for
long-lived, non-financial assets be accounted for as a change in accounting
estimate that is affected by a change in accounting principle. SFAS No. 154 is
effective for accounting changes and corrections of errors made in fiscal years
beginning after December 15, 2005. Earlier application is permitted for
accounting changes and corrections of errors occurring in fiscal years beginning
after June 1, 2005. SFAS No. 154 does not change the transition provisions of
any existing accounting pronouncements, including those that are in a transition
phase as of the date of SFAS No. 154. We do not believe that adoption of SFAS
No. 154 will have a material impact on our financial statements.
In March 2005, the FASB issued FASB Interpretation (FIN) No. 47, Accounting for
Conditional Asset Retirement Obligations - An Interpretation of SFAS No. 143.
The FASB issued FIN 47 to address diverse accounting practices that developed
with respect to the timing of liability recognition for legal obligations
associated with the retirement of a tangible long-lived asset when the timing
and (or ) method of settlement of the obligation are conditional on a future
event. FIN 47 concludes that an entity is required to recognize a liability for
the fair value of a conditional asset retirement obligation when incurred if the
liability's fair value can be reasonably estimated. FIN 47 is effective for the
Company no later than June 30, 2006. The Company is in the process of evaluating
what impact, if any, the adoption of FIN 47 will have on its financial
statements.
On October 22, 2004, the President of the United States signed the American Jobs
Creation Act of 2004. This law 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. The deduction is subject to a number of limitations, and the FASB
issued two Staff Positions to provide guidance on how companies should account
for the effects of the American Jobs Creation Act. The Company is currently
evaluating whether to repatriate any extraordinary dividends.
RISK FACTORS
You should carefully consider the following risk factors and other information
included in this Quarterly Report. The risks and uncertainties described below
are not the only ones we face. Additionally, risks and uncertainties not
currently known to us or that we currently deem immaterial also may impair our
business operations. If any of the following risk factors occur, our business,
financial condition, operating results and cash flows could be materially
adversely affected.
IF WE ARE UNABLE TO COMPETE EFFECTIVELY WITH OUR COMPETITORS, MANY OF WHICH HAVE
GREATER MARKET PRESENCE AND RESOURCES THAN US, OUR PROFITABILITY AND FINANCIAL
CONDITION WILL BE ADVERSELY AFFECTED.
Our financial condition and operating results are directly related to our
ability to compete in the intensely competitive worldwide chemical market. We
face intense competition from global and regional distributors of
28
chemical products, many of which are large chemical manufacturers as well as
distributors. Many of these companies have substantially greater resources than
us, including greater financial, marketing and distribution resources. We cannot
assure you that we will be able to compete successfully with any of these
companies. In addition, increased competition could result in price reductions,
reduced margins and loss of market share for our services, all of which would
adversely affect our business, results of operations and financial condition.
WE MAY INCUR SIGNIFICANT UNINSURED ENVIRONMENTAL AND OTHER LIABILITIES INHERENT
IN THE CHEMICAL DISTRIBUTION INDUSTRY THAT WOULD HAVE A NEGATIVE EFFECT ON OUR
FINANCIAL CONDITION.
The business of distributing chemicals is subject to regulation by numerous
federal, state, local, and foreign governmental authorities. These regulations
impose liability for loss of life, damage to property and equipment, pollution
and other environmental damage that may occur in our business. Many of these
regulations provide for substantial fines and remediation costs in the event of
chemical spills, explosions and pollution. While we believe that we are in
substantial compliance with all current laws and regulations, we can give no
assurance that we will not incur material liabilities that exceed our insurance
coverage or that such insurance will remain available on terms and at rates
acceptable to us. Additionally, if existing environmental and other regulations
are changed, or additional laws or regulations are passed, the cost of complying
with those laws may be substantial, thereby adversely affecting our financial
performance.
We currently have environmental remediation obligations in connection with our
former manufacturing facility in Carlstadt, New Jersey. Estimates of how much it
would cost to remediate environmental contamination at this site have increased
since the facility was closed in 1993, and our environmental consultants
estimated in June 2003 that completing remediation would cost between $1,550 and
$3,200. There have been no significant changes to the estimate of remediation
costs since fiscal 2003. If the actual costs are significantly greater than
estimated, it could have a material adverse effect on our financial condition,
operating results and cash flows.
In March 2006, one of our subsidiaries received notice from the Environmental
Protection Agency (EPA) of its status as a potentially responsible party ("PRP")
under the Comprehensive Environmental Response, Compensation and Liability Act
(CERCLA) for a site described as the Berry's Creek Study Area. Our subsidiary is
one of over 150 PRP's which have potential liability for the required
investigation and remediation of the site. The estimate of our potential
liability is difficult to quantify for a number of reasons, including the
difficulty in determining the extent of contamination and the length of time
remediation may require. In addition, any estimate of our liability must also
consider the number of other potentially responsible parties and their financial
strength. Since an amount of our liability can not be reasonably estimated at
this time, no accrual is recorded for these future costs. The impact of the
resolution of this matter on our results of operations in a particular reporting
period is not known. However, we believe, although can not assure you, that the
ultimate outcome of this matter will not have a material adverse effect on our
financial condition or liquidity.
ASSESSMENTS BY VARIOUS TAX AUTHORITIES MAY BE MATERIALLY DIFFERENT THAN THE
AMOUNTS WE HAVE PROVIDED FOR IN OUR CONSOLIDATED FINANCIAL STATEMENTS.
We are regularly audited by federal, state, and foreign tax authorities. From
time to time, these audits may result in proposed assessments. While we believe
that we have adequately provided for any such assessments, future settlements
may be materially different than we have provided for and thereby adversely
affect our earnings and cash flows.
We operate in various tax jurisdictions, and although we believe that we have
provided for income and other taxes in accordance with the relevant regulations,
if the applicable regulations were ultimately interpreted differently by a
taxing authority, we may be exposed to additional tax liabilities.
OUR ACQUISITION STRATEGY IS SUBJECT TO A NUMBER OF INHERENT RISKS, INCLUDING THE
RISK THAT OUR ACQUISITIONS MAY NOT BE SUCCESSFUL.
We continually seek to expand our business through acquisitions of other
companies that complement our own and through joint ventures, licensing
agreements and other arrangements. Any decision regarding strategic alternatives
would be subject to inherent risks, and we cannot guarantee that we will be able
to identify the appropriate
29
opportunities, successfully negotiate economically beneficial terms,
successfully integrate any acquired business, retain key employees, or achieve
the anticipated synergies or benefits of the strategic alternative selected.
Acquisitions can require significant capital resources and divert our
management's attention from our existing business. Additionally, we may issue
additional shares in connection with a strategic transaction, thereby diluting
the holdings of our existing common shareholders, incur debt or assume
liabilities, become subject to litigation, or consume cash, thereby reducing the
amount of cash available for other purposes.
ANY ACQUISITION THAT WE MAKE COULD RESULT IN A SUBSTANTIAL CHARGE TO OUR
EARNINGS.
We have previously incurred charges to our earnings in connection with acquired
assets, and may continue to experience charges to our earnings for any
acquisitions that we make, including large and immediate write-offs of acquired
assets, or impairment charges. These costs may also include substantial
severance and other closure costs associated with eliminating duplicate or
discontinued products, employees, operations and facilities. These charges could
have a material adverse effect on our results of operations for particular
quarterly periods and they could possibly have an adverse impact on the market
price of our common stock.
OUR REVENUE IS DIFFICULT TO PREDICT.
Our revenue is difficult to predict because it is primarily generated as
customers place orders and customers can change their requirements or cancel
orders. Many of our sales orders are short-term and may be cancelled at any
time. As a result, much of our revenue is not recurring from period to period,
which contributes to the variability of results from period to period. We
believe that quarter-to-quarter comparisons of our operating results are not a
good indication of our future performance.
OUR OPERATING RESULTS MAY FLUCTUATE IN FUTURE QUARTERS, WHICH MAY ADVERSELY
AFFECT THE TRADING PRICE OF OUR COMMON STOCK.
Our operating results will fluctuate on a quarterly basis as a result of a
number of factors, including the timing of contracts, the delay or cancellation
of a contract, and changes in government regulations. Any one of these factors
could have a significant impact on our quarterly results. In some quarters, our
revenue and operating results may fall below the expectations of securities
analysts and investors, which would likely cause the trading price of our common
stock to decline.
FAILURE TO OBTAIN PRODUCTS FROM OUTSIDE MANUFACTURERS COULD ADVERSELY AFFECT OUR
ABILITY TO FULFILL SALES ORDERS TO OUR CUSTOMERS.
We rely on outside manufacturers to supply products for resale to our customers.
Manufacturing problems may occur with these and other outside sources. If such
problems occur, we cannot ensure that we will be able to deliver our products to
our customers profitably or on time.
OUR POTENTIAL LIABILITY ARISING FROM OUR COMMITMENT TO INDEMNIFY OUR DIRECTORS,
OFFICERS AND EMPLOYEES COULD ADVERSELY AFFECT OUR EARNINGS AND FINANCIAL
CONDITION.
We have committed in our bylaws to indemnify our directors, officers and
employees against the reasonable expenses incurred by these persons in
connection with an action brought against him or her in such capacity, except in
matters as to which he or she is adjudged to have breached a duty to us. The
maximum potential amount of future payments we could be required to make under
this provision is unlimited. While we have a "director and officer" insurance
policy that covers a portion of this potential exposure, we may be adversely
affected if we are required to pay damages or incur legal costs in connection
with a claim above our insurance limits.
OUR BUSINESS MAY BE ADVERSELY AFFECTED BY TERRORIST ACTIVITIES.
Our business depends on the free flow of products and services through the
channels of commerce. Instability due to military, terrorist, political and
economic actions in other countries could materially disrupt our overseas
operations and export sales. In fiscal years 2005 and 2004, approximately 49%
and 50%, respectively, of our revenues were attributable to operations conducted
abroad and to export sales. In addition, in fiscal year 2005,
30
approximately 22% and 68% of our purchases came from Europe and Asia,
respectively. In addition, in certain countries where we currently operate or
export, intend to operate or export, or intend to expand our operations, we
could be subject to other political, military and economic uncertainties,
including labor unrest, restrictions on transfers of funds and unexpected
changes in regulatory environments.
FLUCTUATIONS IN FOREIGN CURRENCY EXCHANGE RATES MAY ADVERSELY AFFECT OUR RESULTS
OF OPERATIONS AND FINANCIAL CONDITION.
A substantial portion of our revenue is denominated in currencies other than the
U.S. dollar because certain of our foreign subsidiaries operate in their local
currencies. Our results of operations and financial condition may therefore be
adversely affected by fluctuations in the exchange rate between foreign
currencies and the U.S. dollar.
WE RELY HEAVILY ON KEY EXECUTIVES FOR OUR FINANCIAL PERFORMANCE.
Our financial performance is highly dependent upon the efforts and abilities of
our key executives. The loss of the services of any of our key executives could
therefore have a material adverse effect upon our financial position and
operating results. None of our key executives has an employment agreement with
us and we do not maintain "key-man" insurance on any of our key executives.
VIOLATIONS OF CGMP AND OTHER GOVERNMENT REGULATIONS, BY US OR OUR SUPPLIERS,
COULD HAVE A MATERIAL ADVERSE AFFECT ON OUR BUSINESS, FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
All facilities and manufacturing techniques used to manufacture products for
clinical use or for commercial sale in the United States must be operated in
conformity with current Good Manufacturing Practices ("cGMP") regulations as
required by the FDA. Our facilities, and certain of our supplier facilities, are
subject to scheduled periodic regulatory and customer inspections to ensure
compliance with cGMP and other requirements applicable to such products. A
finding that a facility materially violated these requirements could result in
one or more of regulatory sanctions, loss of a customer contract,
disqualification of data for client submissions to regulatory authorities and a
mandated closing of the facility, which in turn could have a material adverse
effect on our business, financial condition and results of operations.
LITIGATION MAY HARM OUR BUSINESS AND OUR MANAGEMENT AND FINANCIAL RESOURCES.
Substantial, complex or extended litigation could cause us to incur large
expenditures and could distract our management. For example, lawsuits by
employees, stockholders, collaborators, distributors, customers, or end-users of
our products or services could be very costly and substantially disrupt our
business. Disputes from time to time with such companies or individuals are not
uncommon, and we cannot assure you that we will always be able to resolve such
disputes out of court or on favorable terms.
THE MARKET PRICE OF OUR STOCK COULD BE VOLATILE.
The market price of our common stock has been subject to volatility and may
continue to be volatile in the future, due to a variety of factors, including:
o quarterly fluctuations in our operating income and earnings per
share results
o technological innovations or new product introductions by us or
our competitors
o economic conditions
o disputes concerning patents or proprietary rights
o changes in earnings estimates and market growth rate projections
by market research analysts
o sales of common stock by existing holders
o loss of key personnel
o securities class actions or other litigation
The market price for our common stock may also be affected by our ability to
meet analysts' expectations. Any failure to meet such expectations, even
slightly, could have an adverse effect on the market price of our common stock.
In addition, the stock market is subject to extreme price and volume
fluctuations. This volatility has had a
31
significant effect on the market prices of securities issued by many companies
for reasons unrelated to the operating performance of these companies.
INCIDENTS RELATED TO HAZARDOUS MATERIALS COULD ADVERSELY AFFECT OUR BUSINESS.
Portions of our operations require the controlled use of hazardous materials.
Although we are diligent in designing and implementing safety procedures to
comply with the standards prescribed by federal, state, and local regulations,
the risk of accidental contamination of property or injury to individuals from
these materials cannot be completely eliminated. In the event of such an
incident, we could be liable for any damages that result, which could adversely
affect our business.
THERE ARE INHERENT UNCERTAINTIES INVOLVED IN ESTIMATES, JUDGMENTS AND
ASSUMPTIONS USED IN PREPARING FINANCIAL STATEMENTS IN ACCORDANCE WITH U.S.
GENERALLY ACCEPTED ACCOUNTING PRINCIPLES. ANY CHANGES IN THE ESTIMATES,
JUDGMENTS AND ASSUMPTIONS WE USE COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR
FINANCIAL POSITION AND RESULTS OF OPERATIONS.
The consolidated financial statements included in the periodic reports we file
with the SEC are prepared in accordance with U.S. generally accepted accounting
principles ("GAAP"). Preparing financial statements in accordance with GAAP
involves making estimates, judgments and assumptions that affect reported
amounts of assets, liabilities, revenues, expenses and income. Estimates,
judgments and assumptions are inherently subject to change, and any such changes
could result in corresponding changes to the reported amounts.
FAILURE TO MAINTAIN EFFECTIVE INTERNAL CONTROLS IN ACCORDANCE WITH SECTION 404
OF THE SARBANES-OXLEY ACT COULD HAVE AN ADVERSE EFFECT ON OUR BUSINESS AND STOCK
PRICE.
Section 404 of the Sarbanes-Oxley Act requires us to evaluate annually the
effectiveness of our internal controls over financial reporting as of the end of
each fiscal year and to include a management report assessing the effectiveness
of our internal controls over financial reporting in our annual report. Section
404 also requires our independent registered public accounting firm to attest
to, and report on, management's assessment of our internal controls over
financial reporting. If we fail to maintain the adequacy of our internal
controls, we cannot assure you that we will be able to conclude in the future
that we have effective internal controls over financial reporting. If we fail to
maintain effective internal controls, we might be subject to sanctions or
investigation by regulatory authorities, such as the Securities and Exchange
Commission or NASDAQ. Any such action could adversely affect our financial
results and the market price of our common stock and may also result in delayed
filings with the Securities and Exchange Commission.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK SENSITIVE INSTRUMENTS
The market risk inherent in our market-risk-sensitive instruments and positions
is the potential loss arising from adverse changes in investment market prices,
foreign currency exchange-rates and interest rates.
INVESTMENT MARKET PRICE RISK
We had short-term investments of $3,276 at March 31, 2006. Those short-term
investments consisted of government and agency securities, corporate bonds and
corporate equity securities, and they were recorded at fair value and had
exposure to price risk. If this risk is estimated as the potential loss in fair
value resulting from a hypothetical 10% adverse change in prices quoted by stock
exchanges, the effect of that risk would be $328 as of March 31, 2006. Actual
results may differ.
FOREIGN CURRENCY EXCHANGE RISK
In order to reduce the risk of foreign currency exchange rate fluctuations, we
hedge some of our transactions denominated in a currency other than the
functional currencies applicable to each of our various entities. The
instruments used for hedging are short-term foreign currency contracts
(futures). The changes in market value of such contracts have a high correlation
to price changes in the currency of the related hedged transactions. At March
31,
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2006, we had foreign currency contracts outstanding that had a notional amount
of $17,391. The difference between the fair market value of the foreign currency
contracts and the related commitments at inception and the fair market value of
the contracts and the related commitments at March 31, 2006, was not material.
In addition, we enter into cross currency interest rate swaps to reduce foreign
currency exposure on inter-company transactions. In June 2004 we entered into a
one-year cross currency interest rate swap transaction, which expired in June
2005 when the underlying inter-company loan was repaid, and in May 2003 we
entered into a five-year cross currency interest rate swap transaction, both for
the purpose of hedging fixed-interest-rate, foreign-currency-denominated cash
flows under inter-company loans. Under the terms of these derivative financial
instruments, U.S. dollar fixed principal and interest payments to be received
under inter-company loans will be swapped for Euro denominated fixed principal
and interest payments. The change in fair value of the remaining swap from date
of purchase to March 31, 2006, was $(235). The gains or losses on the
inter-company loans due to changes in foreign currency rates will be offset by
the gains or losses on the swap in the accompanying consolidated statements of
income. Since our interest rate swaps qualify as hedging activities, the change
in their fair value, amounting to $43 and $(675) for the nine months ended March
31, 2006 and 2005, respectively, is recorded in accumulated other comprehensive
income included in the accompanying consolidated balance sheets.
We are subject to risk from changes in foreign exchange rates for our
subsidiaries that use a foreign currency as their functional currency and are
translated into U.S. dollars. These changes result in cumulative translation
adjustments, which are included in accumulated other comprehensive income. At
March 31, 2006, we had translation exposure to various foreign currencies, with
the most significant being the Euro, the Chinese Renminbi and the Singapore
dollar. The potential loss at March 31, 2006, resulting from a hypothetical 10%
adverse change in quoted foreign currency exchange rates is $4,853. Actual
results may differ.
INTEREST RATE RISK
Due to our financing, investing and cash-management activities, we are subject
to market risk from exposure to changes in interest rates. We utilize a balanced
mix of debt maturities along with both fixed-rate and variable-rate debt to
manage our exposure to changes in interest rates. Our financial instrument
holdings at year-end were analyzed to determine their sensitivity to interest
rate changes. In this sensitivity analysis, we used the same change in interest
rate for all maturities. All other factors were held constant. If there were an
adverse change in interest rates of 10%, the expected effect on net income
related to our financial instruments would be immaterial. However, there can be
no assurances that interest rates will not significantly affect our results of
operations.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Our disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange
Act")) are designed to ensure that information required to be disclosed in the
reports that we file or submit under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the rules and forms
of the Securities and Exchange Commission. Our chief executive officer and chief
financial officer, with assistance from other members of our management, have
reviewed the effectiveness of our disclosure controls and procedures as of March
31, 2006 and, based on their evaluation, have concluded that the disclosure
controls and procedures were effective as of such date.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
As planned, during the third quarter of fiscal 2006, our U.S. operations went
"live" with our new Enterprise Resource Planning ("ERP") system. Compensating
internal controls were strengthened and additional management reviews were
established during this transitional period to ensure the overall system of
internal control continued to operate effectively. We expect this ERP system to
further advance our control environment by automating manual processes,
improving management visibility and standardizing processes as its full
capabilities are utilized. There were no other changes in our internal control
over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the
Exchange Act) during the nine months ended March 31, 2006 that materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.
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LIMITATIONS ON THE EFFECTIVENESS OF INTERNAL CONTROL
Our management, including our chief executive officer and chief financial
officer, does not expect that our disclosure controls and procedures or our
internal controls will prevent all error and all fraud. A control system, no
matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. Further,
the design of a control system must reflect the fact that the benefits of
controls must be considered relative to their costs. Because of the inherent
limitations in any control system, no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud, if any,
within a company have been detected.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In March 2006, one of our subsidiaries received notice from the Environmental
Protection Agency (EPA) of its status as a potentially responsible party ("PRP")
under the Comprehensive Environmental Response, Compensation and Liability Act
(CERCLA) for a site described as the Berry's Creek Study Area. Our subsidiary is
one of over 150 PRP's which have potential liability for the required
investigation and remediation of the site. The estimate of our potential
liability is difficult to quantify for a number of reasons, including the
difficulty in determining the extent of contamination and the length of time
remediation may require. In addition, any estimate of our liability must also
consider the number of other potentially responsible parties and their financial
strength. Since an amount of our liability can not be reasonably estimated at
this time, no accrual is recorded for these future costs. The impact of the
resolution of this matter on our results of operations in a particular reporting
period is not known. However, we believe, although can not assure you, that the
ultimate outcome of this matter will not have a material adverse effect on our
financial condition or liquidity.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
SHARE REPURCHASE PROGRAM
We are authorized by the Board of Directors to repurchase up to 4,147 shares of
common stock, in the open market or private transactions, at prices not to
exceed the market value of the common stock at the time of such purchase. During
the first nine months of fiscal 2006, we purchased approximately 96 shares of
common stock at an average price per share of $6.05 for $581. At March 31, 2006,
there are 4,051 shares that may yet be purchased under the program, which
expires in May 2008.
ITEM 6. EXHIBITS
The exhibits filed as part of this report are listed below.
15.1 Letter of independent registered public accounting firm re:
unaudited interim financial information
31.1 Certification by Chairman, President and CEO Leonard S. Schwartz
pursuant to U.S.C. Section 1350, as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification by CFO Douglas Roth pursuant to U.S.C. Section
1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
32.1 Certification by Chairman, President and CEO Leonard S. Schwartz
pursuant to U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification by CFO Douglas Roth pursuant to U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ACETO CORPORATION
Date May 8, 2006 By /s/ Douglas Roth
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Douglas Roth, Chief Financial Officer
Date May 8, 2006 By /s/ Leonard S. Schwartz
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Leonard S. Schwartz, Chairman,
President and Chief Executive Officer