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SMGI > SEC Filings for SMGI > Form 10-Q on 13-Nov-2013All Recent SEC Filings

Show all filings for SMG INDIUM RESOURCES LTD.

Form 10-Q for SMG INDIUM RESOURCES LTD.


13-Nov-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 lend, lease or sell indium, if management believes it is advantageous. Based on prevailing market conditions, we may sell up to $6.2 million 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.

Our Company

We were formed to stockpile the metal indium. Our strategy was 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 planned 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 increased in 2013 from the low of $485 per kilogram at December 31, 2012 to $695 per kilogram at September 30, 2013, it 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 may continue to 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, our stock 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.

In August 2013, our board of directors authorized the Manager to sell up to 50% of our stockpile of indium held as of June 30, 2013. Through September 30, 2013, we had net sales of approximately $6.4 million of indium at a gross profit of approximately $1.3 million. At September 30, 2013, we have approximately $6.2 million of indium available for sale, which is classified as a current asset. The remainder of indium inventory of approximately $11.3 million is in long-term assets since the Company does not intend to sell such inventory over the next twelve months.

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, 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) 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, 2013, we own approximately 36.3 metric tons ("mt") of indium for an aggregate original cost (prior to any lower of cost or market adjustment) of approximately $22.3 million or $613 per kilogram. After the lower of cost or market adjustment, the carrying value of inventory is approximately $17.5 million or $483 per kilogram of which approximately $14.2 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, as amended, we have an unconditional obligation to buy back that indium from the third party during the fourth quarter of 2013.

At September 30, 2013, we had cash and cash equivalents of approximately $10.4 million $1.0 million of which will be used in the fourth quarter of 2013 to satisfy our obligation under a USPA, as amended. 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. Although we currently have sufficient cash to satisfy our requirements over the twelve months, if needed to support continued return of capital distributions or repurchases of our securities, we plan to sell indium from our stockpile to cover our cash requirements.

At September 30, 2013, the spot price of indium was $695 per kilogram, representing an increase of 43% from the spot price of $485 per kilogram at December 31, 2012. The annual average price of indium decreased approximately 24% in 2012 from 2011 decreasing 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 Initial Public Oferring ("IPO") in May 2011 to December 31, 2012, our cost of indium has been reduced by lower of cost or market write-downs of certain lots of our indium stockpile aggregating approximately $4.8 million at September 30, 2013. In addition, through September 30, 2013, our NMV per share has declined 13% 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 September 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 was classified as noncurrent as our primary business purpose was to stockpile indium with the objective of achieving long-term appreciation in the value of indium. At June 30, 2013, approximately $11.3 million of indium inventory was reclassified to current assets due to the fact that during the next twelve months the Company intended to sell up to 50% of the indium stockpile to satisfy its cash requirements for its corporate initiatives based on prevailing market conditions. The Company began selling indium in July 2013 and at September 30, 2013, the balance in current indium inventory is approximately $6.2 million in the accompanying unaudited condensed balance sheet. The decrease resulted from sales of indium in the third quarter of 2013.

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 September 30, 2013, June 30, 2013 and March 31, 2013, the spot price of indium was $695, $547.50 and $555 per kilogram, respectively, and accordingly, no adjustments to inventory were recorded in 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.

For the three and nine months ended September 30, 2013, the Company recorded $10 thousand for Federal income taxes. The Company's effective tax rate for the three and nine months ended September 30, 2013 was significantly lower than the statutory rate due to its utilization of its net operating loss carryforwards, which offset the Company's taxable income, except for Federal alternative minimum taxes that are not offset by such operating losses. For the three months ended September 30, 2012, the Company did not record any income tax expense due to the fact that the Company expected to have a net operating loss for 2012. For the nine months ended September 30, 2012, the Company has a net loss resulting in a tax benefit that was fully offset by a valuation reserve.

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, the Company records revenue when there is pervasive evidence that an arrangement exists, delivery has occurred, the price is fixed and determinable and collectibility is reasonably assured. Cost of sales is recorded for the indium carrying value based on specific-identification method. Allowances, if any, are recorded based on management's best estimate for uncollectible accounts. There is no right of return. 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, as amended, is reported as "indium repurchase obligation" in the accompanying unaudited condensed balance sheet at September 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 operations for the three and nine months ended September 30, 2013
and 2012 are as follows:

                                                              For the Three Months Ended September 30,         For the Nine Months Ended September 30,
                                                                  2013                     2012                    2013                     2012
Net sales                                                  $         6,416,122    $                     -   $         6,416,122    $                    -
Cost of sales, including inventory-write down (recovery)             5,153,686                (1,091,346)             5,153,686                   913,242
Gross profit (loss)                                                  1,262,436                  1,091,346             1,262,436                 (913,242)

Operating costs:
Operating expenses - Manager - related party                           168,643                    151,204               476,434                   471,026
Other selling, general and administrative expenses                     118,100                    117,524               463,154                   511,369
Total operating costs                                                  286,743                    268,728               939,588                   982,395

Operating income (loss)                                                975,693                    822,618               322,848               (1,895,637)

Other income:
Interest income                                                          3,559                      5,183                 9,895                    18,930
Other income                                                            52,346                     18,829               101,655                    38,890
Net income (loss) before income taxes                                1,031,598                    846,630               434,398               (1,837,817)
Income tax expense                                                    (10,000)                          -              (10,000)                         -
Net income (loss)                                          $         1,021,598    $               846,630   $           424,398    $          (1,837,817)

Net Income (Loss) Per Share
Basic                                                      $              0.12    $                  0.10   $              0.05    $               (0.21)
Diluted                                                    $              0.12    $                  0.10   $              0.05    $               (0.21)

Weighted Average Number of Shares Outstanding
Basic                                                                8,802,242                  8,832,301             8,803,605                 8,803,104
Diluted                                                              8,834,242                  8,832,301             8,823,004                 8,803,104

Revenues

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. During the third quarter of 2013, we had net sales of approximately $6.4 million of indium.

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

For the three months ended September 30, 2013, net sales were approximately $6.4 million. There were no sales in the 2012 period as we did not begin selling indium until the third quarter of 2013. Previously we were stockpiling the metal indium. Cost of sales was approximately $5.2 million resulting in gross profit of approximately $1.2 million or 20% in the third quarter of 2013. The cost of sales, including inventory recovery of approximately $1.1 million in the 2012 period was due to the fact that the spot price of indium at September 30, 2012 of $535 per kilogram, as published by Metal Bulletin and posted on Bloomberg L.P., had recovered from the $502.50 per kilogram, the price of indium at June 30, 2012. 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. Accordingly in the third quarter of 2012, we recorded a write-up of inventory due to the recovery in the spot price of indium that quarter. There was no lower of cost or market adjustment in the 2013 period and we do not expect any additional write-downs unless the spot price of indium should fall below $485 per kilogram, however, we cannot guarantee that any such write-downs will not occur.

For the three months ended September 30, 2013, total operating expenses were approximately $287 thousand. For the comparable period in 2012, total operating costs were approximately $269 thousand representing a 7% increase. The increase was due principally to an increase in the Manager fee as a result of an increase in NMV caused principally by the increase in the spot price of indium in the 2013 period. Other operating expenses were approximately the same in the third quarter of 2013 when compared to the comparable period in 2012. During the three-month period ended September 30, 2013, other income increased approximately $34 thousand when compared to the third quarter in 2012 due to increased income recorded on indium USPA and lease transactions during the third quarter of 2013.

Income taxes of $10 thousand was provided for in the third quarter of 2013 for the alternative minimum tax that is not offset by net operating losses based on our estimated tax rate.

Net income was approximately $1.0 million for the three months ended September 30, 2013 (or $0.12 per basic and diluted share) compared to a net income of approximately $0.8 million (or $0.10 per basic and diluted share) in the comparable period ended September 30, 2012. The increase of approximately $0.2 million was due to higher gross profits in 2013. As described above, the net income in the third quarter of 2012 was due to approximately $1.1 million in gross profits as a result of a lower of cost or market recovery of indium inventory offset in part by operating expenses. The basic weighted average number of common shares outstanding was 8,802,242 in the third quarter of 2013 compared to 8,832,301 in the third quarter of 2012. The decrease in shares in 2013 was due to the purchase of common shares under our repurchase program.

Nine Months Ended September 30, 2013 compared to September 30, 2012 Comparable Period

For the nine months ended September 30, 2013, net sales were approximately $6.4 million. Cost of sales was approximately $5.2 million resulting in gross profit of approximately $1.2 million or 20%. There were no sales in the comparable period in 2012. Cost of sales, including inventory write-down of approximately $0.9 million in the 2012 period was due to a lower of cost or market write-down of certain lots in indium inventory as a result of the decline in the spot price of indium from the price at the end of the 2011 for certain lots. The spot price of indium at September 30, 2012 was $535 per kilogram, as published by Metal Bulletin and posted on Bloomberg L.P., compared to the $570 per kilogram, the price of indium at December 31, 2011. There was no lower of cost or market adjustment in the 2013 period, and, we do not expect any adjustment unless the spot price of indium should fall below $485 per kilogram, however, we cannot guarantee that any such write-downs will not occur.

For the nine months ended September 30, 2013, total operating costs were approximately $940 thousand compared to approximately $982 thousand in the comparable period in 2012 resulting in a decline of 4% for the nine months ended . . .

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