UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

 

 

For the quarterly period ended November 30, 2013

 

 

For the transition period from              to             

Commission File Number: 000-06936

WD-40 COMPANY

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code: (619) 275-1400

 

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  ☑    No  ☐

 

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

 

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

 

Large accelerated filer  ☑        Accelerated filer  ☐  Non-accelerated filer  ☐       Smaller reporting company  ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes  ☐    No  ☑

 

The number of outstanding shares of the registrant’s common stock, par value $0.001 per share, as of January 2, 2014 was 15,246,308.

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WD-40 COMPANY

QUARTERLY REPORT ON FORM 10-Q

For the Quarter Ended November 30, 2013

 

TABLE OF CONTENTS

 

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WD-40 COMPANY

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

Note 1.  The Company

 

WD-40 Company (“the Company”), based in San Diego, California, is a global consumer products company dedicated to delivering unique, high value and easy-to-use solutions for a wide variety of maintenance needs of “doer” and “on-the-job” users by leveraging and building upon the Company’s fortress of brands. The Company markets multi-purpose maintenance products – under the WD-40® and 3-IN-ONE® brand names. Currently included in the WD-40 brand are the WD-40 multi-use product and the WD-40 Specialist® and WD-40 BikeTM    product lines. The Company launched the WD-40 Specialist product line in early fiscal year 2012 and currently sells this product line in various regions throughout theAmericas, EMEA and Asia-Pacific. The WD-40 Specialist product line has contributed to sales of the multi-purpose maintenance products since its initial launch.  In the fourth quarter of fiscal year 2012, the Company developed the WD-40 Bike product line, which is focused on a comprehensive line of bicycle maintenance products that include wet and dry chain lubricants, heavy-duty degreasers, foaming bike wash and frame protectants that are designed specifically for the avid cyclist, bike enthusiasts and mechanics. The Company also markets the following homecare and cleaning brands: X-14® mildew stain remover and automatic toilet bowl cleaners, 2000 Flushes® automatic toilet bowl cleaners, Carpet Fresh® and No Vac® rug and room deodorizers, Spot Shot® aerosol and liquid carpet stain removers, 1001® household cleaners and rug and room deodorizers and Lava® and Solvol® heavy-duty hand cleaners.

 

The Company’s brands are sold in various locations around the world. Multi-purpose maintenance products are sold worldwide in markets throughout North, Central and South America, Asia, Australia and the Pacific Rim, Europe, the Middle East and Africa. Homecare and cleaning products are sold primarily in North America, the United Kingdom (“U.K.”) and Australia. The Company’s products are sold primarily through mass retail and home center stores, warehouse club stores, grocery stores, hardware stores, automotive parts outlets, sport retailers, independent bike dealers and industrial distributors and suppliers.

 

Note 2.  Basis of Presentation and Summary of Significant Accounting Policies

 

Basis of Consolidation

 

The condensed consolidated financial statements included herein have been prepared by the Company, without audit, according to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been condensed or omitted pursuant to such rules and regulations. The August 31, 2013 year-end condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by U.S. GAAP.

 

In the opinion of management, the unaudited financial information for the interim periods shown reflects all adjustments necessary for a fair statement thereof. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended August 31, 2013, which was filed with the SEC on October 22, 2013.

 

The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated in consolidation.

 

Use of Estimates

 

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Operating results for interim periods are not necessarily indicative of operating results for an entire fiscal year.

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Foreign Currency Forward Contracts

 

In the normal course of business, the Company employs established policies and procedures to manage its exposure to fluctuations in foreign currency exchange rates. The Company’s U.K. subsidiary, whose functional currency is Pound Sterling, utilizes foreign currency forward contracts to limit its exposure in converting forecasted cash balances denominated in non-functional currencies. The principal currency affected is the Euro. The Company regularly monitors its foreign currency exchange rate exposures to ensure the overall effectiveness of its foreign currency hedge positions. While the Company engages in foreign currency hedging activity to reduce its risk, for accounting purposes, none of its foreign currency forward contracts are designated as hedges.

 

Foreign currency forward contracts are carried at fair value, with net realized and unrealized gains and losses recognized currently in other income (expense) in the Company’s condensed consolidated statements of operations. Cash flows from settlements of foreign currency forward contracts are included in operating activities in the condensed consolidated statements of cash flows. Foreign currency forward contracts in an asset position at the end of the reporting period are included in other current assets, while foreign currency forward contracts in a liability position at the end of the reporting period are included in accrued liabilities in the Company’s condensed consolidated balance sheets.  At November 30, 2013, the Company had a notional amount of $9.5 million outstanding in foreign currency forward contracts, which mature from December 2013 through March 2014. Unrealized net gains and losses related to foreign currency forward contracts were not significant at November 30, 2013 and August 31, 2013.

 

Long-lived Assets

 

The Company’s long-lived assets consist of property and equipment and definite-lived intangible assets. Long-lived assets are depreciated or amortized, as applicable, on a straight-line basis over their estimated useful lives. The Company assesses potential impairments to its long-lived assets when there is evidence that events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable and/or its remaining useful life may no longer be appropriate. Any required impairment loss would be measured as the amount by which the asset’s carrying amount exceeds its fair value, which is the amount at which the asset could be bought or sold in a current transaction between willing market participants and would be recorded as a reduction in the carrying amount of the related asset and a charge to results of operations. An impairment loss would be recognized when the sum of the expected future undiscounted net cash flows is less than the carrying amount of the asset.

 

During the fourth quarter of fiscal year 2013, the Company recorded a non-cash, before tax impairment charge of $1.1 million to reduce the carrying value of the 2000 Flushes trade name intangible asset to its fair value. For additional details, refer to the information set forth in Note 5 – Goodwill and Other Intangible Assets.

 

Income Taxes

 

Current income tax expense is the amount of income taxes expected to be payable for the current year. A deferred income tax liability or asset is established for the expected future tax consequences resulting from the differences in financial reporting and tax bases of assets and liabilities. A valuation allowance is provided if it is more likely than not that some or all of the deferred tax assets will not be realized. In addition to valuation allowances, the Company provides for uncertain tax positions when such tax positions do not meet the recognition thresholds or measurement standards prescribed by the authoritative guidance on income taxes. Amounts for uncertain tax positions are adjusted in periods when new information becomes available or when positions are effectively settled. The Company recognizes accrued interest and penalties related to uncertain tax positions as a component of income tax expense.

 

U.S. federal income tax expense is provided on remittances of foreign earnings and on unremitted foreign earnings that are not indefinitely reinvested. U.S. federal income taxes and foreign withholding taxes are not provided when foreign earnings are indefinitely reinvested. The Company determines whether its foreign subsidiaries will invest their undistributed earnings indefinitely based on the capital needs of the foreign subsidiaries and reassesses this determination each reporting period. Changes to the Company’s determination may be warranted based on the Company’s experience as well as its plans regarding future international operations and expected remittances.

 

Earnings per Common Share

 

Unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents, whether paid or unpaid, are participating securities that are required to be included in the computation of earnings per common share pursuant to the two-class method. Accordingly, the Company’s outstanding unvested, if any, and outstanding vested restricted stock units that provide such nonforfeitable rights to dividend equivalents are included

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as participating securities in the calculation of earnings per common share (“EPS”) pursuant to the two-class method.

 

The Company calculates EPS using the two-class method, which provides for an allocation of net income between common stock and other participating securities based on their respective participation rights to share in dividends.  Basic EPS is calculated by dividing net income available to common shareholders for the period by the weighted-average number of common shares outstanding during the period.  Net income available to common shareholders for the period includes dividends paid to common shareholders during the period plus a proportionate share of undistributed net income allocable to common shareholders for the period; the proportionate share of undistributed net income allocable to common shareholders for the period is based on the proportionate share of total weighted-average common shares and participating securities outstanding during the period.

 

Diluted EPS is calculated by dividing net income available to common shareholders for the period by the weighted-average number of common shares outstanding during the period increased by the weighted-average number of potentially dilutive common shares (dilutive securities) that were outstanding during the period if the effect is dilutive. Dilutive securities are comprised of stock options, restricted stock units, performance share units and market share units granted under the Company’s prior stock option plan and current equity incentive plan. 

   

Fair Value Measurements

 

Accounting Standards Codification 820, Fair Value Measurements and Disclosures, defines fair value as the exchange price that would be received for an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company categorizes its financial assets and liabilities measured at fair value into a hierarchy that categorizes fair value measurements into the following three levels based on the types of inputs used in measuring their fair value: 

 

Level 1:  Observable inputs such as quoted market prices in active markets for identical assets or liabilities;

Level 2:  Observable market-based inputs or observable inputs that are corroborated by market data; and

Level 3:  Unobservable inputs reflecting the Company’s own assumptions.

 

Under fair value accounting, assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. As of November 30, 2013, the Company had no assets or liabilities that are measured at fair value in the financial statements on a recurring basis, with the exception of the foreign currency forward contracts. The Company’s financial instruments include cash equivalents, short-term investments, trade accounts receivable, accounts payable, short-term borrowings and foreign currency exchange contracts. The carrying amounts of these financial instruments approximate their fair values due to their short-term maturities.

 

During the three months ended November 30, 2013, the Company did not record any significant nonrecurring fair value measurements for assets or liabilities in periods subsequent to their initial recognition. During the fourth quarter of fiscal 2013, the Company was required to make a nonrecurring fair value measurement related to the 2000 Flushes trade name intangible asset, for which an impairment charge of $1.1 million was recorded during that quarter. For additional details, refer to the information set forth in Note 5 – Goodwill and Other Intangible Assets.

 

Segment Information

 

The Company discloses certain information about its business segments, which are determined consistent with the way the Company’s Chief Operating Decision Maker organizes and evaluates financial information internally for making operating decisions and assessing performance. In addition, the Chief Operating Decision Maker assesses and measures revenue based on product groups. The Company is organized on the basis of geographical area into the following three segments:

 

 

 

Recently Adopted Accounting Standards

 

In December 2011, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2011-11, “Disclosures about Offsetting Assets and Liabilities”. The objective of this updated guidance is to provide enhanced disclosures

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that will enable users of financial statements to evaluate the effect or potential effect of netting arrangements on an entity’s financial position. The new rules require companies to disclose both gross and net information about instruments and transactions eligible for offset in the statement of financial position, as well as instruments and transactions subject to a netting arrangement. In January 2013, the FASB further issued ASU No. 2013-01, “Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities” to address implementation issues surrounding the scope of ASU No. 2011-11 and to clarify the scope of the offsetting disclosures and address any unintended consequences. In September 2013, the Company adopted ASU No. 2011-11 and the adoption of this new authoritative guidance did not have a material impact on the Company’s consolidated financial statement disclosures.

 

Recently Issued Accounting Standards

 

In July 2013, the FASB issued ASU No. 2013-11, “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists”,  which is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The new rules require companies to present in the financial statements an unrecognized tax benefit as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward except to the extent such items are not available or not intended to be used at the reporting date to settle any additional income taxes that would result from the disallowance of a tax position. In such instances, the unrecognized tax benefit is required to be presented in the financial statements as a liability and not be combined with deferred tax assets. The Company is currently evaluating this updated authoritative guidance, but it does not expect the adoption of this guidance to have a material impact on its consolidated financial statements and related disclosures.

 

Note 3.  Inventories

 

Inventories consisted of the following (in thousands): 

 

Note 4.  Property and Equipment

 

Property and equipment, net, consisted of the following (in thousands): 

 

 

Note 5.  Goodwill and Other Intangible Assets

 

Goodwill represents the excess of the purchase price over the fair value of tangible and intangible assets acquired. The carrying value of goodwill is reviewed for possible impairment in accordance with the authoritative guidance on goodwill, intangibles and other. The Company assesses possible impairments to goodwill at least annually during its second fiscal quarter and otherwise when there is evidence that events or changes in circumstances indicate that an

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impairment condition may exist. In performing the annual impairment test of its goodwill, the Company considers the fair value concepts of a market participant and the highest and best use for its intangible assets. In addition to the annual impairment test, goodwill is evaluated each reporting period to determine whether events and circumstances would more likely than not reduce the fair value of a reporting unit below its carrying value. 

 

Intangible assets that are determined to have definite lives are amortized on a straight-line basis over their estimated useful lives and are evaluated each reporting period to determine whether events and circumstances indicate that their carrying amounts may not be recoverable and/or their remaining useful lives may no longer be appropriate.

 

Goodwill

 

The following table summarizes the changes in the carrying amounts of goodwill by segment (in thousands):

 

 

There were no indicators of impairment identified as a result of the Company’s review of events and circumstances related to its goodwill subsequent to February 28, 2013, the date of its most recent annual goodwill impairment test. To date, there have been no impairment losses identified and recorded related to the Company’s goodwill.

 

Definite-lived Intangible Assets

 

The Company’s definite-lived intangible assets, which include the 2000 Flushes, Spot Shot, Carpet Fresh and 1001 trade names, are included in other intangible assets, net in the Company’s condensed consolidated balance sheets. The following table summarizes the definite-lived intangible assets and the related accumulated amortization and impairment (in thousands):

 

During the fourth quarter of fiscal year 2013, as part of the Company’s ongoing evaluation of potential strategic alternatives for certain of its homecare and cleaning products, the Company determined based on its review of events and circumstances that there were indicators of impairment for the Carpet Fresh and 2000 Flushes trade names. Management accordingly performed the Step 1 recoverability test for these two trade names and based on the results of this analysis, it was determined that the total of the undiscounted cash flows significantly exceeded the carrying value for the Carpet Fresh asset group and that no impairment existed for this trade name as of August 31, 2013. However, the Step 1 analysis indicated that the carrying value of the asset group for the 2000 Flushes exceeded its undiscounted future cash flows, and consequently, a second phase of the impairment test (“Step 2”) was performed specific to the 2000 Flushes trade name to determine whether this trade name was impaired. The 2000 Flushes trade name failed Step 1 in the fourth quarter analysis primarily driven by changes in management’s current expectations for future growth and profitability for the 2000 Flushes trade name as compared to those used in the previous Step 1 analysis performed in the third quarter of fiscal year 2013. In performing the Step 2 analysis, the Company determined the fair value of the asset group utilizing the income approach, which is based on the present value of the estimated future cash flows. The calculation that is prepared in order to determine the estimated fair value of an asset group requires management to make assumptions about key inputs in the estimated cash flows, including long-term forecasts, discount rates and terminal growth rates. In estimating the fair value of the 2000 Flushes trade name, the Company applied a discount rate of 11.3%, annual revenue growth rates ranging from negative 13.6% to positive 1.5% and a long-term terminal growth rate of 1.5%. Cash flow projections used were based on management’s estimates of revenue growth rates, contribution margins and earnings before income taxes, depreciation and amortization (“EBITDA”). The discount rate used was based on the weighted-average cost of capital. The Company also considered the fair value concepts of a market participant and thus all amounts included in the long-term forecast reflect management’s best estimate of what a market participant could realize over the

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projection period. After taking all of these factors into consideration, the estimated fair value of the asset group was then compared to the carrying value of the 2000 Flushes trade name asset group to determine the amount of the impairment. The inputs used in the impairment fair value analysis fall within Level 3 of the fair value hierarchy due to the significant unobservable inputs used to determine fair value. Based on the results of this Step 2 analysis, the 2000 Flushes asset group’s estimated fair value was determined to be lower than its carrying value. Consequently, the Company recorded a non-cash, before tax impairment charge of $1.1 million in the fourth quarter of fiscal year 2013 to reduce the carrying value of the 2000 Flushes asset to its fair value of $7.9 million. 

 

An intangible asset valuation is dependent on a number of significant estimates and assumptions, including macroeconomic conditions, overall category growth rates, sales growth rates, cost containment and margin expansion and expense levels for advertising and promotions and general overhead, all of which must be developed from a market participant standpoint. While the Company believes that the estimates and assumptions used in such analyses are reasonable, actual events and results could differ substantially from those included in the valuation. In the event that business conditions change in the future, the Company may be required to reassess and update its forecasts and estimates used in subsequent impairment analyses. If the results of these future analyses are lower than current estimates, an additional impairment charge may result at that time.

 

In addition, there were no indicators of potential impairment identified as a result of the Company’s review of events and circumstances related to its existing definite-lived intangible assets for the quarter ended November 30, 2013.

 

Changes in the carrying amounts of definite-lived intangible assets by segment for the three months ended November 30, 2013 are summarized below (in thousands):

 

 

The estimated amortization expense for the Company’s definite-lived intangible assets in future fiscal years is as follows (in thousands):

Included in the total estimated future amortization expense is the amortization expense for the 1001 trade name intangible asset, which is based on current foreign currency exchange rates, and as a result amounts in future periods may differ from those presented due to fluctuations in those rates.

 

Note 6. Accrued and Other Liabilities

 

Accrued liabilities consisted of the following (in thousands): 

 

Accrued payroll and related expenses consisted of the following (in thousands): 

 

Deferred and other long-term liabilities consisted of the following (in thousands): 

 

 

Note 7. Debt

 

Revolving Credit Facility

 

On June 17, 2011, the Company entered into an unsecured credit agreement with Bank of America, N.A. (“Bank of America”). The agreement consisted of a $75.0 million three-year revolving credit facility. Under the terms of the credit facility agreement, the Company may initiate loans in U.S. dollars or in foreign currencies from time to time during the three-year period, which was set to expire on June 17, 2014. Per the terms of the agreement, all loans denominated in U.S. dollars will accrue interest at the bank’s Prime rate or at LIBOR plus a predetermined margin and all  loans denominated in foreign currencies will accrue interest at LIBOR plus the same predetermined  margin  (together with any applicable mandatory liquid asset costs imposed by non-U.S. banking regulatory authorities).  Interest on outstanding loans is due and payable on a quarterly basis through the credit facility maturity date. The Company may also borrow against the credit facility through the issuance of standby letters of credit. Outstanding letters of credit are subject to a fee equal to a predetermined percent per annum applied to amounts available to be drawn on outstanding letters of credit. The Company will also incur commitment fees for the credit facility at a predetermined annual rate which will be applied to the portion of the total credit facility commitment that has not been borrowed until outstanding loans and letters of credit exceed one half the total amount of the credit facility. 

 

On January 7, 2013, the Company entered into a first amendment (the “Amendment”) to this existing unsecured credit agreement with Bank of America. The Amendment extends the maturity date of the revolving credit facility for five years and increases the revolving commitment to an amount not to exceed $125.0 million.  The new maturity date for the revolving credit facility per the Amendment is January 7, 2018.  In addition, per the terms of the Amendment, the LIBOR margin decreased from 0.90 to 0.85 percent,  the letter of credit fee decreased from 0.90 to 0.85 percent per annum and the commitment fee decreased from an annual rate of 0.15 percent to 0.12 percent.  The Company will incur commitment fees applied to the portion of the total credit facility commitment that has not been borrowed until outstanding loans and letters of credit exceed $62.5 million.  To date, the Company has used the proceeds of the revolving credit facility for its stock repurchases and plans to continue using such proceeds for its general working capital needs and stock repurchases under any existing board approved share buy-back plans. 

 

The agreement includes representations, warranties and covenants customary for credit facilities of this type, as well as customary events of default and remedies. The agreement also requires the Company to maintain minimum consolidated earnings before interest, income taxes, depreciation and amortization (“EBITDA”) of $40.0 million, measured on a trailing twelve month basis, at each reporting period.

 

During the three months ended November 30, 2013, there were no additional borrowings made against the revolving credit facility. The Company regularly converts existing draws on its line of credit to new draws with new maturity

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dates and interest rates, however the balance on these draws has remained within a short-term classification as a result of these conversions. As of November 30, 2013, the Company had a $63.0 million outstanding balance on the revolving credit facility and was in compliance with all debt covenants under this credit facility.

 

Note 8. Share Repurchase Plan 

 

On June 18, 2013, the Company’s Board of Directors approved a share buy-back plan. Under the plan, which is in effect from August 1, 2013 through August 31, 2015, the Company is authorized to acquire up to $60.0 million of its outstanding shares on such terms and conditions as may be acceptable to the Company’s Chief Executive Officer or Chief Financial Officer and subject to present loan covenants and in compliance with all laws and regulations applicable thereto. During the period from August 1, 2013 through November 30, 2013, the Company repurchased 123,616 shares at a total cost of $7.9 million.

 

Note 9.  Earnings per Common Share

 

The table below reconciles net income to net income available to common shareholders (in thousands):

 

 

 

 

 

 

The table below summarizes the weighted-average number of common shares outstanding included in the calculation of basic and diluted EPS (in thousands):

 

 

 

 

 

For the three months ended November 30, 2013, 17,818 weighted-average stock-based equity awards outstanding that are non-participating securities were excluded from the calculation of diluted EPS under the treasury stock method as they were anti-dilutive. For the three months ended November 30, 2012, there were no anti-dilutive weighted-average stock-based equity awards outstanding excluded from the calculation of diluted EPS under the treasury stock method.

 

Note 10.  Related Parties

 

On October 11, 2011, the Company’s Board of Directors elected Mr. Gregory A. Sandfort as a director of WD-40 Company. Mr. Sandfort is President and Chief Executive Officer of Tractor Supply Company (“Tractor Supply”), which is a WD-40 Company customer that acquires products from the Company in the ordinary course of business.

 

The condensed consolidated financial statements include sales to Tractor Supply of $0.2 million for each of the three months ended November 30, 2013 and 2012.  Accounts receivable from Tractor Supply were $0.1 million as of November 30, 2013.  

 

Note 11.  Commitments and Contingencies

 

Purchase Commitments 

 

The Company has ongoing relationships with various suppliers (contract manufacturers) who manufacture the Company’s products.  The contract manufacturers maintain title and control of certain raw materials and components, materials utilized in finished products, and of the finished products themselves until shipment to the Company’s customers or third-party distribution centers in accordance with agreed upon shipment terms.  Although the Company typically does not have definitive minimum purchase obligations included in the contract terms with its contract manufacturers, when such obligations have been included, they have been immaterial. In the ordinary course of business, supply needs are communicated by the Company to its contract manufacturers based on orders

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and short-term projections, ranging from two to five months. The Company is committed to purchase the products produced by the contract manufacturers based on the projections provided.

 

Upon the termination of contracts with contract manufacturers, the Company obtains certain inventory control rights and is obligated to work with the contract manufacturer to sell through all product held by or manufactured by the contract manufacturer on behalf of the Company during the termination notification period. If any inventory remains at the contract manufacturer at the termination date, the Company is obligated to purchase such inventory which may include raw materials, components and finished goods.  Prior to the fourth quarter of fiscal year 2012, amounts for inventory purchased under termination commitments have been immaterial. As a result of the unanticipated termination of the IQ Products Company contract manufacturing agreement in the fourth quarter of fiscal year 2012, the Company is currently obligated to purchase $1.7 million of inventory which is included in inventories in the Company’s condensed consolidated balance sheet as of November 30, 2013. 

 

In addition to the commitments to purchase products from contract manufacturers described above, the Company may also enter into commitments with other manufacturers to purchase finished goods and components to support innovation initiatives and/or supply chain initiatives. As of November 30, 2013,  no such commitments were outstanding.

 

Litigation

 

The Company is party to various claims, legal actions and complaints, including product liability litigation, arising in the ordinary course of business.

 

On May 31, 2012, a legal action was filed against the Company in the United States District Court, Southern District of Texas, Houston Division (IQ Products Company v. WD-40 Company). IQ Products Company, a Texas corporation ("IQPC"), or an affiliate or a predecessor of IQPC, has provided contract manufacturing services to the Company for many years.  The allegations of IQPC’s complaint arose out of a pending termination of this business relationship. In 2011, the Company requested proposals for manufacturing services from all of its domestic contract manufacturers in conjunction with a project to redesign the Company’s supply chain architecture in North America. IQPC submitted a proposal as requested, and the Company tentatively awarded IQPC a new contract based on the information and pricing included in that proposal. IQPC subsequently sought to materially increase the quoted price for such manufacturing services. As a result, the Company chose to terminate its business relationship with IQPC.  IQPC also raised alleged safety concerns regarding a long-standing manufacturing specification related to the Company’s products. The Company believes that IQPC’s safety concerns are unfounded. 

 

In its complaint, IQPC asserts that the Company is obligated to indemnify IQPC for claims and losses based on a 1993 indemnity agreement and pursuant to common law.  IQPC also asserts that it has been harmed by the Company's allegedly retaliatory conduct in seeking to terminate its relationship with IQPC, allegedly in response to the safety concerns identified by IQPC. IQPC seeks declaratory relief to establish that it is entitled to indemnification and also to establish that the Company is responsible for reporting the alleged safety concerns to the United States Consumer Products Safety Commission and to the United States Department of Transportation. The complaint also seeks damages for alleged economic losses in excess of $40.0 million, attorney’s fees and punitive damages based on alleged misrepresentations and false promises.  The Company believes the case is without merit and will vigorously defend this matter. At this stage in the litigation, the Company does not believe that a loss is probable and management is unable to reasonably estimate a possible loss or range of possible loss.

 

Indemnifications

 

As permitted under Delaware law, the Company has agreements whereby it indemnifies senior officers and directors for certain events or occurrences while the officer or director is, or was, serving at the Company’s request in such capacity. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited; however, the Company maintains Director and Officer insurance coverage that mitigates the Company’s exposure with respect to such obligations. As a result of the Company’s insurance coverage, management believes that the estimated fair value of these indemnification agreements is minimal. Thus, no liabilities have been recorded for these agreements as of November 30, 2013.

 

From time to time, the Company enters into indemnification agreements with certain contractual parties in the ordinary course of business, including agreements with lenders, lessors, contract manufacturers, marketing distributors, customers and certain vendors. All such indemnification agreements are entered into in the context of the particular agreements and are provided in an attempt to properly allocate risk of loss in connection with the consummation of the underlying contractual arrangements. Although the maximum amount of future payments that

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the Company could be required to make under these indemnification agreements is unlimited, management believes that the Company maintains adequate levels of insurance coverage to protect the Company with respect to most potential claims arising from such agreements and that such agreements do not otherwise have value separate and apart from the liabilities incurred in the ordinary course of the Company’s business. Thus, no liabilities have been recorded with respect to such indemnification agreements as of November 30, 2013.

 

Note 12.  Income Taxes

 

The Company uses an estimated annual effective tax rate, which is based on expected annual income, statutory tax rates and tax planning opportunities available in the various jurisdictions in which the Company operates, to determine its quarterly provision for income taxes. Certain significant or unusual items are separately recognized in the quarter in which they occur and can be a source of variability in the effective tax rates from quarter to quarter.

 

The provision for income taxes was 30.3% and 31.0% of income before income taxes for the three months ended November 30, 2013 and 2012, respectively. The decrease in the effective income tax rate from period to period was mostly driven by the increasing proportion of the Company’s foreign earnings to total earnings, primarily those in the United Kingdom, which are taxed at lower rates. 

 

The Company is subject to taxation in the U.S. and in various state and foreign jurisdictions. Due to expired statutes, the Company’s federal income tax returns for years prior to fiscal year 2011 are not subject to examination by the U.S. Internal Revenue Service. Generally, for the majority of state and foreign jurisdictions where the Company does business, periods prior to fiscal year 2009 are no longer subject to examination. The Company has estimated that up to $0.1 million of unrecognized tax benefits related to income tax positions may be affected by the resolution of tax examinations or expiring statutes of limitation within the next twelve months. Audit outcomes and the timing of settlements are subject to significant uncertainty.

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Note 13.  Business Segments and Foreign Operations

 

The Company evaluates the performance of its segments and allocates resources to them based on sales and operating income. The Company is organized on the basis of geographical area into the following three segments: the Americas; EMEA; and Asia-Pacific. Segment data does not include inter-segment revenues. Unallocated corporate expenses are general corporate overhead expenses not directly attributable to the operating segments and are reported separate from the Company’s identified segments. The corporate overhead costs include expenses for the Company’s accounting and finance, information technology, human resources, research and development, quality control and executive management functions, as well as all direct costs associated with public company compliance matters including legal, audit and other professional services costs.

 

The Company has updated the financial information previously reported for the business segments to separate out the unallocated corporate expenses. These amounts were included within the Americas segment in the Company’s previously reported business segment information. In addition, effective September 1, 2013, the Company transitioned the management of our India operations to the EMEA segment.  As a result, the India financial results are now being included in the EMEA segment for all periods presented. These amounts were previously included within the Asia-Pacific segment in the Company’s reported business segment information. Summary information about reportable segments is as follows (in thousands):

 

 

 

 

The Company’s Chief Operating Decision Maker does not review assets by segment as part of the financial information provided and therefore, no asset information is provided in the above table.

 

Net sales by product group are as follows (in thousands):

 

 

Note 14. Subsequent Events

 

On December 10, 2013, the Company’s Board of Directors declared a 10% increase in the regular quarterly cash dividend, increasing it from $0.31 per share to $0.34 per share. The dividend is payable on January  31, 2014 to shareholders of record on January 6, 2014.  

 

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

As used in this report, the terms “we,” “our,” “us” and “the Company” refer to WD-40 Company and its wholly-owned subsidiaries, unless the context suggests otherwise. Amounts and percents in tables and discussions may not total due to rounding.

 

The following information is provided as a supplement to, and should be read in conjunction with, the unaudited condensed consolidated financial statements and notes thereto included in Part I―Item 1 of this Quarterly Report and the audited consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the fiscal year ended August 31, 2013, which was filed with the Securities and Exchange Commission (“SEC”) on October 22, 2013.

 

In order to show the impact of changes in foreign currency exchange rates on our results of operations, we have included constant currency disclosures, where necessary, in the Overview and Results of Operations sections which follow. Constant currency disclosures represent the translation of our current fiscal year revenues and expenses from the functional currencies of our subsidiaries to U.S. dollars using the exchange rates in effect for the corresponding period of the prior fiscal year. We use results on a constant currency basis as one of the measures to understand our operating results and evaluate our performance in comparison to prior periods. Results on a constant currency basis are not in accordance with accounting principles generally accepted in the United States of America (“non-GAAP”) and should be considered in addition to, not as a substitute for, results prepared in accordance with GAAP.

 

Forward-Looking Statements

 

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for certain forward-looking statements. This report contains forward-looking statements, which reflect the Company’s current views with respect to future events and financial performance.

 

These forward-looking statements are subject to certain risks and uncertainties. The words “aim,” “believe,” “expect,” “anticipate,” “intend,” “estimate” and other expressions that indicate future events and trends identify forward-looking statements. These statements include, but are not limited to, references to the near-term growth expectations for multi-purpose maintenance products and homecare and cleaning products, the impact of changes in product distribution, competition for shelf space, the impact of competition on product pricing, the level of promotional and advertising spending, plans for and success of product innovation, the impact of new product introductions on the growth of sales, the impact of customer mix and costs of raw materials, components and finished goods on gross margins, the impact of promotional programs on sales, the rate of sales growth in the Asia-Pacific segment, direct European countries and Eastern and Northern Europe, foreign currency exchange rates and fluctuations in those rates, the impact of changes in inventory management, the effect of future income tax provisions and audit outcomes on tax rates, and the effects of, and changes in, worldwide economic conditions and legal proceedings and other risk factors. The Company undertakes no obligation to revise or update any forward-looking statements.

 

Actual events or results may differ materially from those projected in forward-looking statements due to various factors, including, but not limited to, those identified in Part I―Item 1A, “Risk Factors,” in the Company’s Annual Report on Form 10-K for the fiscal year ended August 31, 2013, and in the Company’s Quarterly Reports on Form 10-Q, which may be updated from time to time.

 

 Overview

 

The Company

 

WD-40 Company, based in San Diego, California, is a global consumer products company dedicated to delivering unique, high value and easy-to-use solutions for a wide variety of maintenance needs of “doer” and “on-the-job” users by leveraging and building upon the Company’s fortress of brands. Our vision is to create positive lasting memories by solving problems in the homes and factories around the world. We market multi-purpose maintenance products – under the WD-40® and 3-IN-ONE® brand names. Currently included in the WD-40 brand are the WD-40 multi-use product and the WD-40 Specialist® and WD-40 BikeTM  product lines. We launched the WD-40 Specialist product line in early fiscal year 2012 and currently sell this product line in various regions throughout the Americas, EMEA and Asia-Pacific.  The WD-40 Specialist product line has contributed to sales of the multi-purpose maintenance products since its initial launch.  In the fourth quarter of fiscal year 2012, we developed the WD-40 Bike product line, which is focused on a comprehensive line of bicycle maintenance products that include wet and

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dry chain lubricants, heavy-duty degreasers, foaming bike wash and frame protectants that are designed specifically for the avid cyclist, bike enthusiasts and mechanics. We launched the WD-40 Bike product line in the U.S. during fiscal year 2013. We also market the following homecare and cleaning brands: X-14® mildew stain remover and automatic toilet bowl cleaners, 2000 Flushes® automatic toilet bowl cleaners, Carpet Fresh® and No Vac® rug and room deodorizers, Spot Shot® aerosol and liquid carpet stain removers, 1001® household cleaners and rug and room deodorizers and Lava® and Solvol® heavy-duty hand cleaners.

 

Our brands are sold in various locations around the world. Multi-purpose maintenance products are sold worldwide in markets throughout North, Central and South America, Asia, Australia and the Pacific Rim, Europe, the Middle East and Africa. Homecare and cleaning products are sold primarily in North America, the United Kingdom (“U.K.”) and Australia. We sell our products primarily through mass retail and home center stores, warehouse club stores, grocery stores, hardware stores, automotive parts outlets, sport retailers, independent bike dealers and industrial distributors and suppliers.

 

Highlights

 

The following summarizes the financial and operational highlights for our business during the three months ended November 30, 2013:  

 

 

 

 

 

 

 

 

Our core strategic initiatives and the areas where we will continue to focus our time, talent and resources in future periods include: (i) maximizing the WD-40 brand through geographic expansion and market penetration; (ii) leveraging the WD-40 brand to develop new products and categories within the Company’s prioritized platforms; (iii) expanding product and revenue base; (iv) attracting, developing and retaining people; and (v) operating with excellence.

 

 

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Results of Operations

 

Three Months Ended November 30, 2013 Compared to Three Months Ended November 30, 2012

 

Operating Items

 

The following table summarizes operating data for our consolidated operations (in thousands, except percentages and per share amounts):

 

Net Sales by Segment

 

Effective September 1, 2013, we transitioned the management of our India operations to the EMEA segment.  As a result, the India financial results are now being included in the EMEA segment for all periods presented. These amounts were previously included within the Asia-Pacific segment in the Company’s reported business segment information. The following table summarizes net sales by segment (in thousands, except percentages):

 

 

Americas

 

The following table summarizes net sales by product line for the Americas segment (in thousands, except percentages):

 

 

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Sales in the Americas segment, which includes the U.S., Canada and Latin America, decreased to $44.0 million, down  $1.3 million, or 3%, for the three months ended November 30, 2013 compared to the corresponding period of the prior fiscal year. Changes in foreign currency exchange rates did not have a material impact on sales for the three months ended November 30, 2013 compared to the corresponding period of the prior fiscal year.

 

Sales of multi-purpose maintenance products in the Americas segment increased $0.2 million, or 1%, for the three months ended November 30, 2013 compared to the corresponding period of the prior fiscal year.  This increase was driven primarily by higher sales of the WD-40 Specialist product line in the U.S. due to new distribution and the release of additional product offerings in the line during the first quarter of fiscal year 2014. As a result of fluctuations in the promotional patterns with certain of our key customers, particularly those in the mass retail, home center and warehouse club channels in the U.S., it is common for our sales to vary period over period and year over year.

 

Sales of homecare and cleaning products in the Americas segment decreased $1.5 million, or 16%, for the three months ended November 30, 2013 compared to the corresponding period of the prior fiscal year. Sales of homecare and cleaning products in the U.S. decreased 15% from period to period. This sales decrease was driven primarily by lower sales of the Carpet Fresh and Spot Shot products and the 2000 Flushes automatic toilet bowl cleaners, which were down 52%, 18% and 6%, respectively, in the U.S. for the three months ended November 30, 2013 compared to the corresponding period of the prior fiscal year. While each of our homecare and cleaning products continue to generate positive cash flows, we have continued to experience decreased sales for these products primarily due to lost distribution, reduced product offerings, competition, category declines and the volatility of orders from and promotional programs with certain of our customers, particularly those in the warehouse club and mass retail channels. In the second half of fiscal year 2013, management started to evaluate the strategic alternatives for certain of the Company’s homecare and cleaning products. To date, no decisions have been made to change the strategic plans for these brands. In connection with this evaluation, management assessed the carrying value of the definite-lived intangible assets associated with these trade names in the second half of fiscal year 2013 and determined that the carrying values were not impaired, with the exception of the 2000 Flushes trade name, for which an impairment charge of $1.1 million was recorded.  At November 30, 2013, the carrying value of definite-lived intangible assets associated with these trade names was $23.8 million, of which less than $2.0 million was associated with the Carpet Fresh trade name.  Management will continue to assess the recoverability of these assets periodically based on changes in events or circumstances.  In the event that business conditions change in the future, we may be required to reassess and update our forecasts and estimates used in subsequent analyses. If the results of these future analyses are lower than current estimates, an additional impairment charge may result at that time.

 

For the Americas segment,  80% of sales came from the U.S., and 20% of sales came from Canada and Latin America combined for each of the three months ended November 30, 2013 and 2012.  

 

EMEA

 

The following table summarizes net sales by product line for the EMEA segment (in thousands, except percentages):

 

Sales in the EMEA segment, which includes Europe, the Middle East, Africa and India, increased to $36.5 million, up $0.9 million, or 3%, for the three months ended November 30, 2013 compared to the corresponding period of the prior fiscal year. Changes in foreign currency exchange rates did not have a material impact on sales for the three months ended November 30, 2013 compared to the corresponding period of the prior fiscal year.

 

The countries in Europe where we sell through a direct sales force include the U.K., Italy, France, Iberia (which includes Spain and Portugal) and the Germanics sales region (which includes Germany, Austria, Denmark, Switzerland, Belgium and the Netherlands). Overall, sales from direct markets decreased  $0.5 million, or 2%, for the three months ended November 30, 2013 compared to the corresponding period of the prior fiscal year. We experienced sales decreases throughout part of the Europe direct markets for the three months ended November 30,  

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2013 compared to the corresponding period of the prior fiscal year, with percentage decreases in sales as follows: Italy, 17%; the Germanics region, 15%; and the U.K., 9%. The decreased sales in these regions were mostly offset by the sales increase of 24% in Iberia and 18% in France from period to period. The overall sales decrease in the direct markets was primarily due to the timing of customer orders and a lower level of promotional activities from period to period. Sales from direct markets accounted for 56% of the EMEA segment’s sales for the three months ended November 30, 2013 compared to 59% of the EMEA segment’s sales for the corresponding period of the prior fiscal year.

 

The regions in the EMEA segment where we sell through local distributors include the Middle East, Africa, India, Eastern and Northern Europe. Sales in the distributor markets increased $1.4 million, or 10%, for the three months ended November 30, 2013 compared to the corresponding period of the prior fiscal year primarily due to increased sales of WD-40 multi-use products in all markets and initial sales of the WD-40 Specialist product line in Northern Europe. Overall, sales in the distributor markets were increased from period to period primarily due to the continued growth of the base business in key markets, particularly those in Northern and Eastern Europe. The distributor markets accounted for 44% of the EMEA segment’s total sales for the three months ended November 30, 2013, compared to 41% for the corresponding period of the prior fiscal year.

 

Asia-Pacific

 

The following table summarizes net sales by product line for the Asia-Pacific segment (in thousands, except percentages):

Sales in the Asia-Pacific segment, which includes Australia, China and other countries in the Asia region, increased to $15.0 million, up $0.6 million, or 4%, for the three months ended November 30, 2013 compared to the corresponding period of the prior fiscal year.  Changes in foreign currency exchange rates for the three months ended November 30, 2013 compared to the corresponding period of the prior fiscal year had an unfavorable impact on sales. Sales for the three months ended November 30, 2013 translated at the exchange rates in effect for the corresponding period of the prior fiscal year would have been $15.4 million in the Asia-Pacific segment. Thus, on a constant currency basis, sales would have increased by $1.1 million, or 8%, for the three months ended November 30, 2013 compared to the corresponding period of the prior fiscal year.

 

Sales in Asia, which represented 69% of the total sales in the Asia-Pacific segment for the three months ended November 30, 2013,  increased $0.6 million, or 6%, for the first quarter of fiscal year 2014 as compared to the same period of the prior fiscal year primarily driven by higher sales of WD-40 multi-use products in China. Sales in China increased $0.6 million, or 24%, from period to period primarily due to the ongoing growth of our base business and a higher level of sales which resulted from a significant promotional program that was conducted in the first quarter of fiscal year 2014. Sales in the distributor markets in the Asia region remained constant at $6.9 million for each of the first quarter of fiscal years 2014 and 2013.

 

Sales in Australia remained constant at $4.6 million for each of the three months ended November 30, 2013 and 2012. Changes in foreign currency exchange rates had an unfavorable impact on sales in Australia. On a constant currency basis, sales would have increased by $0.6 million, or 13%, for the three months ended November 30, 2013 compared to the corresponding period of the prior fiscal year due to the launch of the WD-40 Specialist product line and increased promotional activities.

 

Gross Profit

 

Gross profit increased to $49.7 million for the three months ended November 30, 2013 compared to $47.7 million for the corresponding period of the prior fiscal year. As a percentage of net sales, gross profit increased to 52.0% for the three months ended November 30, 2013 compared to 50.1% for the corresponding period of the prior fiscal year due.

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Gross margin was positively impacted by 0.4 percentage points for the three months ended November 30, 2013 compared to the corresponding period of the prior fiscal year due to sales price increases.  These sales price increases were implemented in certain locations and markets in the EMEA and Asia-Pacific segments during fiscal year 2013. Advertising, promotional and other discounts, which are recorded as a reduction to sales, decreased during the three months ended November 30, 2013 compared to the corresponding period of the prior fiscal year, primarily in the Americas segment, positively impacting gross margin by 0.7 percentage points. The decrease in such discounts was due to a lower percentage of sales, particularly those for our homecare and cleaning products, being subject to promotional allowances during the three months ended November 30, 2013 compared to the corresponding period in the prior fiscal year. In general, the timing of advertising, promotional and other discounts may cause fluctuations in gross margin from period to period. The costs associated with certain promotional activities are recorded as a reduction to sales while others are recorded as advertising and sales promotion expenses. Advertising, promotional and other discounts that are given to our customers are recorded as a reduction to sales, whereas advertising and sales promotional costs associated with promotional activities that we pay to third parties are recorded as advertising and sales promotional expenses.

 

In addition, favorable net changes in the costs of petroleum-based materials and aerosol cans positively impacted gross margin by 0.5 percentage points from period to period, primarily in the Asia- Pacific and EMEA segments. There is often a delay of one quarter or more before changes in raw material costs impact cost of products sold due to production and inventory life cycles.  We expect that petroleum-based material costs will continue to be volatile and that volatility will impact our cost of products sold in future periods. Changes in foreign currency exchange rates also positively impacted gross margin by 0.5 percentage points primarily due to the significant fluctuations in the exchange rates for the Euro against the Pound Sterling in our EMEA segment. Gross margin was positively impacted by 0.2 percentage points from period to period due to lower manufacturing fees from our third-party contract manufacturers in the Americas segment which we have realized as a result of the restructure of our North American supply chain. Lower manufacturing costs in our Asia-Pacific segment also positively impacted our gross margin by 0.1 percentage points from period to period.

 

The aforementioned favorable impacts to gross margin were slightly offset by 0.2 percentage points due to higher raw materials costs associated with certain of our homecare and cleaning products. Sales mix changes and other miscellaneous costs negatively impacted gross margin by 0.3 percentage points from period to period.

 

Note that our gross profit and gross margin may not be comparable to those of other consumer product companies, since some of these companies include all costs related to distribution of their products in cost of products sold, whereas we exclude the portion associated with amounts paid to third parties for shipment to our customers from our distribution centers and contract manufacturers and include these costs in selling, general and administrative expenses. These costs totaled $3.8 million and $4.2 million for the three months ended November 30, 2013 and 2012, respectively.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative (“SG&A”) expenses for the three months ended November 30, 2013 increased $1.4 million, or 5%, to $26.7 million from $25.3 million for the corresponding period of the prior fiscal year. As a percentage of net sales, SG&A expenses increased to 27.9% for the three months ended November 30, 2013 from 26.6% for the corresponding period of the prior fiscal year. The increase in SG&A expenses was largely attributable to higher employee-related costs, a higher level of expenses associated with travel and meetings and increased professional services costs.  Employee-related costs, which include salaries, bonuses, profit sharing, stock-based compensation and other fringe benefits, increased $1.4 million for the three months ended November 30, 2013 compared to the corresponding period of the prior fiscal year. This increase was primarily due to annual compensation increases and higher staffing levels as well as higher bonus expense from period to period. Travel and meeting expenses increased $0.2 million due to a higher level of travel expenses associated with the ongoing support of our strategic initiatives. Professional services costs also increased by $0.2 million period over period primarily due to higher legal fees. Other miscellaneous expenses increased by $0.1 million period over period. These increases in SG&A expenses were partially offset by a $0.3 million decrease in freight costs period over period. This decrease was primarily due to lower sales volumes in the Americas segment as well as optimizations which are being realized on shipping customer orders as a result of the North American supply chain restructure which was completed at the end of fiscal year 2013. Changes in foreign currency exchange rates decreased SG&A expenses by $0.2 million for the three months ended November 30, 2013 compared to the corresponding period of the prior fiscal year.

 

We continued our research and development investment, the majority of which is associated with our multi-purpose maintenance products, in support of our focus on innovation and renovation of our products. Research and

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development costs were $0.9 million and $1.2 million for the three months ended November 30, 2013 and 2012, respectively.  Our research and development team engages in consumer research, product development, current product improvement and testing activities. This team leverages its development capabilities by partnering with a network of outside resources including our current and prospective outsource suppliers. The level and types of expenses incurred within research and development can vary or offset each other from period to period depending upon the types of activities being performed.

 

Advertising and Sales Promotion Expenses

 

Advertising and sales promotion expenses for the three months ended November 30, 2013 decreased $0.5 million, or 7%, to $5.6 million from $6.1 million for the corresponding period of the prior fiscal year. As a percentage of net sales, these expenses decreased to 5.9% for the three months ended November 30, 2013 from 6.4% for the corresponding period of the prior fiscal year. The decrease in advertising and sales promotion expenses was primarily due to lower costs associated with promotional programs conducted in the Americas segment and the timing of promotional activities conducted in the Europe segment from period to period.  Changes in foreign currency exchange rates did not have a material impact on advertising and sales promotion expenses for the three months ended November 30, 2013 compared to the corresponding period of the prior fiscal year. Investment in global advertising and sales promotion expenses for fiscal year 2014 is expected to be in the range of 6.5% to 7.5% of net sales.

 

As a percentage of net sales, advertising and sales promotion expenses may fluctuate period to period based upon the type of marketing activities we employ and the period in which the costs are incurred. Total promotional costs recorded as a reduction to sales for the three months ended November 30, 2013 were $3.6 million compared to $4.8 million for the corresponding period of the prior fiscal year. Therefore, our total investment in advertising and sales promotion activities totaled $9.2 million and $10.9 million for the three months ended November 30, 2013 and 2012, respectively.

 

Amortization of Definite-lived Intangible Assets Expense

 

Amortization of our definite-lived intangible assets remained relatively constant at $0.6 million and $0.5 million for the three months ended November 30, 2013 and 2012, respectively.

 

Income from Operations by Segment

 

The financial information previously reported for the EMEA and Asia-Pacific segments has been updated to reflect the transition of the management of the India operations from the Asia-Pacific segment to the EMEA segment effective September 1, 2013. The following table summarizes income from operations by segment (in thousands, except percentages):

 

 

Americas

 

Income from operations for the Americas segment decreased to $10.0 million, down $0.1 million, or 1%, for the three months ended November 30, 2013 compared to the corresponding period of the prior fiscal year, primarily due to a decrease in sales of $1.3 million. As a percentage of net sales, gross profit for the Americas segment decreased slightly from 50.5% to 50.1% period over period. This decrease in the gross margin from period to period was

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primarily due to the negative impact of net increases in the costs of petroleum-based materials and aerosol cans, sales mix changes and increased warehousing costs and storage fees. These negative impacts on gross margin were significantly offset by the lower level of discounts offered to our customers and decreased manufacturing costs from period to period. The lower level of sales from period to period in the Americas segment was accompanied by a $0.7 million decrease in total operating expenses. Operating income as a percentage of net sales increased slightly from 22.4% to 22.7% period over period.

 

EMEA

 

Income from operations for the EMEA segment increased to $8.9 million, up $0.6 million, or 8%, for the three months ended November 30, 2013 compared to the corresponding period of the prior fiscal year, primarily due to a $0.9 million increase in sales and a higher gross margin, which were both partially offset by increased operating expenses of $1.2 million from period to period. As a percentage of net sales, gross profit for the Europe segment increased from 51.4% to 55.2% period over period primarily due to the positive impacts of lower net costs associated with petroleum-based materials and aerosol cans, favorable sales mix changes, sales price increases and fluctuations in the exchange rates for the Euro against the Pound Sterling. Operating income as a percentage of net sales increased from 23.3% to 24.5% period over period.

 

Asia-Pacific

 

Income from operations for the Asia-Pacific segment increased to $4.0 million, up $1.3 million, or 46%, for the three months ended November 30, 2013 compared to the corresponding period of the prior fiscal year, primarily due to a $0.6 million increase in sales and a higher gross margin. As a percentage of net sales, gross profit for the Asia-Pacific segment increased from 45.7% to 49.8% period over period primarily due to the lower level of discounts being offered to our customers and favorable sales mix changes. In addition, total operating expenses for the Asia-Pacific segment decreased $0.4 million from period to period. Operating income as a percentage of net sales for the Asia-Pacific segment increased from 19.3% to 26.9% period over period.

 

Non-Operating Items

 

The following table summarizes non-operating income and expenses for our consolidated operations (in thousands):

 

 

 

 

Interest Income

 

Interest income remained relatively constant for the three months ended November 30, 2013 compared to the corresponding period of the prior fiscal year.

 

Interest Expense

 

Interest expense remained relatively constant for the three months ended November 30, 2013 compared to the corresponding period of the prior fiscal year.

 

Other (Expense) Income, Net

 

Other (expense) income, net changed by $0.3 million for the three months ended November 30, 2013 compared to the corresponding period of the prior fiscal year primarily due to net foreign currency exchange losses which were recorded for the first quarter of fiscal year 2014 compared to net foreign currency exchange gains which were recorded in the same period of the prior fiscal year.

 

Provision for Income Taxes

 

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The provision for income taxes was 30.3% and 31.0% of income before income taxes for the three months ended November 30, 2013 and 2012, respectively. The decrease in the effective income tax rate from period to period was mostly driven by the increasing proportion of the Company’s foreign earnings to total earnings, primarily those in the United Kingdom, which are taxed at lower rates.

 

Net Income

 

Net income was $11.5 million, or $0.74 per common share on a fully diluted basis for the three months ended November 30, 2013 compared to $10.9 million, or $0.69 per common share on a fully diluted basis for the corresponding period of the prior fiscal year. Changes in foreign currency exchange rates did not have a material impact on net income for the three months ended November 30, 2013 compared to the corresponding period of the prior fiscal year.

 

Performance Measures and Non-GAAP Reconciliations

 

In managing our business operations and assessing our financial performance, we supplement the information provided by our financial statements with certain non-GAAP performance measures. These performance measures are part of our 50/30/20 rule, which includes gross margin, cost of doing business, and EBITDA, the latter two of which are non-GAAP performance measures. Cost of doing business is defined as total operating expenses less amortization of definite-lived intangible assets, impairment of definite-lived intangible assets and depreciation in operating departments and EBITDA is defined as net income (loss) before interest, income taxes, depreciation and amortization. We target our gross margin to be at or above 50% of net sales, our cost of doing business to be at or below 30% of net sales, and our EBITDA to be at or above 20% of net sales. Although our results for these performance measures may vary from period to period depending on various factors, including economic conditions and our level of investment in activities for the future, we continue to focus on and work towards achievement of our 50/30/20 targets over the long-term.

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The following table summarizes the results of these performance measures for the periods presented:

 

 

 

 

 

We use the performance measures above to establish financial goals and to gain an understanding of the comparative performance of the Company from period to period. We believe that these measures provide our shareholders with additional insights into the Company’s results of operations and how we run our business. The non-GAAP financial measures are supplemental in nature and should not be considered in isolation or as alternatives to net income, income from operations or other financial information prepared in accordance with GAAP as indicators of the Company’s performance or operations. Reconciliations of these non-GAAP financial measures to our financial statements as prepared in accordance with GAAP are as follows:

 

Cost of Doing Business (in thousands, except percentages)

 

EBITDA (in thousands, except percentages)

 

 

 

Liquidity and Capital Resources 

 

Overview

 

The Company’s financial condition and liquidity remain strong. Net cash provided by operations was $6.7 million for the three months ended November 30, 2013 compared to $15.6 million for the corresponding period of the prior fiscal year. We believe we continue to be well positioned to weather any uncertainty in the capital markets and global economy due to our strong balance sheet and efficient business model, along with our growing and diversified global revenues. We continue to manage all aspects of our business including, but not limited to, monitoring the financial health of our customers, suppliers and other third-party relationships, implementing gross margin enhancement strategies and developing new opportunities for growth. 

 

Our principal sources of liquidity are our existing cash and cash equivalents, short-term investments, cash generated from operations and cash available from our existing $125.0 million revolving credit facility with Bank of America, N.A. (“Bank of America”). To date, we have used the proceeds of the revolving credit facility for our stock

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repurchases and plan to continue using such proceeds for our general working capital needs and stock repurchases under any existing board approved share buy-back plans. During the three months ended November 30, 2013, there were no additional borrowings made against the revolving credit facility. We regularly convert existing draws on our line of credit to new draws with new maturity dates and interest rates, however the balance on these draws has remained within a short-term classification as a result of these conversions. As of November 30, 2013, we had a $63.0 million outstanding balance on the revolving credit facility. The revolving credit facility agreement requires us to maintain minimum consolidated earnings before interest, income taxes, depreciation and amortization (“EBITDA”) of $40.0 million, measured on a trailing twelve month basis, at each reporting period. At November 30, 2013,  we were in compliance with all debt covenants as required by the revolving credit facility and believe it is unlikely we will fail to meet any of these covenants in the foreseeable future. We would need to have a significant decrease in sales and/or a significant increase in expenses in order for us to not meet the debt covenants.

 

At November 30, 2013, we had a total of $51.4 million in cash and cash equivalents. Of this balance, $35.8 million was held in Europe, Australia and China in foreign currencies. It is our intention to indefinitely reinvest all current and future foreign earnings at these locations in order to ensure sufficient working capital, expand operations and fund foreign acquisitions in these locations. We believe that our future cash from domestic operations together with our access to funds available under our unsecured revolving credit facility will provide adequate resources to fund both short-term and long-term operating requirements, capital expenditures, share repurchases, dividend payments, acquisitions and new business development activities in the United States. Although we hold a significant amount of cash outside of the United States and the draws on the credit facility to date have been made by our entity in the United States, we do not foresee any issues with repaying or refinancing these loans with domestically generated funds since we closely monitor the use of this credit facility.  In the event that management elects for any reason in the future to repatriate some or all of the foreign earnings that were previously deemed to be indefinitely reinvested outside of the United States, we would incur additional tax expense upon such repatriation.

 

We believe that our existing consolidated cash and cash equivalents at November 30, 2013, the liquidity provided by our $125.0 million revolving credit facility and our anticipated cash flows from operations will be sufficient to meet our projected consolidated operating and capital requirements for at least the next twelve months. We consider various factors when reviewing liquidity needs and plans for available cash on hand including: future debt, principal and interest payments, future capital expenditure requirements, future share repurchases, future dividend payments (which are determined on a quarterly basis by the Company’s Board of Directors), alternative investment opportunities, debt covenants and any other relevant considerations currently facing our business.

 

Cash Flows

 

The following table summarizes our cash flows by category for the periods presented (in thousands):

 

 

Operating Activities

 

Net cash provided by operating activities decreased $8.9 million to $6.7 million for the three months ended November 30, 2013 from $15.6 million for the corresponding period of the prior fiscal year. This decrease from period to period was primarily due to changes in operating assets and liabilities, the most significant of which were changes in accrued payroll and related expenses, trade accounts receivable and accounts payable and accrued liabilities.  These changes in operating assets and liabilities were slightly offset by increased net income from period to period.

 

Accrued payroll and related expenses decreased from period to period primarily due to the payment of fiscal year 2013 bonuses during the three months ended November 30, 2013 which were significantly higher than those paid in the corresponding period of the prior fiscal year. This decrease was partially offset by an increase in bonus expense accruals for the three months ended November 30, 2013 as compared to the same period of the prior fiscal year. Trade accounts receivable balances increased in the first three months of fiscal year 2014 whereas they decreased during the same period of fiscal year 2013, primarily due to both the timing of sales and the timing of payments

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received from our customers from period to period.   Accounts payable and accrued liabilities combined decreased from period to period primarily due to the timing of payments to vendors.

 

Investing Activities

 

Net cash used in investing activities decreased  $19.0 million to $2.4 million for the three months ended November 30, 2013 from $21.4 million for the corresponding period of the prior fiscal year primarily due to the change in cash outflows related to the purchases of short-term investments that were made by our U.K. subsidiary. During the first quarter of fiscal year 2014, we purchased $1.3 million of short-term investments whereas we purchased $20.9 million of short-term investments in the same period of the prior fiscal year. These decreases were slightly offset by a $0.7 million increase in purchases of property and equipment from period to period.

 

Financing Activities

 

Net cash used in financing activities decreased $4.0 million to $8.1 million for the three months ended November 30, 2013 from $12.1 million for the corresponding period of the prior fiscal year primarily due to a decrease in treasury stock purchases, which was slightly offset by an increase in proceeds from the issuance of common stock upon the exercise of stock options from period to period. 

 

Effect of Exchange Rate Changes

 

All of our foreign subsidiaries currently operate in currencies other than the U.S. dollar and a significant portion of our consolidated cash balance is denominated in these foreign currencies, particularly at our U.K. subsidiary which operates in Pound Sterling. As a result, our cash and cash equivalents balances are subject to the effects of the fluctuations in these currencies against the U.S. dollar at the end of each reporting period. The net effect of exchange rate changes on cash and cash equivalents, when expressed in U.S. Dollar terms, was an increase in cash of $1.7 million and $0.6 million for the three months ended November 30, 2013 and 2012, respectively. The change of $1.1 million is due to fluctuations in the foreign currency exchange rates for the Pound Sterling against the U.S. Dollar and lower Pound Sterling cash and cash equivalent balances from period to period.  During the first three months of fiscal year 2014, the Pound Sterling to U.S. Dollar average exchange rate was 1.6171 whereas the average exchange rate during the first three months of fiscal year 2013 was 1.6094.  

 

Off-Balance Sheet Arrangements

 

We have no off-balance sheet arrangements as defined by Item 303(a)(4)(ii) of Regulation S-K.

 

Commercial Commitments

 

We have ongoing relationships with various suppliers (contract manufacturers) who manufacture our products.  The contract manufacturers maintain title and control of certain raw materials and components, materials utilized in finished products, and of the finished products themselves until shipment to our customers or third-party distribution centers in accordance with agreed upon shipment terms. Although we typically do not have definitive minimum purchase obligations included in the contract terms with our contract manufacturers, when such obligations have been included, they have been immaterial. In the ordinary course of business, supply needs are communicated by us to our contract manufacturers based on orders and short-term projections, ranging from two to five months. We are committed to purchase the products produced by the contract manufacturers based on the projections provided.

 

Upon the termination of contracts with contract manufacturers,  we obtain certain inventory control rights and are obligated to work with the contract manufacturer to sell through all product held by or manufactured by the contract manufacturer on our behalf during the termination notification period.  If any inventory remains at the contract manufacturer at the termination date, we are obligated to purchase such inventory which may include raw materials, components and finished goods.  Prior to the fourth quarter of fiscal year 2012, amounts for inventory purchased under termination commitments have been immaterial. As a result of the unanticipated termination of the IQ Products Company contract manufacturing agreement in the fourth quarter of fiscal year 2012, we are currently obligated to purchase $1.7 million of inventory which is included in inventories in the Company’s condensed consolidated balance sheet as of November 30, 2013. 

 

In addition to the commitments to purchase products from contract manufacturers described above, we may also enter into commitments with other manufacturers to purchase finished goods and components to support innovation initiatives and/or supply chain initiatives. As of November 30, 2013, no such commitments were outstanding.

 

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Share Repurchase Plan

 

On June 18, 2013, the Company’s Board of Directors approved a share buy-back plan. Under the plan, which is in effect from August 1, 2013 through August 31, 2015, the Company is authorized to acquire up to $60.0 million of its outstanding shares on such terms and conditions as may be acceptable to the Company’s Chief Executive Officer or Chief Financial Officer and subject to present loan covenants and in compliance with all laws and regulations applicable thereto. During the period from August 1, 2013 through November 30, 2013, the Company repurchased 123,616 shares at a total cost of $7.9 million.

 

Dividends

 

On December 10, 2013, the Company’s Board of Directors declared a 10% increase in the regular quarterly cash dividend, increasing it from $0.31 per share to $0.34 per share. The dividend is payable on January 31, 2014 to shareholders of record on January 6, 2014. Our ability to pay dividends could be affected by future business performance, liquidity, capital needs, alternative investment opportunities and loan covenants.

 

Critical Accounting Policies

 

Our discussion and analysis of our operating results and financial condition is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America.

 

Critical accounting policies are those that involve subjective or complex judgments, often as a result of the need to make estimates. The following areas all require the use of judgments and estimates: revenue recognition and sales incentives, allowance for doubtful accounts, accounting for income taxes, valuation of goodwill and impairment of definite-lived intangible assets. Estimates in each of these areas are based on historical experience and various judgments and assumptions that we believe are appropriate. Actual results may differ from these estimates.

 

Our critical accounting policies are discussed in more detail in Part II―Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Note 2 to our consolidated financial statements contained in our Annual Report on Form 10-K for the fiscal year ended August 31, 2013, which was filed with the SEC on October 22, 2013.

 

Recently Issued Accounting Standards 

 

In July 2013, the FASB issued ASU No. 2013-11, “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists”,  which is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The new rules require companies to present in the financial statements an unrecognized tax benefit as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward except to the extent such items are not available or not intended to be used at the reporting date to settle any additional income taxes that would result from the disallowance of a tax position. In such instances, the unrecognized tax benefit is required to be presented in the financial statements as a liability and not be combined with deferred tax assets. The Company is currently evaluating this updated authoritative guidance, but it does not expect the adoption of this guidance to have a material impact on its consolidated financial statements and related disclosures.

 

Related Parties

 

On October 11, 2011, the Company’s Board of Directors elected Mr. Gregory A. Sandfort as a director of WD-40 Company. Mr. Sandfort is President and Chief Executive Officer of Tractor Supply Company (“Tractor Supply”), which is a WD-40 Company customer that acquires products from the Company in the ordinary course of business.

 

The condensed consolidated financial statements include sales to Tractor Supply of $0.2 million for each of the three months ended November 30, 2013 and 2012. Accounts receivable from Tractor Supply were $0.1 million as of November 30, 2013.  

 

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

 

Refer to Part II―Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” in our Annual Report on Form 10-K for the fiscal year ended August 31, 2013, which was filed with the SEC on October 22, 2013.

 

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Item 4.  Controls and Procedures

 

The term “disclosure controls and procedures” is defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934 (“Exchange Act”). The term disclosure controls and procedures means controls and other procedures of a Company that are designed to ensure the information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosures. The Company’s Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the Company’s disclosure controls and procedures as of November 30, 2013, the end of the period covered by this report (the Evaluation Date), and they have concluded that, as of the Evaluation Date, such controls and procedures were effective at ensuring that required information will be disclosed on a timely basis in the Company’s reports filed under the Exchange Act. Although management believes the Company’s existing disclosure controls and procedures are adequate to enable the Company to comply with its disclosure obligations, management continues to review and update such controls and procedures. The Company has a disclosure committee, which consists of certain members of the Company’s senior management.

 

There were no changes to the Company’s internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that materially affected, or would be reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II — OTHER INFORMATION

 

Item 1.  Legal Proceedings

 

 The Company is party to various claims, legal actions and complaints, including product liability litigation, arising in the ordinary course of business.

 

On May 31, 2012, a legal action was filed against the Company in the United States District Court, Southern District of Texas, Houston Division (IQ Products Company v. WD-40 Company). IQ Products Company, a Texas corporation ("IQPC"), or an affiliate or a predecessor of IQPC, has provided contract manufacturing services to the Company for many years.  The allegations of IQPC’s complaint arose out of a pending termination of this business relationship. In 2011, the Company requested proposals for manufacturing services from all of its domestic contract manufacturers in conjunction with a project to redesign the Company’s supply chain architecture in North America. IQPC submitted a proposal as requested, and the Company tentatively awarded IQPC a new contract based on the information and pricing included in that proposal. IQPC subsequently sought to materially increase the quoted price for such manufacturing services.  As a result, the Company chose to terminate its business relationship with IQPC.  IQPC also raised alleged safety concerns regarding a long-standing manufacturing specification related to the Company’s products.  The Company believes that IQPC’s safety concerns are unfounded. 

 

In its complaint, IQPC asserts that the Company is obligated to indemnify IQPC for claims and losses based on a 1993 indemnity agreement and pursuant to common law.  IQPC also asserts that it has been harmed by the Company's allegedly retaliatory conduct in seeking to terminate its relationship with IQPC, allegedly in response to the safety concerns identified by IQPC. IQPC seeks declaratory relief to establish that it is entitled to indemnification and also to establish that the Company is responsible for reporting the alleged safety concerns to the United States Consumer Products Safety Commission and to the United States Department of Transportation. The complaint also seeks damages for alleged economic losses in excess of $40.0 million, attorney’s fees and punitive damages based on alleged misrepresentations and false promises.  The Company believes the case is without merit and will vigorously defend this matter. At this stage in the litigation, the Company does not believe that a loss is probable and management is unable to reasonably estimate a possible loss or range of possible loss.

 

Item 1A.  Risk Factors

 

There have been no material changes in our risk factors from those disclosed in Part I―Item 1A, “Risk Factors,” in our Annual Report on Form 10-K for the fiscal year ended August 31, 2013, which was filed with the SEC on October 22, 2013.

 

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

 

On June 18, 2013, the Company’s Board of Directors approved a share buy-back plan. Under the plan, which is in effect from August 1, 2013 through August 31, 2015, the Company is authorized to acquire up to $60.0 million of its outstanding shares on such terms and conditions as may be acceptable to the Company’s Chief Executive Officer or Chief Financial Officer and subject to present loan covenants and in compliance with all laws and regulations applicable thereto. During the period from August 1, 2013 through November 30, 2013, the Company repurchased 123,616 shares at a total cost of $7.9 million.

 

The following table provides information with respect to all purchases made by the Company during the three months ended November 30, 2013. All purchases listed below were made in the open market at prevailing market prices. Purchase transactions between September 3, 2013 and October 10, 2013 and between November 18, 2013 and November 29, 2013 were executed pursuant to trading plans adopted by the Company pursuant to Rule 10b5-1 under the Securities Exchange Act of 1934.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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Item 6.  Exhibits

 

 

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

 

 

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