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NTIC > SEC Filings for NTIC > Form 10-Q on 11-Apr-2014All Recent SEC Filings

Show all filings for NORTHERN TECHNOLOGIES INTERNATIONAL CORP

Form 10-Q for NORTHERN TECHNOLOGIES INTERNATIONAL CORP


11-Apr-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 certain joint ventures.


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 accounts for 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, NTI India and NTI Asean are fully 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. As of February 28, 2014 NTIC consolidated the results of NTI India, which effective as of December 1, 2013 is a majority owned subsidiary. NTIC holds 90% of the equity and 90% of the voting rights of NTI India

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 18.5% and 18.9% during the three and six months ended February 28, 2014, respectively, compared to the three and six months ended February 28, 2013. These increases were primarily a result of increased demand for ZERUSTŪ rust and corrosion inhibiting packaging products and services and Natur-TecŪ products. During the three and six months ended February 28, 2014, 89.3% and 90.2% of NTIC's consolidated net sales, respectively, were derived from sales of ZERUSTŪ products and services, which increased 17.9% and 18.9% to $5,555,051 and $11,304,064 during the three and six months ended February 28, 2014, respectively, compared to $4,710,412 and $9,505,695 during the three and six months ended February 28, 2013, respectively, due to increased demand from both new and existing 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 six months ended February 28, 2014 included $792,720 of sales made to customers in the oil and gas industry compared to $374,790 for the prior fiscal year period. 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 and six months ended February 28, 2014, 10.7% and 9.8%, of NTIC's consolidated net sales were derived from sales of Natur-TecŪ products compared to 10.2% and 9.8% during the three and six months ended February 28, 2013, respectively. Net sales of Natur-TecŪ products increased 23.9% and 18.6% during the three and six months ended February 28, 2014 compared to the three and six months ended February 28, 2013, respectively. These increases were primarily due to finished product sales through NTIC's newly formed majority owned subsidiary in India, Northern Technologies India Private Limited (NTI India).

Cost of goods sold as a percentage of net sales decreased to 65.2% during the three months ended February 28, 2014 compared to 69.3% during the three months ended February 28, 2013 and decreased to 65.5% during the six months ended February 28, 2014 compared to 69.5% during the prior fiscal year period. These decreases were primarily as a result of start-up costs associated with a new customer recognized during the prior fiscal year period.

NTIC's equity in income of joint ventures increased 22.6% and 23.1% to $1,395,451 and $2,823,199, respectively, during the three and six months ended February 28, 2014 compared to $1,138,438 and $2,292,734 during the three and six months ended February 28, 2013, which increases were primarily a result of increases in sales at the joint ventures.

NTIC recognized a 16.2% and 15.2% increase in fees for services provided to joint ventures during the three and six months ended February 28, 2014 compared to the three and six months ended February 28, 2013, respectively. These increases were primarily a result of increases in sales at the joint ventures as fees for services provided are a function of the net sales of NTIC's joint ventures, which were $28,389,158 and $58,050,376 during the three and six months ended February 28, 2014 compared to $26,722,201 and $54,247,135 for the three and six months ended February 28, 2013. 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 11.8%, or $861,644, to $8,141,229 during the six months ended February 28, 2014 compared to the six months ended February 28, 2013. 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 $2,237,865 and $1,850,599 of expense during the six months ended February 28, 2014 and 2013, 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. Such reimbursements totaled $45,788 and $137,364 for the six months ended February 28, 2014 and 2013, 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 136.0%, to $1,025,044, or $0.22 per diluted common share, for the three months ended February 28, 2014 compared to $434,410, or $0.10 per diluted common share, for the three months ended February 28, 2013. Net income attributable to NTIC increased 128.6%, to $1,883,630, or $0.41 per diluted common share, for the six months ended February 28, 2014 compared to $824,032, or $0.18 per diluted common share, for the six months ended February 28, 2013. These increases were 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 $17,690,903 at February 28, 2014, including $6,996,127 in cash and cash equivalents compared to $13,270,452 at August 31, 2013, including $4,314,258 in cash and cash equivalents.

Results of Operations

The following tables set forth NTIC's results of operations for the three and
six months ended February 28, 2014 and 2013.

                                                                            Three Months Ended
                                       February 28,         % of          February 28,         % of              $              %
                                           2014           Net Sales           2013           Net Sales        Change         Change
Net sales, excluding joint ventures   $    5,527,366            88.9 %   $    4,485,203            85.5 %   $ 1,042,163          23.2 %
Net sales, to joint ventures                 691,642            11.1 %          761,147            14.5 %       (69,505 )        (9.1 )%
Cost of goods sold                         4,051,833            65.2 %        3,633,913            69.3 %       417,920          11.5 %
Equity in income of joint ventures         1,395,451            22.4 %        1,138,438            21.7 %       257,013          22.6 %
Fees for services provided to joint
ventures                                   2,057,671            33.1 %        1,770,881            33.8 %       286,790          16.2 %
Selling expenses                           1,291,316            20.8 %        1,174,065            22.4 %       117,251          10.0 %
General and administrative expenses        1,209,933            19.5 %        1,143,987            21.8 %        65,946           5.8 %
Expenses incurred in support of
joint ventures                               366,469             5.9 %          321,456             6.1 %        45,013          14.0 %
Research and development expenses          1,099,345            17.7 %          912,393            17.4 %       186,952          20.5 %



                                                                            Six Months Ended
                                     February 28,         % of          February 28,         % of              $              %
                                         2014           Net Sales           2013           Net Sales        Change         Change
Net sales, excluding joint
ventures                             $  11,132,384            88.9 %   $    9,255,590            87.8 %   $ 1,876,794          20.3 %
Net sales, to joint ventures             1,395,724            11.1 %        1,282,507            12.2 %       113,217           8.8 %
Cost of goods sold                       8,209,864            65.5 %        7,324,885            69.5 %       884,979          12.1 %
Equity in income of joint ventures       2,823,199            22.5 %        2,292,734            21.8 %       530,465          23.1 %
Fees for services provided to
joint ventures                           4,167,319            33.3 %        3,617,158            34.3 %       550,161          15.2 %
Selling expenses                         2,610,202            20.8 %        2,345,160            22.3 %       265,042          11.3 %
General and administrative
expenses                                 2,597,429            20.7 %        2,392,683            22.7 %       204,746           8.6 %
Expenses incurred in support of
joint ventures                             695,733             5.6 %          691,143             6.6 %         4,590           0.7 %
Research and development expenses        2,237,865            17.9 %        1,850,599            17.6 %       387,266          20.9 %

Net Sales. NTIC's consolidated net sales increased 18.5% and 18.9% to $6,219,008 and $12,528,108, respectively, during the three and six months ended February 28, 2014 compared to the three and six months ended February 28, 2013. NTIC's consolidated net sales excluding NTIC's joint ventures increased 23.2% and 20.3% to $5,527,366 and $11,132,384, respectively, during the three and six months ended February 28, 2014 compared to the same respective prior fiscal year periods. These increases were primarily a result of increased demand and sales of ZERUSTŪ rust and corrosion inhibiting packaging products and services and Natur-TecŪ products. Net sales to joint ventures decreased 9.1% and increased 8.8% to $691,642 and $1,395,724 during the three and six months ended February 28, 2014, respectively, compared to the same respective prior fiscal year periods. These changes were primarily due to timing differences with orders placed with our joint ventures.

The following table sets forth NTIC's net sales by product category for the three and six months ended February 28, 2014 and 2013 by segment:

                          Three Months Ended                    Six Months Ended
                    February 28,       February 28,      February 28,      February 28,
                        2014               2013              2014              2013
ZERUSTŪ sales      $    5,555,051     $    4,710,412     $  11,304,064     $   9,505,695
Natur-TecŪ sales          663,957            535,938         1,224,044         1,032,402
Total net sales    $    6,219,008     $    5,246,350     $  12,528,108     $  10,538,097


During the three and six months ended February 28, 2014, 89.3% and 90.2% of NTIC's consolidated net sales, respectively, were derived from sales of ZERUSTŪ products and services, which increased 17.9% and 18.9% to $5,555,051 and $11,304,064 during the three and six months ended February 28, 2014, respectively, compared to $4,710,412 and $9,505,695 during the three and six months ended February 28, 2013, respectively, due to 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 and six months ended February 28, 2014 and 2013:

                                                                        Three Months Ended
                                                    February 28,       February 28,          $            %
                                                        2014               2013           Change        Change
ZERUSTŪ industrial net sales                       $    4,463,169     $    3,705,937     $ 757,232         20.4 %
ZERUSTŪ joint venture net sales                           689,772            758,382       (68,610 )       (9.0 )%
ZERUSTŪ oil & gas net sales                               402,110            246,093       156,017         63.4 %
Total ZERUSTŪ net sales                            $    5,555,051     $    4,710,412     $ 844,639         17.9 %



                                                                         Six Months Ended
                                                   February 28,       February 28,           $             %
                                                       2014               2013            Change        Change
ZERUSTŪ industrial net sales                       $   9,120,008     $    7,851,163     $ 1,268,845        16.2 %
ZERUSTŪ joint venture net sales                        1,391,336          1,279,742         111,594         8.7 %
ZERUSTŪ oil & gas net sales                              792,720            374,790         417,930       111.5 %
Total ZERUSTŪ net sales                            $  11,304,064     $    9,505,695     $ 1,798,369        18.9 %

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 recognized.

During the three and six months ended February 28, 2014, 10.7% and 9.8% of NTIC's consolidated net sales, respectively, were derived from sales of Natur-TecŪ products, which increased 23.9% and 18.6% to $663,957 and $1,224,044 during the three and six months ended February 28, 2014, respectively, compared to the three and six months ended February 28, 2013. These increases were 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 fiscal year quarters.

Cost of Goods Sold. Cost of goods sold increased 11.5% and 12.1% for the three and six months ended February 28, 2014, respectively, compared to the three and six months ended February 28, 2013 primarily as a result of increased net sales as described above. Cost of goods sold as a percentage of net sales decreased to 65.2% during the three months ended February 28, 2014 compared to 69.3% the three months ended February 28, 2013 and decreased to 65.5% during the six months ended February 28, 2014 compared to 69.5% during the six months ended February 28, 2013. These decreases were primarily the result of start-up costs associated with a new customer incurred during the prior fiscal year periods.

Equity in Income of Joint Ventures. NTIC's equity in income of joint ventures increased 22.6% and 23.1% to $1,395,451 and $2,823,199 during the three and six months ended February 28, 2014, respectively, compared to equity in income of joint ventures of $1,138,438 and $2,292,734 during the three and six months ended February 28, 2013, respectively, primarily as a result of increases in sales at the joint ventures. Of the total equity in income of joint ventures, NTIC had equity in income of joint ventures of $1,881,705 attributable to EXCOR during the six months ended February 28, 2014 compared to $1,631,125 attributable to EXCOR during the six months ended February 28, 2013. Of the total equity in income of joint ventures, NTIC had equity in income of joint ventures of $276,948 attributable to NTIC's joint venture in China during the six months ended February 28, 2014 compared to $262,148 attributable to NTIC's joint venture in China during the six months ended February 28, 2013. NTIC had equity in income of all other joint ventures of $664,546 during the six months ended February 28, 2014 compared to $399,461 during the six months ended February 28, 2013.


Fees for Services Provided to Joint Ventures. NTIC recognized fee income for services provided to joint ventures of $2,057,671 and $4,167,319 during the three and six months ended February 28, 2014, respectively, compared to $1,770,881 and $3,617,158 during the three and six months ended February 28, 2013, respectively, representing an increase of 16.2% and 15.2%, respectively. Fee income for services provided to joint ventures are a function of the sales made by the various joint ventures of $28,389,158 and $58,050,376 during the three and six months ended February 28, 2014 compared to $26,722,201 and $54,247,135 for the three and six months ended February 28, 2013, respectively. Total net sales of NTIC's joint ventures for the prior fiscal year periods were adversely affected in part by the European economic slowdown, which NTIC believes also adversely affected net sales of certain of NTIC's other non-European joint ventures, as well as the weakening of the EURO and other currencies compared to the U.S. dollar. 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 joint ventures, fees of $527,111 were attributable to EXCOR during the six months ended February 28, 2014 compared to $492,213 attributable to EXCOR during the six months ended February 28, 2013. Fees of $1,111,633 were attributable to NTIC's joint venture in China during the six months ended February 28, 2014 compared to $943,897 during the six months ended February 28, 2013.

Selling Expenses. NTIC's selling expenses increased 10.0% and 11.3% for the three and six months ended February 28, 2014 compared to the same respective periods in fiscal 2014 due to increases in compensation and employee benefits, lab testing related expenses, commission expenses, travel and related expenses, and consulting expenses. Selling expenses as a percentage of net sales decreased slightly to 20.8% and 20.8% for the three and six months ended February 28, 2014, from 22.4% and 22.3% and during the three and six months ended February 28, 2013.

General and Administrative Expenses. NTIC's general and administrative expenses increased 5.8% and 8.6% for the three and six months ended February 28, 2014 compared to the same respective periods in fiscal 2013 due to increases in consulting expenses to support new business development. As a percentage of net sales, general and administrative expenses decreased to 19.5% and 20.7% for the three and six months ended February 28, 2014 from 21.8% and 22.7% for the three and six months ended February 28, 2013.

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