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Item 8. Financial Statements and Supplementary Data

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549



FORM 10-K



(Mark One)
ý   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

For the fiscal year ended August 31, 2014.

OR

o

 

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

 

 

For the transition period from                               to                                .

Commission file number 001-33633.



Zep Inc.
(Exact name of registrant as specified in its charter)



Delaware   26-0783366
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)

1310 Seaboard Industrial Boulevard,
Atlanta, Georgia

 

 
30318-2825
(Address of principal executive offices)   (Zip Code)

(404) 352-1680
(Registrant's telephone number, including area code)



Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class
 
Name of Each Exchange on which Registered
Common Stock ($0.01 Par Value)   New York Stock Exchange
Preferred Stock Purchase Rights   New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None



Indicate by checkmark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes o    No ý

Indicate by checkmark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes o    No ý

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 ý    No o

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    ý

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

Large Accelerated Filer o   Accelerated Filer ý   Non-accelerated Filer o   Smaller reporting company o

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

Based on the closing price of the registrant's common stock of $17.60 as quoted on the New York Stock Exchange on February 28, 2014, the aggregate market value of voting stock held by nonaffiliates of the registrant was $201,152,037.

The number of shares outstanding of the registrant's common stock, $0.01 par value, was 22,961,274 as of November 6, 2014.

Documents Incorporated by Reference

Location in Form 10K
 
Incorporated Document
Part III   Definitive Proxy Statement for January 7, 2015 Annual Meeting of Stockholders

   


Table of Contents


Zep Inc.

Table of Contents

 
   
  Page No.

 

Cautionary Statement Regarding Forward-Looking Information

  3

Part I

 

 

 
 

Item 1.

 

Business

 
4

Item 1A.

 

Risk Factors

  12

Item 1B.

 

Unresolved Staff Comments

  22

Item 2.

 

Properties

  23

Item 3.

 

Legal Proceedings

  23

Item 4.

 

Mine Safety Disclosures

  23

Part II

 

 

 
 

Item 5.

 

Market for Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities

 
24

Item 6.

 

Selected Financial Data

  26

Item 7.

 

Management's Discussion and Analysis of Financial Condition and Results of Operations

  27

Item 7A.

 

Quantitative and Qualitative Disclosures about Market Risk

  39

Item 8.

 

Financial Statements and Supplementary Data

  41

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

  86

Item 9A.

 

Controls and Procedures

  86

Item 9B.

 

Other Information

  89

Part III

 

 

 
 

Item 10.

 

Directors, Executive Officers and Corporate Governance

 
89

Item 11.

 

Executive Compensation

  89

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

  89

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

  90

Item 14.

 

Principal Accountant Fees and Services

  90

Part IV

 

 

 
 

Item 15.

 

Exhibits and Financial Statement Schedules

 
91

Signatures

 
99

Financial Statement Schedules

 
100

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Cautionary Statement Regarding Forward-Looking Information

This filing contains, and other written or oral statements made by or on our behalf may include, forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. In addition, we, or our executive officers on our behalf, may from time to time make forward-looking statements in reports and other documents we file with the Securities and Exchange Commission ("SEC") or in connection with oral statements made to the media, potential investors or others. Specifically, forward-looking statements may include, but are not limited to:

    statements relating to our future economic performance, business prospects, strategy, revenue, income, and financial condition;

    statements preceded by, followed by, or that include the words "expects," "believes," "intends," "anticipates," and similar terms that relate to future events, performance, or our results.

Forward-looking statements are subject to certain risks and uncertainties that could cause actual results, expectations, or outcomes to differ materially from our historical experience as well as management's present expectations or projections. These risks and uncertainties include, but are not limited to:

    the impact of the fire that occurred at our aerosol manufacturing facility on May 23, 2014 on our financial results, operations and prospects;

    general economic conditions;

    the cost or availability of raw materials;

    competition in the markets we serve;

    our ability to realize anticipated benefits from strategic planning and restructuring initiatives and the timing of the benefits of such actions;

    market demand for our products and/or services;

    our ability to maintain our customer relationships; and

    litigation and other contingent liabilities, such as environmental matters.

In evaluating these forward-looking statements, you also should consider various factors, including the risk factors described in Item 1A. Risk Factors of this Annual Report on Form 10-K and the other factors described in our filings with the SEC. You are cautioned not to place undue reliance on any forward-looking statements, which speak only as of the date of this Annual Report on Form 10-K. Except as required by law, we undertake no obligation to publicly update or release any revisions to these forward-looking statements to reflect any events or circumstances after the date of this Annual Report on Form 10-K or to reflect the occurrence of unanticipated events.

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PART I

Item 1. Business

    Our Business

Zep Inc. is a leading consumable chemical packaged goods company, providing a wide variety of high-performance chemicals and related products and services that help professionals maintain, clean and protect their assets. We market our products and services under well-recognized brand names, including Zep®, Zep Professional®, Zep Commercial®, Zep Automotive® and other Zep Inc. brands. Our common stock is listed on the New York Stock Exchange under the ticker symbol "ZEP".

During our fiscal year ended August 31, 2014, we generated net sales of $696.5 million and net income of $8.4 million. As of August 31, 2014, we had total assets of $556.2 million. We sell our products to nearly 200,000 customers, which are located primarily in the United States. Sales in the United States account for approximately 83% of net sales, while sales in Europe and Canada accounted for 9% and 8%, respectively, of net sales for fiscal 2014.

We believe the worldwide market for all institutional maintenance and cleaning chemicals and services is approximately $75 billion, and in the United States is approximately $18 billion. We sell our products primarily into this market for use in the transportation, industrial maintenance and janitorial and sanitation ("Jan/San") markets. To a certain extent, all three are impacted by general economic conditions, including items such as employment and the level of industrial activity. Transportation-related maintenance and cleaning chemicals account for approximately 25% of the U.S. market and demand in this sub-market is driven by such factors as new-vehicle production, gas prices, miles driven and average vehicle age, among others. Industrial maintenance-related chemicals account for approximately 15% of the U.S. market, with demand driven by such factors as industrial production and employment, among others. Jan/San and Institutional products account for approximately 60% of the U.S. market and demand is driven by such factors as employment and accepted practices in the Jan/San industry, among others.

    Our Transportation teams focus on selling maintenance and cleaning chemicals to vehicle wash operators including both car wash and fleet wash operators, such as Circle K, Penske Truck Rental and Ryder Truck Rental; automotive aftermarket retailers, such as Advance Auto Parts, Inc., AutoZone Parts Inc. and NAPA; automotive manufacturers, such as Kia Motors America, Inc., Subaru of America, Inc. and Toyota Motor Sales USA, Inc.; and other mass and specialty retailers with automotive maintenance and cleaning offerings, such as CarMax, Inc. We utilize a combination of direct sales and service, sales through distributors and sales through retailers to reach our transportation customers.

    Our Industrial Maintenance and Repair ("MRO") teams focus on selling maintenance and cleaning chemicals to industrial customers in a wide variety of industries utilizing a combination of direct sales and service in addition to sales through distributors such as Fastenal Company and W.W. Grainger.

    Our Jan/San and Institutional teams focus on selling maintenance and cleaning chemicals to a wide variety of customers. We utilize a combination of direct sales and service, sales through distributors such as Bunzl, Fastenal Company, HD Supply, Interline Brands, Inc., Lagasse Inc., National Cooperative Purchasing Alliance, TripleS, and W.W. Grainger Inc., and sales through retailers such as Canadian Tire, The Home Depot, Lowes, Meijer, Menard's, Tractor Supply Co. and Wal-Mart, to reach our Jan/San and Institutional customers.

Since becoming a public company in October 2007, we have completed seven acquisitions that we believe enhance our access to growing channels of distribution and to supplement our product offerings. We believe that our multi-channel sales capability is valued by our customers and provides an additional competitive advantage. We believe that customers who purchase from our sales and service organization value the combination of sales and service, which includes expertise regarding application uses, safety aspects, product

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selection, specific formulations, inventory management, customer associate training and equipment. We believe these services often reduce the total cost of our customers' maintenance and cleaning needs. For those customers who prefer the benefits of integrated supply, we make our products available through a wide variety of generalist and specialty distributors. Finally, for those customers who desire the speed and convenience of retailers, we continue to expand the availability of our products at a variety of home improvement retailers, auto parts retailers, mass merchandisers, club stores and specialty retailers.

These sales capabilities are significantly enhanced by a variety of common shared services functions including our integrated supply chain, research and development, customer service and other administrative functions.

Acquisitions

We began to implement our acquisition strategy in fiscal 2010. In January 2010, we acquired Amrep, Inc., ("Amrep"), a leader in maintenance chemicals for the automotive aftermarket as well as the janitorial market sold through distributors. In September 2010, we acquired certain assets and liabilities from Waterbury Companies, Inc., including certain air-care brands. These two acquisitions gave us a solid presence in the industrial distribution market, and strengthened our position in the retail market. The acquisition of Amrep also allowed us to further consolidate our manufacturing operations. In October 2010, we acquired the assets of Niagara National, LLC, ("Niagara") which complements the strength of our direct sales organization in the vehicle-wash market, specifically in the truck and fleet washing equipment markets.

In January 2012, through the acquisition of Hale Group Limited, we built upon our existing European capabilities by establishing a presence in the United Kingdom's cleaning and maintenance chemicals market. In June 2012, we acquired Mykal Industries Limited, also based in the United Kingdom, which represents our first investment targeting Europe's retail and distribution sales channels. The fiscal 2012 acquisition of Washtronics of America expanded our product portfolio and access to market by further strengthening our position in truck and fleet wash.

In December 2012 we completed the acquisition of Ecolab's Vehicle Care division ("EVC"). The combination of EVC, Niagara and our existing North American Sales and Service vehicle wash operations created a new platform that we refer to as "Zep Vehicle Care" or "ZVC". ZVC—which is based in Minnesota—is a leading provider of vehicle care products, including soaps, polishes, sealants, wheel and tire treatments and air fresheners to professional car washes, convenience stores, auto detailers, and commercial fleet wash customers. ZVC provides car, truck and fleet wash operators with high efficacy products for their wash tunnels and facilities.

Fire at Aerosol Manufacturing Facility

On May 23, 2014, a fire occurred at our aerosol manufacturing facility located in Marietta, Georgia (the "Aerosol Facility"). The fire, the cause of which remains unknown, destroyed our chemical raw material warehouse and damaged other supporting infrastructure that contains or supports our production equipment. Some of the work in process, raw material and finished goods inventory located there was also destroyed or damaged. The products manufactured at the Aerosol Facility included cleaning and maintenance chemicals, lubricants and automotive brake cleaner and accounted for approximately 19% of our revenue for fiscal 2013.

We have arranged for contract manufacturers, one of which was already producing certain aerosol products for us, to manufacture products formerly produced in the Aerosol Facility. We also resumed production at the Aerosol Facility on a limited basis in an attempt to mitigate revenue loss resulting from the fire. We are assisting the contract manufacturers in their efforts to satisfy our requirements for the products by loaning them production equipment and assigning some of our associates to work with them, as needed. However, despite these efforts, the contract manufacturers are currently unable to manufacture our products in the volume and mix required to satisfy all customer requirements for the products. Furthermore, we experienced delays in obtaining some raw material supplies necessary for the contract manufacturer to produce our

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products at the required rate as a result of the time needed to replenish raw materials destroyed in the fire. These conditions could continue in the foreseeable future.

Our inability to fulfill customer requirements has resulted in the loss of certain customers and will likely result in temporary or permanent loss of customers or market share for certain of our aerosol products, and, thus, may cause a loss of revenue, which may be material. The impact of lost sales related to the fire for fiscal 2014 was approximately $7.5 million with an estimated impact to profit before tax of $2.4 million. We expect that for at least the next few quarters our business will continue to be impacted by the inability to fully meet customer requirements. We expect that our business interruption insurance will cover these losses for a period of time that will be determined through discussion with our insurance companies. No insurance recoveries have been recorded to date related to lost sales. The timing of the receipt of insurance proceeds from losses relating to the fire may be different than from when those losses are incurred or when cash is spent. Any material loss of revenue resulting from the fire and its aftermath that is not covered by our insurance policy could have a material impact on our financial condition and results of operations.

Through August 31, 2014, we have incurred costs totaling $18.1 million related to the fire, including a $3.0 million write-off of fixed assets and a $2.1 million write-down of inventory. Based on the provisions of the Company's insurance policies and management's estimates, the losses incurred have been reduced by the estimated insurance recoveries. The Company has determined that recovery of the incurred losses is probable and recorded $18.1 million of insurance recoveries through August 31, 2014. In June 2014, we received $5.0 million of insurance proceeds, representing an advance of funds to defray the expenses we incurred to begin cleaning the property, to evaluate the extent of the damage and to outsource the production of our products to the contract manufacturers. As a result, the insurance receivable balance was $13.1 million as of August 31, 2014. In September 2014, we received an additional $11.9 million of insurance proceeds as an advance for the damage to the facility.

See additional information related to the impact of the fire at Note 2—Fire at Aerosol Manufacturing Facility and Part I, Item 1A. Risk Factors.


Our Strategy and Long-Term Financial Objectives

Our strategy is to be a leading provider of maintenance and cleaning products and services to customers engaged in Transportation, Industrial/MRO and Jan/San and Institutional markets. We believe we have transformed our business over the past five years by developing a multi-channel and multi-brand approach designed to serve our customers the way they want to be served. Our primary retail brand, Zep Commercial, is available at thousands of retail locations throughout North America, including Ace Hardware, The Home Depot, Lowes, Menards, Tractor Supply, and True Value. Furthermore, we have significantly increased the percentage of our total sales generated from the distribution and retail channels. We believe the execution of our strategy has increased the global reach of Zep's brands. As part of this strategy, we established a presence in the United Kingdom, and are building our network of distributors in China.

The combination of these actions has driven broader access to markets and an expanded product portfolio, but also increased the complexity that comes with managing distinct information systems, inventories, go-to-market strategies, and related processes. In the near-term, we intend to focus on business simplification while making strategic investments to organically grow the business. In addition to strengthening our balance sheet, we intend for these actions to deliver improved gross margins as well as a reduction in fixed costs. We will continue to invest in product innovation and market expansion as a means to achieve organic revenue growth.

We seek to achieve financial performance in the top quartile of our peer group of companies by growing our share with existing and new customers, expanding our margins and driving economies of scale through our supply chain, administrative functions, and research and development efforts. We believe that the success of our strategy in creating shareholder value will be measured by the following financial objectives:

    Revenue of $1 billion within the next five years;

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    Annualized EBITDA margin improvement of 50 basis points;

    Annualized earnings per share increases of 11 - 13%; and

    Returns on invested capital in excess of cost of capital.


Our Competition

The market for maintenance and cleaning chemicals and related services is both highly competitive and fragmented. Competition is based primarily on product quality, price, brand name recognition and customer service. We compete with numerous market leaders in specialized market verticals such as food processing, vehicle care and automotive maintenance. It is also fragmented with numerous local and regional operators selling directly to customers, or through distributors and national competitors such as Church & Dwight Co., The Clorox Company, Ecolab Inc., NCH Corporation, Inc., Procter & Gamble, S.C. Johnson & Sons, Inc., Sealed Air, and WD-40. Furthermore, barriers to entry and expansion in the industry are low, which may lead to additional competitive pressure in the future. In the industrial and institutional market, we believe we are one of the top four market leaders in the U.S., which we believe collectively hold slightly less than 25% of the total market share.


Seasonality and Cyclicality

Our business exhibits seasonality, with net sales being affected by weather, the annual budget cycles of major customers and the number of available selling days, which favor the second half of our fiscal year in terms of sales, earnings, and cash flow.

Demand for our products is partially dependent on economic conditions such as gross domestic product and on demand drivers in the markets we serve, such as trends in employment, industrial production, new vehicle sales and accepted maintenance and cleaning practices.


Our Products

We maintain a portfolio of over 4,000 formulations to support our customers' maintenance and cleaning solution needs. We frequently refresh our product lines and service offerings through the introduction of new technologies, applications and services designed to meet the demands of our customers and the industries we serve. Our product portfolio consists of three major categories, including automotive cleaning and maintenance; equipment repair and maintenance; and Jan/San products.

Many of our formulations are trade secrets and the value of the formulations to our business depends on our ability to maintain them as trade secrets. We own, or have pending, approximately 600 domestic and foreign trademark registrations. Our trademarks and formulations are important to our business. We employ a staff of chemists and technical support personnel who develop new products and support our sales and marketing organizations and our customers. We also license new products and technologies from third parties and engage others to assist with product development.


Manufacturing

We manufacture our products at nine facilities located in the United States, Canada, the Netherlands, Italy, and United Kingdom. The five United States facilities produce approximately 85% of our manufactured product. Certain finished goods purchased from contract manufacturers and finished goods suppliers supplement the products that we manufacture. Sales of finished products manufactured for us by third party suppliers currently account for approximately 30% of our net sales volume. Outsourced product is predominately manufactured in the United States.

Many of the chemical and packaging raw materials we use are petroleum-based, including surfactants, polymers, resins and solvents, and, therefore, are affected by the price of oil or its derivatives. Additionally, some of the raw materials we use are agriculture-based commodities, which are subject to changes in

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availability and price. We purchase most chemical and packaging raw materials on the open market. Although we do not currently engage in any commodity hedging transactions for raw materials, we have committed, and expect to continue to commit, to purchase certain materials for specified periods of time. Furthermore, we constantly monitor and investigate alternative suppliers and materials based on numerous attributes including quality, service and price. Accordingly, the cost of products sold may be affected by changes in the market price of raw materials or the sourcing of finished goods. Due to the mix of purchases (raw materials, components parts and finished goods), the timing of price increases and other economic and competitive forces within the supply chain, it is not possible to determine the financial impact of future changes in the market price of these raw materials.

Products are shipped to our customers utilizing a variety of common and local carriers from strategically located, company-operated branch warehouses throughout North America and Europe and from warehouses maintained by third party logistics companies, which are supplied directly from our production facilities and by one large distribution center in Atlanta, Georgia.


Environmental Regulation

Our operations are regulated under a number of environmental, health and safety laws and regulations. Compliance with these laws and regulations is a requirement for us and, as a result, we incur significant costs to ensure we are in compliance, including costs due to activities such as transporting and managing hazardous materials, waste disposal and proper storage and handling of materials. Furthermore, if we are found to be in violation of such laws and regulations, we could be subject to fines and penalties, disruptions of our business or product recalls. In addition to an increase in costs of manufacturing and delivering our products, a change in production or product regulations could result in disruptions of our business and potentially cause economic or consequential losses resulting from our inability to meet the demands of our customers for our products.

The environmental regulations we believe are most significant to us are summarized below.

    Toxic Substances

We are subject to various laws and regulations governing the production, transport and import of industrial chemicals. In the United States, the Toxic Substances Control Act gives the U.S. Environmental Protection Agency ("EPA") the authority to track, test and/or ban chemicals that may pose an environmental or human-health hazard. In addition, we are required to comply with certification, testing, labeling and transportation requirements associated with regulated chemicals. In the European Union, we are subject to certain of the compliance obligations under the EU European Community Directive "Registration, Evaluation, Authorization, and Restriction of Chemicals" (EU Directive No. 2006/1907). This directive imposes several requirements related to the identification and management of risks related to chemical substances manufactured or marketed in Europe.

    Globally Harmonized System (GHS)

In 2003, the United Nations issued a standard on hazard communication and labeling of chemical products known as the Globally Harmonized System of Classification and Labeling of Chemicals ("GHS"). GHS is designed to facilitate international trade and to increase safe handling and use of hazardous chemicals through a worldwide system that classifies chemicals based on their intrinsic hazards and communicates information about those hazards through standardized product labels and safety data sheets ("SDSs"). Most countries in which we operate will adopt legislation similar or related to GHS, and numerous countries already have done so. The United States Occupational Safety and Health Administration ("OSHA") updated the Hazard Communication Standard by adopting the GHS standards, with final rules issued in 2012. Employers were required to train associates on the new label elements and SDS format by December 1, 2013, which the Company completed. All companies must update labels and provide compliant SDSs by June 1, 2015, except distributors may ship products labeled by manufacturers under the old system until December 1, 2015. The

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primary cost of compliance revolves around reclassifying products, revising SDSs and product labels, and communications with customers. We estimate that the costs to comply with current GHS requirements could be as much as $2 million for fiscal 2015 and we must complete these requirements by June 2015.

    Pesticide Regulation

Some of our facilities and products are regulated by the EPA pursuant to the Federal Insecticide, Fungicide and Rodenticide Act, as amended ("FIFRA"), and by state agencies under similar state statues. Countries other than the United States typically regulate the same facilities and products under statutes similar to FIFRA. In addition, some states and foreign jurisdictions impose taxes on sales of pesticides.

In general, FIFRA and the similar state and foreign statutes require the registration of pesticides before sale or distribution. Pursuant to FIFRA, a pesticide is any substance intended to prevent, destroy, repel or mitigate any pest or intended for use as a plant regulator. The term includes disinfecting and sanitizing products that kill micro-organisms, such as bacteria, viruses and fungi, because such micro-organisms are considered "pests." To register these products, we must demonstrate to the satisfaction of the regulatory agency that (i) the composition of the product warrants the pesticidal claims made with respect to the product; (ii) the label for the product meets the disclosure standards of the statute or regulations; (iii) the product will perform its intended function without unreasonable adverse effects on the environment; (iv) the product, when used in accordance with widespread and commonly recognized practice, will not generally cause unreasonable adverse effects on the environment; and (v) there is a reasonable certainty that residues of the product in food will cause no harm to consumers. To maintain our registrations, we must file with the various regulatory agencies in the United States and other countries labels reflecting any variations from the approved label on file with the agency.

Most of the pesticidal products we sell were registered by other companies. We sell the product as a distributor under a process called "supplemental distribution." To become a distributor of the product, we are required to file a supplemental distributor notice with the EPA and the other regulatory agencies. If the owner of the registration sells the product to another company, we must obtain a new supplemental distributor notice from the new owner of the registrant and file it with the EPA and the other regulatory agencies. We will be unable to sell the product if we fail to obtain and file the supplemental distributor notice from the new owner on a timely basis.

The cost of maintaining our pesticide registrations and of complying with the various laws and regulations governing the manufacture and sale of pesticides is considerable. Among other things, we are required to employ associates who are knowledgeable regarding the federal and state regulatory scheme. Furthermore, we are required to pay filing fees when we revise labels. If we fail to comply with the regulations, we may incur fines and penalties and we may be required to recall non-compliant products.

In June 2014, we entered into a consent order with the EPA and agreed to pay a civil penalty in the amount of $0.9 million to resolve the EPA's allegations that one of our subsidiaries (i) sold an unregistered pesticide, (ii) sold a misbranded pesticide, and (iii) provided false compliance certification statements regarding good laboratory practices for three studies submitted to the EPA. The Company neither admitted nor denied the EPA's factual allegations and legal conclusions as set forth in the consent order. We agreed to the consent order to avoid the expense of litigation. Our subsidiary no longer manufactures the product at issue.

    Ingredient Regulation

Numerous laws and regulations relate to the sale of products containing phosphorous, volatile organic compounds or other ingredients that may impact human health and the environment. Specifically, the State of California has enacted Proposition 65, which requires us to disclose specified listed chemical ingredients on the labels of our products. Recent California legislation, called the "Green Chemistry Initiative," regulates products that contain chemicals deemed to exhibit a "hazard trait" such as carcinogenicity, toxicity or mutagenicity. Similar legislation is under consideration in other states. As a result of this type of legislation,

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we may be required to disclose certain of our proprietary product formulations, the identity of the chemicals used in certain of our products and chemical and market data with respect to certain of our products to the California Department of Toxic Substance Control (the "DTSC") or other state agencies. We intend to request protective treatment for any proprietary confidential business information that we may be required to disclose. However, we may be unable to retain trade secret protection for our formulations. Loss of trade secret protection for a product formulation could enable our competitors to duplicate the product. Our failure to protect our trademarks and trade names, or any adverse judgment with respect to infringement of others' intellectual property rights, may have a material adverse effect on our business, financial condition, results of operations, and cash flow.

    FDA Antimicrobial Product Requirements

Various laws and regulations regulate certain products manufactured and sold by us for controlling microbial growth on humans, animals and foods. In the United States, these requirements generally are administered by the U.S. Food and Drug Administration ("FDA"). However, the U.S. Department of Agriculture and EPA also may share in regulatory jurisdiction of antimicrobials applied to food. The FDA codifies "Good Manufacturing Practices" for these products in order to ensure product quality, safety and effectiveness. The FDA also has been expanding requirements applicable to such products, including proposing regulations for over-the-counter ("OTC") antiseptic drug products, which may impose additional requirements associated with antimicrobial hand care products and associated costs when finalized by the FDA. To date, such requirements have not had a material adverse effect on our consolidated results of operations, financial position or cash flow.

    Comprehensive Environmental Response, Compensation and Liability Act (CERCLA)

Our operations involve the handling, transportation and use of numerous hazardous substances; therefore, many of our facilities are subject to various laws and regulations governing the discharge, transportation, use, handling, storage and disposal of hazardous substances. In the United States, these statutes include the Clean Air Act, the Clean Water Act, the Resource Conservation and Recovery Act, and CERCLA, as well as analogous state laws. We are also subject to the Superfund Amendments and Reauthorization Act of 1986, including the Emergency Planning and Community Right-to-Know Act, which impose reporting requirements when toxic substances are released into the environment. We may be liable under CERCLA or its state, local or foreign equivalents and under numerous other federal, state and local laws for the costs of environmental contamination on or from our properties and at off-site locations where we disposed of or arranged for the disposal or treatment of hazardous waste. In addition, we are aware that there is soil or groundwater contamination at certain of our facilities resulting from past operations at those locations. Generally, CERCLA imposes liability on each potentially responsible party ("PRP") that actually contributed hazardous waste to a site. Customarily, PRPs will work with the EPA to agree on and implement a plan for site investigation and remediation. Based on our experience with these environmental proceedings and our estimate of the contribution to be made by other PRPs with the financial ability to pay their shares, we believe that our share of the costs at these sites will not have a material adverse effect on our business, financial condition, results of operations or cash flow.

    Environmental Permits and Licensing

In the ordinary course of our business, we are subject to environmental inspections and monitoring by governmental enforcement authorities. In addition, our production facilities, warehouse facilities and operations require operating permits that are subject to renewal, modification and revocation. We believe that we are currently in material compliance with existing permit and licensing requirements at our facilities. Based on available information, we believe that costs associated with any failure to satisfy our permit and licensing obligations will not have a material adverse effect on our business, financial condition, results of operations or cash flow.

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Employees

As of August 31, 2014, we had approximately 2,300 employees, including approximately 1,850 in North America, 450 in Europe and 10 in China. We estimate that 150 of our employees are subject to collective bargaining agreements in the United States and Europe.


International Operations

See Note 18—Geographic Distribution of Operations in the accompanying audited consolidated financial statements for information regarding the geographic distribution of net sales, and long-lived assets.


Available Information

We were incorporated in 2007 under the laws of Delaware. We make our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, and Current Reports on Form 8-K (and all amendments to these reports), together with all reports filed pursuant to Section 16 of the Securities Exchange Act of 1934, as amended ("Exchange Act") by our officers, directors, and beneficial owners of 10% or more of our common stock, available free of charge through the "SEC Filings" link on our website, located at www.zepinc.com, as soon as reasonably practicable after they are filed with or furnished to the SEC. Information included on our website is not incorporated by reference into this Annual Report on Form 10-K. Our reports are also available at the Securities and Exchange Commission's Public Reference Room at 100 F Street, NE, Washington, DC 20549 or on their website at www.sec.gov. The SEC may be contacted regarding such requests at 1-800-SEC-0330.

We have adopted a written Code of Ethics and Business Conduct that applies to all of our directors, officers, and associates, including our chief executive officer and chief financial officer. The Code of Ethics and Business Conduct and our Corporate Governance Guidelines are available free of charge through the "Corporate Governance" link on our website at www.zepinc.com. The charters for our Audit Committee, Compensation Committee and Nominating and Corporate Governance Committee are also available free of charge through the "Corporate Governance" link on our website. Each of the Code of Ethics and Business Conduct, the Corporate Governance Guidelines, and the committee charters is available in print to any of our stockholders by written request. Such requests should be directed to the Corporate Secretary, Zep Inc., 1310 Seaboard Industrial Boulevard, Atlanta, Georgia 30318. We intend to satisfy the disclosure requirement under Item 5.05 of Form 8-K relating to amendments to or waivers from any provision of this Code of Ethics and Business Conduct applicable to our chief executive officer and chief financial officer by posting such information within the investor relations corporate governance sections on our website at www.zepinc.com.

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Item 1A. Risk Factors

The following are important factors that could materially adversely affect our business, financial condition and results of operations. Such factors could also cause our actual results for future periods to differ materially from our expectations, including those expressed in or implied by any forward-looking statements contained in this Annual Report on Form 10-K and in other written or oral statements made by us or on our behalf. These risks could cause the market price of our securities to decrease. The risk factors described below are not the only risks that may affect us. Additional risks and uncertainties not presently known to us also may adversely affect our business, financial condition and results of operations. See the section entitled "Cautionary Statement Regarding Forward-Looking Information."


Risks Related to our Business

    We have identified a material weakness in our internal control over financial reporting which could, if not remediated, result in material misstatements in our financial statements.

In connection with management's annual assessment of the effectiveness of our internal control over financial reporting as of and for the year ended August 31, 2014, we concluded a material weakness exists in the financial statement close process due to the lack of sufficient controls over management's review of account reconciliations and manual journal entries. Specifically, the account reconciliation review control is not being performed at the required precision to detect misstatements and therefore it is reasonably possible that an aggregation of undetected immaterial errors could result in a subsequent material misstatement. Under standards established by the Public Company Accounting Oversight Board, a material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected and corrected on a timely basis. See "Item 9A. Controls and Procedures" in this Annual Report on Form 10-K.

We are in the process of remediating this material weakness, including enhancing our complement of resources with accounting and internal control knowledge through additional hiring and/or training to implement and perform additional controls over the preparation and review of manual journal entries and account reconciliations. We plan to develop formal policies and improved processes, including an approval control for manual journal entries, with the objective of preventing errors prior to posting to the general ledger. When fully implemented and operating effectively, such enhancements are expected to remediate the material weakness described above. The actions that we are taking are subject to ongoing senior management review, as well as Audit Committee oversight. However, we cannot determine how long it will take to remediate the weakness or provide any assurance that these remediation efforts will be successful or that our internal control over financial reporting will be effective as a result of these efforts.

If our remedial measures are insufficient to address the material weakness, or if additional material weaknesses or significant deficiencies in our internal control over financial reporting are discovered or occur in the future, our consolidated financial statements may contain material misstatements and we could be required to restate our financial results. In addition, if we are unable to successfully remediate this material weakness and if we are unable to produce accurate and timely financial statements, our stock price may be adversely affected and we may be unable to maintain compliance with applicable stock exchange listing requirements.

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    We are unable to produce aerosol products at our facility in Marietta, Georgia due to the occurrence of a fire at the facility. As a result of the fire, we have been unable to fulfill customer orders and may be unable to fulfill customer orders in the future which could result in temporary or permanent revenue loss, and we may incur substantial losses and liability to third parties, for which our insurance coverage may not provide adequate compensation. Our efforts to manage the aftermath of the fire are consuming a substantial amount of time and efforts of our organization.

On May 23, 2014, a fire occurred at our Aerosol Facility located in Marietta, Georgia. The fire, the cause of which remains unknown, destroyed our chemical raw material warehouse and damaged other supporting infrastructure that contains or supports our production equipment. Some of the work in process, raw material and finished goods inventory located there was also destroyed or damaged. The products manufactured at the Aerosol Facility included cleaning and maintenance chemicals, lubricants and automotive brake cleaner and accounted for approximately 19% of our revenue for fiscal 2013.

We have arranged for contract manufacturers, one of which was already producing certain aerosol products for us, to manufacture products formerly produced in the Aerosol Facility. We also resumed production at the Aerosol Facility on a limited basis in an attempt to mitigate revenue loss resulting from the fire. We are assisting our contract manufacturers in their efforts to satisfy requirements for our products by loaning them production equipment and assigning some of our associates to work with them, as needed. However, despite these efforts, the contract manufacturers are currently unable to manufacture some of our products in the quantity and in the formulations required to satisfy some customer requirements for the products. Furthermore, because some of the raw materials destroyed in the fire represented long-term supplies that would normally have not been replenished at the rate required after the fire, we experienced delays in obtaining supplies of some of the raw materials needed by the contract manufacturer to produce our products. These conditions could continue in the foreseeable future.

Our inability to fulfill customer requirements has resulted in the loss of certain customers and will likely result in temporary or permanent loss of customers or market share for certain of our aerosol products, and, thus, may cause a loss of revenue, which may be material. The impact of lost sales related to the fire for fiscal 2014 was approximately $7.5 million with an estimated impact to profit before tax of $2.4 million. We expect that for at least the next few quarters our business will continue to be impacted by the inability to fully meet customer requirements. We expect that our business interruption insurance will cover these losses for a period of time that will be determined through discussion with our insurance companies. No insurance recoveries have been recorded to date related to lost sales. The timing of the receipt of insurance proceeds from losses relating to the fire may be materially different from when those losses are incurred versus when cash is spent. Any material loss of revenue resulting from the fire and its aftermath that is not covered by our insurance policy could have a material impact on our financial condition and results of operations.

We may be liable to third parties as a result of damage to or destruction of their property or as a result of the release of hazardous substances into the environment during the fire. We may also be liable to regulatory authorities for potential violations of regulatory requirements and/or for damage to the environment caused by the release of hazardous substances during the fire. We cannot fully estimate the amount of such exposure at this time.

We maintain $300 million in property damage and business interruption insurance coverage subject to various sublimits, including a $500,000 limit for land and water contaminant cleanup, removal and disposal on the property of third parties. We also maintain $75 million of general liability insurance coverage. Until we are able to fully replace the manufacturing capacity internally, we may incur higher operating costs by utilizing third party manufacturers to supply our production. Our insurance coverage may not fully compensate us for all of the losses we incur as a result of the fire, which in turn, could have a material adverse impact on our financial condition and results of operations. Additionally, the timing of our receipt of insurance proceeds from losses relating to the fire is controlled by our insurance carriers and release of proceeds may be materially different from when those losses are incurred or when cash is spent.

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Responding to the fire and its aftermath is consuming a substantial amount of the time and efforts of our senior management team and other associates. As a result, while members of our senior management team and associates throughout the organization tend to fire-related matters, their ability to pursue other selected pre-existing initiatives to improve the efficiency of our operations and to achieve other strategic goals may be delayed. Likewise, the efforts of our supply-chain managers has been diverted to managing our contract manufacturers, to obtaining adequate supplies of raw materials in a timely fashion and to evaluating the possibility of utilizing other contract manufacturers to produce certain of our aerosol products. The diversion of the attention of our management team from other matters is expected to continue indefinitely.

We currently are evaluating several possible courses of action regarding replacement of the previous production capacity at the Aerosol Facility. Our failure to select the best course of action, or our failure to implement that course of action properly, may result in a further interruption to our sales, manufacturing, logistics and customer service. Any of these results could have a material adverse effect on our financial condition and results of operations.

    Our aerosol contract manufacturers could experience business interruptions, which would impact their ability to fulfill our requirements.

As part of our efforts to mitigate our revenue loss from the fire, we have arranged for contract manufacturers to produce a majority of our high demand products. Currently, one contract manufacturer is producing the majority of the outsourced aerosol products. If that contract manufacturer were to experience a business interruption, such as due to a natural disaster or industrial accident, for example, we would be unable to obtain these aerosol products until we were able to move the production to another location of that company or find another contract manufacturer to produce the products for us. The inability to obtain these aerosol products would have a material adverse effect on our financial condition, results of operations and cash flow.

    We may not properly execute, or realize anticipated benefits from, our ongoing strategic or other initiatives.

Our success is partly dependent upon properly executing, and realizing the anticipated benefits from, our ongoing strategic growth initiatives, our information technology initiatives, and other initiatives. These complex initiatives are primarily designed to increase our revenue and market share and to make us more efficient in the sales, manufacture, and distribution of our products. Our failure to implement any of the initiatives properly may, in addition to not providing the anticipated benefits, result in an interruption to our sales, manufacturing, logistics, customer service, or accounting functions. Furthermore, we have invested a significant amount of capital into a number of these initiatives and will invest a significant amount of capital into others, which might have been more efficiently used if the anticipated benefits are not fully realized. Any of these results could have a material adverse effect on our financial condition and results of operations, including the requirement to reduce the book value of certain assets that must be evaluated for impairment.

    Difficult economic conditions could continue to adversely affect our business and financial results.

Difficult economic conditions, in particular, downturns that affect the transportation, food processing, food service, manufacturing, government and housekeeping markets, in the U.S. and globally, have historically and may in the future negatively impact our business and financial results. The global and U.S. recessions that began in 2008 negatively impacted all of these markets. During periods of difficult economic conditions and uncertainty, we experience decreased demand for certain of our products as many customers either defer purchases or purchase lower-cost products. Currently, the European economy is experiencing recessionary conditions and the continuation or worsening of these conditions could have a negative impact on our results of operations. Credit quality also declines during periods of difficult economic conditions, which may negatively impact our ability to collect accounts receivable on a timely basis, or at all, from certain customers. Furthermore, the ability of certain suppliers to fill our orders for raw materials or other goods and services may decline in the future because of the diminished availability of credit. A prolonged period of difficult economic

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conditions, particularly one that affects the end-user markets listed above, could have a material adverse impact on our business, results of operations and financial condition.

    Our results can be adversely affected by fluctuations in the cost or availability of materials used in our manufacturing processes.

The key raw materials we use in our chemical products are surfactants, polymers and resins, fragrances, water, solvents and other petroleum-based materials, and packaging materials. Many of the raw materials that we use are petroleum-based and, therefore, are affected by the price of oil or its derivatives. Some of the raw materials we use are agricultural commodities and are subject to changes in availability and price. Furthermore, there are a limited number of suppliers for some of our raw materials. Competitive conditions, governmental restrictions, natural disasters and other events could limit the quantities of our raw materials that we are able to procure. As a result, the price and availability of the raw materials we use may fluctuate substantially. The fluctuations could materially adversely affect our financial condition and results of operations.

We may not be able to increase the prices of our products to recover the increased cost of the raw materials we use. The volatility in raw material costs can exacerbate the challenges we face in obtaining sufficient pricing to maintain gross profit margins. Significant increases in the prices of products as a result of the increased cost of our raw materials could have a negative effect on demand for our products and on our operating margins. Furthermore, our ability to meet the demand for our products could be negatively impacted by shortages of our raw materials.

We do not currently engage in raw material commodity hedging transactions. We are not always able to enter into a supply agreement for certain raw materials. When we are able to do so, we face the risk that the price of the raw material covered by the contract may decline during the term of the supply agreement.

    We face significant competition and may face more significant competition in the future.

Our industry is highly competitive. Our competition includes numerous local and regional operators and several national competitors. Many of our competitors are privately-held companies that have lower cost structures than ours or that have lower financial-return requirements than we have. Furthermore, barriers to entry and expansion in the industry are low, which may lead to additional competitive pressure in the future. We cannot assure you that we will be able to continue to compete successfully against current or future competitors or that changes in the source or the intensity of competitive pressure in the industry will not result in reduced market share that could negatively impact our financial condition and results of operations.

    We may be unable to sustain our significant customer relationships.

Our relationships with our largest customers depend on our ability to deliver high quality products and services. The loss or consolidation of, or substantial decrease in the volume of purchases by, one or more of our largest customers, including as a result of the fire at our Aerosol Facility, could harm our sales and profitability. We do not have contractual commitments with our largest customers to purchase our products, and they could sever their relationship with us with little or no notice. We have developed plans for reducing our cost structure if we were to lose one or more of our largest customers; however, we could not implement the actions contemplated by these plans immediately and we would incur substantial costs in doing so. Therefore, the loss of one or more of our large customers could have a material adverse effect on our financial condition and results of operations.

    We may not be able to attract and retain sufficiently qualified sales representatives and other key personnel.

Our success is dependent, in large part, upon the continued service of the sales representatives in our direct sales organization. Over the past three years, we have been focused on growth through acquisitions while

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curtailing investments in our salesforce expansion and, as a result, we have fewer sales representatives in our direct sales organization.

On October 1, 2014, we introduced a number of measures intended to improve the productivity of our North American Sales and Service direct sales force. However, we can provide no assurances that these measures will have the intended effect. Some of the measures, such as the cancellation of the exclusive-account agreements that we had with our most experienced North American direct sales representatives, may exacerbate the loss of these experienced sales representatives or may result in various claims against the Company.

We are continuing to increase our efforts to expand our alternative sales channels, including inside sales, retail sales and wholesale distribution. Widespread sales of our products through our alternative sales channels could reduce the sales of our products by our North American direct sales representatives, which could lead to further losses of sales representatives and customers, as well as disputes over the terms of sales and commission agreements. Significant associate turnover and failure to maintain a qualified workforce, including qualified sales representatives, could have a material adverse effect on our financial condition and results of operations

    If we are unable to implement our acquisition growth strategy, the price of our common stock may be adversely affected.

Our strategy is to achieve profitable growth by, among other things, acquiring other product lines and businesses. Our ability to implement our growth strategy depends upon a variety of factors that are not within our control, including the availability of suitable and attractive product lines and businesses for acquisition and the availability of capital. We compete for acquisition opportunities with a diverse group of competitors, many of whom have significantly greater financial resources than we have. Therefore, we may be unable to complete an acquisition that we believe could be important to our growth strategy because one of our competitors may be willing to pay more for a potential acquisition candidate or may be able to use its financial resources to acquire a potential acquisition candidate before we are able to obtain financing.

Our growth strategy may place additional demands on our administrative, operational and financial resources and may increase the demands on our financial systems and controls, particularly as we attempt to integrate acquired product lines and businesses into our existing operations. Our ability to manage our growth successfully may require us to continue to improve and expand these resources, systems and controls. If our management is unable to manage growth effectively, our operating results could be adversely affected. If we are unable to manage our growth, our financial condition and results of operations may be adversely affected.

Our growth strategy requires that we make expenditures in connection with the acquisition of other product lines and companies. We cannot predict the amount of our expenditures in connection with our growth strategy because opportunities for implementing our growth strategy arise unexpectedly. We may be required to seek additional sources of financing as we pursue our growth strategy, which may include issuing debt or equity securities. Our need for additional financing may place us at a disadvantage in competing for acquisitions. When a future acquisition opportunity arises, we may be required to evaluate the sources of financing, which may be limited on short notice, and the terms of the financing available at the time. Certain sources of financing may have a dilutive effect on our earnings per share. If we cannot find financing on acceptable terms, we may be unable to make the acquisition and we may incur significant costs from which we may realize no benefit.

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    We have substantial indebtedness which could impact our financial flexibility and may adversely affect our business, results of operations, financial condition and ability to make distributions to our stockholders, including in the following respects:

As of August 31, 2014, we had net debt (total debt minus cash and cash equivalents) of $192.9 million. Our substantial indebtedness may adversely affect our results of operations and financial condition, including in the following respects:

    limiting our ability to obtain additional financing to fund our operational and strategic needs;

    placing us at a relative competitive disadvantage compared to competitors that have less debt;

    limiting our ability to plan for, or react to, changes in the businesses and industries in which we operate; and

    increasing our vulnerability to adverse general economic and industry conditions.

In addition, since all of our debt is variable rate debt, a significant increase in interest rates would adversely affect our consolidated results of operations and cash flow.

Pursuant to our 2014 Credit Facility (as defined below), we are subject to certain financial and other restrictive covenants. Failure to comply with these covenants could result in an event of default that, if not cured or waived, could have a material adverse effect on us.

    We are subject to a broad range of environmental, health, and safety laws and regulations in the jurisdictions in which we operate, and we may be exposed to substantial environmental, health, and safety costs and liabilities.

Our operations are regulated under a number of federal, state, local and foreign environmental, health and safety laws and regulations that govern, among other things, the manufacture, labeling, storage, distribution, sale and use of our products. Regulation of our products and operations continues to increase with more stringent standards, including evolving climate change standards, causing increased costs of operations and potential for liability if a violation occurs. In addition to existing laws, rules and regulations, new laws, rules and regulations could have a material adverse impact on our business, results of operations and financial condition. We are required to comply with certification, testing, labeling and transportation requirements associated with regulated chemicals. To date, compliance with these laws and regulations has not had a material adverse effect on our business, financial condition, results of operations or cash flow. However, the costs of complying with these laws and regulations, including participation in assessments and remediation of contaminated sites and installation of pollution control facilities, have been, and in the future could be, significant. In addition, these laws and regulations may also result in substantial environmental and product liabilities associated with product usage, divested assets, third party locations, and past activities.

We have accrued a liability for environmental remediation activities at certain of our facilities. The cost of addressing environmental matters (including the timing of any charges related thereto), however, cannot be predicted with certainty. These liabilities may not ultimately be adequate, especially in light of potential changes in environmental conditions (including any such changes resulting from the fire at our Aerosol Facility), changing interpretations of laws and regulations by regulators and courts, the discovery of previously unknown environmental conditions, the risk of governmental orders to carry out additional compliance on certain sites not initially included in remediation in progress, our potential liability to remediate sites for which provisions have not previously been established and the adoption of more stringent environmental laws. Such future developments could result in increased environmental costs and liabilities and could require significant capital and other ongoing expenditures, any of which could have a material adverse effect on our financial condition or results of operations. Furthermore, the failure to comply with our obligations under the environmental laws and regulations could subject us to administrative, civil, or criminal penalties, obligations to pay damages or other costs, and injunctions or other orders, including orders to cease operations. In addition, the presence of environmental contamination at one or more of our properties could adversely

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affect our ability to sell such property, receive full value for the property, use a property as collateral in a financing transaction, or obtain or maintain financing. See Note 4—Commitments and Contingencies in our accompanying consolidated financial statements for additional information regarding Environmental Matters.

We use a variety of hazardous materials and chemicals in our manufacturing processes and in connection with maintenance work on our manufacturing facilities. Because of the nature of these substances, we may be liable for certain costs, including, among others, costs for health-related claims or removal or re-treatment of such substances. In addition, although we have developed environmental, health, and safety programs for our associates, including measures to protect our associates from exposure to hazardous substances, and conduct regular assessments at our facilities, we may be involved in claims and litigation filed on behalf of persons alleging injury as a result of occupational exposure to substances or other hazards at our current or former facilities. It is not possible to predict the ultimate outcome of any such claims or lawsuits that may arise. If any such claims or lawsuits, individually or in the aggregate, were resolved against us, our results of operations and cash flow could be adversely affected.

    Our business could suffer in the event of a work stoppage or increased organized labor activity.

As of August 31, 2014, approximately 150 of our 2,300 associates were covered by collective bargaining agreements in the United States and Europe. While we consider our relations with our associates to be generally good, we may experience work stoppages, strikes, or slowdowns in the future. In addition, we outsource to third parties the manufacturing of certain of our products, including all of our aerosol products manufacturing as a result of the fire at the Aerosol Facility, and these third parties may experience work stoppages, strikes or slowdowns in the future. A prolonged work stoppage, strike, or slowdown at any of our facilities or those of our third party suppliers could have a material adverse effect on our results of operations. Further, upon expiration of any of our existing collective bargaining agreements, we may not be able to reach new agreements without union action or any new agreement may not be on terms satisfactory to us. Moreover, our non-union facilities may become subject to labor union organizing efforts. If any current non-union facilities were to unionize, we would incur increased risk of work stoppages and possibly higher labor costs.

    If we are unable to protect our intellectual property rights, our ability to compete may be negatively impacted.

The market for our products depends to a significant extent upon the goodwill associated with our brand names. We own, or have licenses to use, all of the material trademark and trade name rights we use in connection with the packaging, marketing, and distribution of our major products both in the United States and in other countries where our products are principally sold. In addition, we possess trade secret product formulations and other product information, which are competitively sensitive. Intellectual property protection is important to our business. Although most of our trademarks are registered in the United States and in the foreign countries in which we operate, we may not be successful in asserting trademark or trade name protection. In addition, the laws of some foreign countries may not protect our intellectual property rights to the same extent as the laws of the United States. The costs required to protect our intellectual property rights are substantial.

We cannot be certain that we will be able to assert our intellectual property rights successfully in the future or that they will not be invalidated, circumvented, or challenged. Other parties may infringe on our intellectual property rights and may thereby dilute the value of our brand names in the marketplace. Any infringement of our intellectual property rights would also likely result in a diversion of our time and resources to protect these rights through litigation or otherwise. Others may claim that our business or products infringe on their intellectual property rights.

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    Data security breaches and other disruptions could expose us to liability and data loss, which could negatively affect our results.

As part of our business operations, we collect and store sensitive data on our computer networks, including our intellectual property, proprietary business information and that of our customers and vendors, as well as some personally identifiable information of our associates. Despite our security measures, our networks and systems may be vulnerable to attacks by hackers or breached due to associate error, misconduct, viruses or other events. Any such breach could compromise our networks and the information stored there could be accessed, publicly disclosed, deleted or stolen. Any such access, disclosure or other loss of information could result in legal claims or proceedings, disrupt our operations, and damage our reputation, which could adversely affect our results. We have applied for cyber risk insurance, but, if obtained, this insurance may not be sufficient to cover all of our losses from any future breaches of our systems. In addition, we market some of our brands, products and services via social media sites. These social media sites are hosted on the networks of others and may be vulnerable to attacks by hackers or breached due to associate error or misconduct, putting our marketing strategies, reputation and results at risk.

    If our products are improperly manufactured, packaged, or labeled or become adulterated, we may need to recall those items and may experience product liability claims if individuals are injured.

Our quality control procedures relating to the raw materials and other supplies, including packaging and finished goods, which we receive from third party suppliers, or our quality control procedures relating to our products after our products are formulated and packaged, may not be sufficient. We have previously initiated product removals and recalls. Widespread product removals or recalls could result in significant losses due to the costs of a removal or recall, the destruction of product inventory, and lost sales due to the unavailability of product for a period of time. We may also be liable if the use of any of our products causes injury, and could suffer losses from a significant product liability judgment against us. A significant product removal or recall or product liability case could also result in adverse publicity, damage to our reputation, and a loss of customer confidence in our products, which could have a material adverse effect on our business and financial results.

    We have recorded a significant amount of goodwill and other identifiable intangible assets. We may be required to record non-cash charges for impairment of our goodwill and other identifiable intangible assets, if we do not achieve the anticipated benefits from the transactions that gave rise to the goodwill and other intangible assets.

Goodwill and other net identifiable intangible assets were approximately $242.6 million as of August 31, 2014, or approximately 44% of our total assets. Goodwill, which represents the excess of cost over the fair value of the net assets of the businesses acquired, was approximately $121.0 million as of August 31, 2014, or 22% of our total assets. Goodwill and indefinite-lived intangible assets are recorded at fair value on the date of acquisition and are reviewed at least annually for impairment. Impairment may result from, among other things, deterioration in our performance, adverse market conditions, adverse changes in applicable laws or regulations, including changes that restrict the activities of or affect the products and services sold by our business, and a variety of other factors. The amount of any quantified impairment must be expensed immediately as a non-cash charge to results of operations. In the event we are required to record impairment charges related to our intangible assets in the future, we may not realize the full value of our intangible assets. Any future determination of impairment of a significant portion of goodwill or other identifiable intangible assets would have an adverse effect on our financial condition and results of operations.

    Other legal proceedings could adversely affect our sales and operating results.

We are involved in litigation and other disputes, including in foreign jurisdictions. In general, claims made by or against us in litigation, disputes or other proceedings can be expensive and time-consuming to bring or defend against and could result in settlements, injunctions or damages that could significantly affect our

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business or results of operations or financial condition. It is not possible to predict the final resolution of the litigation, disputes or proceedings with which we currently are or may in the future become involved. The impact of these matters on the Company's business, results of operations and financial condition could be material. See Note 4—Commitments and Contingencies in our accompanying audited consolidated financial statements contained in this Annual Report on Form 10-K for additional information related to these matters.

    Our continued growth through acquisitions or reliance on third party service providers could adversely affect our internal control over financial reporting, which could harm our business and financial results.

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of financial reporting for external purposes in accordance with accounting principles generally accepted in the United States. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of our financial statements would be prevented or detected. Growth and expansion in domestic and global markets, including through acquisitions, joint ventures or other strategic relationships, could place significant additional pressure on our system of internal control over financial reporting. Moreover, we have in the past engaged, and may in the future engage, the services of third parties to assist with our business operations, which inserts additional monitoring obligations and risk into the system of internal control. In addition to other products, we currently contract manufacture our aerosol products through third parties as a result of the fire at our Aerosol Facility. Any failure to maintain an effective system of internal control over financial reporting could limit our ability to report our financial results accurately and on a timely basis or to detect and prevent fraud.

    A failure of key information technology systems could adversely impact our ability to conduct business.

We rely extensively on information technology systems, some of which are managed by third party service providers, in order to conduct our business. These systems include, but are not limited to, programs and processes relating to internal and external communications, ordering and managing materials from suppliers and vendors, converting materials to finished products, shipping products to customers, processing transactions, summarizing and reporting results of operations, complying with regulatory, legal or tax requirements, administrative services, and other processes involved in managing our business. If our existing and/or future technology systems and processes do not adequately support the future growth of our business, our business could be materially adversely impacted. While we have business continuity plans in place, if the systems are damaged or cease to function properly due to any number of causes, including catastrophic events, power outages or other similar events, and if the business continuity plans do not effectively resolve such issues on a timely basis, we may suffer interruptions in the ability to manage or conduct business, which may materially adversely impact our business. Furthermore, if we suffer a loss as a result of a breakdown in our technology system or other breakdown results in disclosure of confidential business information, we may suffer reputational, competitive and/or business harm, which may adversely affect our results of operations and/or financial condition.


Risks Related to our Securities and Our Structure

    The market price for our common stock is volatile, and you may not be able to sell our stock at a favorable price.

Our common stock is traded on the New York Stock Exchange. The market price of our common stock is volatile and subject to wide fluctuations. This volatility may occur for many reasons, including for reasons unrelated to our performance, such as reports by industry analysts, investor perceptions, or negative announcements by our customers, competitors, or suppliers regarding their own performance, as well as general economic and industry conditions and the trading volume of shares of our common stock. Additional

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factors that could cause the market price of our common stock to rise and fall include, but are not limited to, the following:

    variations in our quarterly results;

    industrial accidents such as the fire that occurred at our Aerosol Facility;

    announcements of technological innovations by us or by our competitors;

    introductions of new products or services or new pricing policies by us or by our competitors;

    acquisitions or strategic alliances by us or by our competitors;

    recruitment or departure of key personnel or key groups of personnel;

    the gain or loss of significant orders;

    the gain or loss of significant customers;

    the disruption of supply and/or price of key raw materials;

    significant changes in regulatory requirements;

    increased litigation resulting from product or associate claims;

    adverse developments concerning environmental matters;

    changes in the estimates of our operating performance or changes in recommendations by the securities analysts that follow our stock;

    market conditions in our industry, the industries of our customers, and the economy as a whole; and

    the dilution of our earnings per share caused by our acquisition of another company or product line or because of our issuance of additional shares of our common stock or shares of a series of preferred stock or debt securities that are convertible into shares of our common stock.

    Certain provisions of our certificate of incorporation, bylaws and rights plan may discourage takeovers.

Our certificate of incorporation and bylaws contain certain anti-takeover provisions that may make more difficult or expensive or that may discourage a tender offer, change in control or takeover attempt that is opposed by our Board of Directors. In particular, our certificate of incorporation and by-laws:

    classify our Board of Directors into three groups, so that stockholders elect only one-third of the Board each year;

    permit stockholders to remove directors only for cause and only by the affirmative vote of at least 80% of our voting shares;

    permit a special stockholders' meeting to be called only by a majority of the Board of Directors;

    do not permit stockholders to take action except at an annual or special meeting of stockholders;

    require stockholders to give us advance notice to nominate candidates for election to our Board of Directors or to make stockholder proposals at a stockholders' meeting;

    permit our Board of Directors to issue, without stockholder approval, preferred stock with such terms as the Board may determine;

    require the vote of the holders of at least 80% of our voting shares for stockholder amendments to our by-laws; and

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    require, for the approval of a business combination with stockholders owning 5% or more of our voting shares, the vote of at least 50% of our voting shares not owned by such stockholder, unless certain "fair price" requirements are met or the business combination is approved by our continuing directors.

The preferred stock purchase rights attached to our shares of common stock, in effect, prevent a person or group from acquiring more than 15% of the total number of shares of our common stock outstanding at any time without obtaining prior approval from our Board of Directors, to be granted at the Board's sole discretion. In addition, Delaware law generally restricts mergers and other business combinations between us and any holder of 15% or more of our common stock, unless the transaction or the 15% acquisition is approved in advance by our Board of Directors.

These provisions of our certificate of incorporation and bylaws, Delaware law, and the preferred stock purchase rights could discourage potential acquisition proposals and could delay or prevent a change in control of our Company, even though a majority of our stockholders may consider such proposals, if effected, desirable. Such provisions could also make it more difficult for third parties to remove and replace the members of our Board of Directors. Moreover, these provisions could diminish the opportunities for stockholders to participate in certain tender offers, including tender offers at prices above the then-current market value of our common stock, and may also inhibit increases in the trading price of our common stock that could result from takeover attempts or speculation.

    Our by-laws provide that the Court of Chancery of the State of Delaware will be the exclusive forum for substantially all disputes between us and our stockholders, which could limit our stockholders' ability to obtain a judicial forum viewed by the stockholders as more favorable for disputes with us or our directors, officers or associates.

Our by-laws provide that the Court of Chancery of the State of Delaware is the exclusive forum for any derivative action or proceeding brought on our behalf; any action asserting a breach of fiduciary duty; any action asserting a claim against us arising pursuant to the Delaware General Corporation Law, our certificate of incorporation or our by-laws; or any action asserting a claim against us that is governed by the internal affairs doctrine. The choice of forum provision may limit a stockholder's ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers or other associates, which may discourage such lawsuits against us and our directors, officers and other associates. Alternatively, if a court were to find the choice of forum provision contained in our certificate of incorporation to be inapplicable or unenforceable in an action, we may incur additional costs associated with resolving such action in other jurisdictions, which could adversely affect our business and financial condition.


Item 1B. Unresolved Staff Comments

None.

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Item 2. Properties

Our corporate office and our primary manufacturing facilities are owned by us and are located in the metropolitan Atlanta, Georgia, area. We also have manufacturing facilities located at three additional sites in Georgia and in Texas, Canada, Italy, the Netherlands, and England. We own six of our nine manufacturing facilities. The facilities located in Italy, Canada and one of our other Atlanta locations are leased. Additionally, we own branch and storage facilities in Illinois and Washington. We lease sales offices and storage facilities throughout North America and Europe. Products sold to commercial, industrial and institutional markets are shipped from distribution branches throughout North America and Europe, which are supplied directly from our production facilities, and by one large distribution center in Atlanta. We also utilize warehouses maintained by third party logistics companies in our distribution network. We believe our facilities, which are adequate for our current needs, are in good operating condition. The following table sets forth information regarding our most significant facilities:

Location
  Function   Owned or Leased

Atlanta, Georgia

  Corporate Headquarters;   Owned

  Manufacturing of cleaners, sanitizers, wax, hand care, air fresheners, auto care, solvents, detergents and equipment    

Atlanta, Georgia

 

Equipment manufacturing

 

Leased

Marietta, Georgia*

 

Manufacturing of aerosol cleaners, adhesives, air care, auto care, insecticides, lubricants and polishes

 

Owned

Emerson, Georgia

 

Manufacturing of cleaners, disinfectants and pesticides

 

Owned

DeSoto, Texas

 

Manufacturing of cleaners, sanitizers, grease, and pesticides

 

Owned

Edmonton, Alberta

 

Manufacturing of cleaners, sanitizers and polishes

 

Leased

Bagnolo, Italy

 

Manufacturing of cleaners, sanitizers, solvents and detergents

 

Leased

Bergen op Zoom, The Netherlands

 

Manufacturing of cleaners, sanitizers, polishes and solvents

 

Owned

Widnes, England

 

Manufacturing of cleaners, sanitizers, polishes, specialty blends

 

Owned


*
Damaged by fire. See "Fire at Aerosol Facility" in Item 1 of this report.


Item 3. Legal Proceedings

The Company is party to litigation incidental to our business from time to time. For additional information regarding litigation to which we are a part, see Note 4—Commitments and Contingencies in our accompanying audited consolidated financial statements (Part II, Item 8 of this Form 10-K), which is incorporated by reference into this item.


Item 4. Mine Safety Disclosures

Not applicable.

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PART II


Item 5. Market for Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities

Our common stock is traded on the New York Stock Exchange under the symbol "ZEP". There were 3,118 stockholders of record as of November 6, 2014. This figure does not include an estimate of the indeterminate number of beneficial holders whose shares may be held of record by brokerage firms and clearing agencies. The following table sets forth the New York Stock Exchange high and low sale prices and the dividend payments for our common stock for the periods indicated.

 
  Price per Share    
 
 
  Dividends
Per Share
 
 
  High   Low  

2014

                   

First Quarter

  $ 21.34   $ 14.09   $ 0.05  

Second Quarter

  $ 19.63   $ 15.23   $ 0.05  

Third Quarter

  $ 19.05   $ 16.72   $ 0.05  

Fourth Quarter

  $ 18.26   $ 15.19   $ 0.05  

2013

   
 
   
 
   
 
 

First Quarter

  $ 16.00   $ 11.87   $ 0.04  

Second Quarter

  $ 15.29   $ 12.28   $ 0.04  

Third Quarter

  $ 16.94   $ 14.26   $ 0.04  

Fourth Quarter

  $ 17.04   $ 12.64   $ 0.04  

We increased our dividend payments to an annual rate of $0.20 per share in the first quarter of fiscal 2014. Our Board of Directors evaluates our dividend policy quarterly, taking into consideration the composition of our stockholder base; our financial condition, earnings and funding requirements; our growth prospects; applicable law; and any other factors our Board of Directors deems, in its discretion, relevant. Our Board of Directors reviews our capital structure, including our dividend policy, quarterly to ensure it remains aligned with the best interest of our stockholders.

Our ability to fund a regular quarterly dividend is impacted by our financial results and the availability of surplus funds. All dividends are paid out of current year earnings. Delaware law prohibits the payment of dividends or otherwise distributing funds to our stockholders absent a legally available surplus. There can be no assurance that we will continue to pay quarterly dividends at this level or at all in the future. Also, restrictions under the instruments governing our indebtedness could impair our ability to make dividend payments in the future.

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Stockholder Return Performance Graph

The following Performance Graph and related information shall not be deemed "soliciting material" or deemed to be "filed" with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933, as amended, or the Exchange Act except to the extent that we specifically incorporate such information by reference into such filing.

The following graph compares the change in cumulative total stockholders' return on our common stock with (a) the S&P SmallCap 600 Index and (b) the Russell 2000 Index, for each year from August 31, 2009 through August 31, 2014. The graph assumes an initial investment of $100 at the closing price on August 31, 2009 and assumes all dividends were reinvested. We have presented the Russell 2000 Index in lieu of an industry index or peer group because we believe there is no published industry index or peer group that adequately compares to our business. The figures for the chart and graph set forth below have been calculated based on the closing prices on the last trading day on the New York Stock Exchange for each period indicated.

GRAPHIC

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Item 6. Selected Financial Data

The following table sets forth our selected financial data, which has been derived from our Consolidated Financial Statements for each of the five years ended August 31, 2014:

 
  Years Ended August 31,  
 
  2014   2013   2012   2011   2010  
 
  (In thousands, except per share amounts)
 

Summary of Operations Data:

                               

Net sales

  $ 696,489   $ 689,576   $ 653,533   $ 645,972   $ 568,512  

Operating profit

    32,796     32,789     38,280     33,217     23,852  

Net income

    8,400     15,192     21,909     17,401     13,504  

Basic earnings per share

  $ 0.38   $ 0.69   $ 1.00   $ 0.80   $ 0.62  

Diluted earnings per share

    0.37     0.68     0.98     0.78     0.61  

Cash dividends declared per common share

    0.20     0.16     0.16     0.16     0.16  

Basic weighted average number of shares outstanding

    22,307     21,969     21,768     21,540     21,271  

Diluted weighted average number of shares outstanding

    22,906     22,435     22,166     22,027     21,738  

Balance Sheet Data (at period end):

   
 
   
 
   
 
   
 
   
 
 

Cash and cash equivalents

  $ 14,303   $ 2,402   $ 3,513   $ 7,219   $ 25,257  

Total assets

    556,211     547,758     435,287     403,769     342,848  

Long-term debt (including current portion)

    207,156     209,908     139,250     119,650     92,150  

Stockholders' equity

    193,379     183,969     167,917     149,123     122,173  

Other Data:

   
 
   
 
   
 
   
 
   
 
 

Cash provided by operations

  $ 22,271   $ 50,016   $ 22,607   $ 37,001   $ 34,023  

Operating working capital(1)

    118,086     116,743     111,512     100,007     92,629  

(1)
Operating working capital is defined as the sum of accounts receivable and inventory less accounts payable.

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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with Item 1A. Risk Factors, Item 6. Selected Financial Data, Item 8. Financial Statements and Supplementary Data, including the notes thereto, and the other financial information included elsewhere in this Annual Report on Form 10-K. Statements made in this Item 7 may constitute forward-looking statements. Please see "Cautionary Statement Regarding Forward-Looking Information" for a discussion of the uncertainties, risks and assumptions associated with these statements.


Overview

    Company

Zep Inc. is a leading consumable chemical packaged goods company, providing a wide variety of high-performance chemicals and related products and services that help professionals maintain, clean and protect their assets. We market our products and services under well recognized brand names, including Zep®, Zep Professional®, Zep Commercial®, Zep Automotive® and other Zep Inc. brands. Our product portfolio, which is currently produced using more than 4,000 unique formulations, includes anti-bacterial and industrial hand care products, cleaners, degreasers, deodorizers, disinfectants, floor finishes, sanitizers, pest- and weed-control products, air-care products and delivery systems and a wide variety of automotive maintenance chemicals. We sell our products through a sales and service organization, to national and regional business-to-business distributors that target the transportation, industrial maintenance and janitorial and sanitation markets, and to home improvement stores and automotive after-market retailers.

    Fire at Aerosol Manufacturing Facility

On May 23, 2014, a fire occurred at our aerosol manufacturing facility located in Marietta, Georgia (the "Aerosol Facility"). The fire, the cause of which remains unknown, destroyed our chemical raw material warehouse and damaged other supporting infrastructure that contains or supports our production equipment. Some of the work in process, raw material and finished goods inventory located there was also destroyed or damaged. The products manufactured at the Aerosol Facility included cleaning and maintenance chemicals, lubricants and automotive brake cleaner and accounted for approximately 19% of our revenue for fiscal 2013.

We also have arranged for contract manufacturers, one of which was already producing certain aerosol products for us, to manufacture products formerly produced in the Aerosol Facility. We also resumed production at the Aerosol Facility on a limited basis in an attempt to mitigate revenue loss resulting from the fire. We are assisting the contract manufacturers in their efforts to satisfy our requirements for the products by loaning them production equipment and assigning some of our associates to work with them, as needed. However, despite these efforts, the contract manufacturers are currently unable to manufacture our products in the volume and mix required to satisfy all customer requirements for the products. Furthermore, we have experienced delays in obtaining supplies of some raw materials necessary for the contract manufacturer to produce our products at the required rate. These conditions could continue in the foreseeable future.

Our inability to fulfill customer requirements has resulted in the loss of certain customers and will likely result in temporary or permanent loss of customers or market share for our aerosol products, and, thus, a loss of revenue, which may be material. The impact of lost sales related to the fire for fiscal 2014 was approximately $7.5 million with an estimated impact to profit before tax of $2.4 million. We expect that for at least the next few quarters our business will continue to be impacted by the inability to fully meet customer requirements. We expect that our business interruption insurance will cover these losses for a period of time that will be determined through discussion with our insurance companies. No insurance recoveries have been recorded to date related to lost sales. The timing of the receipt of insurance proceeds from losses relating to the fire may be different than from when those losses are incurred or when cash is spent. Any material loss of revenue resulting from the fire and its aftermath that is not covered by our insurance policy could have a material impact on our financial condition and results of operations.

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Through August 31, 2014, we have incurred costs totaling $18.1 million related to the fire, including a $3.0 million write-off of fixed assets and a $2.1 million write-down of inventory. Based on the provisions of the Company's insurance policies and management's estimates, the losses incurred have been reduced by the estimated insurance recoveries. The Company has determined that recovery of the incurred losses is probable and recorded $18.1 million of insurance recoveries through August 31, 2014. In June 2014, we received $5.0 million of insurance proceeds, representing an advance of funds to defray the expenses we incurred to begin cleaning the property, to evaluate the extent of the damage and to outsource the production of our products to the contract manufacturers. As a result, the insurance receivable balance was $13.1 million as of August 31, 2014. In September 2014, we received an additional $11.9 million of insurance proceeds as an advance for the damage to the facility.

See additional information related to the impact of the fire at Note 2—Fire at Aerosol Manufacturing Facility and Part I, Item 1A. Risk Factors.

    Full Year Highlights

    Net sales for fiscal 2014 were $696.5 million, an increase of $6.9 million, or 1.0%, as compared to $689.6 million reported for the same period a year ago. The increase is due to the inclusion of first quarter fiscal 2014 EVC sales, which added $16.1 million to net sales, partially offset by organic sales volume declines of $8.8 million due to declines in North American Sales and Service sales and our complexity reduction initiative. We realized sales growth in certain strategic end markets, such as transportation, home improvement retailers and oil and gas. In the fourth quarter of fiscal 2014, we estimate that we lost approximately $7.5 million of sales as a result of the fire at our Aerosol Facility, which was partially offset by $7.0 million of raw material sales at no profit to our contract manufacturers to help facilitate the ramp up of aerosol production.

    Gross profit for fiscal 2014 was $326.8 million, an increase of 0.7% compared to $324.5 million reported for the same period a year ago. Gross profit as a percentage of net sales declined slightly to 46.9% in fiscal 2014 as compared to 47.1% in fiscal 2013 due to the impact of raw material sold at no margin to our contract manufacturers in the fourth quarter of fiscal 2014, which reduced our gross profit margin by 0.5%. The reduced gross profit margin was partially offset by improved sales channel mix resulting from our EVC acquisition.

    Fiscal 2014 results have been significantly impacted by four items: the resolution of the California Sales Representative Litigation which began in 2010, a provision for loan loss, the impact of the fire at our Aerosol Facility and continued acquisition and integration costs. We incurred $7.2 million of costs associated with legal fees and settlement costs during the fiscal 2014 associated with the California Sales Representative Litigation. We recorded a $5.3 million provision for loan loss related to sale of a loan receivable. We also incurred $1.1 million of acquisition and integration costs associated with the acquisition of EVC, integration of operations in the United Kingdom and the write-down of a building that was sold in March 2014.

    We reported net income of $8.4 million for fiscal 2014, which is down from $15.2 million for fiscal 2013, primarily due to costs associated with the California Sales Representative Litigation and the loan loss provision.

    Strategy and Outlook

Our strategy is to be a leading provider of maintenance and cleaning products and services to customers engaged in Transportation, Industrial/MRO and Jan/San and Institutional markets. We have made great progress with transforming our business over the past five years by developing a multi-channel and multi-brand approach designed to serve the customers the way they want to be served. Our primary retail brand, Zep Commercial, is available at thousands of retail locations throughout North America including Ace Hardware, The Home Depot, Lowes, Menards, Tractor Supply, and True Value. Furthermore, since 2009 we

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doubled the percentage of our total sales generated from the distribution and retail channels. Execution of our strategy has increased the global reach of Zep's brand. We have established a presence in the United Kingdom and are expanding our network of distributors in China. The combination of these actions has driven broader access to markets and an expanded product portfolio, but also increased the complexity that comes with managing distinct information systems, inventories, go-to-market strategies, and related processes.

In fiscal 2015, we intend to make investments to strengthen our existing platforms for future organic growth. We expect to add sales capacity across the business with a particular focus on the Transportation and Industrial/MRO markets. We expect to continue optimizing our supply chain to realize sourcing efficiencies and minimize shipping and logistics costs. Finally, we expect to invest in bringing innovative products and solutions to market.

We expect the recovery efforts relating to the May 23, 2014 fire at our Aerosol Facility will consume a significant amount of resources during the first half of fiscal 2015. As a result, we expect our supply chain to proceed with the proper cadence, realizing that executing our business continuity plan and preserving existing customer relationships is our top priority, followed closely by realizing longer-term supply chain efficiencies and sourcing and logistics cost reductions.

We expect to see continued organic sales growth in certain markets, potentially offset by sales lost as a result of the fire which could result in flat sales. We believe that our investments in our growth initiatives will yield positive future financial results. We further believe that insurance proceeds will offset property losses and a portion of the margin associated with lost sales.


Results of Operations

    Fiscal Year 2014 Compared with Fiscal Year 2013

The following table sets forth information comparing the components of net income for the year ended August 31, 2014 with the year ended August 31, 2013. Both dollar and percentage changes included within the tables below were calculated from our consolidated statements of operations.

 
  Year Ended August 31,    
 
(dollars in millions)


  2014   % of
net sales
  2013   % of
net sales
  Percent
Change
 

Net sales

  $ 696.5         $ 689.6           1.0  

Gross profit

    326.8     46.9     324.5     47.1     0.7  

Selling, distribution and administrative expenses

    293.4     42.1     283.1     41.1     3.6  

Acquisition and integration costs

    1.1     0.2     3.5     0.5     (69.0 )

Restructuring charges

    (0.5 )   (0.1 )   5.2     0.7      

Operating profit

    32.8     4.7     32.8     4.8      

Other expense (income)

                               

Interest expense, net

    11.8     1.7     9.0     1.3     31.9  

Provision for loan loss

    5.3     0.8              

Other expense, net

    1.6     0.2     0.7     0.1     116.4  

Income before income taxes

    14.1     2.0     23.1     3.3     (38.9 )

Income tax provision

    5.7     0.8     7.9     1.1     (27.8 )

Net income

    8.4     1.2     15.2     2.2     (44.7 )

Net sales totaled $696.5 million for the year ended August 31, 2014, compared with $689.6 million in the prior fiscal year, an increase of $6.9 million, or 1.0%. Volume increases were the result of the inclusion of first quarter of fiscal 2014 EVC sales, which added $16.1 million to net sales, partially offset by organic sales volume declines of $8.8 million due to declines in North American Sales and Service sales and our complexity reduction initiative. During the year ended August 31, 2014, we realized sales growth in our strategic end markets, such as transportation, home improvement retailers and oil and gas that was more than offset by

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declines in certain industrial and institutional end markets, declines caused by our complexity reduction initiative and the impact of severe weather during the December-February time frame that impacted both our operations as well as demand from our customers. In the fourth quarter of fiscal 2014, we estimate that we lost approximately $7.5 million of sales as a result of the fire at our Aerosol Facility, which was partially offset by $7.0 million of raw material sales to our contract manufacturers at no profit to help facilitate the ramp up of aerosol production. Price increases of $1.3 million were offset by unfavorable foreign currency translation of $1.4 million.

Gross profit increased $2.3 million, or 0.7%, to $326.8 million in fiscal year 2014 compared with $324.5 million in the prior fiscal year. Gross profit as a percentage of net sales declined slightly to 46.9% in fiscal 2014 as compared to 47.1% in fiscal 2013 due to the impact of the raw material sold to our contract manufacturers at no margin in the fourth quarter of fiscal 2014, which reduced our gross profit margin by 0.5%. This reduced gross profit margin was partially offset by improved sales channel mix resulting from our EVC acquisition.

Selling, distribution and administrative expenses increased $10.3 million, or 3.6%, over the comparative period in 2013. This was due in part to the inclusion of EVC expenses in the first quarter of fiscal 2014, increased freight costs and higher legal expenses associated with the California Sales Representative Litigation during fiscal 2014, partially offset by lower compensation costs resulting from restructuring actions initiated in the fourth quarter of fiscal 2013. Selling, distribution and administrative expenses also increased as a percentage of net sales due to higher legal expenses associated with the California Sales Representative Litigation and increased freight expenditures.

We incurred $7.2 million of legal fees and settlement costs in fiscal 2014 associated with the California Sales Representative Litigation compared to $1.6 million in fiscal 2013 (see Note 4—Commitments and Contingencies). Of the $7.2 million, $6.0 million was included in selling, distribution and administrative expenses while $1.1 million has been included in interest expense, net, on the consolidated statement of operations.

The 2013 comparative period includes a $1.4 million favorable adjustment related to a legal settlement and a $1.3 million favorable adjustment to the contingent consideration liability associated with a 2011 acquisition.

In fiscal 2013, we began executing a complexity-reduction initiative that includes the consolidation of certain facilities, process simplification, product-line and customer rationalization, and headcount reductions. Pursuant to the initiative, during the fourth quarter of fiscal 2013, we announced we were reducing the number of non-sales associates by approximately 6% and closing certain branch locations. In August 2013, we recognized $5.2 million of expenses within Restructuring charges in connection with these efforts. In the fourth quarter of fiscal 2014, we determined that certain elements of our restructuring plan related to Europe would not be completed and therefore we reversed the previously recorded expense. Restructuring charges, net of $0.5 million for fiscal 2014, include a $0.6 million favorable adjustment related to Europe, partially offset by an additional $0.1 million of costs associated with facility exit costs.

Operating profit of $32.8 million was flat as compared with the prior fiscal year. Operating profit for fiscal 2014 was impacted by the inclusion of the legal and settlement costs described above, and $1.1 million of acquisition and integration costs associated with the acquisition of EVC, the continued integration of recently acquired operations in the United Kingdom and the write-down of the value of a building that was sold in March 2014. Operating profit in fiscal 2013 was similarly impacted by the inclusion of $3.5 million of acquisition and integration costs and $5.2 million of restructuring costs described above.

Interest expense, net increased from $9.0 million in fiscal 2013 to $11.8 million in fiscal 2014 due the inclusion of $1.1 million in interest expense associated with settlements made in the California Sales Representative Litigation as well as increased borrowings under our 2010 Credit Facility (as defined below) that were used to fund the acquisition of EVC. Interest expense also includes the write-off of $0.6 million of debt issuance costs associated with the 2010 Credit Facility that were written off as a result of the refinancing of our credit facility in August 2014. Interest expense, net includes $0.4 million of interest income attributable

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to the loan made to our innovation partner, Adco (see Note 6—Loan to Innovation Partner) as compared to $0.7 million in the prior year. While interest associated with our debt is variable in nature, we expect net interest to range between $6 million and $7 million in fiscal 2015.

In fiscal 2014, we also recorded a $5.3 million provision for loan loss related to the sale of a loan receivable (see Note 6—Loan to Innovation Partner).

The effective tax rate for fiscal 2014 was 40.4%, compared with 34.2% for fiscal 2013. The rate increased from the prior year primarily due to the non-recurrence of the extension of the U.S. research and development tax credit in the third quarter of fiscal year 2013, the non-recurrence of a favorable discrete item in the third quarter of fiscal 2013 for a closed audit, an increase mainly in domestic permanent non-deductible expenses for nonrecurring legal and regulatory fines, an increase in foreign permanent non-deductible expenses and an increase in state tax expense as a result of changes in state law requirements, partially offset by changes in valuation allowances on state tax credits and the recognition of a state benefit for disallowed federal bonus depreciation. We anticipate our effective tax rate for fiscal 2015 will range between 37.0% and 39%, depending on the relative mix of income in various jurisdictions.

Diluted earnings per share generated in fiscal 2014 totaled $0.37, compared to $0.68 in fiscal 2013.

    Fiscal Year 2013 Compared with Fiscal Year 2012

The following table sets forth information comparing the components of net income for the year ended August 31, 2013 with the year ended August 31, 2012. Both dollar and percentage changes included within the tables below were calculated from our consolidated statements of operations.

 
  Year Ended August 31,    
 
(dollars in millions)


  2013   % of
net sales
  2012   % of
net sales
  Percent
Change
 

Net sales

  $ 689.6         $ 653.5           5.5  

Gross profit

    324.5     47.1     300.8     46.0     7.9  

Selling, distribution and administrative expenses

    283.1     41.1     260.8     39.9     8.5  

Acquisition and integration costs

    3.5     0.5     1.7     0.3     105.8  

Restructuring charges

    5.2     0.7             100.0  

Operating profit

    32.8     4.8     38.3     5.9     (14.3 )

Other expense (income)

                               

Interest expense, net

    9.0     1.3     5.5     0.8     63.1  

Bargain purchase gains from business combinations

            (2.1 )   (0.3 )    

Other expense, net

    0.7     0.1     1.0     0.2     (28.9 )

Income before income taxes

    23.1     3.3     33.8     5.2     (31.8 )

Income tax provision

    7.9     1.1     11.9     1.8     (33.8 )

Net income

    15.2     2.2     21.9     3.4     (30.7 )

Net sales totaled $689.6 million for the year ended August 31, 2013, compared with $653.5 million in the prior fiscal year, an increase of $36.0 million, or 5.5%. Incremental revenue associated with the EVC acquisition and higher selling prices added $55.2 million and $5.4 million to Net Sales, respectively. These increases were partially offset by a decline of $19.4 million of organic volume-related sales. During fiscal 2013, we implemented a new enterprise resource planning ("ERP") system in certain portions of our business. While we believe that, over the long-term, our business will benefit from this investment, we attribute some of this $19.4 million decline to the temporary disruption that resulted from this implementation. Separately, our fiscal 2013 included two less selling days than fiscal year 2012, which is responsible for approximately $5.2 million of lower sales volume compared with the prior fiscal year. Overall, Net Sales in fiscal 2013 reflected mixed results as growth in sales to customers that serve the Transportation, and Industrial/MRO, markets was more than offset by sales volume declines with other customers, primarily those in Jan/San and

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institutional markets. The fluctuation of foreign currency had an immaterial effect on our Net Sales during fiscal 2013.

Gross profit increased $23.7 million, or 7.9%, to $324.5 million in fiscal 2013 compared with $300.8 million in the prior fiscal year. Gross profit margin was 47.1% in fiscal year 2013, representing an approximate 110 basis point increase from the prior fiscal year. The improvement in gross profit margin was due primarily to the inclusion of EVC's post-acquisition operating results.

Selling, distribution and administrative expenses increased $22.3 million, or 8.5%, as a percentage of net sales, as compared to the same period in fiscal 2012 primarily due to the inclusion of EVC related identifiable intangible asset amortization expense in our year to date results as well as increased depreciation expense associated with our ERP implementation. While the EVC acquisition and the related non-cash amortization expense adversely impacted our ratio of selling, distribution and administrative expense as a percentage of net sales for fiscal 2013, given the higher gross profit margins generated by EVC, sales through this entity result in a higher overall profit margin for us.

As discussed above, we recognized $5.2 million of expenses within Restructuring Charges in connection with a complexity-reduction initiative that includes the consolidation of certain facilities, process simplification, product-line and customer rationalization, and headcount reductions. We did not incur material restructuring costs during fiscal 2012.

Acquisition and integration costs totaled $3.5 million in fiscal 2013 due to our acquisition of EVC as well as the continued integration of recently acquired operations in the United Kingdom. Acquisition and Integration Costs totaled $1.7 million in fiscal 2012 due to the acquisitions of Washtronics, Hale Group, and Mykal. We expense all costs associated with advisory, legal and other due diligence-related services used in connection with acquisition-related activity in the period that we incur those costs.

We ceased using and subsequently listed a facility in Lancaster, Texas for sale during fiscal 2010. This asset was classified as held-for-sale and actively marketed. During fiscal 2013 and 2012, we recorded write-downs of $0.4 million and $0.5 million, respectively, to properly state this asset in accordance with its fair market value. These write-downs have been included in Acquisition and integration costs.

We incurred approximately $1.6 million of costs associated with legal defense fees during fiscal 2013 in connection with the California Sales Representative Litigation that are discussed further in Note 4—Commitments and Contingencies in the notes to our consolidated financial statements. Total expenses incurred in connection with these matters in fiscal 2012 totaled $2.1 million. We recognize legal costs in Selling, distribution, and administrative expenses within our consolidated statements of operations.

Interest expense, net increased $3.5 million due primarily to the increased borrowings under our 2010 Credit Facility in connection with our funding of the EVC acquisition. Interest expense, net in fiscal 2013 includes $0.9 million of interest income attributable to the loan made to Adco. Bargain purchase gains from business combinations during fiscal 2012 includes approximately $2.1 million of such gains that we recognized upon concluding our purchase accounting evaluation of the Washtronics and Hale Group acquisitions. The gain related to the Hale Group acquisition reflects our recognition of a pension asset whose value was not considered in this acquisition's purchase price and that is associated with the overfunded status of a defined benefit pension plan maintained by the Hale Group. Bargain purchase gains from business combinations did not recur in fiscal 2013. Interest expense, net in fiscal 2012 includes $0.7 million of interest income attributable to the loan made to Adco.

Net income for fiscal 2013 decreased $6.7 million, or 30.7%, to $15.2 million, compared with $21.9 million reported in the prior year period. The effective tax rate for fiscal year 2013 was 34.2%, compared with 35.2% in the prior year. Our effective tax rate declined compared with the same prior year period due to the relative mix of income earned in various jurisdictions; the recognition of a discrete item in the third quarter of fiscal year 2013; and the non-recurrence of prior year acquisition costs that were incurred in the United Kingdom and were non-deductible.

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Diluted earnings per share generated in fiscal 2013 totaled $0.68, representing a decrease of $0.30 per diluted share from the $0.98 per diluted share earned in the prior year. Earnings in fiscal 2013 were negatively impacted by $0.15 per diluted share of restructuring-related charges recorded during August of 2013, and $0.09 per diluted share due to acquisition and integration related costs recorded throughout fiscal 2013.


Liquidity and Capital Resources

The following table sets forth certain indicators of our consolidated financial condition and liquidity as of the end of the fiscal years shown (dollars in thousands):

 
  2014   2013   2012  

Cash and cash equivalents

  $ 14,303   $ 2,402   $ 3,513  

Operating working capital

    118,086     116,743     111,512  

Total debt and capital lease obligations

    207,156     209,908     139,250  

Stockholders' equity

    193,379     183,969     167,917  

We have three principal sources of near-term liquidity: (1) existing cash and cash equivalents; (2) cash generated by operations; and (3) available borrowing capacity under our five-year senior, secured credit facility (the "2014 Credit Facility"), which provides for a maximum borrowing capacity of $325 million. As of August 31, 2014, we had approximately $104 million available under the 2014 Credit Facility. In addition, at August 31, 2014, we had $7.2 million of industrial revenue bonds outstanding that are due in 2018. Our industrial revenue bonds were issued by the City of DeSoto Industrial Development Authority, Inc. in May 1991 in connection with the construction of our facility in DeSoto, Texas. We have outstanding letters of credit totaling $10 million for the purpose of providing credit support for our industrial revenue bonds, securing collateral requirements under our casualty insurance programs and securing certain environmental obligations. These letters of credit were issued under the 2014 Credit Facility as of August 31, 2014, thereby reducing the total availability under the facility by such amount. We have given notice of our intent to redeem the bonds in the first quarter of fiscal 2015 using funds available under the 2014 Credit Facility.

As of August 31, 2014, we had $14.3 million in cash and cash equivalents, of which $4.2 million was held by our foreign subsidiaries. Cash and cash equivalents held by our foreign subsidiaries averaged $12.7 million during fiscal 2014. If in the future it becomes necessary to use all or a portion of the accumulated earnings generated by our foreign subsidiaries for our U.S. operations, we would be required to accrue and pay U.S. taxes on the funds repatriated for use within our U.S. operations. Our plans do not demonstrate a need to repatriate foreign earnings to fund our U.S. operations. Rather, our intent is to reinvest earnings generated by our foreign subsidiaries indefinitely outside of the U.S. for purposes including but not limited to growing our international operations through acquisitions.

We were in compliance with our debt covenants as of August 31, 2014, and we believe that our liquidity and capital resources are sufficient to meet our working capital, capital expenditure and other anticipated cash requirements over the next twelve months. In fiscal 2015, we expect sources of cash to include cash flow from operations as well as insurance proceeds relating to the fire at our Aerosol Facility. Our intended uses of cash in fiscal 2015 include investments in the organization to promote organic growth and rebuilding aerosol production capabilities, while in the past much of our cash uses were focused on external acquisitions. We have an effective shelf registration statement that registers the issuance of up to an aggregate of $300 million of equity, debt, and certain other types of securities through one or more future offerings. The net proceeds from the sale of any securities pursuant to the shelf registration statement may be used for general corporate purposes, which may include funding capital expenditures, pursuing growth initiatives, whether through acquisitions, joint ventures or otherwise, repaying or refinancing indebtedness or other obligations, and financing working capital.

Net debt, which is defined as Current maturities of long-term debt plus Long-term debt, less current maturities minus Cash and cash equivalents, as of August 31, 2014, was $192.9 million, a decrease of

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$14.7 million compared with August 31, 2013. The decrease in net debt primarily reflects net repayments of borrowings under our 2010 Credit Facility in fiscal 2014.

    Cash Flow

We use available cash and cash flow provided by operating activities primarily to fund debt service obligations, operations, capital expenditures and dividend payments to stockholders. Net cash provided by operating activities for the fiscal years ended August 31, 2014, 2013 and 2012 was $22.3 million, $50.0 million and $22.6 million, respectively. Cash flow from operating activities decreased $27.7 million in fiscal 2014 as compared to fiscal 2013 due to changes in our operating working capital, the majority of which relates to inventory increases, increased management bonus payments related to fiscal 2013 and lower management bonus accruals in fiscal 2014, payments made related to our restructuring plans and lower net income.

Through August 31, 2014, we received $5.0 million of insurance proceeds, of which we have classified $3.8 million as operating activities as those funds represented an advance of funds to defray the expenses we incurred in relation to the fire at our Aerosol Facility to begin cleaning the property, to evaluate the extent of the damage, to replace inventory destroyed in the fire, and to outsource the production of our products to the contract manufacturer.

Through August 31, 2014, we have incurred costs totaling $18.1 million related to the fire, including a $3.0 million write-off of fixed assets and a $2.1 million write-down of inventory. Based on the provisions of the Company's insurance policies and management's estimates, the losses incurred have been reduced by the estimated insurance recoveries. The Company has determined that recovery of the incurred losses is probable and recorded $18.1 million of insurance recoveries through August 31, 2014. As noted above, in June 2014, we received $5.0 million of insurance proceeds. As a result, the insurance receivable balance was $13.1 million as of August 31, 2014. In September 2014, we received an additional $11.9 million of insurance proceeds to reimburse us for the damage to the facility.

Included in cash flow from operating activities in fiscal 2014, 2013 and 2012 are $11.2 million, $7.8 million and $5.5 million of interest payments, respectively. Cash flow from operating activities also included $8.2 million, $5.2 million and $8.6 million of cash paid for income taxes in fiscal 2014, 2013 and 2012, respectively.

Net cash provided by operating activities for the fiscal years ended August 31, 2013 and 2012 was $50.0 million and $22.6 million, respectively. Net cash provided by cash for the fiscal year ended August 31, 2013 increased $27.4 million, or 121%, from the prior year, due in part to improvements in our operating working capital, almost all of which was related to inventory reductions. We defined operating working capital as Accounts receivable, less reserve for doubtful accounts, plus Inventories, minus Accounts payable. During the fiscal year ended August 31, 2012, the decision to increase inventory levels in advance of our ERP system implementation and the timing of the payments associated with that inventory resulted in an increase of our operating working capital. As a result, we used approximately $12 million less to fund inventory during fiscal 2013 than was used in the prior fiscal year. The $11.1 million increase to fiscal 2013 operating cash flow from Accrued compensation and other current liabilities reflects accruals for restructuring charges and adjustments to our cash-based incentive programs that were recorded during that year's fourth quarter. See Note 7—Restructuring Charges for further information regarding the 2013 restructuring actions. The $2.8 million of cash used to fund Self-insurance reserves and other long-term liabilities in fiscal 2013 is an improvement of $2.5 million and reflects payments made in the normal course with the earlier-described environmental remediation as well as a decrease in the expenses associated with certain of our insurance programs. The bargain purchase gains recorded during fiscal 2012 did not recur during fiscal 2014 or 2013 and are described further in Note 16—Acquisitions of the accompanying consolidated financial statements.

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The majority of the share-based compensation expense generated through the administration of our share-based equity award programs does not affect our overall cash position. Accordingly, Net cash provided by operating activities includes approximately $3.3 million of share-based expense, which is presented as Other non-cash charges within our consolidated statements of cash flows.

In fiscal 2014, we increased our annualized cash dividends on our common stock from $0.16 per share in fiscal 2013 to $0.20 per share, resulting in cash dividend payments of $4.5 million for fiscal 2014. Our ability to generate positive cash flow from operating activities directly affects our ability to make dividend payments. In addition, restrictions under the instruments governing our indebtedness could impair our ability to make such payments. Payments on our indebtedness and the quarterly dividends are expected to account for the majority of our financing activities as they pertain to normal operations.

Management believes that investing in assets and programs that will over time increase the overall return on our invested capital is a key factor in driving stockholder value. We invested $9.6 million, $12.1 million and $18.4 million in fiscal 2014, 2013 and 2012, respectively, on such assets and programs. The year-over-year decrease in capital spending is primarily due to the funding of ERP implementation activities in fiscal 2012 ahead of the December 1, 2012 implementation date. Fiscal 2013 and 2014 also include ERP implementation costs associated with integrating our EVC acquisition effective December 1, 2013. We continue to invest in these items primarily to improve productivity and product quality, increase manufacturing efficiencies, and enhance customer service capabilities. We expect capital expenditures to be approximately $25 million to $30 million in fiscal 2015, including amounts related to replacing our aerosol production capabilities.


Off Balance Sheet Arrangements

    Contractual Obligations

The following table summarizes our contractual obligations at August 31, 2014 (in thousands):

 
   
  Payments Due by Period  
 
  Total   Less than
One Year
  1 to 3
Years
  3 to 5
Years
  After
5 Years
 

Long-term debt and capital leases(1)

  $ 207,156   $ 20,006   $ 40,000   $ 147,150   $  

Interest obligations(2)

    25,667     6,142     11,003     8,522      

Operating leases(3)

    24,913     7,923     9,666     7,324        

Securitized borrowings(4)

    8,632     8,632              

Purchase obligations(5)

    60,466     60,466              

Other long-term liabilities(6)

    8,051     3,583     1,967     948     1,553  
                       

Total(7)

  $ 334,885   $ 106,752   $ 62,636   $ 163,944   $ 1,553  
                       
                       

(1)
These amounts (which represent outstanding debt at August 31, 2014) are included in our consolidated balance sheets. The current versus long-term presentation of our outstanding debt within these statements reflects our intent and ability to refinance certain amounts of outstanding debt that are otherwise contractually due within one year. Further detail regarding our debt instruments is provided in the preceding Liquidity and Capital Resources section as well as in Note 3—Debt in our accompanying consolidated financial statements.

(2)
These amounts represent expected future interest payments on debt that are contractually due within one year but that we anticipate will remain outstanding for longer periods given a consistent interest rate environment as well as our ability and intent to refinance certain borrowings made under our 2014 Credit Facility. Also included in these expected future interest payments are estimates of interest expense related to our $7.2 million industrial revenue bonds that are scheduled to be redeemed during the first quarter of fiscal 2015.

(3)
Our operating lease obligations are described in Note 13—Property, Plant and Equipment in our accompanying consolidated financial statements.

(4)
Our securitized borrowings under our Master Receivables Purchase Agreement with Bank of America N.A. are described in Note 11—Accounts Receivable in our accompanying consolidated financial statements.

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(5)
Purchase obligations include commitments to purchase goods or services that specify all significant terms, including orders with contract manufacturers to produce aerosol products. This amount is primarily composed of cancelable purchase orders that were open as of August 31, 2014.

(6)
These amounts are included in our consolidated balance sheets and largely represent liabilities on which we are obligated to make future payments pursuant to certain deferred compensation programs addressed within Note 15—Other Long Term Liabilities in our accompanying consolidated financial statements. Estimates of the value and timing of these amounts are based on various assumptions, including interest rates and other variables.

(7)
At August 31, 2014, our liability recorded for uncertain tax positions, including associated interest and penalties, was approximately $0.8 million. Since the ultimate amount and timing of other potential audit related cash settlements cannot be predicted with reasonable certainty, liabilities for uncertain tax positions are excluded from the contractual obligations table above. See further discussion in Note 9—Income Taxes in our accompanying consolidated financial statements.


Critical Accounting Estimates

Our discussion and analysis of our results of operations, liquidity and capital resources are based on our consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP). In connection with the preparation of our consolidated financial statements, we are required to make assumptions and estimates about future events, and apply judgments that affect the reported amounts of assets, liabilities, revenue, expenses, and the related disclosures. We base our assumptions, estimates and judgments on historical experience, current trends and other factors we believe to be relevant at the time we prepare our consolidated financial statements. On a regular basis, we review the accounting policies, assumptions, estimates and judgments to ensure that our consolidated financial statements are presented fairly and in accordance with U.S. GAAP. However, because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material.

Our significant accounting policies are discussed in Note 1—Business and Summary of Significant Accounting Principles of our accompanying consolidated financial statements. We believe the following accounting policies are the most critical to aid in fully understanding and evaluating our reported financial results, as they require management to make difficult, subjective or complex judgments, and to make estimates about the effect of matters that are inherently uncertain. Although management believes that the estimates and judgments discussed herein are reasonable, actual results could differ, which could result in gains or losses that could be material. We have reviewed these critical accounting policies and related disclosures with the Audit Committee of our Board of Directors.

    Accounts Receivable

We record accounts receivable at net realizable value. This value includes an allowance for estimated uncollectible accounts to reflect losses anticipated on accounts receivable balances. The allowance is based on historical write-offs, an analysis of past due accounts based on the contractual terms of the receivables, and the economic status of customers, if known. Management believes that the allowance is sufficient to cover uncollectible amounts; however, there can be no assurance that unanticipated future business conditions of customers will not have a negative impact on our results of operations. We generally do not require collateral for our accounts receivable.

    Inventories

Inventories include materials, direct labor, and related manufacturing overhead, and are stated at the lower of cost (on a first-in, first-out or average cost basis) or market. Management reviews inventory quantities on hand and records a provision for excess or obsolete inventory primarily based on estimated future demand as a function of historical buying patterns and current market conditions. A significant change in customer demand or market conditions could render certain inventory obsolete and thus could have a material adverse impact on our operating results in the period the change occurs.

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    Impairment of Long-Lived Assets

We assess the recoverability of long-lived assets and finite-lived intangible assets whenever events or changes in circumstances indicate that we may not be able to recover the asset's carrying amount. Such events or circumstances include, but are not limited to, a significant decrease in the fair value of the underlying business or a change in utilization of property and equipment. Our judgment regarding the existence of impairment indicators is based on operational, market, and legal conditions. Future events could cause us to conclude that impairment indicators exist and that assets associated with a particular operation are impaired. Evaluating the impairment would also require us to estimate future operating results and cash flow, which also require judgment by management. If we were to identify an impairment, any resulting loss would be calculated based on estimations of the fair value of the affected asset(s).

Long-lived assets include definite-lived intangible assets. Our definite-lived intangible assets consist primarily of customer relationships obtained through acquisitions and are amortized on a straight-line basis over their estimated useful lives. We determined the fair value of the customer relationships related to these acquisitions using the excess earnings method under the income approach. The income approach also helped us determine the useful lives of acquired customer relationships as it considers the periods of expected cash flow and other pertinent factors outlined in relevant accounting guidance. Key inputs into that income-based approach include the attrition rates derived from historical sales data generated by the acquired customer base. Accordingly, attrition rates influence both the useful lives and the fair value of our acquired customer relationships. The excess earnings method can be used to determine the overall fair value of an intangible asset by estimating the amount of discounted residual (or excess) cash flow generated by the asset. The excess earnings method yields multi-year financial projections or cash flow "run-outs". For the purposes of valuing acquired customer relationships, these projections begin with a total sales amount based upon historical sales information. Each year, we apply a consistent growth rate to the preceding year's sales total reflecting our expectation that revenue from acquired/repeat customers will grow. We believe we conduct business in an industry that grows at approximately the rate of U.S. gross domestic product. To that end, our revenue growth assumptions in our recent acquisition excess earnings models were set at modest levels. We recognize that higher growth factors would result in longer useful life periods, but we believe our estimates to be appropriate. We did not include projected synergies between us and our acquired companies when utilizing the excess earnings method. We base the remaining economic useful lives of customer relationships at the point in time we expect to realize substantially all of the benefit of our acquired product lines' projected cash flow. This approach yields useful life determinations that are shorter than the economic benefit realization periods set forth within excess earnings models.

    Impairment of Goodwill and Indefinite Lived Assets

Goodwill represents the excess of the purchase price over the fair value of identifiable net assets of acquired businesses. We test goodwill for impairment on an annual basis (as of the beginning of our fiscal fourth quarter) and, if certain events or circumstances indicate that an impairment loss may have been incurred, on an interim basis. In evaluating goodwill for impairment, we estimate the fair value of our reporting unit by considering market capitalization and other factors if it is more likely than not that the fair value of our reporting unit is less than its carrying value. If our reporting unit's fair value exceeds its carrying value, no further testing is required. If, however, the reporting unit's carrying value exceeds its fair value, we then determine the amount of the impairment charge, if any. If we were to identify an impairment, then any resulting loss would be calculated based on estimations of the reporting unit's fair value. The recognition of an impairment to our goodwill could have a material adverse effect on our results of operations and financial position, but not our cash flow from operations.

Our indefinite-lived intangible assets are not amortized and primarily consist of acquired trademarks. The fair value of the trademarks is determined based on the relief from royalty method under the income approach, which requires us to estimate a reasonable royalty rate, identify relevant projected revenues and expenses, and select an appropriate discount rate. The evaluation of indefinite-lived intangible assets for impairment

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requires management to use significant judgments and estimates including, but not limited to, projected future net sales, operating results, and cash flow of our business. Although management currently believes that the estimates used in the evaluation of indefinite-lived intangible assets are reasonable, differences between actual and expected net sales, operating results, and cash flow could cause these assets to be deemed impaired. If we were to identify an impairment, any resulting loss would be calculated based on estimations of the fair value of affected asset(s).

    Self-Insurance

It is our policy to self-insure, up to certain limits, certain risks including workers' compensation, comprehensive general liability, and auto liability. Our self-insured retention for each claim involving workers' compensation is limited to $0.5 million per occurrence of such claims. Based on our historical claims experience, our comprehensive general liability self-insurance retention limits, including toxic torts and other product liability claims, were increased to $1.5 million per occurrence for claims incurred after August 31, 2008. A provision for claims under this self-insured program, based on our estimate of the aggregate liability for claims incurred, is revised and recorded annually or when changes in trends or circumstances warrant. The estimate is derived from both internal and external sources including but not limited to our independent actuary. We are also self-insured up to certain limits for certain other insurable risks, primarily physical loss to property ($1.0 million per occurrence) and business interruptions resulting from such loss lasting three days or more in duration. Insurance coverage is maintained for catastrophic property and casualty exposures as well as those risks required to be insured by law or contract. We are fully self-insured for certain other types of liabilities, including environmental, product recall, patent infringement, and errors and omissions. The actuarial estimates are subject to uncertainty from various sources, including, among others, changes in claim reporting patterns, claim settlement patterns, judicial decisions, legislation, and economic conditions. Although we believe that the actuarial estimates are reasonable, significant differences related to the items noted above could materially affect our self-insurance obligations, future expense, and cash flow.

We are also self-insured for the majority of our medical benefit plans. We estimate our aggregate liability for claims incurred by applying a lag factor to our historical claims and administrative cost experience. The appropriateness of the lag factor is evaluated at least annually and, if necessary, revised upon review. Although management believes that the current estimates are reasonable, significant differences related to claim reporting patterns, plan designs, legislation, and general economic conditions could materially affect our medical benefit plan liabilities, future expense, and cash flow.

    Environmental Matters

We recognize expense for known environmental claims when payments associated with the claims become probable and the costs can be reasonably estimated. The actual cost of resolving environmental issues may be higher or lower than that reserved primarily due to difficulty in estimating such costs and potential changes in the status of government regulations. We are self-insured for most environmental matters. For more information concerning environmental matters affecting us and our approach towards such, please refer to Note 4—Commitments and Contingencies of our accompanying consolidated financial statements.

    Legal Matters

We are subject to various legal claims arising in the normal course of business. We are self-insured up to specified limits for certain types of claims, including product liability, and are fully self-insured for certain other types of claims, including environmental, product recall, and patent infringement. Based on information currently available, it is the opinion of management that the ultimate resolution of pending and threatened legal proceedings will not have a material adverse effect on our results of operations, financial position, or cash flow. However, in the event of unexpected future developments, it is possible that the ultimate resolution of such matters, if unfavorable, could have a material adverse effect on our results of operations,

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financial position, or cash flow in future periods. We establish accruals for legal claims when the costs associated with the claims become probable and can be reasonably estimated. The actual costs of resolving legal claims may be substantially higher or lower than the amounts reserved for such claims. However, unless otherwise disclosed, we cannot make a meaningful estimate of actual costs or a range of reasonably possible losses that could be higher or lower than the amounts accrued. Based on the facts known as of the time of filing of this Annual Report on Form 10-K, our current accrual of $2.1 million continues to represent our best estimate of the probable cost related to the California Sales Representative Litigation. For more information concerning legal matters affecting us and our approach towards such, please refer to Note 4 of our accompanying consolidated financial statements.


New Accounting Pronouncements

See Note 1—Business and Summary of Significant Accounting Principles in our accompanying consolidated financial statements for a full description of recent accounting pronouncements including the expected dates of adoption and expected effects on results of operations and financial condition.


Item 7A. Quantitative and Qualitative Disclosures about Market Risk

General. We are exposed to market risks that may impact our financial statements due primarily to changing interest rates and foreign exchange rates. The following discussion provides additional information regarding our market risks.

Interest Rates. Interest rate fluctuations expose our variable-rate debt to changes in interest expense and cash flow. Debt outstanding as of August 31, 2014 was attributable to financing facilities with variable interest rates. We have previously entered into interest rate swap arrangements with the intention to manage the variability of interest related cash flow associated with our variable-rate debt. While we may enter into similar instruments in the future, no such arrangements existed as of either August 31, 2014 or the date of this filing.

Based on our current borrowings, the potential change in annual interest expense resulting from a hypothetical 10% fluctuation in market interest rates would be less than $0.1 million. See Note 3—Debt in our accompanying consolidated financial statements for additional information regarding our debt.

Foreign Exchange Rates. The majority of our net sales, expense, and capital purchases are transacted in United States dollars. However, exposure with respect to foreign exchange rate fluctuation exists due to our operations in Canada and Europe. A hypothetical fluctuation in each of the Canadian dollar, the British pound and the Euro of 10% would impact operating profit by approximately $0.5 million, $0.2 million and $0.1 million, respectively. The impact of these hypothetical currency fluctuations has been calculated in isolation from any response we would undertake to address such exchange rate changes in our foreign markets.

Fluctuations in Commodity Prices. The key raw materials used in our products are surfactants, polymers and resins, fragrances, water, solvents, and other petroleum-based materials and packaging materials. We do not engage in commodity hedging transactions for raw materials, though we have committed and will continue to commit to purchase certain materials for specified periods of time. Many of the raw materials that we use are petroleum-based and, therefore, are subject to the availability and price of oil or its derivatives. Some of the raw materials we use are agriculture-based commodities and are subject to fluctuations in availability and price. Significant increases in the prices of our products due to increases in the cost of raw materials or packaging materials could have a negative effect on demand for products and on profitability. It is difficult to estimate the impact that pricing volatility in the commodities markets from which we source raw materials will have on our future earnings. We estimate that the rising costs of raw materials negatively affected our gross profit by approximately $1.8 million in fiscal 2014. The cost of certain commodities, particularly petro-chemicals, is volatile. While we have generally been able to pass along these increases in cost in the form of higher selling prices for our products over time, failure to effectively manage future increases in the costs of these materials could adversely affect our operating margins and cash flow. Furthermore, there are a limited

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number of suppliers for some of our raw materials, packaging materials, and finished goods. Our profitability, volume, and cash flow could be negatively impacted by limitations inherent within the supply chain of certain of these materials, including competitive conditions, governmental issues, legal issues, natural disasters, and other events that could impact both the availability and price of the materials.

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Item 8. Financial Statements and Supplementary Data

Index to Consolidated Financial Statements

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders of Zep Inc.

We have audited the accompanying consolidated balance sheets of Zep Inc. as of August 31, 2014 and 2013, and the related consolidated statements of income, comprehensive income, stockholders' equity, and cash flows for each of the three years in the period ended August 31, 2014. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Zep Inc. at August 31, 2014 and 2013, and the consolidated results of its operations and its cash flows for each of the three years in the period ended August 31, 2014, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Zep Inc.'s internal control over financial reporting as of August 31, 2014, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992 framework) and our report dated November 12, 2014 expressed an adverse opinion thereon.

/s/ Ernst & Young LLP

Atlanta, Georgia
November 12, 2014

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Zep Inc.

CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per-share data)

 
  August 31,
2014
  August 31,
2013
 

ASSETS

             

Cash and cash equivalents

  $ 14,303   $ 2,402  

Accounts receivable, less reserve for doubtful accounts of $4,474 at August 31, 2014 and $3,941 at August 31, 2013

    108,010     104,476  

Inventories, net

    75,950     68,633  

Insurance receivable

    13,106      

Deferred income taxes

    10,452     8,002  

Prepaids and other current assets

    6,254     13,051  
           

Total Current assets

    228,075     196,564  
           

Property, plant and equipment, net of accumulated depreciation of $112,794 at August 31, 2014 and $108,032 at August 31,  2013

    75,361     82,328  

Goodwill

    121,005     121,102  

Identifiable intangible assets, net

    121,643     129,929  

Other long-term assets

    10,127     17,835  
           

Total Assets

  $ 556,211   $ 547,758  
           
           

LIABILITIES AND STOCKHOLDERS' EQUITY

             

Current maturities of long-term debt

  $ 20,006   $ 25,000  

Accounts payable

    65,874     56,366  

Accrued compensation

    19,720     25,226  

Other accrued liabilities

    39,329     41,167  
           

Total Current liabilities

    144,929     147,759  
           

Long-term debt, less current maturities

    186,880     184,908  

Deferred income taxes

    13,931     12,782  

Other long-term liabilities

    17,092     18,340  
           

Total Liabilities

    362,832     363,789  
           

Commitments and Contingencies (Note 4)

             

Stockholders' equity:

             

Preferred stock, $0.01 par value; 50,000,000 shares authorized; none issued and outstanding

         

Common stock, $0.01 par value; 500,000,000 shares authorized; 22,396,229 issued and outstanding at August 31, 2014, and 22,065,059 issued and outstanding at August 31, 2013

    224     221  

Paid-in capital

    108,432     102,573  

Retained earnings

    72,918     69,023  

Accumulated other comprehensive income

    11,805     12,152  
           

Total Stockholders' equity

    193,379     183,969  
           

Total Liabilities and Stockholders' equity

  $ 556,211   $ 547,758  
           
           

   

See accompanying notes to the consolidated financial statements.

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CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per-share data)

 
  Years Ended August 31,  
 
  2014   2013   2012  

Net sales

  $ 696,489   $ 689,576   $ 653,533  

Cost of products sold

    369,697     365,034     352,737  
               

Gross profit

    326,792     324,542     300,796  

Selling, distribution and administrative expenses

    293,361     283,075     260,806  

Acquisition and integration costs

    1,091     3,519     1,710  

Restructuring charges, net

    (456 )   5,159      
               

Operating profit

    32,796     32,789     38,280  

Other expense (income):

                   

Interest expense, net

    11,819     8,958     5,493  

Provision for loan loss

    5,269          

Bargain purchase gains from business combinations

            (2,095 )

Other expense (income), net

    1,610     744     1,046  
               

Total other expense

    18,698     9,702     4,444  
               

Income before income taxes

    14,098     23,087     33,836  

Income tax provision

    5,698     7,895     11,927  
               

Net income

  $ 8,400   $ 15,192   $ 21,909  
               
               

Earnings per share:

                   

Basic earnings per share

  $ 0.38   $ 0.69   $ 1.00  

Diluted earnings per share

  $ 0.37   $ 0.68   $ 0.98  

Shares used in calculation:

                   

Basic

    22,307     21,969     21,768  

Diluted

    22,906     22,435     22,166  

Dividends declared per share

  $ 0.20   $ 0.16   $ 0.16  

   

See accompanying notes to the consolidated financial statements.

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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)

 
  Years Ended August 31,  
 
  2014   2013   2012  

Net income

  $ 8,400   $ 15,192   $ 21,909  

Other comprehensive (loss) income:

                   

Foreign currency translation adjustment

    (738 )   (965 )   (3,929 )

Defined benefit pension plan adjustment

    502     345     (308 )
               

Other comprehensive (loss) income before income taxes

    (236 )   (620 )   (4,237 )

Provision for income taxes related to other comprehensive income (loss) items

    (111 )   (79 )   76  
               

Other comprehensive (loss) income

    (347 )   (699 )   (4,161 )
               

Comprehensive income

  $ 8,053   $ 14,493   $ 17,748  
               
               

   

See accompanying notes to the consolidated financial statements.

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Zep Inc.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

 
  Years Ended August 31,  
 
  2014   2013   2012  

Operating activities

                   

Net income

  $ 8,400   $ 15,192   $ 21,909  

Adjustments to reconcile net income to net cash provided by operating activities:

                   

Depreciation and amortization

    22,122     19,931     14,330  

Provision for loan loss

    5,269          

Loss on assets held for sale and disposal of fixed assets

    359     433     706  

Non-cash impact of write-offs related to fire

    5,161          

Excess tax benefits from share-based payments

    (306 )   124     5  

Deferred income taxes

    1,618     3,011     3,509  

Insurance proceeds for fire related business interruption and property damage

    3,772          

Bargain purchase gains from business combinations

            (2,095 )

Other non-cash charges

    3,319     4,010     3,816  

Changes in assets and liabilities:

                   

Accounts receivable

    (3,823 )   (4,355 )   2,097  

Inventories

    (9,502 )   2,885     (9,141 )

Insurance receivable, prepaid expenses and other current assets

    (6,876 )   (2,493 )   (55 )

Accounts payable

    9,589     2,782     (3,897 )

Accrued compensation and other current liabilities

    (8,433 )   11,066     (736 )

Other long-term liabilities

    (1,035 )   (2,765 )   (5,271 )

Other assets

    (7,363 )   195     (2,570 )
               

Net cash provided by operating activities

    22,271     50,016     22,607  
               

Investing activities

                   

Purchases of property, plant, and equipment

    (9,597 )   (12,068 )   (18,356 )

Insurance proceeds for assets damaged in fire

    1,228          

Acquisitions, net of cash acquired

        (116,692 )   (11,923 )

Loan to innovation partner

            (12,500 )

Proceeds from sale of innovation partner loan

    4,350          

Principal payments from innovation partner loan

    300          

Proceeds from sale of property, plant, and equipment

    1,325     21      
               

Net cash used for investing activities

    (2,394 )   (128,739 )   (42,779 )
               

Financing activities

                   

Proceeds from revolving credit facilities

    762,195     409,808     312,800  

Repayment of borrowings from revolving credit facilities

    (799,787 )   (339,150 )   (293,200 )

Proceeds from issuance of debt

    75,000          

Principal repayment-term loan

    (40,313 )        

Proceeds (payments) from secured borrowings

    (672 )   9,304      

Debt issuance costs

    (2,444 )        

Stock issuances

    2,234     1,207     738  

Excess tax benefits from share-based payments

    306     (124 )   (5 )

Dividend payments

    (4,505 )   (3,536 )   (3,512 )
               

Net cash provided by (used for) financing activities

    (7,986 )   77,509     16,821  
               

Effect of exchange rate changes on cash

    10     103     (355 )
               

Net change in Cash and cash equivalents

    11,901     (1,111 )   (3,706 )

Cash and cash equivalents—beginning of period

    2,402     3,513     7,219  
               

Cash and cash equivalents—end of period

  $ 14,303   $ 2,402   $ 3,513  
               
               

   

See accompanying notes to the consolidated financial statements.

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Zep Inc.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(in thousands)
  Common
stock
  Paid-in
capital
  Retained
earnings
  Accumulated
other
comprehensive
income
  Total
Stockholders'
equity
 

Balance at August 31, 2011

    21,632   $ 216   $ 92,925   $ 38,970   $ 17,012   $ 149,123  

Net income

                21,909         21,909  

Foreign currency translation adjustment (net of tax of $0)

                    (3,929 )   (3,929 )

Defined benefit pension plan adjustment (net of tax of $76)

                    (232 )   (232 )

Amortization, issuance, and forfeitures of restricted stock grants and stock options

    200     2     3,208             3,210  

Deferred compensation plan

            609             609  

Employee stock purchase plan issuances

            211             211  

Stock option exercises

            527             527  

Dividend payments

                (3,512 )       (3,512 )

Tax effect on stock options and restricted stock

            1             1  
                           

Balance at August 31, 2012

    21,832   $ 218   $ 97,481   $ 57,367   $ 12,851   $ 167,917  
                           
                           

Net income

                15,192         15,192  

Foreign currency translation adjustment (net of tax of $0)

                    (965 )   (965 )

Defined benefit pension plan adjustment (net of tax of $79)

                    266     266  

Amortization, issuance, and forfeitures of restricted stock grants and stock options

    233     3     3,473             3,476  

Deferred compensation plan

            536             536  

Employee stock purchase plan issuances

            193             193  

Stock option exercises

            1,014             1,014  

Dividend payments

                (3,536 )       (3,536 )

Tax effect on stock options and restricted stock

            (124 )           (124 )
                           

Balance at August 31, 2013

    22,065   $ 221   $ 102,573   $ 69,023   $ 12,152   $ 183,969  
                           
                           

Net income

                8,400         8,400  

Foreign currency translation adjustment (net of tax of $0)

                    (738 )   (738 )

Defined benefit pension plan adjustment (net of tax of $111)

                    391     391  

Amortization, issuance, and forfeitures of restricted stock grants and stock options

    331     3     2,986             2,989  

Deferred compensation plan

            333             333  

Employee stock purchase plan issuances

            167             167  

Stock option exercises

            2,067             2,067  

Dividend payments

                (4,505 )       (4,505 )

Tax effect on stock options and restricted stock

            306             306  
                           

Balance at August 31, 2014

    22,396   $ 224   $ 108,432   $ 72,918   $ 11,805   $ 193,379  
                           
                           

   

See accompanying notes to the consolidated financial statements.

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Zep Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollar amounts in thousands, except share and per-share data and as indicated)

Note 1: Business and Summary of Significant Accounting Principles

    Description of the Business

Zep Inc. ("Zep" or "we" or "our" or the "Company") is a leading consumable chemical packaged goods company, providing a wide variety of high-performance chemicals and related products and services that help professionals maintain, clean and protect their assets. We market our products and services under well recognized brand names, including Zep®, Zep Professional®, Zep Commercial®, Zep Automotive® and other Zep Inc. brands. Our common stock is listed on the New York Stock Exchange under the ticker symbol "ZEP".

    Basis of Presentation and Consolidation Policy

Our consolidated financial statements include the assets, liabilities, revenue and expense of all wholly-owned subsidiaries and majority owned subsidiaries over which we exercise control and entities in which we exercise control and have a controlling financial interest or are deemed to be the primary beneficiary. The general condition for control is ownership of a majority of the voting interests of an entity. Control may also exist in arrangements where we are the primary beneficiary of a variable interest entity ("VIE"). An entity that will have both the power to direct the activities that most significantly impact the economic performance of the VIE and the obligation to absorb the losses or receive the benefits significant to the VIE is considered a primary beneficiary of that entity. We have determined that we are not a primary beneficiary in any material VIE.

We eliminate all intercompany accounts and transactions from our consolidated financial statements.

    Use of Estimates and Assumptions

The preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (U.S. GAAP) requires us to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities as of the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. The principal areas of judgment relate to (1) accounts receivable, including estimates as to the recoverability of insurance receivables; (2) inventories; (3) long-lived and definite-lived intangible assets; (4) goodwill and indefinite-lived intangibles; (5) self-insurance reserves; (6) assessment of loss contingencies, including environmental and litigation liabilities; and (7) legal and other contingencies. Future events and their effects cannot be predicted with certainty, and accordingly, our accounting estimates require the exercise of judgment. The accounting estimates used in the preparation of our consolidated financial statements may change as new events occur, as more experience is acquired, as additional information is obtained and as our operating environment changes. We evaluate and update our assumptions and estimates on an ongoing basis and may employ outside experts to assist in our evaluations. Actual results could differ from the estimates we have used.

    Revenue Recognition

We record revenue when the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the selling price to the customer is fixed and determinable, and collectability is reasonably assured. Delivery is not considered to have occurred until the customer assumes the risks and rewards of ownership. Provisions for rebates, sales incentives, product returns, and discounts to customers are recorded as an offset to revenue in the same period the related revenue is recorded. We also maintain one-time or on-going marketing and trade-promotion programs with certain customers that require us to estimate and accrue the expected costs of such programs. These arrangements include cooperative marketing programs, merchandising of our products and introductory marketing funds for new products and

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Zep Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Dollar amounts in thousands, except share and per-share data and as indicated)

other trade-promotion activities conducted by the customer. Costs associated with these programs are recorded as a reduction of revenues.

We provide for limited product return rights to certain distributors and customers primarily for slow moving or damaged items subject to certain defined criteria. We monitor product returns and record, at the time revenue is recognized, a provision for the estimated amount of future returns based primarily on historical experience and specific notification of pending returns. Although historical product returns generally have been within expectations, there can be no assurance that future product returns will not exceed historical amounts. A significant increase in product returns could have a material impact on our operating results in future periods.

We include shipping and handling fees billed to customers in Net sales. Shipping and handling costs associated with inbound freight and freight between manufacturing facilities are generally recorded in Cost of products sold, which also includes the cost normally incurred in acquiring and producing inventory for sale, purchasing and receiving costs, and inspection costs. Certain customer-related shipping and handling costs, as well as other distribution costs, are included in Selling, distribution, and administrative expenses. We believe this presentation is consistent with many of our peers and competitors. However, we acknowledge that our gross profit amounts may not be comparable to certain other entities, as some entities may include all of the costs related to their distribution network in their cost of products sold. Customer-related shipping and handling costs included within our Selling, distribution, and administrative expenses totaled $49.3 million, $45.0 million, and $42.3 million for the fiscal years ended August 31, 2014, 2013 and 2012, respectively. Other distribution costs, which primarily consist of the cost of warehousing finished goods inventory, totaled $22.5 million, $22.1 million, and $23.1 million for the fiscal years ended August 31, 2014, 2013 and 2012, respectively.

    Selling, Distribution and Administrative Expenses

Selling, distribution and administrative expenses include selling, distribution, marketing and advertising expenses; research and development costs; salaries, travel and office expenses of administrative associates and contractors; legal and professional fees; software license fees and bad debt expenses.

Research and development costs are expensed as incurred. Research and development expenses ranged between $1.4 million and $1.6 million during the three years ended August 31, 2014. Advertising costs are expensed as incurred and totaled $3.9 million, $4.3 million and $2.7 million for the fiscal years ended August 31, 2014, 2013 and 2012, respectively.

    Restructuring Activities

Restructuring charges, net include employee severance and benefit costs, impairments of assets, and other costs associated with exit activities. We apply the provisions of ASC 420, Exit or Disposal Cost Obligations (ASC 420) or ASC 712, Compensation—Nonretirement Postemployment Benefits, based on the facts and circumstances related to our restructuring activities. Severance costs accounted for under ASC 420 are recognized when management with the proper level of authority has committed to a restructuring plan and communicated those actions to associates. Impairment losses are based upon the estimated fair value less costs to sell, with fair value estimated based on existing market prices for similar assets. Other exit costs include environmental remediation costs and contract termination costs, primarily related to equipment and facility lease obligations. At each reporting date, we evaluate the accruals for restructuring costs to ensure the accruals are still appropriate. See Note 7—Restructuring Charges for further discussion.

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Zep Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Dollar amounts in thousands, except share and per-share data and as indicated)

    Cash and Cash Equivalents

Cash and cash equivalents includes investments that are highly liquid and have maturities of three months or less when purchased. The carrying values of cash and cash equivalents approximate their fair value due to the short-term nature of these instruments. We maintain amounts on deposit with various financial institutions, which may, at times, exceed federally insured limits. However, management periodically evaluates the credit-worthiness of those institutions, and we have not experienced any losses on such deposits.

    Accounts Receivable

We record accounts receivable at net realizable value. This value includes an allowance for estimated uncollectible accounts to reflect losses anticipated on accounts receivable balances. The allowance is based on historical write-offs, an analysis of past due accounts based on the contractual terms of the receivables, and the economic status of customers, if known. We believe that the allowance is sufficient to cover uncollectible amounts; however, there can be no assurance that unanticipated future business conditions of customers will not have a negative impact on our results of operations. We generally do not require collateral for our accounts receivable.

Additions to the allowance for doubtful accounts are made by means of the provision for doubtful accounts. We write-off uncollectible accounts receivable against the allowance for doubtful accounts after exhausting collection efforts. See Note 11—Accounts receivable for further discussion.

    Inventories

Inventories, which include materials, direct labor, and related manufacturing overhead, are stated at the lower of cost or market. We use the first-in, first-out or average cost basis to determine cost. See Note 12—Inventories for further discussion.

    Goodwill and Identifiable Intangible Assets

We test for impairment at least annually at the beginning of the fourth quarter of each fiscal year, unless a triggering event occurs that would require an interim impairment assessment. In performing our goodwill impairment test, we have the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the estimated fair value of a reporting unit is less than its carrying amount. If we perform a qualitative assessment and determine that an impairment is more likely than not, then we perform the two-step quantitative impairment test, otherwise no further analysis is required. We also may elect not to perform the qualitative assessment and, instead, proceed directly to the two-step quantitative impairment test. The ultimate outcome of the goodwill impairment assessment will be the same whether we choose to perform the qualitative assessment or proceed directly to the two-step quantitative impairment test. Zep is one reporting unit and our impairment test is performed at that level. For each of the years ended August 31, 2014, 2013 and 2012 we elected to perform the quantitative assessment.

Indefinite-lived assets are not amortized and consist of trademarks and tradenames. Definite-lived intangible assets consist primarily of customer relationships, patents and technology and are amortized on a straight-line basis or under the undiscounted cash flows method over the estimated economic life of the respective agreements. See Note 14—Goodwill and Intangibles Asset for further information.

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Zep Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Dollar amounts in thousands, except share and per-share data and as indicated)

    Share-Based Compensation

We recognize compensation expense for share based awards in accordance with ASC 718, Compensation—Stock Compensation. Share-based expense includes expense related to restricted stock and options issued, as well as share units deferred into the Director Deferred Compensation Plan and the Supplemental Deferred Savings Plan. Share-based expense is included within Selling, distribution and administrative expenses on the consolidated statement of operations. Equity awards with service-only vesting provisions are accounted for on a straight-line basis. The majority of the share-based compensation expense does not affect our overall cash position. Therefore, certain of these expenses are reflected as Other non-cash charges within our consolidated statements of cash flows. Share-based compensation accounting rules require that the benefit of tax deductions in excess of recognized compensation cost be reported as a financing cash flow, rather than as an operating cash flow. See Note 8—Share-Based Incentive Programs for further discussion.

    Property, Plant, and Equipment and Depreciation

We record land, buildings, capitalized software, leasehold improvements and machinery and equipment at cost. We report depreciation of property, plant and equipment in Cost of products sold and Selling, distribution and administrative expenses based on the nature of the underlying assets. We record depreciation primarily related to the production of inventory within Cost of products sold. We record depreciation related to selling, distribution and administrative functions within Selling, distribution and administrative expenses. Depreciation is determined principally on a straight-line basis using estimated useful lives of plant and equipment (20 to 40 years for buildings and 5 to 12 years for machinery and equipment). We amortize leasehold improvements over the life of the lease or the useful life of the improvement, whichever is shorter.

We retain fully depreciated assets in property and accumulated depreciation accounts until we remove them from service. In case of sale, retirement or disposal, the asset cost and related accumulated depreciation balances are removed from the respective accounts and the resulting net amount, after consideration of any proceeds, is included in Loss (gain) on assets held for sale and disposal of fixed assets. Maintenance and repairs of property and equipment are expensed as incurred. We capitalize replacements and improvements that increase the estimated useful life of an asset.

We account for operating leases under the provisions of ASC 840, Leases. This guidance requires us to recognize escalating rents, including any rent holidays, on a straight-line basis over the term of the lease for those lease agreements where we receive the right to control the use of the entire leased property at the beginning of the lease term.

See Note 13—Property, Plant and Equipment for further discussion.

    Foreign Currency Translation and Other Expense (Income), Net

Other expense (income), net, is composed primarily of gains or losses on foreign currency transactions and other non-operating items. The functional currency for our foreign operations is the local currency. The translation of foreign currencies into United States dollars is performed for balance sheet accounts using exchange rates in effect at the balance sheet dates and for revenue and expense accounts using a weighted average exchange rate each month during the year.

The gains or losses resulting from the translation are included in Comprehensive income on the Consolidated Statements of Comprehensive Income and the Consolidated Statements of Stockholders' Equity and are excluded from net income. Gains or losses relating to foreign currency transactions are included in Other

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Zep Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Dollar amounts in thousands, except share and per-share data and as indicated)

expense (income), net, in our consolidated statements of operations and consisted of expense of $0.9 million, $0.3 million and $0.3 for each of the fiscal years ended August 31, 2014, 2013 and 2012, respectively.

    New Accounting Pronouncements

In March 2013, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2013-05, "Foreign Currency Matters (Topic 830)—Parent's Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity." This standard resolves diversity in practice regarding the release of the cumulative translation adjustment into net income when a parent either sells a part or all of its investments in a foreign entity. In addition, the standard resolves diversity in practice for the treatment of business combinations achieved in stages involving a foreign entity. ASU 2013-05 is effective for annual reporting periods, and interim periods within that period, beginning after December 15, 2013 (our fiscal 2015). We do not expect the updated guidance to have a significant impact on financial statements.

In July 2013, the FASB issued Accounting Standards Update (ASU) No. 2013-11, "Income Taxes (Topic 740)—Presentation of an Unrecognized Tax Benefit When a Net Operation Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists." This standard provides updated guidance on presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss or a tax credit carryforward exists. ASU 2013-11 is effective for annual periods, and interim periods within that period, beginning after December 15, 2014 (our fiscal 2016). We have not yet determined the potential effects of the adoption of ASU 2013-11 on our financial statements.

On September 13, 2013, the Internal Revenue Service released final tangible property regulations under Sections 162(a) and 263(a) of the Internal Revenue Code of 1986 (Code), regarding the deduction and capitalization of expenditures related to tangible property. The final regulations replace temporary regulations that were issued in December 2011. Also released were proposed regulations under Section 168 of the Code regarding dispositions of tangible property. These regulations will result in our adoption of certain mandatory and elective accounting methods with respect to property and equipment, inventory and supplies. These final and proposed regulations are generally effective for taxable years beginning on or after January 1, 2014. We are currently analyzing these accounting method changes but we do not believe they will have a material impact on the consolidated financial statements of the Company's fiscal year ending August 31, 2015.

In April 2014, the FASB issued Accounting Standards Update (ASU) No. 2014-08, "Presentation of Financial Statements (Topic 205) and Property, Plan, and Equipment (Topic 360)—Reporting Discontinued Operation and Disclosures of Disposal of Components of an Entity." This standard changes the criteria for determining which disposals should be presented as discontinued operations and modifies the related disclosure requirements. ASU 2014-09 is effective for annual periods, and interim periods within that annual period, beginning after December 15, 2014 (our fiscal 2016). We do not expect the updated guidance to have a significant impact on financial statements.

In May 2014, the FASB issued Accounting Standards Update (ASU) No. 2014-09, "Revenue from Contracts with Customers." This standard outlines a single comprehensive model for companies to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that revenue is recognized when a customer obtains control of a good or service. A customer obtains control when it has the ability to direct the use of and obtain the benefits from the good or service. Transfer of control is not the same as transfer of risks and rewards, as it is considered in current guidance. ASU 2014-09 is effective for annual reporting periods, and interim periods within that period, beginning after December 15, 2016 (our fiscal year 2018) and early adoption is not permitted. Companies may use either a full retrospective or a modified

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Zep Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Dollar amounts in thousands, except share and per-share data and as indicated)

retrospective approach to adopt ASU 2014-09. We have not yet determined the potential effects of the adoption of ASU 2014-09 on our financial statements.

In June 2014, the FASB issued ASU No. 2014-12, "Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period." This ASU requires that a performance target that affects vesting and could be achieved after the requisite service period be treated as a performance condition. A reporting entity should apply existing guidance in ASC 718, Compensation-Stock Compensation, as it relates to such awards. ASU 2014-12 is effective for annual reporting periods, and interim periods within that period, beginning after December 15, 2015 (our fiscal year 2017) with early adoption permitted using either of two methods: (i) prospective to all awards granted or modified after the effective date; or (ii) retrospective to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter, with the cumulative effect of applying ASU 2014-12 as an adjustment to the opening retained earnings balance as of the beginning of the earliest annual period presented in the financial statements. We do not believe that this guidance will have material impact on our financial statements.


Note 2: Fire at Aerosol Manufacturing Facility

On May 23, 2014, a fire occurred at our aerosol manufacturing facility located in Marietta, Georgia (the "Aerosol Facility"). The fire, the cause of which remains unknown, destroyed our chemical raw material warehouse and damaged other supporting infrastructure that contains or supports our production equipment. Some of the work in process, raw material and finished goods inventory located there was also destroyed or damaged. The products manufactured at the Aerosol Facility included cleaning and maintenance chemicals, lubricants and automotive brake cleaner and accounted for approximately 19% of our revenue for fiscal 2013.

We have arranged for contract manufacturers, one of which was already producing certain aerosol products for us, to manufacture products formerly produced in the Aerosol Facility. We also resumed production at the Aerosol Facility on a limited basis in an attempt to mitigate revenue loss resulting from the fire. We are assisting the contract manufacturers in their efforts to satisfy our requirements for the products by loaning them production equipment and assigning some of our associates to work with them, as needed. However, despite these efforts, the contract manufacturers are currently unable to manufacture some of our products in the quantity and in the formulations required to satisfy some customer requirements for the products. Furthermore, because some of the raw materials destroyed in the fire represented long-term supplies that would normally have not been replenished at the rate required after the fire, we experienced delays in obtaining supplies of some of the raw materials needed by the contract manufacturer to produce our products. These conditions could continue in the foreseeable future.

Our inability to fulfill customer requirements has resulted in the loss of certain customers and will likely result in temporary or permanent loss of customers or market share for certain of our aerosol products, and, thus, may cause a loss of revenue, which may be material. The impact of lost sales related to the fire for fiscal 2014 was approximately $7.5 million with an estimated impact to profit before tax of $2.4 million. We expect that for at least the next few quarters our business will continue to be impacted by the inability to fully meet customer requirements. We expect that our business interruption insurance will cover these losses for a period of time that will be determined through discussion with our insurance companies. No insurance recoveries have been recorded to date related to lost sales. The timing of the receipt of insurance proceeds from losses relating to the fire may be different from when those losses are incurred versus when cash is

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(Dollar amounts in thousands, except share and per-share data and as indicated)

spent. Any material loss of revenue resulting from the fire and its aftermath that is not covered by our insurance policy could have a material impact on our financial condition and results of operations.

We maintain casualty and business-interruption insurance that we believe will cover the losses resulting from the fire after the first $1 million of losses, which is the Company's self-insured retention under such policies. Our insurance covers the costs to repair, rebuild or replace the damaged portions of the Aerosol Facility (without deduction for depreciation) at the same or another site, the gross earnings (defined as income minus variable expenses during the time when production is suspended at the Aerosol Facility) and the increased costs during the disruption of production. The timing of our receipt of insurance proceeds from losses relating to the fire may be materially different from when those losses are incurred.

We also maintain commercial liability insurance, subject to a $1.5 million self-insured retention. We have recorded $2.8 million related to third party claims related to the fire through August 31, 2014.

We maintain workers' compensation insurance, subject to a $500,000 per claim self-insured retention. One workers' compensation claim has been asserted against us as a result of the fire at the Aerosol Facility.

Our insurance coverage may not fully compensate us for all losses we incur as a result of the fire, which in turn, could have a material adverse impact on our financial condition and results of operations. The timing of receipt of insurance proceeds from losses related to the fire may be materially different from when those losses are incurred. The following table reflects the incremental costs related to the fire and related insurance recovery for the fiscal year ended August 31, 2014:

Loss on property, plant and equipment

  $ 3,043  

Loss on inventory

    2,118  

Clean-up and debris removal costs

    5,236  

Third party liability claims

    2,754  

Employee related expenses

    2,150  

Water treatment facility rebuild

    1,015  

Legal costs and penalties

    1,003  

Other fire related costs

    787  
       

    18,106  

Less: Fire related recoveries

    (18,106 )
       

Fire related charges, net

  $  
       
       

Through August 31, 2014, we have incurred costs totaling $18.1 million related to the fire, including a $3.0 million write-off of fixed assets and a $2.1 million write-down of inventory. Based on the provisions of the Company's insurance policies and management's estimates, the losses incurred have been reduced by the estimated insurance recoveries. The Company has determined that recovery of the incurred losses, including amounts related to the retentions described above, is probable and recorded $18.1 million of insurance recoveries through August 31, 2014. In June 2014, we received $5.0 million of insurance proceeds, representing an advance of funds to defray the expenses we incurred to begin cleaning the property, to evaluate the extent of the damage and to outsource the production of our products to the contract manufacturers. As a result, the insurance receivable balance was $13.1 million as of August 31, 2014. In September 2014, we received an additional $11.9 million of insurance proceeds as an advance for the damage to the facility.

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(Dollar amounts in thousands, except share and per-share data and as indicated)


Note 3: Debt

Our indebtedness and credit arrangements consisted of the following:

 
  August 31, 2014   August 31, 2013  

Long-term borrowings:

             

Term loan

  $ 75,000   $ 48,750  

Industrial revenue bonds

    7,150     7,150  

Revolving credit facility and capital leases

    125,006     154,008  
           

    207,156     209,908  

Less debt discount

    (270 )    

Less current maturities of long-term debt

    (20,006 )   (25,000 )
           

  $ 186,880   $ 184,908  
           
           

Future maturities of our outstanding debt obligations are as follows for fiscal years ending August 31:

 
  Amount  

2015

  $ 20,006  

2016

    20,000  

2017

    20,000  

2018

    20,000  

2019

    127,150  

Thereafter

     
       

  $ 207,156  
       
       

    2014 Credit Facility

On August 21, 2014, we entered into a $325 million five-year senior, secured credit facility (the "2014 Credit Facility") with Bank of America, N.A., as Administrative Agent, Swing Line Lender and Letter of Credit Issuer; KeyBank, National Association and SunTrust Bank, as Co-Syndication Agents; BMO Harris Bank, N.A. and Compass Bank, as Co-Documentation Agents; and the other lenders party thereto (collectively, the "Lenders"). The 2014 Credit Facility is comprised of a revolving loan facility that provides for advances in the initial aggregate principal amount of up to $250 million and a term loan to the Company, in the initial aggregate principal amount of $75 million (the "Term Loan," and together with the revolving loan facility, the "Revolving Facility"). Subject to certain terms and conditions contained in the 2014 Credit Agreement, the Company may, at its option and subject to customary conditions, request an increase in the aggregate principal amount available under the Credit Facility by an additional $100 million. The 2014 Credit Facility permits the issuance of letters of credit and swingline loans.

The 2014 Credit Facility is guaranteed by certain of our domestic subsidiaries (the "Guarantors"). Pursuant to the 2014 Credit Facility, the Guarantors guarantee to the Lenders, among other things, all of the obligations of the Company and each other Guarantor under the 2014 Credit Facility. Borrowings under the 2014 Credit Facility are secured by substantially all of the Company's and each Guarantor's owned real and personal property.

Generally, amounts outstanding under the Revolving Facility bear interest at a "Base Rate" or a Eurocurrency Rate (as defined below). Base Rate advances are denominated in U.S. Dollars, and amounts outstanding bear

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(Dollar amounts in thousands, except share and per-share data and as indicated)

interest at a rate per annum equal to the sum of (i) the greater of (A) Bank of America's prime rate, (B) the weighted average of the rates on overnight federal funds transactions with members of the Federal Reserve System plus 0.5% or (C) the Eurocurrency Rate for a one month interest period plus 1%, and (ii) an applicable margin that ranges from 0.75% to 2.00% based upon the Company's leverage ratio. Eurocurrency Rate advances can be denominated in a variety of currencies, including U.S. Dollars, and amounts outstanding bear interest at a rate based upon the London interbank offered rate for the interest period, plus an applicable margin that ranges from 1.75% to 3.00% based upon the Company's leverage ratio (plus any mandatory costs) (the "Eurocurrency Rate"). Under the terms of the 2014 Credit Facility, accrued interest on each loan is payable in arrears on the applicable interest payment date for each loan. Principal repayments on the Term Loan are to be paid quarterly beginning on November 30, 2014 in such amounts as set forth in the 2014 Credit Facility. The Revolving Facility is scheduled to mature on August 21, 2019, at which time all amounts outstanding thereunder will be due and payable.

The Company is required to pay certain fees in connection with the Revolving Facility, including an annual commitment fee equal to the product of the amount of the available revolving commitments under the 2014 Credit Facility multiplied by a percentage that ranges from 0.25% to 0.5% depending upon the Company's leverage ratio, as well as customary administrative fees.

The 2014 Credit Facility contains customary covenants and default provisions for a Revolving Facility of this type, including, but not limited to, financial covenants, limitations on liens and the incurrence of debt, covenants to preserve corporate existence and comply with laws and covenants regarding the use of proceeds of the Revolving Facility. The financial covenants include a maximum leverage ratio, which is the ratio of consolidated net indebtedness to EBITDA (earnings before interest, taxes, depreciation and amortization expense and other items), as defined in the 2014 Credit Facility, starting at 4.50 to 1.00 with step-downs at certain points over the term of the loan, and a minimum fixed charge coverage ratio, which is the ratio of EBITDA (minus certain items) to fixed charges, of 1.25 to 1.0. These ratios are computed at the end of each fiscal quarter for the most recent 12-month period. The default provisions under the 2014 Credit Facility include, among other things, defaults for non-payment, breach of representations and warranties, insolvency, non-performance of covenants, cross-defaults and guarantor defaults. The occurrence of an event of default under the 2014 Credit Facility could result in all loans and other obligations becoming immediately due and payable and the Revolving Facility being terminated.

The 2014 Credit Facility replaces the Company's 5-Year revolving credit agreement, dated as of July 15, 2010 among the Company, Acuity Specialty Products, Inc., certain other subsidiaries of the Company, and JPMorgan Chase Bank, N.A., Wells Fargo Bank, National Association, Regions Bank and the other lenders party thereto, as lenders, which was due to expire on July 15, 2015 (the "2010 Credit Facility").

The base interest rate associated with borrowings made under the 2014 Credit Facility approximated 1.82% since origination in August 2014. In addition to this base interest rate, our effective interest rate includes an applicable margin that adjusts in accordance with our leverage ratio. For fiscal year 2014, this applicable margin has averaged 1.75%.

We were in compliance with our debt covenants as of August 31, 2014, and we believe that our liquidity and capital resources are sufficient to meet our working capital, capital expenditure and other anticipated cash requirements over the next twelve months, excluding acquisitions that we may choose to execute in pursuit of our strategic initiatives. In fiscal 2015, we expect sources of cash to include cash flow from operations as well as insurance proceeds. Our intended uses of cash in fiscal 2015 includes investments in the organization to promote organic growth and rebuilding aerosol production capabilities while in the past much of our cash uses were focused on external acquisitions.

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(Dollar amounts in thousands, except share and per-share data and as indicated)

    2010 Credit Facility

The 2010 Credit Facility was comprised of a revolving loan facility that provided for advances in the initial aggregate principal amount of up to $245 million and a term loan in the initial aggregate principal amount of $75 million. Borrowings under the 2010 Credit Facility were secured by a lien on substantially all of our owned real and personal property. The 2010 Credit Facility required term loan repayments of $2.8 million each quarter until 2015 when the remaining term loan outstanding balance was to become due and payable.

Interest on amounts outstanding under the 2010 Credit Facility was calculated using an "Alternate Base Rate" or a "Eurocurrency Rate." Alternate Base Rate loans bear interest at a rate per annum equal to the sum of (i) the greater of (A) JPMorgan Chase Bank's prime rate, (B) the weighted average of the rates on overnight federal funds transactions with members of the Federal Reserve System plus 0.5% or (C) the Adjusted LIBO Rate (as defined below) for a one month interest period plus 1% (the "Alternate Base Rate"), and (ii) an applicable margin that ranges from 1.25% to 2.50% based on our leverage ratio. Eurocurrency Rate advances outstanding bear interest at a rate based upon the London interbank offered rate for the interest period multiplied by a statutory reserve rate, plus an applicable margin that ranges from 2.25% to 3.50% based upon our leverage ratio (plus any mandatory costs) (the "Adjusted LIBO Rate").

We were also required to pay certain fees in connection with the 2010 Credit Facility, including an annual commitment fee. That fee was paid quarterly in arrears and determined by our leverage ratio as defined in the 2010 Credit Facility. This facility fee ranged from 0.4% to 0.5% of the unused portion of the $320 million commitment of the lenders under the 2010 Credit Facility. Additionally, we were also required to pay certain fees to the Administrative Agent for administrative services. Facility, commitment and amendment fees incurred by us during fiscal 2013 under the 2010 Credit Facility and its predecessor facilities totaled $1.4 million.

The 2010 Credit Facility contained customary covenants and default provisions, including, but not limited to, financial covenants, limitations on liens and the incurrence of debt, covenants to preserve corporate existence and comply with laws and covenants regarding the use of loans made pursuant to the 2010 Credit Facility. In October 2012, we amended our 2010 Credit Facility in support of our $116.8 million acquisition of ZVC on December 1, 2012 (the "Amendment"). The primary purpose of the Amendment was to permit the execution and delivery of the ZVC asset purchase agreement (the "Asset Purchase Agreement") and the consummation of the transactions thereunder within the terms and conditions of the 2010 Credit Facility. The Amendment, among other things, provided that the execution of the Asset Purchase Agreement would not result in an event of default under the 2010 Credit Facility. The Amendment amended the covenant relating to the maximum leverage ratio, which is the ratio of total indebtedness to EBITDA (earnings before interest, taxes, depreciation and amortization expense) such that we will not permit such ratio, determined as of the end of each of our fiscal quarters, all calculated for us and our subsidiaries on a consolidated basis, to be greater than (a) 4.25 to 1.00 for our second, third and fourth quarters of fiscal year 2013, and the first quarter of fiscal year 2014, (b) 4.00 to 1.00 for our second and third quarters of fiscal year 2014, and (c) 3.75 to 1.00 for our fourth quarter of fiscal year 2014 and each fiscal quarter thereafter; provided that, notwithstanding the foregoing, on and after the date, if any, on which we deliver to the administrative agent a covenant reversion notice, the maximum leverage ratio permitted under the 2010 Credit Facility, as amended, will revert to 3.75 to 1.00. Finally, the Amendment also amended the covenant relating to the fixed charge coverage ratio, which is the ratio of EBITDA (minus certain items) to fixed charges, such that we will not permit such ratio, determined as of the end of each of our fiscal quarters for the period of four consecutive fiscal quarters ending with the end of such fiscal quarter, all calculated for us and our subsidiaries on a consolidated basis, to be less than (x) 1.15 to 1.00 for our second, third and fourth quarters of fiscal year 2013, and the first quarter of fiscal year 2014, (y) 1.20 to 1.00 for our second and third quarters of fiscal year 2014, and (z) 1.25 to 1.00 for our fourth

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(Dollar amounts in thousands, except share and per-share data and as indicated)

quarter of fiscal year 2014 and each fiscal quarter thereafter; provided that, notwithstanding the foregoing, on and after the date, if any, on which we deliver to the administrative agent a covenant reversion notice, the minimum fixed charge coverage ratio permitted under the 2010 Credit Facility, as amended, will revert to 1.25 to 1.00.

The 2014 Credit Facility replaced the 2010 Credit Facility, and, as such, there were no amounts outstanding under the 2010 Credit Facility as of August 31, 2014. The base interest rate associated with borrowings made under the 2010 Credit Facility approximated 0.17% during fiscal year 2014. In addition to this base interest rate, our effective interest rate includes an applicable margin that adjusts in accordance with our leverage ratio. During fiscal year 2014, this applicable margin has averaged 3.50%.

    Industrial Revenue Bonds

The industrial revenue bonds due 2018 were issued by the City of DeSoto Industrial Development Authority, Inc. in May 1991 in connection with the construction of our facility in DeSoto, Texas. Pursuant to a loan agreement between us and the DeSoto Industrial Development Authority, we are required to pay the principal and interest on the bonds. The bonds currently bear interest at a weekly rate. The interest rate during the fiscal year ended August 31, 2014 and August 31, 2013 averaged 0.16% and 0.23%, per annum, respectively. The outstanding principal amount of the bonds is payable upon their maturity in 2018. The payment of principal and interest on the bonds is secured by an irrevocable letter of credit issued by Wells Fargo Bank, National Association. We have given notice of our intent to redeem the bonds in the first quarter of fiscal 2015 using funds available under the 2014 Revolving Credit Facility.

    Letters of Credit

We have outstanding letters of credit totaling $10.1 million for the purpose of providing credit support for our industrial revenue bonds, securing collateral requirements under our casualty insurance programs, and securing certain environmental obligations. These letters of credit were issued under the 2014 Credit Facility, as amended, as of August 31, 2014, thereby reducing the total availability under the facility by such amount.

    Interest Expense, Net

Interest expense, net, is composed primarily of interest expense on our variable-rate debt instruments, partially offset by interest income on cash and cash equivalents and interest earned on the loan receivable with our innovation partner. We made interest payments of $11.2 million, $7.8 million and $5.5 million, respectively, in fiscal 2014, 2013 and 2012.

The following table summarizes the components of interest expense, net:

 
  2014   2013   2012  

Interest expense

  $ 12,538   $ 9,950   $ 6,294  

Interest income

    (719 )   (992 )   (801 )
               

Interest expense, net

  $ 11,819   $ 8,958   $ 5,493  
               
               

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(Dollar amounts in thousands, except share and per-share data and as indicated)

Note 4: Commitments and Contingencies

    Self-Insurance

Our insurance program includes the following self-insured retention amounts: workers' compensation—$0.5 million per occurrence; comprehensive general liability claims—$1.5 million per occurrence; auto liability claims—$0.1 million per occurrence; and primary physical loss to property—$1.0 million per occurrence. Our estimate of the aggregate liability for claims incurred, and a provision for claims under this self-insured program is derived from both internal and external sources including but not limited to our independent actuary. We are fully self-insured for certain other types of liabilities, including environmental, product recall, patent infringement, and errors and omissions. We are also self-insured with respect to the majority of our medical benefits plans. We estimate our aggregate liability for claims incurred by applying a lag factor to our historical claims and administrative cost experience. We evaluate the appropriateness of our lag factor annually or when changes in trends or circumstances warrant.

    Litigation

We are subject to various legal claims arising in the normal course of business. Based on information currently available, it is the opinion of management that the ultimate resolution of pending and threatened legal proceedings will not have a material adverse effect on our results of operations, financial position, or cash flows. However, in the event of unexpected future developments, it is possible that the ultimate resolution of such matters, if unfavorable, could have a material adverse effect on our results of operations, financial position, or cash flow.

We establish accruals for legal claims when the costs associated with the claims become probable and can be reasonably estimated. The actual costs of resolving legal claims may be substantially higher or lower than the amounts accrued for such claims. In many cases, we are unable to make a meaningful estimate of actual costs or a range of reasonably possible losses that could possibly be higher or lower than the amounts accrued. In addition, from time to time we may incur expense associated with efforts to enforce our non-compete agreements.

    California Sales Representative Litigation

In December 2010, two of our California-based sales representatives filed suit against us on behalf of themselves and on behalf of all other sales representatives who were employed by Acuity Specialty Products, Inc. in the State of California and similarly situated. Approximately 171 persons were members of the putative class proposed by the plaintiffs. Plaintiffs asserted two primary causes of action against us for (i) failure to reimburse work-related expenses (the "Expense Reimbursement Claim") and (ii) failure to pay wages by reason of unlawful deductions from wages (the "Wage Deduction Claim"), as well as derivative claims under the California Labor Code Private Attorney General Act of 2004 ("PAGA") for civil penalties and under the California Business and Professions Code for unfair business practices. The court denied the plaintiff's motion for class certification. In fiscal 2013, we settled the original two plaintiffs' claims for $48,000 plus interest. In addition, the Company paid the State of California PAGA fees of approximately $275,000. The Court awarded the plaintiffs' lawyers legal fees in the amount of $1,162,000 with respect to the lawsuit filed by the two California sales representatives. The Company believes that the award is excessive and has appealed.

In December 2012, 55 of the current and former sales representatives who were members of the putative class alleged in the first lawsuit filed a lawsuit against the Company in which they asserted the Expense

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(Dollar amounts in thousands, except share and per-share data and as indicated)

Reimbursement Claim, the Wage Deduction Claim and an additional claim for improper wage statements on behalf of themselves individually.

During fiscal 2014, we recorded $7.2 million of expenses associated with legal defense and settlement costs. Of the $7.2 million, $1.1 million is classified as interest expense, net and $6.0 million is classified as selling, distribution and administrative expenses on the consolidated statement of operations. Except for the issue associated with plaintiffs' attorney fees, which will be resolved by the court, all significant matters have been resolved and we do not anticipate material expense in future periods. The ultimate resolution of the plaintiffs' attorney fees associated with the California Sales Representative Litigation is uncertain. We are reserved for this matter based on a settlement offer to plaintiffs' counsel.

    Environmental Matters

    General

Our operations are subject to federal, state, local, and foreign laws and regulations relating to the generation, storage, handling, transportation, and disposal of hazardous substances and solid and hazardous waste, and the remediation of contaminated sites. Permits and environmental controls are required for certain of our operations to limit air and water pollution, and these permits are subject to modification, renewal, and revocation by the issuing authorities. We will incur capital and operating costs relating to environmental compliance on an ongoing basis. Environmental laws and regulations have generally become stricter in recent years, and the cost of responding to future changes may be substantial. While management believes that we are currently in substantial compliance with all material environmental laws and regulations, and have taken reasonable steps to ensure such compliance, there can be no assurance that we will not incur significant costs to remediate violations of such laws and regulations, particularly in connection with acquisitions of existing operating facilities, or to comply with changes in, or stricter or different interpretations of, existing laws and regulations. Such costs could have a material adverse effect on our results of operations.

    Superfund Sites

Certain of our subsidiaries are currently a party to federal and state administrative proceedings arising under federal and state laws enacted for the protection of the environment where a state or federal agency or a private party alleges that hazardous substances generated by our subsidiary have been discharged into the environment and a state or federal agency is requiring a cleanup of soil and/or groundwater pursuant to federal or state superfund laws. In each of these proceedings in which our subsidiary has been named as a party that allegedly generated hazardous substances that were transported to a waste site owned and operated by another party, either: (1) our subsidiary is one of many other identified generators who have reached an agreement regarding the allocation of costs for cleanup among the various generators and our potential liability is not material; (2) our subsidiary has been identified as a potential generator and the sites have been remediated by the Environmental Protection Agency or by a state for a cost that is not material; (3) other generators have cleaned up the site and have not pursued a claim against our subsidiary and our liability, if any, would not be material; or (4) our subsidiary has been identified as a potential generator but has been indemnified by its waste broker and transporter.

    Environmental Remediation Orders

One of our subsidiaries has been named as a responsible party with respect to the facility located on Seaboard Industrial Boulevard in Atlanta, Georgia that it owns and currently uses in the manufacture of our products. Further, our subsidiary has executed a consent order with the Georgia Environmental Protection Division ("EPD") covering this remediation, and is operating under an EPD approved Corrective Action Plan, which

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(Dollar amounts in thousands, except share and per-share data and as indicated)

may be amended from time to time based on the progression of our remediation. In May 2007, we accrued an undiscounted pre-tax liability of $5.0 million representing our best estimate of costs associated with subsurface remediation, primarily to remove, or secure, contaminants from soil underlying this property, and other related environmental issues. While it is reasonably possible that the total remediation cost could range up to $10.0 million, management's best estimate of the probable total remediation costs continues to be $5.0 million. To date, we have expended approximately $2.8 million of the $5.0 million accrual established in May 2007. Further sampling, engineering studies, and/or changes in regulatory requirements could cause us to revise the current estimate. We arrived at the current estimates based on studies prepared by independent third party environmental consulting firms.

One of our subsidiaries has been named as a responsible party with respect to our Aerosol Facility. With regard to the Aerosol Facility, our subsidiary is responsible for the expected costs of implementing an Amended Corrective Action Plan that was conditionally approved by the EPD in June 2012 under the Georgia Hazardous Response Act. As of August 31, 2014 we recorded liabilities related to the remediation of the Aerosol Facility site in an undiscounted, pre-tax amount of approximately $7.3 million, which represents our best estimate of remaining remediation costs for this site and includes the costs to rebuild the water treatment facility destroyed in the fire. We arrived at the current estimates based on studies prepared by independent third party environmental consulting firms. We have not yet been able to fully assess the impact of the fire on the environmental conditions that are the focus of our remediation efforts at the site.

Additionally, one of our subsidiaries previously conducted manufacturing operations at a facility in Cartersville, Georgia that has since been sold and where sub-surface contamination exists. Pursuant to the terms of the sale, the subsidiary retained environmental exposure that might arise from its previous use of this property. Management is preparing a plan to address sub-surface contamination at this location. Based on recent data, the contamination has migrated off site and is present at a greater depth than originally anticipated. As of August 31, 2014, we recorded liabilities related to the remediation of the Cartersville site in an undiscounted, pre-tax amount of approximately $0.6 million, which represents our best estimate of remaining remediation costs for this site.

The actual cost of remediation of the Aerosol Facility and the Cartersville site could vary depending upon the results of additional testing and geological studies, the rate at which site conditions may change, the success of initial remediation designed to address the most significant areas of contamination, and changes in regulatory requirements. While it is reasonably possible that the total costs incurred by us in connection with these matters could range up to an aggregate of $16.0 million, management's best estimate of total remaining remediation costs for these two sites combined is $7.9 million.


Note 5: Common Stock and Related Matters

    Common and Preferred Stock

We have 500 million shares of common stock, par value $0.01 per share, and 50 million shares of preferred stock authorized as of August 31, 2014. No shares of preferred stock were issued as of that date.

    Stockholder Protection Rights Agreement

Our Board of Directors adopted the Stockholder Protection Rights Agreement (the "Rights Agreement") effective October 30, 2007, which was approved by its then sole shareholder. The Rights Agreement contains provisions that are intended to protect our stockholders in the event of an unsolicited offer to acquire us, including offers that do not treat all stockholders equally and other coercive, unfair, or inadequate takeover bids and practices that could impair the ability of our Board of Directors to fully represent stockholders'

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(Dollar amounts in thousands, except share and per-share data and as indicated)

interests. Pursuant to the Rights Agreement, our Board of Directors declared a dividend of one "Right" for each one of our outstanding shares of common stock as of October 30, 2007. The Rights will be represented by, and trade together with, our common stock until and unless certain events occur, including the acquisition of in excess of 15% of our common stock by a person or group of affiliated or associated persons (with certain exceptions, "Acquiring Persons"); provided, however, that our Board of Directors, at its sole discretion, may grant its prior consent to a person or group of affiliated or associated persons to acquire more than 15% of our outstanding common stock, subject to any conditions the Board may impose, without such acquisition triggering the Rights Agreement. Unless previously redeemed by our Board of Directors, upon the occurrence of one of the specified triggering events, each Right that is not held by an Acquiring Person will entitle its holder to purchase one share of common stock or, under certain circumstances, additional shares of common stock at a discounted price. The Rights will cause substantial dilution to a person or group that attempts to acquire us on terms not approved by our Board of Directors. Thus, the Rights are intended to encourage persons who may seek to acquire control of us to initiate such an acquisition through negotiation with our Board of Directors.

    Earnings per Share

Basic earnings per share is computed by dividing net income adjusted for presumed dividend payments on unvested shares by the weighted average number of common shares outstanding during the period. Unvested shares of restricted stock are excluded from basic shares outstanding. Diluted earnings per share is computed similarly, but reflects the potential dilution that would occur if dilutive options were exercised and restricted stock awards were vested.

The following table reflects basic and diluted earnings per common share for the three fiscal years ended August 31, 2014:

 
  Years Ended August 31,  
 
  2014   2013   2012  

Basic earnings per share:

                   

Net income

  $ 8,400   $ 15,192   $ 21,909  

Less: Allocation of earnings and dividends to participating securities

        (16 )   (90 )
               

Net income available to common shareholders—basic

  $ 8,400   $ 15,176   $ 21,819  

Basic weighted average shares outstanding

    22,307     21,969     21,768  
               

Basic earnings per share

  $ 0.38   $ 0.69   $ 1.00  
               
               

Diluted earnings per share:

                   

Net income available to common shareholders—basic

  $ 8,400   $ 15,176   $ 21,819  

Add: Undistributed earnings reallocated to unvested shareholders          

            1  
               

Net income available to common shareholders—diluted

  $ 8,400   $ 15,176   $ 21,820  

Basic weighted average shares outstanding

    22,307     21,969     21,768  

Common stock equivalents (stock options and restricted stock)          

    599     466     398  
               

Diluted weighted average shares outstanding

    22,906     22,435     22,166  
               

Diluted earnings per share

  $ 0.37   $ 0.68   $ 0.98  
               
               

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Dollar amounts in thousands, except share and per-share data and as indicated)

For the years ended August 31, 2014, 2013 and 2012 we excluded from our earnings per share calculation 0.3 million, 0.9 million and 0.8 million common stock equivalents, respectively, because their effect was anti-dilutive.

    Dividends

Our Board of Directors evaluates our dividend policy quarterly, taking into consideration the composition of our stockholder base; our financial condition, earnings and funding requirements; our growth prospects; applicable law; and any other factors our Board of Directors deems, in its discretion, relevant. We review our capital structure, including dividend policy, quarterly to ensure it remains aligned with the best interests of our stockholders.

Our ability to fund a regular quarterly dividend is impacted by our financial results and the availability of surplus funds. All dividends are paid out of current year earnings. Delaware law prohibits the payment of dividends or otherwise distributing funds to our stockholders absent a legally available surplus. Also, restrictions under the instruments governing our indebtedness could impair our ability to make dividend payments in the future.


Note 6: Loan to Innovation Partner

On December 19, 2011, we entered into a $12.5 million bridge loan agreement, as lender, with Adco Products, LLC ("Adco"), as borrower (the "Original Loan"). Adco is a specialty chemical manufacturer that provides products and services to customers in the dry-cleaning industry. It is an affiliate of Equinox Chemicals, LLC ("Equinox"), a contract research company with research, innovation, product development and commercialization capabilities that reach both domestic and foreign markets. On February 28, 2013, we entered into an amended and restated loan and security agreement (the "Amended Loan Agreement") with Adco. We entered into the Amended Loan Agreement to, among other things, (i) convert the term of the Original Loan from one to five years such that the loan would mature on February 28, 2018, and (ii) reduce the outstanding principal amount of the Original Loan by $2.5 million to $10.0 million in exchange for the issuance of warrants in both Adco and Equinox. The warrants issued to us entitled us to purchase equity interests in Equinox and Adco equal to up to 19% of the then economic, beneficial and other equity interests in each company on a fully diluted basis and subject to certain adjustments.

The loan agreement was considered a variable interest and provided the majority of Adco's financing. In connection with this loan, we also entered into a master service agreement with Equinox, pursuant to which Equinox will provide us with product-development services, and a technology sharing agreement with Equinox for access to new-product technology. The master service agreement and Amended Loan Agreement collectively do not provide us either ownership in or control of Adco's operations.

Adco made all interest and principal payments on the loan from inception through June 2014. However, on June 24, 2014, we were informed by Adco that they would not be able to make the required principal payment on June 30, 2014 and requested modifications to the Amended Loan Agreement. As a result, we evaluated the recoverability of the loan receivable and warrants and recorded an impairment charge of $5.7 million in the third quarter of fiscal 2014 as "Provision for loan loss".

On August 29, 2014, we entered into a Loan Purchase and Assignment Agreement with ADCO Professional Products, LLC, a Delaware limited liability company ("Professional Products"), pursuant to which we sold and assigned to Professional Products all of its rights, title and interest in the $10.0 million loan to Adco together with Adco warrants for a total cash purchase price of $4.4 million. As of August 29, 2014, the loan had an outstanding principal balance of $9.4 million and had been valued on our books at the end of our third fiscal

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(Dollar amounts in thousands, except share and per-share data and as indicated)

quarter of 2014, based on its anticipated recoverability, at approximately $4.0 million. Accordingly, we reduced the provision for loan loss recorded in the third quarter by $0.4 million in the fourth quarter. We retained our previously held warrants in Equinox with a carrying value of $2.3 million as of August 31, 2014.


Note 7: Restructuring Charges

During fiscal 2010, Restructuring Charges recorded within our consolidated statements of operations reflect 1) the consolidation of our logistics branch network, 2) the further streamlining of our organizational structure, which resulted in the reduction of non-sales headcount, and 3) the continued integration of ours and then newly acquired Amrep's manufacturing capabilities. We began marketing a facility in Lancaster, Texas after we transferred manufacturing activities at that location to other of our facilities. After assessing the property's fair value in fiscal year 2012 and 2013, we adjusted the asset's fair market value down by $0.5 million and $0.3 million, respectively, to $1.8 million as of August 31, 2013. We adjusted the property's fair value down by an additional $0.4 million, to $1.4 million in the second quarter of fiscal 2014. The sale of the property was finalized in March 2014. We recorded the charges associated with these write-downs in Acquisition and Integration in our consolidated statements of operations.

In the first-half of fiscal 2011, we recorded a pretax restructuring charge of $1.5 million for costs associated with facility consolidations and reduction of non-sales headcount.

In fiscal 2013, we began marketing a facility in Wellingborough, United Kingdom for sale. We reclassified this asset's value of $1.0 million from Buildings and leasehold improvements to Prepaid expenses and other current assets in our consolidated balance sheets in accordance with its held-for-sale status. The facility in Wellinborough, United Kingdom sold in October 2013.

In fiscal 2013, we developed a plan and began executing a variety of complexity-reduction activities, including facilities consolidation, process simplification, product-line and customer rationalization, and headcount reductions related to such activities. During the fourth quarter of fiscal 2013, we recorded a $5.2 million restructuring charge in connection with these efforts.

Since the initiation of the 2013 restructuring plan, we consolidated four branch locations and continue to review our branch network design and logistic alternatives. We have completed the headcount reduction at our corporate headquarters locations and have made $2.9 million in severance payments. In the fourth quarter of fiscal 2014, we determined that certain elements of the plan related to our European operations could not be completed and restructuring reserves were therefore reversed. Restructuring charges, net of $0.5 million for fiscal 2014 includes $0.6 million of favorable adjustment to our European restructuring reserves, partially offset by an additional $0.1 million of costs associated with facility exit costs.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Dollar amounts in thousands, except share and per-share data and as indicated)

As of August 31, 2013 and 2014, the restructuring reserve was classified as short-term and the balances are included in Accrued compensation and Other accrued liabilities on the consolidated balance sheets.

 
  Severance
Costs
  Facility
Exit
Costs
 

Balance as of August 31, 2011

  $ 628   $ 1,880  

Fiscal 2012 restructuring charges, net

         

Payments made from restructuring accruals

    (568 )   (1,323 )
           

Balance as of August 31, 2012

  $ 60   $ 557  

Fiscal 2013 restructuring charges, net

    4,631     528  

Payments made from restructuring accruals

    (387 )   (649 )
           

Balance as of August 31, 2013

  $ 4,304   $ 436  

Fiscal 2014 restructuring charges, net

    (585 )   129  

Payments made from restructuring accruals

    (2,885 )   (304 )
           

Balance as of August 31, 2014

  $ 834   $ 261  
           
           


Note 8: Share-Based Incentive Programs

The Company's Board of Directors has authorized long term incentive plans, under which Zep stock, restricted stock, performance stock and stock options are granted to certain executive officers and key employees. For the fiscal years ended August 31, 2014, 2013 and 2012, we incurred $4.1 million, $4.1 million and $4.0 million, respectively, of share-based expense, which includes an estimate of forfeitures. We did not capitalize any expense related to share-based payments.

On January 7, 2014, our stockholders approved the Amended and Restated Zep Inc. 2010 Omnibus Incentive Plan (the "Omnibus Incentive Plan"), under which 4,580,000 shares of our common stock are reserved for issuance with respect to long-term equity incentive awards. The Omnibus Incentive Plan replaced our previous share-based incentive plan. The number of shares available for issuance under the Omnibus Incentive Plan was reduced on a share-for-share basis by the number of shares reserved for issuance under our previous share-based incentive plans; however, shares that were reserved for issuance under our previous share-based incentive plan, and shares subject to awards under the previous plan that are subsequently forfeited, that are cancelled or that expire are available for issuance pursuant to the Omnibus Incentive Plan. Pursuant to the Omnibus Incentive Plan, the Compensation Committee (the "Committee") of our Board of Directors is authorized to issue awards consisting of stock options, stock appreciation rights, restricted stock and/or unit awards, performance stock and/or unit awards and cash-based awards to eligible employees, non-employee directors and outside consultants.

Stock options granted under the Omnibus Incentive Plan may be either non-qualified stock options or incentive stock options. The exercise price of stock options may not be less than the fair market value of the common stock on the date of grant. Generally, all options granted under the Omnibus Incentive Plan have terms of ten years. Options granted by the Committee generally vest over four years. Vested options held by terminated employees generally allow for an exercise period of three months following termination. Restricted stock and/or units granted under the Omnibus Incentive Plan that are service based generally vest proportionately over four years. The fair value of restricted stock awards is measured based on their grant date fair market value, and the related compensation expense is recognized over a requisite service period equal to the awards' vesting period. Restricted stock and/or units granted under the Omnibus Incentive Plan that become vested upon the attainment of a stock price appreciation target and a related vesting date

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Dollar amounts in thousands, except share and per-share data and as indicated)

("stock appreciation awards") generally have four year service periods that coincide with four stock price appreciation targets and do not vest unless both criteria have been achieved. The fair value of our stock appreciation awards is determined using a Monte-Carlo simulation valuation model that accommodates stock price appreciation and other provisions of these awards. Restricted stock and/or units granted under the Omnibus Incentive Plan having both service- and earnings-based vesting conditions will vest in their entirety on the third anniversary of their grant date provided that the time-based service requirements and threshold performance levels are achieved. The performance levels are based upon cumulative earnings before interest, taxes, depreciation and amortization ("EBITDA") or average Return on Invested Capital ("ROIC") as measured over a three-year performance period.

At August 31, 2014, 1.5 million options to purchase shares of our common stock, 0.4 million restricted stock awards and/or units, and 0.3 million market and performance conditioned restricted stock awards and/or units were outstanding under the Omnibus Incentive Plan, including those that were previously issued and outstanding under our prior plan. A total of 0.8 million shares were available for grant under the Omnibus Incentive Plan at August 31, 2014. Forfeited shares and shares that are exchanged to pay taxes due upon exercise of stock options or the release of awards are returned to the pool of shares available for grant.

    Stock Options

The grant date fair value of each option is estimated using the Black-Scholes model. The dividend yield was calculated based on annual dividends paid and the trailing historical average closing stock price at the time of grant. Expected volatility for awards issued under our long-term incentive programs was historically based on the volatilities of well-established guideline companies as well as our own historical volatility. This method of determining volatility has been phased out because our trading history is now established and is a more appropriate measure of our expected volatility. We base our risk-free rate on the United States Treasury yield for a term equal to the expected life of the options at the time of grant. We use our historic exercise data to determine the expected life of options. All inputs into the Black-Scholes model are estimates made at the time of grant. Actual realized value of each option grant could materially differ from these estimates, though without impact to future reported net income.

The following weighted average assumptions were used to estimate the fair value of stock options in the fiscal years ended August 31, 2013 and 2012. We did not grant stock options during the fiscal year ended August 31, 2014.

 
  2013   2012  

Dividend yield

    1.1 %   0.8 %

Expected volatility

    48.1 %   45.9 %

Risk-free interest rate

    0.8 %   1.4 %

Expected life of options

    6 years     6 years  

Weighted-average fair value of options granted

  $ 6.26   $ 7.44  

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(Dollar amounts in thousands, except share and per-share data and as indicated)

Stock option transactions during the fiscal years ended August 31, 2014, 2013, and 2012 can be summarized as follows:

 
  Outstanding
(share data in thousands)
  Exercisable
(share data in thousands)
 
 
  Number of
Shares
  Weighted
Average
Exercise Price
  Number of
Shares
  Weighted
Average
Exercise Price
 

Outstanding at August 31, 2011

    1,693   $ 13.70     1,045   $ 12.58  
                   
                   

Granted

    113   $ 18.09              

Exercised

    (38 ) $ 13.85              

Forfeited

    (40 ) $ 16.87              
                       

Outstanding at August 31, 2012

    1,728   $ 13.91     1,383   $ 13.10  
                   
                   

Granted

    116   $ 15.18              

Exercised

    (114 ) $ 10.67              

Forfeited

    (35 ) $ 16.68              
                       

Outstanding at August 31, 2013

    1,695   $ 14.16     1,453   $ 13.75  
                   
                   

Granted

                     

Exercised

    (175 ) $ 13.00              

Forfeited

    (12 ) $ 14.50              
                       

Outstanding at August 31, 2014

    1,508   $ 14.29     1,354   $ 14.04  
                   
                   

Range of option exercise prices at August 31, 2014:

                         

$9.50 – $11.00 (average life – 0.9 years)

    234   $ 9.83     234   $ 9.83  

$12.50 – $13.00 (average life – 3.2 years)

    470   $ 12.52     470   $ 12.52  

$15.00 – $17.50 (average life – 5.1 years)

    597   $ 16.14     517   $ 16.29  

$17.51 – $22.00 (average life – 6.5 years)

    207   $ 18.02     132   $ 18.07  

The total intrinsic value of options exercised during the fiscal years ended August 31, 2014, 2013 and 2012 was $1.2 million, $0.5 million and $0.1 million, respectively. The total intrinsic value of options outstanding, expected to vest, and exercisable as of August 31, 2014, 2013 and 2012 was $3.3 million, $2.0 million and $2.8 million, respectively. As of August 31, 2014, the total unrecognized compensation cost related to unvested options, which is expected to be recognized over a weighted-average period of 1.4 years, was $0.5 million. The weighted-average remaining contractual terms of options outstanding and currently exercisable as of August 31, 2014 were both approximately four years.

    Service Conditioned Restricted Stock Awards

The majority of restricted stock and/or unit awards issued to our employees vest over a four-year period in accordance with time-based service conditions. Restricted stock awards issued to our non-employee directors vest one year from the grant date. The grant date fair value of restricted stock is equal to the closing stock price on that date. The recipient of an award will be entitled to receive dividends or similar distributions on the shares of common stock underlying the corresponding awards when they become vested and the recipient of the stock awards will be entitled to vote.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Dollar amounts in thousands, except share and per-share data and as indicated)

Restricted stock transactions during the fiscal years ended August 31, 2014, 2013 and 2012 can be summarized as follows:

 
  Number of
Shares
(in thousands)
  Weighted
Average
Grant Date
Fair Value
 

Outstanding at August 31, 2011

    304   $ 16.79  
           
           

Granted

    174   $ 14.61  

Vested

    (159 ) $ 16.22  

Forfeited

    (22 ) $ 16.47  
           

Outstanding at August 31, 2012

    297   $ 15.87  
           
           

Granted

    299   $ 13.86  

Vested

    (129 ) $ 16.05  

Forfeited

    (22 ) $ 14.95  
           

Outstanding at August 31, 2013

    445   $ 14.50  
           
           

Granted

    207   $ 16.80  

Vested

    (193 ) $ 14.63  

Forfeited

    (19 ) $ 15.28  
           

Outstanding at August 31, 2014

    440   $ 15.50  
           
           

As of August 31, 2014, the total unrecognized compensation cost related to unvested restricted stock and/or unit awards to our employees was $4.1 million and is expected to be recognized over a weighted-average period of approximately two years. The total fair value of shares vested during the years ended August 31, 2014, 2013 and 2012, was approximately $3.0 million, $2.5 million, $2.1 million, respectively.

    Market and Performance Conditioned Restricted Stock Awards

    Market Conditioned Restricted Stock and/or Unit Awards

Stock appreciation awards issued to employees under the Omnibus Incentive Plan generally vest upon the achievement of stock price (market) targets ("Stock Appreciation Target") and service-related target dates ("Target Date"), in each case as specified at the time of grant of the award. The Stock Appreciation Targets may be met at any time during a period, generally four years, beginning on the grant date and ending on the last Target Date. Generally, achievement of a particular Stock Appreciation Target occurs when the average closing price of our common stock on the New York Stock Exchange for 20 consecutive trading days, on a rolling basis, is equal to or exceeds the particular Stock Appreciation Target. If a Stock Appreciation Target is achieved prior to the corresponding Target Date, then that Stock Appreciation Target will be considered to have been met, regardless of changes in the price of a share of our common stock that occurs later. If upon the final Target Date some or all of the Stock Appreciation Targets have not been achieved, any remaining unvested shares of stock appreciation awards will become fully vested as of the final Target Date if our stock price over the period following the grant date equals or exceeds the return of an index or peer group specified at the time of the award over the same period. Any shares of stock appreciation awards not otherwise vested on the last Target Date will be forfeited. Upon the achievement of each Stock Appreciation Target, the recipient of the award will be entitled to receive dividends or similar distributions on, and be entitled to vote, the shares of common stock underlying the corresponding stock appreciation awards.

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(Dollar amounts in thousands, except share and per-share data and as indicated)

The grant date fair value of our stock appreciation awards was derived using a Monte-Carlo simulation model. The following weighted average assumptions were used to estimate the fair value of these stock appreciation awards issued in fiscal 2011 and 2010. We did not issue stock appreciation awards during fiscal 2014, 2013 or 2012. Shares in tranches 1 through 4 of the fiscal 2010 award have vested. Shares in tranche 1 of the fiscal 2011 award have vested. Tranches 2, 3 and 4 of the 2011 award are not expected to vest.

 
  2011   2010  

Dividend yield

    1.0 %   1.1 %

Expected volatility

    49.08 %   43.68 %

Risk-free interest rate

    0.91 %   1.98 %

Weighted-average fair value of stock appreciation awards granted in:

             

Tranche 1

  $ 16.48   $ 13.61  

Tranche 2

  $ 15.98   $ 13.17  

Tranche 3

  $ 15.39   $ 12.82  

Tranche 4

  $ 14.84   $ 12.43  

    Performance Conditioned Restricted Stock Awards/Units

Restricted stock and/or units granted under the Omnibus Incentive Plan with both service and earnings-based (performance) vesting conditions will vest in their entirety on the third anniversary of their grant date provided that both the time-based service requirements are achieved and the thresholds based upon our cumulative EBITDA or average ROIC as measured over a three-year period are attained. The level of cumulative EBITDA and average ROIC achieved will determine the ultimate number of performance shares received by an award holder. The recipient of a stock or unit award will be entitled to receive dividends or similar distributions on the shares of common stock underlying the corresponding awards when they become vested and the recipient of the stock awards will be entitled to vote.

As of August 31, 2014, the total unrecognized compensation cost related to unvested market and performance conditioned awards was approximately $0.9 million. That cost is expected to be recognized over

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(Dollar amounts in thousands, except share and per-share data and as indicated)

a weighted-average period of 0.8 years. Activity involving market and performance conditioned awards during the years ended August 31, 2014, 2013 and 2012 is summarized as follows:

 
  Number of
Shares
(in thousands)
  Weighted
Average
Grant Date
Fair Value
 

Outstanding at August 31, 2011

    114   $ 14.19  
           
           

Granted

    47     18.09  

Vested

    (34 )   14.53  

Forfeited

    (10 )   14.34  
           

Outstanding at August 31, 2012

    117   $ 15.64  
           
           

Granted

    143     15.18  

Vested

    (18 )   12.97  

Forfeited

    (10 )   15.18  
           

Outstanding at August 31, 2013

    232   $ 15.58  
           
           

Granted

    130     16.80  

Vested

    (16 )   12.60  

Forfeited

    (15 )   15.73  
           

Outstanding at August 31, 2014

    331   $ 15.80  
           
           

    Share Units

In fiscal 2008, we adopted the Zep Inc. Nonemployee Director Deferred Compensation Plan, as amended and restated in October 2012. We require our Directors to defer at least 50% of their annual retainer into this program, and our Directors may defer additional amounts at their election. Under this plan, share deferrals are valued at fair market value at the date of deferral. Of the 300,000 shares reserved for issuance under this plan, 25,706 have been issued. As of August 31, 2014, 93,572 fully-vested share units were accounted for in this plan.

We also maintain a non-qualified deferred compensation program, the Zep Inc. Amended and Restated Supplemental Deferred Savings Plan. This program provides for elective deferrals of an eligible employee's compensation. These deferrals may be matched with company contributions as stipulated by the plan. In addition, when participants defer a minimum of 1% of base salary, the plan provides for a supplemental company contribution ranging from 0% to 5% of an eligible employee's compensation, unless otherwise determined by the Committee. Share unit deferrals resulting from the match and supplemental contributions provided by us are valued at their fair market value at the date of deferral and are ultimately distributed to plan participants in stock. Associates may also elect to defer salary and/or bonus into the share units. Of the 400,000 shares of our common stock reserved under the plan, approximately 29,742 have been issued. As of August 31, 2014, of the 115,295 share units outstanding in this plan, 106,648 share units fully vested and were accounted for in this plan.

    Employee Stock Purchase Plan

In fiscal 2008, we adopted the Zep Inc. Employee Stock Purchase Plan for the benefit of eligible employees. Under the plan, associates are able to purchase our common stock at a 5% discount on a monthly basis. Discounts received under this plan are not compensatory. Of the 200,000 shares of common stock reserved for purchase under the plan, approximately 97,100 shares remained available as of August 31, 2014. Eligible employees may participate at their discretion.

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(Dollar amounts in thousands, except share and per-share data and as indicated)


Note 9: Income Taxes

The components of income before taxes are as follows:

 
  Years Ended August 31,  
 
  2014   2013   2012  

United States

    8,832     16,614     26,343  

Foreign

    5,266     6,473     7,493  
               

Income before income taxes

  $ 14,098   $ 23,087   $ 33,836  
               
               

We account for income taxes using the asset and liability approach. This approach requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Using the enacted tax rates in effect for the year in which the differences are expected to reverse, deferred tax liabilities and assets are determined based on the differences between the financial reporting and the tax basis of an asset or liability. Management has established valuation allowances when it determines that it is more likely than not that some portion, or all, of the deferred tax assets will not be realized.

The provision for income taxes consists of the following components:

 
  Years Ended August 31,  
 
  2014   2013   2012  

Current

                   

Federal

  $ 3,537   $ 1,810   $ 6,484  

State and local

    651     459     859  

Foreign

    2,134     2,615     2,527  
               

Total current provision

    6,322     4,884     9,870  

Deferred

   
 
   
 
   
 
 

Federal

    (308 )   3,456     1,592  

State and local

    (89 )   32     522  

Foreign

    (227 )   (477 )   (57 )
               

Total deferred provision (benefit)

    (624 )   3,011     2,057  
               

Total income tax provision

  $ 5,698   $ 7,895   $ 11,927  
               
               

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(Dollar amounts in thousands, except share and per-share data and as indicated)

A reconciliation from the federal statutory rate to the total provision for income taxes is as follows:

 
  Years Ended August 31,  
 
  2014   2013   2012  

Income tax expense (benefit) at federal statutory rate

  $ 4,934   $ 8,080   $ 11,842  

State and local income taxes net of federal tax benefit

    588     485     846  

Permanent items—nondeductible/nontaxable

    602     168     (154 )

Foreign permanent items and tax rate differential

    (55 )   (213 )   (275 )

Change in valuation allowance

    (229 )   (162 )   55  

Tax credits

    (77 )   (120 )   (96 )

Other—net

    (65 )   (343 )   (291 )