NORTHERN TECHNOLOGIES INTERNATIONAL CORP - Quarter Report: 2010 November (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

(Mark one)

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended November 30, 2010

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from            to                    .

 

Commission File Number:  001-11038

 

 

NORTHERN TECHNOLOGIES INTERNATIONAL CORPORATION

(Exact name of registrant as specified in its charter)

 

 

4201 Woodland Rd

Circle Pines, Minnesota  55014

(Address of principal executive offices) (Zip code)

 

(763) 225-6600
(Registrant’s telephone number including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES  x  NO  o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).                YES  o NO  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o  NO  x

 

As of January 14, 2011, 4,328,935 shares of common stock of the registrant were outstanding.

 

 

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NORTHERN TECHNOLOGIES INTERNATIONAL CORPORATION

FORM 10-Q

November 30, 2010

 

TABLE OF CONTENTS

 

Description		Page
PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Balance Sheets as of November 30, 2010 (unaudited) and August 31, 2010	2
	Consolidated Statements of Operations (unaudited) for the Three Months Ended November 30, 2010 and 2009	3
	Consolidated Statements of Cash Flows (unaudited) for the Three Months Ended November 30, 2010 and 2009	4
	Notes to Consolidated Financial Statements (unaudited)	5-14
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15-28
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	28
Item 4.	Controls and Procedures	28-29
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	29
Item 1A.	Risk Factors	29
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	29
Item 3.	Defaults Upon Senior Securities	29
Item 4.	[Removed and Reserved]	29
Item 5.	Other Information	29
Item 6.	Exhibits	30
SIGNATURE PAGE		31
EXHIBIT INDEX		32

 

 

This quarterly report on Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the safe harbor created by those sections.  For more information, see “Part I. Financial Information — Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations— Forward-Looking Statements.”

 

As used in this report, references to “NTIC,” the “Company,” “we,” “our” or “us,” unless the context otherwise requires, refer to Northern Technologies International Corporation, its wholly owned subsidiaries — NTI Facilities, Inc., Northern Technologies Holding Company, LLC and React-NTI, LLC, and its majority owned joint venture, Zerust Prevenção de Corrosão S.A.,  all of which are consolidated on NTIC’s financial statements.

 

All trademarks, trade names or service marks referred to in this report are the property of their respective owners.

 

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PART I - FINANCIAL INFORMATION

 

ITEM 1.                             FINANCIAL STATEMENTS

 

NORTHERN TECHNOLOGIES INTERNATIONAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS AS OF NOVEMBER 30, 2010 (UNAUDITED)

AND AUGUST 31, 2010 (AUDITED)

 

		November 30, 2010			August 31, 2010
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	1,302,444		$	1,776,162
Receivables:
Trade excluding joint ventures, less allowance for doubtful accounts of $20,000 at November 30, 2010 and August 31, 2010		1,864,014			2,227,769
Trade joint ventures		1,494,014			1,216,081
Fees for services provided to joint ventures		1,705,752			1,300,814
Inventories		3,965,496			3,639,169
Prepaid expenses		397,682			143,980
Deferred income taxes		448,600			448,600
Total current assets		11,178,002			10,752,575
PROPERTY AND EQUIPMENT, net		3,442,307			3,452,530
OTHER ASSETS:
Investments in joint ventures		16,824,035			16,055,943
Deferred income taxes		1,505,300			1,505,300
Patents and trademarks, net		883,233			912,718
Other		25,128			18,234
		19,237,696			18,492,195
		$	33,858,005		$	32,697,300
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Current portion of note payable		15,929			1,144,922
Accounts payable		1,411,393			1,721,237
Income tax payable		147,466			174,502
Accrued liabilities:
Payroll and related benefits		744,208			1,155,277
Deferred joint venture royalties		288,000			288,000
Other		322,151			349,714
Total current liabilities		2,929,147			4,833,652
NOTE PAYABLE, NET OF CURRENT PORTION (Note 7)		1,119,782			—
COMMITMENTS AND CONTINGENCIES (Note 14)
EQUITY:
Preferred stock, no par value; authorized 10,000 shares; none issued and outstanding		—			—
Common stock, $0.02 par value per share; authorized 10,000,000 shares; issued and outstanding 4,328,935 and 4,259,321, respectively		86,579			85,186
Additional paid-in capital		9,782,413			9,140,936
Retained earnings		18,811,499			17,911,718
Accumulated other comprehensive income		1,109,337			704,473
Stockholders’ equity		29,789,828			27,842,313
Non-controlling interest		19,248			21,335
Total equity		29,809,076			27,863,648
		$	33,858,005		$	32,697,300

 

See notes to consolidated financial statements.

 

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NORTHERN TECHNOLOGIES INTERNATIONAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

FOR THE THREE MONTHS ENDED NOVEMBER 30, 2010 AND 2009

 

		Three Months Ended
		November 30, 2010			November 30,  2009
NET SALES:
Net sales, excluding joint ventures		$	3,446,303		$	2,182,244
Net sales, to joint ventures		652,138			529,158
NET SALES		4,098,441			2,711,402
Cost of goods sold		2,690,705			1,757,496
Gross profit		1,407,736			953,906
JOINT VENTURE OPERATIONS:
Equity in income of joint ventures		1,695,131			705,899
Fees for services provided to joint ventures		1,451,780			1,151,930
		3,146,911			1,857,829
OPERATING EXPENSES:
Selling expenses		999,053			596,769
General and administrative expenses		1,104,167			920,029
Expenses incurred in support of joint ventures		228,721			244,910
Research and development expenses		1,193,456			611,656
		3,525,397			2,373,364
OPERATING INCOME		1,029,250			438,371
INTEREST INCOME		3,933			1,496
INTEREST EXPENSE		(23,234		)	(25,987		)
OTHER INCOME		6,925			6,825
INCOME BEFORE INCOME TAX EXPENSE (BENEFIT)		1,016,874			420,705
INCOME TAX EXPENSE (BENEFIT)		122,000			(15,000		)
NET INCOME		894,874			435,705
NET LOSS ATTRIBUTABLE TO NON CONTROLLING INTEREST		(4,907		)	—
NET INCOME ATTRIBUTABLE TO NTIC		$	899,781		$	435,705
NET INCOME PER COMMON SHARE:
Basic		$	0.21		$	0.10
Diluted		$	0.21		$	0.10
WEIGHTED AVERAGE COMMON SHARES
ASSUMED OUTSTANDING:
Basic		4,264,187			4,149,096
Diluted		4,324,757			4,165,441

 

See notes to consolidated financial statements.

 

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NORTHERN TECHNOLOGIES INTERNATIONAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

THREE MONTHS ENDED NOVEMBER 30, 2010 AND 2009

 

		Three Months Ended
		November 30, 2010			November 30, 2009
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income		$	894,874		$	435,705
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Expensing of fair value of stock options vested		44,143			46,302
Depreciation expense		85,492			95,254
Amortization expense		39,723			38,475
Equity in income from joint ventures		(1,695,131		)	(705,899		)
Deferred income taxes
Changes in current assets and liabilities:
Receivables:
Trade, excluding joint ventures		363,755			(504,596		)
Trade, joint ventures		(277,933		)	(266,010		)
Fees for services receivables, joint ventures		(404,938		)	465,469
Income taxes		—			23,841
Inventories		(326,327		)	(47,469		)
Prepaid expenses and other		(260,596		)	(134,600		)
Accounts payable		(309,844		)	141,950
Income tax payable		(27,036		)	—
Accrued liabilities		(118,983		)	540,141
Net cash (used in) provided by operating activities		(1,992,801		)	128,563
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment in joint ventures		(38,217		)	—
Dividends received from joint ventures		1,368,599			8,801
Additions to property and equipment		(75,269		)	(10,401		)
Additions to patents		(10,238		)	(59,896		)
Net cash provided by (used in) investing activities		1,244,875			(61,497		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of note payable		(9,211		)	(8,501		)
Net borrowings/(repayments) made on line of credit		—			(1,077,000		)
Proceeds from the issuance of common stock		—			3,195,613
Proceeds from employee stock purchase plan		17,745			16,710
Proceeds from exercise of stock options		261,333			9,225
Net cash provided by financing activities		269,867			2,136,047
EFFECT OF EXCHANGE RATE CHANGES ON CASH:		4,341			—
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS		(473,718		)	2,203,114
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD		1,776,162			138,885
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	1,302,444		$	2,341,999

 

See notes to consolidated financial statements.

 

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NORTHERN TECHNOLOGIES INTERNATIONAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

1.             INTERIM FINANCIAL INFORMATION

 

In the opinion of management, the accompanying unaudited consolidated financial statements contain all necessary adjustments, which are of a normal recurring nature, and present fairly the consolidated financial position of Northern Technologies International Corporation and its subsidiaries (the “Company”) as of November 30, 2010 and the results of their operations for the three months ended November 30, 2010 and November 30, 2009 and their cash flows for the three months ended November 30, 2010 and November 30, 2009, in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”).

 

Certain amounts reported in the consolidated financial statements for the previous reporting periods have been reclassified to conform to the current period presentation.  These reclassifications did not have a material impact on the Company’s previously reported consolidated balance sheets or statements of cash flows. The Company has reclassified various line items in the statements of operations to better provide the results of its joint ventures, as well as its North American operations.  These reclassifications changed the Company’s operating income, but did not impact its net income or net income per common share.

 

These consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes contained in the Company’s annual report on Form 10-K for the fiscal year ended August 31, 2010.  These consolidated financial statements also should be read in conjunction with the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section appearing in this report.

 

Operating results for the three months ended November 30, 2010 are not necessarily indicative of the results that may be expected for the full fiscal year ending August 31, 2011.

 

The Company evaluates events occurring after the date of the consolidated financial statements requiring recording or disclosure in the financial statements.

 

2.             CONSOLIDATION OF ZERUST BRAZIL

 

Beginning in fourth quarter of fiscal 2010, the Company consolidated the results of Zerust Prevenção de Corrosão S.A., the Company’s subsidiary in Brazil (“Zerust Brazil”).  The Company holds 85% of the equity and 85% of the voting rights of Zerust Brazil.  Prior to fourth quarter of fiscal 2010 and as of November 30, 2009, the Company accounted for its Zerust Brazil investment under the equity method.  The Company owned only 50%, which it considered to be less than a majority, of the equity and voting rights of Zerust Brazil prior to September 2006.  The Company acquired an additional 35% ownership interest in Zerust Brazil in September 2006 and held 85% of the equity and voting rights thereafter. Prior to the fourth quarter of fiscal 2010, the Company held the additional 35% ownership interest in Zerust Brazil with the intent of finding an acquiring party, believing its majority control of Zerust Brazil would be temporary and determined not to consolidate Zerust Brazil because the impact on the Company’s consolidated financial statements was immaterial.  During the fourth quarter of fiscal 2010, the Company stopped pursuing a buyer of the 35% ownership and decided to consolidate the financial results of Zerust Brazil as of and for the fiscal year ended August 31, 2010.  The Company believes that the impact of not consolidating Zerust Brazil on the Company’s consolidated financial statements for periods prior to the fourth quarter of fiscal 2010 was immaterial to the Company’s consolidated financial statements.

 

The following is a summary of certain line items of the Company’s consolidated statement of operations for the three months ended November 30, 2009 as reported and on a pro forma basis, assuming the consolidation of Zerust Brazil on the Company’s consolidated financial statements as of the beginning of such period:

 

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					Zerust			Eliminated in
		As Reported			Brazil			Consolidation			Pro Forma
Net sales		$	2,711,402		$	501,446		$	(15,823	)	$	3,197,025
Cost of goods sold		1,757,496			193,711			(15,823		)	1,935,384
Gross profit		953,906			307,735			—			1,261,641
Joint venture operations		1,857,829			—			(3,260		)	1,854,569
Operating expenses		2,373,364			308,986			—			2,682,350
Operating income		438,371			(1,251		)	(3,260		)	433,860
Income before income tax expense		420,705			3,835			(3,260		)	421,280
Income tax benefit		(15,000		)	—			—			(15,000		)
Net income		435,705			3,835			(3,260		)	436,280
Net income attributable to non-controlling interest		—			575			—			575
Net income attributable to controlling interest		435,705			(3,260		)	3,260			435,705
Net income per common diluted share		$	0.10		$	0.00		$	0.00		$	0.10

 

3.             INVENTORIES

 

Inventories consisted of the following:

 

		November 30, 2010			August 31, 2010
Production materials		$	1,275,779		$	1,184,986
Finished goods		2,689,717			2,449,181
		$	3,965,496		$	3,639,169

 

4.             PROPERTY AND EQUIPMENT, NET

 

Property and equipment, net consisted of the following:

 

		November 30, 2010			August 31, 2010
Land		$	310,365		$	310,365
Buildings and improvements		3,099,186			3,099,186
Machinery and equipment		1,792,897			1,717,625
		5,202,447			5,127,176
Less accumulated depreciation		(1,760,140		)	(1,674,646		)
		$	3,442,307		$	3,452,530

 

5.             PATENTS AND TRADEMARKS, NET

 

Patents and trademarks, net consisted of the following:

 

		November 30, 2010			August 31, 2010
Patents and trademarks		$	1,620,598		$	1,610,674
Less accumulated amortization		(737,365		)	(697,956		)
		$	883,233		$	912,718

 

Patent and trademark costs are amortized over seven years.  Costs incurred related to patents and trademarks are capitalized until filed and approved, at which time the amounts capitalized to date are amortized and any further costs, including maintenance costs, are expensed as incurred. Amortization expense is estimated to approximate $160,000 in each of the next five fiscal years.

 

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6.             INVESTMENTS IN JOINT VENTURES

 

The financial statements of the Company’s foreign joint ventures are initially prepared using the accounting principles accepted in the respective joint ventures’ countries of domicile. Amounts related to foreign joint ventures reported in the below tables and the accompanying financial statements have subsequently been adjusted to approximate U.S. GAAP in all material respects. All material profits recorded on sales from the Company to its joint ventures have been eliminated for financial reporting purposes.

 

Financial information from the audited and unaudited financial statements of the Company’s joint venture in Germany, Excor Korrosionsschutz — Technologien und Produkte GmbH (“Germany”), the Company’s joint venture holding company in the Association of Southeast Asian Nations, or ASEAN, region, NTI ASEAN, LLC (“ASEAN”), and all of the Company’s other joint ventures, are summarized as follows:

 

		November 30, 2010
		TOTAL			Germany			ASEAN			All Other
Current assets		$	55,954,949		$	16,081,887		$	14,067,308		$	25,805,754
Total assets		61,869,402			18,559,994			14,329,410			28,979,998
Current liabilities		20,621,393			3,034,450			5,632,744			11,954,199
Noncurrent liabilities		4,847,283			—			841,895			4,005,388
Joint ventures’ equity		36,400,726			15,525,544			7,854,771			13,020,412
Northern Technologies International Corporation’s share of joint ventures’ equity		$	16,824,108		$	7,762,774		$	2,831,061		$	6,230,274

 

		August 31, 2010
		TOTAL			Germany			ASEAN			All Other
Current assets		$	50,031,107		$	16,567,240		$	12,637,967		$	20,825,900
Total assets		55,918,090			18,967,090			12,901,522			24,049,478
Current liabilities		16,478,695			3,089,590			4,721,652			8,667,454
Noncurrent liabilities		4,454,280			—			868,902			3,585,378
Joint ventures’ equity		34,985,115			15,877,500			7,310,968			11,796,646
Northern Technologies International Corporation’s share of joint ventures’ equity		$	16,055,943		$	7,938,751		$	2,467,412		$	5,649,780

 

		Three Months Ended November 30, 2010
		TOTAL			Germany			ASEAN			All Other
Net sales		$	27,101,587		$	8,886,252		$	4,321,308		$	13,894,027
Gross profit		12,706,289			4,490,864			2,051,640			6,163,785
Net income		3,169,841			1,876,545			374,049			919,337
Northern Technologies International Corporation’s share of equity in income of joint ventures		$	1,695,131		$	938,227		$	320,607		$	436,298

 

		Three Months Ended November 30, 2009
		TOTAL			Germany			ASEAN			All Other
Net sales		$	19,480,538		$	6,413,699		$	3,232,215		$	9,834,625
Gross profit		9,600,769			3,199,808			1,774,666			4,626,295
Net income		1,405,086			728,770			554,688			121,628
Northern Technologies International Corporation’s share of equity in income of joint ventures		$	705,899		$	364,385		$	254,214		$	87,300

 

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The Company records expenses that are directly attributable to the joint ventures on the statements of operations on the line “Expenses incurred in support of joint ventures”.  The expenses include items such as employee compensation and benefit expenses, travel expense and consulting expense.

 

In December 2010, the Company invested $38,217 and in January 2010, the Company invested $30,101, in a new joint venture in Russia to specifically engage in the oil and gas industry.  The Company has a 50% ownership interest in the new Russian joint venture.

 

7.             NOTE PAYABLE

 

As of November 30, 2010, the Company had a demand line of credit of $2,300,000 with PNC Bank, National Association (“PNC Bank”) with no amounts outstanding as of November 30, 2010 and August 31, 2010.  Advances made under the demand line of credit were made at the sole discretion of PNC Bank and were due and payable on demand.  Outstanding amounts under the demand line of credit bore interest at an annual rate based on LIBOR plus 2.25%.  As of November 30, 2010, the interest rate was 2.59% and the weighted average rate was 2.63% for the three months ended November 30, 2010.  As of November 30, 2009, the interest rate was 2.49% and the weighted average rate was 2.50% for the three months ended.

 

In connection with the purchase of its corporate headquarters, in September 2006, the Company obtained a term loan with a principal amount of $1,275,000 that was to mature on May 1, 2011, bore interest at a fixed rate of 8.01% and was payable in 59 monthly payments equal to approximately $10,776 (inclusive of principal and interest).

 

On January 10, 2011, the Company refinanced its $1,275,000 original principal amount term loan and increased its line of credit with PNC Bank to $3,000,000.  See Note 15 entitled “Subsequent Event.”As a result, certain portions of the loan have been classified as long-term.

 

8.             STOCKHOLDERS’ EQUITY

 

During the three months ended November 30, 2010, the Company did not purchase or retire any shares of its common stock. The following stock options to purchase shares of common stock were exercised during the three months ended November 30, 2010:

 

Options Exercised		Exercise Price
40,000		$	5.38
2,000		8.01
1,334		9.75
1,333		12.84

 

The Company granted stock options under the Northern Technologies International Corporation 2007 Stock Incentive Plan to purchase an aggregate of 30,000 shares of its common stock to various employees and directors during the three months ended November 30, 2010.  The weighted average per share exercise price of the stock options is $9.43, which is equal to the fair market value of the Company’s common stock on the date of grant.

 

During the three months ended November 30, 2010, the Company granted stock bonuses under the Northern Technologies International Corporation 2007 Stock Incentive Plan for an aggregate of 22,686 shares of its common stock to various employees.  The fair value of the shares of the Company’s common stock as of the date of grant of the stock bonuses was $319,649, based on the closing sale price of a share of the Company’s common stock on the date of grant. The fair value of common stock granted during the three months ended November 30, 2010 was based on fiscal 2010 performance and was included in accrued liabilities at August 31, 2010.

 

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During the three months ended November 30, 2009, the Company did not purchase or retire any shares of its common stock. The following stock options to purchase shares of common stock were exercised during the three months ended November 30, 2009:

 

Options Exercised		Exercise Price
1,500		$	6.15

 

The Company granted stock options under the Northern Technologies International Corporation 2007 Stock Incentive Plan to purchase an aggregate of 122,000 shares of its common stock to various employees and directors during the three months ended November 30, 2009.  The weighted average per share exercise price of the stock options is $7.88, which is equal to the fair market value of the Company’s common stock on the date of grant.

 

In September 2009, the Company completed a $3,552,000 registered direct offering in which it sold an aggregate of 480,000 shares of its common stock to institutional investors at a purchase price of $7.40 per share, resulting in net proceeds of $3,195,613, after deducting placement agent fees and expenses and the Company’s offering expenses.

 

9.             TOTAL COMPREHENSIVE INCOME

 

The Company’s total comprehensive income was as follows:

 

		Three Months Ended November 30,
		2010			2009
Net income		$	894,874		$	435,705
Other comprehensive income — foreign currency translation adjustment		404,864			574,808
Total comprehensive income		$	1,407,645		$	1,010,513

 

10.          NET INCOME PER COMMON SHARE

 

Basic net income per common share is computed by dividing net income by the weighted average number of common shares outstanding. Diluted net income per share assumes the exercise of stock options using the treasury stock method, if dilutive.

 

Options to purchase shares of common stock of 26,000 and 195,139 were excluded from the computation of common share equivalents for both the three months ended November 30, 2010 and 2009, respectively, as stock option exercise prices were greater than market price of a share of common stock.

 

11.          STOCK-BASED COMPENSATION

 

The Company has several stock-based compensation plans under which stock options and other stock-based awards have been granted, including the Northern Technologies International Corporation 2007 Stock Incentive Plan (the “2007 Plan”), the Northern Technologies International Corporation 2000 Stock Incentive Plan (the “2000 Plan”) and the Northern Technologies International Corporation Employee Stock Purchase Plan (the “ESPP”).  The Compensation Committee of the Board of Directors and the Board of Directors administers all of these plans.

 

The 2007 Plan replaced the 2000 Plan, which was terminated with respect to future grants, but continues to govern grants outstanding under such plan.  The 2007 Plan provides for the grant of incentive stock options, non-statutory stock options, stock appreciation rights, restricted stock, stock unit awards, performance awards and stock bonuses to eligible recipients to enable the Company and its subsidiaries to attract and retain qualified individuals through opportunities for equity participation in the Company, and to reward those individuals who contribute to the achievement of the Company’s economic objectives.  Up to a total of 400,000 shares of the Company’s common stock have been reserved for issuance under the 2007 Plan, subject to adjustment as provided in the 2007 Plan.  In

 

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November 2010, the Company’s Board of Directors approved the Northern Technologies International Corporation Amended and Restated 2007 Stock Incentive Plan (the “Amended and Restated 2007 Plan”), subject to approval by the Company’s stockholders at its next annual meeting of stockholders to be held in January 2011.  The Amended and Restated 2007 Plan includes a number of changes from the currently existing 2007 Plan, including an increase in the number of shares of common stock available for issuance under the plan from 400,000 shares to 800,000 shares plus the number of shares subject to awards outstanding under the prior 2000 Plan as of the date of stockholder approval of the Amended and Restated 2007 Plan but only to the extent that such outstanding awards are forfeited, expire or otherwise terminate without the issuance of such shares.  Options granted under the 2007 Plan generally have a term of five years and become exercisable over a three- or four-year period beginning on the one-year anniversary of the date of grant.  Options are granted at per share exercise prices equal to the market value of the Company’s common stock on the date of grant.  To date, only stock options and stock bonuses have been granted under the 2007 Plan.

 

The maximum number of shares of common stock of the Company available for issuance under the ESPP is 100,000 shares, subject to adjustment as provided in the ESPP.  The ESPP provides for six-month offering periods beginning on September 1 and March 1 of each year.  The purchase price of the shares is 90% of the lower of the fair market value of common stock at the beginning or end of the offering period.  This discount may not exceed the maximum discount rate permitted for plans of this type under Section 423 of the Internal Revenue Code of 1986, as amended.  The ESPP is compensatory for financial reporting purposes.

 

The Company granted options to purchase 30,000 and 126,000 shares of its common stock during the three months ended November 30, 2010 and 2009, respectively.  The fair value of option grants is determined at date of grant, using the Black-Scholes option pricing model with the assumptions listed below.  Based on these valuations, the Company recognized compensation expense of $44,143 and $46,302 during the three months ended November 30, 2010 and 2009, respectively, related to the options that vested during such time period. The stock-based expense recorded reduced after-tax net income per share by $0.01 for the three months ended November 30, 2010 and 2009.  As of November 30, 2010, the total compensation cost for non-vested options not yet recognized in the Company’s statements of operations was $304,080, net of estimated forfeitures.  Additional stock-based compensation expense of $132,428 is expected through the remainder of fiscal year 2011, and expense of $139,257 and $32,396 is expected to be recognized during fiscal 2012 and 2013, respectively.  Future option grants will impact the compensation expense recognized.

 

The Company currently estimates a ten percent forfeiture rate for stock options, but will continue to review this estimate in future periods.

 

The fair value of each option grant is estimated on the grant date using the Black-Scholes option-pricing model with the following assumptions and results for the grants:

 

		November 30,
		2010		2009
Dividend yield		0.00	%	2.00	%
Expected volatility		49.2	%	48.1	%
Expected life of option		5 years		5 years
Average risk-free interest rate		1.31	%	2.34	%

 

The weighted average fair value of options granted during the three months ended November 30, 2010 and 2009 was $3.60 and $2.96, respectively.  The weighted average remaining contractual life of the options outstanding as of November 30, 2010 and 2009 was 3.47 years and 3.26 years, respectively.

 

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12.          GEOGRAPHIC AND SEGMENT INFORMATION

 

Net sales by geographic location as a percentage of total consolidated net sales for the three months ended November 30, 2010 and November 30, 2009 were as follows:

 

		Three Months Ended November 30,
		2010		2009
Inside the U.S.A. to unaffiliated customers		67.2	%	74.9	%
Outside the U.S.A. to:
Joint ventures in which the Company is a shareholder directly and indirectly		16.4		19.6
Unaffiliated customers		16.4		5.5
		100.0	%	100.0	%

 

Net sales by geographic location are based on the location of the customer.

 

Fees for services provided to joint ventures by geographic location as a percentage of total fees for services provided to joint ventures the three months ended November 30, 2010 and 2009 were as follows:

 

		Three Months Ended November 30,
		2010			% of Total Fees for Services Provided to Joint Ventures		2009			% of Total Fees for Services Provided to Joint Ventures
Japan		$	276,000		19.0	%	$	223,000		19.4	%
Germany		257,276			17.7	%	269,500			23.4	%
India		200,711			13.8	%	182,692			15.9	%
France		164,482			11.3	%	114,192			9.9	%
Finland		144,211			9.9	%	112,898			9.8	%
Sweden		144,111			9.9	%	94,542			8.2	%
United Kingdom		82,642			5.7	%	95,129			8.3	%
Other		182,347			12.6	%	59,978			5.2	%
		$	1,451,780		100.0	%	$	1,151,930		100.0	%

 

The following table sets forth the Company’s net sales for the three months ended November 30, 2010 and 2009 by segment:

 

		Three Months Ended November 30,
		2010			2009			$ Change			% Change
ZERUST® net sales		$	3,875,428		$	2,627,555		$	1,247,873		47.5	%
Natur-Tec® net sales		223,013			83,846			139,167			166.0	%
		$	4,098,441		$	2,711,402		$	1,387,040		51.2	%

 

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The following table sets forth the Company’s cost of goods sold for the three months ended November 30, 2010 and 2009 by segment:

 

		Three Months Ended November 30,
		2010			% of Segment Sales*		2009			% of Segment Sales*
Direct cost of goods sold
ZERUST®		$	2,190,145		56.5	%	$	1,417,508		53.9	%
Natur-Tec™		180,630			81.0	%	59,018			70.4	%
Indirect cost of goods sold		319,930			NA		280,970			NA
		$	2,690,705				$	1,757,496

 

*                 The percent of segment sales is calculated by dividing the direct cost of sales for each individual segment category by the net sales for each segment category.

 

The Company’s management utilizes product net sales and direct and indirect cost of goods sold for each product in reviewing the financial performance of a product type.  Further allocation of Company expenses or assets, aside from amounts presented in the tables above, is not utilized in evaluating product performance, nor does such allocation occur for internal financial reporting.

 

Sales to the Company’s joint ventures are included in the foregoing geographic and segment information, however, sales by the Company’s joint ventures to other parties are not included.  The foregoing geographic and segment information represents only sales and cost of goods sold recognized directly by the Company.

 

The geographical distribution of long-lived assets is set forth as follows:

 

		November 30,
		2010			2009
United States		$	3,386,100		$	3,457,316
Brazil		56,207			—
Consolidated		$	3,442,307		$	3,457,316

 

Long-lived assets consist primarily of property and equipment. These assets are periodically reviewed to assure the net realizable value from the estimated future production based on forecasted sales exceeds the carrying value of the assets.

 

13.          RESEARCH AND DEVELOPMENT

 

During the year ended August 31, 2009, the Company was awarded multiple research and development contracts.  The Company accrues proceeds received under the grants and offsets research and development expenses incurred in equal installments over the timelines associated with completion of the grants specific objectives and milestones. At November 30, 2010 and August 31, 2010, the Company deferred amounts received of $26,659 and $130,196, respectively, in other accrued liabilities, as the Company had not yet performed under the obligations of the contracts.

 

The Company expenses all costs related to product research and development as incurred.  The Company incurred $1,193,456 and $611,656 of expense during the three months ended November 30, 2010 and 2009, respectively, in connection with its research and development activities.  These costs related to product research and development

 

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are the net amount after being reduced by reimbursements related to the awarding of the multiple research and development contracts of $25,992 and $109,172 for the three months ended November 30, 2010 and 2009, respectively.  The net fees are accounted for in the “Research and Development Expenses” section of the consolidated statements of operations.

 

14.          COMMITMENTS AND CONTINGENCIES

 

On August 27, 2010, the Company’s Board of Directors, upon recommendation of the Compensation Committee, approved the material terms of an annual bonus plan for the Company’s executive officers and certain employees for the fiscal year ending August 31, 2011, the purpose of which is to align the interests of the Company, its executive officers and stockholders by providing an incentive for the achievement of key corporate and individual performance measures that are critical to the success of the Company and linking a significant portion of each executive officer’s annual compensation to the achievement of such measures.  The following is a brief summary of the material terms approved by the Board:

 

·                  The total amount available under the bonus plan will be up to 25% of the Company’s earnings before interest, taxes and other income (“EBITOI”);

 

·                  The total amount available under the bonus plan will be $0 if EBITOI, as adjusted to take into account amounts to be paid under the bonus plan, fall below 70% of target EBITOI; and

 

·                  The payment of bonuses under the plan will be purely discretionary and will be paid to executive officer participants in both cash and stock, the exact amount and percentages of which will be determined by the Company’s Board of Directors, upon recommendation of the Compensation Committee.

 

There was $357,000 for management bonuses accrued for three months ended November 30, 2010 compared to a management bonus accrual of $158,000 for the three months ended November 30, 2009.

 

In fiscal 1999, a subsidiary of the Company, NTI Facilities, Inc., acquired a one-third ownership of Omni-Northern Ltd., which owns and operates a rental property located at 23205 Mercantile Road, Beachwood, Ohio.  The property had an approximate value of $2,205,000, based upon the cash-to-mortgage acquisition price of the property paid in fiscal 2000.  The Company has guaranteed up to $329,082 of Omni-Northern Ltd.’s $1,903,571 mortgage obligation with PNC Bank, Cleveland, Ohio.  The building is fully leased at present.  Total rent expense for the three months ended November 30, 2010 and 2009 was $59,480 and $60,814 respectively. Remaining rentals payable under such leases are as follows: fiscal 2011 - $238,500; fiscal 2012 - $238,500; fiscal 2013 - $238,500; fiscal 2014 - $59,500 and thereafter - $0.

 

One customer accounted for 10.6% of the Company’s trade receivables, excluding joint ventures at August 31, 2010. Two joint ventures accounted for 48.0% of the Company’s trade joint venture receivables at November 30, 2010. One joint venture accounted for 36.4% of the Company’s trade joint venture receivables at August 31, 2010.

 

From time to time, the Company is involved in various legal actions arising in the normal course of business.  Management is of the opinion that any judgment or settlement resulting from any currently pending or threatened actions would not have a material adverse effect on the Company’s financial position or consolidated results of operations.

 

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15.          SUBSEQUENT EVENT

 

On January 10, 2011, the Company refinanced its $1,275,000 original principal amount term loan and increased its line of credit with PNC Bank from $2,300,000 to $3,000,000.

 

The amended term loan is evidenced by an amended and restated term note (the “Term Note”) issued by Northern Technologies Holding Company, LLC (“NTI LLC”) to PNC Bank in the principal amount of approximately $1,141,788.  The term loan matures on January 10, 2016, bears interest at an annual rate based on the daily LIBOR rate plus 2.15% and is payable in 59 consecutive monthly installments equal to approximately $6,343 (inclusive of principal but exclusive of interest) commencing in February 2011.  All of the remaining unpaid principal and accrued interest under the Term Note is due and payable on the January 10, 2016 maturity date.  The term loan is secured by a first lien on the real estate and building owned by NTI LLC and all of the assets of the Company and is guaranteed by the Company.

 

The increased line of credit is evidenced by an amended and restated committed line of credit note in the principal amount of up to $3,000,000 (the “Line of Credit Note”).  The line of credit has a $1,200,000 standby letter of credit subfacility, with any standby letters of credit issued thereunder being at the sole discretion of PNC Bank.  Any standby letters of credit issued under the subfacility are subject to customary fees and charges payable by the Company.  Advances made under the line of credit are due and payable on January 10, 2012.  At the option of the Company, outstanding advances under the line of credit bear interest at either (a) an annual rate based on LIBOR plus 2.15% for the applicable LIBOR interest period selected by the Company or (b) at the rate publicly announced by PNC Bank from time to time as its prime rate. Interest is payable in arrears (a) for the portion of advances bearing interest under the prime rate on the last day of each month during the term thereof and (b) for the portion of advances bearing interest under the LIBOR option on the last day of the respective LIBOR interest period selected for such advance.  Any unpaid interest is payable on the maturity date.

 

Both the term loan and the line of credit are governed under two separate loan agreements (collectively, the “Loan Agreements”).  The Loan Agreements contain standard covenants, including affirmative financial covenants, such as the maintenance of a minimum fixed charge coverage ratio, and negative covenants, which, among other things, limit the incurrence of additional indebtedness, loans and equity investments, disposition of assets, mergers and consolidations and other matters customarily restricted in such agreements. Under the Loan Agreements, the Company is subject to a minimum fixed charge coverage ratio of 1.10:1.00.

 

Under the fixed charge coverage ratio financial covenant, the Company shall not, as of the last calendar day of any fiscal quarter, on a rolling four quarters basis, suffer or permit the ratio of its adjusted EBITDA (defined as the aggregate of (a) its net income for that period, plus (b) its interest expense for that period, plus (c) its federal, state, and local income taxes, if any, for that period, plus (d) its depreciation and amortization charges for that period, plus (e) other non-recurring non-cash expenses reducing net income, minus (f) non-recurring non-cash items increasing net income, plus (g) increases to paid-in capital on stockholders’ equity, minus (h) decreases to paid-in capital on stockholder’s equity) to the aggregate (without duplication) of (i) its interest expense for that period, plus (ii) capital expenditures paid for from the Company’s funds other than funds borrowed as term debt to finance such capital expenditures during that period, plus (iii) all dividends and distributions paid during that period, plus (iv) taxes paid in cash plus, plus (v) payments made under all capital leases, plus (vi) an amount equal to the aggregate of all scheduled payments of principal on all indebtedness for borrowed money having an original term of more than one year, as shown on the Company’s financial statements as current liabilities as of one year prior to the date of determination to be less than 1.10:1.00.  The fixed charge coverage ratio is to be computed and determined on a consolidated basis for the Company and its subsidiaries in accordance with generally accepted accounting principles applied on a consistent basis (subject to normal year-end adjustments).  The Loan Agreements also contain customary events of default, including, without limitation, payment defaults, material inaccuracy of representations and warranties, covenant defaults, bankruptcy and involuntary proceedings, and monetary judgment defaults.

 

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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 technical services in over 55 countries either directly or via a network of joint ventures and independent distributors. NTIC’s primary business is corrosion prevention.  From this base, NTIC has expanded into three new business areas that have started recently to generate revenue (1) corrosion prevention technologies specifically designed for the oil and gas industry, which NTIC sells both directly as well as through joint ventures and independent agents; (2) a proprietary portfolio of bio-plastic compounds and finished products marketed under the Natur-Tec® brand, which NTIC sells directly as well as through distributors and independent agents; and (3) technology and equipment that converts waste plastic into diesel, gasoline and heavy fractions, which is exclusively licensed and sold in North America and Asia through NTIC’s joint venture Polymer Energy, LLC.

 

NTIC has been selling its proprietary ZERUST® brand rust and corrosion inhibiting products and services to the automotive, electronics, electrical, mechanical, military and retail consumer markets for over 35 years.  NTIC also offers worldwide on-site technical consulting for rust and corrosion prevention issues.  In North America, NTIC markets its technical services and products principally to industrial users by a direct sales force as well as a network of independent distributors and agents.  NTIC’s technical service consultants work directly with the end users of NTIC’s products to analyze their specific needs and develop systems to meet their technical requirements.

 

NTIC has developed proprietary corrosion inhibiting technologies for use in the mitigation of corrosion on capital assets used in the petroleum and chemical process industries and is initially targeting the sale of these new ZERUST® products to the oil and gas industry sector. During fiscal 2009, NTIC announced the signing of a multi-year contract between NTIC’s Brazilian subsidiary (Zerust Prevenção de Corrosão S.A.) and Petroleo Brasileiro S.A. (Petrobras) to install and service proprietary corrosion protection technologies on the roofs of an initial set of aboveground oil storage tanks at the Petrobras REDUC refinery in Rio de Janeiro, Brazil.  Also during fiscal 2009, NTIC signed multiple joint research and development contracts with Petrobras’s research and development group at the Leopoldo Américo Miguez de Mello Research & Development Center (CENPES) pursuant to which the parties will undertake a 20-month Petrobras funded effort to explore, understand and resolve bottom plate corrosion issues in aboveground storage tanks.  A second 12-month Petrobras sponsored project has also started aimed at field trials of certain pipeline protection technologies.  All of these projects continued during fiscal 2010 and in the first quarter of fiscal 2011.  NTIC also is pursuing opportunities to market its ZERUST® corrosion prevention technology to other potential customers in the oil and gas industry across several countries through NTIC’s joint venture partners and other strategic partners. During fiscal 2010, NTIC entered into agreements with Iromad VZ, LLC and GF Consulting Services LLC to provide sales and marketing services for NTIC’s oil and gas industry specific corrosion prevention technologies with a particular focus on the markets in the United States, Venezuela, Mexico and Spain.  NTIC believes the sale of its ZERUST® products to customers in the oil and gas industry will involve a long sales cycle, likely including a one- to two-year trial period with each customer and a slow integration process thereafter.

 

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In addition to ZERUST® products and services, NTIC develops and markets a portfolio of bio-based and/or biodegradable (compostable) polymer resin compounds and finished products under the Natur-Tec® brand.  The Natur-Tec® bioplastics portfolio includes flexible film, foam, rigid injection molded materials and engineered plastics. Natur-Tec® biodegradable and compostable finished products include shopping and grocery bags, lawn and leaf bags, can liners, pet waste collection bags, cutlery, packaging foam and coated paper products and are engineered to be fully biodegradable in a composting environment.  During fiscal 2010 and the first quarter of fiscal 2011, NTIC focused on adding additional distributors and generating initial sales with these distributors.

 

NTIC’s Polymer Energy LLC joint venture develops and promotes a system that uses catalytic pyrolysis to convert waste plastic (primarily polyolefins) into hydrocarbons (primarily a mix of diesels, gasoline and heavy fractions) resulting in an economically viable and environmentally responsible alternative to current methods of recycling and disposal of waste plastic.  Each unit can process up to ten tons of waste plastic per day, and the modular design allows for easily scalable capacity.  The crude output is high-grade and can be further processed in a refinery or used as an input for co-generation of electricity.  During fiscal 2010 and the first quarter of fiscal 2011, NTIC’s Polymer Energy LLC joint venture focused on making design improvements to the polymer energy machine and generating initial interest from potential customers in India, Thailand and the United Arab Emirates.

 

NTIC’s Joint Venture Network

 

NTIC participates in 26 active joint venture arrangements in North America, South America, Europe, Asia and the Middle East. Each of these joint ventures generally manufactures and markets finished products in the geographic territory to which it is assigned.  While most of NTIC’s joint ventures currently exclusively sell rust and corrosion inhibiting packaging and products to industrial customers, NTIC also has joint ventures that manufacture, market and sell corrosion prevention solutions for the oil and gas industry and Polymer Energy™ equipment that converts waste plastic into diesel, gasoline and heavy fractions.  NTIC historically has funded its joint venture investments with cash generated from operations.

 

NTIC’s receipt of funds as a result of sales by 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 its German joint venture, NTIC recognizes an agreed upon quarterly fee for such services.  With respect to its ASEAN joint venture holding company, NTIC does not receive a fee for such services, but rather receives a bi-annual dividend based on available cash.  NITC recognizes equity income from its joint ventures based on the overall profitability of the entity.  The profits of NTIC’s joint ventures are shared by the respective joint venture owners in accordance with their respective ownership percentages.  NTIC typically owns only 50% or less 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.  Traditionally, a portion of the equity income recorded in a given fiscal year is paid to the owners of the entity during the following fiscal 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 not consolidate the results of its joint ventures, other than commencing in fourth quarter of 2010, Zerust Prevenção de Corrosão S.A., NTIC’s subsidiary in Brazil (“Zerust Brazil”).  NTIC holds 85% of the equity and 85% of the voting rights of Zerust Brazil.  Prior to fiscal 2010 NTIC accounted for its Zerust Brazil investment under the equity method.  NTIC owned only 50%, which it considered to be less than a majority, of the equity and voting rights of Zerust Brazil prior to September 2006.  NTIC acquired an additional 35% ownership interest in Zerust Brazil in September 2006 and held 85% of the equity and voting rights thereafter.  Prior to the fourth quarter of fiscal 2010, NTIC held the additional 35% ownership interest in Zerust Brazil with the intent of finding an acquiring party, believing its majority control of Zerust Brazil would be temporary and determined not to consolidate Zerust Brazil because the impact on NTIC’s consolidated financial statements was immaterial.  During

 

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the fourth quarter of fiscal 2010, NTIC stopped pursuing a buyer of the 35% ownership and decided to consolidate the financial results of Zerust Brazil as of and for the fiscal year ended August 31, 2010.  NTIC believes that the impact of not consolidating Zerust Brazil on NTIC’s consolidated financial statements for periods prior to the fourth quarter of fiscal 2010 was immaterial to NTIC’s consolidated financial statements. 

 

The following is a summary of certain line items of the Company’s consolidated statement of operations for the three months ended November 30, 2009 as reported and on a pro forma basis, assuming the consolidation of Zerust Brazil on the Company’s consolidated financial statements as of the beginning of such period:

 

					Zerust			Eliminated in
		As Reported			Brazil			Consolidation			Pro Forma
Net sales		$	2,711,402		$	501,446		$	(15,823	)	$	3,197,025
Cost of goods sold		1,757,496			193,711			(15,823		)	1,935,384
Gross profit		953,906			307,735			—			1,261,641
Joint venture operations		1,857,829			—			(3,260		)	1,854,569
Operating expenses.		2,373,364			308,986			—			2,682,350
Operating income		438,371			(1,251		)	(3,260		)	433,860
Income before income tax expense		420,705			3,835			(3,260		)	421,280
Income tax benefit		(15,000		)	—			—			(15,000		)
Net income		435,705			3,835			(3,260		)	436,280
Net income attributable to non-controlling interest		—			575			—			575
Net income attributable to controlling interest.		435,705			(3,260		)	3,260			435,705
Net income per common diluted share		$	0.11		$	0.00		$	0.00		$	0.11

 

NTIC has not consolidated the Polymer Energy LLC joint venture in NTIC’s consolidated financial statements for the three months ended November 30, 2010 or 2009 or any prior period since Polymer Energy LLC has had limited activity since its inception in 2003 and NTIC believes that the impact of not consolidating this entity on NTIC’s consolidated financial statement has been immaterial.  Prior to fiscal 2010, Polymer Energy LLC did not have any financial activity including assets, liabilities, capital contributions, revenues or expenses.  During fiscal 2010, the only financial activity of Polymer Energy LLC was the receipt of license fees which were distributed to its owners in proportion to their respective ownership percentages.  Since NTIC owns a 62.5% ownership interest in Polymer Energy LLC, NTIC received and recorded a portion of these fees for services provided to joint ventures in its fiscal 2010 consolidated financial statements.  No license fees were received by Polymer Energy LLC and no other financial activity took place during the three months ended November 30, 2010.  Accordingly, during the three months ended November 30, 2010, NTIC received and recorded no fees for services provided to joint ventures in its consolidated financial statements attributable to its ownership interest in Polymer Energy LLC.

 

NTIC considers its German joint venture and ASEAN joint venture holding company to be individually significant to NTIC’s consolidated assets and income; and therefore, provides certain additional information regarding these joint ventures 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:  ZERUST® products and services and Natur-Tec® products.  NTIC’s former React-NTI and React, Inc. business segments were eliminated in fiscal 2009 due to inactivity.

 

NTIC’s consolidated net sales increased 51.2% during the three months ended November 30, 2010 compared to the three months ended November 30, 2009.  This increase was primarily a result of increased sales of ZERUST® rust and corrosion inhibiting packaging products and services and sales to NTIC’s joint ventures and the consolidation of Zerust Brazil on NTIC’s consolidated financial statements.  During the three months ended November 30, 2010,

 

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94.6% of NTIC’s consolidated net sales were derived from sales of ZERUST® products and services, which increased 47.5% to $3,875,428 during the three months ended November 30, 2010 compared to $2,627,555 during the three months ended November 30, 2009 due to increased demand primarily as a result of the economic recovery of the domestic manufacturing sector, the addition of new customers and the consolidation of Zerust Brazil. Overall demand for ZERUST® products and services depends heavily on the overall health of the markets in which NTIC sells its products, including in particular the automotive market. NTIC has focused its sales efforts of ZERUST® 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 during the three months ended November 30, 2010 included $517,140 of sales made by Zerust Brazil, and of those sales, $26,822 in sales were made to the oil and gas industry sector in Brazil.  As previously disclosed, during the fourth quarter of fiscal 2010, Zerust Brazil received purchase orders for Flange Savers representing an aggregate of $1.4 million.  Of those orders, Zerust Brazil recognized sales of $518,000 during the fourth quarter of fiscal 2010 and $26,822 during the first quarter of fiscal 2011.  NTIC still anticipates invoicing Petrobras for the remaining amount of these orders during fiscal 2011 as Petrobras rolls this product out to more of its platforms, with a much more significant portion of the orders expected to be recognized as sales during the second quarter of fiscal 2011 than during the first quarter of fiscal 2011.

 

During the three months ended November 30, 2010, $223,013, or 5.4% of NTIC’s consolidated net sales were derived from sales of Natur-Tec® products compared to 3.1% during the three months ended November 30, 2009.  Net sales of Natur-Tec® products increased 166.0% during the three months ended November 30, 2010 compared to the three months ended November 30, 2009. This increase was primarily due to the addition of new Natur-Tec® distributors on the West Coast of the United States.  NTIC is continuing to strengthen and expand its West Coast distribution network in California, while expanding its industrial distribution reach to geographical “green” hotspots such as Oregon, Washington, Minnesota and New England. Additionally, NTIC is targeting key national and regional retailers utilizing independent sales agents. Demand for the Natur-Tec® products depends primarily on the market acceptance and the extent of NTIC’s distribution network.

 

Cost of goods sold as a percentage of net sales increased slightly to 65.7% for the three months ended November 30, 2010 compared to 64.8% for the three months ended November 30, 2009 primarily as a result of slightly reduced margins resulting from a slight increase in raw material prices.

 

NTIC’s equity in income of joint ventures increased 140.1% to $1,695,131 during the three months ended November 30, 2010 compared to $705,899 during the three months ended November 30, 2009. NTIC recognized a 26.0% increase in fees for services provided to joint ventures during the three months ended November 30, 2010 compared to the three months ended November 30, 2009. Both of these increases were primarily a result of a 39.1% increase in total net sales of NTIC’s joint ventures during the three months ended November 30, 2010 compared to the three months ended November 30, 2009.  This increase in total net sales of NTIC’s joint ventures was primarily a result of the economic recovery, to some extent, of the international manufacturing sector that the NTIC joint venture network serves.

 

NTIC’s total operating expenses increased 48.5% during the three months ended November 30, 2010 compared to the three months ended November 30, 2009 primarily as a result of the consolidation of the general and administrative expenses of Zerust Brazil on NTIC’s consolidated financial statements of $205,000, the return of wages for all employees to pre-recession levels and fiscal 2011 raises, the expenses associated with the hiring of 15 employees since November 30, 2009 and the increase in accrual of the management bonus expense of $200,000.

 

NTIC expenses all costs related to product research and development as incurred.  NTIC incurred $1,193,456 and $611,656 of expense during the three months ended November 30, 2010 and 2009, respectively, in connection with its research and development activities.  These costs related to product research and development and represent the net amount after being reduced by reimbursements related to the awarding of the multiple research and development contracts of $25,992 and $109,172 for the three months ended November 30, 2010 and 2009,

 

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respectively.   NTIC anticipates that it will spend between $3,500,000 and $4,000,000 in total during fiscal 2011 on research and development activities related to its core and new technologies.  These amounts represent net amounts after being reduced by reimbursements related to the awarding of multiple research and development contracts.

 

Net income increased 105.4%, to $894,874, or $0.21 per diluted common share, for the three months ended November 30, 2010 compared to $435,705, or $0.10 per diluted common share, for the three months ended November 30, 2009.  This increase was primarily the result of increased income from NTIC’s corporate joint ventures and holding companies and gross profit partially offset by an increase in operating expenses.

 

NTIC’s working capital was $8,248,855 at November 30, 2010, including $1,302,444 in cash and cash equivalents compared to $5,918,923 at August 31, 2010, including $1,776,162 in cash and cash equivalents.  On January 10, 2011, NTIC refinanced its $1,275,000 original principal amount term loan and increased its line of credit with PNC Bank to $3,000,000.

 

Results of Operations

 

NTIC does not consolidate the results of its joint ventures.  NTIC considers its German joint venture and ASEAN joint venture holding company to be individually significant to NTIC’s consolidated assets and income; and therefore, provides certain additional information regarding these joint ventures in the notes to NTIC’s consolidated financial statements and in this section of this report.

 

The following table sets forth NTIC’s results of operations for the three months ended November 30, 2010 and November 30, 2009.

 

		Three Months Ended November 30, 2010			% of Net Sales		Three Months Ended November 30, 2009			% of Net Sales		$ Change			% Change
Net sales, excluding joint ventures		$	3,446,303		84.1	%	$	2,182,244		80.5	%	$	1,264,059		57.9	%
Net sales, to joint ventures		652,138			15.9	%	529,158			19.5	%	122,980			23.2	%
Cost of goods sold		2,690,705			65.7	%	1,757,496			64.8	%	933,209			53.1	%
Equity in income of joint ventures		1,695,131			41.4	%	705,899			26.0	%	989,232			140.1	%
Fees for services provided to joint ventures		1,451,780			35.4	%	1,151,930			42.5	%	299,850			26.0	%
Selling expenses		999,053			24.4	%	596,769			22.0	%	402,284			67.4	%
General and administrative expenses		1,104,167			26.9	%	920,029			33.9	%	184,138			20.0	%
Expenses incurred in support of joint ventures		228,721			5.6	%	244,910			9.0	%	(16,189		)	(6.6	)%
Research and development expenses		1,193,456			29.1	%	611,656			22.6	%	581,800			95.1	%

 

Net Sales. NTIC’s consolidated net sales increased 51.2% to $4,098,441 during the three months ended November 30, 2010 compared to the three months ended November 30, 2009.  NTIC’s consolidated net sales to unaffiliated customers excluding NTIC’s joint ventures increased 57.9% to $3,446,303, during the three months ended November 30, 2010 compared to the same prior year period. This increase was primarily a result of increased sales of ZERUST® rust and corrosion inhibiting packaging products and services and sales to NTIC’s joint ventures and the consolidation of Zerust Brazil on NTIC’s consolidated financial statements. Net sales to joint ventures increased 23.2% to $652,138 during the three months ended November 30, 2010 compared to the three months ended November 30, 2009. This increase was due to an increase in demand primarily as a result of the economic recovery of the international manufacturing sector.

 

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