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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, 2000
/ / TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT OF 1934
For the transition period from ________ to ______
Commission file number 000-29278
KMG CHEMICALS, 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:
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<CAPTION>
Title of Each Class Name of each Exchange on which Registered
<S> <C>
None None
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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: $33,754,285
The aggregate market value of the voting stock held by non-affiliates
computed by reference to sales of such stock as of September 29, 2000 was
$2,495,000.
(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 2000 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. In connection with the acquisition in 1996 of
KMG-Bernuth, Inc., a Delaware corporation ("KMG"), the Company changed its
name to KMG-B, Inc. In 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.
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, par value $.01 per share ("Common Stock"), of the Company. After
giving effect to a 1 for 1.5 reverse split of Common Stock outstanding
immediately prior to the acquisition of KMG, the former stockholders of KMG
became owners of approximately 93% of the issued and outstanding shares of
Common Stock. See "Item 11. Security Ownership of Certain Beneficial Owners
and Management."
Unless the context otherwise requires, references hereinafter to the
"Company" shall mean KMG Chemicals, Inc. and any of its subsidiaries. All
references hereinafter to share amounts reflect the reverse split of Common
Stock.
BUSINESS OF THE COMPANY
GENERAL
The Company manufactures, markets and distributes specialty, niche
chemicals. At the present time, the Company manufactures, markets and
distributes three wood preserving chemicals, pentachlorophenol ("penta"),
creosote and sodium pentachlorophenate ("sodium penta"), to industrial
customers engaged in the wood preserving business. The Company's customers
use these preservatives to treat wood and supply the treated wood products to
end-users in a variety of industries, principally the railroad, utility and
construction industries.
The Company acquired a penta manufacturing and distribution business
in 1988 from an affiliated company that had been engaged in the penta
business since the early 1970's. The Company made several acquisitions after
1988 to expand its wood preserving product lines and distribution network. It
acquired a creosote distribution business in early 1991 and a sodium penta
distribution business late that same year. In 1998, the Company acquired from
AlliedSignal, Inc. ("AlliedSignal") certain assets pertaining to the sale of
creosote and entered into a long-term creosote supply contract with that
firm. In 1999 Reilly Industries, Inc. ("Reilly") acquired AlliedSignal's
carbon products business, including its creosote production and the creosote
supply contract with the Company. After the end of fiscal 2000, a subsidiary
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of the Company acquired an herbicide product line from an affiliate of Zeneca
Ag Products, Inc. ("Zeneca"). See "-New Developments."
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.
NEW DEVELOPMENTS
The Company acquired an herbicides product line from Zeneca,
monosodium and disodium methanearsonic acid herbicides ("MSMA products"), on
October 3, 2000 for $2.3 million plus the payment of an earnout on adjusted
net sales of the herbicides over five years. The acquisition was financed out
of Company working capital. MSMA products are sold under the name Bueno(R) 6
and used in the United States and elsewhere in the world primarily as a
cotton crop herbicide. For several years, however, cotton farmers in the
United States have been planting genetically modified cotton seed that is
resistant to the herbicide Roundup(R) and other glyphosate herbicides. As
farmers converted to that seed and to glyphosate, MSMA products became niche
products used primarily by farmers who are sensitive to the higher cost of
the genetically modified seed program. The Company believes that its sales of
MSMA products in fiscal 2001 will be approximately $5-7 million.
The Company's acquisition of the MSMA product line included the
purchase of pesticide registrations, product trademarks and the manufacturing
equipment necessary to make MSMA products. For the balance of calendar 2000,
a Zeneca affiliate will continue to manufacture MSMA products for the Company
in order to build the inventory that will be needed by customers in the 2001
growing season. The Company intends to begin moving the purchased
manufacturing equipment to its facility in Matamoros, Mexico in January 2000,
to reassemble it and restart production late in calendar 2001.
MSMA products are sold in the United States by the Company and
Drexel Chemical Company, Luxembourg-Pamol, Inc. and Albaugh, Inc., primarily
in the southern cotton-growing states and in California. Those same companies
also sell MSMA products in other countries. The Company will be dependent in
its production of MSMA products on outside suppliers for its raw material
requirements. The Company does not intend to enter into long term supply
contracts with those suppliers. MSMA products are subject to extensive
federal, state and local laws and regulations, including environmental laws
and regulations that require the Company to research and test the chemistry
and toxicology of MSMA products. The Company has joined an industry group
that is conducting that testing. See "-Environmental and Safety
Matters-Licenses, Permits and Product Registrations."
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WOOD PRESERVATIVES OVERVIEW
The Company produces and sells several wood preservative products
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 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, Peru, Ecuador,
Venezuela and Brazil.
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
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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. 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 2000 and is subject to
escalation thereafter during the term.
CUSTOMERS
The Company sells its wood preservative products to approximately 80
customers. One customer, Kerr McGee Chemical Corp., accounted for
approximately 12% of the Company's revenues in fiscal 2000 and 15% in fiscal
1999. No other customer accounted for 10% or more in either fiscal year.
MARKETING
The Company markets its wood preservatives in the United States
through four employees and one independent commissioned sales agent. Outside
the United States, the Company sells its penta and sodium penta directly and
through sales agency contracts to local lumber producers or to chemical
companies for those producers in over 20 countries.
COMPETITION
The Company is one of only two companies producing penta for sale in
the United States. The Company believes that it currently supplies almost
half 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.
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The Company does not supply CCA, the most widely-used wood
preservative. The Company believes that there are three suppliers of CCA in
the United States, Hickson Corporation, Chemical Specialties, Inc. and Osmose
Wood Preserving, Inc. Each of those companies has larger sales volume and
greater financial resources than the Company.
Penta and creosote are pesticides that must be registered prior to
sale under United States law. See "-Environmental and Safety
Matters-Licenses, Permits and Product Registrations." As a condition to
registration, any company wishing to manufacture and sell penta or creosote
must provide to the EPA substantial scientific research and testing data
regarding the chemistry and toxicology of the products. That data must be
generated by the applicant or the applicant must compensate other data
providers for relying on their information. The Company believes that the
cost of satisfying the data submission requirement serves as an impediment to
the entry of new competitors in the United States market, particularly those
with lesser financial resources. While the Company has no reason to believe
that the registration requirement will be discontinued or materially
modified, there can be no assurances as to the effect of such a
discontinuation or modification on the Company's competitive position.
The Company believes that its ability to compete effectively is
dependent upon providing its products at competitive prices, anticipating new
markets and distribution channels for its products and maintaining a strong
commitment to product quality and customer service.
EMPLOYEES
As of the end of fiscal 2000, the Company had a total of 70
full-time employees and one temporary employee. Ten of the Company's
employees worked at the Company's corporate offices in Houston, Texas, 51 at
the Matamoros facility, eight at the Tuscaloosa facility and one worked in
Louisiana. None of the employees in the United States are represented by a
labor union but 29 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 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.
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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 $756 thousand and $721 thousand in connection with the FIFRA
research and testing program in fiscal 2000 and fiscal 1999, respectively.
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ITEM 2. DESCRIPTION OF PROPERTY
Set forth below is information with respect to certain of the Company's
properties.
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LEASE
APPROXIMATE OWNED/ EXPIRATION
LOCATION PRIMARY USE SIZE LEASED DATE
-------- ------------------ ----------------- ---------------- ----
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Houston, Texas Corporate Office 5,000 square feet Leased March 31,
2001
Matamoros, Mexico Manufacturing 7 acres Owned
Tuscaloosa, Alabama Processing 1.5 acres Owned
Distribution
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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 2000 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
2000 and 1999 were as follows:
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Period: High Low
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First quarter fiscal 1999 7.00 4.13
Second quarter fiscal 1999 7.75 6.00
Third quarter fiscal 1999 7.00 5.25
Fourth quarter fiscal 1999 6.38 5.00
First quarter fiscal 2000 6.75 4.50
Second quarter fiscal 2000 6.31 4.00
Third quarter fiscal 2000 6.25 4.00
Fourth quarter fiscal 2000 5.75 4.50
</TABLE>
These 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 29, 2000, there were 7,000,169 shares of Common
Stock issued and outstanding held by 594 shareholders of record and 355 round
lot holders.
KMG declared and paid dividends in fiscal 2000 and 1999 as follows:
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Date declared: Date paid: Amount ($): Per Share ($)
<S> <C> <C> <C>
February 2000 March 2000 140,003 .02
August 1999 September 1999 140,003 .02
February 1999 March 1999 70,002 .01
July 1998 August 1998 140,003 .02
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Additionally, the Company declared and paid dividends of $140,003 in August
2000 and September 2000, respectively. The Company anticipates that future
earnings will be retained to finance the continuing development of its
business. The Company does not anticipate paying substantial dividends on the
Common Stock in the foreseeable future.
In fiscal 2000 the Company granted a warrant to purchase 25,000
shares of Common Stock at $5.50 per share to the assignee of Gilman Financial
Corporation. The warrant expires March 6, 2009 and
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was issued as compensation for that company's acquisition consulting
services. In fiscal 1999 the Company also granted a warrant to acquire 25,000
shares of Common Stock to JP Turner & Company, L.L.C. for consulting services
pertaining to 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 warrants to Gilman Consulting and to JP
Turner & Company, L.L.C. were 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, 2000 and 1999:
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<CAPTION>
Years Ended July 31,
============================================== Increase/
2000 1999 (Decrease)
==================================================================
<S> <C> <C> <C>
Net sales $33,754,285 $36,388,799 ($2,634,514)
Gross profit 13,221,357 12,821,876 399,481
Gross profit as percent of Net Sales 39.2% 35.2% 4.0%
Selling, general and administrative expense 7,070,806 6,765,537 305,269
Operating income 6,150,551 6,056,339 94,212
Other income (expense), net 19,375 (4,134) 23,509
Income before taxes 6,169,926 6,052,205 117,721
Provision for income taxes (2,325,121) (2,299,838) (25,283)
Net income $3,884,805 $3,752,367 $132,438
</TABLE>
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SALES REVENUE
Net sales revenue for fiscal 2000 was 7.2% less than in fiscal 1999.
Net sales revenue declined on reduced sales volume for both the penta-based
and creosote wood treating products sold by the Company.
Penta product volume fell because utility company consolidations in
North America reduced demand for utility poles, the principal wood product
treated with penta, and because diesel oil prices remained at historically
high levels. Diesel oil is used to dissolve penta into a penta-based wood
treating solution and while diesel prices are high, penta solutions suffer
some competitive disadvantage as compared with CCA, a water dissolved wood
preservative. An additional factor, however, was that the Company's
penta-based sapstain product was not renewed for use in its two largest
markets, Chile and Malaysia. Although the Company's sapstain continues to be
used in Europe and elsewhere, management expects that product's volume will
decline significantly over the next several years. Creosote sales were
adversely affected by the continued deferral of railroad crosstie replacement
by major railroads. Management believes that sales of its wood treating
chemicals will likely remain soft during fiscal 2001.
GROSS PROFIT
Gross profit for fiscal 2000 was approximately $399 thousand higher
than in fiscal 1999. Higher per unit creosote and pentachlorophenol sales
revenues coupled with lower per unit manufacturing costs of pentachlorophenol
products helped maintain gross profit in the face of declining net sales
revenue. Management anticipates, however, that the Company will experience
some increase in unit manufacturing costs which will place additional
pressure on gross profit margin in fiscal 2001.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses for fiscal 2000 were
approximately $305 thousand higher than the prior fiscal year. The increase
resulted in part from increased testing and research costs for creosote, and
from expenses incurred in connection with pursuing the Company's plan to grow
by acquiring niche chemical products. See, "-New Developments." Also, the
Company absorbed additional storage and distribution expenses related to
creosote purchased from Rutgers. Prior to November 1998 the Company acted as
an agent on behalf of Rutgers, and those creosote expenses were borne by
Rutgers. In November 1998 the agency arrangement was terminated and the
Company began to purchase creosote from Rutgers for its own account. Under
the new supply agreement, the Company bears creosote related expenses
formerly absorbed by Rutgers.
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 $756 thousand for penta and
creosote testing costs in fiscal 2000 and approximately $721 thousand for
that testing in fiscal 1999. See "-Liquidity and Capital Resources."
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OTHER INCOME (EXPENSE)
During fiscal 2000, the Company made principal reductions of $810
thousand on its term indebtedness and that reduction had the effect of
lowering interest expense for fiscal 2000.
LIQUIDITY AND CAPITAL RESOURCES
At the end of fiscal 2000, the Company had cash and cash equivalents
of approximately $7.8 million as compared with approximately $4.8 million at
the end of fiscal 1999. Net cash provided by operations during fiscal 2000
was approximately $4.5 million as compared with approximately $5.0 million
for fiscal 1999.
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 2001. 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.
The Company's wholly-owned subsidiary, KMG, has 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 $5.0 million, (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 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, 2000 the
Company's borrowing base under the Revolving Credit Facility was $2.5 million
but the Company had no outstanding borrowing on that facility.
In fiscal 1998 the Company entered into a long-term creosote supply
agreement with AlliedSignal and purchased certain creosote registrations from
it. 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
11
<PAGE>
rate of 7.32%. It is being amortized over seven years in equal monthly
installments that total approximately $1 million per year. In fiscal 1999 the
Company prepaid an additional $1 million of principal on the term loan. As of
September 30, 2000, the principal balance outstanding under the term loan was
$3.4 million.
The Company's capital expenditures and operating expenses for
environmental matters, excluding FIFRA testing and data submission costs,
were approximately $281 thousand in fiscal 2000 and $300 thousand in fiscal
1999. The Company estimates that its capital expenditures and operating
expenses for environmental matters other than FIFRA will be approximately
$347 thousand in fiscal 2001. The Company expensed approximately $756
thousand for penta and creosote testing costs under FIFRA in fiscal 2000 and
approximately $721 thousand for penta testing in fiscal 1999. Management
believes that total FIFRA testing costs for penta and creosote will be
approximately $720 thousand in fiscal 2001. 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.
YEAR 2000 ISSUES
The Company 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 also sought verification from its key suppliers
that they were Year 2000 compliant and received positive assurances from most
of the Company's key suppliers. The Company has experienced no disruption
from Year 2000 issues.
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
12
<PAGE>
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 S 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.
13
<PAGE>
ITEM 7. FINANCIAL STATEMENTS
INDEX TO FINANCIAL STATEMENTS
FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Independent Auditors' Report 15
Consolidated Balance Sheets as of July 31, 2000
and 1999 16
Consolidated Statements of Income for the Years Ended
July 31, 2000 and 1999 17
Consolidated Statements of Stockholders' Equity
for the Years Ended July 31, 2000
and 1999 18
Consolidated Statements of Cash Flows for the
Years Ended July 31, 2000 and 1999 19
Notes to Consolidated Financial Statements 20-30
</TABLE>
14
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
KMG Chemicals, Inc.:
We have audited the accompanying consolidated balance sheets of KMG
Chemicals, Inc. and subsidiaries (the "Company") as of July 31, 2000 and
1999, 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 auditing standards generally
accepted in the United States of America. Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the consolidated financial position of KMG Chemicals, Inc. and
subsidiaries as of July 31, 2000 and 1999, and the consolidated results of
their operations and their cash flows for the years then ended in conformity
with accounting principles generally accepted in the United States of America.
/s/ Deloitte & Touche LLP
Houston, Texas
September 27, 2000, except for the
first paragraph of Note 13, as to
which the date is October 3, 2000,
and the second paragraph of Note 13,
as to which the date is October 18, 2000.
15
<PAGE>
KMG CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JULY 31, 2000 AND 1999
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ASSETS 2000 1999
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 7,830,843 $ 4,847,886
Accounts receivable:
Trade, net of allowance for doubtful accounts of $120,000 in 2000 and 1999 3,166,625 3,258,384
Other 73,576 63,549
Notes receivable from related parties - current portion 724,767 381,103
Inventories 2,842,724 2,544,613
Prepaid expenses and other current assets 187,966 228,168
------------ ------------
Total current assets 14,826,501 11,323,703
PROPERTY, PLANT, AND EQUIPMENT - Net of accumulated depreciation 2,189,958 2,300,138
NOTES RECEIVABLE FROM RELATED PARTIES - Less current portion 116,781 551,569
DEFERRED TAX ASSET 289,684 251,498
OTHER ASSETS 7,889,455 8,365,027
------------ ------------
TOTAL $ 25,312,379 $ 22,791,935
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 3,121,500 $ 3,620,999
Accrued liabilities 1,174,621 975,723
Current portion of long-term debt 872,881 809,810
------------ ------------
Total current liabilities 5,169,002 5,406,532
LONG-TERM DEBT 2,554,414 3,427,360
------------ ------------
Total liabilities 7,723,416 8,833,892
------------ ------------
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 2000 and 1999 70,002 70,002
Additional paid-in capital 1,129,507 1,063,385
Retained earnings 16,389,454 12,824,656
------------ ------------
Total stockholders' equity 17,588,963 13,958,043
------------ ------------
TOTAL $ 25,312,379 $ 22,791,935
============ ============
</TABLE>
See notes to consolidated financial statements.
16
<PAGE>
KMG CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED JULY 31, 2000 AND 1999
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
2000 1999
<S> <C> <C>
NET SALES $ 33,754,285 $ 36,388,799
COST OF SALES 20,532,928 23,566,923
------------ ------------
Gross profit 13,221,357 12,821,876
SELLING, GENERAL, AND ADMINISTRATIVE EXPENSES 7,070,806 6,765,537
------------ ------------
Operating income 6,150,551 6,056,339
OTHER INCOME (EXPENSE):
Interest income 322,351 203,796
Interest expense (288,095) (387,599)
Other, net (14,881) 179,669
------------ ------------
Total other income (expense), net 19,375 (4,134)
------------ ------------
INCOME BEFORE INCOME TAXES 6,169,926 6,052,205
PROVISION FOR INCOME TAXES 2,325,121 2,299,838
------------ ------------
NET INCOME $ 3,844,805 $ 3,752,367
============ ============
EARNINGS PER COMMON SHARE:
Basic $ 0.55 $ 0.54
============ ============
Diluted $ 0.55 $ 0.53
============ ============
WEIGHTED-AVERAGE SHARES OUTSTANDING:
Basic 7,000,169 7,000,169
============ ============
Diluted 7,051,292 7,063,271
============ ============
</TABLE>
See notes to consolidated financial statements.
17
<PAGE>
KMG CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED JULY 31, 2000 AND 1999
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
COMMON STOCK
----------------------------- ADDITIONAL TOTAL
SHARES PAR PAID-IN RETAINED STOCKHOLDERS'
ISSUED VALUE CAPITAL EARNINGS EQUITY
<S> <C> <C> <C> <C> <C>
BALANCE, AUGUST 1, 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, JULY 31, 1999 7,000,169 70,002 1,063,385 12,824,656 13,958,043
Warrants issued in exchange for services 66,122 66,122
Dividends (280,007) (280,007)
Net income 3,844,805 3,844,805
------------ ------------ ------------- ------------- --------------
BALANCE, JULY 31, 2000 7,000,169 $ 70,002 $ 1,129,507 $ 16,389,454 $ 17,588,963
============ ============ ============ ============ ============
</TABLE>
See notes to consolidated financial statements.
18
<PAGE>
KMG CHEMICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED JULY 31, 2000 AND 1999
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
2000 1999
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 3,844,805 $ 3,752,367
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 1,065,760 1,042,399
Gain on sale of securities (829)
(Gain) loss on sale or abandonment of equipment (7,271) 501
Warrants issued in exchange for services 66,122
Forgiveness of notes receivable from related parties 71,288
Deferred income tax benefit (38,186) (113,954)
Changes in operating assets and liabilities:
Accounts receivable - trade 91,759 312,124
Accounts receivable - other (10,027) 14,216
Inventories (298,111) (793,267)
Prepaid expenses and other current assets 40,202 (75,786)
Accounts payable (499,499) 278,729
Accrued liabilities 198,898 582,216
------------ ------------
Net cash provided by operating activities 4,524,911 4,999,545
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant, and equipment (231,551) (228,871)
Proceeds from sale of securities 7,752
Proceeds from sale of equipment 8,500 801
Loans to related parties (324,854)
Collection of notes receivable 19,836 8,305
Additions to other assets (286,452) (8,564)
Collection of other assets 29,843 113,954
------------ ------------
Net cash used in investing activities (452,072) (439,229)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of dividends (280,007) (210,006)
Principal payments on borrowings (809,875) (1,710,372)
------------ ------------
Net cash (used in) provided by financing activities (1,089,882) (1,920,378)
------------ ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 2,982,957 2,639,938
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 4,847,886 2,207,948
------------ ------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 7,830,843 $ 4,847,886
============ ============
SUPPLEMENTAL DISCLOSURES FOR CASH FLOW INFORMATION -
Cash paid during the year for:
Interest $ 288,095 $ 387,599
============ ============
Income taxes $ 2,334,730 $ 2,298,187
============ ============
</TABLE>
See notes to consolidated financial statements.
19
<PAGE>
KMG CHEMICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JULY 31, 2000 AND 1999
--------------------------------------------------------------------------------
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. KMG-B
was incorporated in the state of Texas in 1992 under the name Water Point
Manufacturing, Inc. ("Water Point"). Water Point adopted "fresh-start"
accounting as of October 23, 1996 and subsequently changed its name to
KMG-B. 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 agreement and in conjunction with other services.
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 accounting principles generally accepted in the United States of
America 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.
CASH AND CASH EQUIVALENTS - The Company considers all investments with
original 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.
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
20
<PAGE>
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 - The Company has 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.
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 debt at July
31, 2000 and 1999 was estimated to be the same as its carrying value since
the debt obligations 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 - Certain financial statement amounts in 1999 have been
reclassified to conform to the 2000 presentation.
21
<PAGE>
2. INVENTORIES
Inventories are summarized as follows at July 31:
<TABLE>
<CAPTION>
2000 1999
<S> <C> <C>
Chemical raw materials and supplies $ 344,582 $ 317,264
Finished chemical products 2,498,142 2,227,349
---------- ----------
Total $2,842,724 $2,544,613
========== ==========
</TABLE>
3. PROPERTY, PLANT, AND EQUIPMENT
Property, plant, and equipment and related accumulated depreciation and
amortization are summarized as follows at July 31:
<TABLE>
<CAPTION>
2000 1999
<S> <C> <C>
Land $ 302,527 $ 302,527
Buildings 1,163,607 1,103,061
Equipment 2,750,992 2,738,846
Leasehold improvements 38,425 21,502
Construction-in-progress 107,612 46,534
------------ ------------
4,363,163 4,212,470
Less accumulated depreciation and amortization (2,173,205) (1,912,332)
------------ ------------
Total $ 2,189,958 $ 2,300,138
============ ============
</TABLE>
22
<PAGE>
Depreciation is principally computed using a straight-line method over the
estimated useful lives of the assets. Depreciation expense was $333,712
and $310,344 in 2000 and 1999, 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>
4. FOREIGN CURRENCY REMEASUREMENT
Monetary assets and liabilities and income items for KMEX are remeasured
to U.S. dollars at current rates, and certain assets (notably plant and
production equipment) are remeasured at historical rates. Expense items
for KMEX are remeasured at average monthly rates of exchange except for
depreciation and amortization expense. All gains and losses from currency
remeasurement for KMEX are included in operations. Foreign currency
remeasurement resulted in an aggregate exchange loss of $1,901 in 2000 and
an aggregate exchange gain of $15,416 in 1999.
5. INCOME TAXES
The geographical sources of income before income taxes for the two years
ended July 31, 2000 and 1999 were as follows:
<TABLE>
<CAPTION>
2000 1999
<S> <C> <C>
United States $5,883,560 $5,661,546
Foreign 286,366 390,659
------------ ------------
Income before income taxes $6,169,926 $6,052,205
============ ============
</TABLE>
The provision for income taxes consisted of the following:
<TABLE>
<CAPTION>
2000 1999
<S> <C> <C>
Current federal provision $2,050,567 $2,076,502
Current foreign provision 114,546 144,544
Current state provision 198,194 192,746
Deferred income tax benefit (38,186) (113,954)
---------- ----------
Total $2,325,121 $2,299,838
========== ==========
</TABLE>
23
<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, 2000 and 1999 are as
follows:
<TABLE>
<CAPTION>
2000 1999
<S> <C> <C>
Deferred tax assets (liabilities):
Inventory $ 19,944 $ 19,944
Bad debt expense 44,400 72,150
Difference in depreciable basis of property 127,242 118,929
Difference in amortization basis of intangibles 98,098 40,475
-------- --------
Total $289,684 $251,498
======== ========
</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>
2000 1999
<S> <C> <C>
Provision for income taxes at the statutory rate $2,003,210 $1,997,436
State income taxes 207,365 157,858
Other 114,546 144,544
---------- ----------
Total $2,325,121 $2,299,838
========== ==========
</TABLE>
6. OTHER ASSETS
Other assets consisted of the following at July 31:
<TABLE>
<CAPTION>
2000 1999
<S> <C> <C>
Intangible assets, net of accumulated amortization of $625,000
in 2000 and $325,000 in 1999 $3,875,000 $4,175,000
Creosote supply contract, net of accumulated amortization of
$833,335 in 2000 and $433,335 in 1999 3,166,665 3,566,665
Advances for premiums on employee-owned life insurance
policies (see Note 9) 412,217 373,191
Licensing agreement, net of accumulated amortization of
$154,881 in 2000 and $132,024 in 1999 165,119 187,976
Other 270,454 62,195
---------- ----------
Total $7,889,455 $8,365,027
========== ==========
</TABLE>
On June 30, 1998, the Company entered into a long-term supply contract to
purchase creosote (a wood-treating chemical) from Allied Signal, Inc.
("Allied"). At the same time, the Company purchased certain intangible
assets from Allied pertaining to creosote sales and distribution. The
Company paid Allied $4,000,000 and $4,500,000 for entering into the supply
contract and for the intangible assets, respectively. The supply contract
is being amortized on a straight-line basis over a 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
24
<PAGE>
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, 2000 or 1999.
The termination date of this loan agreement is January 31, 2003.
On June 26, 1998, the Company entered into a term loan with an original
maturity date of July 1, 2005 for $6,000,000 with a bank. Starting August
1, 1998, the Company began making monthly principal and interest payments
of $91,498. 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, 2000, 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;
no such prepayments were made during 2000.
The term loan note at July 31, 2000 matures as follows:
<TABLE>
<CAPTION>
YEAR ENDING
JULY 31,
<S> <C>
2001 $ 872,881
2002 942,225
2003 1,013,776
2004 598,413
----------
Total $3,427,295
==========
</TABLE>
25
<PAGE>
8. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES - The Company has noncancelable operating leases for its
office and warehouse facilities and certain transportation equipment. At
July 31, 2000, the Company was obligated under these leases for the
following future minimum lease commitments:
<TABLE>
<S> <C>
2001 $225,779
2002 164,544
2003 97,194
--------
Total $487,517
========
</TABLE>
Rent expense relating to the operating leases was $346,138 and $317,361 in
2000 and 1999, respectively.
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 $756,000 and
$721,000 in fiscal years 2000 and 1999, 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 $720,000 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 position or results of operations.
9. RELATED-PARTY TRANSACTIONS
During 1991, the Company entered into "split-dollar insurance"
arrangements with two officers/stockholders. Under these agreements, the
Company advances funds for insurance premiums and records these advances
as a noncurrent asset. The Company has a security interest in the
insurance
26
<PAGE>
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, which is being forgiven by the Company over a five-year period
beginning January 1, 2000 (see Note 6); such forgiveness was $71,288 in
2000.
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, plus interest at 8 percent, with installment
starting May 15, 2001. The 1994 note is due in semimonthly installments of
$1,000, including interest at 6.5 percent. The amount outstanding under
these notes was $428,057 and $436,918 at July 31, 2000 and 1999,
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 no interest and is due on
September 30, 2000. At the end of fiscal 2000, the aggregate outstanding
balance on the two loans was $262,530 (see Note 13). 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 of 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 participant's
compensation. Company contributions to the plan totaled approximately
$40,000 and $46,000 in 2000 and 1999, respectively.
11. SIGNIFICANT CUSTOMERS
The Company had one significant customer in 2000 and 1999 whose sales as a
percentage of total sales were 12 percent and 15 percent, respectively.
12. STOCKHOLDERS' EQUITY
The Company adopted the 1996 Stock Option Plan (the "Stock Plan") on
October 15, 1996 and reserved 700,000 shares of its common stock for
issuance under the Stock Plan. The Stock Plan provides for the grant of
"incentive stock options," as defined in Section 422 of the Internal
Revenue Code of 1986, as amended, and nonqualified stock options. The
Stock Plan will be administered either by the Company's Board of Directors
or by a committee of two or more nonemployee directors. Subject to the
terms of the Stock Plan, the Board of Directors or the committee has the
authority to grant options under the Stock Plan, to amend, construe, and
interpret it, and to make all other determinations and take any and all
actions necessary or advisable for its administration. The directors,
consultants, and key employees of the Company or any subsidiary are
eligible to receive options under the Plan, which are fully vested upon
issuance, but only salaried employees of the Company or its subsidiaries
are eligible to receive incentive stock options, which vest over a
five-year period from the date of issuance.
27
<PAGE>
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 in consideration for investor relations consulting services. These
options would have vested if before January 1, 2000 the average closing
price of the Company's common stock equaled or exceeded $9.00 per share
for ten consecutive days, however, the options failed to vest and expired
unexercised. 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 immediately exercisable at a price of $5.50 per share of
common stock through March 17, 2003.
In 2000, the Company granted a warrant for the purchase of 25,000 shares
of the Company's common stock to Gilman Financial Corporation, a company
that employs a Director of the Company, in exchange for consulting
services with respect to developing, studying, and evaluating merger and
acquisition proposals. The warrant is exercisable at a price of $5.50 per
share of common stock through March 6, 2009.
Stock option and warrants activity for the Company during fiscal years
2000 and 1999 was as follows:
<TABLE>
<CAPTION>
2000 1999
--------------------------- ---------------------------
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 160,171 $3.69 70,171 $1.73
Granted 34,000 5.17 90,000 5.21
Cancelled (40,000) 5.00 - -
------- ----- ------- -----
Stock options and warrants
outstanding, end of year 154,171 $3.67 160,171 $3.69
======= ===== ======= =====
</TABLE>
Options and warrants outstanding as of July 31, 2000 are as follows:
<TABLE>
<CAPTION>
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>
$ 0.213 43,671 4.22 $ 0.213 43,671 $0.213
4.13 - 5.50 110,500 8.36 5.04 68,000 5.25
</TABLE>
At July 31, 2000, options were exercisable for 111,671 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, 2000, 610,829
shares were available for future option grants.
28
<PAGE>
The weighted-average fair value of options granted during 2000 and 1999
was $114,314 and $95,488, respectively. The effect of these options would
have decreased basic and diluted EPS by $.02 per share during 2000 and
1999, respectively. 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 2000 and 1999:
<TABLE>
<CAPTION>
2000 1999
<S> <C> <C>
Weighted-average expected life 9.66 11.94
Volatility factor 48% 45%
Dividend yield 0.8% 0.2%
Weighted-average risk-free interest 7.26% 6.4%
</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, 2000 YEAR ENDED JULY 31, 1999
----------------------------------------- -----------------------------------------
WEIGHTED- WEIGHTED-
AVERAGE AVERAGE
INCOME SHARES PER SHARE INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) (AMOUNT) (NUMERATOR) (DENOMINATOR) (AMOUNT)
<S> <C> <C> <C> <C> <C> <C>
Basis EPS - Income available
to common stockholders $3,844,805 7,000,169 $0.55 $3,752,367 7,000,169 $0.54
Effect of Dilutive
Securities -
Common stock options 51,123 0.00 63,102 (0.01)
---------- ---------- ----- ---------- ---------- -----
Diluted EPS - Income
available to common
stockholders $3,844,805 7,051,292 $0.55 $3,752,367 7,063,271 $0.53
========== ========== ===== ========== ========== =====
</TABLE>
The Company declared and paid dividends of $140,003 in August and
September 2000, respectively.
13. SUBSEQUENT EVENTS
On October 3, 2000, the Company acquired the monosodium/-disodium
methanearsonic acid (MSMA) herbicides product line and its manufacturing
facility from Zeneca Limited. The Company paid $2.3 million in cash ($1
million due upon equipment delivery) and may pay additional amounts in
future years if certain adjusted net sales targets (as defined in the
agreement) are met. Such additional amounts are payable in the first five
years beginning in the month the Company first sells the MSMA product at
the manufacturing facility. Such facility is being dismantled in Houston,
Texas and will be reassembled at the Company's cost adjacent to the
Company's penta manufacturing facility in Matamoros, Mexico. One half of
the cost of dismantling and 100% of the cost of transporting the MSMA
manufacturing facility will be borne by the Company. Additionally, an
affiliate of Zeneca Limited will produce the MSMA product for the Company
in order for the Company to build the inventory that will be needed by
customers in the 2001 growing season.
29
<PAGE>
On October 18, 2000, the Company completed its purchase of 180,000 shares
of the Company's outstanding common stock from an officer at a price of
$5.00 per share, the value of the Company's common stock on August 29,
2000, the date on which the Board of Directors approved the transaction.
The officer used the proceeds from the sale to purchase the Company's
interest in two loans of $263,530 to NHC, as referred to in Note 9, and to
repay loans of $428,057 made to the officer by the Company in fiscal 1998
and 1994, as also referred to in Note 9.
******
30
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
Pursuant to instruction E.3 to Form 10-KSB, the information required by
Items 9-12 of Part III is incorporated by reference from the Company's
definitive proxy statement to be filed on or about October 29, 2000.
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:
<TABLE>
<S> <C>
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.****
2.1 (iii) Asset Sale Agreement dated October 3, 2000 between
the Company and GB Biosciences Corporation (+).
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.*
31
<PAGE>
10.9 Second Amendment to Revolving Loan Agreement.**
10.10 $2,500,000 Amended and Restated Revolving Note.**
10.11 Third Amendment to Revolving Loan Agreement.***
10.12 $2,500,00 Amended and Restated Revolving Note dated
December 31, 1997.***
10.13 Employment Agreement dated February 1, 1998 with
Bobby D. Godfrey.***
10.14 Creosote Supply Agreement dated as of June 30, 1998
between AlliedSignal Inc. and the Company.****
10.15 Performance Guaranty dated June 30, 1998 by the
Company.****
10.16 Term Loan Agreement between SouthTrust Bank, National
Association and KMG-Bernuth, Inc.****
10.17 $6,000,000 Term Note.****
10.18 Guaranty of Payment by the Company.****
10.19 Fourth Amendment to Revolving Loan Agreement.****
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.C.+
10.23 Manufacturing and Formulation Agreement dated October
3, 2000 between the Company and GB Biosciences
Corporation++
10.24 Warrant for the Purchase of 25,000 Shares of Common
Stock dated as of March 6, 2000 between the Company
and JGIS, Ltd., an assignee of Gilman Financial
Corporation
21.1 Subsidiaries of the Company.*
27.1 Financial Data Schedule.
</TABLE>
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 (*****) were
filed by the Company on March 12, 1999 as part of its report on Form 10-QSB
under file number 000-29278. Documents marked by a (+) were filed by the
Company on October 26, 1999 as part of its report on Form 10-KSB and where
marked by a (++) were filed October 18, 2000 as part of its report on Form
8-K.
(b) No reports on Form 8-K were filed by the Company during the quarter
ended July 31, 2000 but the Company filed a report on Form 8-K on
October 18, 2000 respecting the MSMA products transaction. See "Item 1:
Description of the Company-Business of the Company-New Developments."
32
<PAGE>
SIGNATURES
In accordance with the Exchange Act, the Company caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
KMG CHEMICALS, INC.
By: /s/ David L. Hatcher Date: October 25, 2000
----------------------------------------- ----------------
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, 2000
----------------------------------------- ----------------
Jack Vernie, Controller
By: /s/ Bobby D. Godfrey Date: October 25, 2000
----------------------------------------- ----------------
Bobby D. Godfrey, Director
By: /s/ George W. Gilman Date: October 25, 2000
----------------------------------------- ----------------
George W. Gilman, Director
By: /s/ Fred C. Leonard III Date: October 25, 2000
----------------------------------------- ----------------
Fred C. Leonard III, Director
By: /s/ Charles M. Neff, Jr. Date: October 25, 2000
--------------------------------- ----------------
Charles M. Neff, Jr., Director
By: /s/ Richard L. Urbanowski Date: October 20, 2000
--------------------------------- ----------------
Richard L. Urbanowski, Director
