NTIC

Business Context and Reporting Period

Company: Northern Technologies International Corp (NTIC)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: November 30, 2010
Business Overview: NTIC develops and markets proprietary environmentally beneficial products, primarily corrosion prevention technologies (ZERUST®), bio-plastic compounds (Natur-Tec®), and waste-to-fuel conversion equipment. The company operates globally through a network of 26 joint ventures and direct sales. A significant accounting change occurred in the fourth quarter of fiscal 2010 when NTIC began consolidating its Brazilian subsidiary, Zerust Prevenção de Corrosão S.A. (Zerust Brazil), which it owns 85% of.

Key Financial Metrics

Segment Performance: ZERUST® net sales increased 47.5% to $3.88 million. Natur-Tec® net sales increased 166.0% to $223,013.

Material Changes vs. Prior Period

• Revenue Growth: Consolidated net sales increased 51.2% year-over-year, driven by increased demand in the domestic manufacturing sector, new customer additions, and the consolidation of Zerust Brazil.
• Profitability: Net income increased 105.4% to $894,874. This was primarily due to a 140.1% increase in equity income from joint ventures ($1.70 million vs. $0.71 million) and higher gross profit, partially offset by increased operating expenses.
• Operating Expenses: Total operating expenses rose 48.5% to $3.53 million. Key drivers included the consolidation of Zerust Brazil's G&A expenses ($205,000), increased R&D spending ($1.19 million vs. $0.61 million), and higher management bonus accruals ($357,000 vs. $158,000).
• Cash Flow: Net cash used in operating activities was $1.99 million, a reversal from the $128,563 provided in the prior year. This was due to increases in receivables and inventories and the non-cash nature of equity income from joint ventures. However, investing activities provided $1.24 million, largely due to dividends received from joint ventures ($1.37 million).

Guidance, Outlook, and Risks

Outlook and Commentary:

• Management anticipates spending between $3.5 million and $4.0 million on R&D for fiscal 2011.
• NTIC expects to continue investing in new business areas, specifically corrosion prevention for the oil and gas industry and the Natur-Tec bioplastics line.
• Sales to the oil and gas sector are expected to have a long sales cycle (1-2 years) with slow integration.

Subsequent Event (Debt Refinancing): On January 10, 2011, NTIC refinanced its term loan and increased its line of credit with PNC Bank to $3.0 million. The new term loan of approximately $1.14 million matures in January 2016 with interest at LIBOR + 2.15%. The company is subject to a minimum fixed charge coverage ratio of 1.10:1.00.

Risks and Contingencies:

• Joint Venture Dependence: A significant portion of income is derived from joint ventures; NTIC does not control dividend decisions.
• Foreign Currency: Exposure to fluctuations in the Euro, Yen, Rupee, and other currencies against the USD.
• Raw Materials: Exposure to commodity price changes, specifically plastic resins.
• Concentration: Two joint ventures accounted for 48.0% of trade joint venture receivables as of November 30, 2010.

Investor Verification Checklist

• Joint Venture Receivables: Verify the collectability of the significant receivables from the Indian joint venture, which contributed to an average days outstanding of 208 days.
• Debt Covenants: Confirm compliance with the new 1.10:1.00 fixed charge coverage ratio covenant following the January 2011 refinancing.
• R&D ROI: Monitor the return on the increased R&D spend ($1.19M in Q1) regarding new oil and gas and bioplastic technologies.
• Consolidation Impact: Assess the ongoing financial impact of consolidating Zerust Brazil on future quarters compared to the pro-forma adjustments.
• Asset Sale: Track the closing of the Omni-Northern Ltd. membership interest sale, expected to generate a ~$90,000 gain in Q2 fiscal 2011.