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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON APRIL 23, 1997.
REGISTRATION NO. ________
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-SB
GENERAL FORM FOR REGISTRATION OF SECURITIES OF SMALL BUSINESS ISSUERS
Under Section 12(b) or (g) of the Securities Exchange Act of 1934
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KMG-B, INC.
(Name of Small Business Issuer in its charter)
TEXAS 75-2404468
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10611 HARWIN DRIVE, SUITE 402
HOUSTON, TEXAS 77036
(713) 988-9252
(Address, including zip code, and telephone number,
including area code, of Issuer's principal executive offices)
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Securities to be registered under Section 12(g) of the Act:
COMMON STOCK
(Title of class)
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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. as a
wholly-owned subsidiary of Water Point Systems, Inc. ("Water Point"), a Texas
corporation. Water Point was engaged in the business of selling water
filtration systems for home and office use and designing, constructing and
distributing water vending machines. The Company was formed to purchase
component parts and assemble vending machines for Water Point. However, Water
Point and the Company were unsuccessful in the water filtration business and
they ceased operations late in 1994.
BANKRUPTCY PROCEEDINGS; SUMMARY OF THE PLAN OF REORGANIZATION
Water Point and the Company each filed a petition under Chapter 11 of the
United States Bankruptcy Code on March 10, 1995 and June 30, 1995, respectively,
in the United States Bankruptcy Court for the Northern District of Texas, Dallas
Division (the "Court"). The Court authorized the joint administration of both
cases. On September 1, 1995, the First Amended Joint Plan of Reorganization was
filed for Water Point and the Company by the official committee of unsecured
creditors and the bankruptcy trustee. The First Amended Joint Plan of
Reorganization was confirmed by the Court on October 10, 1995, modified by the
Court on May 29, 1996 and clarified by it on September 12, 1996 (as modified and
clarified, the "Plan").
The Plan provided for the vesting of all the assets of Water Point and the
Company in a liquidating trust administered by a trust committee and
distribution of the proceeds to secured, priority and unsecured creditors.
With respect to the Company, the Plan provided that the Company would
remain in existence, although all capital stock outstanding as of the filing
date of the bankruptcy petition was canceled. Under the Plan, the reorganized
Company issued shares of its common stock, par value $.01 per share (the "Common
Stock") to certain of its creditors. Creditors with allowed unsecured claims
received a PRO RATA distribution of 40% of the newly-issued shares of Common
Stock.
The Company secured a post-petition loan in the amount of $20,000 from
Halter Financial Group, Inc., a Texas corporation ("HFG"), to meet certain of
the costs and expenses associated with the reorganization effort. Under the
Plan, HFG received 60% of the shares of Common Stock in satisfaction of the
$20,000 loan and for services to be rendered and expenses to be incurred by HFG
in connection with an
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anticipated post-confirmation acquisition or merger transaction between the
Company and a privately-held operating business.
According to the Plan, the Company was discharged from any and all debts
and liabilities that arose before October 23, 1996.
In connection with the Company's bankruptcy proceedings, the Company's name
was changed to W.P. Acquisition Corp.
ACQUISITION OF KMG-BERNUTH, INC.
The Company's initial 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 order to further 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 4. Security Ownership of Certain Beneficial Owners
and Management."
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.
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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
products to treat wood products and then 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.
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 578 and 634 million cubic feet of wood in calendar 1995 and 1994,
respectively. CCA was used to treat approximately 78% of the wood in 1995 and
1994. Of the remaining 22%, creosote
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was used to treat approximately 16% and 15% in 1995 and 1994, respectively,
and penta was used to treat 6% and 7% in 1995 and 1994, respectively.
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, Productos de Preservacion, S.A. de
C.V. ("PPSA"), a Mexican maquiladora corporation that began operations in 1986.
The Company arranges for the required phenol and chlorine to be supplied to
PPSA, 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.
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, 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 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
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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., 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.
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CUSTOMERS
The Company sells its products to more than 80 customers on a regular
basis. One customer, Texas Electric Cooperatives, Inc., accounted for
approximately 10% of the Company's revenues for each of fiscal 1996 and 1995.
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 up to
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 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
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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 licensing 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 March 31, 1997, the Company had a total of 58 employees, all of whom
are full-time employees. Nine of the Company's employees were employed at the
Company's corporate offices in Houston, Texas, 43 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 25 of PPSA's
employees in Mexico are represented under a labor contract. The Company
believes that it has good relations with its employees.
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 2. 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
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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, 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
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of the research and testing costs pertaining to penta, based on its market
share. The Company incurred expenses of approximately $0.53 million in
connection with the FIFRA research and testing program in fiscal 1996.
Although a similar industry group funds a creosote research and testing
program, the cost of that effort is borne by VfT.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FISCAL YEARS ENDED JULY 31, 1996 AND 1995
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 fiscal years
ended July 31, 1996 and 1995 and gross profit expressed as a percentage of net
sales:
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Year Ended July 31, Increase/
--------------------------- (Decrease)
1996 1995
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Net sales..................... $19,801,927 $16,401,205 $3,400,722
Cost of sales................. 11,529,603 10,876,962 652,641
Gross profit.................. 8,272,324 5,524,243 2,748,081
Gross profit percent.......... 42% 34%
Selling, general and
administrative expense....... 4,005,742 3,032,564 973,178
Operating income.............. 4,266,582 2,491,679 1,774,903
Other income (expense), net... (81,553) (206,258) 124,705
Income before taxes........... 4,185,029 2,285,421 1,899,608
Provision for income taxes.... (1,533,605) (811,466) (722,139)
Net income.................... 2,651,424 1,473,955 1,177,469
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SALES REVENUE
Net sales for fiscal 1996 increased $3.4 million over fiscal 1995, a 21%
increase. The increase in fiscal 1996 was due to unit price increases and to
increased sales volume. Approximately half of the $3.4 million increase in net
sales came from a 20% unit price increase in certain of the Company's penta
products in the United States. Prices for the Company's international sales of
penta products and for creosote were essentially unchanged from fiscal 1995.
Creosote sales volume, however, increased approximately 33% in 1996, which
accounts for approximately half of the 1996 net sales increase. Management
believes that creosote sales
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increased primarily because of a perception in the market of a quality
advantage for the Company's creosote product and a desire to diversify
sources of supply.
GROSS PROFIT
Gross profit increased by $2.7 million in fiscal 1996, a 50% increase.
Approximately $1.7 million of that increase was due to a 20% average increase
in the unit sales price of certain of the Company's penta products. Higher
production rates at the Company's original Matamoros, Mexico facility due to
the plant closure discussed below contributed approximately an additional
$0.5 million to the gross profit improvement in fiscal 1996. Creosote gross
profit rose about $0.3 million in fiscal 1996 due to higher sales volume.
The balance of the gross profit improvement of approximately $0.2 million was
primarily due to the write-off of certain capitalized plant relocation costs
to cost of goods sold in fiscal 1995.
The Company built penta products inventory in fiscal 1996 in anticipation
of the planned closure of its original Matamoros, Mexico facility to upgrade it
and move it to a new location in Matamoros. The original facility ceased
production in December 1996. See "-Liquidity and Capital Resources." The
Company does not expect the new facility to start commercial production until
May 1997. Although the increased size of the new facility will potentially give
the Company the ability to expand into new product lines, it is not expected
that changes to the original plant and equipment will result in material
increases in penta manufacturing capacity, operating efficiency or cost savings.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses increased approximately
$0.97 million in fiscal 1996. The increase was due in part because of certain
performance bonuses paid in fiscal 1996 to executive officers and one other
employee. Those bonuses increased to an aggregate of approximately
$0.18 million in fiscal 1996 from approximately $0.03 million in the prior
fiscal year. See "Item 6. Executive Compensation."
The increase was also due to costs incurred for penta environmental testing
and plant relocation expenses. 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. In fiscal year 1996 the Company expensed approximately
$0.53 million of penta testing costs as incurred. No penta testing costs were
incurred in fiscal year 1995 but approximately $0.42 million of such costs were
incurred in fiscal years prior to that fiscal year. The Company expects to
continue to incur and expense additional costs for penta testing under FIFRA.
The Company anticipates that such costs will not
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exceed an aggregate of approximately $1.0 million in the next two fiscal years,
although there can be no assurance that the actual costs will not exceed current
estimates.
The Company's fiscal 1996 plant relocation expenses resulted from
preparation for the Company's move to a new Matamoros manufacturing facility
and to move certain operations from Texas to its current Matamoros facility.
Those expenses amounted to $0.34 million in fiscal 1996 versus no comparable
expense in fiscal 1995.
INCOME TAX EXPENSE
The Company's net provision for federal income taxes was 37% of income
before tax in fiscal 1996 and 36% in fiscal 1995.
LIQUIDITY AND CAPITAL RESOURCES
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 1997. 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, institutional investors or individual investors. There can
be no assurance that such financing will be available on acceptable terms.
As of the end of fiscal 1996 the Company had cash and cash equivalents of
approximately $0.55 million. On August 1, 1996 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
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$0.25 million (other than funds to PPSA 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. As of March 31, 1997, the borrowing base under its Revolving Credit
Facility was approximately $2.2 million but no funds had been borrowed.
Net cash provided by operations in fiscal 1996 was approximately $2.39
million as compared with approximately $1.12 million in fiscal 1995. That
increase in net cash flow was due to an approximate $1.18 million increase
in net income in fiscal 1996 as compared with fiscal 1995. Trade accounts
receivable from operations decreased by approximately $0.07 million in fiscal
1996 as the Company improved its management of customer credit risk and
payment terms. In fiscal 1995, the Company's trade accounts receivable
increased by approximately $0.60 million because of penta products price
increases implemented in the United States beginning in January 1995.
Accounts payable in fiscal 1996 increased approximately $0.20 million due to
the creosote volume sales increase in that year. Inventories grew by
approximately $0.86 million (68%) during fiscal 1996. The growth of
inventories was almost entirely the result of the Company's preparation for
the closing of the Matamoros facility. Inventories of penta products were
built to adequately support customer demand until commercial production of
penta begins at the new facility. Management expects that commercial
production will begin at the new facility in May 1997.
The Company's investing activities consisted primarily of capital
expenditures to upgrade the efficiency of the existing Matamoros facility, to
acquire the new Matamoros site where the current facility will be moved and
other initial relocation expenditures. In addition, the Company incurred
capital expenditures to relocate certain manufacturing operations from Texas
to the Matamoros facility. Additions to property, plant and equipment were
$0.82 million in fiscal 1996 and $0.21 million in fiscal 1995. The Company
anticipates that it will incur approximately $1.0 million in fiscal 1997 for
all its capital expenditures, including expenditures for the relocation of
the Matamoros facility. 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 $0.24 million in each of fiscal 1996 and 1995. The
Company estimates that its capital expenditures and operating expenses for
environmental matters other than FIFRA, but including investigation and
remediation at its Matamoros, Mexico and Tuscaloosa, Alabama facilities as
discussed below, will be at approximately the same
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level in fiscal 1997. The Company incurred expenses of approximately $0.53
million for FIFRA testing costs in fiscal 1996. The Company estimates that
additional FIFRA testing expenses will not exceed approximately $1.0 million
through fiscal 1998. 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
is obligated to clean the current Matamoros site of any environmental
contamination. 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.
The Company's financing activities are primarily composed of net payments
under its working capital line of credit of approximately $0.92 in fiscal 1996
and $0.82 in fiscal 1995. The Company declared and paid dividends of $124,995
in August 1996 and $99,996 in August 1995.
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SIX MONTHS ENDED JANUARY 31, 1996 AND 1997
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 six month periods
ended January 31, 1997 and January 31, 1996 and gross profit expressed as a
percentage of net sales:
- - -------------------------------------------------------------------------------
Six Months Ended January 31 Increase/
--------------------------- (Decrease)
1997 1996
- - -------------------------------------------------------------------------------
Net sales.................... $9,471,767 $9,701,163 ($229,396)
Cost of sales................ 5,512,813 5,700,893 (188,080)
Gross profit................. 3,958,954 4,000,270 (41,316)
Gross profit percent......... 42% 41%
Selling, general and
administrative expense...... 1,634,356 1,815,362 (181,006)
Operating income............. 2,324,598 2,184,908 139,690
Other income (expense), net.. 27,021 (34,926) (61,947)
Income before taxes.......... 2,351,619 2,149,982 201,637
Provision for income taxes... (891,627) (724,263) 167,364
Net income................... 1,459,992 1,425,719 34,273
- - -------------------------------------------------------------------------------
SALES REVENUE
Net sales for the six months ended January 31, 1997 decreased approximately
$0.23 million as compared to the six months ended January 31, 1996, a 2%
decrease. The decrease was due to a decline in the volume of sales of certain
penta products. Management believes that the decrease in penta product sales is
within the range of normal variation.
GROSS PROFIT
Gross profit was essentially unchanged in the six months ended January
31, 1997 as compared to the same period in fiscal 1996. Unit prices were
stable over the two periods. The effect on gross profit of increased
production throughput in the first six months of fiscal 1997 as compared to
fiscal 1996 was largely offset by reduced sales of higher gross margin penta
products.
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<PAGE>
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses decreased in the six months
ended January 31, 1997 as compared to the same period in fiscal 1996.
Management believes that the decrease is within the normal range of variation
and not indicative of a trend.
INCOME TAX EXPENSE
The Company's net provision for federal income taxes was 38% of income
before tax in the six months ended January 31, 1997 as compared to 34% for the
same period in fiscal 1996.
LIQUIDITY AND CAPITAL RESOURCES
As of January 31, 1997, the Company had cash and cash equivalents of
approximately $0.14 million as compared to $0.03 million at the end of that same
period in fiscal 1996. Net cash provided by operations during the six months
ended January 31, 1997 was approximately $0.60 million as compared with
$1.03 million for the same period in fiscal 1996.
The decrease in net cash provided by operations is accounted for by a
combination of factors. Net income in the six month period increased
approximately $0.03 million during the first six months of fiscal 1997 as
compared with the same period of fiscal 1996. Trade accounts receivable as of
January 31, 1997 decreased as compared with January 31, 1996 because the mix of
product sales in fiscal 1997 shifted toward products sold on shorter payment
terms. Inventories increased by approximately $0.23 million during the first
six months of fiscal 1997 as inventory was added to support customers during the
move from the Company's original penta facility in Matamoros, Mexico to its new
facility. Production at the original facility ceased early in December 1996.
Accounts payable in the six months ended January 31, 1997 decreased
$0.91 million, a decrease in accounts payable that was $0.77 million greater
than in the comparable period in fiscal 1996. That difference is primarily
because of a reduction in raw material and other purchases in anticipation of
the plant closure and because of normal timing differences in vendor payments.
Income taxes payable were reduced in the first six months of 1997 by only
$0.06 million as compared to $0.33 million in the same period in 1996 because
the Company had been able to defer the payment of approximately $0.30 million of
its fiscal year 1995 taxes to fiscal year 1996. That payment deferral was not
available for fiscal 1996 taxes.
The Company's investing activities consist primarily of capital
expenditures to accomplish the move to the new penta facility in Matamoros,
Mexico. The new plant
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<PAGE>
construction expenditures increased approximately $0.46 million in the six
months ended January 31, 1997. New plant capital expenditures plus other
additions to property, plant and equipment were approximately $0.59 million
in the first six months of fiscal 1997. In the first six months of fiscal
1997, the Company also wrote off approximately $0.39 million in obsolete
equipment and leasehold improvements but the write off had no material effect
on net income since those assets were almost entirely depreciated.
The Company's financing activities are primarily composed of net payments
under its working capital line of credit made in the six months ended
January 31, 1996 of $0.84 million. The Company made no net borrowings or
payments in the comparable period in fiscal 1997.
New accounting standards have been issued for the computation of earnings
per share that are effective for periods ending after December 31, 1997.
Although 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 3. 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 47,000 square Leased Month to
(original facility) feet month
Matamoros, Mexico
(new facility) 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 is
completing the construction of a new manufacturing facility in Matamoros, Mexico
on property owned by PPSA. Production at the original facility ceased in
December 1996. The equipment from the original facility has been moved to the
new location and the
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new facility is expected to begin commercial production in May 1997. The
Company believes that it will turn over the property leased at the original
facility to the landlord in the Summer of 1997.
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 4. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information as of April 21, 1997
with regard to the beneficial ownership of Common Stock by (i) each person known
to the Company to be the beneficial owner of 5% or more of its outstanding
Common Stock, (ii) the officers and directors of the Company individually and
(iii) the officers and directors of the Company as a group. All addresses are
in care of the Company, 10611 Harwin Drive, Suite 402, Houston, Texas 77036.
----------------------------------------------------------------------
NUMBER OF
NAME SHARES OWNED PERCENT
---- ------------ -------
David L. Hatcher.................... 5,078,503 72
Bobby D. Godfrey (1)................ 780,997 11
Fred C. Leonard III (2)............. 651,000 9
George W. Gilman (3)................ 172,238 2
Charles M. Neff, Jr. ............... -- --
Thomas H. Mitchell (4).............. -- --
Directors and executive
officers as a group (6 persons).... 6,682,738 96
----------------------------------------------------------------------
(1) Mr. Godfrey granted to Valves Incorporated of Texas, Inc. a right of
first refusal to purchase the 780,997 shares of Common Stock owned by
Mr. Godfrey. Mr. Leonard is an officer and a principal shareholder of that
corporation and therefore may be deemed, under the Securities Exchange Act of
1934, as amended (the "Exchange Act"), the beneficial owner of that right of
first refusal.
(2) Mr. Leonard is an officer and a principal shareholder of Valves
Incorporated of Texas, Inc. and therefore may be deemed, under the Exchange Act,
the beneficial owner of the 651,000 shares of Common Stock owned by that
corporation.
(3) Mr. Gilman is an employee of Gilman Financial Corporation and the
father of Jeffrey L. Gilman, an officer, director and principal shareholder of
Gilman Financial
17
<PAGE>
Corporation. Mr. Gilman may therefore be deemed, under the Exchange Act, the
beneficial owner of 34,543 shares of Common Stock owned by that corporation. In
addition, Gilman Financial Corporation or persons selected by it will receive
137,695 shares to be issued by the Company pursuant to the GFC Consulting
Agreement (hereinafter defined). See "Item 7. Certain Relationships and Related
Transactions." Mr. Gilman disclaims any beneficial ownership in the shares of
Common Stock owned by Gilman Financial Corporation.
(4) Pursuant to the Company's Stock Option Plan (hereinafter defined) on
October 17, 1996, the Company granted Mr. Mitchell a non-qualified stock option
to purchase 43,671 shares of Common Stock. The option is not exercisable within
six months. See "Item 6. Executive Compensation."
Mr. Hatcher is the owner of approximately 72% of the outstanding shares of
the Common Stock and as such he is able to elect the Board of Directors and
determine the outcome of other matters requiring shareholder action without the
concurrence of any other shareholder.
ITEM 5. MANAGEMENT
Set forth below is certain information regarding the directors, executive
officers and significant employees of the Company. Each of the directors of the
Company will serve until the next annual meeting of shareholders or until his
successor is elected and qualified. Executive officers of the Company are
elected by the Board of Directors to hold office until their respective
successors are elected and qualified.
NAME AGE POSITION(S)
---- --- -----------
David L. Hatcher....... 53 President and Director
Bobby D. Godfrey....... 57 Vice President and Director
Charles M. Neff, Jr. .. 50 Director and Treasurer (KMG only)
Fred C. Leonard III.... 51 Secretary and Director
George W. Gilman....... 54 Director
Thomas H. Mitchell..... 52 Vice President (KMG only)
Jack Vernie............ 52 Controller
Set forth below is a description of the backgrounds of the directors,
executive officers and significant employees of the Company and KMG.
18
<PAGE>
DAVID L. HATCHER has served as a director and President of the Company
since its acquisition of KMG in October 1996. Mr. Hatcher has also served as a
director and President of KMG since 1985. Mr. Hatcher has worked in the wood
treating industry since 1980 for predecessors and affiliates of KMG in various
capacities, including engineer, general manager and President. Mr. Hatcher is
also an officer and director of PPSA, KMG's subsidiary.
BOBBY D. GODFREY has served as a director and Vice President of the Company
since its acquisition of KMG in October 1996. Mr. Godfrey has also served as a
director and Vice President of KMG since 1985.
CHARLES M. NEFF, JR. has served as a director of the Company since its
acquisition of KMG in October 1996. Mr. Neff has also served as a director of
KMG since 1991 and as Treasurer since 1993. Mr. Neff has served as the Chief
Executive Officer and President of Houston National Bank, N.A. since 1988.
FRED C. LEONARD III has served as a director and Secretary of the Company
since its acquisition of KMG in October 1996. Mr. Leonard has also served as a
director of KMG since 1992 and as Secretary since 1993. Mr. Leonard has served
as the Chairman of the Board, Chief Executive Officer and President of Valves
Incorporated of Texas, Inc., a manufacturing company located in Houston, Texas
since 1972. Mr. Leonard also currently serves as the Chairman of the Board and
Treasurer of Agrimpex, Inc., a company that acts as a manufacturers'
representative promoting sales of equipment and services in Turkey, and as
Secretary of North Star Tours, Inc., a travel agency specializing in tours to
Turkey.
GEORGE W. GILMAN has served as a director of the Company since its
acquisition of KMG in October 1996 and has also served as a director of KMG
since 1995. Mr. Gilman has served as the Chief Executive Officer, President and
as a director of Commerce Securities Corporation, a National Association of
Securities Dealers, Inc. member firm, since 1982 and has practiced law with the
law firm of George Gilman, P.C. since 1986.
THOMAS H. MITCHELL has served as Vice President of KMG since 1994.
Mr. Mitchell has been employed by KMG since 1988 in various capacities,
including general sales manager.
JACK VERNIE has served as Controller of the Company since its acquisition
of KMG in October 1996. Mr. Vernie has also served as Controller of KMG since
1994. Prior to his employment with KMG, Mr. Vernie served as Controller of
Golden West Refining Company, a petroleum refining company located in Santa Fe
Springs, California, from 1983 to 1993.
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<PAGE>
The Company is dependent to a significant extent upon the efforts and
ability of Mr. Hatcher and its other executive officers and key personnel to
manage the Company's business and operations. The loss of the services of Mr.
Hatcher, the Company's other executive officers and key personnel could have a
material adverse effect upon the business, financial condition and results of
operations of the Company. None of the executive officers currently have an
employment agreement with the Company.
COMMITTEES OF THE BOARD OF DIRECTORS
The Board of Directors has two committees, an Audit Committee and a
Compensation Committee, each composed of at least two independent directors.
The Audit Committee, composed of Messrs. Leonard, Neff and Gilman, makes
recommendations to the Board of Directors regarding the independent public
accountants of the Company and the annual audit of the Company's financial
statements and accounts. The Compensation Committee, composed of Messrs.
Leonard, Neff and Hatcher, makes recommendations to the Board of Directors
regarding compensation for the Company's executive officers, directors,
employees and agents.
ITEM 6. EXECUTIVE COMPENSATION
EXECUTIVE COMPENSATION
The following table sets forth the cash and non-cash compensation paid by
the Company to its chief executive officer and its two other most highly
compensated executive officers for the fiscal years ended July 31, 1996, 1995
and 1994. None of the Company's other officers or directors received cash or
non-cash compensation in excess of $100,000 for the fiscal year ended July 31,
1996.
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<PAGE>
SUMMARY COMPENSATION TABLE
<TABLE>
- - ------------------------------------------------------------------------------------------
Long-Term
Compensation
Annual Compensation Awards
Name and ------------------- ------------- All Other
Principal Position Year Salary Bonus Options(1) Compensation (2)
- - ------------------ ---- ------ ----- ---------- ----------------
<S> <C> <C> <C> <C> <C>
David L. Hatcher 1996 $274,733 $122,000 $42,673
President 1995 273,435 22,000 44,041
1994 245,943 0 51,699
- - ------------------------------------------------------------------------------------------
Bobby D. Godfrey 1996 88,899 12,100 16,726
Vice President 1995 82,328 0 17,594
1994 85,123 3,000 20,922
- - ------------------------------------------------------------------------------------------
Thomas H. Mitchell 1996 91,596 21,100 4,790
Vice President (KMG only) 1995 84,200 9,511 3,400
1994 79,200 11,500 86 2,400
- - ------------------------------------------------------------------------------------------
</TABLE>
(1) On July 31, 1994, KMG granted to Mr. Mitchell an option to purchase 86
shares of its common stock. The option was to become fully vested on
July 31, 1997 at an exercise price of $109.93 per share. In connection with the
transactions contemplated by the Stock Exchange Agreement, the option was
canceled and a new nonqualified option was granted on October 17, 1996 under the
Stock Option Plan with respect to 43,671 shares of Common Stock. The new option
will become fully vested on July 31, 1997 at an exercise price of $.216 per
share.
(2) Includes payments made by the Company under its 401(k) Profit Sharing
Plan and, for David L. Hatcher and Bobby D. Godfrey, the economic benefit of
premiums paid by the Company under certain split dollar life insurance
agreements. In fiscal 1996, the economic benefit of the split dollar agreements
was $38,813 for Mr. Hatcher and $14,519 for Mr. Godfrey, respectively.
STOCK OPTION PLAN
The Company's 1996 Stock Option Plan (the "Stock Option Plan") was adopted
on October 15, 1996 in order to encourage ownership of Common Stock by certain
of the Company's directors, consultants and key employees and thus to create in
them an increased interest in and a greater concern for the welfare of the
Company. The Company has reserved 700,000 shares of Common Stock for issuance
under the Stock Option Plan pursuant to the exercise of options. Unless
extended or earlier terminated, the Stock Option Plan will terminate on
August 31, 2007.
The Stock Option 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 Option Plan will be administered either
by the Board of Directors or by a committee of two or more "non-employee
directors" within
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<PAGE>
the meaning of Rule 16b-3 of the Exchange Act. Subject to the terms of the
Stock Option Plan, the Board of Directors or the committee has the authority
to grant options under the Stock Option 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 the Company or any subsidiary or parent
corporation are eligible to receive options under the Stock Option Plan, but
only salaried employees of the Company or its subsidiaries or parent are
eligible to receive incentive stock options.
Options will be exercisable during the period specified in each option
agreement and will be exercisable in accordance with a vesting schedule to be
designated by the Board of Directors or the committee. Any option agreement may
provide that options will become immediately exercisable in the event of a
change or threatened change in control of the Company and in the event of
certain mergers and reorganizations of the Company. Options may be subject to
early termination within a designated period following the optionee's cessation
of service with the Company.
As of November 27, 1996, an option to purchase 43,671 shares of Common
Stock had been granted under the Stock Option Plan, no part of which had been
exercised or was exercisable.
DIRECTOR COMPENSATION
Directors who are employees of the Company will not receive additional
compensation for serving as directors. Each director, including directors who
are employees of the Company, will receive a fee of $300 for attending each
meeting of the Board of Directors or any committee of the Board of Directors.
Directors will be reimbursed for out-of-pocket expenses incurred in attending
meetings and for other expenses incurred in performing in their capacity as
directors.
ITEM 7. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
George W. Gilman, a director of the Company, is an employee of Gilman
Financial Corporation ("GFC") and the father of Jeffrey L. Gilman, an officer,
director and principal shareholder of GFC. GFC currently owns 34,543 shares of
Common Stock and the Company will issue 137,695 additional shares of Common
Stock for services rendered regarding the transactions contemplated by the Stock
Exchange Agreement pursuant to a Consulting Agreement ("GFC Consulting
Agreement") with GFC. Such services included (i) locating and performing due
diligence upon potential merger or acquisition candidates, (ii) providing advice
regarding the structure of the contemplated transaction and the corporate
structure of the resulting entity and (iii) reviewing the Stock Exchange
Agreement.
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<PAGE>
The Company initially advanced $218,000 to David L. Hatcher in fiscal 1992.
That indebtedness plus advances in subsequent fiscal years is evidenced by an
unsecured promissory note dated July 15, 1994 in the principal amount of
$252,984. The promissory note provides for semimonthly payments of $1,000,
including interest at 6.5% per year, beginning on January 15, 1995. The amount
owing under the promissory note was $260,302 and $267,265 for the fiscal years
ended 1996 and 1995, respectively, and $249,514 as of January 31, 1997.
The Company entered into split dollar life insurance agreements in 1991
with David L. Hatcher and Bobby D. Godfrey respecting life insurance policies.
At the time the policies were obtained, David B. Hatcher II, the son of
David L. Hatcher, was the agent for the insurance company that issued the
policies. According to the split dollar life insurance agreements, the Company
is obligated to pay the entire premium due on the insurance policies and those
payments are treated as advances to the insured. See "Item 6. Executive
Compensation." All advances are to be repaid to the Company out of the proceeds
of the policy or upon termination of the agreements. Premiums totaling $75,000
were paid by the Company in each of fiscal years 1996 and 1995.
The Company's 401(k) Profit-Sharing Plan and its employee health insurance
plan are also provided to the Company by the insurance company employing
David B. Hatcher II. The Company believes that the premiums and other terms of
the split dollar insurance policies, the 401(k) Profit Sharing Plan and its
employee health insurance plan are comparable to those provided by unrelated
insurers.
ITEM 8. 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 9. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Common Stock has been traded on the OTC Bulletin Board of the National
Association of Securities Dealers, Inc. under the trading symbol "KMGB" since
January 28, 1997. In the period from January 28, 1997 to April 21, 1997, the
approximate high and low bid quotations were $6.00 and $3.00 respectively. 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.
23
<PAGE>
As of April 21, 1997, there were 6,862,474 shares of Common Stock issued
and outstanding held by 492 holders of record.
KMG declared and paid dividends of $124,995 in August 1996 and $99,996 in
August 1995. However, the Company anticipates that future earnings will be
retained to finance the continuing development of its business. Accordingly,
the Company does not anticipate paying dividends on the Common Stock in the
foreseeable future.
ITEM 10. RECENT SALES OF UNREGISTERED SECURITIES
Pursuant to the Plan, the Company issued an aggregate of 352,474 shares of
Common Stock to certain of its creditors on various dates in 1996. Such shares
were issued in accordance with Section 1145 under the United States Bankruptcy
Code and the transaction was thus exempt from the registration requirements of
Section 5 of the Securities Act of 1933, as amended (the "Securities Act").
On October 15, 1996, the Company issued to three stockholders of KMG an
aggregate of 6,510,000 shares of Common Stock in exchange for an aggregate of
12,820 shares of common stock of KMG pursuant to the Stock Exchange Agreement.
Such persons were each sophisticated, knowledgeable investors able to bear the
economic risk of an investment in such shares. The Company relied on Section
4(2) of the Securities Act in that such transactions did not involve a public
offering and were thus exempt from the registration requirements of the
Securities Act. No underwriters were used in connection with the foregoing
transaction.
ITEM 11. DESCRIPTION OF SECURITIES
GENERAL
The Company's authorized capital stock consists of 40,000,000 shares of
Common Stock and 10,000,000 shares of preferred stock, par value $.01 per share
(the "Preferred Stock").
COMMON STOCK
Each share of Common Stock entitles the holder thereof to one vote on all
matters on which holders are permitted to vote. No shareholder has any
preemptive right or other similar right to purchase or subscribe for any
additional securities issued by the Company, and no shareholder has any right to
convert Common Stock into other securities. No shares of Common Stock are
subject to redemption or to any sinking fund provisions. All of the outstanding
shares of Common Stock are fully paid and nonassessable.
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<PAGE>
Subject to rights of holders of Preferred Stock, if any, the holders of
shares of Common Stock are entitled to dividends when, as and if declared by the
Board of Directors from funds legally available therefor and, upon liquidation,
to a pro rata share in any distribution to shareholders. The Company does not
anticipate declaring or paying any cash dividends on the Common Stock in the
foreseeable future.
PREFERRED STOCK
Pursuant to the Company's Amended and Restated Articles of Incorporation,
the Board of Directors has the authority, without further shareholder approval,
to provide for the issuance of up to 1,000,000 shares of Preferred Stock in one
or more series and to determine the dividend rights, conversion rights, voting
rights, rights and terms of redemption, liquidation preferences, the number of
shares constituting any such series and the designation of such series. Because
the Board of Directors has the power to establish the preferences and rights of
each series, it may afford the holders of any Preferred Stock preferences,
powers and rights (including voting rights) senior to the rights of the holders
of Common Stock. No shares of Preferred Stock are currently outstanding.
Although the Company has no present intention to issue shares of Preferred
Stock, the issuance of shares of Preferred Stock, or the issuance of rights to
purchase such shares, may have the effect of delaying, deferring or preventing a
change in control of the Company.
CERTAIN OTHER MATTERS
Certain provisions of Texas law, the Amended and Restated Articles of
Incorporation and the Bylaws of the Company are intended to enhance the
likelihood of continuity and stability in the Board of Directors of the Company
and its policies, but might have the effect of delaying or preventing a change
in control of the Company and may make more difficult the removal of incumbent
management even if such transactions could be beneficial to the interest of the
shareholders of the Company.
LIMITATION ON PERSONAL LIABILITY OF DIRECTORS
Article 1302-7.06 of the Texas Miscellaneous Corporation Laws Act (the
"Miscellaneous Laws") authorizes corporations to include a provision in their
articles of incorporation limiting or eliminating the personal liability of
directors to corporations or its shareholders for monetary damages for an act or
omission in the director's capacity as a director. The Amended and Restated
Articles of Incorporation limit the liability of directors to the fullest extent
permitted by the Miscellaneous Laws. Specifically, directors of the Company
shall not be liable except for (a) a breach of the director's duty of loyalty to
the Company or its shareholders; (b) an act or omission not in good faith that
constitutes a breach of duty of the director to the Company or
25
<PAGE>
an act or omission that involves intentional misconduct or a knowing
violation of the law; (c) a transaction from which the director received an
improper benefit, whether or not the benefit resulted from an action taken
within the scope of the director's office; or (d) an act or omission for
which the liability of the director is expressly provided by an applicable
statute. The inclusion of this provision in the Amended and Restated
Articles of Incorporation, may have the effect of reducing the likelihood of
derivative litigation against directors and may discourage or deter
shareholders or management from bringing a lawsuit against directors for
breach of their duty of care, even though such an action, if successful,
might otherwise have benefitted the Company and its shareholders.
BYLAW PROVISIONS AND AMENDMENT OF BYLAWS
The Board of Directors of the Company, acting by a majority of directors
then in office, may fill any vacancy or newly created directorship, provided
that the Board of Directors may not fill more than two such directorships
between successive annual meetings of the shareholders. The Bylaws provide that
a special meeting of the shareholders may be called only by the President, the
Chairman of the Board of Directors, a majority of the Board of Directors or
shareholders owning a majority of all shares entitled to vote at the meeting.
The Amended and Restated Articles of Incorporation provide that the Board of
Directors has the exclusive power to adopt, alter, amend or repeal the Bylaws.
TRANSFER AGENT
The Company's transfer agent is Securities Transfer Corporation, 16910
Dallas Parkway, Suite 100, Dallas, Texas 75248.
ITEM 12. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Article 2.01-1 of the Texas Business Corporation Act (the "TBCA") provides
that a corporation may indemnify any director or officer who was, is or is
threatened to be made a named defendant or respondent in a proceeding because he
is or was a director or officer, provided that the director or officer (i)
conducted himself in good faith, (ii) reasonably believed (a) in the case of
conduct in his official capacity, that his conduct was in the corporation's best
interests or (b) in all other cases, that his conduct was at least not opposed
to the corporation's best interests and (iii) in the case of any criminal
proceeding, had no reasonable cause to believe his conduct was unlawful.
Subject to certain exceptions, a director or officer may not be indemnified if
the person is found liable to the corporation or if the person is found liable
on the basis that he improperly received a personal benefit. Under Texas law,
reasonable expenses incurred by a director or officer may be paid or reimbursed
by the corporation in advance of a final disposition of the proceeding after the
corporation receives a
26
<PAGE>
written affirmation by the director or officer of his good faith belief that
he has met the standard of conduct necessary for indemnification and a
written undertaking by or on behalf of the director or officer to repay the
amount if it is ultimately determined that the director or officer is not
entitled to indemnification by the corporation. Texas law requires a
corporation to indemnify an officer or director against reasonable expenses
incurred in connection with a proceeding in which he is named a defendant or
respondent because he is or was a director or officer if he is wholly
successful in defense of the proceeding.
The Company's Bylaws also provide for indemnification of its officers and
directors, and the advancement to them of expenses in connection with
proceedings and claims, to the fullest extent permitted under the TBCA.
Texas law permits a corporation to purchase and maintain insurance or
another arrangement on behalf of any person who is or was a director or officer
against any liability asserted against him and incurred by him in such a
capacity or arising out of his status as such a person, whether or not the
corporation would have the power to indemnify him against that liability
under Article 2.02-1 of the TBCA. The Company intends to purchase directors'
and officers' liability insurance policies to cover certain liabilities of
directors and officers arising out of claims based on certain acts or
omissions by them in their capacity as directors or officers.
The above discussion of the TBCA and the Bylaws is not intended to be
exhaustive and is qualified in its entirety by such statute and Bylaws,
respectively.
27
<PAGE>
ITEM 13. FINANCIAL STATEMENTS
INDEX TO FINANCIAL STATEMENTS
FINANCIAL STATEMENTS
Page
----
Independent Auditors' Report 29
Consolidated Balance Sheets as of July 31, 1996
and 1995 (Audited) and as of January 31, 1997 (Unaudited) 30
Consolidated Statements of Income for the Years Ended
July 31, 1996 and 1995 (Audited) and for the
six months ended January 31, 1997 and 1996 (Unaudited) 31
Consolidated Statements of Stockholders' Equity
for the Years Ended July 31, 1996
and 1995 (Audited) and for January 31, 1997 (Unaudited) 32
Consolidated Statements of Cash Flows for the
Years Ended July 31, 1996 and 1995 (Audited)
and for the six months ended January 31, 1997
and 1996 (Unaudited) 33
Notes to Consolidated Financial Statements 34-40
28
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
KMG-B, Inc.
We have audited the accompanying consolidated balance sheets of KMG-B, Inc. and
subsidiaries (the "Company") as of July 31, 1996 and 1995, 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, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of KMG-B, Inc. and
subsidiaries as of July 31, 1996 and 1995, 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 20, 1996 (except for Notes 1 and 12
for which the date is April 16, 1997)
29
<PAGE>
KMG-B, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
- - --------------------------------------------------------------------------------
JULY 31,
JANUARY 31, -------------------------
1997 1996 1995
ASSETS (UNAUDITED)
CURRENT ASSETS:
Cash and cash equivalents $ 142,371 $ 552,550 $ 70,232
Investment 89,040 89,040 89,040
Accounts receivable:
Trade 1,797,707 2,212,942 2,285,899
Other 210,997 134,836 74,644
Note receivable - current 57,200 7,200 14,831
Inventories 2,355,474 2,129,790 1,264,800
Prepaid expenses and other assets 63,329 66,103 68,238
Deferred income tax asset 51,515 110,813 68,450
---------- ---------- ----------
Total current assets 4,767,633 5,303,274 3,936,134
PROPERTY, PLANT AND EQUIPMENT -
Net of accumulated depreciation 1,676,085 1,210,915 730,103
NOTE RECEIVABLE, Less current portion 249,514 253,102 264,644
OTHER ASSETS 664,916 632,265 633,427
---------- ---------- ----------
TOTAL $7,358,148 $7,399,556 $5,564,308
---------- ---------- ----------
---------- ---------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 596,908 $1,505,733 $1,306,140
Accrued liabilities 701,979 912,310 531,295
Notes payable 14,944 29,978
Income taxes payable 23,870 80,175 330,243
---------- ---------- ----------
Total current liabilities 1,322,757 2,513,162 2,197,656
LONG-TERM DEBT 921,184
DEFERRED INCOME TAX LIABILITY 110,502
---------- ---------- ----------
Total liabilities 1,322,757 2,513,162 3,229,342
---------- ---------- ----------
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,
6,862,474 shares issued and
outstanding 68,625 68,625 68,625
Additional paid-in capital 999,814 1,185,814 1,185,814
Retained earnings 4,966,952 3,631,955 1,080,527
---------- ---------- ----------
Total stockholders' equity 6,035,391 4,886,394 2,334,966
---------- ---------- ----------
TOTAL $7,358,148 $7,399,556 $5,564,308
---------- ---------- ----------
---------- ---------- ----------
See notes to consolidated financial statements.
30
<PAGE>
KMG-B, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
- - -------------------------------------------------------------------------------
<TABLE>
SIX MONTHS ENDED
JANUARY 31, YEAR ENDED JULY 31,
----------------------- --------------------------
1997 1996 1996 1995
---------- ---------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C>
NET SALES $9,471,767 $9,701,163 $19,801,927 $16,401,205
COST OF SALES 5,512,813 5,700,893 11,529,603 10,876,962
---------- ---------- ----------- -----------
Gross profit 3,958,954 4,000,270 8,272,324 5,524,243
SELLING, GENERAL AND
ADMINISTRATIVE EXPENSES 1,634,356 1,815,362 4,005,742 3,032,564
---------- ---------- ----------- -----------
Operating income 2,324,598 2,184,908 4,266,582 2,491,679
OTHER INCOME (EXPENSE):
Interest income 21,489 15,784 38,689 26,031
Interest expense (282) (27,076) (30,779) (190,823)
Other 5,814 (23,634) (89,463) (41,466)
---------- ---------- ----------- -----------
Total other income (expense) 27,021 (34,926) (81,553) (206,258)
---------- ---------- ----------- -----------
INCOME BEFORE INCOME TAXES 2,351,619 2,149,982 4,185,029 2,285,421
PROVISION FOR INCOME TAXES (891,627) (724,263) (1,533,605) (811,466)
---------- ---------- ----------- -----------
NET INCOME $1,459,992 $1,425,719 $ 2,651,424 $ 1,473,955
---------- ---------- ----------- -----------
---------- ---------- ----------- -----------
NET INCOME PER SHARE $ 0.21 $ 0.21 $ 0.39 $ 0.21
---------- ---------- ----------- -----------
---------- ---------- ----------- -----------
WEIGHTED AVERAGE SHARES
OUTSTANDING 6,862,474 6,862,474 6,862,474 6,862,474
---------- ---------- ----------- -----------
---------- ---------- ----------- -----------
</TABLE>
See notes to consolidated financial statements.
31
<PAGE>
KMG-B, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
- - -------------------------------------------------------------------------------
<TABLE>
COMMON STOCK
------------------- ADDITIONAL TOTAL
SHARES PAR PAID-IN RETAINED TOCKHOLDERS'
ISSUED VALUE CAPITAL EARNINGS EQUITY
--------- ------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
BALANCE AT
AUGUST 1, 1994 6,862,474 $68,625 $1,185,814 $ (80,547) $1,173,892
Effect of merger (312,881) (312,881)
Net income 1,473,955 1,473,955
--------- ------- ---------- ---------- ----------
BALANCE AT
JULY 31, 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 (unaudited) (124,995) (124,995)
Stock registration costs
(unaudited) (186,000) (186,000)
Net income (unaudited) 1,459,992 1,459,992
--------- ------- ---------- ---------- ----------
BALANCE AT
JANUARY 31, 1997
(unaudited) 6,862,474 $68,625 $ 999,814 $4,966,952 $6,035,391
--------- ------- ---------- ---------- ----------
--------- ------- ---------- ---------- ----------
</TABLE>
See notes to consolidated financial statements.
32
<PAGE>
KMG-B, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
- - ------------------------------------------------------------------------------
<TABLE>
SIX MONTHS ENDED
JANUARY 31, YEAR ENDED JULY 31,
--------------------------- ----------------------------
1997 1996 1996 1995
------------ ------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,459,992 $ 1,425,719 $ 2,651,424 $ 1,473,955
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 138,838 199,137 416,371 341,553
Loss on sale of equipment 166,043
Deferred income tax (benefit) provision 58,509 (66,069) (160,090) (88,555)
Changes in operating assets and liabilities:
Accounts receivable - trade 415,235 116,694 72,957 (598,272)
Accounts receivable - other (76,161) 9,765 (60,192) 2,463
Inventories (225,684) 20,232 (864,990) 110,738
Prepaid expenses and other assets 2,774 (5,270) 2,135 (113,635)
Accounts payable (908,825) (135,046) 199,593 (1,008,625)
Accrued liabilities (210,331) (205,141) 381,015 506,218
Income taxes payable (56,305) (330,822) (250,068) 329,521
------------ ------------ ------------ ------------
Net cash provided by operating activities 598,042 1,029,199 2,388,155 1,121,404
------------ ------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equipment (590,605) (97,957) (824,212) (210,586)
Proceeds from the sale of equipment 150,000
Collection (additions to) of notes receivable (46,412) 5,453 19,173 10,492
Additions to investment (50,000)
Additions to other assets (45,265) (34,664) (64,584) (74,997)
------------ ------------ ------------ ------------
Net cash used in investing activities (682,282) (127,168) (869,623) (175,091)
------------ ------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from notes payable 18,571
Net payments on line of credit (837,711) (921,184) (823,465)
Payment of dividends (124,995) (99,996) (99,996)
Principal payments on borrowings (14,944) (3,679) (15,034) (130,819)
Stock registration costs (186,000)
------------ ------------ ------------ ------------
Net cash used in financing activities (325,939) (941,386) (1,036,214) (935,713)
------------ ------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS (410,179) (39,355) 482,318 10,600
CASH AND CASH EQUIVALENTS AT BEGINNING
OF YEAR 552,550 70,232 70,232 59,632
------------ ------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 142,371 $ 30,877 $ 552,550 $ 70,232
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
SUPPLEMENTAL DISCLOSURES FOR CASH FLOW
INFORMATION:
Cash paid during the year for interest $ 282 $ 27,075 $ 30,779 $ 190,823
Cash paid during the year for income taxes $ 889,425 $ 1,121,155 $ 1,943,763 $ 570,500
</TABLE>
See notes to consolidated financial statements.
33
<PAGE>
KMG-B, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - -------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
GENERAL - KMG-B, Inc. ("KMG-B") was incorporated in the state of Texas in
1992 under the name Water Point Manufacturing, Inc. as a wholly owned
subsidiary of Water Point Systems, Inc. ("Water Point"), a Texas
corporation. Water Point was engaged in the business of selling water
filtration systems for home and office use and designing, constructing and
distributing water-vending machines.
Water Point and KMG-B each filed a petition under Chapter 11 of the United
States Bankruptcy Court during March and June of 1995, respectively.
During 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. The Plan provided for the
vesting of all assets of Water Point and KMG-B in a liquidation trust for
the benefit of secured, priority and unsecured creditors. With respect to
KMG-B, 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. According to the Plan, KMG-B was discharged from any and all
debts and liabilities that arose prior to October 23, 1996.
Following the Chapter 11 reorganization, KMG-B'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. In order to further its initial
business purpose, 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-Bernuth, Inc. ("KMG") in a transaction that has been accounted for as a
reverse merger. 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 the bankruptcy discharge.
Prior to the transaction, KMG-B had no significant assets, liabilities or
operations. The transaction between KMG-B and KMG provided KMG-B with a
viable business enterprise and allowed KMG to became a public Company
without going through an initial public offering. As KMG-B adopted "fresh-
start" accounting as of the October 23, 1996 bankruptcy discharge date, the
historical results of KMG have become the historical results of KMG-B.
KMG is involved in the manufacture and distribution of wood treatment
products. KMG and its 96% owned subsidiary, Products de Preservation, S.A.
de C.V., a Mexican corporation, operate a pentachlorophenol ("penta")
production plant. The penta plant began operations in March 1986 and has
operated as a maquiladora in Matamoros, Mexico, since that date. 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.
A summary of the significant accounting policies applied in the preparation
of the accompanying financial statements follows:
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include
the accounts of KMG-B, KMG, PPSA and a wholly-owned inactive subsidiary
(collectively, the "Company"). All significant intercompany accounts and
transactions have been eliminated in consolidation.
34
<PAGE>
In the opinion of management, the unaudited consolidated financial
statements of the Company include all adjustments (consisting solely of
normal recurring adjustments) necessary for a fair presentation of its
financial position as of January 31, 1997, and the results of its
operations, its cash flows and changes in stockholders equity for each of
the six-month periods ended January 31, 1997 and 1996. Although management
believes the disclosures in the financial statements are adequate to make
the information presented not misleading, certain information and footnote
disclosures normally included in annual financial statements prepared in
accordance with generally accepted accounting principles have been
condensed or omitted pursuant to the rules and regulations of the
Securities and Exchange Commission. The results of operations and cash
flows for the six-month period ended January 31, 1997 are not necessarily
indicative of the results to be expected for the full year.
CASH AND CASH EQUIVALENTS - The Company considers all investments with
original maturities of three months or less to be cash equivalents.
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 $272,639
and $279,370 in 1996 and 1995, respectively. The estimated useful lives of
classes of assets are:
ASSET DESCRIPTION LIFE (YEARS)
Leasehold improvements 5 to 8
Office and laboratory equipment 5
Plant and production equipment 5 to 10
Transportation equipment 3
INCOME TAXES - Deferred income taxes are provided on 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.
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. The Company has not completed its
evaluation of the impact, if any, on the future adoption of this Statement.
35
<PAGE>
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 approximate fair value because of the relatively
short maturity of these instruments. It was not practicable to estimate
the fair value of the Company's investment since it is in an untraded
closely held entity. The notes receivable, including the current portion,
are of a related-party nature and it is not practicable to estimate the
fair value.
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. The
Company places its cash investments with high quality financial
institutions and limits the amount of credit exposure to any one
institution. 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:
1996 1995
Chemical raw materials and supplies $ 195,565 $ 117,137
Finished chemical products 1,934,225 1,147,663
---------- ----------
Total $2,129,790 $1,264,800
---------- ----------
---------- ----------
3. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment and related accumulated depreciation are
summarized as follows:
1996 1995
Plant and production equipment $ 2,321,727 $ 2,018,427
Transportation equipment 191,025 244,041
Office and laboratory equipment 171,835 226,778
Leasehold improvements 338,404 418,065
Construction-in-progress (see Note 8) 427,958
----------- -----------
3,450,949 2,907,311
Less - accumulated depreciation (2,240,034) (2,177,208)
----------- -----------
Total $ 1,210,915 $ 730,103
----------- -----------
----------- -----------
36
<PAGE>
4. FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS
Monetary assets and liabilities are translated to U.S. dollars at current
rates and certain assets (notably plant and production equipment) are
translated at historical rates. Income and expense items for PPSA are
translated at average monthly rates of exchange except for depreciation and
amortization expense. All gains and losses from currency translation for
PPSA are included in operations. Foreign currency translation resulted in
an aggregate exchange gain of $20,666 and $62,270 in 1996 and 1995,
respectively.
5. INCOME TAXES
The provision (benefit) for income taxes consists of the following:
1996 1995
Current federal provision $1,557,011 $827,312
Current state provision 136,684 72,709
Deferred income tax benefit (160,090) (88,555)
---------- --------
Total $1,533,605 $811,466
---------- --------
---------- --------
During 1995, the Company utilized approximately $160,000 of net operating
loss carryforwards to offset current tax expenses. As of July 31, 1995,
there was no net operating loss carryforward available to offset future
taxable income.
Deferred income taxes are provided for temporary differences between the
financial statement carrying amount of existing assets and liabilities and
their respective tax basis. 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 (indicated in other
assets). As of July 31, 1995, deferred income taxes relating to temporary
differences consisted of $68,450 of current deferred tax assets and
$110,502 of noncurrent deferred tax liabilities. No valuation allowance
was required as of July 31, 1996 or 1995.
6. OTHER ASSETS
Other assets consist of the following:
1996 1995
Advances for premiums on employee-owned
life insurance policies (see Note 9) $354,023 $279,024
Licensing agreement, net of accumulated
amortization of $63,452 on July 31, 1996
and $39,524 on July 31, 1995 256,548 280,476
Loan costs, net of accumulated amortization
of $58,097 on July 31, 1995 48,403
Other 21,694 25,524
-------- --------
Total $632,265 $633,427
-------- --------
-------- --------
37
<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 will be due monthly at the base rate
designated by the bank (8.25% at August 1, 1996). The line of credit is
subject to a 1/4% unused line fee. Principal is due on November 30, 1997.
The line of credit 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.
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,
1996, the Company was obligated under these leases for the following future
minimum lease commitments:
YEAR ENDING JULY 31, AMOUNT
1997 $150,000
1998 150,000
1999 112,218
2000 65,756
2001 9,670
--------
Total $487,644
--------
--------
Rent expense relating to the operating leases was $253,713 for the year
ended July 31, 1996 and $258,299 for the year ended July 31, 1995.
MANUFACTURING FACILITY - The Company is in the process of moving its
manufacturing facility to a new location in Matamoros, Mexico. In
connection with the move, the Company has entered into various agreements
and commitments. Management estimates that the total costs related to the
move will be approximately $1.4 million and that the new plant will be
operational by May 1997.
38
<PAGE>
CONTINGENCIES
ENVIRONMENTAL - As a manufacturer and supplier of wood treatment products,
the Company is subject to a variety of federal health, safety and
environmental laws. The federal government 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 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
$525,000 in fiscal year 1996 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.
Management anticipates that the balance of the required testing will be
completed during 1998. Since the EPA has 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 not exceed $1,000,000 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 a
noncurrent asset. 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, 1996 and 1995, $260,302
and $267,265, respectively, was outstanding under this note.
See "Related-Party Transaction" discussed in Note 12.
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 $22,000 and $15,000 in fiscal years 1996
and 1995, respectively.
39
<PAGE>
11. SIGNIFICANT CUSTOMERS
The Company had one significant customer in 1996 and 1995 whose sales as a
percentage of total sales were 9.8% and 10%, respectively.
12. SUBSEQUENT EVENTS
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 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.
As of November 27, 1996, an option to purchase 43,671 shares of common
stock had been granted under the Plan, with no part of the option exercised
or exercisable. The option will become fully vested on July 31, 1997 at an
exercise price of $.216 per share and will be accounted for under the
provisions of APB No. 25.
RELATED-PARTY TRANSACTION - 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. Under the terms of the Consulting Agreement, the Company
is obligated to issue 137,695 shares of its common stock for services
rendered regarding the stock exchange agreement, referred to above, and
other related matters. The number of shares to be issued is valued at
$100,000, based on the estimated fair value of the services provided;
however, issuance of the shares is contingent on the completion of the
stock exchange agreement.
******
40
<PAGE>
ITEM 14. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
ITEM 15. FINANCIAL STATEMENTS AND EXHIBITS
(a) The financial statements filed as part of this Registration Statement in
Item 13 are listed in the Index to Financial Statements contained in such
Item.
(b) The following documents are filed as exhibits to this Registration
Statement:
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. *
21.1 Subsidiaries of the Company. *
27.1 Financial Data Schedule.
Documents marked by an (*) were filed on December 6, 1996 by the Company as part
of its registration statement, file number 000-21839.
41
<PAGE>
SIGNATURES
In accordance with Section 12 of the Securities Act of 1934, the Company
caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized.
KMG-B, INC.
By: /s/ DAVID L. HATCHER Date: April 23, 1997
--------------------------------
David L. Hatcher, President
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM AS OF
AND FOR THE SIX MONTHS PERIOD ENDED JANUARY 31, 1997 AND THE YEAR ENDED
JULY 31, 1996, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<S> <C> <C>
<PERIOD-TYPE> 6-MOS YEAR
<FISCAL-YEAR-END> JUL-31-1996 JUL-31-1996
<PERIOD-START> AUG-01-1996 AUG-01-1995
<PERIOD-END> JAN-31-1997 JUL-31-1996
<CASH> 142,371 552,550
<SECURITIES> 89,040 89,040
<RECEIVABLES> 2,065,267 2,354,978
<ALLOWANCES> 0 0
<INVENTORY> 2,355,474 2,129,790
<CURRENT-ASSETS> 4,767,633 5,303,274
<PP&E> 3,653,884 3,450,949
<DEPRECIATION> (1,977,800) (2,240,034)
<TOTAL-ASSETS> 7,358,148 7,399,556
<CURRENT-LIABILITIES> 1,322,757 2,513,162
<BONDS> 0 0
0 0
0 0
<COMMON> 68,625 68,625
<OTHER-SE> 5,966,766 4,817,769
<TOTAL-LIABILITY-AND-EQUITY> 7,358,148 7,399,556
<SALES> 9,471,767 19,801,927
<TOTAL-REVENUES> 9,471,767 19,801,927
<CGS> 5,512,813 11,529,603
<TOTAL-COSTS> 5,512,813 11,529,603
<OTHER-EXPENSES> 1,634,356 4,005,742
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 282 30,779
<INCOME-PRETAX> 2,351,619 4,185,029
<INCOME-TAX> 891,627 1,533,605
<INCOME-CONTINUING> 1,459,992 2,651,424
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 1,459,992 2,651,424
<EPS-PRIMARY> 0.21 0.39
<EPS-DILUTED> 0 0
</TABLE>
