XNYS:KMG KMG Chemicals Inc Quarterly Report 10-Q Filing - 4/30/2012

Effective Date 4/30/2012

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

(One)

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

For the quarterly period ended April 30, 2012

Mark or

 

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

For the transition period from                     to                     .

Commission file number: 000-29278

 

 

KMG CHEMICALS, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Texas   75-2640529

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

9555 West Sam Houston Parkway South,

Suite 600 Houston, Texas

  77099
(Address of principal executive offices)   (Zip Code)

(713) 600-3800

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 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  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T(§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨ (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of June 11, 2012, there were 11,389,720 shares of the registrant’s common stock outstanding.

 

 

 


TABLE OF CONTENTS

 

PART I - FINANCIAL INFORMATION

  

ITEM 1. FINANCIAL STATEMENTS

     3   

CONDENSED CONSOLIDATED BALANCE SHEETS AS OF APRIL 30, 2012 AND JULY 31, 2011

     3   

CONDENSED CONSOLIDATED STATEMENTS OF INCOME FOR THE THREE AND NINE MONTHS ENDED APRIL 30, 2012 AND 2011

     4   

CONDENSED CONSOLIDATED STATEMENTS OF OTHER COMPREHENSIVE INCOME FOR THE THREE AND NINE MONTHS ENDED APRIL 30, 2012 AND 2011

     5   

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED APRIL 30, 2012 AND 2011

     6   

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

     7   

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     16   

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

     20   

ITEM 4. CONTROLS AND PROCEDURES

     21   

PART II — OTHER INFORMATION

     21   

ITEM 1. LEGAL PROCEEDINGS

     21   

ITEM 1A. RISK FACTORS

     21   

ITEM 5. OTHER INFORMATION

     21   

ITEM 6. EXHIBITS

     21   

SIGNATURES

     22   

 

2


PART I — FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

KMG CHEMICALS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except for share and per share amounts)

 

     April 30,
2012
    July 31,
2011
 
     (Unaudited)        

Assets

    

Current assets

    

Cash and cash equivalents

   $ 5,194      $ 1,826   

Accounts receivable

    

Trade, net of allowance of $16 at April 30, 2012 and $414 at July 31, 2011

     28,840        36,410   

Other

     3,015        3,148   

Inventories, net

     39,995        41,770   

Current deferred tax assets

     721        726   

Prepaid expenses and other

     2,841        2,126   
  

 

 

   

 

 

 

Total current assets

     80,606        86,006   
  

 

 

   

 

 

 

Property, plant and equipment, net

     69,526        71,826   

Restricted cash

     1,000        —     

Deferred tax assets

     1,167        1,176   

Goodwill

     3,778        3,778   

Intangible assets, net

     15,057        19,493   

Other assets, net

     3,167        3,099   
  

 

 

   

 

 

 

Total assets

   $ 174,301      $ 185,378   
  

 

 

   

 

 

 

Liabilities & stockholders’ equity

    

Current liabilities

    

Accounts payable

   $ 26,371      $ 24,899   

Accrued liabilities

     5,763        4,980   

Book overdraft

     —          2,852   

Income taxes payable

     2,160        44   

Current deferred tax liabilities

     7        7   

Current maturities of long-term debt

     —          8,000   
  

 

 

   

 

 

 

Total current liabilities

     34,301        40,782   
  

 

 

   

 

 

 

Long-term debt, net of current maturities

     28,000        41,279   

Deferred tax liabilities

     6,036        5,381   

Other long-term liabilities

     1,359        1,406   
  

 

 

   

 

 

 

Total liabilities

     69,696        88,848   
  

 

 

   

 

 

 

Commitments and contingencies

    

Stockholders’ equity

    

Preferred stock, $0.01 par value, 10,000,000 shares authorized, none issued

     —          —     

Common stock, $0.01 par value, 40,000,000 shares authorized, 11,371,769 shares issued and outstanding at April 30, 2012 and 11,318,941 shares issued and outstanding at July 31, 2011

     114        113   

Additional paid-in capital

     25,997        25,256   

Accumulated other comprehensive loss

     (2,954     (1,233

Retained earnings

     81,448        72,394   
  

 

 

   

 

 

 

Total stockholders’ equity

     104,605        96,530   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 174,301      $ 185,378   
  

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

3


KMG CHEMICALS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

(In thousands, except for per share amounts)

 

     Three Months Ended
April 30,
    Nine Months Ended
April 30,
 
     2012     2011     2012     2011  

Net sales

   $ 66,579      $ 61,899      $ 205,093      $ 184,660   

Cost of sales

     45,973        45,134        148,671        133,545   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     20,606        16,765        56,422        51,115   
  

 

 

   

 

 

   

 

 

   

 

 

 

Distribution expenses

     7,418        7,413        19,290        20,743   

Selling, general and administrative expenses

     6,320        5,211        18,390        15,861   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     6,868        4,141        18,742        14,511   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other income (expense)

        

Interest income

     —          —          1        1   

Interest expense

     (504     (571     (1,610     (1,765

Other, net

     (48     50        (195     (140
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other expense, net

     (552     (521     (1,804     (1,904
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     6,316        3,620        16,938        12,607   

Provision for income taxes

     (2,417     (1,245     (6,643     (4,255
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

     3,899        2,375        10,295        8,352   
  

 

 

   

 

 

   

 

 

   

 

 

 

Discontinued operations:

        

Gain/(loss) from discontinued operations, before income taxes

     182        385        (434     334   

Income tax benefit/(expense)

     (116     (153     101        (139
  

 

 

   

 

 

   

 

 

   

 

 

 

Gain/(loss) from discontinued operations

     66        232        (333     195   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 3,965      $ 2,607      $ 9,962      $ 8,547   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per share:

        

Basic

        

Income from continuing operations

   $ 0.34      $ 0.21      $ 0.91      $ 0.74   

Gain/(loss) from discontinued operations

     0.01        0.02        (0.03     0.01   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 0.35      $ 0.23      $ 0.88      $ 0.75   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

        

Income from continuing operations

   $ 0.33      $ 0.21      $ 0.89      $ 0.73   

Gain/(loss) from discontinued operations

     0.01        0.02        (0.03     0.01   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 0.34      $ 0.23      $ 0.86      $ 0.74   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding:

        

Basic

     11,363        11,313        11,355        11,306   

Diluted

     11,539        11,499        11,523        11,484   

See notes to condensed consolidated financial statements.

 

4


KMG CHEMICALS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OTHER COMPREHENSIVE INCOME

(UNAUDITED)

(In thousands)

 

     Three Months Ended
April 30,
     Nine Months Ended
April 30,
 
     2012      2011      2012     2011  

Net income

   $ 3,965       $ 2,607       $ 9,962      $ 8,547   

Other comprehensive income/ (loss)

          

Foreign currency translation gain/ (loss)

     44         1,869         (1,721     3,050   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total other comprehensive income/ (loss)

     44         1,869         (1,721     3,050   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total comprehensive income

   $ 4,009       $ 4,476       $ 8,241      $ 11,597   
  

 

 

    

 

 

    

 

 

   

 

 

 

See notes to condensed consolidated financial statements.

 

5


KMG CHEMICALS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(In thousands)

 

     Nine Months Ended
April 30,
 
     2012     2011  

Cash flows from operating activities

    

Net income

   $ 9,962      $ 8,547   

Adjustments to reconcile net income to net cash provided by operating activities

    

Depreciation and amortization

     5,285        5,688   

Amortization of loan costs included in interest expense

     107        82   

Stock-based compensation expense

     572        441   

Bad debt recovery

     —          (18

Inventory valuation adjustment

     370        (138

(Gain)/ loss on disposal of property

     (40     131   

Gain on sale of animal health business

     (90     —     

Deferred income tax expense

     654        546   

Tax benefit from stock-based awards

     (179     (196

Changes in operating assets and liabilities

    

Accounts receivable — trade

     7,159        (1,128

Accounts receivable — other

     138        (676

Inventories

     (4,582     (1,598

Other current and noncurrent assets

     (1,045     (1,127

Accounts payable

     1,503        452   

Accrued liabilities and other

     849        (673

Income taxes payable

     2,268        (361
  

 

 

   

 

 

 

Net cash provided by operating activities

     22,931        9,972   
  

 

 

   

 

 

 

Cash flows from investing activities

    

Additions to property, plant and equipment

     (3,887     (5,809

Proceeds from sale of property

     33        59   

Proceeds from sale of animal health business

     10,203        —     

Change in restricted cash

     (1,000     189   
  

 

 

   

 

 

 

Net cash provided by/ (used in) investing activities

     5,349        (5,561
  

 

 

   

 

 

 

Cash flows from financing activities

    

Net payments under revolving loan facility

     (9,946     (2,093

Principal payments on borrowings on term loan

     (11,333     (6,000

Proceeds from exercise of stock options

     32        200   

Tax benefit from stock-based awards

     179        196   

Book overdraft

     (2,852     —     

Payment of dividends

     (908     (735
  

 

 

   

 

 

 

Net cash used in financing activities

     (24,828     (8,432
  

 

 

   

 

 

 

Effect of exchange rate changes of cash

     (84     220   

Net increase/ (decrease) in cash and cash equivalents

     3,368        (3,801

Cash and cash equivalents at beginning of period

     1,826        4,728   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 5,194      $ 927   
  

 

 

   

 

 

 

Supplemental disclosures of cash flow information

    

Cash paid for interest

   $ 1,485      $ 1,746   

Cash paid for income taxes

   $ 3,625      $ 3,748   

See notes to condensed consolidated financial statements.

 

6


KMG CHEMICALS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Presentation

The consolidated balance sheet as of July 31, 2011, which has been derived from audited consolidated financial statements, and the unaudited condensed consolidated financial statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission for interim reporting. As permitted under those requirements, certain footnotes or other financial information that are normally required by generally accepted accounting principles in the United States of America (“GAAP”) have been condensed or omitted. The Company believes that the disclosures made are adequate to make the information not misleading 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. The results of operations for the interim periods are not necessarily indicative of results of operations to be expected for the full year. The unaudited condensed consolidated financial statements included herein should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended July 31, 2011.

These condensed consolidated financial statements are prepared using certain estimates by management and include the accounts of KMG Chemicals, Inc. and its subsidiaries (collectively, the “Company”). All significant intercompany balances and transactions have been eliminated in consolidation.

Certain reclassifications have been made to the prior period consolidated financial statements to conform to the current period presentation.

The consolidated balance sheet as of July 31, 2011 reflected a reclassification of certain accrued taxes payable to “Accounts receivable – other” to conform to the current period presentation. The current period presentation included a net receivable reflecting the offset of the respective tax receivable and tax payable associated with the same tax jurisdiction. This reclassification had no impact on the historical consolidated statements of income or retained earnings.

During the third quarter of fiscal year 2012 the Company sold its animal health business and reported the related results of operations as discontinued operations in its condensed consolidated statements of income. Previously reported amounts for each of the prior year periods presented have been adjusted for the effects of discontinued operations (see Note 2).

The Company began classifying certain expenses as selling, general and administrative expenses in the fourth quarter of fiscal year 2011 which had previously been reported as distribution expenses. Accordingly, the three and nine months ended April 30, 2011, were reclassified to conform to the current year presentation.

2. Discontinued Operations

In fiscal year 2008 the Company discontinued operations of its herbicide product line that had comprised the agricultural chemical segment. During fiscal year 2011 the Company began dismantling the related equipment at its Matamoros, Mexico facility. In connection with the dismantling of the equipment an accident occurred during the second fiscal quarter of 2012 resulting in the injury of two third-party contractors. The Company incurred costs in each of the periods reported for equipment dismantlement, and in addition, the current year periods included medical and other expenses associated with the accident. The Company reported the costs in loss from discontinued operations, before income taxes, which included $200,000 and $57,000 for the three months ended April 30, 2012 and 2011, respectively, and $580,000 and $104,000 for the nine months ended April 30, 2012 and 2011, respectively, reported as loss from discontinued operations, before income taxes.

On March 1, 2012, the Company sold its animal health business that had comprised the animal health segment to Bayer Healthcare LLC. The sale included inventory, equipment and product registrations. The Company retained the real estate and buildings at its facility in Elwood, Kansas. The Company sold the business for approximately $10.2 million, including $1.0 million in restricted cash held in escrow. The purchase price was paid in cash, subject to the escrow. The escrowed amount is to be held pending final acceptance by the United States Environmental Protection Agency (“EPA”) of certain studies being performed at the request of the EPA on tetrachlorvinphos, the active ingredient used in Rabon products. The escrowed funds are to be released to the Company once the EPA has finally accepted the studies, the buyer has voluntarily canceled the products, or after five years. The escrowed funds are to be released to the buyer if the EPA cancels the products to which the studies pertain before the funds are distributed to the Company. Management believes that the EPA will accept the studies within five years.

The Company will continue to operate the facility in Elwood, Kansas to manufacture products for the buyer under a transition services agreement for one year, subject to two six-month extensions. The Company evaluated the transition services agreement and concluded that it did not represent significant continuing involvement or a continuation of activities by the Company in accordance with GAAP.

 

7


As of July 31, 2011 the components of assets and liabilities related to the discontinued operations of the animal health business included in the consolidated balance sheets were as follows (in thousands):

 

Inventories

   $  5,401   

Prepaid commissions

     65   
  

 

 

 

Total current assets

     5,466   

Property, plant and equipment, net

     191   

Intangible assets, net

     4,160   
  

 

 

 

Total assets

   $ 9,817   
  

 

 

 

The Company recognized a gain on sale of approximately $90,000 included in gain (loss) from discontinued operations, before income taxes, in the Company’s condensed consolidated statements of income, calculated as follows (in thousands):

 

Cash consideration

   $ 10,203   

Less: net value of assets sold as of February 29, 2012 and transaction costs

     (10,113
  

 

 

 

Total pre-tax gain

   $ 90   
  

 

 

 

Net sales and income before income taxes on the animal health business reported in discontinued operations were as follows:

 

     Three Months Ended
April 30,
     Nine Months Ended
April 30,
 
     2012      2011      2012      2011  
     (Amounts in thousands)  

Net sales

   $ 1,341       $ 3,176       $ 5,783       $ 7,455   

Income before income taxes

     292         442         56         438   

3. 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 potentially dilutive common shares. The following table presents information for basic and diluted earnings per share for periods indicated:

 

     Three Months Ended
April 30,
     Nine Months Ended
April 30,
 
     2012      2011      2012     2011  
     (Amounts in thousands, except per share data)  

Income from continuing operations

   $ 3,899       $ 2,375       $ 10,295      $ 8,352   

Gain (loss) from discontinued operations

     66         232         (333     195   
  

 

 

    

 

 

    

 

 

   

 

 

 

Net income

   $ 3,965       $ 2,607       $ 9,962      $ 8,547   
  

 

 

    

 

 

    

 

 

   

 

 

 

Weighted average shares outstanding-basic

     11,363         11,313         11,355        11,306   

Dilutive effect of options and stock awards

     176         186         168        178   
  

 

 

    

 

 

    

 

 

   

 

 

 

Weighted average shares outstanding-diluted

     11,539         11,499         11,523        11,484   
  

 

 

    

 

 

    

 

 

   

 

 

 

Basic earnings per share

          

Basic earnings per share from continuing operations

   $ 0.34       $ 0.21       $ 0.91      $ 0.74   

Basic earnings per share on gain/(loss) from discontinued operations

     0.01         0.02         (0.03     0.01   
  

 

 

    

 

 

    

 

 

   

 

 

 

Basic earnings per share

   $ 0.35       $ 0.23       $ 0.88      $ 0.75   
  

 

 

    

 

 

    

 

 

   

 

 

 

Diluted earnings per share

          

Diluted earnings per share from continuing operations

   $ 0.33       $ 0.21       $ 0.89      $ 0.73   

Diluted earnings per share on gain/(loss) from discontinued operations

     0.01         0.02         (0.03     0.01   
  

 

 

    

 

 

    

 

 

   

 

 

 

Diluted earnings per share

   $ 0.34       $ 0.23       $ 0.86      $ 0.74   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

8


Outstanding stock-based awards are not included in the computation of diluted earnings per share under the treasury stock method, if including them would be anti-dilutive. There were no shares of potentially dilutive securities not included in the computation of diluted earnings per share for the three and nine months ended April 30, 2012, respectively, and there were no shares and less than 1,000 shares of potentially dilutive securities not included in the computation of diluted earnings per share for the three and nine months ended April 30, 2011, respectively.

4. Inventories

Inventories are summarized in the following table (in thousands):

 

     April 30,
2012
    July 31,
2011
 

Raw materials

   $ 6,154      $ 7,475   

Work in process

     589        1,034   

Supplies

     1,366        1,405   

Finished products

     32,280        32,189   

Less reserve for inventory obsolescence

     (394     (333
  

 

 

   

 

 

 

Inventories, net

   $ 39,995      $ 41,770   
  

 

 

   

 

 

 

5. Property, Plant and Equipment

Property, plant and equipment and related accumulated depreciation and amortization are summarized as follows (in thousands):

 

     April 30,
2012
    July 31,
2011
 

Land

   $ 9,527      $ 10,081   

Buildings & improvements

     35,968        35,795   

Equipment

     44,891        44,098   

Leasehold improvements

     143        143   
  

 

 

   

 

 

 
     90,529        90,117   

Less accumulated depreciation and amortization

     (27,436     (24,388
  

 

 

   

 

 

 
     63,093        65,729   

Construction-in-progress

     6,433        6,097   
  

 

 

   

 

 

 

Property, plant and equipment, net

   $ 69,526      $ 71,826   
  

 

 

   

 

 

 

6. Stock-Based Compensation

The Company has stock-based incentive plans which are described in more detail in Note 11 to the consolidated financial statements in the Company’s Annual Report on Form 10-K for fiscal year 2011. The Company recognized stock-based compensation costs of approximately $333,000 and $66,000 for the three months ended April 31, 2012 and 2011, respectively, and recognized $572,000 and $440,000 for the nine months ended April 30, 2012 and 2011, respectively, which are recorded as selling, general and administrative expenses in the condensed consolidated statements of income.

As of April 30, 2012, the unrecognized compensation costs related to stock-based awards was approximately $709,000 which is expected to be recognized over a weighted-average period of 1.9 years.

A summary of stock option and stock activity is presented below.

 

9


Stock Options

A summary of activity for the nine months ended April 30, 2012 is presented below. No options were granted in the first nine months of fiscal years 2012 or 2011.

 

     Shares     Weighted-
Average
Exercise Price
 

Outstanding on August 1, 2011

     222,000      $ 3.98   

Granted

     —          —     

Exercised

     (10,000     3.21   

Forfeited/expired

     —          —     
  

 

 

   

Outstanding on April 30, 2012

     212,000      $ 4.02   
  

 

 

   

The following table summarizes information about stock options outstanding at April 30, 2012 based on stock option awards that are fully vested (currently exercisable) and those that are expected to vest:

 

     Options
Outstanding
     Weighted-
Average
Exercise Price
     Weighted-
Average
Remaining
Contractual
Term (years)
     Aggregate
Intrinsic Value
(in thousands) (1)
 

Fully vested and currently exercisable

     182,000       $ 3.96         5.25       $ 2,417   

Expected to vest

     30,000         4.37         11.36         386   
  

 

 

          

 

 

 

Total outstanding stock options

     212,000         4.02         6.12       $ 2,803   
  

 

 

          

 

 

 

 

 

(1) 

The aggregate intrinsic value is computed based on the closing price of the Company’s stock on April 30, 2012.

An option for 10,000 shares was exercised in the three and nine months ended April 30, 2012. The total intrinsic value of options exercised during the nine months ended April 30, 2012 and 2011 was approximately $152,000 and $546,000, respectively.

 

10


Performance Shares

On August 1, 2011, there were 209,305 non-vested performance shares outstanding which reflected the maximum number of shares under the awards. During the nine months ended April 30, 2012, there were no awards vested and there were 124,311 performance-based stock awards granted. The fair value of the awards was measured on the grant dates of February 27, 2012, October 28, 2011 and October 11, 2011 using the Company’s closing stock price of $18.08, $15.30 and $14.16, respectively. Stock-based compensation expense on the awards will be recognized on a straight line basis over the requisite service period beginning on the date of grant through the end of the measurement period ending July 31, 2014, based on the number of shares expected to vest at the end of the measurement period. As of April 30, 2012, the non-vested performance-based stock awards consisted of Series 1 and Series 2 awards granted to certain executives and employees in fiscal years 2012, 2011 and 2010, as summarized below.

 

Date of Grant

   Series
Award
     Maximum
Award
(Shares)
     Closing Stock
Price
(Fair Value)
on Grant Date
     Measurement
Period Ending
     Expected
Percentage of
Vesting
    Shares Expected
to Vest
 

Fiscal Year 2012 Award

                

2/27/2012

     Series 1         300       $ 18.08         07/31/2014         55     165   

2/27/2012

     Series 2         200       $ 18.08         07/31/2014         0     —     
     

 

 

            

 

 

 
        500                 165   
     

 

 

            

 

 

 

10/28/2011

     Series 1         15,300       $ 15.30         07/31/2014         55     8,415   

10/28/2011

     Series 2         10,200       $ 15.30         07/31/2014         0     —     
     

 

 

            

 

 

 
        25,500                 8,415   
     

 

 

            

 

 

 

10/11/2011

     Series 1         58,987       $ 14.16         07/31/2014         55     32,443   

10/11/2011

     Series 2         39,324       $ 14.16         07/31/2014         0     —     
     

 

 

            

 

 

 
        98,311                 32,443   
     

 

 

            

 

 

 

Fiscal Year 2011 Award

                

12/7/2010

     Series 1         61,980       $ 15.65         07/31/2013         30     18,594   

12/7/2010

     Series 2         41,318       $ 15.65         07/31/2013         0     —     
     

 

 

            

 

 

 
        103,298                 18,594   
     

 

 

            

 

 

 

Fiscal Year 2010 Award

                

3/17/2010

     Series 1         63,605       $ 15.55         07/31/2012         30     19,081   

3/17/2010

     Series 2         42,402       $ 15.55         07/31/2012         0     —     
     

 

 

            

 

 

 
        106,007                 19,081   
     

 

 

            

 

 

 

Total

        333,616                 78,698   
     

 

 

            

 

 

 

Series 1: Vesting for the Series 1 awards is subject to a performance requirement composed of certain revenue growth objectives and average annual return on invested capital or equity objectives measured across a three year period. These objectives are measured quarterly using the Company’s budget, actual results and long-term projections. For the fiscal year 2012, 2011 and 2010 awards, the expected percentage of vesting is based on performance through April 30, 2012 and reflects the percentage of shares projected to vest for the respective awards at the end of their measurement periods.

Series 2: Vesting for the Series 2 awards is subject to performance requirements pertaining to the growth rate in the Company’s basic earnings per share over a three year period. The achievement of performance requirements is measured quarterly using the Company’s budget, actual results and long-term projections. For the fiscal year 2012, 2011 and 2010 awards, the expected percentage of vesting is based on performance through April 30, 2012 and reflects the percentage of shares projected to vest for the respective awards at the end of their measurement periods.

The weighted-average grant-date fair value of performance awards outstanding at April 30, 2012 and August 1, 2011 was $14.98 and $15.60, respectively. The weighted-average grant date fair value of performance awards granted during the first nine months of fiscal year 2012 was $14.41.

 

11


Time Based Shares

A summary of activity for time-based stock awards for the nine months ended April 30, 2012 is presented below:

 

     Shares     Weighted-
Average
Grant-Date
Fair Value
 

Non-vested on August 1, 2011

     24,939      $ 16.03   

Granted (1)

     6,632        18.03   

Vested (2)

     (18,773     16.22   

Forfeited

     —          —     
  

 

 

   

Non-vested on April 30, 2012

     12,798      $ 15.60   
  

 

 

   

 

 

 

(1) 

Reflects shares granted to non-employee directors during the third quarter of fiscal year 2012 for the three-month service period ending February 29, 2012. The shares vested on the date of grant.

(2) 

During the nine month period ended April 30, 2012 there were 19,624 shares vested. The number of shares presented here includes an adjustment of 851 shares which do not represent shares that vested during the nine months ended April 31, 2012. The adjustment was related to the fiscal year 2011 non-employee director stock grant and reflects the difference between the number of shares reported as granted and the number of shares vested over the twelve month service period of the award ended November 30, 2011. The number of shares granted was calculated based on the aggregate monetary value of the award divided by the Company’s closing stock price on the respective date of grant. The number of shares vested at the end of each of the three month service periods over the twelve month service period ending November 30, 2011 was based on the Company’s closing stock price at the end of each of the three month periods.

7. Intangible Assets

Intangible assets are summarized as follows (in thousands):

 

     Number of Years      April 30, 2012  
     Weighted Average
Amortization Period
     Original
Cost
     Accumulated
Amortization
    Carrying
Amount
 

Intangible assets subject to amortization: (range of useful life):

          

Creosote supply contract (10 years)

     10.0       $ 4,000       $ (4,000   $ —     

Electronic chemicals-related contracts (3-8 years)

     3.8         1,164         (1,043     121   

Electronic chemicals-related trademarks and patents (10-15 years)

     12.0         117         (44     73   

Electronic chemicals—value of product qualifications (5 years)

     5.0         1,300         (541     759   
     

 

 

    

 

 

   

 

 

 

Total intangible assets subject to amortization

     8.0       $ 6,581       $ (5,628     953   
     

 

 

    

 

 

   

 

 

 

Intangible assets not subject to amortization:

          

Creosote product registrations

             5,339   

Penta product registrations

             8,765   
          

 

 

 

Total intangible assets not subject to amortization

             14,104   
          

 

 

 

Total intangible assets, net

           $ 15,057   
          

 

 

 

 

     Number of Years      July 31, 2011  
     Weighted Average
Amortization Period
     Original
Cost
     Accumulated
Amortization
    Carrying
Amount
 

Intangible assets subject to amortization: (range of useful life):

          

Creosote supply contract (10 years)

     10.0       $ 4,000       $ (3,955   $ 45   

Electronic chemicals-related contracts (3-8 years)

     3.8         1,164         (1,014     150   

Electronic chemicals-related trademarks and patents (10-15 years)

     12.0         117         (36     81   

Electronic chemicals-value of product qualifications (5 years)

     5.0         1,300         (347     953   

Discontinued operations

     17.6         6,529         (2,369     4,160   
     

 

 

    

 

 

   

 

 

 

Total intangible assets subject to amortization

     12.8       $ 13,110       $ (7,721     5,389   
     

 

 

    

 

 

   

 

 

 

Intangible assets not subject to amortization:

          

Creosote product registrations

             5,339   

Penta product registrations

             8,765   
          

 

 

 

Total intangible assets not subject to amortization

             14,104   
          

 

 

 

Total intangible assets, net

           $ 19,493   
          

 

 

 

Intangible assets subject to amortization are amortized over their estimated useful lives. Amortization expense was approximately $104,000 and $227,000 for the three month periods ended April 30, 2012 and 2011, respectively, and $471,000 and $813,000 for the nine month periods ended April 30, 2012 and 2011, respectively.

8. Dividends

Dividends of approximately $341,000 ($0.03 per share) and $283,000 ($0.025 per share) were declared and paid in the third quarter of fiscal years 2012 and 2011, respectively. Dividends of approximately $908,000 ($0.08 per share) and $735,000 ($0.065 per share) were declared and paid in the first nine months of fiscal years 2012 and 2011, respectively.

 

12


9. Segment Information

The Company previously had four reportable segments — Electronic Chemicals, Penta, Creosote and Animal Health. During the first quarter of fiscal year 2012 the Company re-evaluated the criteria used to determine operating segments and concluded that Penta and Creosote met the criteria of a single operating segment. As a result, during the first quarter of fiscal year 2012, the composition of the Company’s reportable segments was revised to reflect a change combining those two reportable segments. The Company sold its animal health business on March 1, 2012, and that former segment is now reported as discontinued operations. Prior year information has been reclassified to conform to the current period presentation.

 

     Three Months Ended
April 30,
     Nine Months Ended
April 30,
 
     2012      2011      2012      2011  
     (Amounts in thousands)  

Sales

           

Electronic Chemicals

   $ 39,422       $ 38,509       $ 116,396       $ 111,303   

Wood Treating Chemicals

     27,157         23,390         88,697         73,357   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total sales for reportable segments

   $ 66,579       $ 61,899       $ 205,093       $ 184,660   
  

 

 

    

 

 

    

 

 

    

 

 

 

Depreciation and amortization

           

Electronic Chemicals

   $ 1,510       $ 1,435       $ 4,413       $ 4,308   

Wood Treating Chemicals

     111         192         384         630   

Other

     119         215         488         750   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total consolidated depreciation and amortization

   $ 1,740       $ 1,842       $ 5,285       $ 5,688   
  

 

 

    

 

 

    

 

 

    

 

 

 

Segment income from operations (1)

           

Electronic Chemicals

   $ 3,904       $ 1,587       $ 9,088       $ 5,943   

Wood Treating Chemicals

     3,932         3,171         12,403         11,372   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total segment income from operations

   $ 7,836       $ 4,758       $ 21,491       $ 17,315   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

 

 

(1) Segment income from operations includes allocated corporate overhead expenses.

Corporate overhead expenses allocated to segment income from operations for the three and nine months ended April 30, 2012 and 2011 were as follows:

 

     Three Months Ended
April 30,
     Nine Months Ended
April 30,
 
     2012      2011      2012      2011  
     (Amounts in thousands)  

Electronic Chemicals

   $ 1,471       $ 1,057       $ 3,977       $ 2,941   

Wood Treating Chemicals

     1,159         845         3,165         2,420   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total corporate overhead expense allocation

   $ 2,630       $ 1,902       $ 7,142       $ 5,361   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

13


A reconciliation of total segment information to consolidated amounts is as follows:

 

     Three Months Ended
April 30,
    Nine Months Ended
April 30,
 
     2012     2011     2012     2011  
     (Amounts in thousands)  

Sales

        

Total sales for reportable segments

   $ 66,579      $ 61,899      $ 205,093      $ 184,660   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net sales

   $ 66,579      $ 61,899      $ 205,093      $ 184,660   
  

 

 

   

 

 

   

 

 

   

 

 

 

Segment income from operations

        

Total segment income from operations

   $ 7,836      $ 4,758      $ 21,491      $ 17,315   

Other corporate expense (1)

     (968     (617     (2,749     (2,804
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     6,868        4,141        18,742        14,511   

Interest income

     —          —          1        1   

Interest expense

     (504     (571     (1,610     (1,765

Other expense, net

     (48     50        (195     (140
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

   $ 6,316      $ 3,620      $ 16,938      $ 12,607   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

 

 

(1) 

Other corporate expense primarily represents employee stock-based compensation expenses and those expenses associated with the company’s operation as a public entity such as board compensation, audit expense and fees related to the listing of our stock. The amounts presented include corporate overhead previously allocated to the animal health business. These amounts were not reallocated to the remaining segments.

10. Long-Term Obligations

The Company’s debt consisted of the following:

 

     April 30,
2012
     July 31,
2011
 
     (Amounts in thousands)  

Senior Secured Debt

     

Note Purchase Agreement, maturing on December 31, 2014, interest rate of 7.43%

   $ 20,000       $ 20,000   

Secured Debt

     

Term Loan Facility, maturing on December 31, 2012, variable interest rates based on LIBOR plus 2.00%

     —           11,333   

Revolving Loan Facility, maturing on December 31, 2016, variable interest rates based on LIBOR plus 2.00% (2.24% at April 30, 2012)

     8,000         17,946   
  

 

 

    

 

 

 

Total debt

     28,000         49,279   

Current maturities of long-term debt

     —           (8,000
  

 

 

    

 

 

 

Long-term debt, net of current maturities

   $ 28,000       $ 41,279   
  

 

 

    

 

 

 

To finance the acquisition of the electronic chemicals business in December 2007, the Company entered into a credit agreement and a note purchase agreement with Wachovia Bank, National Association, a subsidiary of Wells Fargo & Co., Bank of America, N.A., The Prudential Insurance Company of America, and Pruco Life Insurance Company. The credit agreement included a term loan facility and a revolving loan facility. The Company amended the credit agreement in March 2010 and November 2011. The November 2011 amendment of the credit facility raised the maximum amount that may be borrowed under the revolving loan facility from $50.0 million to $60.0 million, extended the maturity date of the credit agreement to December 31, 2016 and allowed advances under the revolving loan facility without reference to a borrowing base restriction. The financial covenant for debt to capitalization was replaced by a current ratio minimum of 1.5 to 1.0. The Company had previously paid off all outstanding advances under the credit facility’s term loan commitment, and in the November 2011 amendment, that aspect of the facility was deleted. The revolving loan bears interest at a varying rate of LIBOR plus a margin based on our funded debt to earnings before interest, taxes, depreciation and amortization (“EBITDA”).

 

14


Ratio of Funded Debt to EBITDA

   Margin  

Equal to or greater than 3.0 to 1.0

     2.75

Equal to or greater than 2.5 to 1.0, but less than 3.0 to 1.0

     2.50

Equal to or greater than 2.0 to 1.0, but less than 2.5 to 1.0

     2.25

Equal to or greater than 1.5 to 1.0, but less than 2.0 to 1.0

     2.00

Less than 1.5 to 1.0

     1.75

Advances outstanding under the revolving loan facility bear interest of 2.24% as of April 30, 2012 and June 1, 2012 (LIBOR plus 2.00%).

Before the term loan facility was paid off and removed from the credit facility, the term facility required principal payments of $458,333 per month for the first 24 months, then, beginning January 2010, principal payments became $666,667 per month for the balance of the term prior to maturity. The purchase of the electronic chemical assets from General Chemical on March 29, 2010 was funded with available cash and borrowings on the revolving loan. During the first quarter of fiscal year 2012 the Company repaid the outstanding balance of the term loan with borrowings on the revolving loan. The Company used the proceeds received on the sale of its Animal Health business to repay $10.0 million of the balance on the revolving loan facility on March 2, 2012. The amount outstanding on the revolving loan facility at April 30, 2012 was $8.0 million.

At July 31, 2011 the Company had a book overdraft of $2.9 million, which represented the amount in excess of the bank balance that was necessary to fund checks that were paid but not yet cleared. GAAP requires that the book overdraft be classified as a current liability on the consolidated balance sheets. For purposes of reporting cash flows, the Company reports the book overdraft as a financing activity. There was no book overdraft as of April 30, 2012.

In fiscal year 2008 the Company also entered into a $20.0 million note purchase agreement with the Prudential Insurance Company of America. Advances under the note purchase agreement mature December 31, 2014, and bear interest at 7.43% per annum. Principal is payable at maturity. At April 30, 2012, $20.0 million was outstanding under the note purchase agreement.

Loans under the amended and restated credit facility and the note purchase agreement are secured by the Company’s assets, including inventory, accounts receivable, equipment, intangible assets, and real property. The credit facility and the note purchase agreement have restrictive covenants, including that the Company must maintain a fixed charge coverage ratio of 1.5 to 1.0, a ratio of funded debt to EBITDA of 3.0 to 1.0, and a current ratio of at least 1.5 to 1.0. For purposes of calculating these financial covenant ratios, we use a pro forma EBITDA. On April 30, 2012, the Company was in compliance with all of its debt covenants.

11. Income Taxes

Income tax expense for the interim periods was computed using the effective tax rate estimated to be applicable for the full fiscal year. The effective tax rate for continuing operations for the third quarter of fiscal years 2012 and 2011 was 38.3% and 34.4%, respectively and 39.2% and 33.8% for the nine months ended April 30 of fiscal years 2012 and 2011, respectively. Income tax expense for the prior year periods was reduced by $208,000 and $618,000 during the three and nine months ended April 30, 2011, respectively for the reversal of the valuation allowance related to a foreign subsidiary.

Earnings associated with our foreign subsidiaries are considered to be permanently reinvested, and no provision for United States federal and state income taxes on these earnings or translation has been provided.

12. Litigation and Other Contingencies

The Company is subject to contingencies, including litigation relating to environmental laws and regulations, commercial disputes and other matters. Certain of these contingencies are discussed below. The ultimate resolution of these contingencies is subject to significant uncertainty, and should the Company fail to prevail in any of them or should several of them be resolved against the Company in the same reporting period, these matters could, individually or in the aggregate, be material to the consolidated financial statements. The ultimate outcome of these matters cannot be determined at this time, nor can the amount of any potential loss be reasonably estimated, and as a result no amounts have been recorded in the Company’s condensed consolidated financial statements except where noted.

 

15


A lawsuit was filed against our wholly-owned subsidiary, KMG de Mexico, relating to the title to the land on which our facility in Matamoros is located. The plaintiffs claim that their title to the land is superior to the person from whom our subsidiary bought the land. The plaintiffs are seeking to have our subsidiary’s purchase overturned, and to recover the land and certain improvements or their value. The lawsuit was initially filed in 1998 in Matamoros, Mexico under Adolfo Cazares Rosas, et al vs. KMG de Mexico and Guillermo Villarreal. In January 2008, the case was sent by the appeals court back to the lower court to obtain additional factual information, and on April 20, 2009 the plaintiffs were required to re-file the case in the First Civil Court in Matamoros, Tamaulipas, Mexico as Adolfo Cazares, Luis Escudero and Juan Cue vs. KMG de Mexico and Guillermo Villarreal. In June 2011 the lower court ruled against KMG de Mexico, and held that the plaintiffs had superior title to the land, but that verdict was overturned on appeal in May 2012, and the case has been returned to the trial court for further action. The Company intends to continue to vigorously defend KMG de Mexico.

When it purchased assets from Air Products, Inc. (“Air Products”) in December 2007, the Company agreed to be responsible for the applicable sales tax on the personal property that it purchased. The Colorado Department of Revenue audited the purchase, and in November 2009 issued a deficiency notice to Air Products for unpaid sales tax on the purchase of approximately $819,000, before interest and penalties. The Company assumed the defense of the matter as allowed under its indemnity of Air Products. The Company classified certain property at the Company’s Pueblo facility as real property not subject to tax, not as personal property subject to sales tax. The matter is now being reviewed internally at the Colorado Department of Revenue. If a satisfactory resolution is not reached, the dispute would be subject to arbitration. In the second quarter of fiscal year 2012, the Company recognized approximately $100,000, including taxes, penalties and interest, related to certain property that it concluded was personal property and subject to sales tax.

The Company’s subsidiary in Italy is currently under examination by the taxing authority there for the period ended July 31, 2009. Adjustments were proposed by the taxing authority at the end of April 2011 that would result in approximately $1.6 million (including interest and penalties) of additional income tax, if all the adjustments are sustained. The Company has provided additional information in response to the proposed adjustments, and intends to vigorously defend its tax positions. The ultimate outcome of this examination is subject to uncertainty and no amount has been recorded in the Company’s consolidated financial statements.

The Company is subject to federal, state, local and foreign laws and regulations and potential liabilities relating to the protection of the environment and human health and safety including, among other things, the cleanup of contaminated sites, the treatment, storage and disposal of wastes, the emission of substances into the air or waterways, and various health and safety matters. The Company expects to incur substantial costs for ongoing compliance with such laws and regulations. The Company may also face governmental or third-party claims, or otherwise incur costs, relating to cleanup of, or for injuries resulting from, contamination at sites associated with past and present operations. The Company accrues for environmental liabilities when a determination can be made that they are probable and reasonably estimable. No accrual has been recorded as of April 30, 2012.

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

We manufacture, formulate and distribute specialty chemicals globally. We operate businesses engaged in electronic chemicals and industrial wood treating chemicals. Our electronic chemicals are used in the manufacturing of semiconductors. Our wood treating chemicals, pentachlorophenol (“penta”) and creosote are used by our industrial customers primarily to extend the useful life of utility poles and railroad crossties.

Sale of the Animal Health Business

On March 1, 2012, we sold certain assets of our animal health business to Bayer Healthcare, LLC for a purchase price of approximately $10.2 million, including $1.0 million held in escrow. The purchase price was paid in cash, subject to the escrow, and we used the proceeds to reduce the amount outstanding on our revolving indebtedness. The escrowed amount is being held pending final acceptance by EPA of certain studies being performed at its request on tetrachlorvinphos, the active ingredient used in Rabon products. The escrowed funds are to be released to us once the EPA has finally accepted the studies, the buyer has voluntarily canceled the products, or after five years. The escrowed funds are to be released to the buyer if the EPA cancels products to which the studies pertain before the funds are distributed to us. The sale included inventory, equipment and product registrations. We retained the real estate and building at our facility in Elwood, Kansas, and we will operate it to manufacture products for the buyer under a transition services agreement for one year, subject to two six-month extensions.

 

16


Results of Operations

Three and Nine Month Periods Ended April 30, 2012 compared with Three and Nine Month Periods Ended April 30, 2011

Segment Data

Segment data is presented for our two reportable segments for the three and nine month periods ended April 30, 2012 and 2011. The segment data should be read in conjunction with our condensed consolidated financial statements and related notes thereto included elsewhere in this report. We previously had four reportable segments for electronic chemicals, penta, creosote and animal health. During the first quarter of fiscal year 2012 we re-evaluated the criteria used to determine operating segments and concluded that our two wood treating product segments met the criteria of a single operating segment. As a result our reportable segments were revised to reflect a change combining those two reportable segments. The animal health business was sold in March 2012, and results of that former segment are included as discontinued operations. Prior year information has been reclassified to conform to the current period presentation.

 

     Three Months Ended
April 30,
     Nine Months Ended
April 30,
 
     2012      2011      2012      2011  
     (Amounts in thousands)  

Sales

           

Electronic Chemicals

   $ 39,422       $ 38,509       $ 116,396       $ 111,303   

Wood Treating Chemicals

     27,157         23,390         88,697         73,357   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net sales

   $ 66,579       $ 61,899       $ 205,093       $ 184,660   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net Sales

Net sales increased $4.7 million, or 7.6%, to $66.6 million in the third quarter of fiscal year 2012 as compared to $61.9 million for the same period of the prior year. For the nine months, net sales increased $20.4 million, or 11.1%, to $205.1 million in the first nine months of fiscal year 2012 as compared with $184.7 million for the same period of the prior year.

In the third quarter of fiscal year 2012, the electronic chemicals segment had net sales of $39.4 million, an increase of $913,000, or 2.4%, as compared to $38.5 million for the prior year period. For the nine month period, the segment had net sales of $116.4 million, an increase of $5.1 million, or 4.6%, as compared to $111.3 million in the prior year. We implemented price increases over the past twelve months in response to increased raw material costs. We expect demand for our electronic chemicals products to improve in calendar 2012, and we will have additional business from a new semiconductor fabrication facility that has come on stream.

Net sales of wood treating chemicals increased $3.8 million, or 16.1%, to $27.2 million in the third quarter of fiscal year 2012 as compared to $23.4 million for the prior year period. For the nine month period, the segment had net sales of $88.7 million, an increase of $15.3 million, or 20.9%, as compared to $73.4 million in the prior year. The increase in net sales for the quarter was due primarily to increases in price, while the increase for the nine month period was attributable almost evenly to higher volumes and increases in price. We expect to see generally flat demand in the segment through the balance of the fiscal year.

Gross Profit

Gross profit increased by $3.8 million, or 22.9%, to $20.6 million in the third quarter of fiscal year 2012 from $16.8 million in the same quarter of the prior year. Gross profit as a percentage of sales increased to 30.9% in the third quarter of fiscal year 2012 from 27.1% in the third quarter of fiscal year 2011. For the nine month period, we had gross profit of $56.4 million, an increase of $5.3 million, or 10.4%, as compared to $51.1 million in the prior year. Gross profit as a percentage of sales was flat for the nine months at 27.5% in fiscal year 2012 and 27.7% in the prior fiscal year.

The increase in aggregate gross profit for the quarter was due primarily to pricing action in the electronic chemicals segment and, now that our consolidation is complete, lower manufacturing costs.

Other companies may include certain of the costs that we record in cost of sales as distribution expenses or selling, general and administrative expenses, and may include certain of the costs that we record in distribution expenses or selling, general and administrative expenses as a component of cost of sales, resulting in a lack of comparability between our gross profit and that reported by other companies.

Distribution Expenses

Distribution expenses were flat at $7.4 million in both the third quarter of fiscal year 2012 and in the prior year period. Distribution expenses were approximately 11.1% and 12.0% of net sales for the third quarter of fiscal years 2012 and 2011, respectively. For the nine month period, we had distribution expenses of $19.3 million, a decrease of $1.5 million, or 7.0%, as compared to $20.7 million in the prior year. Distribution expense as a percentage of sales decreased for the nine months to 9.4% in fiscal year 2012 from 11.2% in the prior fiscal year 2011. The decrease in distribution expenses was attributable to electronic chemicals, which resulted from efficiency improvements in our supply chain and the completion of our integration effort. The decline in distribution expense as a percentage of revenue was attributable fairly evenly to efficiency improvements in the electronic chemicals business and an increase in the weighting of wood treating chemicals’ share of total revenue. The electronic chemicals business comprises over 75% of our distribution expenses.

 

17


Selling, General and Administrative Expenses

Selling, general and administrative expenses increased $1.1 million, or 21.3%, to $6.3 million in the third quarter of fiscal year 2012 from $5.2 million in the same quarter of fiscal year 2011. Those expenses were 9.5% and 8.4% of sales in the third quarter of fiscal years 2012 and 2011, respectively. For the nine month period, we had selling, general and administrative expenses of $18.4 million, an increase of $2.5 million, or 15.9%, as compared to $15.9 million in the prior year. Those expenses as a percentage of sales were 9.5% in fiscal year 2012 and 8.4% in fiscal year 2011 for the third quarter comparison, and were 9.0% in fiscal year 2012 and 8.6% in fiscal year 2011 for the nine month comparison. For the three months ended April 30, 2012, the increase over the prior year was due to employee related expenses and for the nine months ended April 30, 2012, the increase was mainly due to higher employee related costs and non-recurring environmental costs of $1.7 million and $1.1 million, respectively. The environmental expenses were for waste disposal at our Tuscaloosa facility in connection with waste generated on installation of new dissolving equipment, from disposal of out of specification material and from disposal of creosote waste associated with cleaning rail cars.

Interest Expense

Interest expense was $504,000 and $571,000 in the third quarter of fiscal year 2012 and 2011, respectively, and $1.6 million and $1.8 million in the first nine months of fiscal year 2012 and 2011, respectively. The decrease was due to lower borrowings on our loan facility in fiscal year 2012 as compared to the same periods of the prior year, in part because we paid off the outstanding balance of $11.3 million on our term loan under that facility in the first quarter of fiscal year 2012.

Income Taxes

Our effective tax rate for continuing operations was 38.3% and 34.4% in the third quarter of fiscal years 2012 and 2011, respectively, and 39.2% and 33.8% for the first nine months of fiscal years 2012 and 2011, respectively. The prior year period income tax expense was net of discrete period adjustments reflecting the reversal of the valuation allowance related to a foreign subsidiary of $208,000 and $618,000 during the three and nine months ended April 30, 2011, respectively.

Discontinued Operations

Discontinued operations reflected a net gain of $66,000 and $232,000 for the three month periods ended April 30, 2012 and 2011, respectively, and a net loss of $333,000 and a net gain of $195,000 for the nine month periods ended April 30, 2012 and 2011, respectively. We incurred expense in each of the periods in connection with the dismantling of the production facility related to the agricultural chemical segment that was discontinued in fiscal year 2008. The current year periods also included expense related to an accident at our Matamoros facility during the dismantlement of that facility. We recognized a pre-tax gain of approximately $90,000 on the sale of the animal health business. We also recognized a pre-tax gain on the results of operation of that business during the three months ended April 30, 2012 and 2011 of $292,000 and $442,000, respectively, and a pre-tax gain of $56,000and $438,000 for the nine month ended April 30, 2012 and 2011, respectively.

Liquidity and Capital Resources

Cash Flows

Net cash provided by operating activities was $22.9 million for the first nine months of fiscal year 2012 as compared to $10.0 million for the comparable period in 2011. Net income adjusted for depreciation and amortization increased cash $15.2 million in the first nine months of fiscal year 2012 as compared to $14.3 million over the same period of the prior year. Cash flows from operating activities during the current period were favorably impacted by a decrease in trade accounts receivable of $7.2 million and an increase in income taxes payable of $2.3 million. The reduction in trade accounts receivable was due to normal collections activity in our electronic chemicals segment, timing of sales in our wood treating segment and lower balances related to the animal health business which was sold on March 1, 2012. The increase in income taxes payable was associated with the current year income tax accrual. Operating cash flows were unfavorably impacted by an increase in inventories of $4.6 million resulting mainly from the timing of creosote purchases.

Net cash provided by investing activities in the first nine months of fiscal 2012 was $5.3 million as compared to $5.6 million of net cash used in the prior year period. In fiscal year 2012, we received proceeds of $10.2 million from the sale of our animal health business. The additions to property, plant and equipment were $3.9 million and $5.8 million in fiscal years 2012 and 2011, respectively. In fiscal year 2012, the majority of the additions were for electronic chemicals distribution and production equipment. In fiscal year 2011, the additions were primarily for expansion at our Hollister, California facility and for equipment at Pueblo, Colorado. During the current period cash and cash equivalents were reduced by $1.0 million for cash that was restricted in connection with the escrowed amount on the animal health sale.

Net cash used in financing activities was $24.8 million in the first nine months of fiscal year 2012 as compared to $8.4 million in the comparable prior year period. In the first nine months of fiscal year 2012, we made principal payments of $11.3 million on the term loan indebtedness to pay it off entirely, had net payments on our revolving loan of $9.9 million and cleared the book overdraft outstanding at July 31, 2011 of $2.9 million. The book overdraft represented the amount in excess of the bank cash balance necessary to fund the checks that were paid but not yet cleared. In the prior year period, we had a net payment on our revolving loan of $2.1 million and principal payments on our term loan of $6.0 million. In the nine month periods ended April 30, 2012 and 2011, we paid dividends of $908,000 and $735,000, respectively. 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.

 

18


Working Capital

We have a revolving line of credit under an amended and restated credit agreement. At April 30, 2012, we had $8.0 million outstanding under that revolving facility.

Management believes that our current credit facility, combined with cash flows from operations, will adequately provide for our working capital needs for current operations for the next twelve months.

Long Term Obligations

To finance the acquisition of the electronic chemicals business in December 2007, we entered into a credit agreement and a note purchase agreement with Wachovia Bank, National Association, a subsidiary of Wells Fargo & Co., Bank of America, N.A., The Prudential Insurance Company of America, and Pruco Life Insurance Company. The credit facility included a revolving loan facility and a term loan facility.

We amended the credit agreement in March 2010, and amended it again in November 2011. The November 2011 amendment of the credit facility raises the maximum amount that may be borrowed under the revolving loan facility from $50.0 million to $60.0 million, extends the maturity date of the credit agreement to December 31, 2016 and allows advances under the revolving loan facility without reference to a borrowing base restriction. The financial covenant for debt to capitalization was replaced by a current ratio minimum of 1.5 to 1.0. During the first quarter of fiscal year 2012 we paid off all outstanding advances under the credit facility’s term loan commitment, and in the November 2011 amendment, that aspect of the facility was deleted.

Advances under the revolving loan facility mature December 31, 2016 and bears interest at a varying rate of LIBOR plus a margin based on our funded debt to EBITDA, as described below.

 

Ratio of Funded Debt to EBITDA

   Margin  

Equal to or greater than 3.0 to 1.0

     2.75

Equal to or greater than 2.5 to 1.0, but less than 3.0 to 1.0

     2.50

Equal to or greater than 2.0 to 1.0, but less than 2.5 to 1.0

     2.25

Equal to or greater than 1.5 to 1.0, but less than 2.0 to 1.0

     2.00

Less than 1.5 to 1.0

     1.75

Advances outstanding under the revolving loan facility bear interest of 2.24% as of April 30, 2012 and June 1, 2012. Before the term loan facility was paid off and removed from the credit facility, the term facility required principal payments of $458,333 per month for the first 24 months, then beginning January 2010 principal payments became $666,667 per month for the balance of the term prior to maturity. On March 2, 2012, we repaid $10.0 million of the balance on the revolving loan facility from proceeds received from the sale of the animal health business. At April 30, 2012, $8.0 million was outstanding on the revolving facility.

The financing for the acquisition of the electronic chemicals business in fiscal year 2008 included a $20.0 million note purchase agreement with the Prudential Insurance Company of America. Advances under the note purchase agreement mature December 31, 2014, and bear interest at 7.43% per annum. Principal is payable at maturity. At April 30, 2012, $20.0 million was outstanding under the note purchase agreement.

Loans under the amended and restated credit facility and the note purchase agreement are secured by our assets, including inventory, accounts receivable, equipment, intangible assets and real property. The credit facility and the note purchase agreement have restrictive covenants, including that we must maintain a fixed charge coverage ratio of 1.5 to 1.0, a ratio of funded debt to EBITDA of 3.0 to 1.0, and a current ratio of at least 1.5 to 1.0. For purposes of calculating these financial covenant ratios, we use a pro forma EBITDA. On April 30, 2012, we were in compliance with all of our debt covenants.

Off-Balance Sheet Arrangements

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

 

19


Disclosure Regarding Forward Looking Statements

We are including the following discussion to inform our existing and potential security holders generally of some of the risks and uncertainties that can affect us and to take advantage of the “safe harbor” protection for forward-looking statements that applicable federal securities law affords. From time to time, our management or persons acting on our behalf make forward-looking statements to inform existing and potential security holders about our company. These forward-looking statements include information about possible or assumed future results of our operations. All statements, other than statements of historical facts, included or incorporated by reference in this report that address activities, events or developments that we expect or anticipate may occur in the future, including such things as future capital expenditures, business strategy, competitive strengths, goals, growth of our business and operations, plans and references to future successes may be considered forward-looking statements. Also, when we use words such as “anticipate,” “believe,” “estimate,” “intend,” “plan,” “project,” “forecast,” “may,” “should,” “budget,” “goal,” “expect,” “probably” or similar expressions, we are making forward-looking statements. Many risks and uncertainties may impact the matters addressed in these forward-looking statements. Our forward-looking statements speak only as of the date made and we will not update forward-looking statements unless the securities laws require us to do so.

Some of the key factors which could cause our future financial results and performance to vary from those expected include:

 

   

the loss of primary customers;

 

   

our ability to implement productivity improvements, cost reduction initiatives or facilities expansions;

 

   

market developments affecting, and other changes in, the demand for our products and the entry of new competitors or the introduction of new competing products;

 

   

availability or increases in the price of our primary raw materials or active ingredients;

 

   

the timing of planned capital expenditures;

 

   

our ability to identify, develop or acquire, and market additional product lines and businesses necessary to implement our business strategy and our ability to finance such acquisitions and development;

 

   

the condition of the capital markets generally, which will be affected by interest rates, foreign currency fluctuations and general economic conditions;

 

   

cost and other effects of legal and administrative proceedings, settlements, investigations and claims, including environmental liabilities which may not be covered by indemnity or insurance;

 

   

the effects of weather, earthquakes, other natural disasters and terrorist attacks;

 

   

the ability to obtain registration and re-registration of our products under applicable law;

 

   

the political and economic climate in the foreign or domestic jurisdictions in which we conduct business or instability in a region due to criminal activity; and

 

   

other United States or foreign regulatory or legislative developments which affect the demand for our products generally or increase the environmental compliance cost for our products or impose liabilities on the manufacturers and distributors of such products.

The information contained in this report, including the information set forth under the heading “Risk Factors”, identifies additional factors that could cause our results or performance to differ materially from those we express in our forward-looking statements. Although we believe that the assumptions underlying our forward-looking statements are reasonable, any of these assumptions and, therefore, the forward-looking statements based on these assumptions, could themselves prove to be inaccurate. In light of the significant uncertainties inherent in the forward-looking statements which are included in this report and the exhibits and other documents incorporated herein by reference, our inclusion of this information is not a representation by us or any other person that our objectives and plans will be achieved.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

We are exposed to certain market risks in the ordinary course of our business, arising primarily from changes in interest rates and to a lesser extent foreign currency exchange rate fluctuations. Generally we do not utilize derivative financial instruments or hedging transactions to manage that risk. Our exposure to interest rate risk and foreign currency risk is discussed in our Annual Report on Form 10-K for the fiscal year ended July 31, 2011. There has been no material change in that information.

 

20


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 the quarterly period covered by this Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

The information set forth in Note 12 to the condensed consolidated financial statements included in Item 1 of Part I of this report is incorporated herein by reference.

 

ITEM 1A. RISK FACTORS

There have been no material changes to the risk factors contained in our Annual Report on Form 10-K for the fiscal year ended July 31, 2011.

 

ITEM 5. OTHER INFORMATION

The Nominating and Corporate Governance Committee will consider recommendations for directors made by shareholders for fiscal year 2013, if such recommendations are received in writing, addressed to the chair of the committee, Mr. John C. Hunter, in care of the Company, at 9555 W. Sam Houston Parkway S., Suite 600, Houston, Texas 77099 by July 2, 2012.

 

ITEM 6. EXHIBITS

The financial statements are filed as part of this report in Part 1, Item 1. The following documents are filed as exhibits. Documents marked with an asterisk (*) are management contracts or compensatory plans, and portions of documents marked with a dagger (†) have been granted confidential treatment.

 

31.1    Certificates under Section 302 the Sarbanes-Oxley Act of 2002 of the Chief Executive Officer.
31.2    Certificates under Section 302 the Sarbanes-Oxley Act of 2002 of the Chief Financial Officer.
32.1    Certificates under Section 906 of the Sarbanes-Oxley Act of 2002 of the Chief Executive Officer.
32.2    Certificates under Section 906 of the Sarbanes-Oxley Act of 2002 of the Chief Financial Officer.

 

21


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/ J. Neal Butler

   Date: June 11, 2012
   J. Neal Butler   
   President and Chief Executive Officer   
By:   

/s/ John V. Sobchak

   Date: June 11, 2012
   John V. Sobchak   
   Vice President and Chief Financial Officer   

 

22

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