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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, 1999
/ / 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:
Title of Each Class Name of each Exchange on which Registered
None None
- ------------------------------- ----------------------------------------
SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:
Common Stock, $.01 par value
- ------------------------------------------------------------------------------
(Title of Class)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes /X/ No / /
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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. / /
Issuer's revenues for its most recent fiscal year: $36,388,799
The aggregate market value of the voting stock held by non-affiliates
computed by reference to sales of such stock as of September 30, 1999 was
$3,020,947.
(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 1999 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 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.
ACQUISITION OF KMG-BERNUTH, INC.
In October 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 and was discharged from bankruptcy. 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.
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
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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. In 1999 Reilly Industries, Inc. ("Reilly")
acquired AlliedSignal's carbon products business, including its creosote
production and the creosote supply contract with the Company.
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. CCA is used for utility poles and lumber. The Company believes
that wood preserving chemicals are used to treat approximately 600 million
cubic feet of wood each year in the United States and that 6% of that wood is
treated with penta, 15% with creosote and 80% with CCA. 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 the 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 but not with CCA. The Company also supplies
sodium penta, a wood preserving product used primarily to treat freshly-cut
lumber, to customers outside the United States. See "-Competition."
PRODUCTS AND SERVICES
PENTACHLOROPHENOL AND SODIUM PENTACHLOROPHENATE. Penta is formed
through the reaction of phenol with chlorine. The Company manufactures penta
in Matamoros, Mexico through KMG's subsidiary, KMG de Mexico, S.A. de C.V.
("KMEX"), formerly known as Productos de Preservacion, S.A. de C.V., a
Mexican maquiladora corporation that began operations in 1986. The Company
arranges for the required phenol and chlorine to be supplied to KMEX, which
in turn sells the penta it produces to the Company for sale and distribution
to the Company's customers. As a by-product of the penta manufacturing
process, the Matamoros facility also produces hydrochloric acid which is sold
to distributors for use in the steel and oil well service industries in the
United States and Mexico.
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
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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.
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 --
Reilly and Rutgers VFT AG ("Rutgers"). The Company believes that Reilly and
Rutgers are among the world's largest manufacturers of creosote and other
coal tar products. Creosote is sold by the Company to customers throughout
the 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 price of those 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., Pennwalt
De Mexico and Advanced Aromatics, Inc. However, the Company believes that
these raw materials are each readily available from a variety of sources and
the loss of any of the Company's raw material suppliers would not have a
material adverse effect on its business, financial condition or results of
operations.
The Company has two suppliers of the creosote it sells. The
Company's supply contract with Reilly has an initial term ending in 2008 and
thereafter may be renewed annually. The Company must purchase all of the
creosote produced at certain facilities, subject to annual maximum and
minimum quantities, at varying prices per pound. During the initial term, the
annual maximum quantity is approximately 138 million pounds. If Reilly's
actual production exceeds the maximum, the Company has the option to purchase
that additional production.
The Company's creosote supply contract with Rutgers has an initial
term ending December 31, 2001 and is then renewable annually. The Company
must purchase an agreed minimum volume in each calendar year. The purchase
price for creosote is fixed for calendar year 1999 and is subject to
escalation thereafter during the term.
CUSTOMERS
The Company sells its products to approximately 90 customers. One
customer, Kerr McGee Chemical Corp., accounted for approximately 15% of the
Company's revenues in fiscal 1999 but accounted for less than 10% in fiscal
1998. A second customer, Texas Electric Cooperatives, Inc., accounted for
less than 10% of the Company's revenues in fiscal 1999 but represented
approximately 12% of revenues in fiscal 1998.
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.
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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 Koppers Industries, Inc. 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.
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 1999, the Company had a total of 72
full-time employees and eight temporary employees. Nine of the Company's
employees work at the Company's corporate offices in Houston, Texas, 63 at
the Matamoros facility, seven at the Tuscaloosa facility and one works in
Louisiana. None of the employees in the United States are represented by a
labor union but 41 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 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 shares research and
testing costs pertaining to penta based on its relative market share. Since
the beginning of fiscal 1999 when it first acquired certain creosote labels,
the Company has participated as a member in a similar industry group funding
a creosote research and testing program. The Company incurred expenses of
approximately $721 thousand and $331 thousand in connection with the FIFRA
research and testing program in fiscal 1999 and fiscal 1998, respectively.
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ITEM 2. DESCRIPTION OF PROPERTY
Set forth below is information with respect to certain of the
Company's properties.
<TABLE>
<CAPTION>
LEASE
APPROXIMATE OWNED/ EXPIRATION
LOCATION PRIMARY USE SIZE LEASED DATE
- -------- ----------- ----------------- ------ ----------
<S> <C> <C> <C>
Houston, Texas Corporate 8,500 square feet Leased March 31,
Office 2001
Matamoros, Mexico Manufacturing 7 acres Owned
Tuscaloosa, Alabama Processing 1.5 acres Owned
Distribution
</TABLE>
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.
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 1999 to
a vote of security holders through the solicitation of proxies or otherwise.
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ITEM 5. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Common Stock is traded under the trading symbol "KMGB" on The
Nasdaq SmallCap Market. The approximate high and low bid quotations in fiscal
1999 and 1998 were as follows:
<TABLE>
<CAPTION>
Period: High Low
---- ---
<S> <C> <C>
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
First quarter fiscal 1999 6.53 4.50
Second quarter fiscal 1999 7.75 6.00
Third quarter fiscal 1999 7.00 5.25
Fourth quarter fiscal 1999 6.00 5.00
</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, 1999, there were 7,000,169 shares of Common
Stock issued and outstanding held by 603 shareholders of record.
KMG declared and paid dividends in fiscal 1999 and 1998 as follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Date declared: Date paid: Amount ($): Per Share ($)
July 1998 August 1998 140,003 .02
February 1999 March 1999 70,002 .01
</TABLE>
Additonally, the Company declared and paid dividends of $143,003 in August
1999 and September 1999, respectively. 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.
In fiscal 1999 the Company granted an option to acquire 40,000
shares of Common Stock to Halter Financial Group, Inc. in consideration for
investor relations consulting services. The option is exercisable at a price
of $5.00 per share of Common Stock, is subject to a vesting requirement and
may be exercised for five (5) years from the date of vesting. As of September
30, 1999, none of the option shares were vested. Also in fiscal 1999 the
Company granted a warrant to acquire 25,000 shares of Common Stock to JP
Turner & Company, L.L.P. for consulting services as requested by the Company
and pertaining to the evaluation of acquisition and financing transactions
and to investor relations. The warrant is exercisable at a price of $5.50 per
share of Common Stock through March 17, 2003. The option and the warrant were
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issued by the Company in private transactions without registration in
reliance upon the exemption from registration under section 4(2) of the
Securities Act of 1933, as amended.
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 years
ended July 31, 1999 and 1998:
<TABLE>
<CAPTION>
Years Ended July 31,
----------------------------------- Increase/
1999 1998 (Decrease)
-------------- -------------- --------------
<S> <C> <C> <C>
Net sales...................................... $ 36,388,799 $ 22,657,207 $ 13,731,592
Gross profit................................... 12,821,876 8,573,956 4,247,920
Gross profit as percent of Net Sales........... 35.2% 37.8% (2.6)%
Selling, general and administrative expense.... 6,765,537 3,917,205 2,848,332
Operating income............................... 6,056,339 4,656,750 1,399,589
Other income (expense), net.................... (4,134) 514,027 (518,161)
Income before taxes............................ 6,052,205 5,170,778 881,427
Provision for income taxes..................... (2,299,838) (1,964,901) 334,937
Net income..................................... $ 3,752,367 $ 3,205,877 $ 546,490
</TABLE>
SALES REVENUE
Net operating revenues for fiscal 1999 were approximately $36.4
million, approximately $13.7 million (61%) more than fiscal 1998. The
increase was primarily due to a significantly higher volume of creosote sales
to former customers of AlliedSignal beginning in July 1998 when the Company
began purchasing AlliedSignal's output of creosote under a long-term supply
contract. AlliedSignal distilled creosote from coal tar as part of its carbon
products business. When AlliedSignal sold its carbon products business to
Reilly in 1999, the Company's creosote supply contract was transferred by
AlliedSignal to Reilly. Since then the Company's creosote purchases under the
contract have been from Reilly.
GROSS PROFIT
Gross profit for fiscal 1999 rose by approximately $4.2 million
compared to fiscal 1998. Most of that increase was attributable to sales of
creosote purchased from AlliedSignal and Reilly. Gross profit as a percentage
of net operating revenue declined to 35.2% for fiscal 1999 as compared to
37.8% in fiscal 1998 because creosote sales produce a lower gross profit
margin as a percent of sales than do sales of the
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Company's other products. This effect has been mitigated somewhat since
January 1999 by improved creosote margins.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Aggregate selling, general and administrative expenses increased
approximately $2.8 million in fiscal 1999 as compared with fiscal 1998. Most
of that increase was a consequence of the AlliedSignal/Reilly supply
contract. In particular, distribution and storage expenses increased with
creosote sales volume and the Company is amortizing the $4 million of
additional consideration paid upon entering into the supply contract over 10
years and the $4.5 million paid to AlliedSignal for its creosote
registrations and other intangible assets over 15 years.
According to FIFRA, the environmental statute under which penta and
creosote are registered for sale in the United States, the Company is
obligated to provide the EPA with test data concerning their chemistry and
toxicology. The Company expensed approximately $721 thousand for penta and
creosote testing costs in fiscal 1999 and approximately $331 thousand for
penta testing in fiscal 1998. Almost half of the increase in fiscal 1999 was
attributable to creosote testing costs that the Company had not been
responsible for until the beginning of fiscal 1999 when it acquired
AlliedSignal's creosote labels. See "-Liquidity and Capital Resources."
OTHER INCOME (EXPENSE)
The net increase in other expenses in fiscal 1999 as compared to
fiscal 1998 was primarily due to interest expense incurred on the term loan
secured to finance the AlliedSignal transaction. The Company also sold shares
of Sterling Bancshares stock in fiscal 1998 and recognized a gain on that
sale of $343 thousand.
LIQUIDITY AND CAPITAL RESOURCES
At the end of fiscal 1999, the Company had cash and cash equivalents
of approximately $4.8 million as compared with approximately $2.2 million at
the end of fiscal 1998. Net cash provided by operations during fiscal 1999
was approximately $5.0 million as compared with approximately $3.1 million
for fiscal 1998.
The Company's sources of capital have traditionally been externally
generated or from commercial borrowings. The Company's cash needs are
primarily for principal payments on borrowings and 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 2000. 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.
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The Company's wholly-owned subsidiary, KMG, has obtained a working
capital line of credit under 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
KMG not exceed $250 thousand 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, 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 September 30, 1999 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 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%. It is being amortized over seven years in equal
monthly installments that total approximately $1 million per year. In March
1999 the Company prepaid an additional $1 million of principal on the term
loan. As of September 30, 1999, the principal balance outstanding under the
term loan was $4.1 million.
The Company's capital expenditures and operating expenses for
environmental matters, excluding FIFRA testing and data submission costs,
were approximately $300 thousand in fiscal 1999 and $370 thousand in fiscal
1998. The Company estimates that its capital expenditures and operating
expenses for environmental matters other than FIFRA will be approximately
$290 thousand in fiscal 2000. The Company expensed approximately $721
thousand for penta and creosote testing costs under FIFRA in fiscal 1999 and
approximately $331 thousand for penta testing in fiscal 1998. Much of the
FIFRA testing and data submission costs pertaining to penta have already been
incurred and thus management believes that total FIFRA testing costs will
decline to approximately $540 thousand in fiscal 2000. 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.
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 beyond the continuation of periodic
monitoring. The Company does not believe that costs for environmental
investigation and remediation 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.
10
<PAGE>
YEAR 2000 COMPLIANCE
The Company has reviewed its critical accounting and information
systems for Year 2000 compliance and remedied deficiencies by upgrades to
Year 2000 compliant applications and hardware. The cost of these upgrades was
less than $10 thousand. The Company has sought verification from its key
suppliers that they are Year 2000 compliant and asked, if they are not yet so
compliant, those suppliers to provide a description of their plans to become
so. Positive assurances have been received from most of the Company's key
suppliers. The Company has received no indication from any key supplier that
a disruption will occur. However, if suppliers and other third parties with
whom the Company conducts business do not successfully address Year 2000
issues, the Company's business, operating results and financial position
could be materially and adversely affected. As a contingency plan, therefore,
the Company intends to mitigate a portion of that risk by increasing its
finished products and raw materials inventory. Management believes that the
cost of carrying the additional inventory will not be material to the
Company's financial position or results of operations.
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
In June 1998, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standard No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133
establishes accounting and reporting standards for derivative instruments and
hedging activities that require an entity to recognize all derivatives as an
asset or liability measured at fair value. Depending on the intended use of
the derivatives, changes in fair value will be reported in the period of
change as either a component of earnings or a component of other
comprehensive income. In June 1999, FASB deferred SFAS for one year when it
issued SFAS 137, "Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of FASB Statement No. 133." SFAS
133 will be effective for the Company beginning with the first quarter of
fiscal 2001.
In June 1997, FASB issued Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income." That statement
establishes standards for reporting and displaying comprehensive income and
its components in a financial statement with the same prominence as other
financial statements. The purpose of reporting comprehensive income is to
report a measure of all changes in equity of an
11
<PAGE>
enterprise that result from recognized transactions and other economic events
of the period other than transactions with owners in their capacity as
owners. As of July 31, 1999, there are no adjustments (Other Comprehensive
Income) to net income in deriving comprehensive income.
ITEM 7. FINANCIAL STATEMENTS
INDEX TO FINANCIAL STATEMENTS
FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Independent Auditors' Report 13
Consolidated Balance Sheets as of July 31, 1999
and 1998 14
Consolidated Statements of Income for the Years Ended
July 31, 1999 and 1998 15
Consolidated Statements of Stockholders' Equity
for the Years Ended July 31, 1999
and 1998 16
Consolidated Statements of Cash Flows for the
Years Ended July 31, 1999 and 1998 17
Notes to Consolidated Financial Statements 18
</TABLE>
12
<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, 1999 and
1998, 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, 1999 and 1998, 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
October 8, 1999
13
<PAGE>
KMG CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JULY 31, 1999 AND 1998
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ASSETS 1999 1998
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 4,847,886 $ 2,207,948
Accounts receivable:
Trade, net of allowance for doubtful accounts of $120,000
and $50,000 in 1999 and 1998, respectively 3,258,384 3,570,508
Other 63,549 77,765
Note receivable - current portion 361,165 36,311
Inventories 2,544,613 1,751,346
Prepaid expenses and other current assets 228,168 152,382
------------- ------------
Total current assets 11,303,765 7,796,260
PROPERTY, PLANT, AND EQUIPMENT - Net of accumulated depreciation 2,300,138 2,382,913
NOTE RECEIVABLE, Less current portion 400,607 408,912
DEFERRED TAX ASSET 251,498 137,544
OTHER ASSETS 8,535,927 9,373,372
------------- ------------
TOTAL $ 22,791,935 $ 20,099,001
============== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 3,620,999 $ 3,342,270
Accrued liabilities 975,723 533,511
Current portion of long-term debt 809,810 679,241
------------- ------------
Total current liabilities 5,406,532 4,555,022
LONG-TERM DEBT 3,427,360 5,268,301
------------- ------------
Total liabilities 8,833,892 9,823,323
------------- ------------
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 1999 and 1998 70,002 70,002
Additional paid-in capital 1,063,385 1,063,385
Retained earnings 12,824,656 9,142,291
-------------- ------------
Total stockholders' equity 13,958,043 10,275,678
-------------- ------------
TOTAL $ 22,791,935 $ 20,099,001
============== ============
</TABLE>
See notes to consolidated financial statements.
14
<PAGE>
KMG CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED JULY 31, 1999 AND 1998
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
NET SALES $36,388,799 $22,657,208
COST OF SALES 23,566,923 14,083,252
----------- -----------
Gross profit 12,821,876 8,573,956
SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES 6,765,537 3,917,205
----------- -----------
Operating income
6,056,339 4,656,751
OTHER INCOME (EXPENSE):
Interest income 203,796 212,775
Interest expense (387,599) (39,040)
Gain on sale of securities 343,471
Other, net 179,669 (3,178)
----------- -----------
Total other income (expense), net (4,134) 514,028
----------- -----------
INCOME BEFORE INCOME TAXES 6,052,205 5,170,779
PROVISION FOR INCOME TAXES 2,299,838 1,964,901
----------- -----------
NET INCOME $ 3,752,367 $ 3,205,878
=========== ===========
EARNINGS PER COMMON SHARE:
Basic $ 0.54 $ 0.46
=========== ===========
Diluted $ 0.53 $ 0.46
=========== ===========
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic 7,000,169 7,000,169
=========== ===========
Diluted 7,063,271 7,044,814
=========== ===========
</TABLE>
See notes to consolidated financial statements.
15
<PAGE>
KMG CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED JULY 31, 1999 AND 1998
- -------------------------------------------------------------------------------
<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, 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
Dividends (70,002) (70,002)
Net income 3,752,367 3,752,367
----------- --------- ------------ ------------ ------------
BALANCE AT
JULY 31, 1999 7,000,169 $70,002 $1,063,385 $12,824,656 $13,958,043
=========== ========= ============ ============ ============
</TABLE>
See notes to consolidated financial statements.
16
<PAGE>
KMG CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED JULY 31, 1999 AND 1998
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 3,752,367 $ 3,205,878
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 1,042,399 319,007
Gain on sale of securities (343,471)
Loss (gain) on sale or abandonment of equipment 501 (6,032)
Deferred income tax benefit (113,954) (34,881)
Changes in operating assets and liabilities:
Accounts receivable - trade 312,124 (1,304,287)
Accounts receivable - other 14,216 131,333
Inventories (793,267) (568,062)
Prepaid expenses and other current assets (75,786) (39,223)
Accounts payable 278,729 1,870,961
Accrued liabilities 582,216 (136,061)
----------- ----------
Net cash provided by operating activities 4,999,545 3,095,162
----------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant, and equipment (228,871) (819,654)
Proceeds from sale of securities 432,511
Proceeds from sale of equipment 801 7,000
Loans to related parties (324,854) (200,000)
Collection of notes receivable 8,305 7,784
Additions to other assets (8,564) (8,765,464)
Collection of other assets 113,954
----------- ----------
Net cash used in investing activities (439,229) (9,337,823)
----------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from notes payable 6,000,000
Payment of dividends (210,006) (140,003)
Principal payments on borrowings (1,710,372) (52,458)
----------- ----------
Net cash (used in) provided by financing activities (1,920,378) 5,807,539
----------- ----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 2,639,938 (435,122)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 2,207,948 2,643,070
----------- ----------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 4,847,886 $ 2,207,948
=========== ==========
SUPPLEMENTAL DISCLOSURES FOR CASH FLOW INFORMATION:
Cash paid during the year for interest $ 387,599 $ 39,040
Cash paid during the year for income taxes $ 2,298,187 $ 2,058,159
NONCASH TRANSACTION - Dividends declared $ 140,004
</TABLE>
See notes to consolidated financial statements.
17
<PAGE>
KMG CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JULY 31, 1999 AND 1998
- -------------------------------------------------------------------------------
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") and creosote. Penta-manufacturing
operations are conducted through KMG de Mexico ("KMEX"), a Mexican
corporation and 99.98 percent 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 Company has two
main suppliers of creosote. The Company sells creosote throughout the
United States.
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 percent 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 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.
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.
18
<PAGE>
CASH AND CASH EQUIVALENTS - The Company considers all investments with
maturities of three months or less when purchased 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 less accumulated depreciation and amortization. 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 $310,344
and $235,916 in 1999 and 1998, 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 - 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.
CURRENCY TRANSLATION - The U.S. dollar is the functional currency for the
Company's foreign operations. For those operations, remeasurement to U.S.
dollars from currency translations are included in the statement of
income.
STOCK-BASED COMPENSATION - In 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.
INTANGIBLE ASSETS - For financial statement purposes, intangible assets
are being amortized using the straight-line method over the estimated
useful lives of the assets (see Note 6).
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
19
<PAGE>
debt at July 31, 1999 and 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.
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 1998, the Financial Accounting Standards
Board ("FASB") issued Statement of Financial Accounting Standard No. 133,
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS
133"). SFAS 133 establishes accounting and reporting standards for
derivative instruments and hedging activities that require an entity to
recognize all derivatives as an asset or liability measured at fair value.
Depending on the intended use of the derivatives, changes in fair value
will be reported in the period of change as either a component of earnings
or a component of other comprehensive income. In June 1999, FASB issued
SFAS 137, "Accounting for Derivative Instruments and Hedging Activities
- Deferral of the Effective Date of FASB Statement No. 133," which defers
the effective date of SFAS 133 for one year. SFAS 133 will be effective
for the Company for fiscal quarters starting after June 15, 2000. The
Company has not finalized the quantification of the effects of adopting
SFAS 133 on its consolidated financial statements.
RECLASSIFICATIONS - Financial statement amounts in 1998 have been
reclassified to conform to the 1999 presentation.
2. INVENTORIES
Inventories are summarized as follows:
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
Chemical raw materials and supplies $ 317,264 $ 421,081
Finished chemical products 2,227,349 1,330,265
---------- ----------
Total $2,544,613 $1,751,346
========== ==========
</TABLE>
20
<PAGE>
3. PROPERTY, PLANT, AND EQUIPMENT
Property, plant, and equipment and related accumulated depreciation and
amortization are summarized as follows:
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
Land $ 302,527 $ 302,527
Buildings 1,103,061 1,034,487
Equipment 2,738,846 2,586,459
Leasehold improvements 21,502 5,337
Construction-in-progress 46,534 69,506
----------- -----------
4,212,470 3,998,316
Less accumulated depreciation
and amortization (1,912,332) (1,615,403)
----------- -----------
Total $ 2,300,138 $ 2,382,913
=========== ===========
</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 aggregate exchange gains of $15,416 and $12,230
in 1999 and 1998, respectively.
5. INCOME TAXES
The geographical sources of income before income taxes for the two years
ended July 31, 1999 and 1998 were as follows:
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
United States $5,661,546 $4,842,086
Foreign 390,659 328,693
---------- ----------
Income before income taxes $6,052,205 $5,170,779
========== ==========
The provision for income taxes consisted of the following:
1999 1998
Current federal provision $2,076,502 $1,724,311
Current foreign provision 144,544 122,088
Current state provision 192,746 153,383
Deferred income tax benefit (113,954) (34,881)
---------- ----------
Total $2,299,838 $1,964,901
========== ==========
</TABLE>
21
<PAGE>
Deferred income taxes are provided on all temporary differences between
financial and taxable income. Significant components of the Company's
deferred tax assets and liabilities as of July 31, 1999 and 1998 are as
follows:
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
Deferred tax assets (liabilities):
Inventory $ 19,944 $ 13,236
Bad debt expense 72,150 27,750
Difference in depreciable basis of property 118,929 104,218
Difference in amortization basis of intangibles 40,475 (7,660)
--------- ---------
Total $ 251,498 $ 137,544
========= =========
</TABLE>
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>
1999 1998
<S> <C> <C>
Provision for income taxes at the statutory rate $1,997,436 $1,758,064
State income taxes 157,858 153,383
Other 144,544 53,454
---------- ----------
Total $2,299,838 $1,964,901
========== ==========
</TABLE>
6. OTHER ASSETS
Other assets consisted of the following:
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
Intangible assets, net of accumulated amortization of $325,000
in 1999 and $25,000 in 1998 $4,175,000 $4,475,000
Creosote supply contract, net of accumulated amortization of
$433,335 in 1999 and $33,337 in 1998 3,566,665 3,966,663
Advances for premiums on employee-owned life
insurance policies (see Note 9) 373,191 334,352
Licensing agreement, net of accumulated amortization of
$132,024 in 1999 and $109,167 in 1998 187,976 210,833
Other 233,095 386,524
---------- ----------
Total $8,535,927 $9,373,372
========== ==========
</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,
22
<PAGE>
respectively. The supply contract is being amortized on a straight-line
basis over a 10-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.
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 one-fourth percent 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, 1999 or 1998. 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. Starting August 1, 1998, the Company began making monthly
principal and interest payments of $91,498 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
percent per annum. At July 31, 1999, 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. During 1999, prepayments of
$1,000,000 on the term loan note were made by the Company.
The term loan note at July 31, 1999 matures as follows:
<TABLE>
<CAPTION>
YEAR ENDING
JULY 31,
<S> <C>
2000 $ 809,810
2001 875,725
2002 942,225
2003 1,013,776
2004 595,634
----------
Total $4,237,170
==========
</TABLE>
23
<PAGE>
8. COMMITMENTS AND CONTINGENCIES
COMMITMENTS
OPERATING LEASES - The Company has noncancelable operating leases for its
office and warehouse facilities and certain transportation equipment. At
July 31, 1999, the Company was obligated under these leases for the
following future minimum lease commitments:
<TABLE>
<S> <C>
2000 $405,545
2001 80,315
2002 44,000
-------
Total $529,860
========
</TABLE>
Rent expense relating to the operating leases was $317,361 and $178,878 in
1999 and 1998, respectively.
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. In addition, since June 1998 when the Company
acquired certain creosote labels, the Company has participated as a member
in a similar industry group funding a creosote research and testing
program. Costs incurred by the Company of approximately $721,000 and
$331,000 in fiscal years 1999 and 1998, respectively, are included in
general and administrative expenses.
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 $540,000 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.
24
<PAGE>
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 noninterest 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 8%, with installment
starting May 15, 2000. The 1994 note is due in semimonthly installments of
$1,000, including interest at 6.5 percent. The amount outstanding under
these notes was $436,918 and $445,223 at July 31, 1999 and 1998,
respectively.
In August 1998, the Company purchased a $200,000 participation in a loan
by Sterling Bank to National Health Capital, Ltd. ("NHC"), a limited
partnership engaged in purchasing medical receivables. In November 1998,
the Company made an additional loan of $200,000 to NHC. At the time of
these transactions, directors of the Company were directors of the general
partner of NHC, limited partners in NHC and one director was president of
NHC. NHC ceased operations in 1999 and is now in the process of recovering
on its assets and winding up its business. Both loans were modified and
renewed as of October 1999. The participation loan bears no interest and
is due August 20, 2000. The second loan bears interest at 12% per annum
and is due on September 30, 2000. At the end of fiscal 1999, the aggregate
outstanding balance on the two loans was $325,000. The participation loan
has been partially personally guaranteed by a director of the Company.
Both the participation and the additional loan have been personally
guaranteed by the Company's President.
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 percent to
15 percent of their compensation, and the Company makes matching
contributions under this plan equal to 3 percent of the participants'
compensation. Company contributions to the plan totaled approximately
$46,000 and $23,000 in 1999 and 1998, respectively.
11. SIGNIFICANT CUSTOMERS
The Company had one significant customer in 1999 whose sales as a
percentage of total sales were 15% and one significant customer in 1998
whose sales as a percentage of total sales was 11.5%.
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
25
<PAGE>
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.
In 1999 the Company granted an option to acquire 40,000 shares of common
stock to Halter Financial Group, Inc. in consideration for investor
relations consulting services. The option is exercisable at a price of
$5.00 per share of common stock, is subject to a vesting requirement and
may be exercised for 5 years from the date of vesting. These options will
vest, if before January 1, 2000 the average closing price equals or
exceeds $9.00 per share for 10 consecutive trading days. Also in 1999 the
Company granted warrants to acquire 25,000 shares of common stock to JP
Turner & Company L.L.P. for consulting services as requested by the
Company and pertaining to the evaluation of acquisition and financing
transactions and to investor relations. The warrants are exercisable at a
price of $5.50 per share of common stock through March 17, 2003.
Stock option and warrants activity for the Company during fiscal years
1999 and 1998 was as follows:
<TABLE>
<CAPTION>
1999 1998
--------------------- ------------------------
WEIGHTED- WEIGHTED-
NUMBER AVERAGE NUMBER AVERAGE
OF EXERCISE OF EXERCISE
SHARES PRICE SHARES PRICE
<S> <C> <C> <C> <C>
Stock options and warrants outstanding,
beginning of year 70,171 $ 1.73 43,671 $ 0.216
Grant 90,000 5.21 26,500 4.24
------ ------ ------ -------
Stock options and warrants outstanding,
end of year 160,171 $ 3.69 70,171 $ 1.73
======= ====== ====== =======
<CAPTION>
OPTIONS AND WARRANTS OUTSTANDING AS OF JULY 31, 1999 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 5.22 $0.22 43,671 $0.22
4.13 - 5.50 116,500 8.46 4.99 33,500 5.21
</TABLE>
At July 31, 1999, options were exercisable for 77,171 shares at a
weighted-average exercise price of $2.38. The remaining contractual life
of these options was approximately 5.52 years. At July 31, 1999, 604,829
shares were available for future option grants.
26
<PAGE>
The weighted-average fair value of options granted during 1999 and 1998
was $95,488 and $25,970, respectively. The effect of these options would
have decreased basic and diluted EPS by $.02 per share and $.01 per share,
respectively, during 1999, and would have decreased both basic and diluted
EPS by $.01 per share during 1998. 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 1999 and 1998:
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
Weighted-average expected life: 11.94 8.45
Volatility factor: 45% 45%
Dividend yield: 0.2% 1%
Weighted-average risk-free interest: 6.4% 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, 1999 YEAR ENDED JULY 31, 1998
------------------------------------------ ------------------------------------------
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 $3,752,367 7,000,169 $ 0.54 $3,205,878 7,000,169 $0.46
EFFECT OF DILUTIVE
SECURITIES
Common stock
options 63,102 (0.01) 44,645
---------- --------- ------ ---------- --------- -----
DILUTED EPS
Income available to
common
stockholders $3,752,367 7,063,271 $ 0.53 $3,205,878 7,044,814 $0.46
========== ========= ====== ========== ========= =====
</TABLE>
On August 26, 1999, the Company declared a dividend of $.02 per share,
payable September 30, 1999, to common shareholders of record as of
September 15, 1999.
27
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
Pursuant to instruction E.3 to Form 10-KSB, the information required by
Items 9-12 of Part III is incorporated by reference from the Company's
definitive proxy statement to be filed on or about October 29, 1999.
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.*
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.*
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.***
28
<PAGE>
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.****
10.20 Creosote Supply Agreement dated November 1, 1998 between
Rutgers VFT and the Company*****
10.21 Option to Purchase 40,000 Shares of Common Stock dated as of
September 16, 1998 between the Company and Halter Financial
Group, Inc.
10.22 Warrant for the Purchase of 25,000 Shares of Common Stock
dated as of March 17, 1999 between the Company and JP Turner
& Company, L.L.P.
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. The documents marked by a (*****) was filed by the Company on
March 12, 1999 as part of its report on Form 10-QSB under file number 000-29278.
(b) No reports on Form 8-K were filed by the Company during the quarter ended
July 31, 1999.
29
<PAGE>
SIGNATURES
In accordance with the Exchange Act, the Company caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
KMG CHEMICALS, INC.
By: /s/ David L. Hatcher Date: October 25, 1999
------------------------------
David L. Hatcher, President
and Chairman
In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the registrant and in the capacities and
on the dates indicated.
By: /s/ Jack Vernie Date: October 25, 1999
------------------------------
Jack Vernie, Controller
By: /s/ Bobby D. Godfrey Date: October 25, 1999
------------------------------
Bobby D. Godfrey, Director
By: /s/ George W. Gilman Date: October 25, 1999
------------------------------
George W. Gilman, Director
By: /s/ Fred C. Leonard III Date: October 25, 1999
------------------------------
Fred C. Leonard III, Director
By: /s/ Charles M. Neff, Jr. Date: October 25, 1999
------------------------------
Charles M. Neff, Jr., Director
<PAGE>
NEITHER THIS OPTION NOR THE SHARES ISSUABLE UPON EXERCISE HEREOF HAVE BEEN
REGISTERED UNDER THE SECURITIES ACT OF 1933, AND NEITHER THIS OPTION NOR THE
SHARES OF COMMON STOCK ISSUABLE UPON EXERCISE OF THIS OPTION MAY BE SOLD,
TRANSFERRED OR OTHERWISE DISPOSED OF EXCEPT AS EXPRESSLY PERMITTED UNDER THE
TERMS OF THIS OPTION.
OPTION TO PURCHASE 40,000 SHARES
OF COMMON STOCK
of
KMG CHEMICALS, INC.
THIS OPTION AGREEMENT ("Option") is executed effective as of September 16, 1998,
by and between HALTER FINANCIAL GROUP, INC. ("Holder"), a Texas corporation, and
KMG CHEMICALS, INC. ("Company"), a Texas corporation, and pursuant to which
Holder is entitled to purchase an aggregate of Forty Thousand (40,000) shares of
the common stock, $.01 par value, of Company (such shares of the common stock of
Company to which an option is being granted herein called the "Option Shares"
and shares of common stock, $0.01 par value, of Company being herein called the
"Common Stock"), upon payment of the exercise price $5.00 per Option Share (the
"Exercise Price"), which price constitutes fair market value on the Nasdaq
SmallCap Market for Common Stock on the date hereof, in accordance with the
terms and conditions hereof.
1. VESTING OF OPTION SHARES. Holder shall not be entitled to purchase
Option Shares until such shares shall become vested ("Vested Shares"). The
Option Shares shall vest and become Vested Shares, provided the other conditions
of this Option are met, if before January 1, 2000 the average of the closing bid
and asked quotations for Common Stock on the Nasdaq SmallCap Market equals or
exceeds $9.00 per share for ten (10) consecutive trading days. Option Shares
which are not Vested Shares prior to January 1, 2000 shall not become Vested
Shares.
2. OPTION PERIOD AND EXERCISE OF OPTION. Holder may exercise the Option
for Vested Shares within five (5) years after the date upon which such shares
become Vested Shares ("Option Period").
If an Option shall be exercised by the legal representative of a
deceased Holder, or by a person who acquired an Option by bequest or inheritance
or by reason of the death of any Holder, written notice of such exercise shall
be accompanied by
<PAGE>
a certified copy of letter testamentary or equivalent proof of the right of
such legal representation or other person to exercise such Option.
In no event, however, shall any person be entitled to exercise any
Option after the expiration of the period of exerciseability of such Option as
specified herein.
The Option shall be exercised upon delivery of written notice to the
Company setting forth the number of Vested Shares with respect to which this
Option is being exercised, and specifying a business day not more than fifteen
(15) days nor less than five (5) days from the date such notice is given, for
the payment of the Exercise Price against delivery of the Vested Shares being
purchased. Notice shall be delivered in person or by registered mail, return
receipt requested, addressed to the Company at 10611 Harwin, Suite 402, Houston,
Texas 77036, or at such other office as the Company may designate by written
notice to the Holder, and shall be deemed received on actual delivery or within
three (3) days after the date such notice is deposited in the mail.
Subject to the terms of this Option, the Company shall cause
certificates for the Vested Shares so purchased to be delivered to the Holder at
the address specified by the Holder and on the date specified in the notice of
exercise or as soon thereafter as is reasonably practicable, and in any event
within ten (10) days, against payment of the full Exercise Price in cash or
certified check, in form and substance satisfactory to Company; provided,
however, that in lieu of cash or certified check, the Holder may to the extent
permitted by applicable law, exercise this Option in whole or in part, by having
the Company withhold shares of Vested Stock being purchased which have an
aggregate fair market value equal to the Exercise Price of the Vested Shares as
to which the Option is being exercised. The fair market value of the Vested
Shares so withheld shall be the higher of (i) the average of the closing bid and
asked quotations or (ii) the closing transaction, on the Nasdaq SmallCap Market,
Nasdaq National Market or other exchange where the Common Stock of the Company
is listed as of the date immediately preceding the date on which the Option is
exercised (or on the closest date preceding such date for which such quotations
are available), or as may be required in order to comply with or to conform to
the requirements of any applicable laws or regulations.
This Option may be exercised either in whole or in part and, if in
part, from time to time in part; provided, however, that this Option may not be
exercised for less than One Hundred (100) Vested Shares (or such lesser number
of Vested Shares as is covered by this Option); and, provided further, that this
Option may only be exercised by the Holder for the purchase of whole Vested
Shares and not fractions thereof.
2
<PAGE>
The Vested Shares so purchased shall be and are deemed to be
transferred to the Holder as the record owner of such Vested Shares as of the
close of business on the date on which this Option shall have been exercised and
payment shall have been made for such Vested Shares as aforesaid.
3. RESERVATION OF STOCK. The Company covenants and agrees that (a) it
has or will at all appropriate times, so long as this Option is outstanding,
reserve and keep available out of its treasury, Common Stock or authorized but
unissued Common Stock, solely for the purpose of issuing shares, from time to
time, upon the exercise of this Option, an adequate number of shares of Common
Stock for delivery at the times and in the manner provided herein upon exercise
of this Option; (b) the shares delivered upon exercise of the Option shall be
validly issued and outstanding and fully paid and nonassessable shares of Common
Stock; and (c) it will pay when due any and all Federal and state original issue
or similar taxes which may be payable in respect of the issuance of the Option
or of any shares of Common Stock upon exercise of the Option. The Company shall
not, however, be required to pay any transfer tax which may be payable with
respect to any transfer of the Option, the issuance of certificates of Common
Stock in a name other than that of the Holder or any transfer of shares, all
such tax being payable by the Holder.
4. RESTRICTIONS ON TRANSFER. This Option shall not be transferable,
whether by operation of law or otherwise, other than by will or the laws of
descent and distribution, and this Option shall be exercisable, during the
lifetime of the Holder, only by such Holder. No sale, transfer or other
disposition of any of the Option Shares shall be made by the Holder thereof
unless (i) such sale, transfer or other disposition of the Option Shares is
covered by an effective registration statement (on the then appropriate form)
under the Securities Act of 1933 ("Act"), or (ii) if requested by the Company,
the Holder shall have furnished an opinion of Holder's counsel (which opinion
and counsel shall be satisfactory to the Company in its reasonable discretion)
with respect to the sale, transfer or other disposition of such Option Shares as
not requiring registration under the Act and state laws or regulations or (iii)
the Holder sells such Option Shares in full compliance with all of the
provisions of Rule 144 promulgated under the Act, as the same is then in effect,
or of a successor or similar rule ("Rule") of the Securities and Exchange
Commission ("Commission"), affording an exemption from the registration
requirements of the Act in the circumstances and provides the Company with such
supporting documentation as may be required by law.
3
<PAGE>
Certificates representing the Option Shares purchased by Holder shall be
stamped or otherwise imprinted with a legend substantially in the following
form:
The shares represented by this certificate have not been registered under
the Securities Act of 1933 (the "Act") and are "restricted securities" as
that term is defined in Rule 144 under the Act. These shares may not be
offered for sale, sold or otherwise transferred except pursuant to an
effective registration statement under the Act, or pursuant to an exemption
from registration under the Act, the availability of which is to be
established by the Company.
5. CHANGES IN THE COMPANY'S CAPITAL STRUCTURE. The existence of this
Option shall not affect in any way the right or power of the Company or its
stockholders to make or authorize any or all adjustments, recapitalization,
reorganizations or other changes in the Company's capital structure or its
business, or any merger or consolidation of the Company, or any issue of bonds,
debentures, common stock, preferred or prior preference stock ahead of or
affecting the Common Stock or the rights thereof, or the dissolution or
liquidation of the Company, or any sale or transfer of all or any part of its
assets or business, or any other corporate act or proceeding, whether of a
similar character or otherwise.
If the Company shall effect a subdivision or consolidation of shares
or other capital readjustment, the payment of a stock dividend or other increase
or reduction of the number of shares of the Common Stock outstanding without
receiving compensation therefor in money, services or property, then (i) the
number, class and per share Exercise Price of shares subject to this Option
shall be appropriately adjusted in such a manner as to entitle the Holder to
receive upon exercise of this Option, for the same consideration, the same total
number and class of shares or other securities as the Holder would have received
had the Holder exercised this Option in full immediately prior to the event
requiring the adjustment; and (ii) the number and class of shares then reserved
for issuance pursuant to this Option shall be adjusted by substituting for the
total number and class of shares then reserved that number and class of shares
of Common Stock and other securities that would have been received by the Holder
of an equal number of outstanding shares of Common Stock as a result of the
event requiring the adjustment.
After a merger of one or more corporations into the Company, or after
a consolidation of the Company and one or more corporations in which the Company
shall be the surviving corporation, the Holder shall, at no additional cost, be
entitled upon exercise of this Option to receive (subject to any required action
by stockholders) in lieu of the Option Shares, the number and class of shares of
Common Stock or other securities to which the Holder would have been entitled
pursuant to the terms of the
4
<PAGE>
agreement of merger or consolidation if, immediately prior to such merger or
consolidation, the Holder had been the holder of record of the Option Shares.
If the Company is merged into or consolidated with another corporation
under circumstances in which the Company is not the surviving corporation, or if
the Company is liquidated, sells or otherwise disposes of substantially all its
assets to another corporation while this Option is outstanding, (i) subject to
the provisions of clause (ii) below, after the effective date of such merger,
consolidation, liquidation or sale, as the case may be, the Holder shall be
entitled, upon exercise of this Option, to receive, in lieu of the Option
Shares, shares of such stock or other securities as the holders of shares of
Common Stock received pursuant to the terms of the merger, consolidation,
liquidation or sale, or (ii) the Option may be canceled by the Company as of the
effective date of any such merger, consolidation, liquidation or sale provided
(x) notice of such cancellation shall be given to the Holder and (y) the Holder
shall have the right to exercise this Option for Vested Shares in full during
the 30-day period preceding the effective date of such merger, consolidation,
liquidation or sale.
Except as hereinbefore expressly provided in this Section, the
issuance by the Company of shares of stock of any class, or securities
convertible into shares of stock of any class, for cash or property, or for
labor or services, either upon direct sale or upon the exercise of rights or
warrants to subscribe therefor, or upon conversion of shares or obligations of
the Company convertible into such shares or other securities, shall not affect,
and no adjustment by reason thereof shall be made with respect to, this Option.
6. NO RIGHTS AS STOCKHOLDER. The Holder shall not, based solely on his
being a Holder, be entitled to vote or receive dividends or be deemed the holder
of Common Stock or any other security of the Company which may at any time be
issuable on the exercise hereof for any purpose, nor shall anything contained
herein be construed to confer upon the Holder of this Option, as such, any of
the rights of a stockholder of the Company or any right to vote for the election
of directors or upon any matter submitted to stockholders at any meeting
thereof, or to give or withhold consent to any corporate action (whether upon
any recapitalization, issue of stock, reclassification of stock, change to or of
par value, consolidation, merger, conveyance, or otherwise) or to receive notice
of meetings, or to receive dividends or subscription rights or otherwise except
for that portion of Vested Shares in respect of which this Option has been
exercised and payment made.
7. NONNEGOTIABILITY. The Holder of this Option, by accepting the same,
consents and agrees with the Company that this Option is not transferable, in
whole or in part, except pursuant to the laws of descent and distribution.
5
<PAGE>
8. MODIFICATIONS. This Option and any term hereof may be changed,
waived, discharged or terminated only by an instrument in writing signed by the
party against whom enforcement of such change, waiver, discharge or termination
is sought.
9. NOTICES. Any notice to be given to the Company under the terms hereof
shall be addressed to the Company at the address set forth hereinabove and any
notice to the Holder shall be addressed to the Holder's address as reflected on
the signature page of this Option, or at such other address as the Company and
the Holder may hereafter designate in writing to the other. Any such notice
shall have been deemed given when actually received or on the third day after it
is enclosed in a properly sealed envelope or wrapper addressed as aforesaid,
registered or certified and deposited (postage and registry or certification fee
prepaid) in a post office regularly maintained by the United States Government.
10. VIOLATION OF LAW. In addition to any other restrictions contained in
this Option, the Holder may not exercise this Option, in whole or in part at
such times and from time to time as, in the reasonable opinion of counsel to the
Company, the issuance and sale to Holder of the Option Shares, upon exercise of
this Option, is not exempt from the registration provisions of the Act (unless
the Option and/or Option Shares, as applicable, have been registered under the
Act), or violates other applicable laws or regulations. The Company shall use
its best efforts to cure such violation and/or potential violation so as to
permit exercise of this Option.
11. FORMS OF ELECTION TO EXERCISE OPTION. Any notice of exercise shall be
in a form substantially similar to the form attached hereto as EXHIBIT A.
12. SUCCESSORS AND ASSIGNS. This Option and each provision herein shall
be binding upon and applicable to, and shall inure to the benefit of the Company
and the Holder, their successors, assigns, heirs and representatives, except as
otherwise specifically provided in this Option.
13. GENDER, SECTION REFERENCES. Pronouns, wherever used herein, and of
whatever gender, shall include natural persons, corporations and entities of
every kind, the singular shall include the plural wherever and as often as may
be appropriate and the plural shall include the singular wherever and as often
as may be appropriate. The section titles and subtitles ("Titles") used in this
Option are solely for convenience of reference and shall not affect, modify nor
limit the provisions of this Option. Any reference to a particular Title in
this Option shall be construed as referring to the provisions in the indicated
Title within this Option.
14. SEVERABILITY. If any provision of this Option, or the application of
such provision to any person or circumstance, shall be held invalid or
unenforceable for any
6
<PAGE>
reason, the remainder of this Option, or the application of such provision to
persons or circumstances other than those to which it is held invalid or
unenforceable, shall not be affected thereby.
15. GOVERNING LAWS. This Option shall be interpreted, construed, and
enforced in accordance with the laws of the State of Texas.
DATED effective as of the date first above written.
COMPANY:
KMG CHEMICALS, INC.
By: /s/ David L. Hatcher
---------------------------------
David L. Hatcher,
President
HOLDER:
HALTER FINANCIAL GROUP, INC.
/s/ Timothy P. Halter
------------------------------------
Timothy P. Halter
President
Holder Address:
14160 Dallas Parkway, Suite 950
Dallas, Texas 75240
7
<PAGE>
EXHIBIT A
ELECTION TO EXERCISE OPTION
The undersigned, HALTER FINANCIAL GROUP, INC., pursuant to the provisions
of an Option dated effective September 16, 1998, hereby elects to purchase
_________________ (________) shares of common stock of the Company covered by
such Option.
HALTER FINANCIAL GROUP, INC.
Dated:
-------------------- --------------------------------------
Title:
--------------------------------
Holder Address:
14160 Dallas Parkway, Suite 950
Dallas, Texas 75240
<PAGE>
VOID AFTER 5:00 P.M. CENTRAL TIME, ON MARCH 17, 2003
NEITHER THIS WARRANT NOR THE WARRANT STOCK HAS BEEN REGISTERED UNDER THE
SECURITIES ACT OF 1933. THE COMPANY WILL NOT TRANSFER THIS WARRANT OR THE
WARRANT STOCK UNLESS (i) THERE IS AN EFFECTIVE REGISTRATION COVERING SUCH
WARRANT OR SUCH WARRANT STOCK, AS THE CASE MAY BE, UNDER THE SECURITIES ACT OF
1933 AND APPLICABLE STATE SECURITIES LAWS, (ii) IT FIRST RECEIVES A LETTER FROM
AN ATTORNEY, ACCEPTABLE TO THE BOARD OF DIRECTORS OR ITS AGENTS, STATING THAT IN
THE OPINION OF THE ATTORNEY THE PROPOSED TRANSFER IS EXEMPT FROM REGISTRATION
UNDER THE SECURITIES ACT OF 1933 AND UNDER ALL APPLICABLE STATE SECURITIES LAWS,
OR (iii) THE TRANSFER IS MADE PURSUANT TO RULE 144 UNDER THE SECURITIES ACT OF
1933.
KMG CHEMICALS, INC.
(a Texas corporation)
Warrant for the Purchase of 25,000 Shares
of Common Stock
par value $0.01 per share
FOR VALUE RECEIVED, KMG CHEMICALS, INC. ("Company"), a Texas corporation, hereby
certifies that JP TURNER & COMPANY, L.L.P., or assigns ("Holder"), is entitled,
subject to the provisions of this Warrant, to purchase from the Company at any
time, or from time to time during the period commencing on the date hereof and
expiring at 5:00 p.m. Central Time, on March 17, 2003 ("Expiration Date"), up to
Twenty-Five Thousand (25,000) fully paid and non-assessable shares of Common
Stock at a price of $5.50 per share ("Exercise Price").
The term "Common Stock" means the Common Stock, par value $0.01 per share, of
the Company as constituted on March 17, 1999 ("Base Date"), together with any
other equity securities that may be issued by the Company in respect thereof or
in substitution therefor. The number of shares of Common Stock to be received
upon the exercise of this Warrant may be adjusted from time to time as
hereinafter set forth. The shares of Common Stock deliverable or delivered upon
such exercise, as adjusted from time to time, are hereinafter referred to as
"Warrant Stock."
Upon receipt by the Company of evidence reasonably satisfactory to it of the
loss, theft, destruction or mutilation of this Warrant certificate, and (in the
case of loss, theft or destruction) of satisfactory indemnification, and upon
surrender and
<PAGE>
cancellation of this Warrant certificate, if mutilated, the Company shall
execute and deliver a new Warrant certificate of like tenor and date.
1. EXERCISE OF WARRANT. This Warrant may be exercised, subject to
the requirements set forth below, in whole, or in part, at any time during the
period commencing on the date hereof and expiring at 5:00 p.m. Central Time on
the Expiration Date set forth above, or, if such day is a day on which banking
institutions in Houston, Texas are authorized by law to close, then on the next
succeeding day that shall not be such a day, by presentation and surrender of
this Warrant certificate to the Company at its principal office, or at the
office of its stock transfer agent, if any, with the Warrant Exercise Form
attached hereto duly executed and accompanied by payment (either in cash or by
certified or official bank check, payable to the order of the Company) of the
aggregate Exercise Price for the number of shares specified in such form and
instruments of transfer, if appropriate, duly executed by the Holder. If this
Warrant should be exercised in part only, the Company shall, upon surrender of
this Warrant certificate for cancellation, execute and deliver a new Warrant
certificate evidencing the rights of the Holder thereof to purchase the balance
of the shares purchasable hereunder. Upon receipt by the Company of this
Warrant certificate, together with the Exercise Price, at its office, or by the
stock transfer agent of the Company at its office, if any, in proper form for
exercise as described above, together with an agreement to comply with the
restrictions on transfer and related covenants contained herein and a
representation as to investment intent and any other matter required by counsel
to the Company, signed by the Holder (and if other than the original Holder
accompanied by proof, satisfactory to counsel for the Company, of the right of
such person or persons to exercise the Warrant), the Holder shall be deemed to
be the holder of record of the shares of Common Stock issuable upon such
exercise, even if the stock transfer books of the Company shall then be closed
or certificates representing such shares of Common Stock shall not have been
delivered to the Holder. The Holder shall pay any and all documentary stamp or
similar issue or transfer taxes payable in respect of the issue or delivery of
shares of Common Stock on exercise of this Warrant. The Company shall promptly
thereafter issue certificate(s) evidencing the Common Stock so purchased.
2. RESERVATION OF SHARES. The Company shall at all times reserve for
issuance and delivery upon exercise of this Warrant all shares of Common Stock
or other shares of capital stock of the Company (and other securities) from time
to time receivable upon exercise of this Warrant. All such shares (and other
securities) shall be duly authorized and, when issued upon exercise, shall be
validly issued, fully paid and non-assessable.
3. NO FRACTIONAL SHARES. No fractional shares or script representing
fractional shares shall be issued upon the exercise of this Warrant, but the
Company
2
<PAGE>
shall pay the Holder an amount equal to the fair market value of such
fractional share of Common Stock in lieu of each fraction of a share
otherwise called for upon any exercise of this Warrant. For purposes of this
Warrant, the fair market value of a share of Common Stock shall equal the
closing sale price (or if not available the average of the closing bid and
asked prices) on the business day prior to exercise of this Warrant, or, if
the Common Stock is then not publicly traded, then the price determined in
good faith by the Board of Directors of the Company.
4. TRANSFER.
4.1 SECURITIES LAWS. Neither this Warrant nor the Warrant Stock have
been registered under the securities act of 1933. The Company will not transfer
this Warrant or the Warrant Stock unless (a) there is an effective registration
covering such Warrant or such shares, as the case may be, under the Securities
Act of 1933 and applicable states securities laws, (b) it first receives a
letter from an attorney, acceptable to the Company's board of directors or its
transfer agents, stating that in the opinion of the attorney the proposed
transfer is exempt from registration under the Securities Act of 1933 and under
all applicable state securities laws, or (c) the transfer is made pursuant to
Rule 144 under the Securities Act of 1933.
4.2 CONDITIONS TO TRANSFER. Prior to any proposed transfer of this
Warrant or Warrant Stock, and as a condition thereto, if such transfer is not
made pursuant to an effective registration statement under the Securities Act,
the Holder will, if requested by the Company, deliver to the Company (a) an
investment covenant signed by the proposed transferee, (b) an agreement by such
transferee that the restrictive investment legend set forth above be placed on
the certificate or certificates representing the securities acquired by such
transferee, (c) an agreement by such transferee that the Company may place a
"stop transfer order" with its transfer agent or registrar, and (d) an agreement
by the transferee to indemnify the Company to the same extent as set forth in
the next succeeding paragraph.
4.3 INDEMNITY. The Holder acknowledges that the Holder understands
the meaning and legal consequences of this Section, and the Holder hereby agrees
to indemnify and hold harmless the Company, its representatives and each officer
and director thereof from and against any and all loss, damage or liability
(including all attorneys' fees and costs incurred in enforcing this indemnity
provision) due to or arising out of (a) the inaccuracy of any representation or
the breach of any warranty of the Holder contained in, or any other breach of,
this Warrant, (b) any transfer of any of this Warrant or the Warrant Stock in
violation of the Securities Act, the Securities Exchange Act of 1934, as
amended, or the rules and regulations promulgated under either of such acts, (c)
any transfer of this Warrant or any of the Warrant Stock not in accordance with
this Warrant or (d) any untrue statement or omission to state any
3
<PAGE>
material fact in connection with the investment representations or with
respect to the facts and representations supplied by the Holder to counsel to
the Company upon which its opinion as to a proposed transfer shall have been
based.
4.4 TRANSFER. Except as specifically restricted hereby, this Warrant
and the Warrant Stock issued may be transferred by the Holder in whole or in
part at any time or from time to time. Upon surrender of this Warrant
certificate to the Company or at the office of its stock transfer agent, if any,
with an assignment form annexed hereto duly executed and funds sufficient to pay
any transfer tax, and upon compliance with the foregoing provisions, the Company
shall, without charge, execute and deliver a new Warrant certificate in the name
of the assignee named in such instrument of assignment, and this Warrant
certificate shall promptly be canceled. Any assignment, transfer, pledge,
hypothecation or other disposition of this Warrant attempted contrary to the
provisions of this Warrant, or any levy of execution, attachment or other
process attempted upon this Warrant, shall be null and void and without effect.
5. RIGHTS OF THE HOLDER. The Holder shall not, by virtue hereof, be
entitled to any rights of a stockholder in the Company, either at law or in
equity, and the rights of the Holder are limited to those expressed in this
Warrant.
6. ANTI-DILUTION PROVISIONS.
6.1 STOCK SPLITS, DIVIDENDS, ETC.
6.1.1 If the Company shall at any time subdivide its outstanding shares
of Common Stock (or other securities at the time receivable upon the exercise of
the Warrant) by recapitalization, reclassification or split-up thereof, or if
the Company shall declare a stock dividend or distribute shares of Common Stock
to its stockholders, the number of shares of Common Stock subject to this
Warrant immediately prior to such subdivision shall be proportionately
increased, and if the Company shall at any time combine the outstanding shares
of Common Stock by recapitalization, reclassification or combination thereof,
the number of shares of Common Stock subject to this Warrant immediately prior
to such combination shall be proportionately decreased. Any such adjustment and
adjustment to the Exercise Price pursuant to this Section shall be effective at
the close of business on the effective date of such subdivision or combination
or if any adjustment is the result of a stock dividend or distribution then the
effective date for such adjustment based thereon shall be the record date
therefor.
6.1.2 Whenever the number of shares of Common Stock purchasable upon the
exercise of this Warrant is adjusted, as provided in this Section, the Exercise
Price shall be adjusted to the nearest cent by multiplying such Exercise Price
immediately prior
4
<PAGE>
to such adjustment by a fraction (x) the numerator of which shall be the
number of shares of Common Stock purchasable upon the exercise immediately
prior to such adjustment, and (y) the denominator of which shall be the
number of shares of Common Stock so purchasable immediately thereafter.
6.2 ADJUSTMENT FOR REORGANIZATION, CONSOLIDATION, MERGER, ETC. In
case of any reorganization of the Company (or any other corporation, the
securities of which are at the time receivable on the exercise of this Warrant)
after the Base Date or in case after such date the Company (or any such other
corporation) shall consolidate with or merge into another corporation or convey
all or substantially all of its assets to another corporation, then, and in each
such case, the Holder of this Warrant upon the exercise as provided in Section 1
at any time after the consummation of such reorganization, consolidation, merger
or conveyance, shall be entitled to receive, in lieu of the securities and
property receivable upon the exercise of this Warrant prior to such
consummation, the securities or property to which such Holder would have been
entitled upon such consummation if such Holder had exercised this Warrant
immediately prior thereto; in each such case, the terms of this Warrant shall be
applicable to the securities or property received upon the exercise of this
Warrant after such consummation.
6.3 CERTIFICATE AS TO ADJUSTMENTS. In each case of an adjustment in
the number of shares of Common Stock receivable on the exercise of this Warrant,
the Company at its expense shall promptly compute such adjustment in accordance
with the terms of the Warrant and prepare a certificate executed by an officer
of the Company setting forth such adjustment and showing the facts upon which
such adjustment is based. The Company shall forthwith mail a copy of each such
certificate to each Holder.
6.4 NOTICES OF RECORD DATE, ETC. In case:
6.4.1 If the Company shall take a record of the holders of its Common
Stock (or other securities at the time receivable upon the exercise of the
Warrant) for the purpose of entitling them to receive any dividend (other than a
cash dividend at the same rate as the rate of the last cash dividend theretofore
paid) or other distribution, or any right to subscribe for, purchase or
otherwise acquire any shares of stock of any class or any other securities, or
to receive any other right; or
6.4.2 of any voluntary or involuntary dissolution, liquidation or
winding-up of the Company,
then, and in each such case, the Company shall mail or cause to be mailed to
each Holder a notice specifying, as the case may be, (A) the date on which a
record is to
5
<PAGE>
be taken for the purpose of such dividend, distribution or right, and stating
the amount and character of such dividend, distribution or right, or (B) the
date on which such reorganization, reclassification, consolidation, merger,
conveyance, dissolution, liquidation or winding-up is to take place, and the
time, if any, to be fixed, as to which the holders of record of Common Stock
(or such other securities at the time receivable upon the exercise of this
Warrant) shall be entitled to exchange their shares of Common Stock (or such
other securities) for securities or other property deliverable upon such
reorganization, reclassification, consolidation, merger, conveyance,
dissolution, liquidation or winding-up. Such notice shall be mailed at least
ten (10) days prior to the date therein specified, and this Warrant may be
exercised prior to said date during the term of the Warrant.
6.5 THRESHOLD FOR ADJUSTMENTS. Anything in this Section to the
contrary notwithstanding, the Company shall not be required to give effect to
any adjustment until the cumulative resulting adjustment in the Exercise Price
pursuant to Subsection 6 shall have required a change of the Exercise Price by
at least $0.125, but when the cumulative net effect of more than one adjustment
so determined shall be to change the Exercise Price by at least $0.125, such
full change in the Exercise Price shall thereupon be given effect. No
adjustment shall be made by reason of the issuance of shares upon conversion
rights, stock issuance rights or similar rights currently outstanding or any
change in the number of treasury shares held by the Company.
7. LEGEND AND STOP TRANSFER ORDERS. Unless the shares of Warrant
Stock have been registered under the Securities Act, upon exercise of any of
this Warrant and the issuance of any of the shares of Warrant Stock, the Company
shall instruct its transfer agent, if any, to enter stop transfer orders with
respect to such shares, and all certificates representing shares of Warrant
Stock shall bear on the face thereof substantially the following legend, insofar
as is consistent with Texas law:
The shares represented by this certificate have not been
registered under the Securities Act of 1933 (the "Act") and are
"restricted securities" as that term is defined in Rule 144 under
the Act. The shares may not be offered for sale, sold or
otherwise transferred except pursuant to an effective registration
statement under the Act, or pursuant to an exemption from
registration under the Act, the availability of which is to be
established to the satisfaction of the Company.
8. REGISTRATION.
8.1 REGISTRABLE SHARES. For purposes of this Section 8, the term
"Registrable Shares" means the shares of Common Stock issued pursuant to this
Warrant; PROVIDED, HOWEVER, that a share of Common Stock shall cease to be
Registrable Shares
6
<PAGE>
when (a) it has been effectively registered under the Securities Act and
disposed of in accordance with the registration statement covering it, (b) it
has been distributed to the public pursuant to Rule 144 under the Securities
Act, or any similar provision then in effect, or (c) it has otherwise been
transferred to another person and a new certificate or other evidence of
ownership for it not bearing a restrictive legend and not subject to any stop
transfer order with respect to Securities Act matters has been delivered by
or on behalf of Company. The Company shall not be obligated to register any
Warrant under the Securities Act.
8.2 INCIDENTAL REGISTRATION RIGHTS. If at any time prior to the
Expiration Date the Company proposes on its behalf to register any Common Stock
under the Securities Act in connection with a public offering of such securities
solely for cash in a form that would also permit the registration of any of the
Registrable Shares, Company will, each such time, prior to filing give a holder
of this Warrant and record owners of Registrable Shares written notice of such
determination. Upon the written request of any such holder or record owner
given within fifteen (15) days after the such notice by Company, Company shall
use its reasonable best efforts to register under the Securities Act such of the
Registrable Shares as a holder of this Warrant or record owner of Registrable
Shares has requested be registered; PROVIDED, HOWEVER, that Company may postpone
or withdraw any registration pursuant to this Section without obligation to
requesting holders or record owners.
8.3 UNDERWRITING REQUIREMENTS. If the proposed registration of
Registrable Shares which Company has been requested by a holder of this Warrant
or record owner of Registrable Shares to register is to be distributed by or
through an underwriter or underwriters, the underwriter or underwriters shall be
chosen in the discretion of Company, and with regard to the inclusion of
Registrable Shares therein, the holder and/or record owner must agree (a) to
sell such Registrable Shares on the same basis as provided in the underwriting
arrangement approved by Company and (b) to complete and execute, in a timely
manner, all questionnaires, powers of attorney, indemnities, hold-back
agreements, underwriting agreements and other documents required either under
the terms of such arrangement or by the Securities and Exchange Commission. If,
in the opinion of the managing underwriter for an underwritten offering, the
registration of all, or part of, the Registrable Shares requested to be included
in such offering would have an adverse effect thereon, then Company shall be
required to include in the underwriting only that number of Registrable Shares,
if any, which the managing underwriter reasonably believes may be sold without
causing such adverse effect. If the number of shares to be included in the
underwriting in accordance with the foregoing is less than the number of shares
which the holder and/or record owner of Registrable Shares and all other persons
entitled to participate in the registration have requested be included (whether
pursuant to the exercise of registration rights or otherwise), the Company shall
be entitled to
7
<PAGE>
include all shares which it had intended to register, after which holders
and/or record owners of Registrable Shares shall participate in the
underwriting pro rata with the holders of all other shares entitled to
participate in the underwriting pursuant to registration rights or otherwise,
based upon their respective total ownership of shares of Common Stock, and if
any holder and/or record owner of Registrable Shares would thus be entitled
to include more shares than such holder and/or record owner requested to be
registered, the excess shall be allocated among other requesting holders and
shareholders pro rata based upon their respective total ownership of shares
of Common Stock. If requested by any underwriter or underwriters, holders
and/or record owners of Registrable Shares shall agree to sell Registrable
Shares which are subject to the registration to or through such underwriter or
underwriters at the same price to be paid to Company or other selling holders.
8.4 REGISTRATION EXPENSES. In the case of a registration pursuant to
this Section 8, Company shall bear all usual and customary costs and expenses
incidental to the preparation of a registration statement, including
registration, filing and qualification fees, underwriters fees and expenses and
the fees and disbursements of printers, counsel and accountants for Company.
Any cost or expense which is attributable solely to a selling holder and/or
record owner of Registrable Shares and does not constitute a normal cost or
expense shall be allocated to that seller. In addition, each selling holder or
record owner or Registrable Shares shall bear the fees and costs of its own
counsel and fees and expenses of underwriters that are customarily paid by
selling shareholders such as selling expenses and underwriter commissions
attributable to the Registrable Shares.
8.5 INDEMNIFICATION. Company agrees to indemnify and hold harmless
the seller and each other person who controls such seller within the meaning of
the Securities Act, against all losses, damages, liabilities and expenses
(including attorney's fees) arising out of or based upon any untrue or allegedly
untrue statement of a material fact, or any omission or alleged omission to
state a material fact required to be stated or necessary to make the statements
not misleading, contained in any registration statement or prospectus pursuant
to which any of the Registrable Shares are offered or sold pursuant to this
Section, except insofar as such losses, claims, liabilities or expenses arise
out of or are based upon any such untrue statement or omission or allegation
thereof which has been included therein or omitted therefrom in reliance upon
and in conformity with information relating to the seller or its controlling
persons furnished to Company by such seller or controlling person for use
therein, as to which losses, claims, liabilities and expenses (including
attorney's fees) seller agrees to indemnify and hold harmless Company and each
person who controls Company within the meaning of the Securities Act. If any
claim or action shall be brought for which indemnification may be sought
hereunder, the party or controlling person claiming indemnification shall
promptly notify the party from which
8
<PAGE>
indemnification is sought in writing, and such party shall be entitled at its
option to assume the defense thereof, including the employment of counsel and
the payment of all expenses. The indemnified party or controlling person
shall have the right to employ separate counsel and participate in the
defense thereof, but the fees and expenses of such counsel shall be at the
expense of the indemnified party or controlling person unless the employment
thereof has been specifically authorized by the other party in writing or the
party has failed to assume the defense and employ counsel.
9. OFFICER'S CERTIFICATE. Whenever the number or kind of securities
purchasable upon exercise of this Warrant or the Exercise Price shall be
adjusted as required by the provisions hereof, the Company shall forthwith file
with its Secretary or Assistant Secretary at its principal office and with its
stock transfer agent, if any, an officer's certificate showing the adjusted
number of kind of securities purchasable upon exercise of this Warrant and the
adjusted Exercise Price determined as herein provided and setting forth in
reasonable detail such facts as shall be necessary to show the reason for and
the manner of computing such adjustments. Each such officer's certificate shall
be made available at all reasonable times for inspection by the Holder and the
Company shall, forthwith after each such adjustment, mail by certified mail a
copy of such certificate to the Holder.
10. NOTICE. Any notice or other communication required or permitted
to be given hereunder shall be in writing and shall be mailed by certified mail,
return receipt requested, or delivered against receipt, if to the Holder, at
his/her address as shown on the books of the Company, and if to the Company, at
its principal office, 10611 Harwin, Suite 402, Houston, Texas 77036. Any notice
or other communication given by certified mail shall be deemed given at the time
of certification thereof, except for a notice changing a party's address which
shall be deemed given at the time of receipt thereof.
11. BINDING EFFECT. The provisions of this Warrant shall be binding
upon and inure to the benefit of (a) the parties hereto, (b) the successors and
assigns of the Company, (c) if the Holder is a corporation, partnership, or
other business entity, the successors and assignee of the Holder, and (d) if the
Holder is a natural person, the assignees, heirs, and personal representative of
the Holder.
12. PRONOUNS. Any masculine personal pronoun shall be considered to
mean the corresponding feminine or neuter personal pronoun, as the context
requires.
KMG CHEMICALS, INC.
a Texas corporation
By: /s/ David L. Hatcher
-----------------------------------
Date: March 17, 1999 David L. Hatcher, President
9
<PAGE>
WARRANTY EXERCISE FORM
The undersigned hereby irrevocably elects to exercise the within Warrant to the
extent of purchasing [NUMBER] shares of Common Stock of KMG CHEMICALS, INC. and
hereby makes payment of $[AMOUNT] in payment therefor.
- -------------------------- --------------------------------------
Date Signature
--------------------------------------
Signature
(if jointly held)
10
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS FINANCIAL DATA SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED
FROM AS OF AND FOR THE TWELVE MONTHS PERIOD ENDED JULY 31, 1999 AND IS QUALIFIED
IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JUL-31-1999
<PERIOD-START> AUG-01-1998
<PERIOD-END> JUL-31-1999
<CASH> 4,840,963
<SECURITIES> 6,923
<RECEIVABLES> 3,803,098
<ALLOWANCES> (120,000)
<INVENTORY> 2,544,613
<CURRENT-ASSETS> 11,303,765
<PP&E> 4,212,470
<DEPRECIATION> (1,912,332)
<TOTAL-ASSETS> 22,791,935
<CURRENT-LIABILITIES> 5,406,532
<BONDS> 0
0
0
<COMMON> 70,002
<OTHER-SE> 13,888,043
<TOTAL-LIABILITY-AND-EQUITY> 22,791,935
<SALES> 36,388,799
<TOTAL-REVENUES> 36,388,799
<CGS> 23,566,923
<TOTAL-COSTS> 23,566,923
<OTHER-EXPENSES> 6,765,537
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 387,599
<INCOME-PRETAX> 6,052,205
<INCOME-TAX> 2,299,838
<INCOME-CONTINUING> 3,752,367
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,752,367
<EPS-BASIC> 0.54
<EPS-DILUTED> 0.53
</TABLE>
