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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
/X/ ANNUAL REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended July 31, 1998
/ / TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission file number 000-21839
KMG CHEMICALS, INC.
(FORMERLY KMG-B, INC.)
(Name of Small Business Issuer in its charter)
TEXAS 75-2640529
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10611 HARWIN DRIVE, SUITE 402
HOUSTON, TEXAS 77036
(Address of principal executive offices)
(713) 988-9252
(Issuer's telephone number)
SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT:
<TABLE>
<CAPTION>
Title of Each Class Name of each Exchange on which Registered
<S> <C>
None None
- ---------------------------- -----------------------------------------
</TABLE>
SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:
Common Stock, $.01 par value
(Title of Class)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. /X/ Yes / / No
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Check if there is no disclosure of delinquent filers in response to Item 405
of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-KSB or any amendment to this Form 10-KSB. /X/
Issuer's revenues for its most recent fiscal year: $ 22,657,208
The aggregate market value of the voting stock held by non-affiliates
computed by reference to sales of such stock as of September 1, 1998 was
$2,580,845.
(ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS
DURING THE PAST FIVE YEARS)
Check whether the issuer has filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution
of securities under a plan confirmed by a court. Yes /X/ No / /
DOCUMENTS INCORPORATED BY REFERENCE
The proxy statement pertaining to the 1998 annual meeting of shareholders is
incorporated by reference in Part III of this report.
APPLICABLE ONLY TO CORPORATE ISSUERS
The number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date were: 7,000,169 shares of Common
Stock
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
THE COMPANY
GENERAL
KMG Chemicals, Inc., a Texas corporation (the "Company"), was
incorporated in the State of Texas in 1992 under the name Water Point
Manufacturing, Inc. to manufacture water filtration systems. In connection
with the acquisition in 1996 of KMG-Bernuth, Inc., a Delaware corporation
("KMG"), the Company changed its name to KMG-B, Inc. Effective December 11,
1997, the Company changed its name to KMG Chemicals, Inc. 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.
The Company's original water filtration systems business was
unsuccessful and the Company filed a petition under Chapter 11 of the United
States Bankruptcy Code in June 1995. Under a plan of reorganization
confirmed by the bankruptcy court, all the assets of the Company vested in a
liquidating trust for distribution to creditors, the outstanding capital
stock was canceled and the reorganized Company then issued shares of its
common stock, par value $.01 per share (the "Common Stock"), to certain of
its creditors and a post-petition lender. The Company was discharged
effective October 23, 1996.
ACQUISITION OF KMG-BERNUTH, INC.
After the bankruptcy the Company had no significant assets or operations
and its business purpose was to seek an acquisition or merger transaction
with an operating business with growth potential. On October 15, 1996 the
Company acquired all of the issued and outstanding stock of KMG in exchange
for 6,510,000 shares of the Common Stock of the Company. After giving effect
to a 1 for 1.5 reverse split of Common Stock outstanding immediately prior to
the acquisition of KMG, the former stockholders of KMG became owners of
approximately 93% of the issued and outstanding shares of Common Stock. See
"Item 11. Security Ownership of Certain Beneficial Owners and Management."
Unless the context otherwise requires, references hereinafter to the
"Company" shall mean KMG Chemicals, Inc. and any of its subsidiaries. All
references hereinafter to share amounts reflect the reverse split of Common
Stock.
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BUSINESS OF THE COMPANY
GENERAL
The Company manufactures, markets and distributes specialty, niche
chemicals. At the present time, the Company manufactures, markets and
distributes three wood preserving chemicals, pentachlorophenol ("penta"),
creosote and sodium pentachlorophenate ("sodium penta"), to industrial
customers engaged in the wood preserving business. The Company's customers
use these preservatives to treat wood and supply the treated wood products to
end-users in a variety of industries, principally the railroad, utility and
construction industries.
The Company acquired a penta manufacturing and distribution business in
1988 from an affiliated company that had been engaged in the penta business
since the early 1970's. The Company made several acquisitions after 1988 to
expand its wood preserving product lines and distribution network. It
acquired a creosote distribution business in early 1991 and a sodium penta
distribution business late that same year. In 1998, the Company acquired
from AlliedSignal, Inc. ("AlliedSignal") certain assets pertaining to the
sale of creosote and entered into a long-term creosote supply contract with
that firm.
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 while creosote
is used for railroad cross-ties, bridge timbers and utility poles and CCA is
used for utility poles and lumber. Industry
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statistics indicate that wood preserving chemicals were used in the United
States to treat approximately 600 million cubic feet of wood in 1997 and also
in 1996. Penta was used to treat approximately 6% of the wood in each of
those years while creosote was used to treat approximately 15% and CCA was
used to treat approximately 79%. 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 five companies providing creosote to the
United States market. The Company is also one of the few companies that
supplies sodium penta, a wood preserving product used primarily to treat
freshly-cut lumber, to customers outside the United States. See
"-Competition."
PRODUCTS AND SERVICES
PENTACHLOROPHENOL AND SODIUM PENTACHLOROPHENATE. Penta is formed
through the reaction of phenol with chlorine. The Company manufactures penta
in Matamoros, Mexico through KMG's subsidiary, KMG de Mexico, S.A. de C.V.
("KMEX."), formerly known as Productos de Preservation, S.A. de C.V., a
Mexican maquiladora corporation that began operations in 1986. The Company
arranges for the required phenol and chlorine to be supplied to KMEX., which
in turn sells the penta it produces to the Company for sale and distribution
to the Company's customers. As a by-product of the penta manufacturing
process, the Matamoros facility also produces hydrochloric acid which is sold
to distributors for use in the steel and oil well service industries in the
United States and Mexico.
The Matamoros facility produces both solid penta blocks and penta
flakes. Those penta products are sold by the Company to its customers or made
into a liquid solution of penta concentrate at the Matamoros facility or at
the Company's blending and distribution facility in Tuscaloosa, Alabama. The
penta blocks, flakes and solutions are sold to the Company's customers in the
United States, primarily in Washington, Oregon, Oklahoma, Missouri, Arkansas,
Mississippi, Alabama and Georgia. In addition, a portion of the flaked penta
is reacted with caustic soda to produce sodium penta. The Company sells the
sodium penta, which is not registered for use in the United States, to
customers primarily in France, Spain, Portugal, England, Chile, Peru,
Ecuador, Venezuela, Brazil and Malaysia.
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CREOSOTE. Creosote is produced by the distillation of coal tar, a
by-product of the transformation of coal into coke. The Company has two
primary sources of supply for the creosote it sells in the United States --
AlliedSignal and VfT AG ("VfT"), a German corporation. The Company believes
that AlliedSignal and VfT are among the world's largest manufacturers of
creosote and other coal tar products. AlliedSignal ships creosote from three
locations in the United States and VfT ships from Europe to a public storage
facility located in New Orleans, Louisiana. The creosote is sold by the
Company to customers in Texas and the Midwestern and Southeastern United
States.
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 suppliers of those raw materials, 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.
The creosote sold by the Company is supplied primarily by either
AlliedSignal or VfT. The Company entered into a creosote supply contract
with AlliedSignal in 1998. The supply contract has an initial term ending in
2008 and thereafter may be renewed annually. Under the supply contract, the
Company will purchase all of AlliedSignal's creosote production, subject to
annual maximum and minimum quantities, at varying prices per gallon. During
the initial term, the annual maximum quantity is approximately 138 million
pounds. If AlliedSignal's actual production exceeds the maximum, the Company
has the option to purchase that additional production.
The Company's creosote 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
Environmental Protection Agency ("EPA") and certain industry trade groups.
The agreement terminates at the end of calendar 1999 but the parties are
currently negotiating a modified agreement that would extend the term of the
contract. While the Company believes that an agreement can be negotiated
with VfT on acceptable terms, there can be no assurance
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that the Company will be able to successfully conclude such an agreement or
locate an alternative source of supply if a new agreement is not concluded.
If the Company and VfT do not enter into a modified contract for the period
after calendar 1999, there can be no assurance that the Company will be able
to obtain a suitable alternative source of supply. The Company believes that
the failure to obtain a suitable alternative source of supply would have a
material adverse effect upon its business, financial condition and results of
operations.
CUSTOMERS
The Company sells its products to approximately 90 customers on a
regular basis. One customer, Texas Electric Cooperatives, Inc., accounted
for approximately 12% of the Company's revenues in fiscal 1998 and 11% in
fiscal 1997. A second customer, Cahaba Wood Preserving Co., accounted for
approximately 10% of the Company's revenues in fiscal 1997.
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 companies for
those producers in over 20 countries.
COMPETITION
The Company is one of only two companies producing penta for sale in the
United States. The Company believes that it currently supplies approximately
35% of the penta sold in the United States. The other penta producer in the
United States is Vulcan Chemicals, Inc. It is headquartered in Birmingham,
Alabama and produces penta at its facility in Wichita, Kansas. The Company
believes that Vulcan Chemicals, Inc. has larger sales volumes and greater
financial and other resources than the Company. The Company competes
internationally with suppliers from Mexico, China and India.
The Company believes that there are four firms that compete with it in
creosote sales in the United States. The Company's principal competitor is
Koppers Industries, Inc. located in Pittsburgh, Pennsylvania. The Company
believes that firm has larger sales volumes and greater financial and other
resources than the Company. The Company believes that it currently supplies
approximately one third of the creosote sold in the United States.
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The Company does not supply CCA, the most widely-used wood preservative.
The Company believes that there are three suppliers of CCA in the United
States, Hickson Corporation, Chemical Specialties, Inc. and Osmose Wood
Preserving, Inc. Each of those companies has larger sales volume and greater
financial resources than the Company.
Penta and creosote are pesticides that must be registered prior to sale
under United States law. See "-Environmental and Safety Matters-Licenses,
Permits and Product Registrations." As a condition to registration, any
company wishing to manufacture and sell penta or creosote must provide to the
EPA substantial scientific research and testing data regarding the chemistry
and toxicology of the products. That data must be generated by the applicant
or the applicant must compensate other data providers for relying on their
information. The Company believes that the cost of satisfying the data
submission requirement serves as an impediment to the entry of new
competitors in the United States market, particularly those with lesser
financial resources. While the Company has no reason to believe that the
registration requirement will be discontinued or materially modified, there
can be no assurances as to the effect of such a discontinuation or
modification on the Company's competitive position.
The Company believes that its ability to compete effectively is
dependent upon providing its products at competitive prices, anticipating new
markets and distribution channels for its products and maintaining a strong
commitment to product quality and customer service.
EMPLOYEES
As of the end of fiscal 1998, the Company had a total of 76 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, 59 were
employed at the Matamoros facility, seven were employed at the Tuscaloosa
facility and one was employed in Louisiana. None of the employees in the
United States are represented by a labor union but 36 of KMEX'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
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regulations, and violators may be subject to fines, injunctions or both. The
Company believes that it is currently in substantial compliance with all such
applicable laws and regulations. The Company must devote substantial
financial resources to ensure such compliance. For a discussion of the
Company's expenditures regarding environmental matters, see "Item 6.
Management's Discussion and Analysis of Financial Condition and Results of
Operations-Liquidity and Capital Resources."
The Company anticipates that the regulation of its business operations
under federal, state and local environmental regulations in the United States
and abroad will increase over time. The Company cannot at this time estimate
the impact of increased regulation on the Company's operations, future
capital expenditure requirements or the cost of compliance.
UNITED STATES REGULATION. Under the Comprehensive Environmental
Response, Compensation and Liability Act of 1980, as amended ("CERCLA") and
comparable state laws, an owner or operator of property from which releases
of hazardous substances have occurred may be liable for investigation and
remediation of any resulting contamination. In addition, the generator of
hazardous substances may be responsible for all or a portion of any required
investigation or remediation at offsite disposal locations. Under the
Resource Conservation and Recovery Act, as amended ("RCRA"), a facility that
treats, stores or disposes of hazardous wastes on-site may be liable for
corrective action costs. In addition to CERCLA and RCRA, state laws and
regulations may impose the same or broader liability.
The Company's operations also are governed by laws and regulations
relating to workplace safety and worker health, principally the Occupational
Safety and Health Act and the regulations thereunder.
MEXICO REGULATION. The Company's Matamoros facility and its operations
in Mexico are subject to various environmental laws, regulations and
ordinances promulgated by governmental authorities in Mexico. The
Secretariat of Environment, Natural Resources and Fisheries (SECRETARIATE DE
MEDIO AMBIENTE, RECURSOS NATURALES Y PESCA: "SEMARNAP") is given overall
responsibility for environmental regulation in Mexico. SEMARNAP's
responsibilities include enforcement of Mexico's laws and regulations
concerning air and water emissions and hazardous waste treatment, 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
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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 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 research and
testing costs pertaining to penta based on its market share. The Company
incurred expenses of approximately $331 thousand and $198 thousand in
connection with the FIFRA research and testing program in fiscal 1998 and
fiscal 1997, respectively. A similar industry group funds a creosote
research and testing program. In the past the cost of that program has been
borne by VfT. Because the Company acquired AlliedSignal's creosote
registrations under FIFRA in July 1998, the Company will be responsible for a
share of creosote research and testing costs.
ITEM 2. DESCRIPTION OF PROPERTY
Set forth below is information with respect to certain of the Company's
properties.
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<CAPTION>
LEASE
APPROXIMATE OWNED/ EXPIRATION
LOCATION PRIMARY USE SIZE LEASED DATE
-------- ----------- ------------ ------ ----------
<S> <C> <C> <C> <C>
Houston, Texas Corporate Office 8,500 square Leased March 31,
feet 2001
Matamoros, Mexico Manufacturing 7 acres Owned
Tuscaloosa, Alabama Processing 1.5 acres Owned
Distribution
</TABLE>
In fiscal 1998 the Company purchased the Tuscaloosa, Alabama facility it
had been leasing for approximately $169 thousand. The Company believes that
all of these properties are adequately insured, in good condition and
suitable for their anticipated future use. The Company believes that if the
lease for its corporate office were not renewed or were terminated, other
suitable facilities could be leased or purchased.
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ITEM 3. LEGAL PROCEEDINGS
The Company is a not a party to any legal actions or proceedings that it
believes will have a material adverse effect on its business, results of
operations or financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted during the fourth quarter of fiscal 1998 to a
vote of security holders through the solicitation of proxies or otherwise.
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Common Stock was traded under the trading symbol "KMGB" on the OTC
Bulletin Board of the National Association of Securities Dealers, Inc. from
January 28, 1997 to June 2, 1997 and on The Nasdaq SmallCap Market since that
date. The approximate high and low bid quotations in fiscal 1998 were as
follows:
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Period: High Low
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January 28 - January 31, 1997 $ 5.00 $ 5.00
Third quarter fiscal 1997 6.00 3.00
Fourth quarter fiscal 1997 4.50 2.88
First quarter fiscal 1998 5.25 4.125
Second quarter fiscal 1998 5.50 4.75
Third quarter fiscal 1998 5.25 4.00
Fourth quarter fiscal 1998 5.50 4.50
</TABLE>
Such quotations represent prices between dealers, do not include retail
markups, markdowns or commissions and may not represent actual transactions.
The quotations are based on information reported by the National Association
of Securities Dealers, Inc.
As of September 30, 1998, there were 7,000,169 shares of Common Stock
issued and outstanding held by 606 holders of record.
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KMG declared dividends of $140,004 in July 1998 that were paid in
August, 1998 and declared and paid dividends of $140,003 in September 1997.
The Company anticipates that future earnings will be retained to finance the
continuing development of its business. Accordingly, the Company does not
anticipate paying substantial dividends on the Common Stock in the
foreseeable future.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS.
RESULTS OF OPERATIONS
The following table sets forth the Company's net sales and certain other
financial data, including the amount of the change between the twelve month
periods ended July 31, 1998 and July 31, 1997:
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<CAPTION>
Twelve Months Ended Increase/
------------------------- (Decrease)
1998 1997
------------------------- ----------
<S> <C> <C> <C>
Net sales. . . . . . . . . . . . . . . . . . . $22,657,208 $19,485,035 $3,172,173
Gross profit . . . . . . . . . . . . . . . . . 8,573,956 8,219,335 354,621
Gross profit as percent of Net Sales . . . . . 38% 42%
Selling, general and administrative expense. . 3,917,205 3,911,452 5,753
Operating income . . . . . . . . . . . . . . . 4,656,751 4,307,883 348,868
Other income (expense), net. . . . . . . . . . 514,028 62,214 451,814
Income before taxes. . . . . . . . . . . . . . 5,170,779 4,370,097 800,682
Provision for income taxes . . . . . . . . . . (1,964,901) (1,660,637) 304,264
Net income . . . . . . . . . . . . . . . . . . $3,205,878 $2,709,460 $496,418
</TABLE>
SALES REVENUE
Net operating revenues for fiscal 1998 were approximately $22.7 million,
almost $3.2 million (16%) more than fiscal 1997. Approximately 40% of that
increase was due to higher revenue from pentachlorophenol-based products
(including hydrochloric acid) while nearly 60% was attributable to greater
creosote revenues. In both cases, the revenue increase was almost entirely
due to increased volume.
The impact of the Company's long-term creosote supply contract with
AlliedSignal has been significant. AlliedSignal began selling its entire
creosote output to the Company in July 1998 and the Company became the
supplier of creosote to
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AlliedSignal's former customers. The Company's creosote sales volume for
July 1998 was more than three times greater than in the same month in fiscal
1997. Management believes that the additional creosote purchased under the
AlliedSignal contract will add approximately $14 million in sales revenue in
fiscal 1999.
GROSS PROFIT
Gross profit as a percentage of net operating revenue declined to 38%
for fiscal 1998 as compared to 42% in fiscal 1997. The percentage decline
was primarily due to significant revenue increases in lower margin products
(creosote and hydrochloric acid) in fiscal 1998. Despite this downward shift
in average margins, the Company's overall gross profit rose by $355 thousand
for the fiscal year on increased volume.
SELLING, DISTRIBUTION, GENERAL AND ADMINISTRATIVE EXPENSES
Aggregate selling, distribution, general and administrative expenses
were unchanged in fiscal 1998 as compared with fiscal 1997.
According to FIFRA, the environmental statute under which penta is
registered for sale in the United States, the Company is obligated to provide
the EPA with test data concerning the chemistry and toxicology of penta. The
Company expensed approximately $331 thousand for penta testing costs in
fiscal 1998 and approximately $198 thousand in fiscal 1997. With the
acquisition in the fourth quarter of fiscal 1998 of creosote registrations
under FIFRA from AlliedSignal, the Company became responsible for a share of
creosote research and testing costs. The Company expects to continue to incur
and expense additional costs for penta and creosote testing under FIFRA of
approximately $300 thousand in each of the next two fiscal years, although
there can be no assurance that actual costs will not exceed current estimates.
OTHER INCOME
The Company sold approximately 28,000 shares of Sterling Bancshares
stock in fiscal 1998 for $433 thousand and recognized a gain on that sale of
$343 thousand.
LIQUIDITY AND CAPITAL RESOURCES
As of July 31, 1998 the Company had cash and cash equivalents of
approximately $2.2 million as compared with approximately $2.6 million as of
July 31, 1997. Net cash provided by operations during fiscal 1998 was
approximately $3.1 million as compared with approximately $3.4 million for
fiscal 1997. Net cash
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was also significantly affected during fiscal 1998 by $433 thousand received
from the sale of Sterling Bancshares stock, dividend payments of $140
thousand, increases of $1.3 million in trade receivables and $1.9 in accounts
payable, and by capital expenditures of approximately $820 thousand.
The Company's sources of capital have traditionally been externally
generated or from commercial borrowings. The Company's cash needs are
primarily for capital expenditures for maintenance of its property, plant and
equipment. The Company believes that its cash flows from operations and
available borrowing under its Revolving Credit Facility (hereinafter defined)
will be sufficient to fund its anticipated cash requirements in fiscal 1999.
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.
In August 1996 the Company's wholly-owned subsidiary, KMG, obtained a
working capital line of credit by entering into a Revolving Loan Agreement
(as amended from time to time, the "Revolving Credit Facility") with
SouthTrust Bank of Alabama, National Association ("SouthTrust"). Under the
Revolving Credit Facility, the Company may borrow up to the lesser of $2.5
million or a borrowing base (as defined therein). The Revolving Credit
Facility contains various representations and warranties and affirmative and
negative covenants applicable to KMG, including a limitation that equity
investments or loans by the KMG not exceed $250 thousand (other than funds
to KMEX for the relocation of its Matamoros facility in fiscal 1997) and a
requirement to obtain the lender's consent prior to replacing the President
and chairman of the board of directors of KMG, David L. Hatcher, or any
merger, reorganization or recapitalization of KMG. In addition, the
Revolving Credit Facility requires KMG to maintain (i) a tangible net worth
(as defined therein) of not less than $2.5 million in fiscal 2000 and $5.0
million thereafter, (ii) a fixed charge coverage ratio of at least 1.25 to
1.0 beginning at the end of fiscal 1999, and (iii) a ratio of liabilities to
tangible net worth of not more than 3.5 to 1.0 beginning at the end of fiscal
1999 and not more than 2.0 to 1.0 beginning at the end of fiscal 2000. The
Company has had almost no borrowing against its Revolving Credit Facility
since inception. As of
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September 30, 1998 the Company's borrowing base under the Revolving Credit
Facility was $2.5 million but the Company had no outstanding borrowing.
In the fourth quarter of fiscal 1998, the Company entered into a
long-term creosote supply agreement with AlliedSignal and purchased certain
creosote registrations from it. The Company paid AlliedSignal $4 million as
additional consideration for entering into the supply contract and paid $4.5
million for the intangible assets. The transaction was financed out of
working capital and the proceeds of a $6 million term loan to KMG by
SouthTrust. The term loan bears interest at a fixed rate of 7.32% and is
amortized in equal monthly installments of approximately $91 thousand over a
term of seven years. As of September 30, 1998 the balance outstanding under
the term loan was $5.8 million.
In fiscal 1997 the Company moved its manufacturing facility to a new
location in Matamoros, Mexico. Commercial production at the original
facility ceased early in December 1996 and did not restart at the new
facility until May 1997. That relocation of the Company's manufacturing
facility materially affected operating assets and liabilities during fiscal
1997. For example, finished product inventories were increased beginning in
fiscal 1996 in anticipation of the cessation of production during the
relocation. During the latter part of fiscal 1997 inventories were reduced
by approximately $947 thousand, bringing inventories down to approximately
normal operating levels by the end of the fiscal year. In addition, as the
plant relocation was accomplished, accrued liabilities established in
connection with the anticipated move declined in fiscal 1997 by approximately
$243 thousand.
The Company's investing activities in fiscal 1998 consisted primarily of
capital expenditures related to the acquisition of the Tuscaloosa, Alabama
distribution facility for $169 thousand and costs of approximately $390
thousand incurred to relocate and add 4-chlorophenol production capability to
the Company's Matamoros, Mexico manufacturing facility. Total relocation
costs were approximately $1.5 million, of which approximately $1.2 million
has been capitalized. The Company anticipates that it will incur
approximately $350 thousand in fiscal 1999 in capital expenditures, primarily
for additional plant and equipment and upgrades to existing facilities. The
Company believes that cash from operations will be sufficient to pay for
those expenditures.
The Company's capital expenditures and operating expenses for
environmental matters, excluding FIFRA testing and data submission costs,
were approximately $370 thousand in fiscal 1998 and $300 thousand in fiscal
1997. The Company estimates that its capital expenditures and operating
expenses for environmental matters other than FIFRA, but including
investigation and remediation at its Tuscaloosa, Alabama facility as
discussed below, will be approximately $400 thousand
13
<PAGE>
in fiscal 1999. As discussed above, the Company expensed approximately $331
thousand for penta testing costs under FIFRA in fiscal 1998 and approximately
$198 thousand in fiscal 1997. The Company anticipates that FIFRA testing
costs will be approximately $300 thousand in each of the next two fiscal
years. Since environmental laws have traditionally become increasingly
stringent, costs and expenses relating to environmental control and
compliance may increase in the future. While the Company does not believe
that the cost of compliance with existing or future environmental laws and
regulations will have a material adverse effect on its business, financial
condition or results of operations, there can be no assurance that costs of
compliance will not exceed current estimates.
In connection with the relocation of its Matamoros facility, the Company
completed an environmental cleanup of the original site. In addition, the
Company conducts periodic ground water sampling at its facility in
Tuscaloosa, Alabama as required by the Alabama Department of the
Environmental Management ("ADEM"). A 1991 sampling revealed the presence of
penta contamination and more recent sampling continues to show some
contamination, although in lesser amounts. ADEM has not required any
additional response at this time. The Company does not believe that costs
for environmental investigation and remediation at either facility will
materially impact liquidity or have a material adverse effect on the
Company's business, financial condition or results of operations, although
there can be no assurances to this effect.
YEAR 2000 COMPLIANCE
Historically, many computer programs have been written using two digits
rather than four to define the applicable year, which could result in the
program failing to properly recognize a year that begins with "20" instead of
"19". This, in turn, could result in major system failures or
miscalculations, and is generally referred to as the "Year 2000 Issue." The
Company has reviewed its critical accounting and information systems for Year
2000 compliance and has developed a plan to remedy any deficiencies in a
timely manner. The Company expects to resolve Year 2000 compliance issues
relating to its software primarily through normal upgrades of its software
or, when necessary, through replacement of existing software with Year 2000
compliant applications. The Company has upgraded its financial and
accounting software to a version which the software manufacturer has stated
is Year 2000 compliant. The cost of other upgrades or replacements is not
expected to be material to the Company's financial position or results of
operations. In addition, the Company is in the process of seeking
verification from its key distributors, vendors and suppliers that they are
Year 2000 compliant or, if they are not yet so compliant, to provide a
description of their plans to become so. The Company's assessment of the
Year 2000 issue is expected to be completed by the end of fiscal year 1999.
If the Company's present efforts to address the Year 2000 compliance issues
are not successful, or if distributors, suppliers and other third parties
with which the Company conducts business do not successfully address such
issues, the Company's business, operating results and financial position
could be materially and adversely affected. The Company has not yet fully
developed a comprehensive contingency plan to address unavoided or
unavoidable risks but expects to have a contingency plan formulated by the
end of fiscal year 1999.
14
<PAGE>
DISCLOSURE REGARDING FORWARD LOOKING STATEMENTS
Certain information included or incorporated by reference in this report is
forward-looking, including statements contained in "Management's Discussion and
Analysis of Operations". It includes statements regarding the intent, belief
and current expectations of the Company and its directors and officers.
Forward-looking information involves important risks and uncertainties that
could materially alter results in the future from those expressed in these the
statements. These risks and uncertainties include, but are not limited to, the
ability of the Company to maintain existing relationships with long-standing
customers, the ability of the Company to successfully implement productivity
improvements, cost reduction initiatives, facilities expansion and the ability
of the Company to develop, market and sell new products and to continue to
comply with environmental laws, rules and regulations. Other risks and
uncertainties include uncertainties relating to economic conditions,
acquisitions and divestitures, government and regulatory policies, technological
developments and changes in the competitive environment in which the Company
operates. Persons reading this report are cautioned that such statements are
only predictions and that actual events or results may differ materially. In
evaluating such statements, readers should specifically consider the various
factors that could cause actual events or results to differ materially from
those indicated by the forward-looking statements.
ACCOUNTING STANDARDS
A new accounting standard was issued in June 1997 for reporting and
displaying comprehensive income and its components in financial statements. The
new standard will apply to the Company beginning with the first quarter of
fiscal 1999. The Company's management believes that the new standard will not
have a material effect on the financial position or results of operation of the
Company.
15
<PAGE>
ITEM 7. FINANCIAL STATEMENTS.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
FINANCIAL STATEMENTS
Page
----
<S> <C>
Independent Auditors' Report 17
Consolidated Balance Sheets as of July 31, 1998
and 1997 18
Consolidated Statements of Income for the Years Ended
July 31, 1998 and 1997 19
Consolidated Statements of Stockholders' Equity
for the Years Ended July 31, 1998
and 1997 20
Consolidated Statements of Cash Flows for the
Years Ended July 31, 1998 and 1997 21
Notes to Consolidated Financial Statements 22 - 30
</TABLE>
16
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
KMG Chemicals, Inc.
Houston, Texas
We have audited the accompanying consolidated balance sheets of KMG Chemicals,
Inc. and subsidiaries (the "Company") as of July 31, 1998 and 1997, 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 Chemicals,
Inc. and subsidiaries as of July 31, 1998 and 1997, and the results of their
operations and their cash flows for the years then ended in conformity with
generally accepted accounting principles.
Houston, Texas
September 11, 1998
17
<PAGE>
<TABLE>
<CAPTION>
KMG CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS,
JULY 31, 1998 AND 1997
- --------------------------------------------------------------------------------------------
1998 1997
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 2,207,948 $2,643,070
Investments 89,040
Accounts receivable:
Trade, net of allowance for doubtful accounts of
$50,000 and $25,000, respectively 3,570,508 2,266,221
Other 21,218 120,211
Note receivable - current portion 36,311 7,740
Inventories 1,751,346 1,183,284
Prepaid expenses and other assets 152,382 113,159
Income taxes receivable 56,547 88,887
----------- ----------
Total current assets 7,796,260 6,511,612
PROPERTY, PLANT AND EQUIPMENT - Net of accumulated depreciation 2,382,913 1,800,143
NOTE RECEIVABLE, Less current portion 408,912 245,267
OTHER ASSETS 9,510,916 828,543
----------- ----------
TOTAL $20,099,001 $9,385,565
----------- ----------
----------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 3,342,270 $1,331,305
Accrued liabilities 533,511 669,572
Current portion of long-term debt 679,241
----------- ----------
Total current liabilities 4,555,022 2,000,877
LONG-TERM DEBT 5,268,301
DEFERRED TAX LIABILITY 34,881
----------- ----------
Total liabilities 9,823,323 2,035,758
----------- ----------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value; 10,000,000 shares authorized,
none issued
Common stock, $.01 par value; 40,000,000 shares authorized,
7,000,169 shares issued and outstanding in 1998 and 1997 70,002 70,002
Additional paid-in capital 1,063,385 1,063,385
Retained earnings 9,142,291 6,216,420
----------- ----------
Total stockholders' equity 10,275,678 7,349,807
----------- ----------
TOTAL $20,099,001 $9,385,565
----------- ----------
----------- ----------
</TABLE>
See notes to consolidated financial statements.
18
<PAGE>
KMG CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED JULY 31, 1998 AND 1997
- --------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
NET SALES $22,657,208 $19,485,035
COST OF SALES 14,083,252 11,265,700
----------- -----------
Gross profit 8,573,956 8,219,335
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 3,917,205 3,911,452
----------- -----------
Operating income 4,656,751 4,307,883
OTHER INCOME (EXPENSE):
Interest income 212,775 67,629
Interest expense (39,040) (282)
Gain on sale of securities 343,471
Other, net (3,178) (5,133)
----------- -----------
Total other income 514,028 62,214
----------- -----------
INCOME BEFORE INCOME TAXES 5,170,779 4,370,097
PROVISION FOR INCOME TAXES (1,964,901) (1,660,637)
----------- -----------
NET INCOME $ 3,205,878 $ 2,709,460
----------- -----------
----------- -----------
EARNINGS PER COMMON SHARE:
Basic $ 0.46 $ 0.39
----------- -----------
----------- -----------
Diluted $ 0.46 $ 0.39
----------- -----------
----------- -----------
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic $ 7,000,169 $ 6,862,757
----------- -----------
----------- -----------
Diluted $ 7,044,814 $ 6,904,070
----------- -----------
----------- -----------
</TABLE>
See notes to consolidated financial statements.
19
<PAGE>
KMG CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED JULY 31, 1998 AND 1997
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
COMMON STOCK
------------------------ ADDITIONAL TOTAL
SHARES PAR PAID-IN RETAINED STOCKHOLDERS'
ISSUED VALUE CAPITAL EARNINGS EQUITY
<S> <C> <C> <C> <C> <C>
BALANCE AT
AUGUST 1, 1996 6,862,474 $68,625 $1,185,814 $3,631,955 $ 4,886,394
Dividends (124,995) (124,995)
Shares issued 137,695 1,377 98,623 100,000
Stock registration costs (221,052) (221,052)
Net income 2,709,460 2,709,460
--------- ------- ---------- ---------- -----------
BALANCE AT
JULY 31, 1997 7,000,169 70,002 1,063,385 6,216,420 7,349,807
Dividends (280,007) (280,007)
Net income 3,205,878 3,205,878
--------- ------- ---------- ---------- -----------
BALANCE AT
JULY 31, 1998 7,000,169 $70,002 $1,063,385 $9,142,291 $10,275,678
--------- ------- ---------- ---------- -----------
--------- ------- ---------- ---------- -----------
</TABLE>
See notes to consolidated financial statements.
20
<PAGE>
KMG CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED JULY 31, 1998 AND 1997
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 3,205,878 $ 2,709,460
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 319,007 240,085
Gain on sale of securities (343,471)
(Gain) loss on sale or abandonment of equipment (6,032) 36,707
Deferred income tax (benefit) provision (34,881) 145,694
Changes in operating assets and liabilities:
Accounts receivable - trade (1,304,287) (53,279)
Accounts receivable - other 98,993 14,625
Inventories (568,062) 946,506
Prepaid expenses and other assets (39,223) (47,056)
Income taxes receivable 32,340 (88,887)
Accounts payable 1,870,961 (174,428)
Accrued liabilities (136,061) (242,738)
Income taxes payable (80,175)
----------- -----------
Net cash provided by operating activities 3,095,162 3,406,514
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equipment (819,654) (839,315)
Proceeds from sale of securities 432,511
Proceeds from sale of equipment 7,000
Loans to related parties (200,000)
Collection of notes receivable 7,784 7,295
Additions to other assets (8,765,464) (222,983)
----------- -----------
Net cash used in investing activities (9,337,823) (1,055,003)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from notes payable 6,000,000
Payment of dividends (140,003) (124,995)
Principal payments on borrowings (52,458) (14,944)
Issuance of stock 100,000
Stock registration costs (221,052)
----------- -----------
Net cash provided by (used in) financing activities 5,807,539 (260,991)
----------- -----------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (435,122) 2,090,520
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 2,643,070 552,550
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 2,207,948 $ 2,643,070
----------- -----------
----------- -----------
SUPPLEMENTAL DISCLOSURES FOR CASH FLOW INFORMATION:
Cash paid during the year for interest $ 39,040 $ 282
Cash paid during the year for income taxes $ 2,058,159 $ 1,676,784
NONCASH TRANSACTION - Dividends declared $ 140,004
</TABLE>
See notes to consolidated financial statements.
21
<PAGE>
KMG CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JULY 31, 1998 AND 19971.
- -------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
GENERAL - KMG Chemicals, Inc. (the "Company") is involved in the
manufacture and distribution of wood treatment products, principally
pentachlorophenol ("penta"). Penta-manufacturing operations are conducted
through KMG de Mexico ("KMEX"), a Mexican corporation and 97% owned
subsidiary, at a plant in Matamoros, Mexico. The penta plant began
operations in 1986 and was moved to a new location in Matamoros in May
1997.
The historical financial information of the Company reflects the historical
results of KMG-Bernuth ("KMG") and KMEX as a result of a reverse merger of
KMG with KMG-B, Inc. ("KMG-B") in October 1996. Prior to the transaction,
KMG-B had no significant assets, liabilities or operations and its primary
business purpose was to seek an acquisition or merger transaction with an
operating business with growth potential whereby its shareholders would
benefit by owning an interest in a viable business enterprise. On
October 15, 1996, pursuant to a stock exchange agreement dated
September 13, 1996, KMG-B issued 6,510,000 shares of common stock
(approximately 93% of its issued and outstanding common stock) in exchange
for all of the issued and outstanding shares of common stock of KMG. KMG-B
also issued 352,474 shares of common stock to other shareholders as payment
for certain services for KMG-B in connection with the Stock Exchange
Agreements and in conjunction with other services. The transaction between
KMG-B and KMG provided KMG-B with a viable business enterprise and allowed
KMG to become a public company without going through an initial public
offering.
KMG-B was incorporated in the state of Texas in 1992 under the name Water
Point Manufacturing, Inc. ("Water Point"). KMG-B as Water Point filed a
petition under Chapter 11 of the United States Bankruptcy Court during June
of 1995, and in September 1995, a First Amended Joint Plan of
Reorganization (the "Plan") was filed and subsequently confirmed by the
official committee of unsecured creditors and the bankruptcy trustee. With
respect to Water Point, the Plan decided that it would remain in existence,
although all capital stock outstanding as of the filing date of the
petition would be canceled, and that it was discharged from any and all
debts and liabilities that arose prior to October 23, 1996. Water Point
adopted "fresh-start" accounting as of the October 23, 1996 bankruptcy
discharge date and subsequently changed its name to KMG-B. During fiscal
year 1998, the Company changed its name to KMG Chemicals, Inc.
The Company's significant accounting policies are as follows:
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include
the accounts of KMG Chemicals, KMG-Bernuth and KMEX. All significant
intercompany accounts and transactions have been eliminated in
consolidation.
CASH AND CASH EQUIVALENTS - The Company considers all investments with
original maturities of three months or less to be cash equivalents.
INVENTORIES - Inventories are valued at the lower of cost or market. Cost
is determined using the first-in first-out ("FIFO") method.
22
<PAGE>
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 using a straight-line method over the
estimated useful lives of the assets. Depreciation expense was $235,916
and $212,454 in 1998 and 1997, respectively. The estimated useful lives of
classes of assets are as follows:
<TABLE>
<CAPTION>
ASSET DESCRIPTION LIFE (YEARS)
<S> <C>
Building 10 to 30
Equipment 3 to 10
Leasehold improvements 5 to 8
</TABLE>
INCOME TAXES - Deferred income tax assets and liabilities are determined
using the asset and liability method in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income
Taxes." Under this method, deferred tax assets and liabilities are
established for future tax consequences of temporary differences between
the financial statement carrying amounts of assets and liabilities and
their tax bases.
EARNINGS PER SHARE - During fiscal year 1998, the Company implemented
SFAS No. 128, "Earnings per Share," which establishes the requirements for
presenting earnings per share, ("EPS"). SFAS No. 128 requires the
presentation of "basic" and "diluted" EPS on the face of the income
statement. Basic earnings per common share amounts are calculated using
the average number of common shares outstanding during each period.
Diluted earnings per share assume the exercise of all stock options having
exercise prices less than the average market price of the common stock
using the treasury stock method. The earnings per share data for prior
years has been restated in accordance with SFAS No. 128 standards.
STOCK-BASED COMPENSATION - In fiscal year 1998, the Company adopted SFAS
No. 123, "Accounting for Stock Based Compensation." Under SFAS No. 123,
the Company is permitted to either record expenses for stock options and
other employee compensation plans based on their fair value at the date of
grant or to continue to apply its current accounting policy under
Accounting Principles Board Opinion No. 25 ("APB No. 25") and recognize
compensation expense, if any, based on the intrinsic value of the equity
instrument at the measurement date. The Company elected to continue
following APB No. 25. The adoption of SFAS No. 123 in 1998 had no effect
on the Company's results of operations.
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 amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
these estimates.
INTANGIBLE ASSETS - For financial statement purposes, intangible assets are
being amortized using the straight-line method over the estimated useful
life of the asset (see Note 6).
23
<PAGE>
FAIR VALUE OF FINANCIAL INSTRUMENTS - The carrying value of financial
instruments, including cash and cash equivalents, accounts receivable and
accounts payable approximate fair value because of the relatively short
maturity of these instruments. The notes receivable, including the current
portion, are of a related-party nature and it is not practicable to
estimate their fair value. The fair value of the Company's debt at
July 31, 1998 was estimated to be the same as its carrying value since the
debt obligation bears interest at a rate consistent with current market
rates. It is not practicable to estimate the fair value of the Company's
investments. In fiscal 1997 the Company held securities in untraded,
closely held entities that are recorded at cost.
CONCENTRATIONS OF CREDIT RISKS - Financial instruments that potentially
subject the Company to significant concentrations of credit risk consist
principally of cash and cash equivalents and accounts receivable. Although
the amount of credit exposure to any one institution may exceed federally
insured amounts, the Company limits its cash investments to high-quality
financial institutions in order to minimize its credit risk. With respect
to accounts receivable, such receivables are primarily from wood-treating
manufacturers located worldwide. The Company extends credit based on an
evaluation of the customer's financial condition, generally without
requiring collateral. Exposure to losses on receivables is dependent on
each customer's financial condition.
NEW ACCOUNTING STANDARD - In June 1997, the Financial Accounting Standards
Board issued SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130
establishes standards for reporting and displaying comprehensive income and
its components in a financial statement that is displayed with the same
prominence as other financial statements. "Comprehensive income," as
defined, includes all changes in equity (net assets) during a period from
nonowner sources. Examples of items to be included in comprehensive
income, which are excluded from net income, include foreign currency
translation adjustments, unrealized gain/loss on available-for-sale
securities, and mark-to-market adjustments on hedging activities. The
disclosures prescribed by SFAS No. 130 must be made beginning with the
first quarter of fiscal year 1999. The Company does not believe that SFAS
No. 130 will have a material effect on the Company; however, the Company
will continue to analyze this during the first quarter of fiscal year 1999.
2. INVENTORIES
Inventories are summarized as follows:
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Chemical raw materials and supplies $ 421,081 $ 333,502
Finished chemical products 1,330,265 849,782
---------- ----------
Total $1,751,346 $1,183,284
---------- ----------
---------- ----------
</TABLE>
24
<PAGE>
3. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment and related accumulated depreciation and
amortization are summarized as follows:
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Land $ 302,527 $ 267,947
Buildings 1,034,487 651,018
Equipment 2,586,459 2,237,023
Leasehold improvements 5,337 28,276
Construction-in-progress 69,506 33,693
----------- -----------
3,998,316 3,217,957
Less accumulated depreciation and
amortization (1,615,403) (1,417,814)
----------- -----------
Total $ 2,382,913 $ 1,800,143
----------- -----------
----------- -----------
</TABLE>
4. FOREIGN CURRENCY REMEASUREMENT
Monetary assets and liabilities and income items for KMEX are remeasured to
U.S. dollars at current rates, and certain assets (notably plant and
production equipment) are remeasured at historical rates. Expense items
for KMEX are remeasured at average monthly rates of exchange except for
depreciation and amortization expense. All gains and losses from currency
remeasurement for KMEX are included in operations. Foreign currency
remeasurement resulted in an aggregate exchange gain of $12,230 and $15,151
in fiscal years 1998 and 1997, respectively.
5. INCOME TAXES
The provision for income taxes consisted of the following:
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Current federal and foreign provision $1,846,399 $1,383,866
Current state provision 153,383 131,077
Deferred income tax (benefit) provision (34,881) 145,694
---------- ----------
Total $1,964,901 $1,660,637
---------- ----------
---------- ----------
</TABLE>
As of July 31, 1998, net deferred income taxes relating to temporary
differences were $0. As of July 31, 1997, deferred income taxes relating
to temporary differences consisted of $34,881 in net deferred liabilities.
No valuation allowance was required as of July 31, 1998 or 1997.
25
<PAGE>
The following table accounts for the differences between the actual tax
provision and the amounts obtained by applying the applicable statutory
U.S. federal and Mexican income tax rate to earnings before income taxes
for the year ended July 31:
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Provision for income taxes at the statutory rate $1,758,064 $1,485,543
State income taxes 153,383 131,077
Other 53,454 44,017
---------- ----------
Total $1,964,901 $1,660,637
---------- ----------
---------- ----------
</TABLE>
6. OTHER ASSETS
Other assets consisted of the following:
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Intangible assets, net of accumulated amortization of $25,000
as of July 31, 1998 $4,475,000
Creosote supply contract, net of accumulated amortization of
$33,337 as of July 31, 1998 3,966,663
Advances for premiums on employee-owned life
insurance policies (see Note 9) 334,352 $428,733
Licensing agreement, net of accumulated amortization of
$109,167 as of July 31, 1998 and $86,309 as of July 31, 1997 210,833 233,691
Other 524,068 166,119
---------- --------
Total $9,510,916 $828,543
---------- --------
---------- --------
</TABLE>
On June 30, 1998, the Company entered into a long-term supply contract to
purchase creosote (a wood-treating chemical) from AlliedSignal, Inc.
("Allied"). At the same time, the Company purchased certain intangible
assets from Allied pertaining to creosote sales and distribution. The
Company paid Allied $4,000,000 and $4,500,000 for entering into the supply
contract and for the intangible assets, respectively. The supply contract
is being amortized on a straight-line basis over a ten-year term, which is
the initial term of the contract. The intangible assets, including
Allied's creosote customer list, one customer contract, certain rail car
leases and Allied's rights in creosote product registrations, are being
amortized on a straight-line basis over a 15-year term which approximates
the life of the assets purchased.
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.
26
<PAGE>
7. LONG-TERM DEBT
Effective August 1, 1996, the Company entered into a revolving
line-of-credit agreement with a 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. The line of credit is
subject to a 1/4% unused line fee and is secured by the Company's
receivables, inventory and general intangibles. The loan agreement
includes, among other things, restrictions on equity investments and loans
made by the Company and requires the maintenance of a minimum fixed-charge
coverage ratio and minimum net worth requirements. No borrowings were
outstanding under this agreement at July 31, 1998 or 1997. The termination
date of this loan agreement is January 15, 2000.
On June 26, 1998, the Company entered into a term loan for $6,000,000 with
a bank. Principal and interest payments of $91,498 will be due monthly,
starting August 1, 1998, until July 1, 2005, at which time the remaining
outstanding balance will be due. This term loan is secured by the
Company's receivables, inventory and general intangibles. The interest
rate of the term loan is fixed at 7.32% per annum. At July 31, 1998, the
Company was in compliance with its various debt covenants, which among
other things, has restrictions on equity investments and loans made by the
Company and requires the maintenance of a minimum fixed-charge coverage
ratio and minimum and ratio requirements on tangible net worth. At
July 31, 1998, $5,947,542 was outstanding under this agreement.
The term loan note at July 31, 1998 matures as follows:
<TABLE>
<CAPTION>
YEAR ENDING
JULY 31,
<S> <C>
1999 $ 679,241
2000 736,985
2001 792,780
2002 852,798
2003 917,361
Thereafter 1,968,377
----------
Total $5,947,542
----------
----------
</TABLE>
8. COMMITMENTS AND CONTINGENCIES
COMMITMENTS
OPERATING LEASES - The Company has non-cancelable operating leases for its
office and warehouse facilities and certain transportation equipment. At
July 31, 1998, the Company was obligated under these leases for the
following future minimum lease commitments:
<TABLE>
<CAPTION>
<S> <C>
1999 $294,505
2000 151,229
2001 32,315
--------
Total $478,049
--------
--------
</TABLE>
Rent expense relating to the operating leases was $178,878 and $250,691 for
the years ended July 31, 1998 and 1997, respectively.
27
<PAGE>
CONTINGENCIES
ENVIRONMENTAL - As a manufacturer and supplier of wood treatment products,
the Company is subject to a variety of health, safety and environmental
laws within the countries in which it operates. These governments may
implement new laws or regulations which amend or impose restrictions on the
sale or use of the Company's raw materials and products. In management's
opinion, the Company is currently in compliance with all applicable laws
and regulations, and no actions or proceedings against the Company are
known to be in process.
In August 1988 the U.S. Environmental Protection Agency ("EPA") issued a
comprehensive data call-in notice for test data on all products covered
under the Federal Insecticide, Fungicide and Rodenticide Act. This notice
required product registrants, including the Company, 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, the
Company 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 the Company of approximately
$331,000 and $198,000 in fiscal years 1998 and 1997, respectively, are
included in general and administrative expenses. Costs of approximately
$943,000 were expensed prior to fiscal year 1997.
During 1997, the mandate of the penta data task force changed to include
possible compliance testing required by foreign governments. Since these
governments have the authority to amend testing protocols and/or to mandate
additional tests, future costs to the Company are difficult to quantify.
However, management estimates that these future costs will be approximately
$300,000 per year and intends to expense these costs as incurred.
LAWSUITS - The Company is involved in various claims and lawsuits in the
normal course of business. Management does not believe that the outcome of
any of these matters will have a materially adverse effect on the Company's
consolidated financial condition or operations.
9. RELATED-PARTY TRANSACTIONS
During 1991, the Company entered into "split-dollar insurance" arrangements
with two officers/stockholders. Under these agreements, the Company
advances funds for insurance premiums and records these advances as 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). During fiscal 1998, the agreement with one such
officer was terminated and converted to a non-interest bearing promissory
note.
The Company advanced funds to an officer under unsecured promissory notes
dated May 15, 1998 and July 15, 1994. The 1998 note is due in annual
installments of $28,571, including interest at prime rate. The 1994 note
is due in semimonthly installments of $1,000, including interest at 6.5%.
As of July 31, 1998 and 1997, $445,223 and $253,007, respectively, was
outstanding under these notes.
28
<PAGE>
Effective October 15, 1996, an entity, that employs a director and
shareholder of the Company, entered into a consulting agreement (the
"Consulting Agreement") with the Company. The Company issued 137,696
shares of its common stock for services rendered by the entity regarding
the stock exchange agreement (as discussed in Note 12) and other related
matters. The number of shares issued was valued at $100,000, based on the
estimated fair value of the services provided.
10. EMPLOYEE BENEFIT PLAN
The Company has a defined contribution 401(k) plan covering substantially
all its U.S. employees. The participants may contribute from 3% to 15% of
their compensation, and the Company makes matching contributions under this
plan equal to 3% of the participants' compensation. Company contributions
to the plan totaled approximately $23,000 and $18,000 in fiscal years 1998
and 1997, respectively.
11. SIGNIFICANT CUSTOMERS
The Company had one significant customer in 1998 whose sales as a
percentage of total sales were 11.5% and two significant customers in 1997
whose sales as a percentage of total sales were 10.7% and 10.3%.
12. STOCKHOLDERS' EQUITY
The Company 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 Company's 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 the Company or any subsidiary are eligible
to receive options under the Plan, which are fully vested upon issuance,
but only salaried employees of the Company or its subsidiaries are eligible
to receive incentive stock options, which vest over a five-year period from
the date of issuance.
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 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 option holder's
cessation of service with the Company.
Stock option activity for the Company during fiscal years 1998 and 1997 was
as follows:
<TABLE>
<CAPTION>
1998 1997
------------------ ------------------
WEIGHTED- WEIGHTED-
NUMBER AVERAGE NUMBER AVERAGE
OF EXERCISE OF EXERCISE
SHARES PRICE SHARES PRICE
<S> <C> <C> <C> <C>
Stock options outstanding, beginning of year 43,671 $0.216 43,671 $0.216
Grant 26,500 4.24
------ ------ ------ ------
Stock options outstanding, end of year 70,171 $ 1.73 43,671 $0.216
------ ------ ------ ------
------ ------ ------ ------
</TABLE>
29
<PAGE>
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING AS OF JULY 31, 1998 OPTIONS EXERCISABLE
---------------------------------------------------- -------------------------
WEIGHTED-
AVERAGE WEIGHTED- WEIGHTED-
RANGE OF REMAINING AVERAGE AVERAGE
EXERCISE SHARES CONTRACTUAL EXERCISE SHARES EXERCISE
PRICE OUTSTANDING LIFE PRICE EXERCISABLE PRICE
<S> <C> <C> <C> <C> <C>
$0.216 43,671 6.22 $0.216 43,671 $0.216
4.13 - 4.50 26,500 10.30 4.240 4,000 4.500
</TABLE>
At July 31, 1998, options were exercisable for 47,671 shares at a weighted-
average exercise price of $0.58. The remaining contractual life of these
options was approximately eight years. At July 31, 1998, 629,829 shares
were available for future option grants.
Assuming the Company had used the fair market value method of accounting
for its stock-based compensation plan in 1997, there would be no pro forma
effect on the Company's net income and net income per share.
The weighted average fair value of options granted during 1998 was $25,970
and would have decreased basic and diluted EPS by $0.01 per share. Fair
value of the options is estimated at the date of grant using the
Black-Scholes option pricing model with the following assumptions for
fiscal years 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Weighted-average expected life: 8.45 7.22
Volatility factor: 45% 22%
Dividend yield: 1% 1%
Weighted-average risk-free interest: 6% 6%
</TABLE>
The following is a reconciliation of the numerators and denominators of
basic and diluted earnings per share computations, in accordance with SFAS
No. 128:
<TABLE>
<CAPTION>
YEAR ENDED JULY 31, 1998 YEAR ENDED JULY 31, 1997
------------------------------------- --------------------------------------
INCOME SHARES PER SHARE INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) (AMOUNT) (NUMERATOR) (DENOMINATOR) (AMOUNT)
<S> <C> <C> <C> <C> <C> <C>
BASIC EPS
Income available to
common stockholders $3,205,878 7,000,169 $0.46 $2,709,460 6,862,757 $0.39
EFFECT OF DILUTIVE SECURITIES
Common stock options 44,645 41,313
---------- --------- ----- ---------- --------- -----
DILUTED EPS
Income available to
common stockholders $3,205,878 7,044,814 $0.46 $2,709,460 6,904,070 $0.39
---------- --------- ----- ---------- --------- -----
---------- --------- ----- ---------- --------- -----
</TABLE>
On September 2, 1997, the Company declared a dividend of $0.02 per share,
payable September 30, 1997, to common shareholders of record as of
September 15, 1997. On July 22, 1998, the Company declared a dividend of
$0.02 per share, payable August 21, 1998 to common shareholders of record
as of August 14, 1998. As of July 31, 1998, dividends declared but unpaid
of $140,004 were accrued in accounts payable.
30
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
PART III
Pursuant to instruction E.3 to Form 10-KSB, the information required by
Items 9-12 of Part III is incorporated by reference from the Company's
definitive proxy statement to be filed on or about October 23, 1998.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8K.
(a) The financial statements filed as part of this report in Item 7 are listed
in the Index to Financial Statements contained in such Item. The following
documents are filed as exhibits to this report:
2.1 (i) First Amended Joint Plan of Reorganization dated September 1,
1995, as modified and clarified to date.*
2.1 (ii) Asset Purchase and Sale Agreement dated June 26, 1998 with
AlliedSignal, Inc.****
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.*
3 (iii) Articles of Amendment to Restated and Amended Articles of
Incorporation, filed December 11, 1997.**
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.*
31
<PAGE>
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. Split Dollar Insurance Agreement dated December 13, 1991 between
KMG-Bernuth, Inc. and Bobby D. Godfrey.*
10.9 Second Amendment to Revolving Loan Agreement.**
10.10 $2,500,000 Amended and Restated Revolving Note.**
10.11 Third Amendment to Revolving Loan Agreement.***
10.12 $2,500,00 Amended and Restated Revolving Note dated
December 31, 1997.***
10.13 Employment Agreement dated February 1, 1998 with
Bobby D. Godfrey.***
10.14 Creosote Supply Agreement dated as of June 30, 1998 between
AlliedSignal Inc. and the Company.****
10.15 Performance Guaranty dated June 30, 1998 by the Company.****
10.16 Term Loan Agreement between SouthTrust Bank, National Association
and KMG-Bernuth, Inc.****
10.17 $6,000,000 Term Note.****
10.18 Guaranty of Payment by the Company.****
10.19 Fourth Amendment to Revolving Loan Agreement.****
21.1 Subsidiaries of the Company.*
27.1 Financial Data Schedule.
Documents marked by an (*) were filed by the Company on December 6, 1996 as part
of its Form 10, file number 000-21839. Documents marked by a (**), (***) or
(****) were filed by the Company on, respectively, December 12, 1997 as part of
its report on Form 10-QSB for the first quarter of fiscal 1998, March 12, 1998
as part of its report on Form 10-QSB for the second quarter of fiscal 1998, and
on July 10, 1998 as part of its report on Form 8-K, in each case under file
number 000-29278.
(b) A report on Form 8-K was filed by the Company on July 10, 1998. The report
disclosed information concerning the Company's creosote supply transaction
with AlliedSignal under items 2 and 5 of the report. No financial
statements were included in the Form 8-K.
32
<PAGE>
SIGNATURES
In accordance with the Exchange Act, the Company caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
KMG CHEMICALS, INC.
By: /s/ David L. Hatcher Date: October 9, 1998
-----------------------------
David L. Hatcher, President
and Chairman
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.
<TABLE>
<CAPTION>
<S> <C>
By: /s/ Jack Vernie Date: October 9, 1998
----------------------------------
Jack Vernie, Controller
By: /s/ Bobby D. Godfrey Date: October 9, 1998
----------------------------------
Bobby D. Godfrey, Director
By: /s/ George W. Gilman Date: October 9, 1998
----------------------------------
George W. Gilman, Director
By: /s/ Fred C. Leonard III Date: October 9, 1998
----------------------------------
Fred C. Leonard III, Director
By: /s/ Charles M. Neff, Jr. Date: October 9, 1998
----------------------------------
Charles M. Neff, Jr., Director
</TABLE>
33
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM AS OF AND
FOR THE TWELVE MONTHS PERIOD ENDED JULY 31, 1998 AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JUL-31-1998
<PERIOD-START> AUG-01-1997
<PERIOD-END> JUL-31-1998
<CASH> 2,207,948
<SECURITIES> 0
<RECEIVABLES> 3,734,584
<ALLOWANCES> (50,000)
<INVENTORY> 1,751,346
<CURRENT-ASSETS> 7,796,260
<PP&E> 3,998,316
<DEPRECIATION> (1,615,403)
<TOTAL-ASSETS> 20,099,001
<CURRENT-LIABILITIES> 4,555,022
<BONDS> 0
0
0
<COMMON> 70,002
<OTHER-SE> 10,205,676
<TOTAL-LIABILITY-AND-EQUITY> 20,099,001
<SALES> 22,657,208
<TOTAL-REVENUES> 22,657,208
<CGS> 14,083,252
<TOTAL-COSTS> 14,083,252
<OTHER-EXPENSES> 3,917,205
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 39,040
<INCOME-PRETAX> 5,170,779
<INCOME-TAX> 1,964,901
<INCOME-CONTINUING> 3,205,878
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,205,878
<EPS-PRIMARY> 0.46
<EPS-DILUTED> 0.46
</TABLE>
