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 January  31, 2005

 

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)

 

 

10611 Harwin Drive, Suite 402

Houston, Texas 77036

(Address of principal executive offices)

 

(713) 988-9252

(Registrant’s telephone number including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of th/e 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:

 

The number of shares outstanding of the issuer’s of common stock as of February 28, 2005: 7,575,019 shares of common stock.

 

 

 

Part I. --- FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS.

 

KMG CHEMICALS, INC.

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

 

		January 31,			July 31,
		2005			2004
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	1,957,336		$	974,284
Accounts receivable:
Trade, net		5,254,408			6,816,922
Other		305,903			493,058
Inventories		7,670,140			6,692,084
Prepaid expenses and other current assets		139,443			304,878
Total current assets		15,327,230			15,281,226
PROPERTY, PLANT AND EQUIPMENT -
Property, plant and equipment		10,945,409			10,592,938
Accumulated depreciation and amortization		(5,461,069		)	(4,959,459		)
Net property, plant and equipment		5,484,340			5,633,479
DEFERRED TAX ASSET		386,001			457,014
GOODWILL		3,778,434			3,778,313
INTANGIBLE ASSETS, net of accumulated amortization		16,433,785			16,856,023
OTHER ASSETS		1,464,105			1,233,647
TOTAL		$	42,873,895		$	43,239,702
LIABILITIES & STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable		$	4,535,156		$	5,075,661
Accrued liabilities		636,746			652,181
Current portion of long-term debt		1,559,996			1,529,996
Total current liabilities		6,731,898			7,257,838
LONG-TERM DEBT		10,442,929			11,235,427
OTHER LONG TERM LIABILITIES		187,785			156,436
COMMITMENTS AND CONTINGENCIES
Total liabilities		17,362,612			18,649,701
STOCKHOLDERS’ EQUITY
Preferred stock, $.01 par value, 10,000,000 shares authorized, none issued
Common stock, $.01 par value, 40,000,000 shares authorized, 7,755,019 shares issued and 7,575,019 shares outstanding at January 31, 2005 and 7,730,019 issued and 7,550,019 outstanding at July 31, 2004.		77,551			77,301
Additional paid-in capital		3,733,330			3,671,080
Treasury stock, at cost (180,000 shares at January 31, 2005 and July 31, 2004)		(900,000		)	(900,000		)
Accumulated other comprehensive income		25,314			18,096
Retained earnings		22,575,088			21,723,524
Total stockholders’ equity		25,511,283			24,590,001
TOTAL		$	42,873,895		$	43,239,702

 

See notes to consolidated financial statements.

 

 

1

 

KMG CHEMICALS, INC.

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

 

		Three Months Ended						Six Months Ended
		January 31,						January 31,
		2005			2004			2005			2004
NET SALES		$	12,476,804		$	8,536,767		$	26,071,381		$	16,908,877
COST OF SALES		8,301,326			6,108,027			17,660,562			11,933,933
Gross Profit		4,175,478			2,428,740			8,410,819			4,974,944
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES		3,326,022			2,566,039			6,350,258			4,643,803
Operating income (loss)		849,456			(137,299		)	2,060,561			331,141
OTHER INCOME (EXPENSE):
Interest & dividend income		11,253			6,750			19,766			16,204
Interest expense		(137,232		)	(86,160		)	(263,210		)	(146,755		)
Gain on sale of securities								0			114,829
Other		(7,706		)	(10,893		)	(17,415		)	(28,092		)
Total other income (expense)		(133,685		)	(90,303		)	(260,859		)	(43,814		)
INCOME (LOSS) BEFORE INCOME TAX		715,771			(227,602		)	1,799,702			287,327
Provision for income tax		(271,993		)	86,489			(683,887		)	(109,184		)
NET INCOME (LOSS)		$	443,778		$	(141,113	)	$	1,115,815		$	178,143
EARNINGS (LOSS) PER SHARE:
Basic		$	0.06		$	(0.02	)	$	0.15		$	0.02
Diluted		$	0.06		$	(0.02	)	$	0.14		$	0.02
WEIGHTED AVERAGE SHARES OUTSTANDING:
Basic		7,552,193			7,550,019			7,551,106			7,536,935
Diluted		7,928,597			7,550,019			7,779,667			7,608,127

 

See notes to consolidated financial statements.

 

 

2

 

KMG CHEMICALS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(UNAUDITED)

 

													ACCUMULATED
		COMMON STOCK					ADDITIONAL						OTHER								TOTAL
		SHARES		PAR			PAID-IN			TREASURY			COMPREHENSIVE					RETAINED			STOCKHOLDERS’
		ISSUED		VALUE			CAPITAL			STOCK			INCOME					EARNINGS			EQUITY
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																		(451,890		)		(451,890		)
Employee options exercised		37,038		371			6,904															7,275
Value of options issued for WPP acquisition							298,200															298,200
Net income																		1,763,364				1,763,364
Change in unrealized gain on available for sale securities due to sale of stock during first quarter (net of taxes of $62,919)															(70,230		)					(70,230		)
Change in unrealized gain on interest rate swap (net of taxes of $9,109)															14,573							14,573
BALANCE AT JULY 31, 2004		7,730,019		77,301			3,671,080			(900,000		)			18,096			21,723,524				24,590,001
Cash dividends																		(264,251		)		(264,251		)
Options exercised		25,000		250			62,250															62,500
Net income																		1,115,815				1,115,815
Change in unrealized gain (loss) on interest rate swap (net of taxes of $4,423)															7,218							7,218
BALANCE AT JANAURY 31, 2005		7,755,019		$	77,551		$	3,733,330		$	(900,000	)			$	25,314		$	22,575,088			$	25,511,283

 

See notes to consolidated financial statements.

 

 

3

 

KMG CHEMICALS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

 

 

		Six Months Ended
		January 31,
		2005			2004
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	1,115,815		$	178,143
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		926,807			769,802
Bad debt expense		30,000			20,000
Gain (loss) on sale of equipment		714			(2,072		)
Gain on sale of securities		0			(114,829		)
Deferred income taxes		78,230			(66,143		)
Unrealized gain on securities held for sale
Changes in operating assets and liabilities:
Accounts receivable - trade		1,532,514			2,270,408
Accounts receivable - other		183,665			(62,277		)
Inventories		(978,056		)	(394,271		)
Prepaid expenses and other assets		151,194			79,569
Accounts payable		(540,505		)	(1,153,491		)
Accrued liabilities		7,763			(791,800		)
Net cash provided by operating activities		2,508,141			733,039
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equipment		(356,143		)	(230,801		)
Product line purchases					(6,194,598		)
Proceeds from sale of equipment		0			2,072
Proceeds from sale of securities		0			169,830
Collection of notes receivable		14,241			27,510
Additions to other assets		(218,938		)	(299,728		)
Net cash used in investing activities		(560,840		)	(6,525,715		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal borrowings		0			6,348,000
Principal payments on borrowings		(762,498		)	(449,498		)
Proceeds from exercise of stock options		62,500			7,275
Payment of dividends		(264,251		)	(225,390		)
Net cash provided by (used in) financing activities		(964,249		)	5,680,387
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		983,053			(112,289		)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD		974,284			1,490,357
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	1,957,336		$	1,378,068
SUPPLEMENTAL DISCLOSURES FOR CASH FLOW INFORMATION:
Cash paid during the period for interest		$	253,740		$	131,379
Cash paid during the period for income taxes		$	726,168		$	527,657

 

See notes to consolidated financial statements.

 

 

4

 

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, 2004.

 

(2)           Earnings Per Share.  Basic earnings per share have been computed by dividing net income by the weighted average shares outstanding.  Diluted earnings per share have 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						Six Months Ended
		January 31,						January 31,
		2005			2004			2005			2004
BASIC EARNINGS PER SHARE
Net income (loss)		$	443,778		$	(141,113	)	$	1,115,815		$	178,143
Weighted average shares outstanding		7,552,193			7,550,019			7,551,106			7,536,935
Basic earnings (loss) per share		$	0.06		$	(0.02	)	$	0.15		$	0.02
DILUTED EARNINGS PER SHARE
Net income (loss)		$	443,778		$	(141,113	)	$	1,115,815		$	178,143
Weighted average shares outstanding		7,552,193			7,550,019			7,551,106			7,536,935
Shares issuable from assumed conversion of common share options		376,404			—			228,561			71,192
Weighted average shares outstanding		7,928,597			7,550,019			7,779,667			7,608,127
Diluted earnings (loss) per share		$	0.06		$	(0.02	)	$	0.14		$	0.02

 

 

5

 

 (3)          Inventories.  Inventories are summarized as follows:

 

		Janaury 31,				July 31,
		2005				2004
Chemical raw materials and supplies		$		3,006,254		$	2,348,828
Finished chemical products		4,663,886				4,343,256
		$	7,670,140			$		6,692,084

 

 

(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  six months ended January 31, 2005 and 2004 is illustrated below:

 

		Three months ended						Six months ended
		January 31,						January 31,
		2005			2004			2005			2004
Net earnings (loss), as reported		$	443,778		$	(141,113	)	$	1,115,815		$	178,143
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		(193,504		)	(103,773		)	(213,767		)	(112,762		)
Pro forma net earnings (loss)		$	250,274		$	(244,886	)	$	902,048		$	65,381
Earnings (loss) per share:
Basic, as reported		$	0.06		$	(0.02	)	$	0.15		$	0.02
Basic, pro forma		$	0.03		$	(0.03	)	$	0.12		$	0.01
Diluted, as reported		$	0.06		$	(0.02	)	$	0.14		$	0.02
Diluted, pro forma		$	0.03		$	(0.03	)	$	0.12		$	0.01

 

 

6

 

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

 

		January 31,			July 31,
		2005			2004
Intangible assets not subject to amortization:
Creosote sales and distribution assets		$	4,500,000		$	4,500,000
Creosote product registrations		2,018,000			2,018,000
Other creosote related assets		77,604			77,604
Penta product registrations		2,360,000			2,360,000
Rabon product registrations and related assets		3,557,042			3,557,042
Ravap product registration		937,546			937,546
		13,450,192			13,450,192
Intangible assets subject to amortization:
Creosote supply contract		4,000,000			4,000,000
Other Creosote related assets		131,000			131,000
Other Penta related assets		1,254,000			1,254,000
MSMA product registrations and related assets		1,200,000			1,200,000
Other MSMA related assets		97,652			97,652
Licensing agreement		320,000			320,000
Ravap trademark		317,000			317,000
Other Rabon related assets		204,000			204,000
Loan Costs		118,158			118,158
		7,641,810			7,641,810
Total intangible assets		21,092,002			21,092,002
Less accumulated amortization		(4,658,217		)	(4,235,979		)
		$	16,433,785		$	16,856,023
Other assets consisted of the following:
Cash surrender value on key man life insurance policies		$	1,400,828		$	1,182,012
Other		63,277			51,635
		$	1,464,105		$	1,233,647

 

 

Amortization expense was $205,396 and $422,238 for the three and six month periods ended January 31, 2005, respectively, and $154,379 and $267,153 for the three and six month periods ended January 31, 2004, respectively.

 

(6)           Dividends.  Dividends of $264,251 ($0.035 per share) and $225,390 ($0.03 per share) were declared and paid in the first quarter of fiscal 2005 and 2004, respectively.  No further dividends were declared or paid in the second quarter of fiscal 2005 or 2004.

 

 

7

 

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 six month periods ended January 31, 2005 and 2004:

 

		Three Months Ended									Six Months Ended
		January 31,						Increase /			January 31,								Increase /
		2005			2004			(Decrease)			2005				2004				(Decrease)
Net sales		$	12,476,804		$	8,536,767		$	3,940,037		$	26,071,381			$	16,908,877			$	9,162,504
Gross profit		$	4,175,478		$	2,428,740		$	1,746,738		$		8,410,819		$		4,974,944		$	3,435,875
Gross profit as a percent of net sales		33.5		%	28.5		%	5.0		%	32.3			%	29.4			%	2.8		%
Net income (loss) per share		$	443,778		(141,113		)	$	584,891		$		1,115,815		$		178,143		$	937,672
Basic earnings (loss) per share		$	0.06		(0.02		)	$	0.08		$		0.15		$		0.02		$	0.13
Weighted average shares outstanding		7,552,193			7,550,019			2,174			7,551,106				7,536,935				14,171

 

Sales Revenue and Gross Profit

 

Net sales revenue for the second quarter of fiscal 2005 increased 46.2% as compared with the second quarter of fiscal 2004.  Net sales revenue for the first six months of fiscal 2005 increased 54.2% over the prior year period.  In both the second quarter of fiscal 2005 and for the first six months, more than 40% of the increase in sales revenue over the prior year periods came from pentachlorophenol (penta) sales.  Our penta products are used principally to treat utility poles.  Penta volume was up primarily because of the effect of our acquisition of the penta distribution business of Wood Protection Products, Inc. in December 2003.  Most of the remainder of the increase in the second quarter and in the first six months of fiscal 2005 over the same periods in fiscal 2004 came from increased creosote sales volume.  Our volume increased in both periods on continuing strong demand from major railroads for crossties treated with creosote, and also because of our acquisition of a creosote distribution business in June 2004.

 

We also saw improved net sales revenue in our animal health pesticides and our agricultural chemicals over the prior fiscal year, particularly because one major animal health products customer accelerated the timing of its purchase for the season.  Most of the sales in our animal health pesticides and in our agricultural chemical occur in the second half of our fiscal year.

 

8

 

Our net sales revenue for the second quarter and the first six months of fiscal 2005 and 2004 is presented in the following table:

 

		Net Sales Revenue (in thousands)
		Three Months Ended										Six Months Ended
		January 31,										January 31,
		2005					2004					2005					2004
Wood treating products		$	11,143		89.3	%	$	8,106		95.0	%	$	23,954		91.9	%	$	16,081		95.1	%
Other products		1,334			10.7	%	431			3.5	%	2,117			8.1	%	828			4.9	%
		$	12,477		100.0	%	$	8,537		98.4	%	$	26,071		100.0	%	$	16,909		100.0	%

 

Gross profit increased $1.7 million in the second quarter of fiscal 2005 over the second quarter of the prior year and increased $3.4 in the first six months of fiscal 2005 over the prior year period.  Gross profit as a percent of sales improved to 33.5% for the second quarter of this fiscal year from 28.5% for the same quarter of fiscal 2004.  The margin improvement holds up over the six-month period as well, 32.3% gross margin in fiscal 2005 as compared with 29.4% in fiscal 2004.  The margin improvement comes primarily from a greater reliance in this fiscal year on lower cost sources of creosote, and on the effect of calendar year end volume incentives from one supplier.  Although margins have improved, they will continue to be impacted in fiscal 2005 by the higher penta raw material costs that first began to appear in May, 2002.  Phenol and chlorine costs stabilized at relatively high levels in the fourth quarter of fiscal 2003 but in the fourth quarter of fiscal 2004, prices for these key raw materials began to move upward once again.  We now spend over $1.5 million more for penta raw materials annually than our average cost in the last five years.  We have not been able to fully pass along the increased cost of penta raw materials, and our margins on penta products have suffered.  We expect penta raw material costs will continue at high levels maintaining pressure on our margins throughout fiscal 2005.

 

Selling, General and Administrative Expenses

 

As a percentage of net revenue, selling, general, and administrative expenses decreased in the second quarter of this fiscal year to 26.7% from 30.1% for the second quarter of the prior fiscal year.  Those expenses also decreased as a percentage of net revenue for the six-month comparison, declining to 24.4% this fiscal year from 27.5% for the last fiscal year.  Selling, general and administrative expenses for the second quarter of fiscal 2005 were approximately $760 thousand (29.6%) higher than in the same quarter of the prior fiscal year.  For the six-month period, the increase over the prior year was $1.7 million (36.7%).  Most of the increase was from higher selling and distribution expense due to greater creosote and penta sales volume, and higher regulatory costs for each of our products.  The addition of a chief operating officer and a new product manager increased executive compensation relative to the prior year.  Amortization of intangibles associated with our fiscal 2004 acquisitions also contributed to the increase over the prior year.

 

9

 

Interest Expense

 

Interest expense was $137 thousand in the second quarter of fiscal 2005 as compared with $86 thousand in the same quarter of fiscal 2004.  Over the first six months, interest expense increased to $263 thousand from $147 thousand from the prior year.  The increase was due to an increase in term loan borrowings to conclude our animal health and wood treating product distribution acquisitions.

 

Income Taxes

 

Our effective tax rate was 38% in the second quarter and in the first six months of both fiscal 2005 and 2004.

 

Liquidity and Capital Resources

 

Cash Flows

 

Net cash from operating activities was $2.5 million since the beginning of fiscal 2005.  Net income of $1.1 million, a decrease of $1.5 million in trade receivables, and depreciation and amortization of $927 thousand were the primary contributors to net cash thus far in fiscal 2005.  These factors were partially offset by a decline in trade payables due to normal variance in the timing of creosote cargo shipments by one of our suppliers.  In fiscal 2004, net cash from operating activities was $733 thousand on net income of $178 thousand.

 

Net cash used in investing activities in the first six months of fiscal 2005 was $561 thousand.  Net cash used in investing activities in the same period of fiscal 2004 was significantly higher at $6.5 million due to the purchase of a penta distribution business in December 2003.

 

We used $964 thousand in net cash for financing activities in the first six months of fiscal 2005.  Of that total, $762 thousand was used to make principal payments on our borrowings and $264 thousand was paid in dividends.  It is our policy to pay dividends from available cash after taking into consideration our profitability, capital requirements, financial condition, growth, business opportunities and other factors which our board of directors may deem relevant.  In fiscal 2004, net cash used in financing activities increased $5.7 million on borrowings, primarily to consummate the acquisition of a penta distribution business.

 

Working Capital

 

We have a working capital line of credit under a revolving credit facility with SouthTrust Bank.  At January 31, 2005, we had not borrowed on that facility and our borrowing base availability was $5.0 million.  The working capital facility was renewed in December 2004 for an additional three years and the borrowing base was increased from $3.5 million to $5.0 million.  Management believes that the revolving credit facility, combined with cash flows from operations, adequately provide for the Company’s anticipated need for working capital in fiscal 2005.

 

10

 

Long Term Obligations

 

Our purchase of the Rabon animal health products business in fiscal 2003 and our acquisitions in fiscal 2004 were financed in part by two term loans under a senior credit facility with SouthTrust Bank.  The principal balance of our two term loan facilities with SouthTrust was approximately $12.0 million as of January 31, 2005.  Our purchase of the Rabon product category in December 2002 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 January 31, 2005 the principal balance outstanding on that facility was $4.0 million.  Our acquisitions in fiscal 2004 were financed by a second term loan from SouthTrust Bank.  The original principal amount of the second term loan was $6.0 million in December 2003, but the loan was refinanced in June 2004 to reflect an additional $3.0 million advance to fund acquisitions.  The principal amount of that loan is being repaid monthly on a seven year amortization schedule, but the maturity date is June 1, 2009.  The second term loan carries interest at a varying rate initially equal to LIBOR plus 1.75%.  Interest was changed to LIBOR plus 2.0% on December 1, 2004.  The principal amount of the loan was $8.0 million at the end of the second quarter of fiscal 2005.

 

Off-Balance Sheet Arrangements

 

We have no off-balance sheet arrangements, such as financing or unconsolidated variable interest entities.

 

New Accounting Rules

 

Accounting pronouncements that became effective in fiscal 2004 or the first six months of fiscal 2005, and those that are expected to become effective in the balance of fiscal 2005, did not have, and are not expected to have, any significant effect on our financial position, results of operations or cash flows.

 

Critical Accounting Policies

 

Our 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 — We recognize revenue for chemical products sold in the open market at the time of shipment to the customer.

 

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Allowance for Doubtful Accounts - We provide an allowance for accounts receivable we believe we 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 our 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 our historical loss experience, customer-by-customer analyses of our accounts receivable balances each period and subjective assessments of our future bad debt exposure.  Write offs of accounts receivable balances have been insignificant historically.

 

Inventories - Inventories consist primarily of raw materials and finished goods that we hold for sale in the ordinary course of business.  We use the first-in, first-out method to value inventories at the lower of cost or market.  Management believes we have not incurred impairments in the carrying value of our inventories.

 

Goodwill and Other Intangible Assets - The initial recording of goodwill and other intangibles requires estimation of the fair value of assets and liabilities using fair value measurements, which include quoted market price, present value techniques (estimate of future cash flows), and other valuation methods.  Additionally, SFAS 142 requires goodwill and other intangible assets to be reviewed for possible impairment on an annual basis, or if circumstances indicate that impairment may exist.  Determining fair value and the implied fair value is judgmental and often involves the use of significant estimates and assumptions. These estimates and assumptions could have a significant impact on the recording of intangible assets, whether or not an impairment charge is recognized and also the magnitude of the impairment charge. Our estimates of fair value are primarily determined using present value techniques of projected future cash flows. This approach uses significant assumptions such as multi-year sales projections with associated expenses.  We have performed impairment analyses on its goodwill and intangible assets of indefinite life which indicated as of July 31, 2004 an impairment charge was not appropriate.

 

Impairment of Long-lived Assets - Periodically we review the carrying value of our long-lived assets held and used and assets to be disposed of at least annually or when events and circumstances warrant such a review.  The carrying value of long-lived assets is evaluated for potential impairment on a product line basis.  We have concluded on the basis of our evaluation that the long lived assets are not impaired.

 

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 our intent, belief and current expectations, and our 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, our ability to maintain existing relationships with long-standing customers, our ability to successfully implement productivity improvements, cost reduction initiatives, facilities expansion and our ability 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 we operate.  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.

 

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ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

We are 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.  We generally do not utilize derivative financial instruments or hedging transactions to manage that risk; however, we did enter into an interest rate swap transaction in February, 2003 that effectively fixed the interest rate on one of our term loans at 5.0% for the remainder of the loan’s term.  An increase or decrease in interest rates would not affect our 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 decrease then the value of the swap would decrease.  Conversely, an increase in the financial market’s expectations for future interest rates would cause an increase in the value of the swap.  The swap is recorded currently on the books as an asset.  It is possible that the future expectations for interest rates could change enough to cause the swap to cease being recorded as an asset, and to be recorded as a liability.  The swap expires December 2007.  At January 31, 2005 the market value of the swap was an asset of $41 thousand.

 

ITEM 4.  CONTROLS AND PROCEDURES.

 

The term “disclosure controls and procedures” is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934.  This term refers to the controls and procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission.  Our management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report.  Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

 

There were no changes to our internal control over financial reporting during our last fiscal quarter that has materially affected, or is reasonable likely to materially affect, our internal control over financial reporting.

 

PART II - --- OTHER INFORMATION

 

ITEM 1.  LEGAL PROCEEDINGS.

 

We are not a party to any material legal actions or proceedings, other than routine litigation incidental to the business, and we do not believe any such actions or proceedings will have a material adverse effect on our business, results of operations or financial position.

 

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ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

 

The annual meeting of the shareholders of the Company was held on November 16, 2004.  At that meeting, the shareholders voted to elect all the nominees for director as follows:

 

Nominees		Votes For		Votes Against		Abstentions
David L. Hatcher		7,057,874		624		3,000
George W. Gilman		7,057,874		624		3,000
Fred C. Leonard, III		7,058,134		364		3,000
Charles L. Mears		7,058,134		364		3,000
Charles M. Neff, Jr.		7,040,381		18,117		3,000
Richard L. Urbanowski		7,058,134		364		3,000

 

The shareholders also voted to approve the adoption of the 2004 Long-Term Incentive Plan.  The vote was 6,584,876 for, 364 against and 3,000 abstentions.

 

ITEM 5.  OTHER INFORMATION.

 

The Nominating and Corporate Governance Committee will consider recommendations for director made by shareholders for fiscal 2006 if those recommendations are received in writing, addressed to the chairman of the Committee, Mr. Urbanowski, in care of the KMG Chemicals, Inc., at 10611 Harwin, Suite 402, Houston, Texas 77036 by July 31, 2005.  Recommendations by shareholders that are made in accordance with these procedures will receive equal consideration by the committee.  Directors and members of management may also suggest candidates for director.

 

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