NORTHERN TECHNOLOGIES INTERNATIONAL CORP annual report, FY2014

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Northern Technologies International Corporation — FY2014 Form 10-K

Reporting period: Fiscal year ended August 31, 2014. The filing also reports fourth-quarter results for the quarter ended August 31, 2014; it is an annual report, not a standalone quarterly filing.

Business context

NTIC develops and sells corrosion-prevention products and services under the ZERUST brand and biobased, compostable plastics under Natur-Tec. ZERUST generated 88.9% of consolidated sales; Natur-Tec generated 11.1%. NTIC operates in over 60 countries, including through 20 equity-method joint ventures. Joint-venture sales are not consolidated as NTIC product sales, but NTIC records related service fees and its share of joint-venture earnings.

Financial performance and liquidity

  • Sales: Consolidated net sales were $26.83 million, up 19.2% from $22.50 million. Sales excluding joint ventures rose 19.7% to $23.60 million; sales to joint ventures increased 16.1% to $3.22 million.
  • Products: ZERUST sales grew 16.6% to $23.85 million. Oil-and-gas ZERUST sales rose 71.1% to about $1.70 million. Natur-Tec sales increased 45.8% to $2.98 million.
  • Joint ventures: NTIC recorded $5.92 million of equity income and $8.14 million of service fees. The joint ventures reported aggregate sales of $118.85 million, up 5.0%; those sales are not included in NTIC’s consolidated net sales.
  • Profit and margins: Gross profit was $9.02 million, up 28.4%; gross margin was 33.6%, versus 31.2%. Operating income was $6.69 million, compared with $4.96 million. Net income was $5.54 million; net income attributable to NTIC was $4.11 million, or $0.90 per diluted share, versus $3.37 million, or $0.75, in FY2013. Operating income includes joint-venture income and service fees.
  • Fourth quarter: Sales were $7.38 million versus $6.09 million in FY2013 Q4. Net income attributable to NTIC was $1.24 million, or $0.27 diluted per share, versus $1.62 million, or $0.36, a year earlier.
  • Cash flow: Operating activities used $8,394, near breakeven, compared with $1.25 million used in FY2013. Equity-method income is not operating cash received when recognized; working-capital changes also affected cash flow. NTIC received $7.43 million in joint-venture dividends.
  • Liquidity and debt: Working capital was $17.85 million. Cash and cash equivalents were $2.48 million, and available-for-sale securities were $5.52 million. NTIC repaid its $933,414 term loan in January 2014 and had no line-of-credit borrowings at year-end. A $3.0 million revolving facility was available, subject to its terms and covenants.
  • Balance sheet: Total assets were $54.06 million and total equity was $49.59 million at August 31, 2014. Investments in joint ventures were $22.96 million.

Material changes versus FY2013

  • Sales growth across both product lines lifted gross profit and operating income; higher-margin oil-and-gas sales and the absence of prior-year start-up costs contributed to the gross-margin improvement.
  • Joint-venture equity income rose 13.0% and service fees rose 10.7%, alongside improved joint-venture sales, which management attributed partly to better European conditions.
  • Operating expenses increased 11.9% to $16.39 million, including higher selling, administrative and R&D spending. R&D expense increased 14.5% to $4.37 million.
  • Other income fell to $4,393 from $670,126, mainly because FY2013 included life-insurance proceeds.
  • Cash declined by $1.84 million, while working capital increased from $13.27 million to $17.85 million, reflecting, among other things, joint-venture dividends and the purchase of available-for-sale securities.

Outlook, risks and other notable items

  • Management expected FY2015 R&D spending of $4.0–$4.5 million and capital expenditures of approximately $400,000–$600,000. It believed available liquidity, forecast operating cash flows, joint-venture distributions and financing capacity would fund at least the next 12 months; this is forward-looking and not a guarantee.
  • Management expects continued quarterly earnings volatility, particularly from variable joint-venture performance and the timing of oil-and-gas and Natur-Tec orders. Oil-and-gas sales can involve one- to multi-year trials and gradual customer integration.
  • Key risks include dependence on joint-venture fees and discretionary dividends; concentration in ZERUST and significant contributions from the German and Chinese ventures; competitive pricing and margin pressure; limited suppliers for certain materials, including Natur-Tec base resins; foreign-exchange exposure (not hedged); and execution, market-acceptance and funding risks in growth initiatives.
  • NTIC purchased a Beachwood, Ohio property for $1.1 million and expected to move personnel there after its existing lease expired. Management reported no legal proceeding with a reasonably possible material loss. The independent auditor gave unqualified opinions on the financial statements and internal control over financial reporting.
  • The board did not anticipate paying a common-stock dividend in the near future. The $3.0 million credit line had a January 7, 2015 maturity date at the report date; management anticipated renewal, but renewal was not assured.

Important facts for investors to verify

  • Track actual cash conversion and collections: annual operating cash flow was slightly negative despite reported net income and receipt of joint-venture dividends.
  • Assess the sustainability and cash availability of joint-venture earnings and fees, including dividend decisions outside NTIC’s control and the large contribution from EXCOR.
  • Monitor whether oil-and-gas and Natur-Tec growth continues, and whether associated spending delivers profitable sales given long sales cycles and competitive pressures.
  • Confirm renewal or replacement of the revolving credit facility after its stated January 2015 maturity, and review covenant compliance and funding needs.
  • Consider tax-credit realizability: the filing reports valuation allowances against foreign tax credits and certain research-and-development and capital-loss carryforwards, including approximately $602,900 of foreign tax credits set to expire by August 31, 2015 if unused.