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Northern Technologies International 10-Q 2011 UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________________
FORM 10-Q
(Mark one)
For the quarterly period ended February 28, 2011
Commission File Number: 001-11038
____________________
NORTHERN TECHNOLOGIES INTERNATIONAL CORPORATION
(Exact name of registrant as specified in its charter)
(763) 225-6600
(Registrant’s telephone number including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [x] NO [ ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES [ ] NO [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES [ ] NO [x]
As of April 13, 2011, there were 4,343,601 shares of common stock of the registrant outstanding.
NORTHERN TECHNOLOGIES INTERNATIONAL CORPORATION
FORM 10-Q
February 28, 2011
TABLE OF CONTENTS
This quarterly report on Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the safe harbor created by those sections. For more information, see “Part I. Financial Information – Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations– Forward-Looking Statements.”
As used in this report, references to “NTIC,” the “Company,” “we,” “our” or “us,” unless the context otherwise requires, refer to Northern Technologies International Corporation, its wholly owned subsidiaries – NTI Facilities, Inc., and Northern Technologies Holding Company, LLC, and its majority owned joint venture in Brazil, Zerust Prevenção de Corrosão S.A., all of which are consolidated on NTIC’s financial statements.
All trademarks, trade names or service marks referred to in this report are the property of their respective owners.
PART I - FINANCIAL INFORMATION
NORTHERN TECHNOLOGIES INTERNATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS AS OF FEBRUARY 28, 2011 (UNAUDITED)
AND AUGUST 31, 2010 (AUDITED)
NORTHERN TECHNOLOGIES INTERNATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
FOR THE THREE AND SIX MONTHS ENDED FEBRUARY 28, 2011 AND 2010
See notes to consolidated financial statements
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NORTHERN TECHNOLOGIES INTERNATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
SIX MONTHS ENDED FEBRUARY 28, 2011 AND 2010
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NORTHERN TECHNOLOGIES INTERNATIONAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. INTERIM FINANCIAL INFORMATION
In the opinion of management, the accompanying unaudited consolidated financial statements contain all necessary adjustments, which are of a normal recurring nature, and present fairly the consolidated financial position of Northern Technologies International Corporation and its subsidiaries (the “Company”) as of February 28, 2011 and the results of their operations for the three and six months ended February 28, 2011 and February 28, 2010 and their cash flows for the six months ended February 28, 2011 and February 28, 2010, in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”).
Certain amounts reported in the consolidated financial statements for the previous reporting periods have been reclassified to conform to the current period presentation. These reclassifications did not have a material impact on the Company’s previously reported consolidated balance sheets or statements of cash flows. The Company has reclassified various line items in the consolidated statements of operations to better provide the results of its joint ventures, as well as its North American operations. These reclassifications changed the Company’s operating income, but did not impact its net income or net income per common share.
These consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes contained in the Company’s annual report on Form 10-K for the fiscal year ended August 31, 2010. These consolidated financial statements also should be read in conjunction with the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section appearing in this report.
Operating results for the three and six months ended February 28, 2011 are not necessarily indicative of the results that may be expected for the full fiscal year ending August 31, 2011.
The Company evaluates events occurring after the date of the consolidated financial statements requiring recording or disclosure in the financial statements.
2. CONSOLIDATION OF ZERUST BRAZIL
Beginning in the fourth quarter of fiscal 2010, the Company consolidated the results of Zerust Prevenção de Corrosão S.A., the Company’s subsidiary in Brazil (“Zerust Brazil”). The Company holds 85% of the equity and 85% of the voting rights of Zerust Brazil. Prior to the fourth quarter of fiscal 2010 and as of February 28, 2010, the Company accounted for its Zerust Brazil investment under the equity method. The Company owned only 50%, which it considered to be less than a majority, of the equity and voting rights of Zerust Brazil prior to September 2006. The Company acquired an additional 35% ownership interest in Zerust Brazil in September 2006 and held 85% of the equity and voting rights thereafter. Prior to the fourth quarter of fiscal 2010, the Company held the additional 35% ownership interest in Zerust Brazil with the intent of finding an acquiring party, believing its majority control of Zerust Brazil would be temporary and determined not to consolidate Zerust Brazil because the impact on the Company’s consolidated financial statements was immaterial. During the fourth quarter of fiscal 2010, the Company stopped pursuing a buyer of the 35% ownership interest and decided to consolidate the financial results of Zerust Brazil as of and for the fiscal year ended August 31, 2010. The Company believes that the impact of not consolidating Zerust Brazil on the Company’s consolidated financial statements for periods prior to the fourth quarter of fiscal 2010 was immaterial to the Company’s consolidated financial statements.
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The following is a summary of certain line items of the Company’s consolidated statements of operations for the three months ended February 28, 2010 as reported and on a pro forma basis, assuming the consolidation of Zerust Brazil on the Company’s consolidated financial statements as of the beginning of such period:
The following is a summary of certain line items of the Company’s consolidated statements of operations for the six months ended February 28, 2010 as reported and on a pro forma basis, assuming the consolidation of Zerust Brazil on the Company’s consolidated financial statements as of the beginning of such period:
3. INVENTORIES
Inventories consisted of the following:
4. PROPERTY AND EQUIPMENT, NET
Property and equipment, net consisted of the following:
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5. PATENTS AND TRADEMARKS, NET
Patents and trademarks, net consisted of the following:
Patent and trademark costs are amortized over seven years. Costs incurred related to patents and trademarks are capitalized until filed and approved, at which time the amounts capitalized to date are amortized and any further costs, including maintenance costs, are expensed as incurred. Amortization expense is estimated to approximate $160,000 in each of the next five fiscal years.
6. INVESTMENTS IN JOINT VENTURES
The financial statements of the Company’s foreign joint ventures are initially prepared using the accounting principles accepted in the respective joint ventures’ countries of domicile. Amounts related to foreign joint ventures reported in the below tables and the accompanying financial statements have subsequently been adjusted to approximate U.S. GAAP in all material respects. All material profits recorded on sales from the Company to its joint ventures have been eliminated for financial reporting purposes.
Financial information from the audited and unaudited financial statements of the Company’s joint venture in Germany, Excor Korrosionsschutz – Technologien und Produkte GmbH (“Germany”), the Company’s joint venture holding company in the Association of Southeast Asian Nations, or ASEAN, region, NTI ASEAN, LLC (“ASEAN”), and all of the Company’s other joint ventures, are summarized as follows:
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The Company records expenses that are directly attributable to the joint ventures on the consolidated statements of operations on the line “Expenses incurred in support of joint ventures”. The expenses include items such as employee compensation and benefit expenses, travel expense and consulting expense.
In December 2010, the Company invested $38,217 and in January 2010, the Company invested $30,101, in a new joint venture in Russia to specifically engage in the oil and gas industry. The Company has a 50% ownership interest in the new Russian joint venture.
7. NOTE PAYABLE AND LINE OF CREDIT
In connection with the purchase of its corporate headquarters, in September 2006, Northern Technologies Holding Company, LLC (“NTI LLC”) obtained a term loan from PNC Bank, National Association (“PNC Bank”) with a principal amount of $1,275,000 that was to mature on May 1, 2011. On January 10, 2011, NTI LLC refinanced its term loan in the then principal amount of approximately $1,141,788. The term loan matures on January 10, 2016, bears interest at an annual rate based on the daily LIBOR rate plus 2.15% and is payable in 59 consecutive monthly installments equal to approximately $6,343 (inclusive of principal but exclusive of interest) commencing in February 2011. The term loan is secured by a first lien on the real estate and building owned by NTI LLC and all of the assets of the Company and is guaranteed by the Company.
As of February 28, 2011, the Company had a revolving line of credit with PNC Bank of $3,000,000 with no amounts outstanding as of such date. As of August 31, 2010, the Company had a demand line of credit of $2,300,000 with PNC Bank with no amounts outstanding as of such date. Any advances made under the revolving line of credit are due and payable on January 10, 2012. At the option of the Company, outstanding advances under the line of credit bear interest at either (a) an annual rate based on LIBOR plus 2.15% for the applicable LIBOR interest period selected by the Company or (b) at the rate publicly announced by PNC Bank from time to time as its
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prime rate. Interest is payable in arrears (a) for the portion of advances bearing interest under the prime rate on the last day of each month during the term thereof and (b) for the portion of advances bearing interest under the LIBOR option on the last day of the respective LIBOR interest period selected for such advance. Any unpaid interest is payable on the maturity date. Outstanding amounts under the prior demand line of credit bore interest at an annual rate based on LIBOR plus 2.25%. As of February 28, 2011, the interest rate was 2.35% and the weighted average rate was 2.39% for the six months ended February 28, 2011. As of February 28, 2010, the interest rate was 3.08% and the weighted average rate was 3.36% for the six months ended February 28, 2010.
Both the term loan and the line of credit are governed under two separate loan agreements (collectively, the “Loan Agreements”). The Loan Agreements contain standard covenants, including affirmative financial covenants, such as the maintenance of a minimum fixed charge coverage ratio, and negative covenants, which, among other things, limit the incurrence of additional indebtedness, loans and equity investments, disposition of assets, mergers and consolidations and other matters customarily restricted in such agreements. Under the Loan Agreements, the Company is subject to a minimum fixed charge coverage ratio of 1.10:1.00.
8. STOCKHOLDERS’ EQUITY
During the six months ended February 28, 2011, the Company did not purchase or retire any shares of its common stock. The following stock options to purchase shares of common stock were exercised during the six months ended February 28, 2011:
The Company granted stock options under the Northern Technologies International Corporation Amended and Restated 2007 Stock Incentive Plan to purchase an aggregate of 30,000 shares of its common stock to various employees and directors during the six months ended February 28, 2011.
During the six months ended February 28, 2011, the Company granted stock bonuses under the Northern Technologies International Corporation Amended and Restated 2007 Stock Incentive Plan for an aggregate of 22,686 shares of its common stock to various employees. The fair value of the shares of the Company’s common stock as of the date of grant of the stock bonuses was $319,649, based on the closing sale price of a share of the Company’s common stock on the date of grant. The fair value of common stock granted during the six months ended February 28, 2011 was based on fiscal 2010 performance and was included in accrued liabilities at August 31, 2010.
During the six months ended February 28, 2010, the Company did not purchase or retire any shares of its common stock. The following stock options to purchase shares of common stock were exercised during the six months ended February 28, 2010:
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The Company granted stock options under the Northern Technologies International Corporation 2007 Stock Incentive Plan to purchase an aggregate of 122,000 shares of its common stock to various employees and directors during the six months ended February 28, 2010.
In September 2009, the Company completed a $3,552,000 registered direct offering in which it sold an aggregate of 480,000 shares of its common stock to institutional investors at a purchase price of $7.40 per share, resulting in net proceeds of $3,195,613, after deducting placement agent fees and expenses and the Company’s offering expenses.
9. TOTAL COMPREHENSIVE INCOME
The Company’s total comprehensive (loss) income was as follows:
10. NET INCOME PER COMMON SHARE
Basic net income per common share is computed by dividing net income by the weighted average number of common shares outstanding. Diluted net income per share assumes the exercise of stock options using the treasury stock method, if dilutive.
No options to purchase shares of common stock were excluded from the computation of common share equivalents for both the three and six months ended February 28, 2011. Options to purchase 64,140 shares of common stock were excluded from the computation of common share equivalents for both the three and six months ended February 28, 2010, as stock option exercise prices were greater than the market price of a share of common stock.
11. STOCK-BASED COMPENSATION
The Company has several stock-based compensation plans under which stock options and other stock-based awards have been granted, including the Northern Technologies International Corporation Amended and Restated 2007 Stock Incentive Plan (the “2007 Plan”), the Northern Technologies International Corporation 2000 Stock Incentive Plan (the “2000 Plan”) and the Northern Technologies International Corporation Employee Stock Purchase Plan (the “ESPP”). The Compensation Committee of the Board of Directors and the Board of Directors administers all of these plans.
The 2007 Plan replaced the 2000 Plan, which was terminated with respect to future grants, but continues to govern grants outstanding under such plan. The 2007 Plan provides for the grant of incentive stock options, non-statutory stock options, stock appreciation rights, restricted stock, stock unit awards, performance awards and stock bonuses to eligible recipients to enable the Company and its subsidiaries to attract and retain qualified individuals through opportunities for equity participation in the Company, and to reward those individuals who contribute to the achievement of the Company’s economic objectives. Subject to adjustment as provided in the 2007 Plan, up to a maximum of 800,000 shares of the Company’s common stock plus the number of shares subject to awards outstanding under the prior 2000 Plan as of January 20, 2011 but only to the extent that such outstanding awards are forfeited, expire or otherwise terminate without the issuance of such shares, are available for issuance under the 2007 Plan. Options granted under the 2007 Plan generally have a term of five years and become exercisable over a three- or four-year period beginning on the one-year anniversary of the date of grant. Options are granted at per share exercise prices equal to the market value of the Company’s common stock on the date of grant. To date, only stock options and stock bonuses have been granted under the 2007 Plan.
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The maximum number of shares of common stock of the Company available for issuance under the ESPP is 100,000 shares, subject to adjustment as provided in the ESPP. The ESPP provides for six-month offering periods beginning on September 1 and March 1 of each year. The purchase price of the shares is 90% of the lower of the fair market value of common stock at the beginning or end of the offering period. This discount may not exceed the maximum discount rate permitted for plans of this type under Section 423 of the Internal Revenue Code of 1986, as amended. The ESPP is compensatory for financial reporting purposes.
The Company granted options to purchase 30,000 and 128,333 shares of its common stock during the six months ended February 28, 2011 and 2010, respectively. The fair value of option grants is determined at date of grant, using the Black-Scholes option pricing model with the assumptions listed below. Based on these valuations, the Company recognized compensation expense of $109,880 and $94,210 during the six months ended February 28, 2011 and 2010, respectively, related to the options that vested during such time period. The stock-based expense recorded reduced after-tax net income per share by $0.02 for each of the six months ended February 28, 2011 and 2010. As of February 28, 2011, the total compensation cost for non-vested options not yet recognized in the Company’s consolidated statements of operations was $237,875 net of estimated forfeitures. Additional stock-based compensation expense of $80,457 is expected through the remainder of fiscal year 2011, and expense of $129,342 and $28,076 is expected to be recognized during fiscal 2012 and fiscal 2013, respectively. Future option grants will impact the compensation expense recognized.
The Company currently estimates a ten percent forfeiture rate for stock options and continually reviews this estimate for future periods.
The fair value of each option grant is estimated on the grant date using the Black-Scholes option-pricing model with the following assumptions and results for the grants:
The weighted average per share fair value of options granted during the six months ended February 28, 2011 and 2010 was $3.60 and $2.99, respectively. The weighted average remaining contractual life of the options outstanding as of February 28, 2011 and 2010 was 3.20 years and 3.01 years, respectively.
12. GEOGRAPHIC AND SEGMENT INFORMATION
Net sales by geographic location as a percentage of total consolidated net sales for the three and six months ended February 28, 2011 and February 28, 2010 were as follows:
Net sales by geographic location are based on the location of the customer.
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Fees for services provided to joint ventures by geographic location as a percentage of total fees for services provided to joint ventures during the three and six months ended February 28, 2011 and 2010 were as follows:
The following table sets forth the Company’s net sales for the three and six months ended February 28, 2011 and 2010 by segment:
The following table sets forth the Company’s cost of sales for the three and six months ended February 28, 2011 and 2010 by segment:
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* The percent of segment sales is calculated by dividing the direct cost of sales for each individual segment category by the net sales for each segment category.
The Company’s management utilizes product net sales and direct and indirect cost of goods sold for each product in reviewing the financial performance of a product type. Further allocation of Company expenses or assets, aside from amounts presented in the tables above, is not utilized in evaluating product performance, nor does such allocation occur for internal financial reporting.
Sales to the Company’s joint ventures are included in the foregoing geographic and segment information, however, sales by the Company’s joint ventures to other parties are not included. The foregoing geographic and segment information represents only sales and cost of goods sold recognized directly by the Company.
The geographical distribution of long-lived assets is set forth as follows:
Long-lived assets consist primarily of property and equipment. These assets are periodically reviewed to assure the net realizable value from the estimated future production based on forecasted sales exceeds the carrying value of the assets.
13. RESEARCH AND DEVELOPMENT
During the year ended August 31, 2009, the Company was awarded multiple research and development contracts. The Company accrues proceeds received under the grants and offsets research and development expenses incurred in equal installments over the timelines associated with completion of the grants specific objectives and milestones. At February 28, 2011 and August 31, 2010, the Company deferred amounts received of $0 and $130,196, respectively, in other accrued liabilities, as the Company had not yet performed under the obligations of the contracts.
The Company expenses all costs related to product research and development as incurred. The Company incurred $2,100,626 and $1,565,698 of expense during the six months ended February 28, 2011 and 2010, respectively, in connection with its research and development activities. These costs related to product research and development are the net amount after being reduced by reimbursements related to the awarding of the multiple research and development contracts of $212,992 and $286,479 for the six months ended February 28, 2011 and 2010, respectively. The net fees are accounted for in the “Research and Development Expenses” section of the consolidated statements of operations.
14. COMMITMENTS AND CONTINGENCIES
On August 27, 2010, the Company’s Board of Directors, upon recommendation of the Compensation Committee, approved the material terms of an annual bonus plan for the Company’s executive officers and certain employees for the fiscal year ending August 31, 2011, the purpose of which is to align the interests of the Company, its executive officers and stockholders by providing an incentive for the achievement of key corporate and individual performance measures that are critical to the success of the Company and linking a significant portion of each executive officer’s annual compensation to the achievement of such measures. The following is a brief summary of the material terms approved by the Board:
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There was $765,000 for management bonuses accrued for six months ended February 28, 2011 compared to a management bonus accrual of $266,311 for the six months ended February 28, 2010.
The Company operates a rental property located at 23205 Mercantile Road, Beachwood, Ohio for research and development purposes. Total rent expense for the six months ended February 28, 2011 and 2010 was $119,690 and $60,814 respectively. Remaining rentals payable under such leases are as follows: fiscal 2011 - $119,690; fiscal 2012 - $238,500; fiscal 2013 - $238,500; fiscal 2014 - $59,500 and thereafter - $0.
One customer accounted for 28.9% of the Company’s trade receivables, excluding joint ventures at August 31, 2010. One customer accounted for 10.6% of the Company’s trade receivables, excluding joint ventures at August 31, 2010. Three joint ventures accounted for 69.0% of the Company’s trade joint venture receivables at February 28, 2011. One joint venture accounted for 36.4% of the Company’s trade joint venture receivables at August 31, 2010.
From time to time, the Company is involved in various legal actions arising in the normal course of business. Management is of the opinion that any judgment or settlement resulting from any currently pending or threatened actions would not have a material adverse effect on the Company’s financial position or consolidated results of operations.
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ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Management’s Discussion and Analysis provides material historical and prospective disclosures intended to enable investors and other users to assess NTIC’s financial condition and results of operations. Statements that are not historical are forward-looking and involve risks and uncertainties discussed under the heading “Part I. Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Forward-Looking Statements.” The following discussion of the results of the operations and financial condition of NTIC should be read in conjunction with NTIC’s consolidated financial statements and the related notes thereto included under the heading “Part I. Item 1. Financial Statements.”
Business Overview
NTIC develops and markets proprietary environmentally beneficial products and technical services in over 55 countries either directly or via a network of joint ventures and independent distributors. NTIC’s primary business is corrosion prevention. From this base, NTIC has expanded into three new business areas that have started recently to generate revenue (1) corrosion prevention technologies specifically designed for the oil and gas industry, which NTIC sells both directly as well as through joint ventures and independent agents; (2) a proprietary portfolio of bio-plastic compounds and finished products marketed under the Natur-Tec® brand, which NTIC sells directly as well as through distributors and independent agents; and (3) technology and equipment that converts waste plastic into diesel, gasoline and heavy fractions, which is exclusively licensed and sold in North America and Asia through NTIC’s joint venture Polymer Energy, LLC.
NTIC has been selling its proprietary ZERUST® brand rust and corrosion inhibiting products and services to the automotive, electronics, electrical, mechanical, military and retail consumer markets for over 35 years. NTIC also offers worldwide on-site technical consulting for rust and corrosion prevention issues. In North America, NTIC markets its technical services and products principally to industrial users by a direct sales force as well as a network of independent distributors and agents. NTIC’s technical service consultants work directly with the end users of NTIC’s products to analyze their specific needs and develop systems to meet their technical requirements.
NTIC has developed proprietary corrosion inhibiting technologies for use in the mitigation of corrosion on capital assets used in the petroleum and chemical process industries and is initially targeting the sale of these new ZERUST® products to the oil and gas industry sector. During fiscal 2009, NTIC announced the signing of a multi-year contract between NTIC’s Brazilian subsidiary (Zerust Prevenção de Corrosão S.A.) and Petroleo Brasileiro S.A. (Petrobras) to install and service proprietary corrosion protection technologies on the roofs of an initial set of aboveground oil storage tanks at the Petrobras REDUC refinery in Rio de Janeiro, Brazil. Also during fiscal 2009, NTIC signed multiple joint research and development contracts with Petrobras’s research and development group at the Leopoldo Américo Miguez de Mello Research & Development Center (CENPES) pursuant to which the parties will undertake a 20-month Petrobras funded effort to explore, understand and resolve bottom plate corrosion issues in aboveground storage tanks. A second 12-month Petrobras sponsored project has also started aimed at field trials of certain pipeline protection technologies. All of these projects continued during fiscal 2010 and the first six months of fiscal 2011. NTIC also is pursuing opportunities to market its ZERUST® corrosion prevention technology to other potential customers in the oil and gas industry across several countries through NTIC’s joint venture partners and other strategic partners. During fiscal 2010, NTIC entered into agreements with Iromad VZ, LLC and GF Consulting Services LLC to provide sales and marketing services for NTIC’s oil and gas industry specific corrosion prevention technologies with a particular focus on the markets in the United States, Venezuela, Mexico and Spain. NTIC believes the sale of its ZERUST® products to customers in the oil and gas industry will involve a long sales cycle, likely including a one- to two-year trial period with each customer and a slow integration process thereafter.
In addition to ZERUST® products and services, NTIC develops and markets a portfolio of bio-based and/or biodegradable (compostable) polymer resin compounds and finished products under the Natur-Tec® brand. The
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Natur-Tec® bioplastics portfolio includes flexible film, foam, rigid injection molded materials and engineered plastics. Natur-Tec® biodegradable and compostable finished products include shopping and grocery bags, lawn and leaf bags, can liners, pet waste collection bags, cutlery, packaging foam and coated paper products and are engineered to be fully biodegradable in a composting environment. During fiscal 2010 and the first six months of fiscal 2011, NTIC focused on adding additional distributors and generating initial sales with these distributors.
NTIC’s Polymer Energy LLC joint venture develops and promotes a system that uses catalytic pyrolysis to convert waste plastic (primarily polyolefins) into hydrocarbons (primarily a mix of diesels, gasoline and heavy fractions) resulting in an economically viable and environmentally responsible alternative to current methods of recycling and disposal of waste plastic. Each unit can process up to ten tons of waste plastic per day, and the modular design allows for easily scalable capacity. The crude output is high-grade and can be further processed in a refinery or used as an input for co-generation of electricity. During fiscal 2010 and the first six months of fiscal 2011, NTIC’s Polymer Energy LLC joint venture focused on making design improvements to the Polymer Energy™ equipment and generating initial interest from potential customers in India, Thailand and Indonesia.
NTIC’s Joint Venture Network
NTIC participates in 26 active joint venture arrangements in North America, South America, Europe, Asia and the Middle East. Each of these joint ventures generally manufactures and markets finished products in the geographic territory to which it is assigned. While currently most of NTIC’s joint ventures exclusively sell rust and corrosion inhibiting packaging and products to industrial customers, NTIC also has joint ventures that manufacture, market and sell corrosion prevention solutions for the oil and gas industry and Polymer Energy™ equipment that converts waste plastic into diesel, gasoline and heavy fractions. NTIC historically has funded its joint venture investments with cash generated from operations.
NTIC’s receipt of funds from its joint ventures is dependent upon fees for services that NTIC provides to its joint ventures based primarily on the revenues of the joint ventures and NTIC’s receipt of dividend distributions from the joint ventures. NTIC receives fees for services provided to its joint ventures based primarily on the net sales of the individual joint ventures. The fees for services provided to joint ventures are determined based on either a flat fee or a percentage of sales depending on local laws and tax regulations. With respect to its German joint venture, NTIC recognizes an agreed upon quarterly fee for such services. With respect to its ASEAN joint venture holding company, NTIC does not receive a fee for such services, but rather receives a bi-annual dividend based on available cash. NTIC recognizes equity income from its joint ventures based on the overall profitability of the entity. The profits of NTIC’s joint ventures are shared by the respective joint venture owners in accordance with their respective ownership percentages. NTIC typically owns only 50% or less of its joint venture entities and thus does not control the decisions of these entities regarding whether to pay dividends and, if paid, how much they should be in a given year. The payment of a dividend by an entity is determined by a joint vote of the owners and is not at the sole discretion of NTIC.
NTIC does not consolidate the results of its joint ventures, other than commencing in the fourth quarter of 2010, Zerust Prevenção de Corrosão S.A., NTIC’s subsidiary in Brazil (“Zerust Brazil”). NTIC holds 85% of the equity and 85% of the voting rights of Zerust Brazil. Prior to fiscal 2010 NTIC accounted for its Zerust Brazil investment under the equity method. NTIC owned only 50%, which it considered to be less than a majority, of the equity and voting rights of Zerust Brazil prior to September 2006. NTIC acquired an additional 35% ownership interest in Zerust Brazil in September 2006 and held 85% of the equity and voting rights thereafter. Prior to the fourth quarter of fiscal 2010, NTIC held the additional 35% ownership interest in Zerust Brazil with the intent of finding an acquiring party, believing its majority control of Zerust Brazil would be temporary and determined not to consolidate Zerust Brazil because the impact on NTIC’s consolidated financial statements was immaterial. During the fourth quarter of fiscal 2010, NTIC stopped pursuing a buyer of the 35% ownership interest and decided to consolidate the financial results of Zerust Brazil as of and for the fiscal year ended August 31, 2010. NTIC believes that the impact of not consolidating Zerust Brazil on NTIC’s consolidated financial statements for periods prior to the fourth quarter of fiscal 2010 was immaterial to NTIC’s consolidated financial statements.
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The following is a summary of certain line items of the Company’s consolidated statements of operations for the three months ended February 28, 2010 as reported and on a pro forma basis, assuming the consolidation of Zerust Brazil on the Company’s consolidated financial statements as of the beginning of such period:
The following is a summary of certain line items of the Company’s consolidated statements of operations for the six months ended February 28, 2010 as reported and on a pro forma basis, assuming the consolidation of Zerust Brazil on the Company’s consolidated financial statements as of the beginning of such period:
NTIC has not consolidated the Polymer Energy LLC joint venture in NTIC’s consolidated financial statements for the six months ended February 28, 2011 or 2010 or any prior period since Polymer Energy LLC has had limited activity since its inception in 2003 and NTIC believes that the impact of not consolidating this entity on NTIC’s consolidated financial statement has been immaterial. Prior to fiscal 2010, Polymer Energy LLC did not have any financial activity including assets, liabilities, capital contributions, revenues or expenses. During fiscal 2010, the only financial activity of Polymer Energy LLC was the receipt of license fees which were distributed to its owners in proportion to their respective ownership percentages. Since NTIC owns a 62.5% ownership interest in Polymer Energy LLC, NTIC received and recorded a portion of these fees for services provided to joint ventures in its fiscal 2010 consolidated financial statements. No license fees were received by Polymer Energy LLC and no other financial activity took place during the six months ended February 28, 2011. Accordingly, during the six months ended February 28, 2011, NTIC received and recorded no fees for services provided to joint ventures in its consolidated financial statements attributable to its ownership interest in Polymer Energy LLC.
NTIC considers its German joint venture and ASEAN joint venture holding company to be individually significant to NTIC’s consolidated assets and income; and therefore, provides certain additional information regarding these joint ventures in the notes to NTIC’s consolidated financial statements and in this section of this report.
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Financial Overview
NTIC’s management, including its chief executive officer who is NTIC’s chief operating decision maker, reports and manages NTIC’s operations in two reportable business segments based on products sold, customer base and distribution center: ZERUST® products and services and Natur-Tec® products.
NTIC’s consolidated net sales increased 66.1% and 58.9% during the three and six months ended February 28, 2011, respectively, compared to the three and six months ended February 28, 2010. These increases were primarily a result of increased sales of ZERUST® rust and corrosion inhibiting packaging products and services and sales to NTIC’s joint ventures and the consolidation of Zerust Brazil on NTIC’s consolidated financial statements. During the three and six months ended February 28, 2011, 95.8% and 95.2% of NTIC’s consolidated net sales, respectively, were derived from sales of ZERUST® products and services, which increased 64.3% and 56.1% to $4,576,313 and 8,451,741 during the three and six months ended February 28, 2011, respectively, compared to $2,785,454 and $5,413,009 during the three and six months ended February 28, 2010, respectively, due to increased demand primarily as a result of the economic recovery of the domestic manufacturing sector, the addition of new customers and the consolidation of Zerust Brazil, partially offset by decreased pricing due to increased competition. During the three and six months ended February 28, 2011, 4.2% and 4.8%, respectively, of NTIC’s consolidated net sales were derived from sales of Natur-Tec® products compared to 3.2% and 3.1% during the three and six months ended February 28, 2010, respectively. Net sales of Natur-Tec® products increased 166.0% and 142.9% during the three and six months ended February 28, 2011, respectively, compared to the three and six months ended February 28, 2010. These increases were primarily due to the addition of new Natur-Tec® distributors on the west coast of the United States.
Cost of goods sold as a percentage of net sales decreased slightly to 62.9% and 64.2% for the three and six months ended February 28, 2011, respectively, compared to 64.0% and 64.4% for the three and six months ended February 28, 2010, respectively, primarily as a result of increased net sales, partially offset by slightly reduced margins resulting from a slight increase in raw material prices.
NTIC’s equity in income of joint ventures increased 63.3% and 102.1% during the three and six months ended February 28, 2011, respectively. Equity in income of joint ventures was $1,129,659 and $2,824,790 during the three and six months ended February 28, 2011, respectively, compared to $691,687 and $1,397,586 during the three and six months ended February 28, 2010, respectively. NTIC recognized a 22.0% and 24.0% increase in fees for services provided to joint ventures during the three and six months ended February 28, 2011, respectively, compared to the three and six months ended February 28, 2010. Both of these increases were primarily a result of a 34.0% increase in total net sales of NTIC’s joint ventures during the six months ended February 28, 2011 compared to the six months ended February 28, 2010. This increase in total net sales of NTIC’s joint ventures was primarily a result of the economic recovery, to some extent, of the international manufacturing sector that the NTIC joint venture network serves.
NTIC’s total operating expenses increased 33.9% during the six months ended February 28, 2011 compared to the six months ended February 28, 2010 primarily as a result of the consolidation of the selling and general and administrative expenses of Zerust Brazil on NTIC’s consolidated financial statements of $450,828, the return of wages for all employees to pre-recession levels and fiscal 2011 raises, the hiring of 15 employees since November 30, 2009 and the increase in accrual of the management bonus of $499,000.
NTIC expenses all costs related to product research and development as incurred. NTIC incurred $2,100,626 and $1,565,698 of expense during the six months ended February 28, 2011 and 2010, respectively, in connection with its research and development activities. These costs related to product research and development are the net of reimbursement of multiple research and development contracts of $212,992 and $286,479 for the six months ended February 28, 2011 and 2010, respectively. NTIC anticipates that it will spend between $3,500,000 and $4,000,000 in total during fiscal 2011 on research and development activities related to its core and new technologies. These
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amounts represent net amounts after being reduced by reimbursements related to the awarding of multiple research and development contracts.
Net income attributable to NTIC increased 173.8%, to $949,039, or $0.22 per diluted common share, for the three months ended February 28, 2011 compared to $346,641, or $0.08 per diluted common share, for the three months ended February 28, 2010. Net income attributable to NTIC increased 136.3%, to $1,848,820, or $0.42 per diluted common share, for the six months ended February 28, 2011 compared to $782,346, or $0.19 per diluted common share, for the six months ended February 28, 2010. These increases were primarily the result of increased income from NTIC’s corporate joint ventures and holding companies and gross profit, partially offset by an increase in operating expenses. We anticipate that our quarterly net income will remain subject to significant volatility primarily due to the financial performance of our joint ventures and sales of our ZERUST® products and services into the oil and gas industry and Natur-Tec® bioplastics products, which sales fluctuate more on a quarterly basis than our traditional ZERUST® business.
NTIC’s working capital was $9,267,637 at February 28, 2011, including $1,864,215 in cash and cash equivalents compared to $5,918,923 at August 31, 2010, including $1,776,162 in cash and cash equivalents. On January 10, 2011, NTIC refinanced its $1,275,000 original principal amount term loan and increased its line of credit with PNC Bank, National Association (“PNC Bank”) to $3,000,000.
Results of Operations
NTIC does not consolidate the results of its joint ventures. NTIC considers its German joint venture and ASEAN joint venture holding company to be individually significant to NTIC’s consolidated assets and income; and therefore, provides certain additional information regarding these joint ventures in the notes to NTIC’s consolidated financial statements and in this section of this report.
The following table sets forth NTIC’s results of operations for the three months ended February 28, 2011 and February 28, 2010.
The following table sets forth NTIC’s results of operations for the six months ended February 28, 2011 and February 28, 2010.
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Net Sales. NTIC’s consolidated net sales increased 66.1% and 58.9% to $4,778,118 and $8,876,559, respectively during the three and six months ended February 28, 2011 compared to the three and six months ended February 28, 2010. NTIC’s consolidated net sales to unaffiliated customers excluding NTIC’s joint ventures increased 60.6% and 59.4% to $4,093,107 and $7,539,410, respectively, during the three and six months ended February 28, 2011 compared to the same respective prior year periods. These increases were primarily a result of increased sales of ZERUST® rust and corrosion inhibiting packaging products and services and sales to NTIC’s joint ventures and the consolidation of Zerust Brazil on NTIC’s consolidated financial statements as discussed in more detail below. Net sales to joint ventures increased 108.5% and 55.9% to $685,011 and $1,337,149 during the three and six months ended February 28, 2011, respectively, compared to the same respective prior year periods. These increases were due to increases in demand primarily as a result of the economic recovery of the international manufacturing sector, partially offset by decreased pricing due to increased competition.
The following table sets forth NTIC’s net sales by product category for the three and six months ended February 28, 2011 and 2010 by segment:
During the three and six months ended February 28, 2011, 95.8% and 95.2% of NTIC’s consolidated net sales, respectively, were derived from sales of ZERUST® products and services, which increased 64.3% and 56.1% to $4,576,313 and $8,451,741 during the three and six months ended February 28, 2011, respectively, compared to $2,785,452 and $5,413,009 during the three and six months ended February 28, 2010, respectively, due to increased demand primarily as a result of the economic recovery of the domestic manufacturing sector, the addition of new customers and the consolidation of Zerust Brazil, partially offset by decreased pricing due to increased competition. Overall demand for ZERUST® products and services depends heavily on the overall health of the markets in which NTIC sells its products, including in particular the automotive market. NTIC has focused its sales efforts of ZERUST® products and services by strategically targeting customers with specific corrosion issues in new market areas, including the oil and gas industry and other industrial sectors that offer sizable growth opportunities. NTIC’s consolidated net sales during the three and six months ended February 28, 2011 included $1,034,483 and $1,551,623, respectively, of sales made by Zerust Brazil, and of those sales, $600,200 and $627,022, respectively, in sales were made to the oil and gas industry sector in Brazil. As previously disclosed, during the fourth quarter of fiscal 2010, Zerust Brazil received purchase orders for Flange Savers representing an aggregate of $1.4 million. Of those orders, Zerust Brazil recognized sales of $518,000 during the fourth quarter of fiscal 2010, $26,822 during the first quarter of fiscal 2011 and $600,200 during the second quarter of fiscal 2011. NTIC anticipates sales to Petrobras for the remaining $254,978 of these orders during fiscal 2011 as Petrobras rolls this product out to more of its platforms. NTIC also anticipates that its sales of ZERUST® products and services into the oil and gas industry will remain subject to significant volatility from quarter to quarter as sales are converted and purchase orders are filled.
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Net sales of Natur-Tec® products increased 121.7% and 142.9% to $201,805 and $424,818 during the three and six months ended February 28, 2011, respectively, compared to the three and six months ended February 28, 2010. These increases were primarily due to the addition of new Natur-Tec® distributors on the West Coast of the United States. NTIC anticipates additional revenue in future periods from anticipated sales of film-grade resin to customers in both the North American and European markets, primarily to meet anticipated demand for biodegradable plastic bags that comply with various regulations. Additionally, NTIC is continuing to strengthen and expand its west coast distribution network in California, while expanding its industrial distribution reach to geographical “green” hotspots such as Oregon, Washington, Minnesota and New England. Additionally, NTIC is targeting key national and regional retailers utilizing independent sales agents. Demand for the Natur-Tec® products depends primarily on market acceptance of the products and the extent of NTIC’s distribution network, which as of February 28, 2011 consisted of approximately 15 distributors and independent manufacturer’s sales representatives.
Cost of Goods Sold. Cost of goods sold increased 63.3% and 59.8% for the three and six months ended February 28, 2011, respectively, compared to the three and six months ended February 28, 2010 primarily as a result of increased net sales as described above. Cost of goods sold as a percentage of net sales decreased slightly to 62.9% and 64.2% for the three and six months ended February 28, 2011, respectively, compared to 64.0% and 64.4% for the three and six months ended February 28, 2010, respectively, primarily as a result of increased net sales, partially offset by slightly reduced margins resulting from a slight increase in raw material prices.
Equity in Income of Joint Ventures. NTIC had equity in income of joint ventures of $1,129,659 and $2,824,790 during the three and six months ended February 28, 2011, respectively, compared to equity in income of joint ventures of $691,687 and $1,397,586 during the three and six months ended February 28, 2010, respectively. The increase in equity in income was due to increased profitability of NTIC’s joint ventures primarily resulting from increased sales. Of the total equity in income of joint ventures, NTIC had equity in income of joint ventures of $1,547,773 attributable to its joint venture in Germany during the six months ended February 28, 2011 compared to $731,452 attributable to its joint venture in Germany during the six months ended February 28, 2010. Of the total equity in income of joint ventures, NTIC had equity in income of joint ventures of $558,260 attributable to its ASEAN joint venture holding company during the six months ended February 28, 2011 compared to $419,324 attributable to its ASEAN joint venture holding company during the six months ended February 28, 2010. NTIC had equity in income of all other joint ventures of $718,757 during the six months ended February 28, 2011 compared to $246,810 during the six months ended February 28, 2011.
Fees for Services Provided to Joint Ventures. NTIC recognized fee income for services provided to joint ventures of $1,402,149 and $2,853,929 during the three and six months ended February 28, 2011, respectively, compared to $1,149,338 and $2,301,268 during the three and six months ended February 28, 2010, respectively, representing an increase of 22.0% and 24.0%, respectively. These increases in fees for services provided to joint ventures were due primarily to increases in net sales of NTIC’s joint ventures, which increased to $53,405,322 in the six months ended February 28, 2011 compared to $39,854,071 in the six months ended February 28, 2010, representing an increase of 34.0%. Sales of NTIC’s joint ventures, other than Zerust Brazil, are not included in NTIC’s product sales and are not combined with NTIC’s sales in NTIC’s consolidated financial statements or in any description of NTIC’s sales.
Of the total fee income for services provided to its joint ventures, fees of $521,753 were attributable to NTIC’s joint venture in Germany during the six months ended February 28, 2011 compared to $521,098 attributable to its joint venture in Germany during the six months ended February 28, 2010. This slight increase was the result of foreig | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||