---

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x

Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

For Quarterly Period Ended December 31, 2003

OR

o

Transition Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

Commission File Number 1-8137

AMERICAN PACIFIC CORPORATION
(Exact name of registrant as specified in its charter)

|Delaware                                                           |  | 59-6490478                              
|------------------------------------------------------------------ |  | ----------------------------------------
|(State or   other jurisdiction   of incorporation or organization) |  | (I.R.S.   Employer   Identification No.)
|                                                                   |  |                                         
|3770 Howard Hughes Parkway, Suite   300   Las Vegas, NV            |  | 89109                                   
|(Address   of principal executive offices)                         |  | (Zip Code)                              

(702) 735-2200
(Registrants telephone number, including area code)

NOT APPLICABLE
(Former name, former address and former fiscal year, if changed since last report.)

Indicate by check mark whether the registrant has filed all reports required to be filed by Sections 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
o
|----- | ----

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

|YES
o | NO
x
|----- | ----

Applicable Only to Corporate Issuers

Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date:  7,283,000 as of January 31, 2004.

---



PART I.   FINANCIAL INFORMATION

|ITEM 1. | Condensed Consolidated Financial Statements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|        | The information required by Rule 10-01 of Regulation   S-X is provided on pages 4 through 14 of this Report on Form 10-Q.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|ITEM 2. | Managements Discussion and Analysis of Financial   Condition and Results of Operations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|        | The information required by Item 303 of Regulation   S-K is provided on pages 15 through 20 of this Report on Form 10-Q.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|ITEM 3. | Quantitative and Qualitative Disclosure About Market   Risk.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|        | Market risk represents the risk of loss arising from   adverse changes in market rates and prices, commodity prices and foreign   currency exchange rates.  We had   certain long-term fixed-rate debt that was redeemed on March 1, 2003.  In December 2002, we entered into a   revolving line of credit facility that is secured by certain inventory and   receivables.  To date, we have not   drawn upon the line of credit.  At   December 31, 2003, we did not have any derivative-based financial   instruments.  However, the amount of   outstanding debt may fluctuate and we may at some time be subject to   financing risk.
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|ITEM 4. | Controls and Procedures.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|        | Based on their evaluation, as of a date within 90   days of the filing of this Form 10-Q, our Chief Executive Officer and Chief   Financial Officer have concluded that our disclosure controls and procedures   (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange   Act of 1934) are effective.  There   have been no significant changes in internal controls or in other factors   that could significantly affect these controls subsequent to the date of   their evaluation, including any corrective actions with regard to significant   deficiencies and material weaknesses.                           

PART II.  OTHER INFORMATION

|ITEM 1. | Legal Proceedings.                                                                                                      
|------- | ------------------------------------------------------------------------------------------------------------------------
|        |                                                                                                                         
|        | The information required by Item 103 of Regulation   S-K is provided on pages 10 through 11 of this Report on Form 10-Q.
|        |                                                                                                                         
|ITEM 2. | Changes in Securities and Use of Proceeds.                                                                              
|        |                                                                                                                         
|        | None.                                                                                                                   
|        |                                                                                                                         
|ITEM 3. | Defaults Upon Senior Securities.                                                                                        
|        |                                                                                                                         
|        | None.                                                                                                                   
|        |                                                                                                                         
|ITEM 4. | Submission of Matters to a Vote of Security Holders.                                                                    
|        |                                                                                                                         
|        | None.                                                                                                                   

- 2 -



|ITEM 5. | Other Information.               
|------- | ---------------------------------
|        |                                  
|        | None.                            
|        |                                  
|ITEM 6. | Exhibits and Reports on Form 8-K.
|        |                                  
|        | a)                               
|        |                                  
|        |                                  
|        |                                  
|        |                                  
|        |                                  
|        |                                  
|        |                                  
|        |                                  
|        |                                  
|        |                                  
|        |                                  
|        | b)                               
|        |                                  
|        |                                  

SIGNATURES

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

|                          | AMERICAN PACIFIC CORPORATION                                                                                                                     
|------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------
|                          |                                                                                                                                                  
|Date:    February 4, 2004 | /s/ JOHN R. GIBSON                                                                                                                               
|                          |                                                                                                                                                  
|                          | John R.   Gibson    Chief Executive Officer and President                                                                                        
|                          |                                                                                                                                                  
|                          |                                                                                                                                                  
|Date:    February 4, 2004 | /s/ DAVID N. KEYS                                                                                                                                
|                          |                                                                                                                                                  
|                          | David N.   Keys    Executive Vice President,    Chief Financial Officer,    Secretary and Treasurer; Principal   Financial and Accounting Officer

- 3 -



AMERICAN PACIFIC CORPORATION Condensed Consolidated Statements of Income For the Three Months Ended December 31,(unaudited)

|                                         |  | 2003 |            | 2002 |  
|---------------------------------------- |  | ---- | ---------- | ---- | -
|                                         |  |      |            |      |  
|Sales and Operating Revenues             |  | $    | 4,794,000  |      | $
|Cost of Sales                            |  |      | 4,324,000  |      |  
|                                         |  |      |            |      |  
|Gross Profit                             |  |      | 470,000    |      |  
|Operating Expenses                       |  |      | 3,764,000  |      |  
|                                         |  |      |            |      |  
|Operating Income (Loss)                  |  |      | (3,294,000 | )    |  
|Net Interest and Other Expense  (Income) |  |      | 96,000     |      |  
|                                         |  |      |            |      |  
|Income (Loss) Before Income Taxes        |  |      | (3,390,000 | )    |  
|Income Taxes                             |  |      | (1,186,000 | )    |  
|                                         |  |      |            |      |  
|Net Income (Loss)                        |  | $    | (2,204,000 | )    | $
|                                         |  |      |            |      |  
|Basic Net Income (Loss) Per Share        |  | $    | (.30       | )    | $
|                                         |  |      |            |      |  
|Average Shares Outstanding               |  |      | 7,256,000  |      |  
|                                         |  |      |            |      |  
|Diluted Net Income (Loss) Per Share      |  | $    | (.30       | )    | $
|                                         |  |      |            |      |  
|Diluted Shares                           |  |      | 7,256,000  |      |  
|                                         |  |      |            |      |  

See the accompanying Notes to Condensed Consolidated Financial Statements.

- 4 -



AMERICAN PACIFIC CORPORATION Condensed Consolidated Balance Sheets(unaudited)

|                                                      |  | December 31,   2003 |            | September   30,   2003 |  
|----------------------------------------------------- |  | ------------------- | ---------- | ---------------------- | -
|                                                      |  |                     |            |                        |  
|ASSETS                                                |  |                     |            |                        |  
|Current Assets:                                       |  |                     |            |                        |  
|Cash and Cash   Equivalents                           |  | $                   | 20,791,000 |                        | $
|Accounts and Notes   Receivable                       |  |                     | 6,442,000  |                        |  
|Related Party Notes and   Accrued Interest Receivable |  |                     | 306,000    |                        |  
|Inventories                                           |  |                     | 17,544,000 |                        |  
|Prepaid Expenses and   Other Assets                   |  |                     | 1,462,000  |                        |  
|Deferred Income Taxes                                 |  |                     | 1,286,000  |                        |  
|                                                      |  |                     |            |                        |  
|Total   Current Assets                                |  |                     | 47,831,000 |                        |  
|Property, Plant and Equipment, Net                    |  |                     | 8,996,000  |                        |  
|Intangible Assets, Net                                |  |                     | 16,604,000 |                        |  
|Investment in and Advances to Joint Venture           |  |                     | 10,127,000 |                        |  
|Deferred Income Taxes                                 |  |                     | 10,207,000 |                        |  
|Other Assets, Net                                     |  |                     | 3,719,000  |                        |  
|                                                      |  |                     |            |                        |  
|TOTAL   ASSETS                                        |  | $                   | 97,484,000 |                        | $
|                                                      |  |                     |            |                        |  

See the accompanying Notes to Condensed Consolidated Financial Statements.

- 5 -



AMERICAN PACIFIC CORPORATION Condensed Consolidated Balance Sheets(unaudited)

|                                             |  | December   31,   2003 |             | September   30,   2003 |  
|-------------------------------------------- |  | --------------------- | ----------- | ---------------------- | -
|                                             |  |                       |             |                        |  
|LIABILITIES AND SHAREHOLDERS   EQUITY       |  |                       |             |                        |  
|Current Liabilities:                         |  |                       |             |                        |  
|Accounts Payable and   Accrued Liabilities   |  | $                     | 6,514,000   |                        | $
|Dividend Payable                             |  |                       | 3,055,000   |                        |  
|                                             |  |                       |             |                        |  
|Total   Current Liabilities                  |  |                       | 9,569,000   |                        |  
|Other Long-Term   Liabilities                |  |                       | 4,701,000   |                        |  
|                                             |  |                       |             |                        |  
|TOTAL   LIABILITIES                          |  |                       | 14,270,000  |                        |  
|                                             |  |                       |             |                        |  
|Commitments and Contingencies                |  |                       |             |                        |  
|Warrants to Purchase Common Stock            |  |                       |            |                        |  
|Shareholders Equity:                        |  |                       |             |                        |  
|Common Stock                                 |  |                       | 931,000     |                        |  
|Capital in Excess of Par Value               |  |                       | 85,663,000  |                        |  
|Retained Earnings                            |  |                       | 14,490,000  |                        |  
|Treasury Stock                               |  |                       | (16,982,000 | )                      |  
|Accumulated Other Comprehensive Loss         |  |                       | (888,000    | )                      |  
|                                             |  |                       |             |                        |  
|Total   Shareholders Equity                 |  |                       | 83,214,000  |                        |  
|                                             |  |                       |             |                        |  
|TOTAL   LIABILITIES AND SHAREHOLDERS EQUITY |  | $                     | 97,484,000  |                        | $
|                                             |  |                       |             |                        |  

See the accompanying Notes to Condensed Consolidated Financial Statements.

- 6 -



AMERICAN PACIFIC CORPORATION Condensed Consolidated Statements of Cash Flows For the Three Months Ended December 31,(unaudited)

|                                                  |  | 2003 |            | 2002 |  
|------------------------------------------------- |  | ---- | ---------- | ---- | -
|                                                  |  |      |            |      |  
|Cash Flows From Operating Activities              |  | $    | (5,274,000 | )    | $
|                                                  |  |      |            |      |  
|Cash Flows From Investing Activities:             |  |      |            |      |  
|Capital Expenditures                              |  |      | (321,000   | )    |  
|Investment in and   Advances to Joint Venture     |  |      | (144,000   | )    |  
|                                                  |  |      |            |      |  
|Net Cash From Investing Activities                |  |      | (465,000   | )    |  
|                                                  |  |      |            |      |  
|Cash Flows From Financing Activities:             |  |      |            |      |  
|Issuance of Common   Stock                        |  |      | 2,142,000  |      |  
|Treasury Stock Acquired                           |  |      | (2,752,000 | )    |  
|                                                  |  |      |            |      |  
|Net Cash From Financing Activities                |  |      | (610,000   | )    |  
|                                                  |  |      |            |      |  
|Net Change in Cash and Cash Equivalents           |  |      | (6,349,000 | )    |  
|Cash and Cash Equivalents, Beginning of Period    |  |      | 27,140,000 |      |  
|                                                  |  |      |            |      |  
|Cash and Cash Equivalents, End of Period          |  | $    | 20,791,000 |      | $
|                                                  |  |      |            |      |  
|Supplemental Disclosure of Cash Flow Information: |  |      |            |      |  
|Cash paid during quarter for taxes                |  |      |           |      | $
|                                                  |  |      |            |      |  

See the accompanying Notes to Condensed Consolidated Financial Statements

- 7 -



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED):

|1. | BASIS OF   REPORTING                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   | The accompanying Condensed Consolidated Financial   Statements are unaudited and do not include certain information and   disclosures included in the Annual Report on Form 10-K of American Pacific   Corporation (the Company, we, us, or our).  The Condensed Consolidated Balance Sheet as of September 30,   2003, was derived from the Consolidated Financial Statements included in our   Annual Report on Form 10-K for the year ended September 30, 2003.  Such statements should therefore be read   in conjunction with the Consolidated Financial Statements and Notes thereto   included in our Annual Report on Form 10-K for the year ended September 30,   2003.  In our opinion, however, all   adjustments necessary for a fair presentation have been included.  The operating results and cash flows for   the three-month period ended December 31, 2003 are not necessarily indicative   of the results that will be
achieved for the full fiscal year or for future periods.                                                                                                                                             
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   | A summary of our significant accounting policies is   included in our Annual Report on Form 10-K for the year ended September 30,   2003.  We believe that the application   of these policies on a consistent basis enables us to provide the users of the   financial statements with useful reliable information about our operating   results and financial condition.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   | The preparation of financial statements in   conformity with accounting principles generally accepted in the United States   of America requires us to make estimates and assumptions that affect the   reported amounts of assets and liabilities, disclosure of contingent assets   and liabilities and the reported amounts of revenue and expenses.  Judgments and assessments of uncertainties   are required in applying our accounting policies in many areas.  For example, key assumptions and estimates   are particularly important when determining our projected liabilities for   pension benefits, useful lives for depreciable and amortizable assets, and   the recoverability of deferred tax assets and long-lived assets, including   intangible assets.  Other areas in   which significant uncertainties exist include, but are not limited to, costs   that may be incurred in connection with environmental matters and the   resolution of litigation and other
contingencies.  Actual results will inevitably differ to some extent from   estimates on which our Condensed Consolidated Financial Statements were   prepared.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   | During the first quarter of fiscal 2002, we adopted   Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and   Other Intangible Assets.  The   adoption of SFAS No. 142 did not have a material effect on our results of   operations or financial position.    Under the provisions of SFAS No. 142, the intangible asset related to   our perchlorate acquisition (the Acquisition) in fiscal 1998 will continue   to be amortized under its originally assigned life of ten years.  At December 31, 2003, this intangible   asset had a gross carrying value of approximately $39.0 million and accumulated   amortization of approximately $22.9 million.    Amortization expense was approximately $1.0 million during the three   months ended December 31, 2003 and 2002.    Amortization expense is estimated to amount to approximately $3.9   million in each of the years during the four-year period ending September
30,   2007, and approximately $1.5 million during the fiscal year ending September   30, 2008.                                                                                                
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   | During the first quarter of fiscal 2002, we adopted   SFAS No. 145.  SFAS No. 145 requires   that gains and losses from extinguishment of debt be classified as   extraordinary items only if they meet the criteria in Accounting Principles   Board Opinion No. 30 (Opinion No. 30).    Applying the provisions of Opinion No. 30 will distinguish   transactions that are part of an entitys recurring operations from those   that are unusual and infrequent that meet the criteria for classification as   an extraordinary item.  We have   reclassified previously reported extraordinary losses on debt extinguishments   to a separate line item above the caption Income Before Income Taxes in our   Condensed Consolidated Statements of Income.                                                                                                                                                                                                                                                                                                                                                                                      
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|   | Our only component of other comprehensive income   (loss) represents a minimum pension liability adjustment.  The changes in such adjustment were   approximately $680,000 and $112,000 (net of                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         

- 8 -



| | applicable income taxes) during the three-month   periods ended December 31, 2003 and 2002, respectively.  Comprehensive income (loss) for the   three-month periods ended December 31, 2003 and 2002, was as follows:
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                     |  | Three   Months Ended   December 31, 2003 |            | Three   Months Ended   December 31, 2002 |  
|------------------------------------ |  | ---------------------------------------- | ---------- | ---------------------------------------- | -
|                                     |  |                                          |            |                                          |  
|Net income (loss)                    |  | $                                        | (2,204,000 | )                                        | $
|Minimum pension liability adjustment |  |                                          | 680,000    |                                          |  
|                                     |  |                                          |            |                                          |  
|Comprehensive income (loss)          |  | $                                        | (1,524,000 | )                                        | $
|                                     |  |                                          |            |                                          |  

|2. | NET   INCOME (LOSS) PER COMMON SHARE                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   | Basic per share amounts are computed by dividing net   income (loss) by average shares outstanding during the period.  Diluted per share amounts are calculated   by dividing net income by average shares outstanding plus the dilutive effect   of common share equivalents.  Since we   incurred a net loss during the three-month period ended December 31, 2003,   the dilutive effect of outstanding stock options and warrants of   approximately 86,000 shares were not included in diluted per share   calculations.  The effect of warrants   outstanding to purchase approximately 2.9 million shares of common stock were   not included in diluted per share calculations during the three-month period   ended December 31, 2002, since the exercise price of the warrants was greater   than the average price of our common stock during this period.  Such warrants expired on December 31,   2003, and the value assigned at the time of their issuance of $3.6 million
was recognized as an adjustment to retained earnings in the first quarter of   fiscal 2004.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   | In December 2002, SFAS No. 148, Accounting for   Stock-Based Compensation-Transition and Disclosure, which amends SFAS No.   123, Accounting for Stock-Based Compensation was issued.  SFAS 148 is effective for fiscal years   ending after December 15, 2002, and gives further guidance regarding methods   of transition for a voluntary change to the fair-value-based method of   accounting for stock-based employee compensation and regarding disclosure   requirements as previously defined in SFAS 123.  We have elected to follow APB No. 25, Accounting for Stock   Issued to Employees and related interpretations in accounting for our stock   options.  Under APB No. 25, if the   exercise price of our employee stock options equals the market price of the   underlying stock on the date of the grant, no compensation expense is   recognized.                                                                                                                                                                                                         
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   | We granted stock options to our employees and   directors in fiscal 2001 and 2003.    The effect on net income and earnings per share if we had applied the   fair value recognition provisions of SFAS No. 123 to our stock option grants   would have been as follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

|                                                                                                          |  | Three   Months Ended   December 31 |           
|--------------------------------------------------------------------------------------------------------- |  | ---------------------------------- | ----------
|                                                                                                          |  |                                    |           
|                                                                                                          |  | 2003                               |           
|                                                                                                          |  |                                    |           
|Net income (loss):                                                                                        |  |                                    |           
|As reported                                                                                               |  | $                                  | (2,204,000
|Total stock based   employee compensation expense using the fair value based method, net of   related tax |  |                                    | 122,000   
|                                                                                                          |  |                                    |           
|Pro forma                                                                                                 |  | $                                  | (2,326,000
|                                                                                                          |  |                                    |           
|Diluted earnings (loss) per share:                                                                        |  |                                    |           
|As reported                                                                                               |  | $                                  | (.30      
|Pro forma                                                                                                 |  | $                                  | (.32      
|                                                                                                          |  |                                    |           
|Basic earnings (loss) per share:                                                                          |  |                                    |           
|As reported                                                                                               |  | $                                  | (.30      
|Pro forma                                                                                                 |  | $                                  | (.32      
|                                                                                                          |  |                                    |           

- 9 -



| | The estimated weighted-average fair value of the   individual options granted during the fiscal year 2003 was $3.68 on the date   of grant.  This fair value was   determined using a Black-Scholes option-pricing model with the following   assumptions:
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                        |  | 2003 |          
|----------------------- |  | ---- | ---------
|                        |  |      |          
|Dividend yield          |  |      | 0        
|Volatility              |  |      | 50       
|Risk-free interest rate |  |      | 2.9      
|Expected life           |  |      | 4.5 years

|3. | INVENTORIES                          
|-- | -------------------------------------
|   |                                      
|   | Inventories consist of the following:

|                           |  | December   31,    2003 |            | September   30,    2003 |  
|-------------------------- |  | ---------------------- | ---------- | ----------------------- | -
|                           |  |                        |            |                         |  
|Work-in-process            |  | $                      | 5,989,000  |                         | $
|Raw materials and supplies |  |                        | 11,555,000 |                         |  
|                           |  |                        |            |                         |  
|Total                      |  | $                      | 17,544,000 |                         | $
|                           |  |                        |            |                         |  

|4. | DEBT                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   | On March 1, 2003, we redeemed all of our outstanding   91⁄4% Senior Unsecured Notes (the Notes). The redemption was at a price of   102.313% of the principal amount of the Notes, plus accrued interest to the   date of redemption, or in the amount of approximately $43.4 million.  We recognized a loss on the redemption of   $1.5 million, including a non-cash charge of $0.6 million to write-off   remaining debt issue costs.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   | In December 2002, we entered into a revolving line   of credit with a bank.  The maximum   available credit under the line is the lesser of $10.0 million, or the sum of   85% of eligible receivables and 50% of qualifying inventory.  No funds have been borrowed under the line   of credit.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|5. | COMMITMENTS   AND CONTINGENCIES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   | In 1997, the Southern Nevada Water Authority   detected trace amounts of perchlorate chemicals in Lake Mead and the Las   Vegas Wash, bodies of water near our real estate development property in   Henderson, Nevada (in the Las Vegas area).    Lake Mead is a source of drinking water for the City of Las Vegas,   neighboring areas and certain areas of metropolitan Southern California.  Perchlorate chemicals (including ammonium   perchlorate, or AP) are a potential health concern because they can interfere   with the production of a growth hormone by the thyroid gland, although they   are not currently included in the list of hazardous substances compiled by   the Environmental Protection Agency (EPA).    However, perchlorates have been added to the EPAs Contaminant   Candidate List and will likely be regulated.    We manufactured perchlorate chemicals at a facility on the Henderson   site until May 1988, after which we relocated
our perchlorate production to   our current facilities in Iron County, Utah.    For many years, Kerr-McGee Chemical, LLC (Kerr-McGee) operated a   perchlorate production facility at a site near our Henderson site.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   | The Water Authoritys testing has shown perchlorate   concentrations of 8 to 14 parts per billion (ppb) in Clark County drinking   water.  In response to this discovery,   we have engaged environmental consultants to drill monitor wells in order to   characterize ground water at and in the vicinity of  the Henderson site.  The   results of our tests have shown perchlorate concentrations in the ground   water at the Henderson property ranging from 0 to approximately 750,000 ppb   at certain monitoring wells.  Since   1998, we have spent in excess of $6.0 million on the investigation and evaluation   of the source or sources of these trace amounts,                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

- 10 -



| | possible environmental impacts, and potential   remediation methods.  Our ground water   characterization investigations indicate that the ground water containing   perchlorate at and around our former Henderson manufacturing site has not   reached Lake Mead and, accordingly, has not been introduced into any source   of drinking water.  Based upon flow   rates and modeling techniques, such ground water is not expected to reach a   source of drinking water for at least 10 years.  However, we have begun a pilot remediation testing process to   treat groundwater containing perchlorate at and near the Henderson site using   a biological in situ method.  To date,   the pilot remediation process is proceeding in accordance with our plan and   has shown promising results, but there can be no assurance as to its   efficacy.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | The EPA is conducting a risk assessment for the   purpose of recommending a proposed reference dose for perchlorates.  The EPA has recommended a preliminary   reference dose that would equate to 1 ppb in drinking water.  Certain states are also conducting risk   assessments and some have set preliminary levels as low as 1 ppb.  To our knowledge, virtually all   independent and qualified experts believe that such preliminary levels have   been arbitrarily established and are not based upon credible science.  At the request of the EPA, the National   Academy of Science (NAS) recently began an evaluation and assessment of the   health effects of perchlorates.  This   NAS evaluation is currently scheduled to be completed by January, 2005.  Public statements indicate that the EPA   intends to complete its risk assessment and make a final reference dose   recommendation, presumably after the findings of NAS, although we do not
know   when that will occur.  We are   cooperating with Federal, State and local agencies, and with Kerr-McGee and   other interested firms, in the investigation and evaluation of the source or   sources of these trace amounts, possible environmental impacts, potential   remediation methods, and a proper reference dose.  Until one or more of these matters have reached definitive   conclusions, it will not be possible for us to determine the extent to which,   if at all, we may be called upon to contribute to or assist with future   remediation efforts, or the financial impact, if any, of such cooperation,   contribution or assistance.    Accordingly, no accrual for potential costs has been made in our   Consolidated Financial Statements.    However, the lower the level at which the final reference dose is   established, the more severe the negative impact will likely be on our   financial condition, results of operations and ability to manufacture and   handle perchlorate
chemicals.
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | In January 2002, we received a demand for payment   from Frontier Insurance Company (Frontier) of approximately $1.7 million as   a result of the failure of a local developer to complete a project that had   been bonded by Frontier.  The local   developer was an owner of a company that is the managing member of a limited   liability company (LLC) in which we are also a member.  The LLC recently completed development of   a residential project and has wound down its operations.  In 1995, we entered into indemnity   agreements relating to the development of this project.  In February 2002, we (along with other   plaintiffs) filed a complaint for declaratory relief in District Court, Clark   County, Nevada.  The complaint seeks a   judgment declaring that the indemnity agreements have been terminated and that   we have no liability to Frontier.  The   complaint has been stayed for the time being pending the
reorganization of   Frontier.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | On April 11, 2002, an accident occurred at our   sodium azide plant that resulted in the death of an employee.  No other employees were involved and there   was no significant damage to the facility.    We have received fines from Utah OSHA relating to this accident, but   believe that the ultimate payment by us for these fines will be less than $75,000.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | We have been and are also involved in other   lawsuits.  We believe that these other   lawsuits, individually or in the aggregate, will not have a material adverse   effect on our financial condition or results of operations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | As of December 31, 2003, we had approximately $2.1   million in outstanding standby letters of credit.  These letters of credit principally secure performance of   certain environmental protection equipment sold by us and payment of fees   associated with the delivery of natural gas and power.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

- 11 -



|6. | SEGMENT INFORMATION                                                                                                                                                                                                                                                                                                                                                                                                                       
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   | Our three reportable operating segments are   specialty chemicals, environmental protection equipment and real estate sales   and development.  These segments are   based upon business units that offer distinct products and services, are   operationally managed separately and produce products using different   production methods.                                                                                               
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   | We evaluate the performance of each operating   segment and allocate resources based upon operating income or loss before an   allocation of interest expense and income taxes.  The accounting policies of each reportable operating segment   are the same as ours.                                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   | Our specialty chemicals segment manufactures and   sells perchlorate chemicals used principally in solid rocket propellants for   the space shuttle and defense programs, sodium azide used principally in the   inflation of certain automotive airbag systems and Halotron®   clean
gas fire extinguishing agents designed to replace halons.  The specialty chemicals segment production   facilities are located in Iron County, Utah.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   | Our environmental protection equipment operating   segment designs, manufactures and markets systems for the control of noxious   odors, the disinfection of waste water streams and the treatment of   seawater.  These operations are also   located in Iron County, Utah.                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   | At December 31, 2003, our real estate operating   segment had approximately 14 remaining acres of improved land in the Gibson   Business Park near Las Vegas, Nevada.    Recent activity has consisted of sales of land parcels.                                                                                                                                                                                                          
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   | We also hold an equity method investment in a joint   venture entity that owns a commercial explosives business.  (See Note 7.)                                                                                                                                                                                                                                                                                                           
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   | We had one customer that accounted for 10% or more   of our total sales during at least one of the three-month periods ended   December 31, 2003 and 2002.  Sales to   this customer during the three months ended December 31 were as follows:                                                                                                                                                                                           

|Customer |  |  | Chemical     |  | 2003 |         | 2002 |  
|-------- |  |  | ------------ |  | ---- | ------- | ---- | -
|         |  |  |              |  |      |         |      |  
|A        |  |  | Perchlorates |  | $    | 435,000 |      | $

| | Additional information about our operations in   different segments for the three months ended December 31, is provided below.
| | ------------------------------------------------------------------------------------------------------------------------------

|                                                                                          |  | 2003 |            | 2002 |  
|----------------------------------------------------------------------------------------- |  | ---- | ---------- | ---- | -
|                                                                                          |  |      |            |      |  
|Revenues:                                                                                 |  |      |            |      |  
|Specialty chemicals                                                                       |  | $    | 4,627,000  |      | $
|Environmental   protection                                                                |  |      | 163,000    |      |  
|Real estate                                                                               |  |      | 4,000      |      |  
|                                                                                          |  |      |            |      |  
|Total revenues                                                                            |  | $    | 4,794,000  |      | $
|                                                                                          |  |      |            |      |  
|Operating income (loss):                                                                  |  |      |            |      |  
|Specialty chemicals                                                                       |  | $    | (2,915,000 | )    | $
|Environmental   protection                                                                |  |      | (168,000   | )    |  
|Real estate                                                                               |  |      | (211,000   | )    |  
|                                                                                          |  |      |            |      |  
|Total segment operating   income (loss)                                                   |  |      | (3,294,000 | )    |  
|Unallocated net expenses (principally net interest   and equity in loss of joint venture) |  |      | 96,000     |      |  
|                                                                                          |  |      |            |      |  
|Income (Loss) before income taxes                                                         |  | $    | (3,390,000 | )    | $
|                                                                                          |  |      |            |      |  

- 12 -



|7. | INVESTMENT   IN AND ADVANCES TO JOINT VENTURE                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   | On December 11, 2002, we made an investment of   approximately $10.7 million in Energetic Systems Inc., LLC (ES), a joint   venture entity formed to acquire and manage a commercial explosives business.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   | The form of our investment in ES represents a   combination of term and revolving debt, preferred stock and common   equity.  The term and revolving debt,   including accrued interest receivable, amounted to $10.2 million at September   30, 2003.  Both the term and revolving   debt bear interest at 8% per annum.    The term debt, in the amount of $7.0 million, was initially payable in   equal annual installments over the next ten years (see below).  During the three months ended December 31,   2003, net interest and other expense (income) includes approximately $0.2   million in interest income relating to the term and revolving debt.                                                                                                                                                                                                                                                                                             
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   | The investment was made and is held by our,   wholly-owned subsidiary, Energetic Additives Inc., LLC (EA).  EA holds a 50% equity interest in ES.  The remaining 50% equity interest is held   by a private entity with extensive experience in the explosives industry.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   | On December 11, 2002, ES completed the purchase of   certain assets and the assumption of certain liabilities of Slurry Explosives   Corporation and Universal Tech Corporation (collectively SEC/UTC),   subsidiaries within LSB Industries, Inc.    SEC/UTC is involved in the manufacture and distribution of commercial   explosives, and is also a research, development and testing organization   specializing in the development and testing of products and processes for   commercial explosives and energetic compounds.  We have accounted for our investment in ES using the equity   method of accounting.                                                                                                                                                                                                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   | At December 31 2003, ES had current assets,   noncurrent assets, current liabilities, noncurrent liabilities, total assets   and equity of approximately $3.8 million, $8.1 million, $4.8 million, $8.3   million, $11.9 million, and ($1.2) million respectively.  Since the purchase on December 11, 2002,   ES had revenues of approximately $13.9 million, gross profit of approximately   $3.2 million and incurred a net loss of approximately $2.4 million.  Our share of the net loss during the first   quarter of fiscal 2004 of $0.4 million is included in net interest and other   expense (income) in the accompanying Condensed Consolidated Statements of   Income.                                                                                                                                                                                                                                                                            
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   | The financial performance of ES has not met our   expectations.  As a result of the   lower than expected operating results, ES was not able to make the   installment payment on the term debt due to us in January 2004.  As a result, we modified the terms of the   term and revolving debt.  Payment of   principal on the revolving debt was extended to December 31, 2004 (with   certain further extension provisions), although interest will continue to be   paid on a current monthly basis.    Interest on the term debt for the years ended December 31, 2003 and   December 31, 2004 was (and will be) added to the principal amount of the   debt, and the revised amount of the term debt will be due in ten equal annual   installment payments, including principal and interest, beginning December   2005.  Based upon current projections,   we do not believe any impairment loss has been incurred as a result of such   modifications.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|8. | DIVIDEND   AND STOCK  REPURCHASE PROGRAM                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   | In January 2003, our Board of Directors approved a   Dividend and Stock Repurchase Program (the Program).  The Program is designed to allocate a   portion of our annual free cash flows (as calculated) for the purposes of   paying cash dividends and repurchasing our Common Stock.  The amount available for these purposes   each fiscal year will equal 25% of our annual cash flows from operating   activities less our annual capital expenditures, plus the amount of cash   received from the issuance of our Common Stock resulting from the exercise of   stock options.  We will subtract the   total amount spent on the repurchase of our Common Stock (if any) during the   fiscal year from the total amount otherwise available under the Program, and   pay the resultant amount as an annual dividend to our shareholders.  As part of the stock                                                                                       

- 13 -



| | repurchase portion of the Program, our Board of   Directors has approved a provision that permits the repurchase of Common   Stock from our employees and directors.                                                                                                                                                      
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                                                                                                                           
| | In accordance with the provisions of the Program, on   December 18, 2003, our Board of Directors declared a cash dividend of $0.42   per share payable on January 9, 2004, to shareholders of record on December 29,   2003.  The total amount of the cash   dividend paid in January 2004 was approximately $3.1 million.

- 14 -



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

We are principally engaged in the production of our top grade of AP (Grade I AP) for the aerospace and national defense industries.  In addition, we produce and sell sodium azide, the primary component of a gas generant used in automotive airbag safety systems, and Halotron®, a
chemical used in fire extinguishing systems ranging from portable fire extinguishers to airport firefighting vehicles.  The perchlorate, sodium azide and Halotron® facilities
are located on our property in Southern Utah and the chemicals produced and sold at these facilities collectively represent our specialty chemicals operating segment.  Our other lines of business include the development of real estate which is winding down, and the production of environmental protection equipment, including waste water and seawater treatment systems.  As discussed in Note 7 to our Condensed Consolidated Financial Statements, we also hold a 50% equity interest in an entity that manufactures and distributes commercial explosives.

Critical Accounting Estimates.  A summary of our significant accounting policies is included in Note 1 to our Condensed Consolidated Financial Statements.  We believe that the application of these policies on a consistent basis enables us to provide the users of our financial statements with useful and reliable information about our operating results and financial condition.

The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities and the reported amounts of revenue and expenses.  Judgments and assessments of uncertainties are required in applying our accounting policies in many areas.  For example, key assumptions are particularly important when determining our projected liabilities for pension benefits.  Information with respect to pension expenses and liabilities, together with the impact of changes in key assumptions is discussed in Note 8 to our Consolidated Financial Statements included in our September 30, 2003 Annual Report on Form 10-K.

Other areas in which significant uncertainties exist include, but are not limited to, projected costs to be incurred in connection with environmental matters, tax matters, and the resolution of litigation, and the recoverability of investments in and advances to our joint venture.  A discussion of environmental and legal matters is included in Note 5 to our Condensed Consolidated Financial Statements.  Information on some of the key estimates and assumptions on which our annual provision for income taxes is based may be found in Note 7 to our Consolidated Financial Statements included in our September 30, 2003 Annual Report on Form 10-K.  A discussion regarding the recoverability of investments in and advances to our joint venture is included in Note 7 to our Condensed Consolidated Financial Statements.

Actual results will inevitably differ to some extent from the estimates on which our Condensed Consolidated Financial Statements are prepared at any given point in time.  Despite these inherent limitations, we believe that our Managements Discussion and Analysis and Condensed Consolidated Financial Statements provide a meaningful and fair perspective on our company.

Sales and Operating Revenues.  Sales of our perchlorate chemical products accounted for approximately 64% and 82% of revenues during the three-month periods ended December 31, 2003 and 2002, respectively.  In general, demand for Grade I AP is driven by a relatively small number of Department of Defense (DOD) and National Aeronautics and Space Administration (NASA) contractors.  As a result, any one individual AP customer usually accounts for a significant portion of our revenues.

In connection with the Acquisition, we entered into an agreement with the Thiokol Propulsion Division of Alcoa (Thiokol) with respect to the supply of AP through the year 2008.  The agreement, as amended, provides that during its term Thiokol will make all of its AP purchases from us.  In addition to the Grade I AP

- 15 -



purchased from us, Thiokol may use AP inventoried by it in prior years.  The agreement also establishes a pricing matrix under which Grade I AP unit prices vary inversely with the quantity of Grade I AP sold by us to all of our customers.  Grade I AP unit prices in the matrix at all quantity levels escalate each year through fiscal 2003 and, in fiscal 2004, are adjusted downward by approximately 20%.  Such downward adjustment will have the effect of reducing revenues and operating cash flows on Grade I AP sold to Thiokol by 20% in fiscal 2004.  After the adjustment, AP unit prices continue to escalate each year through fiscal 2008.

In connection with the Acquisition, we entered into an agreement with Alliant Techsystems, Inc. (Alliant) to extend an existing agreement through the year 2008.  The agreement establishes prices for any Grade I AP purchased by Alliant from us during the term of the agreement as extended.  Under this agreement, Alliant agrees to use its efforts to cause our Grade I AP to be qualified on all new and current programs served by Alliants Bacchus Works.

During 2001, Alliant acquired Thiokol.  We have agreed with Alliant that the individual agreements in place prior to Alliants acquisition of Thiokol remain in place.  All Thiokol programs existing at the time of the Alliant acquisition (principally the Space Shuttle and Minuteman) will continue to be priced under the Thiokol Agreement.  All Alliant programs (principally the Delta, Pegasus and Titan) will be priced under the Alliant Agreement.

Our annual sales volumes of Grade I AP were approximately 15.5 million, 16.4 million and 12.6 million pounds during the fiscal years ended September 30, 2003, 2002 and 2001 respectively.  Based upon information we have received from our customers, we are currently estimating that our annual sales volumes of Grade I AP will range between 10.0 and 11.0 million pounds in fiscal 2004.  Our revenues, operating income and cash flows from operating activities will be significantly less at these lower volume levels.  In addition, demand for Grade I AP is program specific and we have no ability to influence demand levels.

In January 2004, President Bush announced a new initiative for the Nations space exploration program.  The President committed the United States to a long-term human and robotic program to explore the solar system, starting with a return to the Moon.  The Presidents plan is summarized as follows:

| | The United States will complete its work on the   International Space Station (ISS) by 2010.    To accomplish this goal, NASA will return the Space Shuttle to flight   and the Shuttles chief purpose over the next several years will be to help   finish assembly of the ISS.  The Space   Shuttle will be retired at the end of this decade.
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                                                                                                                    
| | The United States will begin developing a new manned   exploration vehicle (MEV).  The MEV   will be developed and tested by 2008 and conduct its first manned mission no   later than 2014.                                                                                                                                                     
|  |                                                                                                                                                                                                                                                                                                                                                    
| | The United States will return to the Moon as early   as 2015 and no later than 2020 and use it as a stepping stone for more   ambitious missions.                                                                                                                                                                                                  

The Presidents plan for NASA will likely have a significant impact on the demand for Grade I AP.  The ultimate impact on the demand for Grade I AP is uncertain at this time, and will depend upon, among other things, the following factors:

| | The timing of the Space Shuttles return to flight.                                                                                      
|- | -----------------------------------------------------------------------------------------------------------------------------------------
| | The number of Shuttle flights between now and the   retirement of the Shuttle fleet.                                                     
| | The timing of the retirement of the Space Shuttle   fleet.                                                                               
| | The amount of inventory of Grade I AP owned by our   customers.                                                                          
| | The amount of NASAs annual budget over the next   several years.                                                                        
| | The type of propulsion technology used to launch the   MEV.                                                                              
| | The timing of the development and testing of the MEV   and the number of MEV launches.                                                   
| | The type of heavy lift vehicle used to transport   material and supplies to the ISS and the Moon after retirement of the Shuttle   fleet.

- 16 -



We also produce and sell other perchlorates.  Other perchlorates have a wide range of prices per pound, depending upon the type and grade of the product.  We have recently experienced a change in the sales mix of other perchlorates, from lower price per pound products to higher price and margin per pound products.  For example, shipments of other perchlorates accounted for annual sales of between $2.6 million and $3.2 million during the fiscal years 2001, 2000 and 1999.  In fiscal 2003 and 2002, shipments of other perchlorates accounted for sales of $7.7 and $6.9  million, respectively, although there was no substantial change in volumes.  Other perchlorates are used in a variety of applications, including munitions, explosives, propellants, and initiators.  Some of these applications are in a development phase, and there can be no assurance that sales of the higher price and higher margin products will continue.  Sales of
other perchlorates accounted for revenues of $0.7 million and $2.8 million during the three-month periods ended December 31, 2003 and 2002, respectively.  A significant reduction in these sales would have a material adverse effect on our results of operations and financial condition.

Sodium azide sales accounted for approximately 22% and 5% of revenues during the three-month periods ended December 31, 2003 and 2002, respectively.  Worldwide sodium azide demand has declined significantly during the last two fiscal years.  Our sodium azide sales volumes declined approximately 54% during fiscal 2003 and 10% in fiscal 2002.  Worldwide demand for sodium azide is substantially less than worldwide supply.  Based principally upon market information received from airbag inflator manufacturers, we expect sodium azide use to continue to decline and that inflators using sodium azide will be phased out over some period of time.

Sales of Halotron® amounted to approximately 10% and 4% of revenues during the three-month periods ended December 31, 2003 and 2002, respectively.  Halotron® is
designed to replace halon-based fire extinguishing systems.  Accordingly, demand for Halotron® depends upon a number of factors including the willingness of consumers to switch from halon-based systems, as well as existing and potential governmental regulations.

There were no real estate sales during the three-month periods ended December 31, 2003 and 2002.  We have approximately 14 acres remaining in our Nevada portfolio and real estate sales will cease after the sale of this property.

Environmental protection equipment sales accounted for approximately 4% and 9% of revenues during the three-month periods ended December 31, 2003 and 2002, respectively.

Cost of Sales.  The principal elements comprising our cost of sales are raw materials, electric power, labor, manufacturing overhead, depreciation and amortization and the book basis in real estate sold.  The major raw materials used in our production processes are graphite, sodium chlorate, ammonia, hydrochloric acid, sodium metal, nitrous oxide and HCFC 123.  Significant increases in the cost of raw materials may have an adverse impact on margins if we are unable to pass along such increases to our customers.

Prices paid by us for raw materials have historically been relatively stable, although we have experienced cost increases on certain raw materials.  All raw materials used in our manufacturing processes have been available in commercial quantities, although we have recently had difficulty obtaining a long-term commitment for the supply of graphite.  Graphite is critical to the production of our perchlorate chemicals and we are working to resolve this issue.

Net Income (Loss).  Although our net income (loss) and diluted net income (loss) per common share have not been subject to seasonal fluctuations, they have been and are expected to continue to be subject to variations from quarter to quarter and year to year due to the following factors, among others:  (i) the impact of President Bushs new space exploration plan on the demand for Grade I AP, and related budgeting constraints, (ii) as discussed in Note 5 to our Condensed Consolidated Financial Statements, we may incur material legal and other costs associated with certain litigation and contingencies; (iii) the magnitude, pricing and timing of perchlorate chemicals, sodium azide, Halotron®, and
environmental protection equipment sales in the future is uncertain; (iv) weighted average common and common equivalent shares for purposes of calculating diluted

- 17 -



net income per common share are subject to fluctuations based upon changes in the market price of our Common Stock due to outstanding options; (v) the results of periodic reviews of impairment issues; (vi) the ability to pass on increases in raw material costs to our customers; and (vii) the financial performance of ES.  (See Liquidity and Capital Resources and Forward Looking Statements/Risk Factors below.)

RESULTS OF OPERATIONS

Three Months Ended December 31, 2003 Compared to Three Months Ended December 31, 2002

Sales and Operating Revenues.  Sales decreased $10.3 million, or 68%, during the three months ended December 31, 2003, to $4.8 million from $15.1 million in the corresponding period of the prior year.  This decrease was principally attributable to a decrease in specialty chemical sales of approximately $9.3 million and a decrease in environmental protection equipment sales of approximately $1.2 million.

The decrease in specialty chemical sales was primarily due to a decrease in perchlorate chemical sales of approximately 75% in the first quarter of fiscal 2004, compared to the first quarter of fiscal 2003.  Although the quarterly timing of shipments is not certain, as noted above, we estimate that annual Grade I AP shipments will amount to between 10.0 and 11.0 million pounds in fiscal 2004.

Cost of Sales.  Cost of sales decreased $4.4 million, or 51%, in the three months ended December 31, 2003, to $4.3 million from $8.7 million in the corresponding period of the prior year.  As a percentage of sales, cost of sales was 90% in the first quarter of fiscal 2004, compared to 58% in the first quarter of fiscal 2003.  The decreases in cost of sales and gross margins were principally due to a significant decrease in perchlorate chemicals sales volumes.

Operating Expenses.  Operating (selling, general and administrative) expenses increased $0.1 million, or 3%, in the three months ended December 31, 2003, to $3.8 million from $3.7 million in the corresponding period of 2002.  Operating expenses in each of the three-month periods ended December 31, 2003 and 2002, include approximately $0.5 million in costs associated with the investigation and evaluation of the trace amounts of perchlorate chemicals found in Lake Mead.  (See Note 5 to our Condensed Consolidated Financial Statements.)

Net Interest and Other Expense (Income).  Net interest and other expense decreased to $0.1 million in the three months ended December 31, 2003, from $0.9 million in the corresponding period of the prior year.  The decrease was principally due to the redemption of the Notes.  This decrease was partially offset by our equity in the loss of ES.  (See Note 7 to our Condensed Consolidated Financial Statements.)

Segment Operating Income (Loss).  Operating income (loss) of our industry segments during the three-month periods ended December 31, 2003 and 2002 was as follows:

|                                   |  | 2003 |            | 2002 |  
|---------------------------------- |  | ---- | ---------- | ---- | -
|                                   |  |      |            |      |  
|Specialty chemicals                |  | $    | (2,915,000 | )    | $
|Environmental protection equipment |  |      | (168,000   | )    |  
|Real Estate                        |  |      | (211,000   | )    |  
|                                   |  |      |            |      |  
|Total                              |  | $    | (3,294,000 | )    | $
|                                   |  |      |            |      |  

The decrease in operating income in our specialty chemicals industry segment was principally due to decreased perchlorate chemical sales.  The decrease in operating income in our environmental protection equipment segment was attributable to decreased sales as a result of the timing of shipments.

- 18 -



INFLATION

General inflation did not have a significant effect on our sales and operating revenues or costs during the three months ended December 31, 2003 and 2002.  General inflation may have an effect on gross profit in the future as certain of our agreements relating to Grade I AP and sodium azide customers require fixed prices, although certain of such agreements contain escalation features that should somewhat insulate us from increases in costs associated with inflation.

LIQUIDITY AND CAPITAL RESOURCES

Cash flows provided by (used for) operating activities were $(5.3) million and $1.4 million during the three months ended December 31, 2003 and 2002, respectively.  The significant reduction in cash flows from operating activities, as referred to above, was primarily due to decreased perchlorate chemical and environmental protection equipment sales.  We believe that our cash flows from operations and existing cash balances will be adequate for the foreseeable future to satisfy the needs of our operations, including the repurchase of our Common Stock and/or dividends under the Program.  However, the resolution of litigation and contingencies, and the timing, pricing and magnitude of orders for perchlorates, sodium azide and Halotron, may have an effect on the use and availability of cash.

The combination of the lower levels of expected Grade I AP sales, the 20% price reduction on Grade I AP sold to Thiokol beginning in fiscal 2004, and declining real estate sales is expected to significantly reduce our revenues and cash flows from operating activities in fiscal 2004.  As a result of these factors and absent the consideration of any changes in working capital, we currently expect that our cash flows from operating activities will be at least 50% less in fiscal 2004 as compared to fiscal 2003.

Capital expenditures were $0.3 million and $0.4 million during the three months ended December 31, 2003 and 2002, respectively.  Capital expenditures relate principally to specialty chemicals segment capital improvement projects.  Capital expenditures are expected to be funded from existing cash balances and operating cash flows.

As discussed in Note 7 to our Condensed Consolidated Financial Statements, in December 2002 we made an investment of approximately $10.7 million in ES.  The form of our investment in ES represents a combination of term and revolving debt, preferred stock and common equity.  We have modified the repayment terms of the term and revolving debt, but do not presently expect to incur any impairment loss related to such modifications.

In the first quarter of fiscal 2004, we issued $2.1 million of our Common Stock as a result of the exercise of stock options.  During the three-month period ended December 31, 2003, we repurchased $2.8 million of our Common Stock.  As discussed in Note 8 to our Condensed Consolidated Financial Statements, our Program became effective in fiscal 2003.  Under the provisions of this Program, on December 18, 2003, our Board of Directors declared a cash dividend of $0.42 per share, which was paid on January 9, 2004, to shareholders of record on December 29, 2003.

As a result of the litigation and contingencies discussed in Note 5 to our Condensed Consolidated Financial Statements, we have incurred legal and other costs, and we may incur material legal and other costs associated with the resolution of litigation and contingencies in future periods.  Any such costs, to the extent not recovered by insurance, would adversely affect our liquidity.  We are currently unable to predict or quantify the amount or range of such costs or the period of time over which such costs may be incurred.

FORWARD-LOOKING STATEMENTS/RISK FACTORS

Certain matters discussed in this Report may be forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those projected.  Such risks and uncertainties include, but are not limited to, the risk factors set forth below.

- 19 -



The following risk factors, among others, may cause our operating results and/or financial position to be adversely affected from time to time:

|1. | (a)    Declining demand (including excess customer inventories) or downward   pricing pressure for our products as a result of general or specific economic   conditions, (b) governmental budget decreases affecting the DOD or NASA,   including the status of the Space Shuttle Program and the Presidents new   initiative for the Nations space exploration program, that would cause a   decrease in demand for Grade I AP, (c) technological advances and   improvements with respect to existing or new competitive products causing a   reduction or elimination of demand for perchlorates, sodium azide or Halotron®, (d)
the ability and desire of purchasers to change existing products or   substitute other products for our products based upon perceived quality,   environmental effects and pricing, and (e) the fact that perchlorate   chemicals, sodium azide, Halotron® and
our environmental products have limited applications and highly   concentrated customer bases.
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|2. | The cost and effects of legal and administrative   proceedings, settlements and investigations, particularly those matters   described in Note 5 to our Condensed Consolidated Financial Statements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|3. | Our ability to profitably integrate, manage and   operate new businesses and/or investments competitively and cost effectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|4. | Competitive factors including, but not limited to,   our limitations respecting financial resources and our ability to compete   against companies with substantially greater resources, significant excess   market supply in the sodium azide market and in the perchlorate market,   potential patent coverage issues, and the development or penetration of   competing new products, particularly in the propulsion, airbag inflation,   fire extinguishing businesses, and explosives.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|5. | Underutilization of our manufacturing facilities   resulting in production inefficiencies and increased costs, the inability to   recover facility costs, reductions in margins, and impairment issues.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|6. | The near depletion of our Clark County, Nevada   commercial real estate, with only 14 acres remaining for sale.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|7. | The effects of, and changes in, trade, monetary and   fiscal policies, laws and regulations and other activities of governments,   agencies or similar organizations, including, but not limited to,   environmental, safety and transportation issues.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|8. | The dependence upon a single facility for the   production of most of our products.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|9. | Provisions of our Certificate of Incorporation and   By-laws and Series D Preferred Stock, and the dividend of preference stock   purchase rights and related Rights Agreement, could have the effect of making   it more difficult for potential acquirors to obtain a control position in us.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     

- 20 -