<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
/X/ ANNUAL REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the fiscal year ended July 31, 1997
/ / TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT OF 1934
For the transition period from ________ to ______
Commission file number 000-21839
KMG-B, INC.
(Name of Small Business Issuer in its charter)
TEXAS 75-2640529
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10611 HARWIN DRIVE, SUITE 402
HOUSTON, TEXAS 77036
(Address of principal executive offices)
(713) 988-9252
(Issuer's telephone number)
SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT:
Title of Each Class Name of each Exchange on which Registered
None None
------------------------------ ------------------------------
SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:
Common Stock, $.01 par value
----------------------------------------------------------------------
(Title of Class)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes /X/ No / /
Check if there is no disclosure of delinquent filers in response to Item 405
of Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-KSB or any amendment to this Form 10-KSB. /X/
Issuer's revenues for its most recent fiscal year: $19,485,035
The aggregate market value of the voting stock held by non-affiliates
computed by reference to the average bid and asked prices of such stock as of
October 10, 1997 was $2,433,345.
ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS
DURING THE PAST FIVE YEARS
Check whether the issuer has filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of
securities under a plan confirmed by a court. Yes /X/ No / /
DOCUMENTS INCORPORATED BY REFERENCE
The proxy statement pertaining to the 1997 annual meeting of shareholders is
incorporated by reference in Part III of this report.
APPLICABLE ONLY TO CORPORATE ISSUERS
The number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date were: 7,000,169 shares of Common
Stock
<PAGE>
PART I
ITEM 1. DESCRIPTION OF BUSINESS
BACKGROUND OF THE COMPANY
GENERAL
KMG-B, Inc., a Texas corporation (the "Company"), was incorporated in
the State of Texas in 1992 under the name Water Point Manufacturing, Inc. to
act as a manufacturer of water filtration systems. The Company was
unsuccessful in that business and filed a petition under Chapter 11 of the
United States Bankruptcy Code in June 1995 in the United States Bankruptcy
Court (the "Court"). The Court confirmed the Company's plan of
reorganization on October 10, 1995 (as modified and clarified by the Court,
the "Plan"). Under the Plan all the assets of the Company vested in a
liquidating trust administered by a trust committee for distribution to
secured, priority and unsecured creditors. All capital stock outstanding as
of the filing date of the bankruptcy petition was canceled and the
reorganized Company issued shares of its common stock, par value $.01 per
share (the "Common Stock") to certain of its creditors and a post-petition
lender, Halter Financial Group, Inc., a Texas corporation. According to the
Plan, the Company was discharged from any and all debts and liabilities that
arose before October 23, 1996.
ACQUISITION OF KMG-BERNUTH, INC.
After discharge from bankruptcy, the Company's business purpose was to
seek an acquisition or merger transaction with an operating business with
growth potential, whereby its shareholders would benefit by owning an
interest in a viable business enterprise. Although the Company had no
significant assets or operations, it possessed a shareholder base which made
it an attractive acquisition or merger candidate to a privately-held
corporation.
In pursuit of its initial business purpose, on October 15, 1996 the
Company acquired all of the issued and outstanding stock of KMG-Bernuth,
Inc., a Delaware corporation ("KMG") formed in 1988, pursuant to a stock
exchange agreement (the "Stock Exchange Agreement") dated September 13, 1996.
In accordance with the Stock Exchange Agreement, the common stock of KMG was
acquired from its former stockholders in exchange for 6,510,000 shares of
Common Stock. After giving effect to a 1 for 1.5 reverse split of Common
Stock outstanding immediately prior to the acquisition of KMG, the former
stockholders of KMG became owners of approximately 93% of the issued and
outstanding shares of Common Stock. See "Item 11. Security Ownership of
Certain Beneficial Owners and Management."
1
<PAGE>
In connection with the acquisition of KMG, the Company changed its name
to KMG-B, Inc., the Company's sole officer and director resigned and the
Company's shareholders elected the persons serving on KMG's board of
directors as directors of the Company.
Unless the context otherwise requires, references hereinafter to the
"Company" shall mean KMG-B, Inc. and any of its subsidiaries, including KMG.
All references hereinafter to share amounts reflect the 1 for 1.5 reverse
split of Common Stock. The Company's principal executive office is located
at 10611 Harwin Drive, Suite 402, Houston, Texas 77036 and its telephone
number is (713) 988-9252.
CURRENT BUSINESS OF THE COMPANY
GENERAL
The Company manufactures, markets and distributes specialty, niche
chemicals. At the present time, the Company principally manufactures,
markets and distributes three wood preserving chemicals, pentachlorophenol
("penta"), creosote and sodium pentachlorophenate ("sodium penta"), to
industrial customers engaged in the wood preserving business. The Company's
customers use these preservatives to treat wood and supply the treated wood
products to end-users in a variety of industries, principally the railroad,
utility and construction industries.
The Company acquired a penta manufacturing and distribution business in
1988 from an affiliated company that had been engaged in the penta business
since the early 1970's. The Company made several acquisitions after 1988 to
expand its wood preserving product lines and distribution network. It
acquired a creosote distribution business in early 1991 and a sodium penta
distribution business late that same year.
The Company's strategy is to continue to expand through acquisitions and
internal development. The Company intends to seek, on a selective basis,
acquisitions of businesses that have product lines that complement and expand
its existing product lines, desirable new product lines, strategic
distribution locations or attractive customer bases. The ability of the
Company to implement its growth strategy will be dependent on its ability to
identify, consummate and assimilate acquisitions on desirable economic terms,
to successfully integrate new product lines and expand its existing product
lines. There can be no assurance that the Company will be successful in
implementing its growth strategy. Furthermore, the Company's ability to
implement its growth strategy may be dependent to a certain extent upon
obtaining financing for expansion, and there can be no assurance that
financing will be available on acceptable terms.
2
<PAGE>
INDUSTRY OVERVIEW
Wood preservative products are pesticides that prolong the useful life
of treated wood by protecting the wood from mold, mildew, fungus and insects.
The three primary chemicals used by the United States wood preserving
industry are penta, creosote and chromated copper arsenate ("CCA"). Penta is
used primarily to treat electric and telephone utility poles, creosote is
used primarily for railroad cross-ties, bridge timbers and utility poles and
CCA is used primarily for utility poles and lumber. Based on industry
statistics available to the Company, wood preserving chemicals were used in
the United States to treat approximately 592 and 578 million cubic feet of
wood in calendar years 1996 and 1995, respectively. CCA was used to treat
approximately 79% of the wood in 1996 and 78% in 1995. Creosote was used to
treat approximately 15% and 16% in 1996 and 1995, respectively, and penta was
used to treat approximately 6% in 1996 and 1995. Management of the Company
believes that CCA is used more widely than penta and creosote principally
because CCA-treated lumber has a dry, non-oily appearance that makes it more
suitable for the fences, decks and other home applications that comprise the
largest part of the treated wood market.
The Company currently supplies the United States wood treating industry
with penta and creosote, each of which are supplied by only a few companies.
The Company is one of two companies that manufactures penta for distribution
to the United States market. Furthermore, the Company believes that
worldwide there are only three other penta manufacturers. In addition, the
Company is one of approximately six companies registered to supply creosote
to the United States market. The Company is also one of the few companies
that supplies sodium penta, a wood preserving product used primarily to treat
freshly-cut lumber, to customers outside the United States. See
"-Competition."
PRODUCTS AND SERVICES
PENTACHLOROPHENOL AND SODIUM PENTACHLOROPHENATE. Penta is formed
through the reaction of phenol with chlorine. The Company manufactures penta
in Matamoros, Mexico through KMG's subsidiary, KMG de Mexico, S.A. de C.V
("KMEX"), formerly known as Productos de Preservacion, S.A. de C.V., a
Mexican maquiladora corporation that began operations in 1986. The Company
arranges for the required phenol and chlorine to be supplied to KMEX, which
in turn sells the penta it produces to the Company for sale and distribution
to the Company's customers. As a by-product of the penta manufacturing
process, the Matamoros facility also produces hydrochloric acid which is sold
to distributors for use in the steel and oil well service industries in the
United States and Mexico.
3
<PAGE>
The Matamoros facility produces both solid penta blocks and penta flakes.
Those penta products are sold by the Company to its customers or made into a
liquid solution of penta concentrate at the Matamoros facility or at the
Company's blending and distribution facility in Tuscaloosa, Alabama. The penta
blocks, flakes and solutions are sold to the Company's customers in the United
States, primarily in Washington, Oregon, Oklahoma, Missouri, Arkansas,
Mississippi, Alabama and Georgia. In addition, a portion of the flaked penta is
reacted with caustic soda to produce sodium penta. The Company sells the sodium
penta, which is not registered for use in the United States, to customers
primarily in France, Portugal, England, Chile, Peru, Ecuador, Venezuela and
Malaysia.
CREOSOTE; DISTRIBUTION AGREEMENT WITH VFT AG. Creosote is produced by the
distillation of coal tar, a by-product of the transformation of coal into coke.
The Company markets and distributes creosote in the United States on an
exclusive basis for VfT AG ("VfT"), a German corporation that the Company
believes is among the world's largest manufacturers of creosote and other coal
tar products. VfT is the primary supplier of creosote to the Company. VfT
ships creosote from Europe to a public storage facility located in New Orleans,
Louisiana. The creosote is then sold by the Company as VfT's agent to customers
in Alabama, Georgia, Louisiana, Mississippi and Texas.
The Company's agreement with VfT provides for VfT to supply quantities of
creosote based on the mutual agreement of the parties and to pay the Company a
fluctuating commission based on the FOB Europe price. The Company is obligated
under the agreement to arrange for transportation and insurance of the creosote
and to represent VfT in the United States with the EPA and certain industry
trade groups. The agreement renews automatically each year but may be
terminated by either party upon two years' notice. While the Company does not
have any reason to believe that the distribution agreement will be terminated,
there can be no assurance that the Company will be able to obtain a suitable
alternative source of supply in the event of a termination. See "-Suppliers."
The Company also purchases a limited quantity of creosote directly from United
States manufacturers for distribution to its customers.
SUPPLIERS
The Company is dependent upon outside suppliers for all of its raw material
requirements for its penta and sodium penta manufacturing operations and,
therefore, is subject to fluctuations in the prices of such materials. The
principal raw materials used in those operations are phenol, chlorine, solvent
and caustic, each of which the Company purchases from a limited number of
suppliers. The Company does not maintain supply contracts with any of its
principal raw material suppliers, which include Aristech Chemical Corporation,
CYDSA, Eastman Chemical Co.,
4
<PAGE>
Fenoquimia, S.A. de C.V. and Pennwalt De Mexico. However, the Company
believes that these raw materials are each readily available from a variety
of sources and the loss of any of its raw material suppliers would not have a
material adverse effect on its business, financial condition or results of
operations.
Most of the creosote sold by the Company is supplied by VfT. If the
Company's contract with VfT were terminated, there can be no assurance that the
Company would be able to obtain a suitable source of supply. The Company
believes that the failure to obtain a suitable alternative source of supply in
the event of such termination would have a material adverse effect upon its
business, financial condition and results of operations.
CUSTOMERS
The Company sells its products to approximately 70 customers on a regular
basis. One customer, Texas Electric Cooperatives, Inc., accounted for
approximately 11% of the Company's revenues in fiscal 1997 and 10% in fiscal
1996. A second customer, Cahaba Wood Preserving Co., accounted for
approximately 10% of the Company's revenues in fiscal 1997 and less than 10% in
fiscal 1996.
MARKETING
The Company markets its products in the United States through four
employees and one independent commissioned sales agent. Outside the United
States, the Company sells its penta and sodium penta directly and through sales
agency contracts to local lumber producers or to chemical suppliers for those
producers in over 20 countries.
COMPETITION
The Company is one of only two companies producing penta for sale in the
United States. The Company believes that it currently supplies
approximately 35% of the penta sold in the United States. The other penta
producer in the United States is Vulcan Chemicals, Inc. It is headquartered in
Birmingham, Alabama and produces penta at its facility in Wichita, Kansas. The
Company believes that Vulcan Chemicals, Inc. has larger sales volumes and
greater financial and other resources than the Company. The Company's
international competitors include suppliers from Mexico, China and India.
The Company believes that there are six producers of creosote that sell the
product commercially in the United States, the largest of which is Koppers
Industries, Inc. located in Pittsburgh, Pennsylvania. Other companies that
produce
5
<PAGE>
creosote for sale in the United States include AlliedSignal, Inc. and Reilly
Industries, Inc. The Company believes that each of those three creosote
producers has larger sales volumes and greater financial and other resources
than the Company. The Company believes that it currently supplies up to
approximately 10% of the creosote sold in the United States.
The Company does not supply CCA, the most widely-used wood preservative.
The Company believes that there are three suppliers of CCA in the United States,
Hickson Corporation, Chemical Specialties, Inc. and Osmose Wood Preserving, Inc.
Each of those companies has larger sales volume and greater financial resources
than the Company.
Penta and creosote are pesticides that must be registered prior to sale
under United States law. See "-Environmental and Safety Matters-Licenses,
Permits and Product Registrations." As a condition to registration, any company
wishing to manufacture and sell penta or creosote must provide to the
Environmental Protection Agency substantial scientific research and testing data
regarding the chemistry and toxicology of the products. That data must be
generated by the applicant or the applicant must compensate other data providers
for relying on their information. The Company believes that the cost of
satisfying the data submission requirement serves as an impediment to the entry
of new competitors in the United States market, particularly those with lesser
financial resources. While the Company has no reason to believe that the
registration requirement will be discontinued or materially modified, there can
be no assurances as to the effect of such a discontinuation or modification on
the Company's competitive position.
The Company believes that its ability to compete effectively is dependent
upon providing its products at competitive prices, anticipating new markets and
distribution channels for its products and maintaining a strong commitment to
product quality and customer service.
EMPLOYEES
As of September 30, 1997, the Company had a total of 74 employees, 73 of
whom are full-time employees. Nine of the Company's employees were employed at
the Company's corporate offices in Houston, Texas, 59 were employed at the
Matamoros facility and six were employed at the Tuscaloosa facility. None of
the employees in the United States are represented by a labor union but 22 of
KMEX's employees in Mexico are represented under a labor contract. The Company
believes that it has good relations with its employees.
6
<PAGE>
ENVIRONMENTAL AND SAFETY MATTERS
The Company's operations are subject to extensive federal, state and local
laws, regulations and ordinances in the United States and abroad relating to the
generation, storage, handling, emission, transportation and discharge of certain
materials, substances and waste into the environment, and various other health
and safety matters. Governmental authorities have the power to enforce
compliance with their regulations, and violators may be subject to fines,
injunctions or both. The Company believes that it is currently in substantial
compliance with all such applicable laws and regulations. The Company must
devote substantial financial resources to ensure such compliance. For a
discussion of the Company's expenditures regarding environmental matters, see
"Item 6. Management's Discussion and Analysis of Financial Condition and
Results of Operations-Liquidity and Capital Resources."
The Company anticipates that the regulation of its business operations
under federal, state and local environmental regulations in the United States
and abroad will increase over time. The Company cannot at this time estimate
the impact of increased regulation on the Company's operations, future capital
expenditure requirements or the cost of compliance.
UNITED STATES REGULATION. Under the Comprehensive Environmental Response,
Compensation and Liability Act of 1980, as amended ("CERCLA") and comparable
state laws, an owner or operator of property from which releases of hazardous
substances have occurred may be liable for investigation and remediation of any
resulting contamination. In addition, the generator of hazardous substances may
be responsible for all or a portion of any required investigation or remediation
at offsite disposal locations. Under the Resource Conservation and Recovery
Act, as amended ("RCRA"), a facility that treats, stores or disposes of
hazardous wastes on-site may be liable for corrective action costs. In addition
to CERCLA and RCRA, state laws and regulations may impose the same or broader
liability.
The Company's operations also are governed by laws and regulations relating
to workplace safety and worker health, principally the Occupational Safety and
Health Act and the regulations thereunder.
MEXICO REGULATION. The Company's Matamoros facility and its operations in
Mexico are subject to various environmental laws, regulations and ordinances
promulgated by governmental authorities in Mexico. The Secretariat of
Environment, Natural Resources and Fisheries (SECRETARIATE DE MEDIO AMBIENTE,
RECURSOS NATURALES Y PESCA: "SEMARNAP") is given overall responsibility for
environmental regulation in Mexico. SEMARNAP's responsibilities include
enforcement of Mexico's laws and regulations concerning air and water emissions
and hazardous waste treatment,
7
<PAGE>
storage and disposal. SEMARNAP is given broad authority to enforce
compliance with environmental laws and regulations and can require that
operations be suspended pending completion of required remedial action.
LICENSES, PERMITS AND PRODUCT REGISTRATIONS. Certain licenses, permits and
product registrations are required for the Company's products and operations in
the United States, Mexico and other countries in which the Company does
business. Such licenses, permits and product registrations are subject to
revocation, modification and renewal by governmental authorities. In the United
States in particular, producers of pesticides such as penta and creosote are
required to obtain a registration for their products under the Federal
Insecticide, Fungicide and Rodenticide Act ("FIFRA") from the Environmental
Protection Agency (the "EPA") in order to sell those products in the United
States. Compliance with the registration system under FIFRA has had and will in
the future have a material effect on the Company's business, financial condition
and results of operations. The registration system requires an ongoing
submission to the EPA of substantial scientific research and testing data
regarding the chemistry and toxicology of pesticide products by manufacturers.
Under an agreement reached with the other industry participant, the Company is
responsible for its proportionate share of the research and testing costs
pertaining to penta, based on its market share. The Company incurred expenses
of approximately $198 thousand and $525 thousand in connection with the FIFRA
research and testing program in fiscal 1997 and fiscal 1996, respectively.
Although a similar industry group funds a creosote research and testing program,
the cost of that effort is borne by VfT.
8
<PAGE>
ITEM 2. DESCRIPTION OF PROPERTY
Set forth below is information with respect to certain of the Company's
properties.
LEASE
APPROXIMATE OWNED/ EXPIRATION
LOCATION PRIMARY USE SIZE LEASED DATE
- -------- ----------- ------------ ------ ------------
Houston, Texas Corporate 8,500 square Leased October 31,
Office feet 1997
Matamoros, Mexico Manufacturing 7 acres Owned
Tuscaloosa, Alabama Processing 1.5 acres Leased Month to
Distribution month
The Company believes that all of these properties are adequately insured,
in good condition and suitable for their anticipated future use. The Company
believes that if the leases for any of its facilities were not renewed or were
terminated, other suitable facilities could be leased or purchased.
ITEM 3. LEGAL PROCEEDINGS
The Company is a not a party to any legal actions or proceedings that it
believes will have a material adverse effect on its business, results of
operations or financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submited during the fourth quarter of fiscal 1997 to a vote
of security holders, through the solicitation of proxies or otherwise.
9
<PAGE>
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Common Stock was traded under the trading symbol "KMGB" on the OTC
Bulletin Board of the National Association of Securities Dealers, Inc. from
January 28, 1997 to June 2, 1997 and on The Nasdaq SmallCap Market since that
date. The approximate high and low bid quotations in fiscal 1997 were as
follows:
Period: High Low
---- ---
January 28 - January 31, 1997 $ 5.00 $ 5.00
Third quarter fiscal 1997 6.00 3.00
Fourth quarter fiscal 1997 4.50 2.88
Such quotations represent prices between dealers, do not include retail markups,
markdowns or commissions and may not represent actual transactions. The
quotations are based on information reported by the National Association of
Securities Dealers, Inc.
As of October 10, 1997, there were 7,000,169 shares of Common Stock issued
and outstanding held by 559 holders of record.
KMG declared and paid dividends of $140,003 in September, 1997 and $124,995
in August 1996. The Company anticipates that future earnings will be retained to
finance the continuing development of its business. Accordingly, the Company
does not anticipate paying substantial dividends on the Common Stock in the
foreseeable future.
10
<PAGE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS.
RESULTS OF OPERATIONS
The following table sets forth the Company's net sales and certain other
financial data, including the amount of the change between the twelve month
periods ended July 31, 1997 and July 31, 1996 and gross profit expressed as a
percentage of net sales:
<TABLE>
Twelve Months Ended July 31 Increase/
--------------------------- (Decrease)
1997 1996
----------------------------------------
<S> <C> <C> <C>
Net sales...................................... $19,485,035 $19,801,927 $(316,892)
Cost of sales.................................. 11,265,700 11,529,603 (263,903)
Gross profit................................... 8,219,335 8,272,324 (52,989)
Gross profit percent........................... 42% 42%
Selling, general and administrative expense ... 3,911,452 4,005,742 (94,290)
Operating income............................... 4,307,883 4,266,582 41,301
Other income (expense), net.................... 62,214 (81,553) 143,767
Income before taxes............................ 4,370,097 4,185,029 185,068
Provision for income taxes .................... (1,660,637) (1,533,605) (127,032)
Net income .................................... $ 2,709,460 $ 2,651,424 $ 58,036
</TABLE>
SALES REVENUE
Net sales in fiscal 1997 decreased approximately $317 thousand as compared
to fiscal 1996, a 1.6% decrease. The decrease was attributable primarily to a
decline in the Company's export sales of sodium penta in the first two quarters
of fiscal 1997 as compared with the same two quarters of fiscal 1996. The
sodium penta decrease resulted when certain foreign producers made significant
inroads into the South American and Far Eastern markets with an aggressive
pricing strategy. The Company has taken steps to counter this threat by
emphasizing the quality of its products and by granting certain concessions
where appropriate. As a result of those actions, sodium penta sales during the
last two quarters of fiscal 1997 were approximately level as compared with the
last two quarters of fiscal 1996.
11
<PAGE>
GROSS PROFIT
Despite the decline in net sales in fiscal 1997 as compared to fiscal 1996,
gross profit was essentially unchanged due to reductions in cost of goods sold.
In the fourth quarter of fiscal 1996, the Company began producing sodium penta
at its plant in Matamoros, Mexico, replacing a higher-cost, contract
manufacturer that had been the Company's source for that product. That change
resulted in significant cost savings during fiscal 1997 that essentially offset
the impact of the net sales declines described above.
SELLING, DISTRIBUTION, GENERAL AND ADMINISTRATIVE EXPENSES
Aggregate selling, distribution, general and administrative expenses were
unchanged in fiscal 1997 as compared with fiscal 1996.
According to FIFRA, the environmental statute under which penta is
registered for sale in the United States, the Company is obligated to provide
the EPA with test data concerning the chemistry and toxicology of penta. The
Company expensed approximately $198 thousand for penta testing costs in fiscal
1997 and approximately $525 thousand in fiscal 1996. The Company expects to
continue to incur and expense additional costs for penta testing under FIFRA of
approximately $300 thousand in each of the next two fiscal years, although there
can be no assurance that actual costs will not exceed current estimates.
LIQUIDITY AND CAPITAL RESOURCES
The Company's sources of capital have traditionally been externally
generated or from commercial borrowings. The Company's cash needs are primarily
for capital expenditures for maintenance of its property, plant and equipment.
The Company believes that its cash flows from operations and available borrowing
under its Revolving Credit Facility (hereinafter defined) will be sufficient to
fund its anticipated cash requirements in fiscal 1998. In the event that those
sources are not sufficient to fund the Company's expenditures, the Company would
be required to seek additional debt or equity financing from commercial lenders,
institutional investors or individual investors. There can be no assurance that
such financing will be available on acceptable terms.
The Company's strategy includes expansion through acquisitions. There can
be no assurance that the Company will be successful in its ability to identify,
consummate and assimilate acquisitions on desirable economic terms.
Furthermore, the Company's ability to consummate such acquisitions may be
dependent to a certain extent upon obtaining additional debt or equity financing
from commercial lenders,
12
<PAGE>
institutional investors or individual investors. There can be no assurance
that such financing will be available on acceptable terms.
In early fiscal 1997 the Company's wholly-owned subsidiary, KMG, obtained a
working capital line of credit by entering into a Revolving Loan Agreement with
SouthTrust Bank of Alabama, National Association (the "Revolving Credit
Facility"), replacing a previous loan agreement. Under the Revolving Credit
Facility, the Company may borrow up to the lesser of $2.5 million or a borrowing
base (as defined therein). The Revolving Credit Facility contains various
representations and warranties and affirmative and negative covenants applicable
to KMG, including a limitation that equity investments or loans by the KMG not
exceed $250 thousand (other than funds to KMEX for the new Matamoros facility)
and a requirement to obtain the lender's consent prior to replacing the
President and chairman of the board directors of KMG, David L. Hatcher, or any
merger, reorganization or recapitalization of KMG. In addition, the Revolving
Credit Facility requires KMG to maintain a tangible net worth (as defined
therein) of not less than $2.5 million and a fixed charge coverage ratio of 1.5
to 1.0. In fiscal 1996 the Company paid approximately $921 thousand toward its
then existing revolving credit facility with BNY Financial Corporation. The
Company had virtually no borrowing against its current Revolving Credit Facility
during fiscal 1997. As of September 30, 1997 the Company's borrowing base under
the Revolving Credit Facility was approximately $2.0 million but the Company had
no outstanding borrowing.
As of July 31, 1997 the Company had cash and cash equivalents of
approximately $2.6 million as compared with approximately $553 thousand as of
July 31, 1996. Net cash provided by operations during fiscal 1997 was
approximately $3.4 million as compared with approximately $2.4 million for
fiscal 1996.
In fiscal 1997 the Company moved its manufacturing facility to a new
location in Matamoros, Mexico. Commercial production at the original facility
ceased early in December 1996 and did not restart at the new facility until
May 1997. That relocation of the Company's manufacturing facility materially
affected operating assets and liabilities during fiscal 1997. For example,
finished product inventories were increased beginning in fiscal 1996 in
anticipation of the cessation of production during the relocation. During
fiscal 1997 inventories were reduced by approximately $947 thousand, bringing
inventories down to approximately normal operating levels by the end of the
fiscal year. In addition, as the plant relocation was accomplished, accrued
liabilities established in connection with the anticipated move declined in
fiscal 1997 by approximately $243 thousand.
13
<PAGE>
The Company's investing activities consisted primarily of capital
expenditures related to site acquisition and construction costs for relocation
of its Matamoros, Mexico manufacturing facility. Total relocation costs were
approximately $1.5 million, of which approximately $1.2 million has been
capitalized. The Company anticipates that it will incur approximately
$750 thousand in fiscal 1998 in capital expenditures, primarily for additional
plant and equipment and upgrades to existing facilities. The Company believes
that cash from operations will be sufficient to pay for those expenditures.
The Company's capital expenditures and operating expenses for environmental
matters, excluding FIFRA testing and data submission costs, were approximately
$300 thousand in fiscal 1997 and $240 thousand in fiscal 1996. The Company
estimates that its capital expenditures and operating expenses for environmental
matters other than FIFRA, but including investigation and remediation at its
Tuscaloosa, Alabama facility as discussed below, will be approximately
$300 thousand in fiscal 1998. As discussed above, the Company expensed
approximately $198 thousand for penta testing costs under FIFRA in fiscal 1997
and approximately $525 thousand in fiscal 1996. The Company anticipates that
FIFRA testing costs will be approximately $300 thousand in each of the next two
fiscal years. Since environmental laws have traditionally become increasingly
stringent, costs and expenses relating to environmental control and compliance
may increase in the future. While the Company does not believe that the cost of
compliance with existing or future environmental laws and regulations will have
a material adverse effect on its business, financial condition or results of
operations, there can be no assurance that costs of compliance will not exceed
current estimates.
In connection with the relocation of its Matamoros facility, the Company
completed an environmental cleanup of the original site. In addition, the
Company conducts periodic ground water sampling at its facility in Tuscaloosa,
Alabama as required by the Alabama Department of the Environmental Management
("ADEM"). A 1991 sampling revealed the presence of penta contamination and more
recent sampling continues to show some contamination, although in lesser
amounts. ADEM has not required any additional response at this time. The
Company does not believe that costs for environmental investigation and
remediation at either facility will materially impact liquidity or have a
material adverse effect on the Company's business, financial condition or
results of operations, although there can be no assurances to this effect.
ACCOUNTING STANDARDS
New accounting standards have been issued for the computation of earnings
per share that are effective for periods ending after December 31, 1997.
Although
14
<PAGE>
the Company has not completed its evaluation of the impact, if any, of the
future adoption of the new standards, management believes that their adoption
will not have a material effect on the financial position or results of
operation of the Company.
ITEM 7. FINANCIAL STATEMENTS.
INDEX TO FINANCIAL STATEMENTS
FINANCIAL STATEMENTS
Page
----
Independent Auditors' Report 16
Consolidated Balance Sheets as of July 31, 1997
and 1996 17
Consolidated Statements of Income for the Years Ended
July 31, 1997 and 1996 18
Consolidated Statements of Stockholders' Equity
for the Years Ended July 31, 1997
and 1996 19
Consolidated Statements of Cash Flows for the
Years Ended July 31, 1997 and 1996 20
Notes to Consolidated Financial Statements 21-27
15
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
KMG-B, Inc.
Houston, Texas
We have audited the accompanying consolidated balance sheets of KMG-B, Inc. and
subsidiaries as of July 31, 1997 and 1996, and the related consolidated
statements of income, stockholders' equity and cash flows for the years then
ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of KMG-B, Inc. and subsidiaries as of
July 31, 1997 and 1996, and the results of their operations and their cash
flows for the years then ended in conformity with generally accepted accounting
principles.
DELOITTE & TOUCHE LLP
Houston, Texas
September 12, 1997
16
<PAGE>
KMG-B, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS,
JULY 31, 1997 AND 1996
- -------------------------------------------------------------------------------
ASSETS 1997 1996
CURRENT ASSETS:
Cash and cash equivalents $2,643,070 $ 552,550
Investments 89,040 89,040
Accounts receivable:
Trade, net of allowance for doubtful accounts
of $25,000 and $0, respectively 2,266,221 2,212,942
Other 120,211 134,836
Note receivable - current 7,740 7,200
Inventories 1,183,284 2,129,790
Prepaid expenses and other assets 113,159 66,103
Deferred income tax asset 110,813
Income taxes receivable 88,887
---------- ----------
Total current assets 6,511,612 5,303,274
PROPERTY, PLANT AND EQUIPMENT - Net of
accumulated depreciation 1,800,143 1,210,915
NOTE RECEIVABLE, Less current portion 245,267 253,102
OTHER ASSETS 828,543 632,265
---------- ----------
TOTAL $9,385,565 $7,399,556
---------- ----------
---------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $1,331,305 $1,505,733
Accrued liabilities 669,572 912,310
Notes payable 14,944
Income taxes payable 80,175
---------- ----------
Total current liabilities 2,000,877 2,513,162
DEFERRED TAX LIABILITY 34,881
---------- ----------
Total liabilities 2,035,758 2,513,162
---------- ----------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value, 10,000,000
shares authorized, none issued
Common stock, $.01 par value; 40,000,000
shares authorized, 7,000,169 shares and
6,862,474 shares issued and outstanding
in 1997 and 1996, respectively 70,002 68,625
Additional paid-in capital 1,063,385 1,185,814
Retained earnings 6,216,420 3,631,955
---------- ----------
Total stockholders' equity 7,349,807 4,886,394
---------- ----------
TOTAL $9,385,565 $7,399,556
---------- ----------
---------- ----------
See notes to consolidated financial statements.
-17-
<PAGE>
KMG-B, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED JULY 31, 1997 AND 1996
- -------------------------------------------------------------------------------
1997 1996
NET SALES $19,485,035 $19,801,927
COST OF SALES 11,265,700 11,529,603
----------- -----------
Gross profit 8,219,335 8,272,324
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 3,911,452 4,005,742
----------- -----------
Operating income 4,307,883 4,266,582
OTHER INCOME (EXPENSE):
Interest income 67,629 38,689
Interest expense (282) (30,779)
Other (5,133) (89,463)
----------- -----------
Total other income (expense) 62,214 (81,553)
----------- -----------
INCOME BEFORE INCOME TAXES 4,370,097 4,185,029
PROVISION FOR INCOME TAXES (1,660,637) (1,533,605)
----------- -----------
NET INCOME $ 2,709,460 $ 2,651,424
----------- -----------
----------- -----------
EARNINGS PER COMMON SHARE $ 0.39 $ 0.39
----------- -----------
----------- -----------
WEIGHTED AVERAGE SHARES OUTSTANDING 6,862,757 6,862,474
----------- -----------
----------- -----------
See notes to consolidated financial statements.
-18-
<PAGE>
KMG-B, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
- --------------------------------------------------------------------------------
<TABLE>
Common Stock
---------------------- Additional Total
Shares Par Paid-In Retained Stockholders'
Issued Value Capital Earnings Equity
<S> <C> <C> <C> <C> <C>
BALANCE AT
AUGUST 1, 1995 6,862,474 $68,625 $1,185,814 $1,080,527 $2,334,966
Dividends (99,996) (99,996)
Net income 2,651,424 2,651,424
--------- ------- ---------- ---------- ----------
BALANCE AT
JULY 31, 1996 6,862,474 68,625 1,185,814 3,631,955 4,886,394
Dividends (124,995) (124,995)
Shares issued 137,695 1,377 98,623 100,000
Stock registration costs (221,052) (221,052)
Net income 2,709,460 2,709,460
--------- ------- ---------- ---------- ----------
BALANCE AT
JULY 31, 1997 7,000,169 $70,002 $1,063,385 $6,216,420 $7,349,807
--------- ------- ---------- ---------- ----------
--------- ------- ---------- ---------- ----------
</TABLE>
See notes to consolidated financial statements.
-19-
<PAGE>
KMG-B, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED JULY 31, 1997 AND 1996
- --------------------------------------------------------------------------------
<TABLE>
1997 1996
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,709,460 $ 2,651,424
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 240,085 343,368
Loss on sale or abandonment of equipment 36,707 73,003
Deferred income tax (benefit) provision 145,694 (160,090)
Changes in operating assets and liabilities:
Accounts receivable - trade (53,279) 72,957
Accounts receivable - other 14,625 (60,192)
Inventories 946,506 (864,990)
Prepaid expenses and other assets (47,056) 2,135
Income taxes receivable (88,887)
Accounts payable (174,428) 199,593
Accrued liabilities (242,738) 381,015
Income taxes payable (80,175) (250,068)
----------- -----------
Net cash provided by operating activities 3,406,514 2,388,155
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equipment (839,315) (824,212)
Collection of note receivable 7,295 19,173
Additions to other assets (222,983) (64,584)
----------- -----------
Net cash used in investing activities (1,055,003) (869,623)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net payments on line of credit (921,184)
Payment of dividends (124,995) (99,996)
Principal payments on borrowings (14,944) (15,034)
Issuance of stock 100,000
Stock registration costs (221,052)
----------- -----------
Net cash used in financing activities (260,991) (1,036,214)
----------- -----------
NET INCREASE IN CASH AND CASH EQUIVALENTS 2,090,520 482,318
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 552,550 70,232
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 2,643,070 $ 552,550
----------- -----------
----------- -----------
SUPPLEMENTAL DISCLOSURES FOR CASH FLOW INFORMATION:
Cash paid during the year for interest $ 282 $ 30,779
Cash paid during the year for income taxes $ 1,676,784 $ 1,943,763
</TABLE>
See notes to consolidated financial statements.
-20-
<PAGE>
KMG-B, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
KMG-B, Inc. and its subsidiaries (the "Company") is involved in the
manufacture and distribution of wood treatment products, principally
pentachlorophenol ("penta"). Penta manufacturing operations are conducted
through KMG de Mexico (formerly Productos de Preservation, S.A. de C.V.)
("KMEX"), a Mexican corporation and 97% owned subsidiary, at a plant in
Matamoros, Mexico. The penta plant began operations in 1986 and was moved
to a new location in Matamoros in May 1997.
The historical financial information for the Company prior to September 13,
1996 reflects the historical results of KMG-Bernuth ("KMG") and KMEX as a
result of a reverse merger of KMG with KMG-B in September 1996. Prior to the
transaction, KMG-B, Inc. ("KMG-B") had no significant assets, liabilities or
operations and its primary business purpose was to seek an acquisition or
merger transaction with an operating business with growth potential whereby
its shareholders would benefit by owning an interest in a viable business
enterprise. On October 15, 1996, pursuant to a stock exchange agreement
dated September 13, 1996, KMG-B issued 6,510,000 shares of common stock
(approximately 93% of its issued and outstanding common stock) in exchange
for all of the issued and outstanding shares of common stock of KMG; KMG-B
also issued 352,474 shares of common stock to other shareholders for certain
services for KMG-B in connection with the Stock Exchange Agreements and in
conjunction with other services. The transaction between KMG-B and KMG
provided KMG-B with a viable business enterprise and allowed KMG to become a
public company without going through an initial public offering.
On March 31, 1995, KMG merged with its former parent, Harwin Interests, Inc.
("HII"), with HII ceasing to exist. HII's principal asset was its
investment in KMG. This transaction has been accounted for at historical
cost in a manner similar to a pooling-of-interests, with KMG assuming
$312,881 of net tax liabilities of its previous parent.
KMG-B was incorporated in the state of Texas in 1992 under the name Water
Point Manufacturing, Inc. ("Water Point"). KMG-B as Water Point filed a
petition under Chapter 11 of the United States Bankruptcy Court during June
of 1995 and in September 1995, a First Amended Joint Plan of Reorganization
(the "Plan") was filed and subsequently confirmed by the official committee
of unsecured creditors and the bankruptcy trustee. With respect to Water
Point, the Plan provided that it would remain in existence, although all
capital stock outstanding as of the filing date of the petition would be
canceled, and that it was discharged from any and all debts and liabilities
that arose prior to October 23, 1996. Water Point adopted "fresh-start"
accounting as of the October 23, 1996 bankruptcy discharge date and
subsequently changed its name to KMG-B.
The Company's significant accounting policies are as follows:
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include
the accounts of KMG-B, KMG and KMEX. All significant intercompany accounts
and transactions have been eliminated in consolidation.
CASH AND CASH EQUIVALENTS - The Company considers all investments with
original maturities of three months or less to be cash equivalents.
-21-
<PAGE>
INVENTORIES - Inventories are valued at the lower of cost or market. Cost
is determined using the first-in first-out ("FIFO") method.
PROPERTY, PLANT AND EQUIPMENT - Property, plant and equipment is stated at
cost. Major renewals and betterments are capitalized. Repairs and
maintenance costs are expensed as incurred.
Depreciation is principally computed on a straight-line method over the
estimated useful lives of the assets. Depreciation expense was $212,454 and
$272,639 in 1997 and 1996, respectively. The estimated useful lives of
classes of assets are as follows:
ASSET DESCRIPTION LIFE (YEARS)
Buildings 10 to 30
Equipment 3 to 10
Leasehold improvements 5 to 8
INCOME TAXES - Deferred income taxes assets and liabilities are determined
using the asset and liability method in accordance with Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes."
Under this method, deferred tax assets and liabilities are established for
the temporary differences between financial and taxable income. These
differences result principally from computing depreciation and amortization
using different methods for tax and financial reporting purposes.
STOCK OPTIONS - The Company accounts for stock-based employee compensation
under Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees."
EARNINGS PER SHARE - Earnings per share are calculated based on the weighted
average number of shares of common stock and common stock equivalents
outstanding during the period.
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128 ("SFAS No. 128") "Earnings per
Share". SFAS No. 128 establishes standards for computing and presenting
earnings per share ("EPS") and applies to entities with publicly held common
stock or potential common stock. This statement simplifies the standards
for computing EPS previously found in Accounting Principles Board Opinion
No. 15, "Earnings per Share", and makes them comparable to international EPS
standards. This statement is effective for financial statements issued for
periods ending after December 15, 1997, including interim periods; earlier
application is not permitted. This statement requires restatement of all
prior-period EPS data presented. Considering the guidelines as prescribed
by SFAS No. 128, management believes that the adoption of this statement
will not have a material effect on EPS; and pro forma EPS, as suggested for
all interim and annual periods prior to required adoption, has been omitted
due to immateriality.
USE OF ESTIMATES - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amount of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from these
estimates.
FAIR VALUE OF FINANCIAL INSTRUMENTS - The carrying value of financial
instruments, including cash and cash equivalents, accounts receivable,
accounts payable, and debt, approximates fair value because of the
relatively short maturity of these instruments. The notes receivable,
including the current portion, are of a related-party nature, and it is not
practicable to estimate the fair value.
-22-
<PAGE>
It is not practicable to estimate the fair value of the Company's
investments. The Company holds securities in untraded closely held entities
that are recorded at cost.
CONCENTRATIONS OF CREDIT RISKS - Financial instruments that potentially
subject the Company to significant concentrations of credit risk consist
principally of cash and cash equivalents and accounts receivable. Although
the amount of credit exposure to any one institution may exceed federally
insured amounts, the Company limits its cash investments to high quality
financial institutions in order to minimize its credit risk. With respect
to accounts receivable, such receivables are primarily from wood treating
manufacturers located worldwide. The Company extends credit based on an
evaluation of the customer's financial condition, generally without
requiring collateral. Exposure to losses on receivables is dependent on
each customer's financial condition.
RECLASSIFICATIONS - Certain prior year balances have been reclassed to
conform to the current year's presentation.
2. INVENTORIES
Inventories are summarized as follows:
1997 1996
Chemical raw materials and supplies $ 333,502 $ 195,565
Finished chemical products 849,782 1,934,225
---------- ----------
Total $1,183,284 $2,129,790
---------- ----------
---------- ----------
3. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment and related accumulated depreciation are
summarized as follows:
1997 1996
Land $ 267,947 $ 169,357
Buildings 651,018
Equipment 2,237,023 2,515,230
Leasehold improvements 28,276 338,404
Construction-in-progress 33,693 427,958
----------- -----------
3,217,957 3,450,949
Less accumulated depreciation and amortization (1,417,814) (2,240,034)
----------- -----------
Total $ 1,800,143 $ 1,210,915
----------- -----------
----------- -----------
4. FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS
Monetary assets and liabilities and income items for KMEX are translated to
U.S. dollars at current rates, and certain assets (notably buildings and
equipment) are translated at historical rates. Expense items for KMEX are
translated at average monthly rates of exchange except for depreciation and
amortization expense. All gains and losses from currency translation for
KMEX are included in operations. Foreign
-23-
<PAGE>
currency translation resulted in an aggregate exchange gain of $15,151 and
$20,666 in fiscal years 1997 and 1996, respectively.
5. INCOME TAXES
The provision (benefit) for income taxes consists of the following:
1997 1996
Current federal provision $1,383,866 $1,557,011
Current state provision 131,077 136,684
Deferred income tax provision (benefit) 145,694 (160,090)
---------- ----------
Total $1,660,637 $1,533,605
---------- ----------
---------- ----------
Deferred income taxes are provided for temporary differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax basis. As of July 31, 1997, deferred income taxes
relating to temporary differences consisted of $34,881 of noncurrent
deferred tax liabilities. As of July 31, 1996, deferred income taxes
relating to temporary differences consisted of $110,813 of current deferred
tax assets and $7,225 of noncurrent deferred tax assets (included in other
assets). No valuation allowance was required as of July 31, 1997 or 1996.
The following table accounts for the differences between the actual tax
provision and the amounts obtained by applying the applicable statutory U.S.
federal income tax rate to the earnings before income taxes for the year
ended July 31:
1997 1996
Provision for income taxes at the
statutory rate $1,485,543 $1,422,910
State income taxes 131,077 136,684
Other 44,017 (25,989)
---------- ----------
Total $1,660,637 $1,533,605
---------- ----------
---------- ----------
6. OTHER ASSETS
Other assets consist of the following:
1997 1996
Advances for premiums on employee-owned
life insurance policies (see Note 9) $428,733 $354,023
Licensing agreement, net of accumulated
amortization of $86,309 on July 31, 1997
and $63,452 on July 31, 1996 233,691 256,548
Other 166,119 21,694
-------- --------
Total $828,543 $632,265
-------- --------
-------- --------
-24-
<PAGE>
During 1991, the Company entered into a technology licensing agreement
resulting in the granting to the Company of an exclusive worldwide right and
license to use and sublease certain proprietary and sales information and to
manufacture and sell certain products for an indefinite period of time.
Total cost to the Company for this license was $320,000, which is being
amortized on a straight-line basis over a 15-year term which approximates
the patent life of the products represented by this agreement.
7. LONG-TERM DEBT
During 1996, the Company maintained a line of credit with a bank that
provided for borrowings of up to $3,500,000. The borrowing base was limited
by a formula defined in the agreement based upon the amount of receivables
and inventory. Interest payments were due monthly at 1% over the higher of
the prime rate or the federal funds rate plus 1/2% with a minimum rate of
6%. The Company had no borrowings outstanding as of July 31, 1996. This
agreement was terminated on July 31, 1996.
Effective August 1, 1996, the Company entered into a new revolving line-of-
credit agreement with a different bank that provides for borrowings of up to
$2,500,000. The borrowing base under this agreement is limited by a formula
defined in the agreement based on the amount of receivables and inventory.
Interest payments are due monthly. The line of credit is subject to a 1/4%
unused line fee, is secured by the Company's receivables, inventory and
general intangibles and is partially guaranteed by the Company's majority
stockholder. The loan agreement includes, among other things, restrictions
on equity investments and loans made by the Company and requires the
maintenance of a minimum fixed-charge coverage ratio and minimum net worth
requirements. No borrowings were outstanding under this agreement at
July 31, 1997.
Effective September 1, 1997, the revolving line-of-credit agreement was
amended to extend the loan termination date until January 15, 1999. In
addition, the interest rate was amended to be either the base rate as
designated by the bank (8.50% at September 1, 1997) or 90 or 180 day LIBOR
plus 2%. The Company has the right to specify the rate to be effective
during given periods. At September 1, 1997, 90 and 180 day LIBOR rates were
5.75% and 5.88%, respectively.
8. COMMITMENTS AND CONTINGENCIES
COMMITMENTS
OPERATING LEASES - The Company has operating leases for its office and
warehouse facilities and certain transportation equipment. At July 31,
1997, the Company was obligated under these leases for the following future
minimum lease commitments:
Year Ending July 31, Amount
1998 $154,120
1999 112,218
2000 65,756
2001 9,670
2002
--------
Total $341,764
--------
--------
Rent expense relating to the operating leases was $250,691 and $253,713 for
the years ended July 31, 1997 and 1996, respectively.
-25-
<PAGE>
CONTINGENCIES
ENVIRONMENTAL - As a manufacturer and supplier of wood treatment products,
the Company is subject to a variety of health, safety and environmental laws
within the countries in which it operates. These governments may implement
new laws or regulations which amend or impose restrictions on the sale or
use of the Company's raw materials and products. In management's opinion,
the Company is currently in compliance with all applicable laws and
regulations, and no actions or proceedings against the Company are known to
be in process.
In August 1988 the U.S. Environmental Protection Agency ("EPA") issued a
comprehensive data call-in notice for test data on all products covered
under the Federal Insecticide, Fungicide and Rodenticide Act. This notice
required product registrants, including KMG, to perform an extensive series
of controlled tests and to provide the EPA with the results of those tests.
To meet the EPA requirements and to mitigate the cost of doing so, KMG
joined with another pentachlorophenol manufacturer in the creation of a
"penta data task force" in July 1989. To date, this task force has
performed the bulk of the EPA mandated tests. The data from these tests are
consistent with historical pentachlorophenol test results and, as such, will
not, in management's opinion, hinder the re-registration of
pentachlorophenol products. Costs incurred by KMG of approximately $198,000
and $525,000 in fiscal years 1997 and 1996, respectively, are included in
general and administrative expenses. No costs were incurred in fiscal year
1995; however, costs of approximately $418,000 were expensed prior to fiscal
year 1995.
During 1997, the mandate of the penta data task force changed to include
possible compliance testing required by foreign governments. Since these
governments have the authority to amend testing protocols and/or to mandate
additional tests, future costs to KMG are difficult to quantify. However,
management estimates that these future costs will be approximately $300,000
per year and intends to expense these costs as incurred.
LAWSUITS - The Company is involved in various claims and lawsuits in the
normal course of business. Management does not believe that the outcome of
any of these matters will have a materially adverse effect on the Company's
consolidated financial condition or operations.
9. RELATED-PARTY TRANSACTIONS
During 1991, the Company entered into "split-dollar insurance" arrangements
with two officers/stockholders. Under these agreements, the Company
advances funds for insurance premiums and records these advances as
noncurrent assets. The Company has a security interest in the insurance
policies to the extent of the advances made. The security is to be
satisfied either from death benefit proceeds or, in the event of termination
of the agreement(s), by reimbursement from the officer(s)/stockholder(s).
The Company advanced funds to an officer under an unsecured promissory note
dated July 15, 1994. The amount is due in semimonthly installments of
$1,000, including interest at 6.5%. As of July 31, 1997 and 1996, $253,007
and $260,302, respectively, was outstanding under this note.
Effective October 15, 1996, an entity that employs a director of the
Company, which is also a shareholder of the Company, entered into a
consulting agreement (the "Consulting Agreement") with the Company. The
Company issued 137,695 shares of its common stock for services rendered
under the Consulting
-26-
<PAGE>
Agreement regarding the stock exchange agreement (as discussed in Note 1)
and other related matters. The number of shares issued was valued at
$100,000, based on the estimated fair value of the services provided.
10. EMPLOYEE BENEFIT PLAN
The Company has a defined contribution 401(k) plan covering substantially
all its U.S. employees. The participants may contribute from 3% to 15% of
their compensation, and the Company makes matching contributions under this
plan equal to 3% of the participants' compensation. Company contributions
to the plan totaled approximately $18,000 and $22,000 in fiscal years 1997
and 1996, respectively.
11. SIGNIFICANT CUSTOMERS
The Company had two significant customers in 1997 whose sales as a
percentage of total sales were 10.3% and 10.7%, respectively, and one
significant customer in 1996 whose sales as a percentage of total sales was
9.8%.
12. STOCK OPTION PLAN
KMG-B adopted the 1996 Stock Option Plan (the "Stock Plan") on October 15,
1996 and reserved 700,000 shares of its common stock for issuance under the
Stock Plan. The Stock Plan provides for the grant of "incentive stock
options," as defined in Section 422 of the Internal Revenue Code of 1986, as
amended, and nonqualified stock options. The Stock Plan will be
administered either by the KMG-B Board of Directors or by a committee of two
or more nonemployee directors. Subject to the terms of the Stock Plan, the
Board of Directors or the committee has the authority to grant options under
the Stock Plan, to amend, construe and interpret it, and to make all other
determinations and take any and all actions necessary or advisable for its
administration. The directors, consultants and key employees of KMG-B or
any subsidiary are eligible to receive options under the Stock Plan, but
only salaried employees of KMG-B or its subsidiaries are eligible to receive
incentive stock options.
Options will be exercisable during the period specified in each option
agreement and in accordance with a vesting schedule to be designated by the
Board of Directors or the committee. Any option agreement may provide that
options become immediately exercisable in the event of a change or
threatened change in control of KMG-B and in the event of certain mergers
and reorganizations of KMG-B. Options may be subject to early termination
within a designated period following the optionee's cessation of service
with the Company.
An option to purchase 43,671 shares of common stock had been granted to an
employee in 1994. The option became fully vested on July 31, 1997 at an
exercise price of $.216 per share, which approximated fair market value at
the date of grant, and was accounted for under the provisions of APB Opinion
No. 25.
13. DIVIDENDS
On September 2, 1997, the Company declared a dividend of $0.02 per share
payable September 30, 1997, to common shareholders of record as of
September 15, 1997.
-27-
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
PART III
Pursuant to instruction E.3 to Form 10-KSB, the information required by
Items 9-12 of Part III is incorporated by reference from the Company's
definitive proxy statement to be filed on or about November 15, 1997.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8K.
(a) The financial statements filed as part of this report in Item 7 are listed
in the Index to Financial Statements contained in such Item. The following
documents are filed as exhibits to this report:
2.1 First Amended Joint Plan of Reorganization dated September 1, 1995,
as modified and clarified to date. *
2.2 Stock Exchange Agreement dated September 13, 1996 by and between
W.P. Acquisition Corp., Halter Financial Group, Inc., KMG-Bernuth,
Inc. and certain shareholders of KMG-Bernuth, Inc. *
3 (i) Amended and Restated Articles of Incorporation. *
3 (ii) Bylaws. *
4.1 Form of Common Stock Certificate. *
10.1 Agency Agreement dated January 1, 1987 by and between Bernuth,
Lembcke Co. Inc. and VfT AG. *
10.2 Revolving Loan Agreement dated August 1, 1996 by and between
KMG-Bernuth, Inc. and SouthTrust Bank of Alabama, National
Association. *
10.3 $2,500,000 Revolving Note dated August 1, 1996 payable by
KMG-Bernuth, Inc. to SouthTrust Bank of Alabama, National
Association. *
10.4 1996 Stock Option Plan. *
10.5 Stock Option Agreement dated October 17, 1996 by and between
KMG-B, Inc. and Thomas H. Mitchell. *
10.6 Consulting Agreement dated October 15, 1996 by and between the
Company and Gilman Financial Corporation. *
10.7 Split Dollar Insurance Agreement dated November 8, 1991 between
KMG-Bernuth, Inc. and David L. Hatcher. *
10.8 Split Dollar Insurance Agreement dated December 13, 1991 between
KMG-Bernuth, Inc. and Bobby D. Godfrey. *
28
<PAGE>
21.1 Subsidiaries of the Company. *
27.1 Financial Data Schedule.
Documents marked by an (*) were filed by the Company on December 6, 1996 as
part of its Form 10, file number 000-21839.
(b) No Forms 8-K were filed during the last quarter of the period covered by
this report.
29
<PAGE>
SIGNATURES
In accordance with the Exchange Act, the Company caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
KMG-B, INC.
By: /s/ David L. Hatcher Date: October 16, 1997
-----------------------------------
David L. Hatcher, President
and Chairman
In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the registrant and in the capacities
and on the dates indicated.
By: /s/ Jack Vernie Date: October 16, 1997
-----------------------------------
Jack Vernie, Controller
By: /s/ Bobby D. Godfrey Date: October 16, 1997
-----------------------------------
Bobby D. Godfrey, Director
By: /s/ George W. Gilman Date: October 16, 1997
-----------------------------------
George W. Gilman, Director
By: /s/ Fred C. Leonard III Date: October 16, 1997
-----------------------------------
Fred C. Leonard III, Director
By: /s/ Charles M. Neff, Jr. Date: October 16, 1997
-----------------------------------
Charles M. Neff, Jr., Director
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM AS
OF AND FOR THE TWELVE MONTHS PERIOD ENDED JULY 31, 1997 AND IS QUALIFIED
IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUL-31-1997
<PERIOD-START> AUG-01-1996
<PERIOD-END> JUL-31-1997
<CASH> 2,643,070
<SECURITIES> 89,040
<RECEIVABLES> 2,508,059
<ALLOWANCES> (25,000)
<INVENTORY> 1,183,284
<CURRENT-ASSETS> 6,511,612
<PP&E> 3,217,957
<DEPRECIATION> (1,417,814)
<TOTAL-ASSETS> 9,385,565
<CURRENT-LIABILITIES> 2,000,877
<BONDS> 0
0
0
<COMMON> 70,002
<OTHER-SE> 7,279,805
<TOTAL-LIABILITY-AND-EQUITY> 9,385,565
<SALES> 19,485,035
<TOTAL-REVENUES> 19,485,035
<CGS> 11,265,700
<TOTAL-COSTS> 11,265,700
<OTHER-EXPENSES> 3,911,452
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 282
<INCOME-PRETAX> 4,370,097
<INCOME-TAX> 1,660,637
<INCOME-CONTINUING> 2,709,460
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,709,460
<EPS-PRIMARY> 0.39
<EPS-DILUTED> 0.00
</TABLE>
