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SMGI > SEC Filings for SMGI > Form 10-Q on 14-Aug-2013All Recent SEC Filings

Show all filings for SMG INDIUM RESOURCES LTD.

Form 10-Q for SMG INDIUM RESOURCES LTD.


14-Aug-2013

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 or sell indium, lack of any internationally recognized exchanges for indium, limited number of potential suppliers of indium and potential customers who purchase or borrow 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 herein in Part II under "Risk Factors" and in our 2012 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 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 November 2012, our board of directors and stockholders approved an amendment to our certificate of incorporation to reduce our authorized shares of common stock to 25,000,000. We were formed to stockpile the specialty metal indium. From time to time, we may lend, lease or sell indium, if management believes it is advantageous. Based on prevailing market conditions, we may sell up to 50% of our indium stockpile over the next 12 months to fund our cash requirements for our corporate initiatives. These corporate initiatives currently include funding our stock repurchase program and returning cash to shareholders via quarterly return of capital distributions. Subsequent to June 30, 2013, we began selling indium and through the filing hereof, we sold $2.5 million of indium.

Our Company

We were formed to 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 any 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.

We physically store and insure our indium 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, will negotiate 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) 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 June 30, 2013, we purchased approximately 47.0 metric tons ("mt") of indium for an aggregate original cost (prior to any lower of cost or market adjustment) of approximately $28.6 million of which approximately $25.3 million is currently stored in a secure insured bonded warehouse facility located in New York owned by Brink's. The facility is visited at least once per year for inspection. Of the remaining indium, approximately $2.4 million has been leased to a third party and approximately $0.9 million was sold to a third party under an unconditional sale and purchase agreement ("USPA"). Under the terms of the USPA, we have an unconditional obligation to buy back that indium from the third party during the third quarter of 2013.
At June 30, 2013, we had cash and cash equivalents of approximately $5.7 million of which $1.0 million will be used in the third quarter of 2013 to satisfy our obligation under a USPA. Our expenses will be required to be satisfied by cash on hand. Our annual cash operating expenses, including management fees, are estimated to be approximately $1.2 million. Further, our board of directors approved in 2013 a stock repurchase plan for up to $3.0 million of our securities and we may return additional capital to our stockholders subject to prevailing market conditions. We plan to sell indium from our stockpile to cover our aforementioned cash requirements. Subsequent to June 30, 2013, we sold approximately $2.5 million of indium from our stockpile.

At June 30, 2013, the spot price of indium was $547.50 per kilogram, representing an increase of 13% from the spot price of $485 at December 31, 2012. The annual average price of indium decreased approximately 24.1% in 2012 from 2011. It decreased from $696 per kilogram in 2011 to $528 per kilogram in 2012. As a result of the decline in the price of indium since the closing of our IPO in May 2011, we recorded write-downs of certain lots of our indium stockpile aggregating approximately $5.9 million through June 30, 2013. In addition, through June 30, 2013, our NMV per share has declined 25% since the closing of our 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 gives us a choice of net-cash settlement or settlement in its own shares (physical settlement or net-share settlement) and (ii) is index 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) give the counterparty a choice of net-cash settlement or settlement in shares (physical settlement or net-share settlement) or (iii) are 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 June 30, 2013.

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 a service is required to be provided 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 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. The stockpile of the physical metal indium and the related repurchase right is classified as noncurrent as our primary business purpose is to stockpile indium with the objective of achieving long-term appreciation in the value of indium. However, we may sell indium during the next twelve months to satisfy our cash requirements. 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 obtained from Metal Bulletin on Bloomberg L.P., a real-time financial information services data platform. We 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. Through December 31, 2012, certain lots of indium in inventory were adjusted to reflect a lower of cost or market write-down aggregating approximately $5.9 million based on the spot price of indium of $485 per kilogram at December 31, 2012. As a result, the cost basis of all lots in inventory for accounting purposes is $485 or less per kilogram. We will not record any additional write-downs unless the spot price of indium falls below $485 per kilogram and inventory cannot be increased above its cost based on increases in the spot price of indium. At June 30, 2013 and March 31, 2013, the spot price of indium was $547.50 and $555 per kilogram, respectively, and accordingly, no adjustments to inventory were recorded during the three or six months ended June 30, 2013.

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. We will recognize potential interest and penalties related to income tax positions as a component of the provision for income taxes on the statements of operations in any future periods in which the Company must record a liability.

Accounting for Direct Sales, Lending and Leasing Transactions

The stockpile of indium may be used from time to time for "direct sales," "lending" or "lease" 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 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 evaluate whether, and in what period, other income may be recognized based on the specific terms of any arrangements. We disclose unconditional purchase obligations under these arrangements and, if applicable, accrue net losses on such unconditional purchase obligations. Further, the cost of inventory-indium under an open USPA is reported as "indium repurchase obligation" in the accompanying unaudited condensed balance sheet at June 30, 2013. Income arising from leasing transactions is reported as 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 statements.

Results of Operations

The results of operation for the three and six months ended June 30, 2013 and
2012 are as follows:

                                           For the Three Months Ended June 30,             For the Six Months Ended June 30,
                                            2013                      2012                    2013                   2012

Operating costs:
Inventory-indium write-downs          $             -       $            1,496,548     $              -       $      2,004,588
Operating expenses - Manager -
related party                                 150,359                      154,734              307,792                319,822
Officer and directors compensation
expense                                        24,750                       36,625               49,650                 70,850
Other operating expenses                      167,551                      206,554              295,403                322,995
Total Operating Costs                         342,660                    1,894,461              652,845              2,718,255

Other income:
Interest income                               (3,235)                      (5,922)              (6,335)               (13,747)
Other income                                 (39,353)                            -             (49,309)               (20,060)
Net Loss                              $     (300,072)       $          (1,888,539)     $      (597,201)       $    (2,684,448)

Net Loss Per Share
Basic and Diluted                     $        (0.03)       $               (0.21)     $         (0.07)       $         (0.31)

Weighted Average Number of Shares
Outstanding
Basic and Diluted                           8,802,968                    8,832,301            8,804,298              8,788,345

Revenues

We have not generated any revenues through June 30, 2013. Subsequent to June 30, 2013, we began selling indium from our stockpile to generate cash to fund our corporate initiatives, including our share buyback program and any additional distributions to our stockholders that we may undertake in the future, based on prevailing market conditions.

Three Months Ended June 30, 2013 Compared to June 30, 2012 Comparable Period

For the three months ended June 30, 2013, total operating expenses were approximately $343 thousand. For the comparable period in 2012, total operating costs were approximately $1.9 million including lower of cost or market write-downs of certain lots in indium inventory of approximately $1.5 million. Exclusive of the lower of cost or market write-downs, operating expenses approximated $398 thousand for the three months ended June 30, 2012, and when compared to the second quarter of 2013 represent a 14% decrease. There was no write-down of indium inventory during the three months ended June 30, 2013 due to the fact that the spot price of indium at June 30, 2013 of $547.50 per kilogram, as published by Metal Bulletin and posted on Bloomberg L.P., was greater than the accounting cost basis of all lots in inventory at that date. We do not expect any additional write-downs of inventory unless the spot price of indium falls below $485 per kilogram; however, we cannot guarantee that any such write-downs will not occur.

Operating expenses-Manager-related party in the second quarter of 2013 were approximately the same when compared to the second quarter of 2012. Officer and directors compensation expense declined approximately $12 thousand or 33% due principally to a cash bonus paid to our CFO in 2012. There was no such bonus in the current period. Other operating expenses decreased from approximately $207 thousand in the second quarter of 2012 to approximately $168 thousand in 2013 or 19% principally due to lower professional fees. Based on our current business plan, we expect that our normal annual cash operating expenses will approximate $1.2 million annually. Interest income decreased approximately $3 thousand during the quarter ended June 30, 2013, when compared to the comparable quarter in 2012 principally as a result of lower cash and cash equivalents available for investment. During the three-month period ended June 30, 2013, other income increased approximately $39 thousand when compared to the second quarter in 2012 due to the aggregate income recorded on USPA and indium lease transactions during the second quarter of 2013. There were no such transactions in the second quarter of 2012.

Net loss was approximately $0.3 million for the three months ended June 30, 2013 (or $0.03 per basic and diluted share) compared to a net loss of approximately $1.9 million (or $0.21 per basic and diluted share) in the comparable period ended June 30, 2012. As described above, the net loss in the second quarter of 2012 included approximately $1.5 million in lower of cost or market write-downs of indium inventory and approximately 0.1 million of higher operating costs. The weighted average number of common shares outstanding was 8,802,968 in the second quarter of 2013 compared to 8,832,301 in the second quarter of 2012.

Six Months Ended June 30, 2013 compared to June 30, 2012 Comparable Period

For the six months ended June 30, 2013, total operating costs were approximately $653 thousand compared to approximately $2.7 million in the comparable period in 2012. The 2012 period included approximately $2.0 million for non-cash lower of cost or market write-downs of indium. Total operating costs, exclusive of the write-down were approximately $714 thousand for the six months ended June 30, 2012 and when compared to the 2013 period resulted in a decline of 9% for the six months ended June 30, 2013. Manager expenses declined approximately $12 thousand or 4% due to the decline in average NMV for the six month period; officer and director compensation declined approximately $21 thousand or 30% due to no CFO bonus in 2013 and lower director fees in the 2013 period; and other operating expenses declined approximately $28 thousand or 9% due to lower professional fees in 2013. Interest income decreased $7 thousand when compared to the same period in 2012 principally as a result of lower cash available to invest. During the six months ended June 30, 2013, there was approximately $49 thousand in other income representing the aggregate income relating to USPAs and indium lease transactions compared to $20 thousand in the 2012 period. The increase was due to an increase in the number of transactions in the 2013 period.

For the six months ended June 30, 2013, we reported net loss of approximately $0.6 million (or $0.07 per basic and diluted share) as compared with a net loss for the six months ended June 30, 2012 of approximately $2.7 million (or $0.31 per basic and diluted share). As mentioned above the six months ended June 30, 2012 included a $2.0 million inventory write-down in the first half of 2012. The weighted average number of common shares outstanding was approximately the same in both periods at 8,804,298 in the six months ended June 30, 2013 compared to 8,788,345 in the 2012 period.

We expect our monthly expenses may increase or decrease with the change in our NMV. The monthly management fee payable to our Manager, a related party, is directly correlated to our NMV, which fluctuates primarily based on the price of indium. Furthermore, our monthly storage and insurance expense is directly correlated to the quantity of indium held in inventory and to the increase or decrease in the value of our indium stockpile.

GAAP vs. Non-GAAP Disclosure

We use the term NMV throughout this report when we discuss the value of our indium holdings. We define the term NMV, as used in this report, as the product of multiplying the number of kilograms of indium held by the Company at any given point by the spot price for indium as published by Metal Bulletin and posted on Bloomberg L.P., plus cash and other Company assets, less any liabilities. The use of the term NMV is a non-GAAP financial measurement.

A reconciliation of the Non-GAAP NMV to the GAAP historical net book value is as follows:

                                                             June 30,        December 31,
                                                               2013              2012
U.S. GAAP  net book value                                 $ 27,147,211     $   28,635,908
Excess of the indium at spot price over GAAP book value      3,066,039            122,689
NMV                                                       $ 30,213,250     $   28,758,597

The reasons why the Company relies on the NMV measurement are as follows:

it is a measurement of the true value of the Company's indium holdings at any given point and thus is a primary factor in evaluating the general liquidity of the Company should the Company ever decide to sell any or all of its indium holdings;

it provides the greatest transparency to our shareholders in evaluating how the Company is performing relative to the indium purchased by the Company when compared to the current market prices for indium as published by Metal Bulletin and posted on Bloomberg L.P.;

it is used internally to evaluate the performance of the Manager, a related party, who is entitled to a management fee based upon the NMV metric each month;

it provides additional disclosures about the value of our indium holdings and the potential impact that such value would have on our operating results on a true period-to-period basis in terms of the market value of such indium holdings;

it provides the most useful tool for shareholders and potential investors to evaluate how management has performed in terms of the indium purchased versus the NMV at any given point;

it more readily provides a market value metric that may be useful in analyzing trends or other market conditions that a historical cost presentation might not; and

it provides a meaningful liquidity measurement for the Company's indium stockpile.

No assurances can be given that the Company could liquidate its indium holdings at the market prices published by Metal Bulletin.

Liquidity and Capital Resources

Since our inception and through June 30, 2013, we have incurred an accumulated deficit of approximately $12.0 million (including approximately $2.4 million non-cash dividend to Class A common stockholders) and we have not yet achieved . . .

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