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SMGI > SEC Filings for SMGI > Form 10-Q on 13-Nov-2012All Recent SEC Filings

Show all filings for SMG INDIUM RESOURCES LTD.

Form 10-Q for SMG INDIUM RESOURCES LTD.


13-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Cautionary Note Regarding Forward-Looking Statements

Unless otherwise indicated, the terms "SMG Indium," "SMG," the "Company," "we," "us," and "our" refer to SMG Indium Resources Ltd. In this Quarterly Report on Form 10-Q, we may make certain forward-looking statements, including statements regarding our plans, strategies, objectives, expectations, intentions and resources that are made pursuant to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995.

The statements contained in this Quarterly Report on Form 10-Q that are not historical fact are forward-looking statements (as such term is defined in the Private Securities Litigation Reform Act of 1995), within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended. Forward-looking statements may be identified by the use of forward-looking terminology such as "should," "could," "may," "will," "expect," "believe," "estimate," "anticipate," "intends," "continue," or similar terms or variations of those terms or the negative of those terms. These statements appear in a number of places in this Form 10-Q and include statements regarding the intent, belief or current expectations of SMG Indium Resources Ltd. Forward-looking statements are merely our current predictions of future events. Investors are cautioned that any such forward-looking statements are inherently uncertain, are not guaranties of future performance and involve risks and uncertainties. Actual results may differ materially from our predictions. There are a number of factors that could negatively affect our business and the value of our securities, including and not limited to indium price volatility from supply and demand factors, international export quotas that could affect the availability of indium and our ability to purchase indium, lack of any internationally recognized exchanges for indium, limited number of potential suppliers of indium and potential customers who purchase indium, disruption of mining operations, technological obsolescence, substitution of other materials decreasing the demand for indium, regulatory requirements regarding indium, risks associated with international economic and political events, lack of operational liquidity, lack of investment liquidity, factors affecting our Net Market Value, and changes in interest rates. Such factors could materially affect our Company's future operating results and could cause actual events to differ materially from those described in forward-looking statements relating to our Company. Although we have sought to identify the most significant risks to our business, we cannot predict whether, or to what extent, any of such risks may be realized, nor is there any assurance that we have identified all possible issues that we might face. We assume no obligation to update our forward-looking statements to reflect new information or developments. We urge readers to carefully review and consider the various disclosures we make in this report and our other reports filed with the Securities and Exchange Commission ("SEC") that attempt to advise interested parties of the risks, uncertainties and other factors that may affect our business including the risk factors disclosed in our 2011 Annual Report on Form 10-K, as filed with the SEC.

Overview

We were formed under the laws of the State of Delaware on January 7, 2008. On April 2, 2008, we changed our name from Specialty Metals Group Indium Corp. to SMG Indium Resources Ltd. On May 4, 2011, we amended our certificate of incorporation to provide for 40,000,000 shares of authorized common stock, par value $0.001 per share and 1,000,000 shares of authorized preferred stock, par value $0.001. In addition, we amended our corporate charter extending the life of the Company to perpetuity. We were formed to purchase and stockpile the specialty metal indium. We intend to utilize cash derived from the proceeds of offerings of our capital stock, debt, or a combination of cash, capital stock and debt for acquiring and storing indium.

In May 2011, we completed an Initial Public Offering ("IPO") of an aggregate of 5,084,750 units at $5.00 per unit and raised aggregate net proceeds of approximately $24.0 million including the partial exercise of the underwriters' overallotment option. Each IPO unit consisted of one share of the Company's common stock and one redeemable common stock purchase warrant. Each warrant entitles the holder to purchase from the Company one share of common stock at an exercise price of $5.75 per share commencing with the effective date of the registration statement and expiring on May 4, 2016. Of the total raised in the IPO, 85% of the net proceeds, or approximately $20.4 million, was committed to be used to purchase and stockpile indium and 15% of the net proceeds, or approximately $3.6 million, is used for general working capital to fund operations. We have purchased sufficient quantity of indium to satisfy our commitment to use 85% of the net proceeds of the IPO for the purchase of indium.

On January 5, 2012, we closed a private placement ("2012 Private Placement") of an aggregate of 2.0 million shares of our common stock at $3.75 per share to two accredited investors, Raging Capital Fund, L.P. and Raging Capital Fund (QP), L.P., for aggregate net proceeds of approximately $7.5 million. Raging Capital Management, LLC is the general partner of Raging Capital Fund, L.P. and Raging Capital Fund (QP), L.P., and collectively, the entities represent our largest stockholder(s). Such entities are affiliated and controlled by William C. Martin, our director and, through his control of RCM Indium, LLC, a member of our Manager, Specialty Metals Group Advisors LLC. Although we have no legal requirement on how we spend the proceeds from the 2012 Private Placement, the Company intends to use 85% of the gross proceeds, or approximately $6.4 million, from such transaction to purchase and stockpile the metal indium and 15% of the gross proceeds, or approximately $1.1 million, for general corporate purposes. As of September 30, 2012, there is $2.9 million of gross proceeds remaining that the Company intends to use to purchase indium.

Our Company

We were formed to purchase and stockpile the metal indium. Our strategy is to achieve long-term appreciation in the value of our indium stockpile, and not to actively speculate with regard to short-term fluctuations in indium prices. We plan to achieve long-term appreciation in the value of our indium stockpile primarily through price appreciation of the physical metal. Although the price of indium has declined substantially from its high in March 2005, it is our belief that the long-term industry prospects for indium are attractive, and over time, the price of the metal will appreciate. However, there is no assurance that the price of indium or the value of the Company's securities will increase over time. To our knowledge, this is currently the only investment that allows potential stockholders to participate in the price appreciation of indium other than physical delivery of the metal itself. Our structure provides a simple and efficient mechanism by which a potential public stockholder may benefit from any appreciation in the price of indium. Our stockholders have the ability to effectively purchase an interest in indium in a manner that does not directly include the risks associated with ownership of companies that explore for, mine and process indium. Our common shares represent an indirect interest in the physical indium we own.

All of the indium we purchase and own is, and will be, insured and physically stored in third-party warehouses or storage facilities located in the United States, Canada, the Netherlands and/or the United Kingdom. Our Manager, Specialty Metals Group Advisors LLC, which is a related party, negotiates storage arrangements for our indium holdings and is required to use commercially reasonable efforts to ensure that the indium holdings have the benefit of insurance arrangements obtained on standard industry terms.

We utilize and expect to continue to utilize facilities that meet our requirements that are either (i) located closest in proximity to our indium suppliers in order to reduce transportation fees or (ii) facilities located closest in proximity to our corporate headquarters or satellite offices in order to facilitate our ability to inspect our inventory and reduce future corporate expenses associated with travel. We believe there are numerous third-party storage facilities that provide more than adequate services that meet our criteria, which eliminates the need for hiring a custodian. As of September 30, 2012, we purchased approximately 46.5 metric ton of indium at an aggregate original cost (prior to any lower of cost or market adjustment) of approximately $28.4 million that is currently stored in a secure insured bonded warehouse facility located in New York owned by Brink's Incorporated ("Brink's"). The facility is visited at least once per year for inspection. We may insure the warehouse contents above and beyond a bonded warehouse to guarantee we will not sustain a loss in the event of an unforeseen catastrophe or if we deem the warehouse company's insurance inadequate.

Our expenses will be required to be satisfied by cash on hand that is not set aside for the purchase of indium. Cash on hand is expected to be sufficient to satisfy our expenses for approximately three years. If we expend our cash on hand to repurchase the full amount of common stock authorized under the $1 million stock repurchase plan, we expect to have cash sufficient to satisfy our expenses for at least two years. Our annual cash operating expenses, including management fees, are estimated to be approximately $1.3 million. We may subsequently lend or sell some, or all, of our indium stockpile to cover our operating expenses. Alternatively, we may seek to raise additional capital to cover our operating expenses through potentially dilutive equity offerings or debt financing. We are a taxable U.S. corporation and are subject to federal and state taxes.

Our stockpile of indium may decrease over time due to sales of indium necessary to pay our annual operating expenses. Without increases in the price of indium sufficient to compensate for such decreases, our net market value ("NMV") may also decline. Regardless of our ability to purchase indium in a timely manner, we expect to incur projected yearly cash operating expenses of approximately $1.3 million. Further, we have and expect to continue to incur, from time to time, non-cash share-based compensation expenses, which are not included in the aforementioned yearly cash operating expenses. The price of indium would need to appreciate substantially to offset the reduction in our NMV due to the operating expenses noted above. The percentage increase required cannot be accurately determined at this time. It is highly dependent upon several variables including, but not limited to, the exact number of kilograms of indium purchased, the average price paid and the amount of time it takes for us to fully spend the proceeds from the 2012 Private Placement to complete our indium stockpile.

The annual average price of indium increased approximately 23.0% in 2011. It increased from an average price of $567 per kilogram in 2010 to an average price of $696 per kilogram in 2011. According to the US Geological Survey, the U.S. producer price for indium began the year 2011 at $570 per kilogram, increased to $690 per kilogram in April, and rose further to $785 per kilogram in May; the price remained at that level through early November. The New York dealer price range for indium began the year at $520 - $570 per kilogram and increased through early June, reaching a high of $800 - $875 per kilogram. The price then decreased to $630 - $670 per kilogram by early November before falling further to $540 - $600 per kilogram by the end of December. The price of indium at September 30, 2012 was $535 per kilogram as published by Metal Bulletin and posted on Bloomberg L.P. Since the closing of our IPO in May 2011, the price of indium has declined 29.1% through September 30, 2012, resulting in aggregate write-downs of indium inventory of approximately $4.2 million since the closing of the IPO.

Critical Accounting Policies and Estimates

Use of Estimates

The preparation of financial statements and related disclosures in conformity with United States generally accepted accounting principles ("U.S. GAAP") requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Estimates are used for, but not limited to, valuation of indium inventories, income taxes, share-based compensation and revenue recognition. Management will base its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results could differ from these estimates under different assumptions or conditions.

Common Stock Purchase Contracts

We classify as equity any common stock purchase contracts that: (i) require physical settlement or net-share settlement or give us a choice of net-cash settlement or settlement in its own shares (physical settlement or net-share settlement) and (ii) are indexed to our common stock. We classify as assets or liabilities any common stock purchase contracts that: (i) require net-cash settlement (including a requirement to net-cash settle the contract if an event occurs and that event is outside our control), (ii) gives the counterparty a choice of net-cash settlement or settlement in shares (physical settlement or net-share settlement) or (iii) is not indexed to our common stock. We assess classification of our equity-classified contracts at each reporting date to determine whether a change in classification between assets and liabilities is required. Our outstanding common stock purchase contracts (warrants and unit purchase options) were accounted for as equity through September 30, 2012.

Share-Based Payment Arrangements

We measure the cost of services received in exchange for an award of equity instruments (share-based payments or "SBP") based on the grant-date fair value of the award. That cost is recognized over the period during which an employee is required to provide service in exchange for the SBP award-the requisite service period (vesting period). For SBP awards subject to performance conditions compensation is not recognized until the performance condition is probable of occurrence. The grant-date fair value of share options is estimated using the Black-Scholes-Merton option pricing model. Compensation expense for SBP awards granted to nonemployees is remeasured each period as the underlying options vest.

Inventory of the Metal Indium

Our inventory or "stockpile" of the metal indium is recorded at cost including all associated costs of delivering the indium to the bonded storage warehouse on the date we take delivery of the physical metal. Cost is determined using the specific-identification method. The stockpile of the physical metal indium is classified as noncurrent as we do not expect to sell any of the indium during the next twelve months. The stockpile of the physical metal indium is carried at the lower of cost or market with cost being determined on a specific-identification method and market being determined as the net realizable value based on the spot prices published by Metal Bulletin and posted on Bloomberg L.P., a real-time financial information services data platform. We will charge against earnings on an interim basis the amount by which the spot price of indium is less than cost on a specific-identification basis. Increases in the spot price of indium for the same lot of indium held in inventory in later interim periods within the fiscal year are recognized in the later interim period. Increases in value recognized on an interim basis do not exceed the previously recognized diminution in value within that fiscal year. However, it should be noted that there may not be a correlation between the spot price of indium as published by Metal Bulletin and posted on Bloomberg L.P. and the amount we may realize upon selling indium in the open market.

Further, we periodically review the indium stockpile to determine if a loss should be recognized where the utility of indium has been impaired on an other-than-temporary basis. Where such impairment is viewed as something other than temporary, we will charge against earnings the amount by which the fair market value is less than the cost. Realized gains (losses) from sale transactions will be determined for income tax and for financial reporting purposes on a specific-identification method when incurred.

The spot price of indium at September 30, 2012 was $535 per kilogram as published by Metal Bulletin and posted on Bloomberg L.P. which is higher than $502.50 per kilogram, the price of indium at June 30, 2012. As a result of the spot price at September 30, 2012 being higher than the spot price used at June 30, 2012 to calculate the lower of cost or market adjustment, the Company recorded a lower of cost or market recovery for certain lots of indium inventory during the third quarter of 2012 aggregating approximately $1.1 million. For the nine months ended September 30, 2012 and 2011, the net lower of cost or market adjustment was a charge that aggregated approximately $0.9 million and $0.7 million, respectively, and for the three months ended September 30, 2011 such adjustment was approximately $0.7 million.The spot price of indium on November 1, 2012 was $537.50 per kilogram which is about the same as the spot price on September 30, 2012 of $535 per kilogram. Based on the spot price of indium on December 31, 2012, the Company may be required to record an additional recovery or write-down in the fourth quarter of 2012.

Income Taxes

Income taxes are accounted under the asset-and-liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and the respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The portion of any deferred tax asset for which it is more likely than not that a tax benefit will not be realized must then be offset by recording a valuation allowance. A valuation allowance has been established against all of the deferred tax assets, as it is more likely than not that these assets will not be realized given our history of operating losses. We recognize the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs.

Accounting for Direct Sales and Lending Transactions

The stockpile of indium may be used from time to time for "direct sales" and or "lending" transactions. Under a "direct sale" transaction, we would record a gain (loss) equal to the difference between the proceeds received from the sale of indium and the indium carrying value. We may also elect to enter into a lending transaction. In indium lending transactions, we would exchange a specified tonnage and purity of indium for cash. Title and the risks and rewards of such indium ownership would pass to the purchaser/counterparty in the lending transaction. We would simultaneously enter into an agreement with such counterparty in which it would unconditionally commit to purchase and the counterparty would unconditionally commit to sell a specified tonnage and purity of indium that would be delivered to us at a fixed price and at a fixed future date in exchange for cash (the Unconditional Sale and Purchase Agreement or "USPA"). The USPA would also contain terms providing the counterparty with substantial disincentives ("penalty fees") for nonperformance of the return of indium to the Company as a means to assure our future supply of indium. While we believe that this risk would be mitigated by the penalty fee features of the USPA, it is nonetheless a risk associated with a transaction of this type. We account for any USPA transaction on a combined basis (sale and purchase) and will evaluate whether, and in what period, other income may be recognized based on the specific terms of any arrangements. We will disclose unconditional purchase obligations under these arrangements and, if applicable, accrue net losses on such unconditional purchase obligations.

During the nine months ended September 30, 2012, the Company entered into USPAs where we sold 99.99% purity indium at a fixed price and the buyers subsequently sold back to us the same quantity of 99.99% purity indium at a fixed price that was at a discount from the price per kilogram that we originally sold indium to the buyer. Any USPA is accounted for on a combined basis resulting in a gain as a result of the discount that is recorded in other income.

Recently Issued Accounting Pronouncements

Recently issued accounting pronouncements did not, or are not believed by management to, have a material effect on the Company's present or future financial statement.

Results of Operations



The results of operation for the three months and nine months ended September
30, 2012 and 2011 are as follows:



                                                         For the                                  For the
                                            Three Months Ended September 30,          Nine Months Ended September 30,
                                                2012                  2011                2012                 2011

Operating costs (income):
Inventory-indium write-down (recovery)    $      (1,091,346 )     $     729,245     $        913,242       $     729,245
Operating expenses - Manager - related
party                                               151,204             154,694              471,026             556,601
Officers and directors compensation
expense                                              21,450              27,100               92,300             213,850
Other operating expenses                             96,074             154,851              419,069             470,206
Total Operating Costs (Income)                     (822,618 )         1,065,890            1,895,637           1,969,902

Other expense (income):
Interest expense - Manager - related
party                                                     -                   -                    -               5,300
Interest income                                      (5,183 )           (11,174 )            (18,930 )           (20,913 )
Other income                                        (18,829 )                 -              (38,890 )                 -
Net Income (Loss)                                   846,630          (1,054,716 )         (1,837,817 )        (1,954,289 )

Preferential Dividend to Class A Common
Stockholders                                              -                   -                    -          (2,359,755 )

Net Income (Loss) Applicable to Common
Stockholders                              $         846,630       $  (1,054,716 )   $     (1,837,817 )     $  (4,314,044 )

Earnings (Loss) Per ShareApplicable to
Common Stockholders
Basic and Diluted                         $            0.10       $       (0.15 )   $          (0.21 )     $       (1.19 )

Weighted Average Number of  Shares
Basic and Diluted                                 8,832,301           6,832,301            8,803,104           3,637,839

Revenues

We have not generated any revenues to date. We do not expect to generate revenues since our primary business plan is to purchase and stockpile already mined and processed indium ingots. Notwithstanding the rise and fall of the price of indium from period to period, the value of our indium stockpile or inventory of indium, will be recorded on our balance sheet at the lower of cost or market. We will not record any revenues until such time we sell indium from our inventory.

Three Months Ended September 30, 2012 Compared to September 30, 2011 Comparable Period

For the three months ended September 30, 2012, total operating income was approximately $0.8 million including a non-cash lower of cost or market recovery of indium inventory of approximately ($1.1) million. For the comparable period in 2011, total operating costs were approximately $1.1 million including a lower of cost or market write-down of approximately $0.7 million. The spot price of indium at September 30, 2012 was $535 per kilogram, as published by Metal Bulletin and posted on Bloomberg L.P., which is higher than $502.50 per kilogram, the price of indium at June 30, 2012. As a result of the spot price in this quarter being higher than the spot price used at June 30, 2012 to calculate the lower of cost or market adjustment, the Company recorded a lower of cost or market recovery for certain lots of indium inventory during the third quarter of 2012 whereas in the comparable period in 2011 there was a write-down of indium as a result of a continued decline in the spot price of indium in the third quarter of 2011. For the three months ended September 30, 2012 and 2011, total operating costs exclusive of the inventory write-down (recovery) were approximately $269 thousand and $337 thousand, respectively, representing a decrease of 20%. Operating expenses-Manager-related party in the third quarter of 2012 approximated the same as the comparable period in 2011. Officers and directors compensation expense declined approximately $6 thousand. Other operating expenses declined from approximately $155 thousand in the 2011 period to approximately $96 thousand in 2012 principally due to lower professional fees and franchise tax. Based on our current business plan, we expect that our normal annual cash operating expenses will approximate $1.3 million annually over the next few years. Interest income decreased approximately $6 thousand during the quarter ended September 30, 2012, when compared to the comparable quarter in 2011 principally as a result of lower cash and cash equivalents available for investment during the third quarter of 2012 when compared to the comparable quarter in 2011 where our cash and cash equivalents available for investment were at a higher level due to the receipt of the net proceeds from our IPO received in the second quarter of 2011. During the three-month period ended September 30, 2012, there was approximately $19 thousand in other income relating to the USPA transaction in the quarter.

Net income was approximately $0.8 million for the three months ended September 30, 2012 (or $0.10 per basic and diluted share) compared to a net loss of approximately ($1.1) million (or $0.15 per basic and diluted share) in the comparable period ended September 30, 2011. The net income in the third quarter of 2012 was principally a result of approximately $1.1 million from the recovery of indium inventory, described above, compared to a write-down of approximately $0.7 million in the comparable period in 2011 plus lower operating expenses in 2012. The weighted average number of common shares increased from 6,832,301 in 2011 to 8,832,301 in the third quarter of 2012 as a result of the shares issued in the 2012 Private Placement.

Nine months Ended September 30, 2012 Compared to September 30, 2011 Comparable Period

For the nine months ended September 30, 2012, total operating costs were approximately $1.9 million including approximately $0.9 million for non-cash lower of cost or market write-down of indium. Total operating costs for the nine months ended September 30, 2011 were approximately $2.0 million including an indium write-down of approximately $0.7 million. Both the nine months ended September 30, 2012 and 2011 included a write-down to indium inventory as a . . .

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