UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

ý                                 QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended April 30, 2004

 

o                                 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE EXCHANGE ACT

 

For the transition period from                  to

 

Commission file number 000-29278

 

KMG CHEMICALS, INC.

(Exact name of registrant as specified in its charter)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 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 ý      No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes o      No ý

 

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY

PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

 

Indicate by check mark whether the registrant filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.

Yes o      No o

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 7,550,019 shares of common stock.

 

 

Part I. — FINANCIAL INFORMATION

 

KMG CHEMICALS, INC.

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

 

		April 30, 2004			July 31, 2003
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	1,004,776		$	1,490,357
Marketable securities		0			164,735
Accounts receivable:
Trade, net		6,525,560			7,397,654
Other		382,138			352,962
Notes receivable - current portion		128,231			98,442
Inventories		6,200,388			5,285,870
Prepaid expenses and other current assets		339,022			178,573
Total current assets		14,580,115			14,968,593
PROPERTY, PLANT AND EQUIPMENT -
Property, plant & equipment		10,140,835			9,502,055
Less accumulated depreciation and amortization		(4,706,221		)	(4,014,751		)
Net property, plant and equipment		5,434,614			5,487,304
NOTES RECEIVABLE, Less current portion		0			65,844
DEFERRED TAX ASSET		518,958			510,929
GOODWILL		3,050,375			0
INTANGIBLE ASSETS, net of accumulated amortization		13,651,663			10,397,761
OTHER ASSETS		1,217,305			907,079
TOTAL		$	38,453,030		$	32,337,510
LIABILITIES & STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable		$	3,858,521		$	3,388,311
Accrued liabilities		807,905			1,165,071
Current portion of long-term debt		1,228,996			504,996
Total current liabilities		5,895,422			5,058,378
LONG-TERM DEBT		8,911,676			4,250,423
COMMITMENTS AND CONTINGENCIES
Total liabilities		14,807,098			9,308,801
STOCKHOLDERS’ EQUITY
Preferred stock, $.01 par value, 10,000,000 shares authorized, none issued
Common stock, $.01 par value, 40,000,000 shares authorized, 7,730,019 shares issued and 7,550,019 shares outstanding at April 30, 2004 and, 7,692,981 issued and 7,512,981 outstanding at July 31, 2003.		77,301			76,930
Additional paid-in capital		3,671,080			3,365,976
Treasury stock		(900,000		)	(900,000		)
Accumulated other comprehensive income		7,964			73,753
Retained earnings		20,789,587			20,412,050
Total stockholders’ equity		23,645,932			23,028,709
TOTAL		$	38,453,030		$	32,337,510

 

2

 

KMG CHEMICALS, INC.

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

 

		Three Months Ended April 30,						Nine Months Ended April 30,
		2004			2003			2004			2003
NET SALES		$	12,423,676		$	8,979,786		$	29,332,552		$	23,320,714
COST OF SALES		8,727,443			6,164,918			20,661,376			15,732,113
Gross Profit		3,696,233			2,814,868			8,671,176			7,588,601
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES		2,534,691			1,969,328			7,178,497			5,756,113
Operating income		1,161,542			845,540			1,492,679			1,832,488
OTHER INCOME (EXPENSE):
Interest & dividend income		4,740			20,612			20,944			42,132
Interest expense		(97,223		)	(57,294		)	(243,979		)	(95,041		)
Gain on sale of securities								114,829
Other		(18,595		)	(6,008		)	(46,687		)	(14,363		)
Total other income (expense)		(111,078		)	(42,690		)	(154,893		)	(67,272		)
INCOME BEFORE INCOME TAX		1,050,464			802,850			1,337,786			1,765,216
Provision for income (tax)		(399,175		)	(272,971		)	(508,358		)	(600,175		)
NET INCOME		$	651,289		$	529,879		$	829,428		$	1,165,041
EARNINGS PER SHARE:
Basic		$	0.09		$	0.07		$	0.11		$	0.16
Diluted		$	0.08		$	0.07		$	0.11		$	0.15
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic		7,550,019			7,512,981			7,541,233			7,512,981
Diluted		7,704,343			7,547,362			7,640,924			7,549,829

 

See notes to consolidated financial statements.

 

3

 

KMG CHEMICALS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(UNAUDITED)

 

							ADDITIONAL PAID-IN CAPITAL			TREASURY STOCK			ACCUMULATED OTHER COMPREHENSIVE INCOME			RETAINED EARNINGS			TOTAL STOCKHOLDERS’ EQUITY
		COMMON STOCK
		SHARES ISSUED		PAR VALUE
BALANCE AT JULY 31, 2002		7,692,981		$	76,930		$	3,365,976		$	(900,000	)	$	88,429		$	18,889,315		$	21,520,650
Cash dividends																(394,429		)	(394,429		)
Net income																1,917,164			1,917,164
Change in unrealized gain on available for sale securities (net of taxes of $12,499)													(18,199		)				(18,199		)
Unrealized gain on interest rate swap (net of taxes of $1,982)													3,523						3,523
BALANCE AT JULY 31, 2003		7,692,981		76,930			3,365,976			(900,000		)	73,753			20,412,050			23,028,709
Cash dividends																(451,891		)	(451,891		)
Employee options exercised		37,038		371			6,904												7,275
Value of options issued for WPP acquisition							298,200												298,200
Net income																829,428			829,428
Change in unrealized gain on available for sale securities due to sale of stock during first quarter (net of taxes of $36,504)													(38,827		)				(38,827		)
Unrealized loss on interest rate swap (net of taxes of $2,899													(26,962		)				(26,962		)
BALANCE AT APRIL 30, 2004		7,730,019		$	77,301		$	3,671,080		$	(900,000	)	$	7,964		$	20,789,587		$	23,645,932

 

See notes to consolidated financial statements.

 

4

 

KMG CHEMICALS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

		Nine Months Ended April 30,
		2004			2003
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	829,428		$	1,165,041
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		1,202,184			1,055,554
Bad debt expense		40,000			25,000
Gain on sale of equipment		(2,072		)	(18,500		)
Gain on sale of securities		(114,829		)
Forgiveness of notes receivable from related parties					25,635
Deferred income taxes		(8,030		)	(170,915		)
Changes in operating assets and liabilities:
Accounts receivable - trade		832,094			1,032,612
Accounts receivable - other		(29,176		)	25,997
Inventories		(709,918		)	(1,252,218		)
Prepaid expenses and other assets		(150,450		)	7,632
Accounts payable		470,210			595,302
Accrued liabilities		(967,162		)	(793,685		)
Net cash provided by operating activities		1,392,279			1,697,455
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equipment		(550,828		)	(204,121		)
Rabon product line purchase					(3,855,572		)
Wood Protection Products acquisition		(6,194,598		)
Proceeds from sale of equipment		105,072			18,500
Proceeds from sale of securities		169,830
Notes receivable		36,055			5,138
Additions to other assets		(384,028		)	(305,994		)
Net cash used in investing activities		(6,818,497		)	(4,342,049		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal borrowings		6,348,000			5,256,000
Principal payments on borrowings		(962,746		)	(1,713,864		)
Proceeds from exercise of stock options		7,274
Payment of dividends		(451,891		)	(394,429		)
Net cash provided by financing activities		4,940,637			3,147,707
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS		(485,581		)	503,113
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD		1,490,357			1,234,581
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	1,004,776		$	1,737,694
SUPPLEMENTAL DISCLOSURES FOR CASH FLOW INFORMATION:
Cash paid during the period for interest		$	228,917		$	88,496
Cash paid during the period for income taxes		$	701,741		$	910,411

 

See notes to consolidated financial statements.

 

5

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

(1)                                  Basis of Presentation.  The unaudited condensed consolidated financial statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim reporting, and in the opinion of management reflect all adjustments, including those of a normal recurring nature, that are necessary for a fair presentation of financial position and results of operations for the interim periods presented. These financial statements include the accounts of KMG Chemicals, Inc. and its subsidiaries (the “Company”). All significant intercompany balances and transactions have been eliminated in consolidation.  As permitted under those requirements, certain footnotes or other financial information that are normally required by GAAP (accounting principles generally accepted in the United States of America) have been condensed or omitted.  The financial statements included herein should be read in conjunction with the financial statements and notes thereto included in the Company’s annual report on Form 10-K for the year ended July 31, 2003.

 

(2)                                  Earnings Per Share.  Basic earnings per share has been computed by dividing net income by the weighted average shares outstanding.  Diluted earnings per share has been computed by dividing net income by the weighted average shares outstanding plus dilutive potential common shares.  The following table presents information necessary to calculate basic and diluted earnings per share for periods indicated:

 

		Three Months Ended April 30						Nine Months Ended April 30
		2004			2003			2004			2003
BASIC EARNINGS PER SHARE
Net Income		$	651,289		$	529,879		$	829,428		$	1,165,041
Weighted Average Shares Outstanding		7,550,019			7,512,981			7,541,233			7,512,981
Basic Earnings Per Share		$	0.09		$	0.07		$	0.11		$	0.16
DILUTED EARNINGS PER SHARE
Net Income		$	651,289		$	529,879		$	829,428		$	1,165,041
Weighted Average Shares Outstanding		7,550,019			7,512,981			7,541,233			7,512,981
Shares Issuable from Assumed Conversion of Common Share Options		154,324			34,381			99,691			36,848
Weighted Average Shares Outstanding, as Adjusted		7,704,343			7,547,362			7,640,924			7,549,829
Diluted Earnings Per Share		$	0.08		$	0.07		$	0.11		$	0.15

 

6

 

(3)                                  Inventories.  Inventories are summarized as follows:

 

		April 30, 2004			July 31, 2003
Chemical raw materials and supplies		$	1,666,760		$	827,292
Finished chemical products		4,533,628			4,458,578
		$	6,200,388		$	5,285,870

 

(4)                                  Stock-based Compensation.  The pro forma effect on net earnings and earnings per share if the Company had applied the fair value recognition provision of Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-based Compensation” (FAS 123), to stock-based employee compensation for the three and nine months ended April 30, 2004 and 2003 is illustrated below:

 

		Three months ended April 30						Nine months ended April 30
		2004			2003			2004			2003
Net earnings, as reported		$	651,289		$	529,879		$	829,428		$	1,165,041
Add: Total stock-based employee compensation expense included in reported net earnings under intrinsic value based method for all awards, net of related tax effects
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(120,484		)	(80,736		)	(214,196		)	(155,067		)
Pro forma net earnings		$	530,805		$	449,143		$	615,232		$	1,009,974
Earnings per share:
Basic, as reported		$	0.09		$	0.07		$	0.11		$	0.16
Basic, pro forma		$	0.07		$	0.06		$	0.08		$	0.13
Diluted, as reported		$	0.08		$	0.07		$	0.11		$	0.15
Diluted, pro forma		$	0.07		$	0.06		$	0.08		$	0.13

 

7

 

(5)                                  Intangible and Other Assets.  Intangible and other assets are summarized as follows:

 

		April 30, 2004			July 31, 2003
Intangible assets not subject to amortization:
Creosote sales and distribution assets		$	4,500,000		$	4,500,000
Other creosote related assets		77,604			77,604
Penta product registrations		2,360,000
Rabon product registrations and related assets		3,557,042			3,557,042
		10,494,646			8,134,646
Intangible assets subject to amortization:
Creosote supply contract		4,000,000			4,000,000
Other Penta related assets		1,254,000
MSMA product registrations and related assets		1,200,000			1,200,000
Other MSMA related assets		97,652			101,904
Licensing agreement		320,000			320,000
Other Rabon related assets		204,000			204,000
Loan Costs		87,985			42,985
Other intangible assets		45,831
		7,209,468			5,868,889
Total intangible assets		17,704,114			14,003,535
Less accumulated amortization		(4,052,451		)	(3,605,774		)
		$	13,651,663		$	10,397,761
Other assets consisted of the following:
Advances for premiums on employee-owned life insurance policies		$			$	521,740
Cash surrender value on key man life insurance policies		1,182,012			357,386
Other		35,293			27,953
		$	1,217,305		$	907,079

 

Amortization expense was $179,524 and $446,677 for the three and nine months ended April 30, 2004 respectively and $112,775 and $320,864 for the three and nine months ended April 30, 2003, respectively.

 

8

 

(6)           Acquisitions.  The Company purchased certain assets of Wood Protection Products, Inc. (“WPP”), a penta solutions distributor, on December 5, 2003.  The consideration paid included $6,194,600 in cash at closing, plus an agreement to pay an additional $610,000 in six equal payments over the subsequent six month period, and an option to purchase 175,000 shares of common stock in the company.  The option is exercisable over a period of five years at an exercise price equal to $2.50 per share, and has been valued at $298,200.  The cash purchase price was mostly financed with a $6 million term loan from SouthTrust Bank.  The table below summarizes the total consideration paid for the WPP assets.

 

Cash paid at closing		$	6,194,600
Payment commitments over the subsequent 6 months		610,000
Total cash paid in fiscal year 2004		$	6,804,600
Estimated value of stock option granted		298,200
Other costs of acquisition		63,175
Total consideration paid		$	7,165,975

 

The acquisition included WPP’s distribution and plant equipment along with its inventory and product registrations.  It also included a consulting agreement and a non-compete agreement with its principal shareholder.  The table below summarizes the purchase price allocation for the transaction.

 

Equipment		$	297,000
Inventory		204,600
Total tangible assets		$	501,600
Product registrations, consulting and non-compete agreements		$	3,614,000
Goodwill		3,050,375
Total intangible assets including goodwill		­$	6,664,375
Total assets acquired		$	7,165,975

 

The following table presents the pro forma effect of the WPP acquisition and associated financing on the Company’s historical results for the three month and nine month periods ended April 30, 2004 and 2003 as if the transaction had occurred on August 1, 2002.

 

		Three Months Ended April 30,						Nine Months Ended April 30,
		2004			2003			2004			2003
Revenues		$	12,423,676		$	10,413,871		$	31,585,251		$	28,108,019
Operating income		1,161,542			1,089,334			1,875,638			2,646,330
Net income		651,289			651,183			1,023,115			1,583,377
Basic earnings per share		$	0.09		$	0.09		$	0.14		$	0.21

 

In addition, the Company completed two acquisitions in June of 2004, which are not believed to be material to the Company’s financial statements. These acquisitions were completed using available cash, borrowing under the company’s revolving loan with SouthTrust Bank, and by increasing one of the Company’s senior term loans with SouthTrust by $2,954,000.

 

(7)                                  Dividends.  Dividends of $225,390 ($0.03 per share) and $169,042 ($0.0225 per share) were declared and paid in the first quarter of fiscal 2004 and 2003 respectively.  In addition, dividends of $226,501 ($0.03 per share) and $225,387 ($0.03 per share) were declared and paid in the third quarter of fiscal 2004 and 2003 respectively.  No further dividends were declared or paid in the first nine months of fiscal 2004 or 2003.

 

9

 

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS 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 three and nine month periods ended April 30, 2004 and 2003:

 

		Three Months Ended April 30						Increase/ (Decrease)			Nine Months Ended April 30						Increase/ (Decrease)
		2004			2003						2004			2003
Net sales		$	12,423,676		$	8,979,786		$	3,443,890		$	29,332,552		$	23,320,714		$	6,011,838
Gross profit		$	3,696,233		$	2,814,868		$	881,365		$	8,671,176		$	7,588,601		$	1,082,575
Gross profit as a percent of net sales		29.8		%	31.3		%	(1.5		)%	29.6		%	32.5		%	(2.9		)%
Net income (loss)		$	651,289		$	529,879		$	121,410		$	829,428		$	1,165,041		$	(335,613	)
Basic earnings (loss) per share		$	0.09		$	0.07		$	0.02		$	0.11		$	0.16		$	(0.05	)
Weighted average shares outstanding		7,550,019			7,512,981			37,038			7,541,233			7,512,981			28,252

 

Sales Revenue and Gross Profit

 

Net sales revenue for the third quarter of fiscal 2004 increased 38% as compared with the third quarter of fiscal 2003.  Net sales revenue for the first nine months of fiscal 2004 also showed an increase of 26% over

 

10

 

the prior year period.  More than half of the increase in sales revenue came from pentachlorophenol (“penta”) sales.  The Company’s penta products are used principally to treat utility poles.  Penta volume was up significantly in the third quarter because of the effect of the Company’s acquisition of the penta distribution business of Wood Protection Products, Inc. (“WPP”) in December 2003.  Management believes that the acquisition will add approximately $6 million in annualized net sales revenue.  The Company also benefited from the penta price increase that was effective in June 2003.  Most of the remainder of the increase in the third quarter and the first nine months came from improvement in the Company’s creosote sales volume because of increased demand by Class 1 railroads for crossties treated with creosote.

 

Net sales revenue from the Company’s non-wood treating products were also up in the third quarter and the first nine months of the fiscal year as compared with last fiscal year; however, sales of those products are heavily concentrated in the fourth fiscal quarter.

 

Gross profit increased $881 thousand in the third quarter over the prior year and increased $1.1 million for the first nine months comparison.  Gross profit as a percent of sales, however, declined to 29.8% for the third quarter of this fiscal year from 31.3% for the same quarter of fiscal 2003.  The nine months comparison also showed a decrease to 29.6%  from 32.5%.  Effective in December 2003, the Company entered a long term supply agreement with the other United States penta producer in order to support the increased sales volume resulting from the Company’s acquisition of WPP.  Purchases of penta blocks from the other producer adversely affect penta margins because they are somewhat more costly than penta blocks produced by the Company.  The Company has also experienced higher penta raw material costs and higher creosote purchase costs than in the same periods of the prior fiscal year.  Phenol and chlorine reached a peak in the fourth quarter of fiscal 2003, and have remained at relatively high levels since then.  The Company expects that those increased costs will affect gross margins adversely over the entire fiscal year.

 

Selling, General and Administrative Expenses

 

As a percentage of net revenue, selling, general, and administrative expenses decreased in the third quarter of this fiscal year to 20.4% from 21.9% for the prior fiscal year third quarter and decreased to 24.5%  from 24.7% for the nine month comparison.  Selling, general and administrative expenses for the third quarter of fiscal 2004 were approximately $565 thousand (28.7%) higher than in the same quarter of the prior fiscal year and over the first nine months those expenses were $1.4 million (24.7%) higher.  The increase was primarily due to higher regulatory costs for each of the Company’s products, and higher selling and distribution expense because of greater creosote and penta sales volume, including additional penta volume from customers acquired in connection with the Company’s WPP acquisition in December 2003.  Higher intangible amortization associated with the Company’s WPP and Rabon acquisitions and certain non-recurring legal and related expenses also contributed to the increase.

 

Liquidity and Capital Resources

 

The principal balance of the Company’s two term loan facilities with SouthTrust was approximately $10.1 million as of April 30, 2004.  The Company purchased its Rabon product category in December 2003, and that purchase was provided for by refinancing and increasing the Company’s then existing term loan facility with SouthTrust.  The principal amount of that loan is being amortized monthly over ten years but the maturity date is December 20, 2007.  The loan carries interest at a varying rate equal to LIBOR plus 1.8%.  However, in February 2003, the Company entered into an interest rate swap transaction with SouthTrust which effectively fixed the interest rate at 5.0% for the remainder of the term.  As of April 30, 2004 the principal balance outstanding on that facility was approximately $4.4 million.

 

The Company acquired certain assets of

 

11

 

WPP as of December 5, 2003.  The purchase was financed largely by a $6 million term loan from SouthTrust.  The Company also granted an option to acquire 175,000 shares of the common stock of the Company, exercisable at $2.50 per share.  The acquisition included WPP’s distribution and plant equipment along with its inventory and product registrations and a consulting and non-compete agreement with its principal shareholder.  The principal amount of that loan is being amortized monthly over ten years but the maturity date is December 1, 2008.  The loan carries interest at a varying rate initially equal to LIBOR plus 1.75%.  As of April 30, 2004, the principal amount of that loan was approximately $5.7 million.

 

As of April 30, 2004, there was no amount outstanding on the Company’s revolving loan with SouthTrust and its borrowing base availability under that loan was $3.5 million.  Management believes that the term loan and the revolving credit facility, combined with cash flows from operations, adequately provide for the Company’s anticipated need for liquidity and capital resources in fiscal 2004.

 

During the second quarter the Company terminated its split dollar insurance plan with David Hatcher.  Mr. Hatcher transferred his interest in the $1.2 million insurance policy on his life to the Company for approximately $92 thousand, the difference between the cash value of the policy and the premiums paid by the Company under the terminated plan.

 

Changes in Contractual Obligations

 

Effective December 5, 2003, the Company borrowed $6 million from SouthTrust Bank via a term loan.  This is the Company’s second term loan with SouthTrust Bank. This term loan matures on December 1, 2008 and carries interest at a varying rate equal initially to 1.75% over LIBOR. The premium over LIBOR could increase up to a maximum of 2.25% depending upon the calculated coverage ratio as defined in the loan agreement.   Principal repayments for the $6 million term loan are as follows:

 

January 1, 2004 to December 1, 2004		$59,000 per month
January 1, 2005 to December 1, 2005		$63,000 per month
January 1, 2006 to December 1, 2006		$67,000 per month
January 1, 2007 to December 1, 2007		$71,000 per month
January 1, 2008 to December 1, 2008		$75,000 per month
Maturity date (December 1, 2008)		Remaining principal balance is due

 

Also, on December 5, 2003, the Company entered into an agreement to pay $610,000 in six equal monthly payments beginning on January 5, 2004 and ending on June 5, 2004 as part of the consideration for the WPP asset (see Notes to Consolidated Financial Statements, note 6).

 

The Company completed two acquisitions in June 2004 using available cash, borrowings under the Company’s revolving loan with SouthTrust and by increasing the $6 million term loan by $2.95 million.  See, Notes to Consolidated Financial Statements, note 6.

 

Off-Balance Sheet Arrangements

 

The Company does not have any off-balance sheet arrangements.

 

12

 

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 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 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 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.

 

13

 

New Accounting Rules

 

In February 2003, SFAS No. 148 was issued, “Accounting for Stock Based Compensation-Transition and Disclosure and Amendment of FASB Statement No. 123.”  SFAS No. 148 amends SFAS No. 123 to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation.  It also amends the disclosure provisions of that Statement to require prominent disclosure about the effects on reported net income of an entity’s accounting policy decisions with respect to stock-based compensation.  The Company has chosen not to voluntarily change to the fair value based method of accounting for stock-based employee compensation but has adopted the disclosure rules of SFAS No. 148.

 

The Company has adopted SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” The adoption of SFAS No. 149 did not have an impact on the Company’s financial position or results of operations.

 

The Company has adopted SFAS No. 150 “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.” This statement requires issuers to classify a financial instrument that is within its scope as a liability instead of equity.  The adoption of SFAS No. 150 did not have an impact on the Company’s financial position or results of operations.

 

Critical Accounting Policies

 

The Company’s consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America.  The preparation of these financial statements requires the use of estimates, judgments, and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented.  The significant accounting principles that we believe are the most important to aid in fully understanding our financial results are the following:

 

Revenue Recognition – The Company essentially has only one revenue recognition transaction in which the Company’s chemical products sold in the open market are recognized as revenue as risk of loss and title to the products transfer to customers, which usually occurs at the time a shipment is made.

 

Allowance for Doubtful Accounts - The Company provides an allowance for accounts receivable it believes it may not collect in full.  A provision for bad debt expense recorded to selling, general and administrative expenses increases the allowance.  Accounts receivable that are written off the Company’s books decrease the allowance.  The amount of bad debt expense recorded each period and the resulting adequacy of the allowance at the end of each period are determined using a combination of the Company’s historical loss experience, customer-by-customer analyses of the Company’s accounts receivable balances each period and subjective assessments of the Company’s future bad debt exposure.

 

Inventories - - Inventories consist primarily of raw materials and finished goods that the Company holds for sale in the ordinary course of business.  It uses the first-in, first-out method to value inventories at the lower of cost or market.   Management believes the Company has not incurred impairments in the carrying value of its inventories.

 

14

 

Impairment of Long-lived Assets - The Company periodically reviews the carrying value of its long-lived assets held and used and assets to be disposed of, including supply contracts and other intangible assets, at least annually or when events and circumstances warrant such a review.  The carrying value of long-lived assets are evaluated for potential impairment on a product line basis.  The Company has concluded on the basis of its evaluation that the long lived assets are not impaired.

 

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

The Company is exposed to certain market risks arising from transactions that are entered into in the ordinary course of business, primarily from changes in foreign exchange rates.  The Company generally does not utilize derivative financial instruments or hedging transactions to manage that risk.  However, the Company did enter into an interest rate swap transaction in February, 2003 that effectively fixed the interest rate on its term loan at 5.0% for the remainder of the loan’s term.  An increase or decrease in interest rates would not affect the Company’s earnings or cash flow over the life of the term loan because the interest rate swap serves to fix the interest rate at 5.0%.   Should the financial market’s expectations for interest rates in the future increase then the value of the swap, recorded as an asset on the consolidated balance sheets, would increase.  Conversely, a drop in the financial market’s expectations for future interest rates would cause a drop in the value of that recorded asset.  It is possible that the future expectations for interest rates could decline enough to cause the swap to be recorded no longer as an asset, but as a liability, until the swap expires.

 

ITEM 4.  CONTROLS AND PROCEDURES.

 

Within 90 days prior to the filing of this report, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), an evaluation of the effectiveness of the Company’s disclosure controls and procedures was performed.  Based on this evaluation, the CEO and CFO have concluded that the Company’s disclosure controls and procedures are effective to ensure that material information is recorded, processed, summarized and reported by management of the Company on a timely basis in order to comply with the Company’s disclosure obligations under the Securities Exchange Act and the rules of the SEC.  There were no significant changes in the Company’s internal controls or in other  factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

PART II — OTHER INFORMATION

 

ITEM 1.  LEGAL PROCEEDINGS.

 

The Company is not a party to any material legal actions or proceedings, other than ordinary routine litigation incidental to the business, and it does not believe any such actions or proceedings will have a material adverse effect on its business, results of operations or financial position.

 

15

 

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K.

 

(a)                                  Exhibits:

 

The financial statements are filed as Part I of this report.  The following documents are filed as exhibits by the Company and documents marked by an asterisk (*) were previously filed (file number 29278):

 

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*
2.1 (iv)		Asset Purchase Agreement dated December 30, 2002 between Boehringer Ingelheim Vetmedica, Inc. and KMG-Bernuth, 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		$2,500,000 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.*

 

16

 

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 Rütgers 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.*
10.25		Employment Agreement with Thomas H. Mitchell dated July 11, 2001.*
10.26		Employment Agreement with John V. Sobchak dated June 26, 2001.*
10.27		Supplemental Executive Retirement Plan dated effective August 1, 2001.*
10.28		Sales Agreement dated January 1, 2002 between Reilly Industries, Inc. and the Company.*
10.29		Contract Manufacturing Agreement dated December 30, 2002 between Boehringer Ingelheim Vetmedica, Inc. and KMG-Bernuth, Inc.*
10.30		Amended and Restated Promissory Note dated December 30, 2002 made payable by KMG-Bernuth, Inc. to SouthTrust Bank.*
10.31		Employment Agreement with Roger C. Jackson dated August 1, 2002.*
21.1		Subsidiaries of the Company.*
31		Certificates under Section 302 the Sarbanes-Oxley Act of 2002 of David L. Hatcher and John V. Sobchak pertaining to this report
32		Certificates under Section 906 of the Sarbanes-Oxley Act of 2002 of David L. Hatcher and John V. Sobchak pertaining to this report
99.1		Direct Stock Purchase Plan.*

 

17

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

KMG Chemicals, Inc.
By:	/s/ David L. Hatcher		Date:	June 14, 2004
	David L. Hatcher, President
By:	/s/ John V. Sobchak		Date:	June 14, 2004
	John V. Sobchak,
	Chief Financial Officer

 

18