KMG CHEMICALS INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Edgar Glimpses Via Acquire Media NewsEdge) We manufacture, formulate and distribute specialty chemicals globally. We
operate businesses engaged in electronic chemicals and industrial wood treating
chemicals. Our electronic chemicals are sold to the semiconductor industry,
where they are used primarily to clean and etch silicon wafers in the production
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 escrowed amount is being held pending final
acceptance by the United States Environmental Protection Agency of certain
studies being performed at its request on tetrachlorvinphos. We retained the
real estate and building at our facility in Elwood, Kansas, and we operate it to
manufacture products for the buyer under a transition services agreement for one
year, subject to two six-month extensions.
Results of Operations
Three Month Period Ended October 31, 2012 compared with Three Month Period Ended
October 31, 2011
Segment data is presented for our two reportable segments for the three month
periods ended October 31, 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. Our 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
(Amounts in thousands)
Electronic chemicals $ 39,507 $ 38,378
Wood treating chemicals 25,700 33,161
Total sales for reportable segments $ 65,207 $ 71,539
Segment net sales decreased $6.3 million, or 8.9%, to $65.2 million in the first
quarter of fiscal year 2013 as compared to $71.5 million for the same period of
the prior year. Although net sales in our electronic chemicals segment were up
$1.1 million in the first quarter of fiscal year 2013 over the prior year
period, that increase was offset by a $7.5 million decline in net sales in our
wood treating chemicals segment.
In the first quarter of fiscal year 2013, the electronic chemicals segment had
net sales of $39.5 million, an increase of $1.1 million, or 2.9%, as compared to
$38.4 million for the prior year period. The first quarter sales for fiscal year
2013 were affected by weakening demand, particularly in Europe. We expect demand
for our electronic chemicals products to decline in the second quarter of fiscal
2013 from first quarter levels before strengthening in the second half of the
fiscal year in calendar 2013.
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Net sales of wood treating chemicals decreased $7.5 million, or 22.5%, to
$25.7 million in the first quarter of fiscal year 2013 as compared to
$33.2 million for the prior year period. The decrease in net sales for the
quarter was due to a decrease in creosote sales volume. Creosote sales volume in
the first quarter of fiscal 2013 was adversely impacted by customers
pre-treating railroad ties with boron solutions as a way of reducing the amount
of creosote needed. Some customers have adopted that practice as a way of
holding down costs in response to higher creosote pricing. We anticipate further
weakening of demand for wood treating chemicals in the second fiscal quarter
before strengthening in the second half of fiscal 2013.
Gross profit increased by $1.4 million, or 7.6%, to $20.1 million in the first
quarter of fiscal year 2013 from $18.7 million in the same quarter of the prior
year. Gross profit as a percentage of sales increased to 30.7% in the first
quarter of fiscal year 2013 from 26.1% in the first quarter of fiscal year 2012.
The increase in aggregate gross profit for the quarter was due to the completed
integration of our fiscal 2010 acquisition in the electronic chemicals segment,
and due to the reduced weighting of creosote in our overall product portfolio.
Creosote is our lowest gross margin product, and sales of that product decline
as a percentage of our total revenue, the decline has the effect of increasing
our overall gross profit margin.
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 increased to $7.1 million in the first quarter of fiscal
year 2013 from $6.1 million in the prior year period, a 16.2% increase.
Distribution expenses were approximately 10.8% and 8.5% of net sales for the
first quarter of fiscal years 2013 and 2012, respectively. The increase in
distribution expenses was primarily attributable to an increase in average
freight costs and a decline in tender of performance by our lowest cost carrier.
Selling, General and Administrative Expenses
Selling, general, and administrative expenses increased $317,000, or 5.6%, to
$5.9 million in the first quarter of fiscal year 2013 from $5.6 million in the
same quarter of fiscal year 2012. Those expenses were 9.1% and 7.8% of net sales
in the first quarter of fiscal years 2013 and 2012, respectively. The increase
in the current period was due to $577,000 of additional project costs primarily
for consulting and professional services.
Interest Expense, net
Interest expense was $411,000 and $550,000 in the first quarter of fiscal years
2013 and 2012, respectively. The decrease was due to lower borrowings on our
loan facility in fiscal year 2013 as compared to the same period of the prior
year, in part because we paid off the outstanding balance on our term loan under
that facility in the first quarter of fiscal year 2012.
Our effective tax rate for continuing operations was 36.7% and 39.3% in the
first quarter of fiscal years 2013 and 2012, respectively.
Our Mexico subsidiary has undistributed earnings. It is our intention to
continue to remain permanently reinvested in Mexico on its prior year cumulative
undistributed earnings. Additionally, any undistributed earnings of the Italian
subsidiary are considered to be permanently reinvested. Accordingly, no
provision for United States income taxes has been provided with respect to
undistributed earnings. Upon repatriation of those earnings, we will be subject
to both United States income taxes (subject to an adjustment for foreign tax
credits) and potentially withholding taxes payable to the foreign country.
Discontinued operations reflected a loss, before income taxes, of $102,000 and
$526,000 for the first quarter of fiscal year 2013 and 2012, respectively. We
sold our animal health business in March 2012. In the first quarter of fiscal
year 2013, we had certain post-closing adjustments related to that sale, and the
loss in fiscal year 2012 included a first quarter loss of $483,000 from that
business. We also 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.
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Liquidity and Capital Resources
Net cash provided by operating activities was $6.3 million for the first three
months of fiscal year 2013 as compared to $13.6 million for the comparable
period in 2012. Net income adjusted for depreciation and amortization increased
cash by $5.9 million in fiscal year 2013 as compared to $5.3 million over the
same period of the prior year. Cash flows from operating activities during the
current period were favorably impacted by $2.7 million due to a reduction in
trade accounts receivable from lower sales in our electronic chemicals segment
in the first quarter of fiscal year 2013 versus the fourth quarter of fiscal
year 2012, and also favorably impacted by $1.9 million of increased accounts
payable from the timing of payments and inventory purchases in our wood treating
segment. Operating cash flows were unfavorably impacted by a $5.0 million
increase in inventories primarily due to the timing of creosote purchases and,
to a lesser extent, higher inventories in our electronic chemicals segment.
Net cash used by investing activities in the first quarter of fiscal 2013 was
$1.5 million as compared to $1.8 million in the prior year period, in each case
for additions to property, plant and equipment.
Net cash used in financing activities was $2.3 million in the first quarter of
fiscal year 2013 as compared to $8.4 million in the prior year period. In the
first three months of fiscal year 2013, we made payments of $2.0 million on our
revolving loan. In the prior year period we made principal payments of
$11.3 million on the term loan indebtedness to pay it off entirely, borrowed
$6.1 million on our revolving loan, 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 three month periods ended October 31, 2012 and 2011, we paid dividends of
$342,000 and $283,000, 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.
We have a revolving line of credit under an amended and restated credit
agreement. At October 31, 2012, we had $2.0 million outstanding under that
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 November 2011, raising the maximum amount
that may be borrowed under the revolving loan facility from $50.0 million to
$60.0 million, extending the maturity date of the credit agreement to
December 31, 2016 and allowing 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 mature December 31, 2016. They each bear
interest at 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 under the revolving loan bear interest at 2.11% as of October 31, 2012
(LIBOR plus 2.00%). At October 31, 2012, $2.0 million was outstanding on the
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Before the term loan facility was paid off in October 2011, 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.
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 October 31, 2012, $20.0 million was outstanding under the note
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
October 31, 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, other than operating leases.
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
• availability or increases in the price of energy, our primary raw
materials and 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
• 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
• 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; 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.
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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.
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