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ITEM 2. 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, industrial wood treating chemicals and animal health products. Our electronic chemicals are used in the manufacturing of semiconductors. Our wood preserving chemicals, pentachlorophenol ("penta") and creosote, are used by our industrial customers primarily to extend the useful life of utility poles and railroad crossties. Our animal health products include biotech feed additives, farm and ranch hygiene products and pesticide products used on cattle, other livestock and poultry to protect the animals from flies and other pests. Results of Operations Three Month and Six Month Periods Ended January 31, 2011 compared with Three and Six Month Periods Ended January 31, 2010 Segment Data Segment data is presented for our four reportable segments for the three and six month periods ended January 31, 2011 and 2010. 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 five reportable segments, Electronic Chemicals-North America, Electronic Chemicals-International, and segments for penta, creosote and animal health. During the fourth quarter of fiscal year 2010 we re-evaluated the criteria used to determine operating segments, and we concluded that our electronic chemicals product line met the criteria of a single operating segment. As a result our reportable segments were revised to reflect a change from five to four reportable segments, electronic chemicals, penta, creosote and animal health. Prior year information has been reclassified to conform to the current period presentation. Three Months Ended Six Months Ended January 31, January 31, 2011 2010 2011 2010 (Amounts in thousands) Sales Electronic Chemicals $ 36,001 $ 22,894 $ 72,794 $ 45,905 Penta 5,275 5,107 11,746 11,050 Creosote 20,532 14,670 38,221 34,197 Animal Health 3,128 2,463 4,279 3,396 Net sales $ 64,936 $ 45,134 $ 127,040 $ 94,548 Net Sales Net sales increased $19.8 million, or 43.9%, to $64.9 million in the second quarter of fiscal year 2011 as compared with $45.1 million for the same period of the prior year. For the six month comparison, net sales increased $32.5 million, or 34.4%, to $127.0 million in fiscal year 2011 from $94.5 million in fiscal year 2010. In the second quarter of fiscal year 2011, the electronic chemicals segment had net sales of $36.0 million, an increase of $13.1 million, or 57.3%, as compared to $22.9 million for the prior year period. For the six month comparison, net sales in the electronic chemicals segment increased $26.9 million, or 58.6%, to $72.8 million in fiscal year 2011 from $45.9 million in fiscal year 2010. We had increased sales from our March 2010 acquisition of General Chemical's electronic chemicals business, and demand recovered in the segment from the effect of the economic downturn in the semiconductor industry. Net sales of penta products increased $168,000, or 3.3%, to $5.3 million in the second quarter of fiscal year 2011 as compared to $5.1 million for the prior year period. For the six month comparison, net sales in the penta segment increased $696,000, or 6.3%, to $11.7 million in fiscal year 2011 from $11.1 million in fiscal year 2010. The increases in sales for both the three and six month periods were due to higher volume. We benefited from an incremental improvement in purchases of treated poles by utility companies. Creosote net sales also increased in the second quarter of fiscal year 2011, as compared with the prior year period, by $5.9 million, or 40.0%, to $20.5 million. For the six month comparison, net sales in the creosote segment increased $4.0 million, or 11.8%, to $38.2 million in fiscal year 2011 from $34.2 million in fiscal year 2010. For the three and six month periods the increase was due to higher volumes offset in part by lower average prices. Demand by railroads for crossties treated with creosote eased in 2010 from the high levels of previous years, but now appears to be rebounding as the United States comes out of the recession. Crosstie purchases appear to be moving back toward about 18 million ties for the United States market. However, average pricing for creosote for both the quarter and the six month period declined because of a shift in product mix and renegotiated pricing following consolidation of our wood treating customer base. We anticipate that pricing will remain relatively flat through fiscal year 2011, but we believe that creosote sales volume will increase in the second half of the fiscal year as rail tie production rates more closely approximate tie purchases. 15 -------------------------------------------------------------------------------- Table of Contents Net sales of animal health pesticides increased by $665,000, or 27.0%, to $3.1 million in the second quarter of fiscal year 2011 as compared with $2.5 million in the prior year period. For the six month comparison, net sales in the animal health segment increased $883,000, or 26.0%, to $4.3 million in fiscal year 2011 from $3.4 million in fiscal year 2010. The increase was primarily driven by improvement in demand for pest control in the United States in the feed animal sector. However, we have seen a significant increase in orders for ear tag products in Australia, and because we are continuing to add registered products in South America, we see increased animal health sales in that region. Although we are working to have EPA re-establish appropriate tolerances, pending a successful conclusion of that effort, sales of our Rabon products in the U.S. may be adversely affected. Sales of our Rabon products in the U.S. constituted approximately 2% of our fiscal year 2010 consolidated net sales. Seasonal usage of animal health pesticides is dependent on varying seasonal patterns, weather conditions and weather-related pressure from pests, as well as customer marketing programs and requirements. Our revenue from the animal health pesticides segment is seasonal and weighted to the third and fourth quarters of our fiscal year. Revenues from products subject to significant seasonal variations represented 5.0% of our fiscal year 2010 revenues. Gross Profit Gross profit increased by $1.6 million, or 9.3%, to $18.3 million in the second quarter of fiscal year 2011 from $16.7 million in the same quarter the prior year. For the six month comparison, gross profit increased $531,000, or 1.5%, to $35.6 million in fiscal year 2011 from $35.1 million in fiscal year 2010. Gross profit as a percentage of sales decreased to 28.1% in the second quarter of fiscal year 2011 from 37.0% in the second quarter of fiscal year 2010, and decreased to 28.0% for the first six months of fiscal year 2011 from 37.1% for the prior fiscal year. The increase in aggregate gross profit for both the three and six month periods came from improved sales in our electronic chemicals segment, as discussed above. As a percentage of sales, however, profit margins in our electronic chemicals segment was down for the second quarter and for the full six months of fiscal year 2011 as compared to the prior year. In our electronic chemicals segment margins were impacted in both the second quarter and the six months period by duplicative costs associated with the integration of our March 2010 acquisition of General Chemicals' business, and by rising raw material costs. In connection with the integration, we are shifting operations to our Hollister, CA and Pueblo, CO facilities, but we have continued to incur expense for contract manufacturing in Dallas, TX and Bay Point, CA. We expect that duplication will be eliminated by the end of the fiscal year as we complete the transition to Hollister and Pueblo. We implemented a global price increase to take effect during the third fiscal quarter to address our increased raw material costs. In our creosote segment, we have experienced increased costs this fiscal year as compared to the prior year, and a lower average price. At the end of fiscal year 2010 we entered into a long-term contract to sell creosote to our largest customer following its acquisition of another of our large customers. Although this arrangement has had the effect of increasing creosote volume substantially, margins have declined from the unusually high levels experienced in fiscal year 2010 to what we believe is a more normal level. 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 are presented as a line item separate from our selling, general and administrative expenses in the consolidated statements of income. Prior year information has been reclassified to conform to this presentation. Distribution expenses increased $3.0 million, or 68.8%, to $7.4 million in the second quarter of fiscal year 2011 as compared with $4.4 million in the prior year period. For the six month comparison, distribution expense increased $4.3 million, or 46.3%, to $13.7 million in fiscal year 2011 from $9.4 million in fiscal year 2010. Distribution expenses were approximately 11.3% and 10.8% of net sales for the second quarter and for the first six months of fiscal year 2011, respectively, and 9.7% and 9.9% for the comparable prior year periods. 16 -------------------------------------------------------------------------------- Table of Contents We recognized an increase in distribution expense in our electronic chemicals segment of approximately $2.7 million and $3.8 million for the three and six months ended January 31, 2011, respectively, as compared to the same prior year periods. The increase was primarily due to increased expense on greater volume from the General Chemical acquisition for storage, handling and freight of about $2.4 million and $3.5 million for the three and six month periods, respectively, as compared to the prior year periods. For electronic chemicals, distribution expense was 17.4% of net sales in the second quarter and 15.9% for the six month period in fiscal year 2011, as compared to 15.6% and 16.9%, respectively, for the comparable periods in the prior year. The increase in distribution expense as a percent of sales was due to higher diesel fuel costs, the impact of our integration effort and additional freight incurred to meet shortage conditions arising from unscheduled plant outages at two suppliers in the United States. Those suppliers have now resumed production. Our two wood preservatives segments and our animal health segments had an aggregate increase of approximately $300,000 and $500,000 in distribution expenses in the second quarter and first six months of fiscal year 2011, respectively, mainly because of higher freight costs, storage and steaming costs for creosote storage and higher, volume related railcar cleaning expenses. With increased creosote throughput and milder temperatures, we expect storage and steaming costs will decline in the second half of the fiscal year. Selling, General and Administrative Expenses Selling, general, and administrative expenses were $6.1 million in the second quarter of fiscal year 2011 and $5.4 million in the same quarter of fiscal year 2010. Those expenses were 9.4% of sales in the second quarter of fiscal year 2011 and 12.0% of sales in the second quarter of the prior year. For the six month comparison, selling, general and administrative expense increased $693,000, or 6.4%, to $11.5 million in fiscal year 2011 from $10.9 million in fiscal year 2010. Selling, general and administrative expenses associated with our electronic chemicals segment increased approximately $710,000, to $3.1 million, in the second quarter of fiscal year 2011 as compared to $2.4 million for the second quarter of fiscal year 2010, and increased $1.1 million, to $6.0 million, for the six month period as compared to the same prior year period. The increases in both the three and six month periods were primarily related to higher employee costs of approximately $300,000 and $500,000, respectively. The three and six month periods included integration costs of approximately $61,000 and $237,000, respectively, in connection with the electronic chemicals business we acquired from General Chemical in March 2010. We also recognized modest increases in other professional services for both the three and six month periods. Selling, general and administrative expenses related to each of our other segments were relatively flat. Other corporate expense decreased by approximately $137,000 and $517,000 for the three and six month periods, respectively, as compared to the prior year periods. Other corporate expense represents those expenses associated with our operation as a public entity and includes costs such as board compensation, audit expense and fees related to the listing of our stock. See Note 11 to the condensed consolidated financial statements. Interest Expense Interest expense was $599,000 in the second quarter and $1.2 million in the first six months of fiscal year 2011 as compared with $535,000 and $1.1 million in the comparable periods of fiscal year 2010. The increase was due to an increase in our revolving loan facility balance to finance the acquisition of the electronic chemicals business of General Chemical in March 2010. Income Taxes Our effective tax rate was 38.1% and 33.5% in the second quarter and the first six months, respectively, of fiscal years 2011, and 37.3% for each of the prior year periods. The current six month period income tax expense was net of a discrete period adjustment of $410,000 recognized in the first quarter of fiscal year 2011 reflecting the reversal of a portion of the valuation allowance related to a foreign subsidiary. 17 -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources Cash Flows Net cash provided by operating activities was $10.4 million for the first six months of fiscal year 2011 as compared to $5.2 million for the comparable period in 2010. Net income adjusted for depreciation and amortization increased cash to $9.8 million in the first six months of fiscal year 2011. Changes in operating assets and liabilities included an increase of $1.6 million in accounts payable and a decrease in prepaid expenses and other current assets of approximately $939,000, both of which had a favorable impact on cash. The increase in accounts payable was primarily related to our recently acquired electronic chemicals business and the timing of creosote purchases. Prepaid expense and other current assets decreased as a result of a reduction in prepaid insurance. Cash was unfavorably impacted by a decrease in accrued liabilities of $1.9 million and an increase in inventories of $632,000. Accrued liabilities decreased mainly as a result of a reduction in our employee bonus accrual. The net increase in inventories was due to increased inventories in our electronic chemicals segment mostly offset by reduced inventories in our creosote segment. Net cash used in investing activities in the first six months of fiscal 2011 was $3.8 million as compared with $390,000 in the prior year period. We made additions to property, plant and equipment of $4.0 million during the first six months of fiscal year 2011 as compared to $500,000 in the same period of fiscal year 2010. In the first six months of fiscal year 2011 we spent approximately $1.3 million in connection with our ongoing expansion project at our Hollister, CA facility. We additionally made approximately $1.7 million of capital expenditures at our Pueblo, CO facility for equipment purchases and upgrades, some of which are in connection with our ongoing consolidation of our United States based electronic chemicals manufacturing. We also made expenditures of $411,000 for equipment at our Milan, Italy facility. The remaining capital expenditures were for normal equipment and system upgrades and purchases across our different locations. The expenditures in the prior year period were primarily in our electronic chemicals segment. Net cash used in financing activities was $7.1 million in the first six months of fiscal year 2011 as compared to $3.2 million in the comparable prior year period. In the first six months of fiscal year 2011, we made principal payments of $4.0 million on the term loan indebtedness we incurred when we purchased the electronic chemicals business in December 2007. We additionally made payments of $3.0 million on our revolving credit line in the six month period which reflects amounts borrowed to fund our March 2010 acquisition. In the first six months of fiscal year 2010, we made principal payments of $3.0 million on the term loan indebtedness. We paid dividends of $452,000 and $445,000 in the first six months of fiscal years 2011 and 2010, respectively. On February 24, 2011, we announced an increase in our quarterly dividend rate to $0.025 per share from $0.020 per share, a 25% increase. 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, and the increase in the quarterly dividend reflects that analysis. Working Capital We have a revolving line of credit under an amended and restated credit agreement. At January 31, 2011, we had $17.0 million outstanding under that revolving facility, and our net borrowing base availability was $18.2 million. 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 new credit facility included a revolving loan facility of $35.0 million and a term loan facility of $35.0 million. We amended those facilities in March 2010 to increase the amount that may be borrowed under the revolving loan facility to $50.0 million. Advances under the revolving loan and the term loan mature December 31, 2012. 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 % As of February 28, 2011, advances bear interest at 2.26% per year (LIBOR plus 2.00%). For the first 24 months of the term facility, principal payments were $458,333 per month, and 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 chemicals assets from General Chemical on March 29, 2010 was funded with available cash and borrowings under the revolving loan. At January 31, 2011, $17.0 million was outstanding on the revolving facility and $15.3 million was outstanding on the term loan. 18 -------------------------------------------------------------------------------- Table of Contents 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 January 31, 2011, $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, and a ratio of funded debt to EBITDA of 3.0 to 1.0. We are also obligated to maintain a debt to capitalization ratio of not more than 50%. For purposes of calculating these financial covenant ratios, we use a pro forma EBITDA. On January 31, 2011, 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. Recent Accounting Standards We have considered all recently issued accounting standards updates and SEC rules and interpretive releases, and believe that only the following item could have a material impact on our consolidated financial statements. In December 2010, the Financial Accounting Standards Board issued new accounting guidance for the disclosure of supplementary pro forma information for business combinations. The guidance clarifies the acquisition date that should be used for reporting the pro forma financial information disclosures when comparative financial statements are presented and specifies that the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The guidance also expands the supplemental pro forma disclosure requirements to include a description of the nature and amount of material, non recurring pro forma adjustments directly attributable to the business combination included in the reported pro forma information. The new guidance is effective prospectively for business combinations with an acquisition date on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. We do not expect the new guidance to have a material impact on its consolidated financial statements. Critical Accounting Policies and Estimates Our condensed consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America. The preparation of these condensed consolidated financial statements requires the use of estimates, judgments, and assumptions that affect the reported amounts of assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the periods presented. There were no significant changes in our critical accounting policies as described in our Annual Report on Form 10-K for the fiscal year ended July 31, 2010. 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. 19 -------------------------------------------------------------------------------- Table of Contents 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 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; 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. |