Northern Technologies International Corporation (NTIC) Q2 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Northern Tech International Corporation's Second Quarter 2015 Earnings Conference Call and Webcast. At this time, all participants are in a listen-only mode. Later, we'll conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, today's conference is being recorded. I'd now like to introduce your host for today's conference Patrick Lynch, President and CEO. Sir, you may begin.

Thank you. Good morning. I am Patrick Lynch, NTIC's Chief Executive Officer and I am here with Matt Wolsfeld, NTIC's Chief Financial Officer. Please note that our second quarter of fiscal 2015 financial results were included in the press release issued earlier this morning, a copy of which is now available at ntic.com. During this call, we will review various key aspects of our second quarter and year-to-date fiscal 2015 financial results, give a brief business update, include developments in China, comment on our annual sales and earnings guidance for fiscal 2015, and then conclude with a short question-and-answer session. As part of the discussion today, we'll be making certain forward-looking statements regarding NTIC's future financial and operating results, as well as our business plans, objectives and expectations. Please be advised that these forward-looking statements are covered under the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995, and that NTIC desires to avail itself of the protections of the Safe Harbor for these statements. Please also be advised that actual results could differ materially from those stated or implied by our forward-looking statements due to certain risks and uncertainties, including those described in our most recent annual report on Form 10-K, subsequent quarterly reports on Form 10-Q and our recent press releases. Please read these reports and other future filings that we will make with the SEC including our second quarterly report on Form 10-Q, which we intend to file with the SEC during the next couple of days. We disclaim any duty to update or revise our forward-looking statements. During the second quarter of fiscal 2015, which ended on February 28, 2015, our total net sales continued to show year-over-year improvement. At the same time, we achieved additional key objectives in all three of the market segments that NTIC serves. Furthermore, I should also point out that our competitive position, operations and balance sheet are all stronger today than they were a year ago. Although the termination of our former joint venture relationship in China adversely affected our financial results during the second quarter, we believe that our new wholly owned subsidiary, which we refer to as NTIC China will eventually be able to capture the business of our former joint venture entity in China and aggressively grow that business going forward. NTIC’s total net sales increased over 11% in the first six months of fiscal 2015 to almost $14 million compared to the same period in fiscal 2014. This growth was largely attributable to the sales of our industrial ZERUST products to new and existing customers in North America as well as significant growth in Natur-Tec products in North America and India. As announced in January, on December 31, 2014, NTIC terminated our joint venture agreements with Tianjin ZERUST, our former joint venture in China. Since then, we have recently initiated litigation against our former Chinese partner and are seeking amongst other things an orderly liquidation of that joint venture entity. In its place, we’ve established NTIC Shanghai Company Limited as our newly formed wholly owned subsidiary. As of January 1, 2015, this subsidiary again, which we refer to as NTIC China, is the only authorized source of ZERUST and Excor branded products and services in the PRC. While the primary cause for this significant shift in strategy was unfortunate and was the impetus for our now pending litigation against our former Chinese joint venture partner, we believe it has also given us the opportunity to invest in and grow our business in this market much more aggressively than before. Currently, NTIC China is focusing its efforts on transitioning ZERUST customers from Tianjin ZERUST, our former joint venture in China, to NTIC China. NTIC China will then shift its attention more aggressively towards new business. Commencing with second quarter of fiscal 2015, our consolidated financial statements include the financial results of NTIC China. The largest impact to our financial results of our operations in China was $833,000 of expense related to the termination of our joint venture agreements with Tianjin ZERUST, recently initiated litigation by us against our former Chinese joint venture partner in the course of Tianjin and the formation and ongoing operations of NTIC China. Additionally, during second quarter, NTIC did not record any royalty or equity income from Tianjin ZERUST. This had a negative impact on our total joint venture operations as Tianjin ZERUST contributed over $440,000 of royalties and equity income to NTIC during the second quarter of fiscal 2014. Obviously, this impact on NTIC’s earnings was significant during the second quarter of fiscal 2015 and will continue to be so during the next few quarters until our new operations in China hit their stride and begin to recognize significant sales. Sales by our joint ventures which are not consolidated with our financial results showed a decrease of $5.9 million or a 10% decrease to $52.2 million during the six months ended February 28, 2015, compared to the same period last year. This decrease was primarily attributable to the termination of our joint venture agreements with Tianjin ZERUST. Sales at Tianjin ZERUST in the first quarter of fiscal 2015 were $4.3 million for comparative purposes. The remainder of the decrease in sales at our joint ventures was primarily attributable to the continued weakening of the Euro to the U.S. dollar. All said, NTIC earned $0.19 per diluted common share during the six months ended February 28, 2015, compared to $0.41 per diluted share during the same period in fiscal 2014, which is a 53% decrease. Starting in the second quarter of fiscal 2015, our consolidated financial statements include the financial results of our new NTIC China subsidiary. Our annual report on Form 10-K each year breaks out certain financial information on our joint ventures including our former Chinese joint venture and on our quarterly reports on Form 10-Q also contain financial information on our former Chinese joint venture because of its significance to our total financial results. As previously disclosed in our fiscal 2014 Form 10-K, our former Chinese joint venture had net sales of almost $16 million and operating income before paying royalties to shareholders of over $5.5 million during fiscal 2014. Our 30% portion of the Chinese joint venture's operating income was over $1.6 million during fiscal 2014, which means that assuming we eventually successfully -- we are eventually successful in transitioning the bulk, if not all of the sales of our former Chinese joint venture to NTIC China, our earning should significantly increase since we will fully consolidate 100% of NTIC China’s net sales and operating income. Although, we're doing our best to aggressively go after these sales, there is obviously risk associated with us transitioning these sales to NTIC China. With the consolidation of NTIC China, we also expect our NTIC’s overall net sales, cost of goods sold and operating expenses will increase and our equity and income from joint ventures and fee income from services provided to joint ventures will decrease in future periods compared to the fiscal -- the prior fiscal year periods. We recognize that it may take some time to transition customers from our former Chinese joint venture to NTIC China and that this will result in some volatility in our operating results during the next few quarters. This will be especially true with respect to our third and fourth quarters of fiscal 2015, during which we expect to incur losses at NTIC China prior to recognizing any significant income. During the first six months of fiscal 2015, we incurred approximately $883,000 of direct expenses related to the termination of our ZERUST Tianjin -- termination of ZERUST Tianjin and the formation of NTIC China. These expenses consisted primarily of legal expenses and personal expenses associated with the establishing the subsidiary, as well as hiring a seasoned management sales and operations team. These expenses are reflected in increased selling and general administrative expenses and increased expenses incurred in support of joint ventures during the six months ended February 28, 2015. The decision to go direct in China came under circumstances that were very disappointing to NTIC and our federation of joint venture partners. However, we are now focusing this as an excellent opportunity to finally grow this very important international market on our own terms. Moving on to our oil and gas business; in the first half of fiscal 2015, our oil and gas team continued to focus its sales efforts on protecting the bottom plates of oil storage tanks from corrosion. In this effort, our team continued to successfully target terminal operators and refineries in North America. Having seen the need for and acceptance of our innovative solutions, we expect this growth opportunity to continue during the remainder of fiscal 2015 and beyond. With continued low global oil prices, key perspective ZERUST clients in the oil and gas industry may decide to review their maintenance budgets in the coming months. In this event, we expect acid preservation to take precedence over acid expansion keeping the performance of our ZERUST oil and gas team in line with expectations. However, as we have repeatedly mentioned, this is still a relatively new market for us. So we expect that any associated benefits to our financial results will not be immediate and may be choppy with spikes in sales when opportunities are converted and revenue is recognized over the next few years. Now, turning to our Natur-Tec bioplastics business; net sales of Natur-Tec products increased almost 57% during the first half of fiscal 2015 compared to the prior fiscal year period. This increase was partially due to finished product sales through NTIC's majority-owned subsidiary in India and also due to increased sales in North America through our domestic distributors. We continue to see strong demand for finished products such as compostable bags and cutlery in North America as a direct result of increased adoption of zero waste initiatives and favorable local and state waste management regulation. We expect both of these segments to continue to be strong growth areas as we continue to target and convert additional manufacturers to the use of Natur-Tec sustainable packaging solutions in Asia and worldwide. I'll now turn the call over to Matt Wolsfeld to summarize in more detail our financial results for the first half of fiscal 2015.

Thanks, Patrick. Sales of NTIC's ZERUST products increased across all market segments during the six months ended February 28, 2015, compared to the same period in fiscal 2014. Sales of industrial ZERUST corrosion inhibiting products increased over 6% as we experienced increased demand from both existing and new customers. Sales of ZERUST Oil & Gas solutions increased almost 11% in the first half of 2015 as we completed implementation of multiple new and existing customer sites in North America. Sales of ZERUST corrosion inhibiting products to our joint ventures increased over 5% during the six months ended February 28, 2015, compared to the prior fiscal year period. Income provided by our joint venture operations decreased by over 11% to $6.2 million during the first half of fiscal 2015 compared to the prior fiscal year period. However, that was mostly attributable to the termination of our joint venture agreement with Tianjin Zerust, our former joint venture in China, as previously discussed. Lastly, sales of Natur-Tec products increased over 56% to almost $2 million during the first half of fiscal '15 compared to the same period in fiscal 2014. Our total operating expenses increased over 9% to $8.9 million during the first half of fiscal 2015, compared to the prior fiscal year period, primarily due to an increase in selling, general and administrative expenses, and expenses incurred in support of joint ventures, which was previously mentioned were related primarily to the change in our Chinese operation. Overall, net income attributable to NTIC decreased 53% to $879,000, or $0.19 per diluted common share for the six months ended February 28, 2015, compared to $0.41 to the prior fiscal year period. As of February 28, 2015, our working capital was $17.8 million, including $3.4 million in cash and cash equivalents and $3.5 million in available for sale securities, compared to $17.8 million, including $2.5 million in cash and cash equivalents and $5.5 million in available for sale securities as of August 31, 2014. Now turning to NTIC's annual guidance. For the fiscal year ending August 31, 2015, we continue to expect our sales to be in the estimated range of $32 million to $34 million. However, there's still significant uncertainties in this estimate due to the recent information and establishment of NTIC China. We anticipate that we will be in a position to better update our net sales guidance after the third quarter of fiscal 2015. We expect net income of between $2.8 million and $3.1 million, or between $0.62 and $0.68 per diluted share. But this estimate is also subject to significant uncertainties relating to our new operations in China. With that update, I will now -- we will now answer any questions you may have.

Thank you. [Operator Instructions] Our first question comes from Dick Feldman with Axiom Capital. Your line is open.

Good morning.

Good morning.

My questions revolve at first around China. What type of volume do you need from NTIC China to breakeven? And then the second question is what is the substance of your suit in China?

As far as breakeven, when I look at -- Dick, this is Matt. When I look at breakeven in China, I look at it more from the standpoint of how do we get back to -- what volume of sales level do we need to get back to the $1.6 million of contribution that the joint venture contributed in our fiscal 2014. And by our estimates, we need right around $6 million -- $6 million to $7 million of annual sales in order to hit that $1.6 million of, say, operating income from China.

As to your question regarding the law suit, I would say the -- a bulk of it is related to -- or focused on improper related party transactions.

Getting back to my first question about the -- could you give us any guidance as to how revenues are currently ramping up in China?

You're asking how our sales developing? I mean, we have converted…

And, you know, obviously, also your potential customers probably had inventory, so they have to work through that inventory as -- before you start to see business.

Once we -- at the time we canceled the JV contract to talk right in the normal calendar New Year, which quickly transitioned by the beginning of February into Chinese New Year. So really the first month of real sales activity didn't happen until March. So, the results you saw in the second quarter are not really indicative of what we expect to see coming in future quarters.

Okay. I'll let other people to have a call. Thanks for answering the questions.

Thank you. [Operator Instructions] Our next question comes from Tim Clarkson with Van Clemens Capital. Your line is open.

Hi guys. Two questions. First of all, in terms of the two smaller joint ventures, the oil and gas deal and the compostable, how close are we to being breakeven in those two businesses?

With Natur-Tec we're on-track to still be breakeven this year. With oil and gas, we actually expect to be in line with our budget this year, which is -- I mean, we're expecting significantly higher sales than last year in the next -- by the end of the fiscal year. We still have to see exactly how much the lower oil prices are going to swing our sales expectations one way or the other. As I mentioned early on the call, if rather than asset expansion people focus on asset maintenance that's actually good for us.

Right, right. Okay. And then in terms of forgetting about the exact numbers in China, I mean, at this point I'm guessing that 80% of your business in China comes from what, eight or 10 customers?

I think it's little bit more diversely spread out than that. But there are certain very large customers in China, particularly the named OEMs household automotive companies that you would know of. But there is also a very significant portion of the business of Tier 1 and Tier 2 suppliers to those major automotive companies. And so, I would not say that it's just 10 customers that make the bubble of business. It's little bit -- it's more of a -- let me try it again, a more -- a bigger pool of customers.

Are those guys in line to convert to NTIC? Is there a lot of resistance, or what's the backdrop on that?

Some have had no issues. Some are putting us through an evaluation process because it's just part of their routine to evaluate any new supplier. So, there is that process to go through. But on the whole, it's been going reasonably well.

Is it -- has it gone a lot differently than what you would have expected?

No.

All right. I'm done. Thanks.

Thank you. Our next question comes from Walter Ramsley with Walrus Partners. Your line is open.

Thanks very much. Good morning. Congratulations. Got a question for Matt, I guess. The taxes -- income taxes in second quarter anyway, they were higher than pretax income, so if you could explain how that happened, I'd appreciate it. And also, if you could just give us kind of a ballpark idea of what the full-year tax rate is expected to be to generate that $0.62 to $0.68 estimate.

Sure. The tax expenses recorded in second quarter isn't based just on second quarter earnings. The tax expenses recorded in second quarter is based off of our projections for the full-year. That takes into account full-year worth of dividends, our expectations for what we are going to record as income in third and fourth quarter. So, that it's more of a blended rate, so that we don't have a large income tax -- a large tax in one quarter, a small one in the second quarter, so it’s more of a consistent number based on yearend expectation. We still expect our effective tax rate to be pretty consistent with where it was -- with where it was last year. We don’t see it being significantly out of line because of anything that’s going on.

Okay. And just maybe for Patrick, the lawsuit that’s underway in China, if the company, Northern Technologies prevails and liquidate still the joint venture, does that put your former partner completely out of business or is he in the process of starting up a new company of his own or what’s the lay of the land as far as that one goes?

Well, our former joint venture partner already owns a number of different companies in China. I don’t expect him to be completely out of business and pick up other business areas -- business areas. We certainly would not be surprised if he tries to compete against us in the future. But it’s still too early to see or to tell how this court case is going to pan out.

But assuming it did prevail, wouldn’t he be required to go through that same song and dance that you guys are going through now to get qualified and so at it to get his new business off the ground?

Yes, we would.

Okay. And just one last thing I guess in Europe and perhaps elsewhere in the world the currencies have been pretty negative at least as far as America is concerned, can you just kind of walk us through what the unit volume trends look like and how much the currency is subtracting from that?

Sure. If I look at it, the biggest impact on NTIC from the foreign currency, the foreign currency situation has to do obviously with our equity income and our royalty income. I did a calculation couple of days ago, I was looking at the impact in equity income on our year-to-date results and basically if I took the exact same foreign currency amounts in all the different currencies that we operate in and made them consistent with as if there is no foreign currency change in each of the countries that we operate in, we would have essentially had about $250,000 of increased equity income. So the change in the Euro mostly and several other currencies have impacted our equity income to a negative variance of about $250,000. The royalty income if I look at Germany specifically, that pays us a flat amount of royalty each quarter, we took in about comparing the six months ended in 2014 to the six months ended in 2015 about $86,000 less in royalty income. If I look at that proportionally compared to the other joint ventures I would estimate that the royalty income is down for the six months by about $250,000 simply because of the foreign currency translation, the foreign currency issues with the strengthening of the dollar. So by my estimates in the six months ended 2015, we had about $500,000 -- we had about $500,000 of decreased joint venture income simply because of the situation with the U.S. dollar compared to other foreign currencies. As an example you can see in the last year February 28, 2014, the Euro was at about 1.4 and now is that February 28 this year, it was at about 1.1, which is roughly a 20% decrease in the -- for comparative purposes.

Okay. All right. That’s very helpful. That’s very precise answer. Thanks a lot, Matt. Okay, that's it from me. Thanks very much.

Thank you. Our next question comes from [Gerry Well] [ph], who is the Private Investor. Your line is open.

Good morning guys. See I have two questions. One is in your estimated guidance for the second half of this year, how much reliance is there relating to the China revenue increasing? And the second question is to get some more detail on the tank business, I don’t know if you keep track on backlog as far as specific numbers and if you’re still seeing the same large opportunity and what the Op scores are to getting that business to grow even faster?

I can cover the revenue piece Gerry and Patrick can comment on the tank business, from a revenue standpoint, we were let’s say very conservative in the amount of revenue that we wanted to include for China, specifically because we’re still in territories where we are actively converting customers as far as how quickly they're going to convert and when the orders will start. A lot of it is still up in the air. So it’s difficult for us to let’s say put an aggressive number out there for the amount of Chinese sales, sales we would have in China. So our expectations are that -- our expectations are that we were conservative in the number and that we will be hopefully looking to increase that as we have a better understanding of what’s going on after third quarter and then ultimately the guidance -- the guidance that I’m more concerned about is what’s going to happen in our fiscal 2016, because that's when we'll obviously have a better idea of what existing customers we already have converted and then what new markets we will be able to go after as far as where the future growth in China is going to -- is going to be.

All right. Let me address the tank question. Compared to the same time last year, we have put out or have been asked for more than double the number of proposals than compared to last year. So assuming that we have a conversion rate in line with what we had last year, our sales should be significantly up for the year. In terms of long-term prospects, we've increased our sales force. We're increasing some of the solutions we're introducing in the market. So, on the whole we expect good things from the oil and gas sector. Again on the assumption also that going forward due to the current low oil prices that the oil companies will also be focusing more of their expenses on asset maintenance rather than asset growth.

You still see the significant opportunity of the longer term in the tank business so it’s just hard. What’s the biggest obstacle in capturing more of that market? Is it people? Is it conversion of clients to product, or what do you see? It seems to me the opportunity is really huge and that once it starts that all the clients would kind of sign up for it if you will?

Yes, but you're still talking about a -- of a somewhat conservative, we’re not somewhat, a reasonably conservative industry. We’ve been doing these installations now for somewhat slightly over a year. So some of our customers both prospective and existing are I guess are a little cautious in terms of doing a complete conversion. They like to see how we perform over a period of time before they really turn over the keys to us.

Okay. Thanks.

Thank you. Our next question comes from Michael Ross with Van Clemens & Company. Your line is open.

Yes the way I surmised it, it sounds like this conversion is maybe about through 2016, is that exact your estimate would you say?

Are we talking conversion of oil storage tanks or are we talking about conversion of customers in China?

Customers in China?

Yes. That would be a fair assessment.

Okay. Thank you.

Thank you. We have a follow-up from Dick Feldman with Axiom Capital. Your line is open.

My question concerns the oil and gas, first on the tank business, we read in the newspapers how all the storage tanks are filled up and so that raises the question, are there any empty tanks available to be refurbished?

Well, our solutions for storage tank bottoms, we can implement those on tanks that are in use if necessary and as you mentioned since all these storage tanks are full, they need to keep those in use because any leakage would automatically render those tanks unusable until the repairs have been made. So that's actually incentive for people to implement our solutions rather than a detriment, but of course there are certain obstacles to implementation. I’ll take as an example we just got a very favorable evaluation and approval for the storage tank bottom solution in Brazil, but given the current political scandals that are going on regarding the President of Brazil and her relationship with Petrobras, the Petrobras Senior Management is in a major shakeup and until those things settle down, we don’t expect to see any implementations of storage tank bottom solutions in Brazil within the next six months or so.

Are you seeing again in the tank side of the business from what type of reorder rate, are you seeing from early users and then could you talk about new adaptors?

I would say that, as I mentioned earlier, we are -- we’ve already send out more than twice as many of proposals for implementations this year than we had last year and I would say a great proportion of those are for repeat customers. So I think that the customers that we have done implementations with last year were very pleased with how professional we did it and are pleased with the service overall. We’ll see one on a case by case basis, how quickly they expand that implementation. We certainly have not had any case where somebody said, thank you but we’re not going to do business with you in the future. That has not happened.

Could you give us any guidance as to from the studies that you’ve done, what type of rate of return do customers get for adopting your tank bottom solution?

While we essentially -- that’s always on a case by case basis where the customer and their operating costs basically what we claim is that by implementing our solutions you extend the service life of the asset between maintenance. So that they can operate without having to affect maintenance for longer period of time or if they have regulatory requirements to have maintenance in certain periods that the downtime is much shorter. So that's saving them money because they can utilize our asset more fully over a longer period of time, but again that’s -- we're very conservative in those claims that we make to our customers, but they obviously still feel that it's worth to implement our solution.

On the non-tank oil and gas business, I take the comment you made about Petrobras is the tank bottoms also would relate to land shape of this well?

We're getting consistent monthly orders from Petrobras for plant savers. So it’s an ongoing business for us. But certainly we have not -- we’re not getting some of the increase in orders that we hadn’t anticipated by now.

And non-Petrobras and non-tank bottom oil and gas, is there much activity there?

Non-Petrobras, non-oil and gas, I’m sorry I’m not quite sure understand your question.

We talked plant shapers, we’ve talk about tank bottoms, you also stated in past calls, their other potential uses in the oil and gas business, are you seeing any uptake there?

Yes, we're getting some new business in different storage tank solutions. Also we're getting some increased business in the maintenance and preservation of heat exchangers and heat exchangers are very commonly used in oil refineries and chemical processing plants all over the world.

Okay, well thank you. Those were still modest.

Those were still what please?

Modest. I am sorry.

Yes, those are still modest, yes.

Okay. Once again thanks for taking the questions.

Yes.

Thank you. We have a follow-up question from the line of Gerry Well who is a private investor. Your line is open.

Are you there Gerry? Hello.

Yes, guys sorry about that. See if you could give me probably Matt question, that it varies a lot per tank on the size of the job and whatever, but roughly Matt, have you done the numbers as far as on an annual basis, which you did to get to for tanks to be done on an annual basis to kind of get to a breakeven for that division?

I haven't run it specifically on -- I don’t have numbers that I can you give you specifically on the number of tanks that you would need to breakeven in oil and gas. I can certainly say that based on where we're trending and based on the increase in the number of tanks that we expect to have in this fiscal year that, if we continue to see that run rate that oil and gas will hit a level, it will be beyond breakeven shortly if they continue with similar run rates.

Okay. Thank you.

Yeah.

Thank you. I’m showing no further questions. I would like to turn the call back to Patrick Lynch for closing remarks.

I’d like to thank everyone for participating today and for your interest in NTIC. Have a good day.