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SMGI > SEC Filings for SMGI > Form 10-K on 28-Mar-2014All Recent SEC Filings

Show all filings for SMG INDIUM RESOURCES LTD.

Form 10-K for SMG INDIUM RESOURCES LTD.


28-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations

The following discussion and analysis of our results of operations and financial condition should be read in conjunction with our financial statements and related notes appearing elsewhere in this report. This discussion and analysis contains forward looking statements that involve risks, uncertainties and assumptions. The actual results may differ materially from those anticipated in these forwarding looking statements as a result of certain factors, including but not limited to, those which are not within our control.

Overview

We were formed under the laws of the State of Delaware on January 7, 2008. In November, 2012, our board of directors and stockholders approved an amendment to our certificate of incorporation to reduce our authorized shares from 40,000,000 to 25,000,000. Since inception, our primary business purpose has been to stockpile indium, a specialty metal that is being increasingly used as a raw material in a wide variety of consumer electronics manufacturing applications. We have also lent, leased and sold indium when management believed it was advantageous. In December 2013, our board of directors authorized management to sell our entire stockpile over the next twelve months based on prevailing market conditions. As a result, we currently do not anticipate purchasing any additional indium. Further, we have entered into a supply agreement with one of our customers to sell, over a twelve-month period in 2014, approximately 78% of our stockpile at December 31, 2013. We have begun evaluating strategic options including the merger or acquisition of a new line of business or the sale or full liquidation of the Company.

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 a 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, LP and Raging Capital Fund (QP), LP, for an aggregate purchase price of $7.5 million. In January 2013, substantially all of the assets of Raging Capital Fund LP and Raging Capital Fund (QP), LP were transferred to Raging Capital Master Fund, Ltd. Raging Capital Management, LLC is the general partner of Raging Capital Master Fund, Ltd. and the entity represents our largest stockholder(s). Such entities are affiliated and controlled by William C. Martin, our director and member of the Manager, Specialty Metals Group Advisors LLC.

All of the indium we purchased and own (except for inventory that is at a customer location) 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. The 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 December 31, 2013, we owned approximately 31.7 mt of indium for an aggregate original cost (prior to any lower of cost or market adjustment) of approximately $15.3 million. Our stockpile is currently stored in a secure insured bonded warehouse facility located in New York owned by Brink's except for 7.0 mt that is stored at customer locations at December 31, 2013. The Brink's 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 we deem the warehouse company's insurance inadequate.

Our expenses will be required to be satisfied by cash on hand at December 31, 2013 of approximately $2.1 million. Cash on hand is expected to be sufficient to satisfy our estimated expenses of approximately $1.2 million in 2014. Our Board of Directors, in December 2013 authorized the Manager to sell our entire indium stockpile to cover our cash needs to fund our corporative initiatives. Our Board of Directors approved in 2013 a stock repurchase plan for up to $3.0 million of our securities of which we have acquired 270,304 common shares for an aggregate of $0.7 million. We may suspend this program based on the Manager's assessment of our cash availability. We may seek to raise additional capital to cover our corporate strategies through potentially dilutive equity offerings or debt financing.

Without increases in the price of indium sufficient to compensate for decreases caused by operating expenses and any decreases resulting from the sale of indium, our NMV may also decline. The price of indium would need to appreciate substantially to offset the reduction in our NMV due to our cash operating expenses. Based on our current stockpile of approximately 31.7 mt of indium, the price of indium would need to appreciate approximately $39 per kilogram in 2014 to offset the potential reduction in NMV as a result of projected annual operating expenses of $1.2 million. NMV at December 31, 2013 was $2.59 per common share based on the spot price of indium at December 31, 2013 of $675 per kilogram. Our traded market price of our common stock was $1.66 representing a 36% discount from NMV. Our book value per share was $1.88 as adjusted for lower of cost or market write-downs for certain lots in inventory to $482 per kilogram.

The annual average price of indium, as published by Metal Bulletin and posted on Bloomberg L.P., increased from $528 per kilogram in 2012 to $594 per kilogram in 2013, an increase of 12.5%. In 2013, indium traded at a range of $450 per kilogram to $720 per kilogram and ended the year at $675 per kilogram, which represented an increase of 39% from $485 per kilogram, the price of indium at December 31, 2012. Indium decreased from $696 per kilogram in 2011 to $528 per kilogram in 2012; a decline of 24.1%. In 2012, indium traded in a range from $450 per kilogram to $600 per kilogram and ended the year at $485 per kilogram, which represented a decrease of 14.9% from the closing price of $570 per kilogram at the end of 2011.

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 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) 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 December 31, 2013.

Share-Based Payment Arrangements

We measure the cost of employee 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 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. The stockpile of the physical metal indium was classified as noncurrent through December 31, 2012 as our primary business purpose was to stockpile indium with the objective of achieving long-term appreciation in the value of indium, if any. At December 31, 2013, our entire indium stockpile was reclassified to current assets due to the fact that during the next twelve months we intend to sell up to 100% of the indium stockpile to satisfy our cash requirements for our corporate initiatives based on prevailing market conditions.

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. 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. At 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 December 31, 2013, the spot price of indium was $675 and, accordingly, no lower of cost or market adjustments to inventory were recorded in 2013. 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. At December 31, 2013, the aggregate write down against inventory was approximately $4.0 million. The reduction in the write-down of indium in 2013 was due to the sale of certain lots of inventory 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 and due to the fact that there is uncertainty that these assets will be realized because we cannot predict at what prices we will be able to liquidate our indium stockpile in future years. 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, Lending and Lease 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 or determinable and collectability is reasonably assured. Cost of sales is recorded for the indium carrying value based on a specific-identification method. Allowances, if any, are recorded based on management's best estimate for uncollectible accounts. There is no right of return. Under indium lending transactions, we 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 simultaneously enter into an agreement with such counterparty in which it unconditionally commits to purchase and the counterparty unconditionally commits 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 also contains terms providing the counterparty with 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 is 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 balance sheet at December 31, 2013. Indium "lease" transactions are generally for a period of less than one year. Under the lease, a specified amount of indium is leased to the customer for a period of time. At the end of the lease, the lessee is obligated to return indium of the equivalent quantity and purity of the indium that was delivered to the lessee at the beginning of the lease. In certain circumstances, we may sell indium to the counterparty in a USPA or to the lessee in a lease transaction at a negotiated price. The monthly rental income is recorded as other income over the term of the lease.

Recently Issued Accounting Pronouncements

In July 2013, the Financial Accounting Standard Board (FASB) issued Accounting Standard Update (ASU) 2013-11, "Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carry-forward, a Similar Tax Loss, or a Tax Credit Carry-forward Exists." This ASU will eliminate the diversity in practice in presentation of unrecognized tax benefits when a net operating loss carry-forward, a similar tax loss, or a tax credit carry-forward exists at the reporting date. This new guidance requires the netting of unrecognized tax benefits against a deferred tax asset for a loss or other carry-forward that would apply in settlement of the uncertain tax positions. Under the new guidance, unrecognized tax benefits will be netted against all available same-jurisdiction loss or other tax carry-forward that would be utilized, rather than only against carryforwards that are created by the unrecognized tax benefits. This guidance is effective prospectively, but allows optional retrospective adoption (for all periods presented), for reporting periods beginning after December 15, 2013. As this guidance relates to presentation only, the adoption of this guidance will not impact our financial position or results of operations.

The FASB recently issued ASU "Presentation of Financial Statements (Topic 205) Liquidation Basis of Accounting" (ASU 2013-07) that requires an entity to prepare its financial statements using the liquidation basis of accounting when liquidation is imminent, as defined in ASU 2013-7. ASU 2013-7's objective is to eliminate diverse practices by providing guidance about when and how to apply the model. The guidance applies to all entities except for investment companies regulated under the Investment Company Act of 1940. Since there is no imminent plan to liquidate the Company, this ASU does not apply.

Results of Operations

Year 2013 compared to Year 2012

The results of operations for the years ended December 31, 2013 and 2012 are as follows:

                                                        For the Year Ended December 31,
                                                           2013                 2012
Net sales                                            $      9,505,044    $                -
Cost of sales, including inventory-write down               7,420,792             2,700,553
Gross profit (loss)                                         2,084,252           (2,700,553)

Operating costs:
Operating expenses - Manager - related party                  626,565               620,349
Other selling, general and administrative expenses            607,048               627,453
Total operating costs                                       1,233,613             1,247,802

Operating income (loss)                                       850,639           (3,948,355)

Other income:
Interest income                                                14,882                22,802
Other income                                                  141,501                38,890
Net income (loss) before income taxes                       1,007,022           (3,886,663)
Income tax expense                                           (25,000)                     -
Net income (loss)                                    $        982,022    $      (3,886,663)

Net Income (Loss) Per Share
Basic                                                $           0.11    $           (0.44)
Diluted                                              $           0.11    $           (0.44)

Weighted Average Number of Shares Outstanding
Basic                                                       8,781,501             8,810,035
Diluted                                                     8,811,016             8,810,035

Year ended December 31, 2013 compared to December 31, 2012 comparable period

For the year ended December 31, 2013, net sales were approximately $9.5 million. Cost of sales was approximately $7.4 million resulting in gross profit of approximately $2.1 million or 22%. There were no sales in the comparable period in 2012. Cost of sales, including non-cash inventory write-downs of approximately $2.7 million in the 2012 period was due to a lower of cost or market write-downs of certain lots in indium inventory as a result of the decline in the spot price of indium from $570 per kilogram at the end of the 2011 to $485 per kilogram at the end of 2012. The spot price of indium at December 31, 2013 was $675 per kilogram, as published by Metal Bulletin and posted on Bloomberg L.P. As a result, there was no lower of cost or market adjustments in the 2013, 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 both the year ended December 31, 2013 and 2012, total operating costs were approximately $1.2 million. Manager expenses for both 2013 and 2012 were approximately $0.6 million. Other selling, general and administrative expenses declined approximately 3% due to lower professional fees offset in part by higher CFO compensation. Interest income decreased approximately $8 thousand in 2013 when compared to the same period in 2012 principally as a result of lower cash available to invest. During the year ended December 31, 2013, there was approximately $142 thousand in other income representing the aggregate income relating to indium USPA and lease transactions compared to approximately $39 thousand in the 2012 period. The increase was primarily due to the lease transaction in the 2013 period. There was no lease transaction in the 2012 period.

Income taxes of approximately $25 thousand was provided for in the year ended December 31, 2013 for the alternative minimum tax that is not offset by net operating loss carryforwards based on our estimated tax rate for 2013. There were no income taxes in 2012 due to the company's operating losses.

For the year ended December 31, 2013, we reported net income of approximately $1.0 million (or $0.11 per basic and diluted share) as compared with a net loss for the year ended December 31, 2012 of approximately ($3.9) million (or ($0.44) per basic and diluted share). The improvement of approximately $4.9 million in net income was due principally to the approximate $2.1 million of gross profit on net sales in 2013 and the fact that there was no lower of cost or market write-down to inventory in the 2013 period. As mentioned above, the year ended December 31, 2012 included an approximate $2.7 million non-cash inventory write-down. The basic weighted average number of common shares outstanding was 8,781,501 in the year ended December 31, 2013 compared to 8,810,035 in the 2012 period. The decrease was due to the weighted average effect of our purchases of treasury shares.

Our current estimate of our operating expenses for 2014 is approximately $1.2 million. We no longer expect our operating expenses to change significantly based on changes to our NMV as our manager fee is now fixed under an amendment to the MSA.

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 us at any given point
by the spot price for indium as published by the Metal Bulletin as posted on
Bloomberg L.P., plus cash and our other 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:

                                                                 December 31,
                                                              2013           2012
U.S. GAAP net book value                                  $ 16,063,538   $ 28,635,908
Excess of the indium at spot price over GAAP book value      6,105,148        122,689
NMV                                                       $ 22,168,686   $ 28,758,597

The reason why the Company relies on this term is because:

it is a measurement of the current value of our 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 stockholders in evaluating how we are doing relative to the indium purchased by us when compared to the current market prices for indium as published by Metal Bulletin on Bloomberg L.P.;

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

to provide 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 stockholders and potential investors to evaluate how management has done 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 our indium stockpile.

No assurances can be given that we could liquidate our indium holdings at the market prices published by Metal Bulletin as posted on Bloomberg L.P.

Liquidity and Capital Resources

Since our inception and through December 31, 2013, we have incurred accumulated deficits of approximately $10.4 million of which approximately $2.4 million was due to a non-cash preferential dividend to Class A Common Stockholders in 2011. Of the approximate $8.0 million in remaining net losses, approximately $5.9 million represents non-cash charges for the write down of our indium inventory due to declines in the spot price of indium in prior years with the balance of accumulated net losses due primarily to our operating expenses. In 2013, we began selling indium and as a result of the gross profit on sales, we earned net income of approximately $1.0 million.

Our NMV at December 31, 2013 was calculated using the spot price of indium of $675 per kilogram at December 31, 2013. The spot price of indium on March 19, 2014 was $750 per kilogram.

As of December 31, 2013, we have cash and cash equivalents of approximately $2.1 million compared to cash and cash equivalents of approximately $6.2 million at December 31, 2012. The decrease of approximately $4.1 million was due primarily to approximately $12.9 million of cash distributions to stockholders offset in part by approximately $9.5 million in cash from operations in 2013. Our primary source of funds has been from the public and private sale of equity securities. In May 2011, we raised net proceeds of approximately $24.0 million in connection with our IPO and in January 2012, we raised net proceeds of $7.5 million from the 2012 Private Placement (see note 3 of notes to financial statements).

. . .

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