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SMGI > SEC Filings for SMGI > Form 10-Q on 14-May-2014All Recent SEC Filings

Show all filings for SMG INDIUM RESOURCES LTD.

Form 10-Q for SMG INDIUM RESOURCES LTD.


14-May-2014

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, but 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 sell indium, lack of any internationally recognized exchanges for indium, limited number of potential customers who purchase 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 ("NMV"), 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 Annual Report on Form 10-K for the year ended December 31, 2013, as filed with the SEC.

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 in 2014 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 that existed at December 31, 2013. We have begun evaluating strategic options including the acquisition of a new line of business or the sale or full liquidation of the Company. However, there can be no assurance that we will enter into any such transaction, and if so, on terms favorable to us.

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 March 31, 2014, we owned approximately 21.0 mt of indium for an aggregate original cost (prior to any lower of cost or market adjustment) of approximately $12.6 million. Our stockpile is currently stored in a secure insured bonded warehouse facility located in New York owned by Brink's, except for indium that is stored at customer locations at March 31, 2014. 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.

At March 31, 2014, we had cash and cash equivalents of approximately $6.4 million which we believe will be sufficient to fund operations and any purchases of our common stock for at least the next twelve months. Our expenses will be required to be satisfied by cash on hand. Our annual cash operating expenses, including manager fees and income taxes, 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 of which $2.3 million remains available for repurchase under the program.

At March 31, 2014, the spot price of indium was $745 per kilogram, representing an increase of 10% from the spot price of $675 per kilogram at December 31, 2013 and 54% from the spot price of $485 at December 31, 2012. However, the annual average price of indium had decreased approximately 24% in 2012 from 2011 decreasing from $696 per kilogram in 2011 to $528 per kilogram in 2012. As a result of that decline in the price of indium since the closing of our Initial Public Offering ("IPO") in May 2011 to December 31, 2012, our cost of indium has been reduced by the lower of cost or market write-downs of certain lots of our indium stockpile aggregating approximately $2.4 million at March 31, 2014.

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 March 31, 2014.

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

The Company's 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 the Company takes delivery of the physical metal. The stockpile of the physical metal indium and the related repurchase right were classified as a current asset at March 31, 2014 and December 31, 2013 as the Company intends to sell its stockpile of indium in 2014 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 adjusted cost based on increases in the spot price of indium. At March 31, 2014 and December 31, 2013, the spot price of indium was $745 and $675, respectively, 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 March 31, 2014, the aggregate write down against inventory was approximately $2.4 million. The reduction in the write-down of indium from 2012 was due to the sale of certain lots of inventory in 2013 and the first quarter of 2014.

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 the fact that we cannot predict whether or at what prices we will be able to liquidate our stockpile in 2014. 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" at the end of the reporting period.

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 Standards Board (FASB) issued Accounting Standards Update (ASU) 2013-11, "Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists." This ASU will eliminate the diversity in practice in presentation of unrecognized tax benefits when a net operating loss carryforward, 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 carryforward 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 did not have any impact our financial position or results of operations.

The FASB recently issued ASU 2013-07, "Presentation of Financial Statements (Topic 205) Liquidation Basis of Accounting" that requires an entity to prepare its financial statements using the liquidation basis of accounting when liquidation is imminent, as defined in ASU 2013-07. ASU 2013-07'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 is not applicable for the Company's current period financial statements.

Results of Operations



The results of operations for the three months ended March 31, 2014 and 2013 are
as follows:



                                                              For the Three Months Ended March 31,
                                                                  2014                     2013
Net sales                                                  $        6,953,414       $                -
Cost of sales                                                       5,102,310                        -
Gross profit                                                        1,851,104                        -

Operating costs:
Operating expenses - Manager - related party                          162,891                  157,432
Other selling, general and administrative expenses                    128,846                  152,753
Total operating costs                                                 291,737                  310,185

Operating income (loss)                                             1,559,367                 (310,185 )

Other income:
Interest income                                                         1,556                    3,100
Other income                                                           32,745                    9,956
Net income (loss) before income taxes                               1,593,668                 (297,129 )
Income tax expense                                                    (32,000 )                      -
Net income (loss)                                          $        1,561,668       $         (297,129 )

Net Income (Loss) Per Share
Basic                                                      $             0.18       $            (0.03 )
Diluted                                                    $             0.18       $            (0.03 )

Weighted Average Number of Shares Outstanding
Basic                                                               8,561,997                8,805,644
Diluted                                                             8,562,759                8,805,644

Three Months Ended March 31, 2014 Compared to Three Months Ended March 31, 2013

For the three months ended March 31, 2014, net sales were approximately $7.0 million. There were no sales in the 2013 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 $5.1 million resulting in gross profit of approximately $1.9 million or 27% in the first quarter of 2014.

For the three months ended March 31, 2014, total operating expenses were approximately $292 thousand. For the comparable period in 2013, total operating costs were approximately $310 thousand, representing a 6% decrease. The decrease was due principally to lower storage and professional fees in the first quarter of 2014. Based on our current business plan, we expect that our normal annual cash expenses, including income taxes, will approximate $1.2 million in 2014. During the three-month period ended March 31, 2014, other income increased approximately $23 thousand when compared to the first quarter in 2013 due to increased income recorded on indium lease transactions during the first quarter of 2014.

Income taxes of $32 thousand were provided for in the first quarter of 2014 for the alternative minimum tax that is not offset by net operating losses based on our estimated tax rate.

Net income was approximately $1.6 million for the three months ended March 31, 2014 (or $0.18 per basic and diluted share) compared to a net loss of approximately $0.3 million (or $0.03 per basic and diluted share) in the comparable period ended March 31, 2013. The increase was due to the gross profit on sales in the 2014 period. As described above, there were no sales in the first quarter of 2013 and the net loss was due to primarily operating expenses. The basic weighted average number of common shares outstanding was 8,561,997 in the first quarter of 2014 compared to 8,805,644 in the first quarter of 2013. The decrease in shares in 2014 was due to the purchase of common shares under our repurchase program.

GAAP vs. Non-GAAP Disclosure

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

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

                                                            March 31,       December 31,
                                                               2014             2013
U.S. GAAP net book value                                   $ 17,626,456     $  16,063,538
Excess of the indium inventory at spot price over GAAP
book value                                                    5,515,542         6,105,148
NMV                                                        $ 23,141,998     $  22,168,686

The reasons we rely on NMV measurements are as follows:

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

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

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

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

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

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

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

No assurances can be given that 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 March 31, 2014, we have incurred accumulated deficits of approximately $8.9 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 $6.5 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 in 2013 and $1.6 million the first quarter of 2014.

Our NMV at March 31, 2014 was calculated using the spot price of indium of $745 per kilogram at March 31, 2014. The spot price of indium on May 9, 2014 was $740 per kilogram.

As of March 31, 2014, we have cash and cash equivalents of approximately $6.4 million compared to cash and cash equivalents of approximately $2.1 million at December 31, 2013. The increase of approximately $4.3 million was due to net cash provided by operations in the first quarter of 2014. 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 private placement of 2.0 million shares of our common stock in 2012.

We believe that the cash and cash equivalents at March 31, 2014 should be sufficient to pay our operating expenses for at least the next year, which we currently estimate to be approximately $1.2 million annually. Our annual cash operating expenses include paying the annual related party Manager's fee of $652 thousand for the sale, lease or loan, storage, and insuring of indium on our behalf and reviewing corporate, title, environmental, and financial documents and material agreements regarding the storage, insuring and disposition of indium on our behalf. We also anticipate that we will incur annual cash expenses including: (i) storage and insurance for indium - $0.1 million; (ii) director and officer compensation expense - $0.1 million (iii) director and officer liability insurance premiums - $0.1 million; and (iv) other general and administrative expenses including public company costs including legal and . . .

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