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NTIC > SEC Filings for NTIC > Form 10-Q on 10-Jan-2014All Recent SEC Filings

Show all filings for NORTHERN TECHNOLOGIES INTERNATIONAL CORP

Form 10-Q for NORTHERN TECHNOLOGIES INTERNATIONAL CORP


10-Jan-2014

Quarterly Report


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 services in over 60 countries either directly or via a network of joint ventures, independent distributors and agents. NTIC's primary business is corrosion prevention marketed mainly under the ZERUSTŪ brand. NTIC has been selling these proprietary ZERUSTŪ products and services to the automotive, electronics, electrical, mechanical, military and retail consumer markets for over 35 years, and more recently, has expanded its target market to include the oil and gas industry. NTIC also sells a portfolio of bio-based and biodegradable (compostable) polymer resin compounds and finished products marketed under the Natur-TecŪ brand. These products are intended to reduce NTIC's customers' carbon footprint and provide environmentally sound waste disposal options.

NTIC's ZERUSTŪ rust and corrosion inhibiting products include plastic and paper packaging, liquids and coatings, rust removers and cleaners, diffusers and variations of these products designed specifically for the oil and gas industry. NTIC's also offers worldwide on-site technical consulting for rust and corrosion prevention issues. NTIC's technical service consultants work directly with the end users of NTIC's ZERUSTŪ rust and corrosion inhibiting products to analyze their specific needs and develop systems to meet their technical requirements. In North America, NTIC sells its ZERUSTŪ corrosion prevention solutions through a direct sales force as well as a network of independent distributors and agents. Internationally, NTIC sells its ZERUSTŪ corrosion prevention solutions through its majority owned subsidiary in Brazil, Zerust Prevenįão de Corrosão S.A. (Zerust Brazil), its majority owned joint venture holding company for NTIC's joint venture investments in the Association of Southeast Asian Nations (ASEAN) region, and joint venture arrangements in North America, Europe and Asia.

One of NTIC's strategic initiatives is to expand into and penetrate other markets for its ZERUSTŪ corrosion prevention solutions. Consequently, for the past several years, NTIC has focused its sales and marketing efforts on the oil and gas industry, as the infrastructure that supports that industry is typically constructed using metals that are highly susceptible to corrosion. NTIC believes that its ZERUSTŪ corrosion prevention solutions will minimize maintenance downtime on critical oil and gas industry infrastructure, extend the life of such infrastructure and reduce the risk of environmental pollution due to corrosion leaks.

NTIC markets and sells its ZERUSTŪ rust and corrosion prevention solutions to customers in the oil and gas industry across several countries either directly, through Zerust Brazil or through NTIC's joint venture partners and other strategic partners. The sale of ZERUSTŪ corrosion prevention solutions to customers in the oil and gas industry has typically involved a long sales cycle, often including a one- to multi-year trial period with each customer and a slow integration process thereafter.

Natur-TecŪ bio-based and biodegradable plastics are manufactured using NTIC's patented and/or proprietary technologies and are intended to replace conventional petroleum-based plastics. The Natur-TecŪ biopolymer resin compound portfolio include formulations that have been optimized for a variety of applications including blown-film extrusion, extrusion coating, injection molding, and engineered plastics. These resin compounds are fully biodegradable in a composting environment and are currently being used to produce finished products including shopping and grocery bags, lawn and leaf bags, can liners, pet waste collection bags, cutlery, packaging foam and coated paper products. In North America, NTIC markets its Natur-TecŪ resin compounds and finished products primarily through a network of regional and national distributors as well as independent agents. NTIC continues to see significant opportunities for finished bioplastic products and, therefore, continues to strengthen and expand its North American distribution network for finished Natur-TecŪ bioplastic products. Internationally, NTIC sells its Natur-TecŪ resin compounds and finished products both directly and through its recently formed majority owned subsidiary in India, Northern Technologies India Private Limited (NTI India), and some of its joint ventures.


In 2011, the Italian government passed legislation banning the use of non-biodegradable disposable plastic shopping bags. However, enforcement of this law, has been delayed for a number of reasons, including a recent legal challenge as to the validity of the ban in a European Union member country by the government of the United Kingdom. Consequently, NTIC's sales of Natur-TecŪ film grade resin compounds to Italy were adversely affected during fiscal 2013 and the first quarter of fiscal 2014. It is NTIC's understanding that these objections have now been addressed by the recently passed European Commission directive to reduce the consumption of lightweight plastic bags in the EU, and the ban on sale of non-biodegradable plastic shopping bags within Italy is expected to be implemented by early calendar 2014. NTIC expects its resin sales to customers in Italy to increase during the remainder of fiscal 2014 compared to the same period in fiscal 2013.

NTIC's Joint Venture Network

NTIC participates in 21 active joint venture arrangements in North America, Europe and Asia. Each of these joint ventures generally manufactures and markets products in the geographic territory to which it is assigned. While most of NTIC's joint ventures exclusively sell rust and corrosion inhibiting products, some of the joint ventures sell NTIC's Natur-TecŪ resin compounds. NTIC has historically funded its investments in joint ventures 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 NTIC's primary joint venture in Germany (EXCOR), NTIC recognizes an agreed upon quarterly fee for such services. NTIC recognizes equity income from its joint ventures based on the overall profitability of its joint ventures. Such profitability is subject to variability from quarter to quarter which, in turn, subjects NTIC's earnings to variability from quarter to quarter. The profits of NTIC's joint ventures are shared by the respective joint venture owners in accordance with their respective ownership percentages. NTIC typically directly or indirectly owns 50% or less of each 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 an equity consolidation of the investments and financial results of its 21 joint ventures in its financial statements utilizing the equity method of accounting.

The results of Zerust Brazil and NTI Asean are consolidated in NTIC's consolidated financial statements. NTIC holds 85% of the equity and 85% of the voting rights of Zerust Brazil. Beginning in the first quarter of fiscal 2013, NTIC consolidated the results of NTI Asean, which effective as of September 1, 2012 is a majority owned subsidiary of NTIC. NTIC holds 60% of the equity and 60% of the voting rights of NTI Asean. NTI Asean holds investments in eight entities that operate in the following eight territories located in the ASEAN region: China, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan and Thailand.

With respect to NTIC's joint ventures, NTIC considers EXCOR and China to be individually significant to NTIC's consolidated assets and income; and therefore, provides certain additional information regarding EXCOR and China in the notes to NTIC's consolidated financial statements and in this section of this report.


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: ZERUSTŪ products and services and Natur-TecŪ products.

NTIC's consolidated net sales increased 19.2% during the three months ended November 30, 2013 compared to the three months ended November 30, 2012. This increase was primarily a result of increased sales of ZERUSTŪ rust and corrosion inhibiting packaging products and services. During the three months ended November 30, 2013, 91.1% of NTIC's consolidated net sales were derived from sales of ZERUSTŪ products and services, which increased 19.9% to $5,749,013 during the three months ended November 30, 2013, compared to the same prior fiscal year period due to increased demand from existing customers and the addition of new customers. NTIC has focused its sales efforts of ZERUSTŪ 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 for the three months ended November 30, 2013 included $390,610 of sales made to customers in the oil and gas industry compared to $128,697 for the three months ended November 30, 2012. Overall demand for ZERUSTŪ products and services depends heavily on the overall health of the markets in which NTIC sells its products, including the automotive market in particular.

During the three months ended November 30, 2013, 8.9% of NTIC's consolidated net sales were derived from sales of Natur-TecŪ products compared to 9.4% during the three months ended November 30, 2012. Net sales of Natur-TecŪ products increased 12.8% during the three months ended November 30, 2013 compared to the three months ended November 30, 2012. This increase was due to improved sales to Natur-TecŪ distributors in the United States as NTIC has continued to strengthen and expand its U.S. industrial distribution. Additionally, NTIC has continued to target key national and regional retailers utilizing independent sales agents. Demand for the Natur-TecŪ products depends primarily on market acceptance and the extent of NTIC's distribution network.

Cost of goods sold as a percentage of net sales decreased to 65.9% during the three months ended November 30, 2013 compared to 69.8% during the three months ended November 30, 2012 primarily as a result of start-up costs associated with a new customer recognized during the three months ended November 30, 2012.

NTIC's equity in income of joint ventures increased 23.7% to $1,427,748 during the three months ended November 30, 2013 compared to $1,154,296 during the three months ended November 30, 2012. Additionally, fees for services provided to joint ventures increased 14.3% to $2,109,648 during the three months ended November 30, 2013 compared to $1,846,277 during the three months ended November 30, 2012. These increases were primarily a result of a 7.8% or $2,136,284, increase in total net sales of NTIC's joint ventures to $29,661,218 during the three months ended November 30, 2013 compared to $27,524,934 for the three months ended November 30, 2012. Total net sales of NTIC's joint ventures appear to be slightly improving from the depressed sales levels experienced as a result of the European economic slowdown over the past few years.

NTIC's total operating expenses increased to $4,174,166 during the three months ended November 30, 2013 compared to $3,727,684 for the three months ended November 30, 2012. This increase was primarily the result of an increase in selling expenses, general and administrative expenses and expenses incurred in support of joint ventures, and overall reflected NTIC's efforts to support its new business efforts.

NTIC expenses all costs related to product research and development as incurred. NTIC incurred $1,138,520 and $938,206 of expense during the three months ended November 30, 2013 and 2012, respectively, in connection with its research and development activities. These represent net amounts after being reduced by reimbursements related to certain research and development contracts of $45,788 and $68,682 during the three months ended November 30, 2013 and 2012, respectively. NTIC anticipates that it will spend between $3,800,000 and $4,000,000 in total during fiscal 2014 on research and development activities related to its new technologies. This estimate is a net range after being reduced by anticipated reimbursements related to certain research and development contracts.


Net income attributable to NTIC increased 120.4% to $858,586, or $0.19 per diluted common share, for the three months ended November 30, 2013 compared to $389,622, or $0.09 per diluted common share, for the three months ended November 30, 2012. This increase was primarily the result of increases in gross profit of NTIC's North American businesses and increases in joint venture operations. NTIC anticipates that its quarterly net income will remain subject to significant volatility primarily due to the financial performance of its joint ventures and sales of its ZERUSTŪ products and services into the oil and gas industry and Natur-TecŪ bioplastics products, which sales fluctuate more on a quarterly basis than the traditional ZERUSTŪ business.

NTIC's working capital was $13,222,558 at November 30, 2013, including $3,907,371 in cash and cash equivalents compared to $13,270,452 at August 31, 2013, including $4,314,258 in cash and cash equivalents. As of November 30, 2013, NTIC had a term loan with a principal amount of $914,384 outstanding from PNC Bank, National Association, which it repaid in full on January 3, 2014.

Results of Operations

The following tables set forth NTIC's results of operations for the three months
ended November 30, 2013 and 2012.

                                                                          Three Months Ended
                                      November 30,         % of          November 30,         % of             $            %
                                          2013           Net Sales           2012           Net Sales       Change        Change
Net sales, excluding joint
ventures                             $    5,605,018            88.8 %   $    4,770,387            90.1 %   $ 834,631         17.5 %
Net sales, to joint ventures                704,082            11.2 %          521,360             9.9 %     182,722         35.0 %
Cost of goods sold                        4,158,031            65.9 %        3,690,972            69.8 %     467,059         12.7 %
Equity in income of joint ventures        1,427,748            22.6 %        1,154,296            21.8 %     273,452         23.7 %
Fees for services provided to
joint ventures                            2,109,648            33.4 %        1,846,277            34.9 %     263,371         14.3 %
Selling expenses                          1,318,886            20.9 %        1,171,095            22.1 %     147,791         12.6 %
General and administrative
expenses                                  1,387,496            22.0 %        1,248,696            23.6 %     138,800         11.1 %
Expenses incurred in support of
joint ventures                              329,264             5.2 %          369,687             7.0 %     (40,423 )      (10.9 )%
Research and development expenses         1,138,520            18.0 %          938,206            17.7 %     200,314         21.4 %

Net Sales. NTIC's consolidated net sales increased 19.2% to $6,309,100 during the three months ended November 30, 2013 compared to the three months ended November 30, 2012. NTIC's consolidated net sales to unaffiliated customers excluding NTIC's joint ventures increased 17.5% to $5,605,018 during the three months ended November 30, 2013 compared to the same prior fiscal year period. This increase was primarily a result of increased sales of ZERUSTŪ rust and corrosion inhibiting packaging products and services and Natur-TecŪ products. Net sales to joint ventures increased 35.0% to $704,082 during the three months ended November 30, 2013 compared to the same prior fiscal year period. This increase partially correlated with the 7.8% increase in total net sales of NTIC's joint ventures for the three months ended November 30, 2013 compared to the same prior fiscal year period.

The following table sets forth NTIC's net sales by product category for the three months ended November 30, 2013 and 2012 by segment:

                                              Three Months Ended
                          November 30,       November 30,           $             %
                              2013               2012            Change        Change
Total ZERUSTŪ sales      $    5,749,013     $    4,795,283     $   953,730        19.9 %
Total Natur-TecŪ sales          560,087            496,464          63,623        12.8 %
Total net sales          $    6,309,100     $    5,291,747     $ 1,017,353        19.2 %


During the three months ended November 30, 2013, 91.1% of NTIC's consolidated net sales were derived from sales of ZERUSTŪ products and services, which increased 19.9% to $5,749,013 during the three months ended November 30, 2013 compared to $4,795,283 during the same prior fiscal year period, due primarily from increased demand from existing customers and the addition of new customers. NTIC has strategically focused its sales efforts for ZERUSTŪ products and services on customers with sizeable corrosion problems in industry sectors that offer sizable growth opportunities, including the oil and gas sector. The following table sets forth NTIC's net sales of ZERUSTŪ products for the three months ended November 30, 2013 and 2012:

                                                      Three Months Ended
                                   November 30,       November 30,          $            %
                                       2013               2012           Change       Change
ZERUSTŪ industrial net sales      $    4,656,839     $    4,145,226     $ 511,613        12.3 %
ZERUSTŪ joint venture net sales          701,564            521,360       180,204        34.6 %
ZERUSTŪ oil & gas net sales              390,610            128,697       261,913       203.5 %
Total ZERUSTŪ net sales           $    5,749,013     $    4,795,283     $ 953,730        19.9 %

NTIC anticipates that its sales of ZERUSTŪ 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.

During the three months ended November 30, 2013, 8.9% of NTIC's consolidated net sales were derived from sales of Natur-TecŪ products, which increased 12.8% to $560,087 during the three months ended November 30, 2013 compared to the three months ended November 30, 2012. This increase was due primarily to increased sales to NTIC's Natur-TecŪ distributors in the United States. Additionally, NTIC continues to target key regional and national retailers through independent sales agents. Demand for Natur-TecŪ products depends primarily on market acceptance and the reach of NTIC's distribution network. Because of the typical size of individual orders and overall size of NTIC's net sales derived from sales of Natur-TecŪ products, the timing of one or more orders can affect materially NTIC's quarterly sales of Natur-TecŪ products and the comparisons to prior year quarters.

Cost of Goods Sold. Cost of goods sold increased 12.7% for the three months ended November 30, 2013 compared to the three months ended November 30, 2012 primarily as a result of increased net sales as described above. Cost of goods sold as a percentage of net sales decreased to 65.9% for the three months ended November 30, 2013 compared to 69.7% for the three months ended November 30, 2012 primarily as a result of start-up costs associated with a new customer incurred during the three months ended November 30, 2012.

Equity in Income of Joint Ventures. NTIC's equity in income of joint ventures increased 23.7% to $1,427,748 during the three months ended November 30, 2013 compared $1,154,296 during the three months ended November 30, 2012 primarily as a result of a 7.8% increase in total net sales of NTIC's joint ventures during the three months ended November 30, 2013 compared to the three months ended November 30, 2012. Of the total equity in income of joint ventures, NTIC had equity in income of joint ventures of $926,654 attributable to EXCOR during the three months ended November 30, 2013 compared to $785,187 during the three months ended November 30, 2012. Of the total equity in income of joint ventures, NTIC had equity in income of joint ventures of $149,354 attributable to its joint venture in China during the three months ended November 30, 2013 compared to $147,001 during the three months ended November 30, 2012. NTIC had equity in income of all other joint ventures of $351,740 during the three months ended November 30, 2013 compared to $222,108 during the three months ended November 30, 2012.

Fees for Services Provided to Joint Ventures. NTIC recognized fee income for services provided to joint ventures of $2,109,648 during the three months ended November 30, 2013 compared to $1,846,277 during the three months ended November 30, 2012, representing an increase of $263,371, or 14.3%. This increase was primarily a result of the 7.8% increase in total net sales of NTIC's joint ventures to $29,661,218 during the three months ended November 30, 2013 compared to $27,524,934 for the three months ended November 30, 2012. Sales of NTIC's joint ventures 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 $588,182 and $263,555 were attributable to NTIC's joint venture in China and EXCOR, respectively, during the three months ended November 30, 2013 compared to $493,312 and $242,700 attributable to China and EXCOR during the three months ended November 30, 2012. The increase in fee income for services provided to joint ventures attributable to NTIC's joint venture in China was primarily the result of increased sales during the most recent period and the decrease in fee income for services provided to joint ventures attributable to EXCOR was primarily the result of foreign currency exchange rate fluctuations.


Selling Expenses. NTIC's selling expenses increased 12.6% for the three months ended November 30, 2013 compared to the same period in fiscal 2013 due to increases in compensation and employee benefits, lab testing related expenses, commission expenses, travel and related expenses, and consulting expenses and selling expenses incurred at Zerust Brazil. Selling expenses as a percentage of net sales decreased slightly to 20.9% for the three months ended November 30, 2013, from 22.1% during the three months ended November 30, 2012 due primarily to the increase in net sales, partially offset by the increase in fixed selling expenses as previously described.

General and Administrative Expenses. NTIC's general and administrative expenses increased 11.1% for the three months ended November 30, 2013 compared to the same period in fiscal 2012 due to an increase in consulting and service expenses. As a percentage of net sales, general and administrative expenses decreased to 22.0% for the three months ended November 30, 2013 from 23.6% for the three months ended November 30, 2012 due primarily to the increase in net sales, partially offset by the increase in fixed general and administrative expenses as previously described.

Expenses Incurred in Support of Joint Ventures. Expenses incurred in support of NTIC's joint ventures were $329,264 during the three months ended November 30, 2013 compared to $369,687 during the three months ended November 30, 2012, representing a decrease of 10.9%.

Research and Development Expenses. NTIC's research and development expenses increased 21.4% for the three months ended November 30, 2013 compared to the same period in fiscal 2012. The increase was primarily due to compensation and benefit expenses associated with increased headcount and an increase in consulting expenses, partially offset by reimbursements related to certain research and development contracts.

Interest Income. NTIC's interest income decreased to $1,789 during the three months ended November 30, 2013 compared to $25,346 during the three months ended November 30, 2012.

Interest Expense. NTIC's interest expense increased to $13,670 during the three months ended November 30, 2013 compared to $6,474 during the three months ended November 30, 2012.

Income Before Income Tax Expense. Income before income tax expense increased to $1,502,418 for the three months ended November 30, 2013 compared to $892,536 for the three months ended November 30, 2012.

Income Tax Expense. Income tax expense was $198,000 during the three months ended November 30, 2013 compared to $134,000 during the three months ended November 30, 2012. Income tax expense was calculated based on management's estimate of NTIC's annual effective income tax rate. NTIC's annual effective income tax rate during the three months ended November 30, 2013 and 2012 was lower than the statutory rate primarily due to NTIC's equity in income of joint ventures being recognized based on after-tax earnings of these entities. To the extent undistributed earnings of NTIC's joint ventures are distributed to NTIC, it is not expected to result in any material additional income tax liability after the application of foreign tax credits. NTIC records a tax valuation allowance when it is more likely than not that some portion or all of its deferred tax assets will not be realized to reduce deferred tax assets to the amount expected to be realized. NTIC determined based on all available evidence, including historical data and projections of future results, that it is more likely than not that all of its deferred tax assets, except for its foreign tax credit carryforwards and Minnesota state research and development credit carryforwards, will be fully realized. In addition, NTIC determined based upon all available evidence, including new IRS guidance, historical results, projected future taxable income and foreign tax credit utilization, that it was not more likely than not that the federal research and development credits would be utilized during the carryforward period and as a result, a valuation allowance was recorded against all of NTIC's federal research and development . . .

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