10-Q 1 t10q-8930.txt 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2005 Commission file number 000-04217 --------- ACETO CORPORATION (Exact name of registrant as specified in its charter) New York 11-1720520 -------- ---------- (State or other jurisdiction of (I.R.S. Employer Identification incorporation or organization) Number) One Hollow Lane, Lake Success, Ny 11042 --------------------------------------- (Address of principal executive offices (516) 627-6000 (Registrant's telephone number, including area code) www.aceto.com ------------- (Registrant's website address) Name of each exchange on which registered: The Nasdaq National Market. Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer" and "large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer Accelerated filer X Non-accelerated filer --- --- --- Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No X --- --- The Registrant has 24,230,051 shares of common stock outstanding as of February 7, 2006. ACETO CORPORATION AND SUBSIDIARIES QUARTERLY REPORT FOR THE PERIOD ENDED DECEMBER 31, 2005 TABLE OF CONTENTS PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets - December 31, 2005 (unaudited) and June 30, 2005 Consolidated Statements of Income - Six Months Ended December 31, 2005 and 2004 (unaudited) Consolidated Statements of Income - Three Months Ended December 31, 2005 and 2004 (unaudited) Consolidated Statements of Cash Flows - Six Months Ended December 31, 2005 and 2004 (unaudited) Notes to Consolidated Financial Statements (unaudited) Report of Independent Registered Public Accounting Firm Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosures About Market Risk Item 4. Controls and Procedures PART II. OTHER INFORMATION Item 1. Legal Proceedings Item 2. Unregistered Sales of Equity Securities and Use of Proceeds Item 4. Submission of Matters to a Vote of Security Holders Item 6. Exhibits Signatures Exhibits
PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS ACETO CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands, except per-share amounts) December 31, June 30, 2005 2005 ---- ---- (unaudited) ASSETS Current assets: Cash in banks $ 23,561 $ 19,950 Investments 5,003 5,068 Trade receivables, less allowance for doubtful accounts (December, $432, June $427) 50,684 49,636 Other receivables 1,254 1,421 Inventory 51,930 51,722 Prepaid expenses and other current assets 1,500 821 Assets held for sale - 242 Deferred income tax benefit, net 2,799 2,780 --------- --------- Total current assets 136,731 131,640 Long-term notes receivable 591 624 Property and equipment, net 5,399 5,543 Goodwill 1,703 1,720 Intangible assets, net 3,798 3,153 Deferred income tax benefit, net 2,220 3,626 Other assets 2,615 2,722 --------- --------- TOTAL ASSETS $ 153,057 $ 149,028 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Drafts and acceptances payable $ 2,409 $ 2,462 Short term bank loans - 126 Accounts payable 23,579 24,783 Note payable - related party 500 500 Accrued expenses 12,845 9,474 Liabilities relating to assets held for sale - 46 --------- --------- Total current liabilities 39,333 37,391 Long-term liabilities 4,734 3,811 Minority interest 157 171 --------- --------- Total liabilities 44,224 41,373 Commitments and contingencies (Note 13) Shareholders' equity: Common stock, $.01 par value, 40,000 shares authorized; 25,644 shares issued; 24,222 and 24,282 shares outstanding at December 31, 2005 and June 30, 2005, respectively 256 256 Capital in excess of par value 56,727 56,903 Retained earnings 64,568 62,864 Treasury stock, at cost, 1,422 and 1,362 shares at December 31, 2005 and June 30, 2005, respectively (13,735) (13,505) Accumulated other comprehensive income 1,017 1,137 --------- --------- Total shareholders' equity 108,833 107,655 --------- --------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 153,057 $ 149,028 ========= ========= See accompanying notes to consolidated financial statements and accountants' review report. 3
ACETO CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (unaudited and in thousands, except per-share amounts) Six Months Ended December 31, 2005 2004 ---- ---- Net sales $144,460 $157,187 Cost of sales 120,489 130,390 -------- -------- Gross profit 23,971 26,797 Selling, general and administrative expenses 20,019 19,619 -------- -------- Operating income 3,952 7,178 Other income (expense): Interest expense (61) (40) Interest and other income, net 1,178 855 -------- -------- 1,117 815 -------- -------- Income from continuing operations before income taxes 5,069 7,993 Provision for income taxes 1,521 2,234 -------- -------- Income from continuing operations 3,548 5,759 Loss from discontinued operations, net of income taxes (Note 3) (27) (431) -------- -------- Net income $ 3,521 $ 5,328 ======== ======== Basic income per common share: Income from continuing operations $ 0.15 $ 0.24 Loss from discontinued operations - $ (0.02) Net income $ 0.15 $ 0.22 Diluted income per common share: Income from continuing operations $ 0.14 $ 0.23 Loss from discontinued operations - $ (0.01) Net income $ 0.14 $ 0.22 Weighted average shares outstanding: Basic 24,280 24,145 Diluted 24,595 24,690 See accompanying notes to consolidated financial statements and accountants' review report. 4
ACETO CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (unaudited and in thousands, except per-share amounts) Three Months Ended December 31, 2005 2004 ---- ---- Net sales $ 69,467 $ 76,738 Cost of sales 57,999 63,456 -------- -------- Gross profit 11,468 13,282 Selling, general and administrative expenses 9,657 10,189 -------- -------- Operating income 1,811 3,093 Other income (expense): Interest expense (37) (20) Interest and other income, net 395 306 -------- -------- 358 286 -------- -------- Income from continuing operations before income taxes 2,169 3,379 Provision for income taxes 622 989 -------- -------- Income from continuing operations 1,547 2,390 Loss from discontinued operations, net of income taxes (Note 3) - (438) -------- -------- Net income $ 1,547 $ 1,952 ======== ======== Basic income per common share: Income from continuing operations $ 0.06 $ 0.10 Loss from discontinued operations - $ (0.02) Net income $ 0.06 $ 0.08 Diluted income per common share: Income from continuing operations $ 0.06 $ 0.10 Loss from discontinued operations - $ (0.02) Net income $ 0.06 $ 0.08 Weighted average shares outstanding: Basic 24,273 24,163 Diluted 24,557 24,722 See accompanying notes to consolidated financial statements and accountants' review report. 5
ACETO CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited and in thousands) Six Months Ended December 31, 2005 2004 ---- ---- Operating activities: Net income $ 3,521 $ 5,328 Loss from discontinued operations 27 431 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 686 647 Provision for doubtful accounts - 230 Non-cash stock compensation 50 90 Deferred income taxes 1,387 908 Changes in assets and liabilities: Investments - trading securities 65 (53) Trade accounts receivable (1,240) 6,135 Other receivables 135 (495) Inventory (401) (8,256) Prepaid expenses and other current assets (681) (120) Other assets (307) (739) Drafts and acceptances payable (61) (1,235) Accounts payable (1,111) (5,004) Accrued compensation (21) (83) Accrued environmental remediation (43) (80) Income taxes receivable - 606 Other accrued expenses and long-term liabilities 2,562 1,729 -------- -------- Net cash provided by operating activities 4,568 39 -------- -------- Investing activities: Purchases of investments - (718) Sales of investments - 348 Payments received on notes receivable 31 42 Purchases of property and equipment (268) (3,025) -------- -------- Net cash used in investing activities (237) (3,353) -------- -------- Financing activities: Purchases of treasury stock (581) - Proceeds from exercise of stock options 105 856 Income tax benefit on exercise of stock options 21 215 Payment of note payable - related party - (500) Payments of short-term bank loans (126) - -------- -------- Net cash (used in) provided by financing activities (581) 571 -------- -------- Net cash (used in) provided by discontinued operations (38) 23 -------- -------- Effect of exchange rate changes on cash (101) 529 -------- -------- Net increase (decrease) in cash 3,611 (2,191) Cash at beginning of period 19,950 23,330 -------- -------- Cash at end of period $ 23,561 $ 21,139 ======== ======== See accompanying notes to consolidated financial statements and accountants' review report. 6
ACETO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited and in thousands, except per-share amounts) (1) BASIS OF PRESENTATION The consolidated financial statements of Aceto Corporation and subsidiaries (the "Company") included herein have been prepared by the Company and reflect all adjustments (consisting solely of normal recurring adjustments) necessary to present fairly the financial position, results of operations and cash flows for all periods presented. Interim results are not necessarily indicative of results that may be achieved for the full year. The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses reported in those financial statements. These judgments can be subjective and complex, and consequently actual results could differ from those estimates and assumptions. The Company's most critical accounting policies relate to revenue recognition; allowance for doubtful accounts; inventory; goodwill and other intangible assets; environmental matters and other contingencies; and income taxes. These consolidated financial statements do not include all disclosures associated with consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles. Accordingly, these statements should be read in conjunction with the Company's consolidated financial statements and notes thereto contained in the Company's Form 10-K for the year ended June 30, 2005. Certain reclassifications have been made to the prior consolidated financial statements to conform to the current presentation. (2) STOCK-BASED COMPENSATION Prior to July 1, 2005, the Company accounted for stock-based employee compensation under the intrinsic value method as outlined in the provisions of APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations while disclosing pro-forma net income and net income per share as if the fair value method had been applied in accordance with Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation." Under the intrinsic value method, no compensation expense was recognized if the exercise price of the Company's employee stock options equaled or exceeded the market price of the underlying stock on the date of grant. Since the Company had issued all stock option grants with exercise prices equal to, or greater than, the market value of the common stock on the date of grant, through June 30, 2005 no compensation cost was recognized in the consolidated statements of income. Effective July 1, 2005, the Company adopted SFAS No. 123(R), "Share-based Payment." SFAS No. 123(R) replaces SFAS No. 123 and supersedes APB Opinion No. 25. SFAS 123(R) requires that all stock-based compensation be recognized as an expense in the financial statements and that such costs be measured at the fair value of the award. This statement was adopted using the modified prospective method, which requires the Company to recognize compensation expense on a prospective basis. Therefore, prior period financial statements have not been restated. Under this method, in addition to reflecting compensation expense for new share-based payment awards, expense is also recognized to reflect the remaining vesting period of awards that had been included in pro-forma disclosures in prior periods. Since all options outstanding as of June 30, 2005 were fully vested, there was no compensation expense recognized for those options in the consolidated statements of income for the three and six month periods ended December 31, 2005. SFAS 123(R) also requires that tax benefits related to stock option exercises be reflected as financing cash inflows instead of operating cash inflows. For the six months ended December 31, 2004, this new treatment resulted in increased cash flows from financing activities of $215, which reduced cash flows from operating activities by the same amount. The Company's policy is to satisfy stock-based compensation awards with treasury shares. 7 ACETO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited and in thousands, except per-share amounts) The following table illustrates the effect on net income per common share for the three and six month periods ended December 31, 2004 as if the Company had consistently measured the compensation cost for the Company's stock option programs under the fair value method adopted in fiscal 2006: Six months ended Three months ended December 31, December 31, 2004 2004 ---- ---- Net income - as reported $ 5,328 $ 1,952 Add: Stock-based compensation included in reported net income Deduct: Total stock-based 90 9 employee compensation expense determined under fair value method for all awards, net of related tax effects (4,369) (411) ---------- ---------- Net income - pro forma $ 1,049 $ 1,550 Net income per share: Basic - as reported $ 0.22 $ 0.08 Basic - pro forma $ 0.04 $ 0.06 Diluted - as reported $ 0.22 $ 0.08 Diluted - pro forma $ 0.04 $ 0.06 Stock-based employee compensation expense under the fair value method for the six months ended December 31, 2004 includes $6,046, which represents the entire fair value of 1,322 options granted to employees and 61 options granted to directors in September 2004, all of which had an exercise price equal to or greater than the market value of the common stock on the date of grant, as those options were fully vested as of their date of grant. In January 2006, the Company granted 131 options to certain employees and directors at an exercise price equal to the market value of the common stock on the date of grant. These options vest over one year and will expire ten years from the date of grant. In accordance with SFAS 123(R), compensation expense of $326, as determined using the Black-Scholes option pricing model, will be charged over the vesting period beginning in the third quarter. (3) SALE OF INSTITUTIONAL SANITARY SUPPLIES SEGMENT During June 2005, the Company entered into an agreement to sell the majority of the product lines formulated and marketed by CDC Products Corp. ("CDC"), which is one of the two subsidiaries forming part of the Institutional Sanitary Supplies segment. The sale of certain product lines of CDC was completed on August 24, 2005 for $75 and a note receivable of $44 due in April 2006, which resulted in a pre-tax gain of $66, included in other income in the statement of income for the six months ended December 31, 2005. Excluded from the sale of CDC's product lines was Anti-Clog, an EPA-registered biocide that has a unique delivery system and is used in commercial air-conditioning systems. As a result of management's decision to retain the Anti-Clog product, the Company has reclassified all of CDC's operating results previously reported as "discontinued operations" for the period ended December 31, 2004 to "continuing operations" in the consolidated statements of income for the three and six month periods ended December 31, 2005 and 2004. On September 6, 2005, the Company completed the sale of certain assets of Magnum Research Corp. for $81, of which $66 was received as of December 31, 2005, the remaining subsidiary forming part of the Institutional Sanitary Supplies segment, the operating results of which are included in discontinued operations in the consolidated statements of income. In December 2005, the Company exited the leased space previously occupied by CDC and Magnum Research Corp. As a result, the Company recorded a pre-tax charge of $378, included in selling, general 8 ACETO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited and in thousands, except per-share amounts) and administrative expenses, representing the present value of the remaining lease obligation, reduced by estimated sub-lease rental income over the remaining lease term, which expires in December 2009. Assets held for sale of the disposal group included in the accompanying consolidated balance sheet as of June 30, 2005, consist of current assets (primarily accounts receivable and inventory) of $217, and goodwill of $25. Liabilities related to the assets held for sale reported in the accompanying consolidated balance sheet as of June 30, 2005, consist of accounts payable and accrued expenses of $46. Operating results of discontinued operations were as follows:
Six months ended Three months ended December 31, December 31, 2005 2004 2005 2004 ---- ---- ---- ---- Net sales $ 154 $ 726 - $ 355 ------ ------ ------ ------ Income from operations of discontinued business 44 27 - 16 Provision for income taxes (17) (10) - (6) Non-cash impairment charge - (723) - (723) Benefit for income taxes - 275 - 275 ------ ------ ------ ------ Loss from discontinued operations $ (27) $ (431) - $ (438) ====== ====== ====== ======
(4) SHORT-TERM INVESTMENTS A summary of short-term investments were as follows:
December 31, 2005 June 30, 2005 ----------------- ------------- Fair Value Cost Basis Fair Value Cost Basis ---------- ---------- ---------- ---------- Trading securities ------------------ Corporate equity securities $ 638 $ 152 $ 657 $ 152 Available for sale securities ----------------------------- Corporate bonds 1,179 1,210 1,194 $ 1,210 Government and agency securities 3,186 3,253 3,217 $ 3,253 ------- ------- $ 5,003 $ 5,068 ======= =======
(5) GOODWILL AND OTHER INTANGIBLE ASSETS Goodwill of $1,703 and $1,720 as of December 31, 2005 and June 30, 2005, respectively, relates to the Health Sciences segment. During December 2004, the Company recorded a non-cash impairment charge of $448, net of taxes of $275, for the write-down of goodwill relating to the Institutional Sanitary Supplies segment. 9 ACETO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited and in thousands, except per-share amounts) Intangible assets subject to amortization as of December 31, 2005 and June 30, 2005 were as follows: Gross Carrying Accumulated Net Book Value Amortization Value ----- ------------ ----- December 31, 2005 ----------------- Customer relationships $2,600 $ 743 $1,857 Customer lists 600 570 30 Non-compete agreements 637 507 130 EPA Registration 150 - 150 Patent License 838 19 819 ------ ------ ------ $4,825 $1,839 $2,986 ====== ====== ====== June 30, 2005 ------------- Customer relationships $2,648 $ 567 $2,081 Customer lists 600 510 90 Non-compete agreements 641 486 155 ------ ------ ------ $3,889 $1,563 $2,326 ====== ====== ====== Amortization expense for intangible assets subject to amortization amounted to $275 and $327 for the six months ended December 31, 2005 and 2004, respectively. The estimated aggregate amortization expense for intangible assets subject to amortization for each of the succeeding years ended December 31 are as follows: 2006: $543; 2007: $513; 2008: $513; 2009: $467; 2010: $469 and thereafter: $481. As of December 31, 2005 and June 30, 2005, the Company also had $812 and $827, respectively, of intangible assets pertaining to trademarks which are not subject to amortization. Changes in goodwill and the gross carrying value of certain intangible assets are attributable to foreign currency exchange rates used to translate the financial statements of foreign subsidiaries. (6) ACCRUED EXPENSES The components of accrued expenses as of December 31, 2005 and June 30, 2005 were as follows: December 31, June 30, 2005 2005 ---- ---- Accrued compensation $ 2,535 $ 2,566 Accrued environmental remediation costs 1,152 1,195 Accrued dividends payable 1,816 - Other accrued expenses 7,342 5,713 -------- -------- $ 12,845 $ 9,474 ======== ======== (7) COMMON STOCK On December 2, 2005, the Company's board of directors declared a regular semi-annual cash dividend of $0.075 per share which was paid on January 11, 2006 to shareholders of record on December 23, 2005. The amount paid for the cash dividend of $1,816 was included in other accrued expenses at December 31, 2005. On December 2, 2004, the Company's board of directors declared a 3-for-2 stock split, effected in the form of a dividend, and a cash dividend of $0.15 per share, to be paid semi-annually. The stock split, effected in the form of a dividend, and semi-annual cash dividend of $0.075 were paid January 10, 2005, to shareholders of record on 10 ACETO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited and in thousands, except per-share amounts) December 24, 2004. The amount paid for the cash dividend of $1,820 was included in other accrued expenses at December 31, 2004. The Company transferred $80 to common stock from capital in excess of par value, representing the aggregate par value of the 8,073 shares issued for the stock split. (8) NET INCOME PER COMMON SHARE Basic income per common share is based on the weighted average number of common shares outstanding during the period. Diluted income per common share includes the dilutive effect of potential common shares outstanding. The Company's only potential common shares outstanding are stock options, which resulted in a dilutive effect of 284 and 559 shares for the three months ended December 31, 2005, and 2004, respectively. There were 1,610 stock options outstanding as of December 31, 2005, that were not included in the calculation of diluted income per common share for the three months ended December 31, 2005 because their effect would have been anti-dilutive. There were no stock options outstanding as of December 31, 2004 that were not included in the calculation of diluted income per common share for the three months ended December 31, 2004 because their effect would have been anti-dilutive. (9) COMPREHENSIVE INCOME Comprehensive income consists of net income and other gains and losses affecting shareholders' equity that, under generally accepted accounting principles, are excluded from net income. The components of comprehensive income were as follows:
Six months ended Three months ended December 31, December 31, 2005 2004 2005 2004 ---- ---- ---- ---- Comprehensive income: Net income $3,521 $5,328 $1,547 $1,952 Foreign currency translation adjustment (128) 3,028 (310) 2,569 Unrealized loss on available for sale securities (46) (87) (5) (207) Change in fair value of cross currency interest rate swaps 54 (1,112) 145 (944) ------ ------ ------ ------ Total $3,401 $7,157 $1,377 $3,370 ====== ====== ====== ======
The financial statements of the Company's foreign subsidiaries are measured using the local currency as the functional currency. Exchange gains or losses resulting from the translation of financial statements of foreign operations are accumulated in other comprehensive income. The currency translation adjustments are not adjusted for income taxes as they relate to indefinite investments in non-US subsidiaries. (10) DEFERRED INCOME TAXES The decrease in the deferred income tax assets of $1,387 and $908 during the six months ended December 31, 2005 and 2004, respectively, related to the reduction of taxes payable due to the utilization of foreign net operating loss carryforwards. The reduction of taxes payable during the six months ended December 31, 2004 was partially offset by a $275 deferred tax asset established for the write-down of goodwill. 11 ACETO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited and in thousands, except per-share amounts) (11) SUPPLEMENTAL CASH FLOW INFORMATION Cash paid for interest and income taxes for the six months ended December 31, 2005 and 2004 were as follows: 2005 2004 ---- ---- Interest $ 48 $ 31 Income taxes, net of refunds 497 929 The semi-annual cash dividend of $0.075 paid January 11, 2006, to shareholders of record on December 23, 2005 of $1,816 was included in other accrued expenses at December 31, 2005. (12) RELATED PARTY TRANSACTIONS Certain directors of the Company are affiliated with law firms that serve as counsel to the Company on various corporate matters. During the six months ended December 31, 2005 and 2004, the Company incurred legal fees of $157 and $57, respectively, for services rendered to the Company by these law firms. (13) COMMITMENTS AND CONTINGENCIES As of December 31, 2005, the Company had outstanding purchase obligations totaling $49,488 with suppliers to acquire certain products for resale to third party customers. The Company and its subsidiaries are subject to various claims that have arisen in the normal course of business. The impact of the final resolution of these matters on the Company's results of operations or liquidity in a particular reporting period is not known. Management is of the opinion, however, that the ultimate outcome of these matters will not have a material adverse effect upon the Company's financial condition or liquidity. One of the Company's subsidiaries was a defendant in a legal action alleging patent infringement. The patent in question covered a particular method of applying one of the products in the Company's Agrochemicals segment. In September 2005, shortly before a trial was expected to begin, the parties agreed to a settlement. Under the terms of the settlement agreement, the Company was obligated to pay $1,375, of which $625 was paid in December 2005 and the remaining $750 will be paid in equal installments over the next five years. As a result of the settlement, the company recorded an intangible asset of $838 for the patent license, which will be amortized over its remaining life of 11 years, and a charge of $537, included in SG&A expense, for the six months ended December 31, 2005. Commercial letters of credit are issued by the Company during the ordinary course of business through major domestic banks as requested by certain suppliers. The Company had open letters of credit of approximately $1,306 and $1,783 as of December 31, 2005 and June 30, 2005, respectively. The terms of these letters of credit are all less than one year. No material loss is anticipated due to non-performance by the counterparties to these agreements. (14) RECENT ACCOUNTING PRONOUNCEMENTS In June 2005, the Financial Accounting Standards Board ("FASB") issued SFAS No. 154, "Accounting Changes and Error Corrections," a replacement of APB Opinion No. 20, "Accounting Changes", and FASB SFAS No. 3, "Reporting Accounting Changes in Interim Financial Statements." SFAS No. 154 applies to all voluntary changes in accounting principles, and changes the requirements for accounting for and reporting of a change in accounting principle. SFAS No. 154 requires retrospective application to prior periods' financial statements of a voluntary change in accounting principle unless it is impracticable. SFAS No. 154 also requires that a change in method of depreciation, amortization, or depletion for long-lived, non-financial assets be accounted for as a change in accounting estimate that is affected by a change in accounting principle. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Earlier application is permitted for accounting changes and corrections of errors occurring in fiscal years beginning after June 1, 2005. SFAS No. 154 does not change the transition provisions of any existing accounting pronouncements, including those 12 ACETO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited and in thousands, except per-share amounts) that are in a transition phase as of the date of SFAS No. 154. The Company does not believe that adoption of SFAS No. 154 will have a material impact on its financial statements. In March 2005, the FASB issued FASB Interpretation (FIN) No. 47, Accounting for Conditional Asset Retirement Obligations - An Interpretation of SFAS No. 143. The FASB issued FIN 47 to address diverse accounting practices that developed with respect to the timing of liability recognition for legal obligations associated with the retirement of a tangible long-lived asset when the timing and (or ) method of settlement of the obligation are conditional on a future event. FIN 47 concludes that an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation when incurred if the liability's fair value can be reasonably estimated. FIN 47 is effective for the Company no later than June 30, 2006. The Company is in the process of evaluating what impact, if any, the adoption of FIN 47 will have on its financial statements. On October 22, 2004, the President of the United States signed the American Jobs Creation Act of 2004. This law creates a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85% dividends-received deduction for certain dividends from controlled foreign corporations. The deduction is subject to a number of limitations, and the FASB issued two Staff Positions to provide guidance on how companies should account for the effects of the American Jobs Creation Act. The Company is currently evaluating whether to repatriate any extraordinary dividends. (15) SEGMENT INFORMATION The Company's three continuing reportable segments, organized by product, are as follows: o Health Sciences - includes the active ingredients for generic pharmaceuticals, vitamins, and nutritional supplements, as well as products used in preparing pharmaceuticals, primarily by major innovative drug companies, and biopharmaceuticals. o Chemicals & Colorants - products include a variety of specialty chemicals used in plastics, resins, adhesives, coatings, food, flavor additives, fragrances, cosmetics, metal finishing, electronics, air-conditioning systems and many other areas; dye and pigment intermediates used in the color-producing industries like textiles, inks, paper, and coatings; intermediates used in the production of agrochemicals. o Agrochemicals - products include herbicides, fungicides and insecticides, as well as a sprout inhibitor for potatoes. The Institutional Sanitary Supplies segment reported in prior years, which included cleaning solutions, fragrances and deodorants for commercial and industrial customers, was successfully divested from the Company's ongoing business. During June 2005, the Company entered into an agreement to sell the majority of the product lines formulated and marketed by CDC, which was one of the two subsidiaries forming the Institutional Sanitary Supplies segment. The sale of certain product lines of CDC was completed on August 24, 2005. Excluded from the sale of CDC's product lines was Anti-Clog, an EPA-registered biocide that has a unique delivery system and is used in commercial air-conditioning systems. As a result of management's decision to retain the Anti-Clog product, the Company has reclassified all of CDC's operating results previously reported as "discontinued operations" for the period ended December 31, 2004 to "continuing operations" in the consolidated statements of income for the three and six month periods ended December 31, 2005 and 2004. Commencing July 1, 2005, the operating results of CDC, which consist primarily of Anti-Clog sales, are included in the Chemicals & Colorants segment. On September 6, 2005, the Company completed the sale of certain assets of Magnum Research Corp., the remaining subsidiary forming part of the former Institutional Sanitary Supplies segment, the operating results of which are included in discontinued operations in the consolidated statements of income. 13 ACETO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited and in thousands, except per-share amounts) Six months ended December 31, 2005 and 2004:
Institutional Health Chemicals & Sanitary Consolidated Sciences Colorants Agrochemicals Supplies Totals -------- --------- ------------- -------- ------ 2005 ---- Net sales $ 82,732 $ 51,879 $ 9,849 - $ 144,460 Gross profit 16,265 8,093 1,938 - 26,296 Unallocated cost of sales (1) (2,325) --------- Net gross profit $ 23,971 --------- 2004 ---- Net sales $ 97,622 $ 48,548 $ 8,997 $ 2,020 $ 157,187 Gross profit 17,673 7,917 2,791 333 28,714 Unallocated cost of sales (1) (1,917) --------- Net gross profit $ 26,797 ---------
Three months ended December 31, 2005 and 2004:
Institutional Health Chemicals & Sanitary Consolidated Sciences Colorants Agrochemicals Supplies Totals -------- --------- ------------- -------- ------ 2005 ---- Net sales $ 38,056 $ 25,731 $ 5,680 - $ 69,467 Gross profit 7,432 4,004 1,282 - 12,718 Unallocated cost of sales (1) (1,250) --------- Net gross profit $ 11,468 --------- 2004 ---- Net sales $ 45,383 $ 24,543 $ 5,882 $ 930 $ 76,738 Gross profit 8,133 4,024 1,973 137 14,267 Unallocated cost of sales (1) (985) --------- Net gross profit $ 13,282 ---------
(1) Certain freight and storage costs are not allocated to the segments as such costs are managed on an entity-wide basis, and the information to reasonably allocate such costs is not readily available. The Company does not allocate assets by segment. The Company's chief operating decision maker evaluates performance of the segments based on net sales and gross profit. The Company does not allocate assets by segment because the chief operating decision maker does not review the assets by segment to assess the segments' performance, as the assets are managed on an entity-wide basis. Net sales and gross profit by location for the six months ended December 31, 2005 and 2004 and long-lived assets by location as of December 31, 2005 and June 30, 2005 were as follows:
Net Sales Gross Profit Long-lived Assets --------- ------------ ----------------- Six months ended Six months ended As of December 31, December 31, December 31, June 30, 2005 2004 2005 2004 2005 2005 ---- ---- ---- ---- ---- ---- United States $ 91,273 $ 87,532 $13,448 $13,703 $1,516 $1,469 Germany 27,199 31,658 7,013 7,685 447 509 Netherlands 5,491 4,010 927 935 240 285 France 5,767 5,414 713 718 90 90 Asia-Pacific 14,730 28,573 1,870 3,756 3,106 3,190 -------- -------- ------- ------- ------ ------ Total $144,460 $157,187 $23,971 $26,797 $5,399 $5,543 ======== ======== ======= ======= ====== ======
14 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors and Shareholders Aceto Corporation We have reviewed the consolidated balance sheet of Aceto Corporation and subsidiaries as of December 31, 2005, and the related consolidated statements of income for the three-month and six-month periods ended December 31, 2005, and the related consolidated statement of cash flows for the six-month period ended December 31, 2005 included in the accompanying Securities and Exchange Commission Form 10-Q for the period ended December 31, 2005. These interim financial statements are the responsibility of the Company's management. We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our reviews, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with accounting principles generally accepted in the United States of America. The consolidated balance sheet of Aceto Corporation and subsidiaries as of June 30, 2005, and the related consolidated statements of income, shareholders' equity and comprehensive income (loss), and cash flows for the year then ended (not presented herein) have been previously audited by other independent public accountants, in accordance with the standards of the Public Company Accounting Oversight Board; and in their report dated September 8, 2005, they expressed an unqualified opinion on those consolidated financial statements. /s/ BDO Seidman, LLP Melville, New York February 3, 2006 15 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CAUTIONARY STATEMENT RELATING TO THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 This Quarterly Report on Form 10-Q and the information incorporated by reference includes "forward-looking statements" within the meaning of section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. We intend those forward looking-statements to be covered by the safe harbor provisions for forward-looking statements. All statements regarding our expected financial position and operating results, our business strategy, our financing plans and the outcome of any contingencies are forward-looking statements. Any such forward-looking statements are based on current expectations, estimates and projections about our industry and our business. Words such as "anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates," or variations of those words and similar expressions are intended to identify such forward-looking statements. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those set forth or implied by any forward-looking statements. Factors that could cause actual results to differ materially from forward-looking statements include, but are not limited to, unforeseen environmental liabilities, uncertain military actions in the world, the mix of products sold and their profit margins, order cancellation or a reduction in orders from customers, the nature and pricing of competing products, the availability and pricing of key raw materials, dependence on key members of management, risks of entering into new European markets, continued successful integration of acquisitions, and economic and political conditions in the United States and abroad. NOTE REGARDING DOLLAR AMOUNTS In this quarterly report, all dollar amounts are expressed in thousands, except for share prices and per-share amounts. EXECUTIVE SUMMARY We are reporting net sales of $144,460 for the six months ended December 31, 2005, which represents an 8.1% decrease over the $157,187 reported in the comparable prior period. Our income from continuing operations of $3,548, or $0.14 per diluted share was $2,211 lower than the comparable prior period. As discussed in prior quarterly and annual reports, this decrease is directly attributable to the loss of business on two previously launched API's. Our financial position as of December 31, 2005 remains strong, as we had cash of $23,561, working capital of $97,398, no long-term debt, and shareholders' equity of $108,833. Our business is separated into three principal segments: Health Sciences, Chemicals & Colorants and Agrochemicals. The Health Sciences segment is our largest segment in terms of both sales and gross profits. This segment is comprised of APIs, pharmaceutical intermediates, diagnostic chemicals and nutritional supplements. APIs comprise about 65% of this segment's revenues. We have a pipeline of new generic products poised to reach commercial levels over the coming years as the patents on existing drugs expire, both in the United States and Europe. We typically partner with both customers and suppliers years in advance of a drug coming off patent to provide the generic equivalent. In addition, as new members join the European Union, primarily from Eastern Europe, they become subject to the same regulatory standards as their Western Europe counterparts. Given our regulatory expertise, we believe this represents an opportunity for us, and we believe we are well positioned to take advantage of that opportunity. The Chemicals & Colorants segment supplies chemicals used in the color-producing industries such as textiles, ink, paper and coatings, as well as chemicals used in plastic, resins, adhesives, coatings, food, flavor additives, air-conditioning systems and the production of agrochemicals. Our sales of these products are predominantly in the United States and purchases are primarily from China and Western Europe. 16 The Agrochemicals segment sells herbicides, pesticides, and other Agrochemicals, primarily in the United States and Western Europe. Our joint venture with Nufarm, which markets Butoxone(R) is expected to increase our market share of the peanut, soybean and alfalfa herbicide markets. We formerly also reported under the Institutional Sanitary Supplies segment, which included cleaning solutions, fragrances and deodorants for commercial and industrial customers. This segment was successfully divested from our ongoing business. Specifically, during June 2005, we entered into an agreement to sell the majority of the product lines formulated and marketed by CDC Products Corp. ("CDC"), which was one of the two subsidiaries forming the Institutional Sanitary Supplies segment. The sale of certain product lines of CDC was completed on August 24, 2005. Excluded from the sale of CDC's product lines was Anti-Clog, an EPA-registered biocide that has a unique delivery system and is used in commercial air-conditioning systems. As a result of management's decision to retain the Anti-Clog product, the Company has reclassified all of CDC's operating results previously reported as "discontinued operations" for the period ended December 31, 2004 to "continuing operations" in the consolidated statements of income for the three and six month periods ended December 31, 2005 and 2004. Commencing July 1, 2005, the operating results of CDC, which consist primarily of Anti-Clog sales, are included in the Chemicals & Colorants segment. On September 6, 2005, we completed the sale of certain assets of Magnum Research Corp., the remaining subsidiary forming part of the Institutional Sanitary Supplies segment, the operating results of which are included in discontinued operations in the consolidated statements of income. In December 2005, the Company exited the leased space previously occupied by CDC and Magnum Research Corp. As a result, the Company recorded a pre-tax charge of $378, included in selling, general and administrative expenses, representing the present value of the remaining lease obligation reduced by estimated sub-lease rental income over the remaining lease term, which expires in December 2009. Our main business strengths are sourcing, regulatory support and quality control. We believe that we are currently the largest buyer of pharmaceutical and specialty chemicals for export from China, purchasing from over 500 different factories. In this Management's Discussion and Analysis section, we explain our general financial condition and results of operations, including the following: o factors that affect our business o our earnings and costs in the periods presented o changes in earnings and costs between periods o sources of earnings o the impact of these factors on our overall financial condition When you read this Management's Discussion and Analysis section, you should refer to the accompanying consolidated statements of income, which present the results of our operations for the three and six month periods ended December 31, 2005 and 2004. We analyze and explain the differences between periods in the specific line items of the consolidated statements of income. CRITICAL ACCOUNTING ESTIMATES AND POLICIES As disclosed in our Form 10-K for the year ended June 30, 2005, the discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. In preparing these financial statements, we were required to make estimates and assumptions that affect the amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We regularly evaluate our estimates including those related to allowances for bad debts, inventories, goodwill and intangible assets, environmental and other contingencies, and income taxes. We base our estimates on various factors, including historical experience, advice from outside subject-matter experts, and various assumptions that we believe to be reasonable under the circumstances, which together form the basis for our making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. Since June 30, 2005, there have been no significant changes to the assumptions and estimates related to those critical accounting estimates and policies. 17 RESULTS OF OPERATIONS SIX MONTHS ENDED DECEMBER 31, 2005 COMPARED TO SIX MONTHS ENDED DECEMBER 31, 2004
NET SALES BY SEGMENT Six months ended December 31, Comparison 2005 2005 2004 Over/(Under) 2004 ---- ---- ----------------- % of % of $ % Segment Net sales total Net sales total change change ------- --------- ----- --------- ----- ------ ------ Health Sciences $ 82,732 57.3% $ 97,622 62.1% $(14,890) (15.3)% Chemicals & Colorants 51,879 35.9 48,548 30.9 3,331 6.9 Agrochemicals 9,849 6.8 8,997 5.7 852 9.5 Institutional Sanitary Supplies - - 2,020 1.3 (2,020) (100.0) -------- ------ -------- ------ -------- ------- Net sales $144,460 100.0% $157,187 100.0% $(12,727) (8.1)% ======== ====== ======== ====== ======== ======= GROSS PROFIT BY SEGMENT Six months ended December 31, Comparison 2005 2005 2004 Over/(Under) 2004 ---- ---- ----------------- % of % of $ % Segment Net sales sales Net sales sales change change ------- --------- ----- --------- ----- ------ ------ Health Sciences $ 16,265 19.7% $ 17,673 18.1% $ (1,408) (8.0)% Chemicals & Colorants 8,093 15.6 7,917 16.3 176 2.2 Agrochemicals 1,938 19.7 2,791 31.0 (853) (30.6) Institutional Sanitary Supplies - - 333 16.5 (333) (100.0) -------- ------ -------- ------ -------- ------- Segment gross profit 26,296 18.2 28,714 18.3 (2,418) 8.4 Freight and storage costs (1) (2,325) (1.6) (1,917) (1.2) (408) (21.3) -------- ------ -------- ------ -------- ------- Gross profit $ 23,971 16.6% $ 26,797 17.0% $ (2,826) 10.5% ======== ====== ======== ====== ======== ======= (1) Represents certain freight and storage costs that are not allocated to a segment.
18 NET SALES Net sales decreased $12,727, or 8.1%, to $144,460 for the six months ended December 31, 2005, compared with $157,187 for the comparable prior period. We reported a sales decrease in our Health Sciences segment during this period, which was partially offset by sales increases in our Chemicals & Colorants and Agrochemicals segments, as explained below. HEALTH SCIENCES Net sales for the Health Sciences segment decreased by $14,890 for the six months ended December 31, 2005, to $82,732, which represents a 15.3% decrease from net sales of $97,622 for the prior period. The sales decrease from the prior period is directly attributed to the loss of foreign business of $15,491 from two previously launched APIs due to increased competition. The six month results, net of the two lost APIs, include a sales reduction of $1,235 from our foreign operations which was offset by a sales increase of $1,890 from our domestic operations over the prior year. CHEMICALS & COLORANTS Net sales for the Chemicals & Colorants segment were $51,879 for the six months ended December 31, 2005, compared to $48,548 for the prior period. This increase of $3,331, or 6.9%, over the prior period is primarily attributable to an increase in the Agricultural intermediate and food, beverage and cosmetic product groups of $2,961 over the comparable period last year. Sales of Chemicals & Colorants products by our foreign subsidiaries for the six months ended December 31, 2005, showed a modest increase of $258 over the prior period. Our chemical business is diverse in terms of products, customers and consuming markets. In addition, net sales for this segment includes a $1,086 increase relating to our former CDC business, including the Anti-Clog product. One customer within our color-pigment and pigment-intermediate business purchased $1,721 less product during the six months ended December 31, 2005 as their contract had expired. This reduction was more than offset by an increase over the prior period in domestic sales of our chemical and colorants offerings; in particular products with increased sales were coatings and miscellaneous intermediates. AGROCHEMICALS Net sales for the Agrochemical segment increased to $9,849 for the six months ended December 31, 2005, an increase of $852, or 9.5%, over net sales of $8,997 for the prior period. The increase in net sales was primarily attributable to $325 higher sales of the product sold by our joint venture with Nufarm and an increased demand for a fungicide used on pecans of $297. GROSS PROFIT Gross profit by segment before unallocated cost of sales (primarily storage and certain freight costs) decreased $2,418 to $26,296 (18.2% of net sales) for the six months ended December 31, 2005, as compared to $28,714 (18.3% of net sales) for the prior period. HEALTH SCIENCES Health Sciences' gross profit of $16,265 for the six months ended December 31, 2005, was $1,408 or 8.0% lower than the prior period. This decrease in gross profit was directly attributable to the loss of business on two larger previously-launched APIs in Asia of $2,221 due to significant competitive pressures. This lost gross profit was partially offset by an increase in gross profit from sales increases from our domestic APIs of $468 and pharmaceutical intermediates products of $260 over the prior period. The gross margin increased to 19.7% compared to a gross margin of 18.1% for the prior period due primarily to a shift in the product mix of net sales to higher margin products during the six months ended December 31, 2005. 19 CHEMICALS & COLORANTS Gross profit for the six months ended December 31, 2005, increased by $176, or 2.2%, over the prior period. The gross margin percentage was 15.6% for the six months ended December 31, 2005 compared to 16.3% for the prior period due to a shift in product mix to slightly lower margin products. AGROCHEMICALS Gross profit for the Agrochemicals segment decreased to $1,938 for the six months ended December 31, 2005, versus $2,791 for the prior period, a decrease of $853 or 30.6%. Gross margin for the period was 19.7% compared to the prior period gross margin of 31.0%. The primary reasons for the decrease in gross profit was due to lower royalty payments from our foreign customers of $278 compared to last year, and higher cost of goods for our largest selling product, of $245. The gross profits and margins were also negatively affected by $194 due to higher costs associated with maintaining our EPA registered products. We believe our gross margin for the balance of the fiscal year will be more in line with historical levels. Unallocated cost of sales increased $408, to $2,325 for the six months ended December 31, 2005 compared to $1,917 in the prior period, representing a 21.3% increase. The higher costs were mainly a result of higher stock levels and freight costs due to rising fuel surcharges on shipments to customers. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses ("SG&A") increased $400, or 2.0% to $20,019 for the six months ended December 31, 2005 compared to $19,619 for the prior period. As a percentage of sales, SG&A increased to 13.9% for the six months ended December 31, 2005 versus 12.5% for the prior period. This increase was primarily due to the inclusion of a $537 charge for a settlement of legal claims against our Agrochemicals subsidiary. The increase was partially offset by a decrease in bad debt expense of $230 and a general decrease in SG&A expenses of $200 as a result of recent cost saving initiatives. Operating expenses include a $378 charge to exit the facility occupied by our former CDC business. The exit charge is included in the total CDC SG&A expenses during the six months of $1,126 which is $90 less than the same period last year. We expect the CDC operating expenses to decrease significantly in the coming quarters. OPERATING INCOME For the six months ended December 31, 2005, operating income was $3,952 compared to $7,178 in the prior period, a decrease of $3,226 or 44.9%. This decrease was due to the overall decrease in gross profit of $2,826 and the $400 increase in SG&A expenses. INTEREST AND OTHER INCOME (EXPENSE) Interest and other income (expense) was $1,178 for the six months ended December 31, 2005, which represents an increase of $323 over the prior period. The increase is primarily attributable to an increase of $102 regarding a government subsidy paid annually for doing business in a free trade zone in Shanghai, China, proceeds from credit insurance of $211, sale of distribution rights for a particular product in certain European countries of $133 and proceeds from the sale of certain task force data of $55, partially offset by a net loss on foreign currency of $224. PROVISION FOR INCOME TAXES The effective tax rate for the six months ended December 31, 2005 increased to 30.0% from 27.9% for the prior period. The increase in the effective tax rate was primarily due to increased earnings in foreign tax jurisdictions with higher tax rates, primarily Germany, and reduced earnings in foreign tax jurisdictions with lower tax rates, primarily Shanghai. 20 DISCONTINUED OPERATIONS The net loss from discontinued operations was $27 and $431 for the six months ended December 31, 2005 and 2004, respectively. The net loss from discontinued operations for the six months ended December 31, 2004 includes a non-cash write-down of goodwill of $448, net of taxes of $275. THREE MONTHS ENDED DECEMBER 31, 2005 COMPARED TO THREE MONTHS ENDED DECEMBER 31, 2004
NET SALES BY SEGMENT Three months ended December 31, Comparison 2005 2005 2004 Over/(Under) 2004 ---- ---- ----------------- % of % of $ % Segment Net sales total Net sales total change change ------- --------- ----- --------- ----- ------ ------ Health Sciences $ 38,056 54.7% $ 45,383 59.1% $ (7,327) (16.1)% Chemicals & Colorants 25,731 37.0 24,543 32.0 1,188 4.8 Agrochemicals 5,680 8.2 5,882 7.7 (202) (3.4) Institutional Sanitary Supplies - - 930 1.2 (930) (100.0) -------- ------ -------- ------ -------- ------- Net sales $ 69,467 100.0% $ 76,738 100.0% $ (7,271) (9.4)% ======== ====== ======== ====== ======== ======= GROSS PROFIT BY SEGMENT Three months ended December 31, Comparison 2005 2005 2004 Over/(Under) 2004 ---- ---- ----------------- % of % of $ % Segment Net sales sales Net sales sales change change ------- --------- ----- --------- ----- ------ ------ Health Sciences $ 7,432 19.5% $ 8,133 17.9% $ (701) (8.6)% Chemicals & Colorants 4,004 15.6 4,024 16.4 (20) - Agrochemicals 1,282 22.6 1,973 33.5 (691) (35.0) Institutional Sanitary Supplies - - 137 1.0 (137) (100.0) -------- ------ -------- ------ -------- ------- Segment gross profit 12,718 18.3 14,267 18.6 (1,549) (10.9)% Freight and storage costs (1) (1,250) (1.8) (985) (1.3) (265) (26.8)% -------- ------ -------- ------ -------- ------- Gross profit $ 11,468 16.5% $ 13,282 17.3% $ (1,814) (13.7)% ======== ====== ======== ====== ======== ======= (1) Represents certain freight and storage costs that are not allocated to a segment.
21 NET SALES Net sales decreased $7,271or 9.4%, to $69,467 for the three months ended December 31, 2005, compared with $76,738 for the comparable prior period. We reported sales decreases in our Health Sciences and Agrochemicals segments partially offset by a sales increase in our Chemicals & Colorants, as explained below. HEALTH SCIENCES Net sales for the Health Sciences segment decreased by $7,327 for the three months ended December 31, 2005, to $38,056, which represents a 16.1% decrease from net sales of $45,383 for the prior period. The sales decrease from the prior period is directly attributable to the loss of foreign business of $5,347 from two previously launched APIs due to increased competition. Additionally, our foreign subsidiaries reported a sales reduction of $3,396 primarily from Germany and France. The French API business was affected by recent changes in the government's generic reimbursement policy. This loss of business was partially offset by a $1,416 increase in net sales from our domestic operations over the prior period. CHEMICALS & COLORANTS Net sales for the Chemicals & Colorants segment were $25,731 for the three months ended December 31, 2005, compared to $24,543 for the prior period. This increase of $1,188, or 4.8%, over the prior period is primarily attributable to an increase in the Ag intermediate product group of $1,246. Our chemical business is diverse in terms of products, customers and consuming markets. One customer within our color-pigment and pigment-intermediate business purchased $886 less product during the three months ended December 31, 2005 due to the expiration of their contract. This reduction was more than offset by a $1,018 increase over the prior period in domestic sales of our chemical and colorants offerings; in particular products with increased sales were dye intermediates, coatings, and food beverage and cosmetics. In addition, net sales includes a $312 increase due to the inclusion of Anti-Clog sales in this segment. AGROCHEMICALS Net sales for the Agrochemicals segment decreased to $5,680 for the three months ended December 31, 2005, a decrease of $202, or 3.4%, over net sales of $5,882 for the prior year. The decrease in net sales was primarily attributable to $246 lower royalty income from our foreign customers. GROSS PROFIT Gross profit by segment before unallocated cost of sales (primarily storage and certain freight costs) decreased $1,549 to $12,718 (18.3% of net sales) for the three months ended December 31, 2005, as compared to $14,267 (18.6% of net sales) for the prior period. HEALTH SCIENCES Health Sciences' gross profit of $7,432 for the three months ended December 31, 2005, was $701 or 8.6% lower than the prior period. This decrease in gross profit was directly attributed to the loss of business on two larger previously launched APIs in Asia of $755 due to significant competitive pressures. This lost gross profit was partially offset by an increase in gross profit from our domestic operations of $373 and lower gross profit from our German operation of $554 caused by reduced sales volume compared to the prior year. CHEMICALS & COLORANTS Gross profit for the three months ended December 31, 2005, decreased by $20, or less than 1%, over the prior period. The gross margin percentage was 15.6% for the three months ended December 31, 2005 compared to 16.4% for the prior period due to increasing costs and a shift in product mix to slightly lower margin products. 22 AGROCHEMICALS Gross profit for the Agrochemicals segment decreased to $1,282 for the three months ended December 31, 2005, versus $1,973 for the prior period, a decrease of $691 or 35.0%. Gross margin for the period was 22.6% compared to the prior period gross margin of 33.5%. The primary cause of the decrease in gross profit was lower royalty payments from our foreign customers of $246. Lower sales and gross margins on our second highest volume product caused the gross profit to decrease by $106 compared to the same period in the prior year. The gross profits and margins were also negatively affected by $89 due to higher costs associated with maintaining our EPA registered products and increased rebate expenses of $141. Unallocated cost of sales increased $265, to $1,250 for the three months ended December 31, 2005 compared to $985 in the prior period, representing a 26.8% increase. The higher costs were mainly a result of higher stock levels and freight costs due to rising fuel surcharges on shipments to customers. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses ("SG&A") decreased $532, or 5.2%, to $9,657 for the three months ended December 31, 2005 compared to $10,189 for the prior period. As a percentage of sales, SG&A was 13.9% for the three months ended December 31, 2005 versus 13.3% for the prior period. The decrease in SG&A expenses was primarily due to lower travel expenses of $223, a reduction in bad debt expenses of $190, a general decrease in SG&A expenses as a result of certain cost saving initiatives, lower consulting fees of $59 as well as a reduction of $87 in SGA expenses related to the previously sold CDC business as compared to last year. The overall reduction in CDC expenses includes a charge to exit the facility previously occupied by CDC in the amount of $378. OPERATING INCOME For the three months ended December 31, 2005, operating income was $1,811 compared to $3,093 in the prior period, a decrease of $1,282 or 41.4%. This decrease was due to the overall decrease in gross profit of $1,814 partially offset by the $532 decrease in SG&A expenses. INTEREST AND OTHER INCOME (EXPENSE) Interest and other income (expense) was $395 for the three months ended December 31, 2005, which represents an increase of $89 over the prior period. The increase is primarily attributable to the sale of distribution rights for a particular product in certain European countries of $133 and proceeds from the sale of certain task force data of $55, partially offset by an unrealized loss on short-term investments of $121. PROVISION FOR INCOME TAXES The effective tax rate for the three months ended December 31, 2005 was 28.7% as compared to 29.3% for the prior period. DISCONTINUED OPERATIONS The net loss from discontinued operations was $438 for the three months ended December 31, 2004. The net loss from discontinued operations for the three months ended December 31, 2004 includes a non-cash write-down of goodwill of $448, net of taxes of $275. LIQUIDITY AND CAPITAL RESOURCES CASH FLOWS At December 31, 2005, we had $23,561 in cash, $5,003 in short-term investments and no debt. 23 Our cash position at December 31, 2005 increased $3,611 from the June 30, 2005 level. Operating activities provided cash of $4,568, primarily from net income of $3,521, partially offset by a net decrease caused by changes in assets and liabilities. Investing activities for the six months ended December 31, 2005 used cash of $237 primarily related to purchases of property and equipment. Financing activities for the six months ended December 31, 2005 used cash of $581 primarily as a result of treasury stock purchases of $581. CREDIT FACILITIES We have credit facilities with certain foreign financial institutions. These facilities provide us with a line of credit of $17,474, of which $33 was utilized as of December 31, 2005 leaving $17,441 of this facility unused. We are not subject to any financial covenants under these arrangements. We have a revolving credit facility with a domestic financial institution which expires June 30, 2007 and provides for available credit of $10,000. At December 31, 2005, we had utilized $1,149 in letters of credit, leaving $8,851 of this facility unused. Under the credit agreement, we may obtain credit through direct borrowings and letters of credit. Our obligations under the credit agreement are guaranteed by certain of our subsidiaries and are secured by 65% of the capital of certain of our non-domestic subsidiaries. There is no borrowing base on the credit agreement. Interest under the credit agreement is at LIBOR plus 1.50%. The credit agreement contains several covenants requiring, among other things, minimum levels of debt service and tangible net worth. We are also subject to certain restrictive debt covenants, including covenants governing liens, limitations on indebtedness, limitations on cash dividends, guarantees, sale of assets, sales of receivables, and loans and investments. We were in compliance with all covenants at December 31, 2005. WORKING CAPITAL OUTLOOK Working capital was $97,398 at December 31, 2005 versus $94,249 at June 30, 2005. The increase in working capital was attributable to various factors including net income during the period. We continually evaluate possible acquisitions of or investments in businesses that are complementary to our own, and such transactions may require the use of cash. We believe that our cash, other liquid assets, operating cash flows, borrowing capacity and access to the equity capital markets, taken together, provide adequate resources to fund ongoing operating expenditures and the anticipated continuation of semi-annual cash dividends. Further, we may obtain additional credit facilities to enhance our liquidity. 24 OFF-BALANCE SHEET ARRANGEMENTS AND COMMITMENTS AND CONTINGENCIES We have no material financial commitments other than those under operating lease agreements, letters of credit and unconditional purchase obligations. We have certain contractual cash obligations and other commercial commitments which will impact our short-term and long-term liquidity. At December 31, 2005, we had no significant obligations for capital expenditures. At December 31, 2005, contractual cash obligations and other commercial commitments were as follows:
Payments Due and/or Amount of Commitment Expiration Per Period --------------------- Less Than 1-3 4-5 After Total 1 Year Years Years 5 Years --------- -------- ------- ------- --------- Operating leases $ 7,754 $ 1,774 $ 3,169 $ 2,437 $ 374 Commercial letters of credit 1,182 1,182 Standby letters of credit 124 124 Unconditional purchase obligations (a) 49,488 49,488 - - - --------- -------- ------- ------- --------- Total $ 58,548 $ 52,568 $ 3,169 $ 2,437 $ 374 ========= ======== ======= ======= =========
Other significant commitments and contingencies included the following: 1. Our non-qualified deferred compensation plans are intended to provide certain executives with supplemental retirement benefits beyond our 401(k) plan, as well as to permit additional deferral of a portion of their compensation. All compensation deferred under the plans is held by us in a grantor trust, which is considered our asset. We had a liability under the plan, included in long-term liabilities, of $2,622, and the assets held by the grantor trust, included in other assets, amounted to $2,330 as of December 31, 2005. 2. One of our subsidiaries markets certain agricultural chemicals which are subject to the Federal Insecticide, Fungicide and Rodenticide Act ("FIFRA"). FIFRA requires that test data be provided to the Environmental Protection Agency ("EPA") to register, obtain and maintain approved labels for pesticide products. The EPA requires that follow-on registrants of these products compensate the initial registrant for the cost of producing the necessary test data on a basis prescribed in the FIFRA regulations. Follow-on registrants do not themselves generate or contract for the data. However, when FIFRA requirements mandate that new test data be generated to enable all registrants to continue marketing a pesticide product, often both the initial and follow-on registrants establish a task force to jointly undertake the testing effort. We are presently a member of two such task force groups and historically, our payments have been in the range of $250 - $500 per year. We may be required to make additional payments in the future. 3. We, together with our subsidiaries, are subject to pending and threatened legal proceedings that have arisen in the normal course of business. We do not know how the final resolution of these matters will affect our results of operations in a particular reporting period. Our management is of the opinion, however, that the ultimate outcome of such matters will not have a material adverse effect upon our financial condition or liquidity. One of our subsidiaries was a defendant in a legal action alleging patent infringement. The patent in question covered a particular method of applying one of the products in our Agrochemicals segment. In September 2005, shortly before a trial was expected to begin, the parties agreed to a settlement. 25 Under the terms of the settlement agreement, we are required to make payments totaling $750 over the next five years. RELATED PARTY TRANSACTIONS Certain of our directors are affiliated with law firms which serve as our counsel on various corporate matters. During the three months ended December 31, 2005 and 2004, we incurred legal fees of $157 and $57, respectively, for services rendered to us by these law firms. The fees charged by such firms were at rates comparable to rates obtainable from other firms for similar services. IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS In June 2005, the Financial Accounting Standards Board ("FASB") issued SFAS No. 154, "Accounting Changes and Error Corrections", a replacement of APB Opinion No. 20, Accounting Changes, and FASB SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements. SFAS No. 154 applies to all voluntary changes in accounting principles and changes the requirements for accounting for and reporting of a change in accounting principle. SFAS No. 154 requires retrospective application to prior periods' financial statements of a voluntary change in accounting principle unless it is impracticable. SFAS No. 154 also requires that a change in method of depreciation, amortization, or depletion for long-lived, non-financial assets be accounted for as a change in accounting estimate that is affected by a change in accounting principle. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Earlier application is permitted for accounting changes and corrections of errors occurring in fiscal years beginning after June 1, 2005. SFAS No. 154 does not change the transition provisions of any existing accounting pronouncements, including those that are in a transition phase as of the date of SFAS No. 154. We do not believe that adoption of SFAS No. 154 will have a material impact on our financial statements. In March 2005, the FASB issued FASB Interpretation (FIN) No. 47, Accounting for Conditional Asset Retirement Obligations - An Interpretation of SFAS No. 143. The FASB issued FIN 47 to address diverse accounting practices that developed with respect to the timing of liability recognition for legal obligations associated with the retirement of a tangible long-lived asset when the timing and (or ) method of settlement of the obligation are conditional on a future event. FIN 47 concludes that an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation when incurred if the liability's fair value can be reasonably estimated. FIN 47 is effective for the Company no later than June 30, 2006. The Company is in the process of evaluating what impact, if any, the adoption of FIN 47 will have on its financial statements. On October 22, 2004, the President of the United States signed the American Jobs Creation Act of 2004. This law creates a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85% dividends-received deduction for certain dividends from controlled foreign corporations. The deduction is subject to a number of limitations, and the FASB issued two Staff Positions to provide guidance on how companies should account for the effects of the American Jobs Creation Act. The Company is currently evaluating whether to repatriate any extraordinary dividends. RISK FACTORS You should carefully consider the following risk factors and other information included in this Quarterly Report. The risks and uncertainties described below are not the only ones we face. Additionally, risks and uncertainties not currently known to us or that we currently deem immaterial also may impair our business operations. If any of the following risk factors occur, our business, financial condition, operating results and cash flows could be materially adversely affected. IF WE ARE UNABLE TO COMPETE EFFECTIVELY WITH OUR COMPETITORS, MANY OF WHICH HAVE GREATER MARKET PRESENCE AND RESOURCES THAN US, OUR PROFITABILITY AND FINANCIAL CONDITION WILL BE ADVERSELY AFFECTED. Our financial condition and operating results are directly related to our ability to compete in the intensely competitive worldwide chemical market. We face intense competition from global and regional distributors of 26 chemical products, many of which are large chemical manufacturers as well as distributors. Many of these companies have substantially greater resources than us, including greater financial, marketing and distribution resources. We cannot assure you that we will be able to compete successfully with any of these companies. In addition, increased competition could result in price reductions, reduced margins and loss of market share for our services, all of which would adversely affect our business, results of operations and financial condition. WE MAY INCUR SIGNIFICANT UNINSURED ENVIRONMENTAL AND OTHER LIABILITIES INHERENT IN THE CHEMICAL DISTRIBUTION INDUSTRY THAT WOULD HAVE A NEGATIVE EFFECT ON OUR FINANCIAL CONDITION. The business of distributing chemicals is subject to regulation by numerous federal, state, local, and foreign governmental authorities. These regulations impose liability for loss of life, damage to property and equipment, pollution and other environmental damage that may occur in our business. Many of these regulations provide for substantial fines and remediation costs in the event of chemical spills, explosions and pollution. While we believe that we are in substantial compliance with all current laws and regulations, we can give no assurance that we will not incur material liabilities that exceed our insurance coverage or that such insurance will remain available on terms and at rates acceptable to us. Additionally, if existing environmental and other regulations are changed, or additional laws or regulations are passed, the cost of complying with those laws may be substantial, thereby adversely affecting our financial performance. We currently have environmental remediation obligations in connection with our former manufacturing facility in Carlstadt, New Jersey. Estimates of how much it would cost to remediate environmental contamination at this site have increased since the facility was closed in 1993, and our environmental consultants estimated in June 2003 that completing remediation would cost between $1,550 and $3,200. There have been no significant changes to the estimate of remediation costs since fiscal 2003. If the actual costs are significantly greater than estimated, it could have a material adverse effect on our financial condition, operating results and cash flows. ASSESSMENTS BY VARIOUS TAX AUTHORITIES MAY BE MATERIALLY DIFFERENT THAN THE AMOUNTS WE HAVE PROVIDED FOR IN OUR CONSOLIDATED FINANCIAL STATEMENTS. We are regularly audited by federal, state, and foreign tax authorities. From time to time, these audits may result in proposed assessments. While we believe that we have adequately provided for any such assessments, future settlements may be materially different than we have provided for and thereby adversely affect our earnings and cash flows. We operate in various tax jurisdictions, and although we believe that we have provided for income and other taxes in accordance with the relevant regulations, if the applicable regulations were ultimately interpreted differently by a taxing authority, we may be exposed to additional tax liabilities. OUR ACQUISITION STRATEGY IS SUBJECT TO A NUMBER OF INHERENT RISKS, INCLUDING THE RISK THAT OUR ACQUISITIONS MAY NOT BE SUCCESSFUL. We continually seek to expand our business through acquisitions of other companies that complement our own and through joint ventures, licensing agreements and other arrangements. Any decision regarding strategic alternatives would be subject to inherent risks, and we cannot guarantee that we will be able to identify the appropriate opportunities, successfully negotiate economically beneficial terms, successfully integrate any acquired business, retain key employees, or achieve the anticipated synergies or benefits of the strategic alternative selected. Acquisitions can require significant capital resources and divert our management's attention from our existing business. Additionally, we may issue additional shares in connection with a strategic transaction, thereby diluting the holdings of our existing common shareholders, incur debt or assume liabilities, become subject to litigation, or consume cash, thereby reducing the amount of cash available for other purposes. ANY ACQUISITION THAT WE MAKE COULD RESULT IN A SUBSTANTIAL CHARGE TO OUR EARNINGS. We have previously incurred charges to our earnings in connection with acquired assets, and may continue to experience charges to our earnings for any acquisitions that we make, including large and immediate write-offs of acquired assets, or impairment charges. These costs may also include substantial severance and other closure costs 27 associated with eliminating duplicate or discontinued products, employees, operations and facilities. These charges could have a material adverse effect on our results of operations for particular quarterly periods and they could possibly have an adverse impact on the market price of our common stock. OUR REVENUE IS DIFFICULT TO PREDICT. Our revenue is difficult to predict because it is primarily generated as customers place orders and customers can change their requirements or cancel orders. Many of our sales orders are short-term and may be cancelled at any time. As a result, much of our revenue is not recurring from period to period, which contributes to the variability of results from period to period. We believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance. OUR OPERATING RESULTS MAY FLUCTUATE IN FUTURE QUARTERS, WHICH MAY ADVERSELY AFFECT THE TRADING PRICE OF OUR COMMON STOCK. Our operating results will fluctuate on a quarterly basis as a result of a number of factors, including the timing of contracts, the delay or cancellation of a contract, and changes in government regulations. Any one of these factors could have a significant impact on our quarterly results. In some quarters, our revenue and operating results may fall below the expectations of securities analysts and investors, which would likely cause the trading price of our common stock to decline. FAILURE TO OBTAIN PRODUCTS FROM OUTSIDE MANUFACTURERS COULD ADVERSELY AFFECT OUR ABILITY TO FULFILL SALES ORDERS TO OUR CUSTOMERS. We rely on outside manufacturers to supply products for resale to our customers. Manufacturing problems may occur with these and other outside sources. If such problems occur, we cannot ensure that we will be able to deliver our products to our customers profitably or on time. OUR POTENTIAL LIABILITY ARISING FROM OUR COMMITMENT TO INDEMNIFY OUR DIRECTORS, OFFICERS AND EMPLOYEES COULD ADVERSELY AFFECT OUR EARNINGS AND FINANCIAL CONDITION. We have committed in our bylaws to indemnify our directors, officers and employees against the reasonable expenses incurred by these persons in connection with an action brought against him or her in such capacity, except in matters as to which he or she is adjudged to have breached a duty to us. The maximum potential amount of future payments we could be required to make under this provision is unlimited. While we have a "director and officer" insurance policy that covers a portion of this potential exposure, we may be adversely affected if we are required to pay damages or incur legal costs in connection with a claim above our insurance limits. OUR BUSINESS MAY BE ADVERSELY AFFECTED BY TERRORIST ACTIVITIES. Our business depends on the free flow of products and services through the channels of commerce. Instability due to military, terrorist, political and economic actions in other countries could materially disrupt our overseas operations and export sales. In fiscal years 2005 and 2004, approximately 49% and 50%, respectively, of our revenues were attributable to operations conducted abroad and to export sales. In addition, in fiscal year 2005, approximately 22% and 68% of our purchases came from Europe and Asia, respectively. In addition, in certain countries where we currently operate or export, intend to operate or export, or intend to expand our operations, we could be subject to other political, military and economic uncertainties, including labor unrest, restrictions on transfers of funds and unexpected changes in regulatory environments. FLUCTUATIONS IN FOREIGN CURRENCY EXCHANGE RATES MAY ADVERSELY AFFECT OUR RESULTS OF OPERATIONS AND FINANCIAL CONDITION. A substantial portion of our revenue is denominated in currencies other than the U.S. dollar because certain of our foreign subsidiaries operate in their local currencies. Our results of operations and financial condition may therefore be adversely affected by fluctuations in the exchange rate between foreign currencies and the U.S. dollar. 28 WE RELY HEAVILY ON KEY EXECUTIVES FOR OUR FINANCIAL PERFORMANCE. Our financial performance is highly dependent upon the efforts and abilities of our key executives. The loss of the services of any of our key executives could therefore have a material adverse effect upon our financial position and operating results. None of our key executives has an employment agreement with us and we do not maintain "key-man" insurance on any of our key executives. VIOLATIONS OF CGMP AND OTHER GOVERNMENT REGULATIONS, BY US OR OUR SUPPLIERS, COULD HAVE A MATERIAL ADVERSE AFFECT ON OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS. All facilities and manufacturing techniques used to manufacture products for clinical use or for commercial sale in the United States must be operated in conformity with current Good Manufacturing Practices ("cGMP") regulations as required by the FDA. Our facilities, and certain of our supplier facilities, are subject to scheduled periodic regulatory and customer inspections to ensure compliance with cGMP and other requirements applicable to such products. A finding that a facility materially violated these requirements could result in one or more of regulatory sanctions, loss of a customer contract, disqualification of data for client submissions to regulatory authorities and a mandated closing of the facility, which in turn could have a material adverse effect on our business, financial condition and results of operations. LITIGATION MAY HARM OUR BUSINESS AND OUR MANAGEMENT AND FINANCIAL RESOURCES. Substantial, complex or extended litigation could cause us to incur large expenditures and could distract our management. For example, lawsuits by employees, stockholders, collaborators, distributors, customers, or end-users of our products or services could be very costly and substantially disrupt our business. Disputes from time to time with such companies or individuals are not uncommon, and we cannot assure you that we will always be able to resolve such disputes out of court or on favorable terms. THE MARKET PRICE OF OUR STOCK COULD BE VOLATILE. The market price of our common stock has been subject to volatility and may continue to be volatile in the future, due to a variety of factors, including: o quarterly fluctuations in our operating income and earnings per share results o technological innovations or new product introductions by us or our competitors o economic conditions o disputes concerning patents or proprietary rights o changes in earnings estimates and market growth rate projections by market research analysts o sales of common stock by existing holders o loss of key personnel o securities class actions or other litigation The market price for our common stock may also be affected by our ability to meet analysts' expectations. Any failure to meet such expectations, even slightly, could have an adverse effect on the market price of our common stock. In addition, the stock market is subject to extreme price and volume fluctuations. This volatility has had a significant effect on the market prices of securities issued by many companies for reasons unrelated to the operating performance of these companies. INCIDENTS RELATED TO HAZARDOUS MATERIALS COULD ADVERSELY AFFECT OUR BUSINESS. Portions of our operations require the controlled use of hazardous materials. Although we are diligent in designing and implementing safety procedures to comply with the standards prescribed by federal, state, and local regulations, the risk of accidental contamination of property or injury to individuals from these materials cannot be completely eliminated. In the event of such an incident, we could be liable for any damages that result, which could adversely affect our business. 29 THERE ARE INHERENT UNCERTAINTIES INVOLVED IN ESTIMATES, JUDGMENTS AND ASSUMPTIONS USED IN PREPARING FINANCIAL STATEMENTS IN ACCORDANCE WITH U.S. GENERALLY ACCEPTED ACCOUNTING PRINCIPLES. ANY CHANGES IN THE ESTIMATES, JUDGMENTS AND ASSUMPTIONS WE USE COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR FINANCIAL POSITION AND RESULTS OF OPERATIONS. The consolidated financial statements included in the periodic reports we file with the SEC are prepared in accordance with U.S. generally accepted accounting principles ("GAAP"). Preparing financial statements in accordance with GAAP involves making estimates, judgments and assumptions that affect reported amounts of assets, liabilities, revenues, expenses and income. Estimates, judgments and assumptions are inherently subject to change, and any such changes could result in corresponding changes to the reported amounts. FAILURE TO MAINTAIN EFFECTIVE INTERNAL CONTROLS IN ACCORDANCE WITH SECTION 404 OF THE SARBANES-OXLEY ACT COULD HAVE AN ADVERSE EFFECT ON OUR BUSINESS AND STOCK PRICE. Section 404 of the Sarbanes-Oxley Act requires us to evaluate annually the effectiveness of our internal controls over financial reporting as of the end of each fiscal year and to include a management report assessing the effectiveness of our internal controls over financial reporting in our annual report. Section 404 also requires our independent registered public accounting firm to attest to, and report on, management's assessment of our internal controls over financial reporting. If we fail to maintain the adequacy of our internal controls, we cannot assure you that we will be able to conclude in the future that we have effective internal controls over financial reporting. If we fail to maintain effective internal controls, we might be subject to sanctions or investigation by regulatory authorities, such as the Securities and Exchange Commission or NASDAQ. Any such action could adversely affect our financial results and the market price of our common stock and may also result in delayed filings with the Securities and Exchange Commission. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK MARKET RISK SENSITIVE INSTRUMENTS The market risk inherent in our market-risk-sensitive instruments and positions is the potential loss arising from adverse changes in investment market prices, foreign currency exchange-rates and interest rates. INVESTMENT MARKET PRICE RISK We had short-term investments of $5,003 at December 31, 2005. Those short-term investments consisted of government and agency securities, corporate bonds and corporate equity securities, and they were recorded at fair value and had exposure to price risk. If this risk is estimated as the potential loss in fair value resulting from a hypothetical 10% adverse change in prices quoted by stock exchanges, the effect of that risk would be $500 as of December 31, 2005. Actual results may differ. FOREIGN CURRENCY EXCHANGE RISK In order to reduce the risk of foreign currency exchange rate fluctuations, we hedge some of our transactions denominated in a currency other than the functional currencies applicable to each of our various entities. The instruments used for hedging are short-term foreign currency contracts (futures). The changes in market value of such contracts have a high correlation to price changes in the currency of the related hedged transactions. At December 31, 2005, we had foreign currency contracts outstanding that had a notional amount of $15,977. The difference between the fair market value of the foreign currency contracts and the related commitments at inception and the fair market value of the contracts and the related commitments at December 31, 2005, was not material. In addition, we enter into cross currency interest rate swaps to reduce foreign currency exposure on inter-company transactions. In June 2004 we entered into a one-year cross currency interest rate swap transaction, which expired in June 2005 when the underlying inter-company loan was repaid, and in May 2003 we entered into a five-year cross currency interest rate swap transaction, both for the purpose of hedging fixed-interest-rate, foreign-currency-denominated cash flows under inter-company loans. Under the terms of these derivative financial instruments, U.S. dollar fixed principal and interest payments to be received under inter-company loans will be swapped for Euro denominated fixed principal and interest payments. The change in fair value of the remaining swap from date 30 of purchase to December 31, 2005, was $(224). The gains or losses on the inter-company loans due to changes in foreign currency rates will be offset by the gains or losses on the swap in the accompanying consolidated statements of income. Since our interest rate swaps qualify as hedging activities, the change in their fair value, amounting to $54 and $(1,112) for the six months ended December 31, 2005 and 2004, respectively, is recorded in accumulated other comprehensive income included in the accompanying consolidated balance sheets. We are subject to risk from changes in foreign exchange rates for our subsidiaries that use a foreign currency as their functional currency and are translated into U.S. dollars. These changes result in cumulative translation adjustments, which are included in accumulated other comprehensive income. On December 31, 2005, we had translation exposure to various foreign currencies, with the most significant being the Euro, the Chinese Renminbi and the Singapore dollar. The potential loss as of December 31, 2005, resulting from a hypothetical 10% adverse change in quoted foreign currency exchange rates amounted to $3,556. Actual results may differ. INTEREST RATE RISK Due to our financing, investing and cash-management activities, we are subject to market risk from exposure to changes in interest rates. We utilize a balanced mix of debt maturities along with both fixed-rate and variable-rate debt to manage our exposure to changes in interest rates. Our financial instrument holdings at year-end were analyzed to determine their sensitivity to interest rate changes. In this sensitivity analysis, we used the same change in interest rate for all maturities. All other factors were held constant. If there were an adverse change in interest rates of 10%, the expected effect on net income related to our financial instruments would be immaterial. However, there can be no assurances that interest rates will not significantly affect our results of operations. ITEM 4. CONTROLS AND PROCEDURES EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES Our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Our chief executive officer and chief financial officer, with assistance from other members of our management, have reviewed the effectiveness of our disclosure controls and procedures as of December 31, 2005 and, based on their evaluation, have concluded that the disclosure controls and procedures were effective as of such date. CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during the six months ended December 31, 2005 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. NEW ENTERPRISE RESOURCE PLANNING ("ERP") SYSTEM We are in the process of implementing a new ERP system for our U.S. operations which will result in changes to business processes and related controls. Once fully implemented, we believe that one of the benefits of the new ERP system will be an improvement of our internal controls. We currently expect to implement the ERP system during the third quarter of fiscal 2006 and believe we are taking the necessary precautions to ensure that the transition to the new ERP system will not have a negative impact on our internal control environment during this transition. LIMITATIONS ON THE EFFECTIVENESS OF INTERNAL CONTROL Our management, including our chief executive officer and chief financial officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that the benefits of controls must be considered relative to their costs. Because of the inherent limitations in any control system, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. 31 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS In April 2004, Aceto Agricultural Chemicals Corp., one of our subsidiaries, was added as a named defendant in a complaint that was filed in the United States District Court in the District of Idaho (Case No. CV99-0482-S-ECR) by Darol Forsythe, John Forsythe and 1,4Group, Inc. The plaintiffs claimed that the defendants had infringed on a patent involving the application of a product sold in our Agrochemicals segment. The plaintiffs were seeking monetary damages. Under the terms of the settlement agreement, we were obligated to pay $1,375, of which $625 was paid in December 2005 and the remaining $750 will be paid in equal installments over the next five years. As a result of the settlement, we recorded an intangible asset of $838 for the patent license, which will be amortized of its remaining life of 11 years, and a charge of $537, included in SG&A expense, for the six months ended December 31, 2005. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS SHARE REPURCHASE PROGRAM We are authorized by the Board of Directors to repurchase up to 4,147 shares of common stock, in the open market or private transactions, at prices not to exceed the market value of the common stock at the time of such purchase. During the first six months of fiscal 2006, we purchased approximately 96 shares of common stock for $585 as outlined in the following table:
Total Number of Shares Maximum Number of Purchased as Part of a Shares that May Yet Total Number of Average Price Paid Publicly Announced Be Purchased Under Period Shares Purchased Per Share Program (1) the Program ------ ---------------- --------- ----------- ----------- July 2005 - - - 4,147 August 2005 - - - 4,147 September 2005 - - - 4,147 October 2005 - - - 4,147 November 2005 63 6.06 63 4,084 December 2005 33 6.13 33 4,051 -- -- Total 96 6.09 96 4,051 == ==
(1) On May 4, 2005, the Board of Directors authorized the extension of the share repurchase program, of up to 4,147 shares of common stock, for an additional three years, expiring May 2008. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. The Company held an annual meeting of its shareholders on December 1, 2005. The election of nominees Leonard S. Schwartz, Robert A. Wiesen, Stanley H. Fischer, Albert L. Eilender, Ira S. Kallem, Hans C. Noetzli and William N. Britton as directors of the Company until the next annual meeting was voted on at the annual meeting. 32 The votes were cast for this matter as follows: FOR WITHHELD/ABSTAIN Leonard S. Schwartz 15,887 5,096 Robert A. Wiesen 15,795 5,188 Stanley H. Fischer 15,877 5,106 Albert L. Eilender 19,871 1,112 Ira S. Kallem 19,903 1,080 Hans C. Noetzli 19,908 1,075 William N. Britton 20,364 619 Each nominee was elected a director of the Company. ITEM 6. EXHIBITS The exhibits filed as part of this report are listed below. 15.1 Letter of independent registered public accounting firm re: unaudited interim financial information 31.1 Certification by Chairman, President and CEO Leonard S. Schwartz pursuant to U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification by CFO Douglas Roth pursuant to U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification by Chairman, President and CEO Leonard S. Schwartz pursuant to U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification by CFO Douglas Roth pursuant to U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 33 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ACETO CORPORATION DATE February 9, 2006 BY /s/ Douglas Roth ----------------------- ---------------- Douglas Roth, Chief Financial Officer DATE February 9, 2006 BY /s/ Leonard S. Schwartz ----------------------- ----------------------- Leonard S. Schwartz, Chairman, President and Chief Executive Officer 34