Northern Technologies International Corp: Form 10-Q for the period ended Feb 28, 2023

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” in this report and under “Part 1. Item 1A. Risk Factors” in our annual report on Form 10-K for the fiscal year ended August 31, 2022. 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 services in over 65 countries either directly or via a network of subsidiaries, joint ventures, independent distributors, and agents. NTIC’s primary business is corrosion prevention marketed mainly under the ZERUST® brand. NTIC has been selling its proprietary ZERUST® products and services to the automotive, electronics, electrical, mechanical, military, and retail consumer markets for almost 50 years and, more recently, has also expanded into the oil and gas industry. Additionally, NTIC markets and sells a portfolio of proprietary bio-based and certified compostable (fully biodegradable) polymer resin compounds and finished products under the Natur-Tec® brand. These products are intended to reduce NTIC’s customers’ carbon footprint and provide environmentally sound waste disposal options.

NTIC’s ZERUST® rust and corrosion inhibiting products include plastic and paper packaging, liquids, coatings, rust removers, cleaners, and diffusers as well as engineered solutions designed specifically for the oil and gas industry. NTIC also offers worldwide, on-site, technical consulting for rust and corrosion prevention issues. NTIC’s technical service consultants work directly with the end users of NTIC’s ZERUST® rust and corrosion inhibiting products to analyze their specific needs and develop systems to meet their performance requirements. In North America, NTIC sells its ZERUST® corrosion prevention solutions through a network of independent distributors and agents supported by a direct sales force.

Internationally, NTIC sells its ZERUST® corrosion prevention solutions through its wholly-owned subsidiary in China, NTIC (Shanghai) Co., Ltd. (NTIC China), starting September 1, 2021 its wholly-owned subsidiary in India, HNTI Ltd. (Zerust India), its majority-owned joint venture holding company for NTIC’s joint venture investments in the Association of Southeast Asian Nations (ASEAN) region, NTI Asean LLC (NTI Asean), certain majority-owned and wholly-owned subsidiaries, and joint venture arrangements in North America, Europe, and Asia. NTIC also sells products directly to its European joint venture partners through its wholly-owned subsidiary in Germany, NTIC Europe GmbH (NTI Europe).

One of NTIC’s strategic initiatives is to expand into and penetrate other markets for its ZERUST® corrosion prevention technologies. Consequently, for the past several years, NTIC has focused significant sales and marketing efforts on the oil and gas industry, as the infrastructure that supports that industry is typically constructed using metals that are highly susceptible to corrosion. NTIC believes that its ZERUST® corrosion prevention solutions will minimize maintenance downtime on critical oil and gas industry infrastructure, extend the life of such infrastructure, and reduce the risk of environmental pollution due to leaks caused by corrosion. NTIC markets and sells its ZERUST® rust and corrosion prevention solutions to customers in the oil and gas industry in a continuously increasing number of countries either directly, through its subsidiaries, or through its joint venture partners and other strategic partners. The sale of ZERUST® corrosion prevention solutions to customers in the oil and gas industry typically involves long sales cycles, often including multi-year trial periods with each customer and a slow integration process thereafter.

Natur-Tec® bio-based and compostable plastics are manufactured using NTIC’s patented and/or proprietary technologies and are intended to replace conventional petroleum-based plastics. The Natur-Tec® biopolymer resin compound portfolio includes formulations that have been optimized for a variety of applications, including blown-film extrusion, extrusion coating, injection molding, and engineered plastics. These resin compounds are certified to be fully biodegradable in a composting environment and are currently being used to produce finished products, including can liners, shopping and grocery bags, lawn and leaf bags, branded apparel packaging bags and accessories, and various foodservice items, such as disposable cutlery, drinking straws, food-handling gloves, and coated paper products. In North America, NTIC markets its Natur-Tec® resin compounds and finished products primarily through a network of regional and national distributors as well as independent agents. NTIC continues to see significant opportunities for finished bioplastic products and, therefore, continues to strengthen and expand its North American distribution network for finished Natur-Tec® bioplastic products.

Internationally, NTIC sells its Natur-Tec® resin compounds and finished products both directly and through its wholly-owned subsidiary in China and majority-owned subsidiaries in India and Sri Lanka, and through distributors and certain joint ventures.

Impact of COVID-19

As a result of the novel coronavirus (COVID-19) and related government mandated restrictions on NTIC’s business, as well as the businesses of its joint ventures, customers and suppliers, disruption to the Company’s business and the manufacture and sale of its products and services continued to occur during the first six months of fiscal 2023, including in particular China, and may continue during the remainder of fiscal 2023. While demand in China improved during the second quarter of fiscal 2023 as a result of government restrictions that were lifted, NTIC continued to experience softened demand for its products in China during the first six months of fiscal 2023.

Worldwide Supply Chain Disruptions

Worldwide supply chain disruptions, which were initially brought about by the impact of COVID-19, have persisted despite the recovery in the global economy and financial markets. These issues continued during the first six months of fiscal 2023 and, although these issues have shown some improvement, are expected to continue to some degree throughout the remainder of fiscal 2023. NTIC has experienced longer lead times for raw materials, has been forced to find new suppliers of certain raw materials, and has experienced raw material cost increases compared to prior fiscal quarters. Additionally, NTIC has experienced significantly longer shipping times and significant price increases per shipping container compared to prior fiscal quarters due to ocean freight capacity issues resulting from increased demand for shipping and reduced capacity and equipment. These and other issues resulting from worldwide supply chain disruptions have recently improved but are expected to continue to some degree throughout the remainder of fiscal 2023 and could continue to have a material adverse effect on NTIC’s business, operating results and financial condition. The precise financial impact and duration, however, cannot be reasonably estimated at this time.

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.

Highlights of NTIC’s financial results for the three and six months ended February 28, 2023 include the following, with increases or decreases in each case as compared to the respective prior fiscal year period:

• NTIC’s consolidated net sales increased 9.1% and 9.4% during the three and six months ended February 28, 2023, respectively, compared to the three and six months ended February 28, 2022 primarily as a result of an increase in sales of and demand for both Zerust® products, as well as targeted price increases on certain products. During the six months ended February 28, 2023, 78.0% of NTIC’s consolidated net sales were derived from sales of ZERUST® products and services, which increased 8.3% over the prior fiscal year period, and 22.0% of NTIC’s consolidated net sales were derived from sales of Natur-Tec® products, which increased 13.4% over the prior fiscal year period. NTIC’s consolidated net sales for the six months ended February 28, 2023 included $3,427,132 of sales made to customers in the oil and gas industry, a 121.1% increase over the prior fiscal year period.
• Cost of goods sold as a percentage of net sales decreased to 65.0% during the three months ended February 28, 2023, compared to 70.2% during the three months ended February 28, 2022, and decreased to 66.6% during the six months ended February 28, 2023, compared to 69.4% during the prior fiscal year period primarily as a result of passing along price increases to customers and increased sales made to customers in the oil and gas industry, which products carry higher margins than our Zerust industrial products and Natur-Tec® products.
• NTIC’s equity in income from joint ventures increased 22.3% and 0.9% during the three and six months ended February 28, 2023, respectively, to $1,128,731 and $2,318,135, respectively, compared to $922,832 and $2,297,581 during the three and six months ended February 28, 2022, respectively. These increases were primarily due to an improvement in gross margins and operating profits at the joint ventures. Net sales at the joint ventures increased 3.6% and decreased 2.7% to $25,482,590 and $50,212,879 during the three and six months ended February 28, 2023, respectively, compared to $24,601,767 and $51,624,762 during the three and six months ended February 28, 2022, respectively.
• NTIC’s total operating expenses increased 11.7% and 11.8% to $7,497,356 and $15,392,113 during the three and six months ended February 28, 2023, respectively, compared to $6,708,853 and $13,778,779 for the three and six months ended February 28, 2022. These increases were primarily due to increased personnel expenses, including benefits and travel, and expenses incurred during the current fiscal year periods in connection with the startup of a new indirect, majority owned subsidiary formed to assume the operations of a former joint venture in Taiwan, partially offset by payroll tax credits.
• NTIC incurred net income attributable to NTIC of $885,248, or $0.09 per diluted common share, for the three months ended February 28, 2023, compared to $182,847, or $0.02 per diluted common share, for the three months ended February 28, 2022. NTIC incurred net income attributable to NTIC of $1,387,490 or $0.14 per diluted common share, for the six months ended February 28, 2023, compared to $4,676,606, or $0.48 per diluted common share, for the six months ended February 28, 2022. Of the net income attributable to NTIC incurred in the six months ended February 28, 2022, $3,951,550 was due to the gain from the Zerust India acquisition.

Results of Operations

The following table sets forth NTIC’s results of operations for the three and six months ended February 28, 2023 and 2022.

Net Sales. NTIC’s consolidated net sales increased 9.1% and 9.4% to $18,270,825 and $38,223,591 during the three and six months ended February 28, 2023, respectively, compared to the three and six months ended February 28, 2022. These increases were primarily a result of increased demand across all market segments, including oil and gas, as well as targeted price increases on certain products.

The following table sets forth NTIC’s net sales by product segment for the three and six months ended February 28, 2023 and 2022:

During the three and six months ended February 28, 2023, 79.1% and 78.0% of NTIC’s consolidated net sales, respectively, were derived from sales of ZERUST® products and services, which increased 10.2% and 8.3% to $14,458,747 and $29,828,748, respectively, compared to $13,117,777 and $27,541,562 during the three and six months ended February 28, 2022, respectively. These increases were primarily a result of increased demand in North America, as well as targeted price increases on certain products.

The following table sets forth NTIC’s net sales of ZERUST® products for the three and six months ended February 28, 2023 and 2022:

NTIC’s total ZERUST® net sales increased during the three and six months ended February 28, 2023, compared to the prior fiscal year periods, primarily due to increased sales to new and existing oil and gas customers. Overall, demand for ZERUST® products and services depends heavily on the overall health of the markets in which NTIC sells its products, including the automotive, oil and gas, agriculture, and mining markets in particular.

ZERUST® oil and gas net sales increased 212.4% and 121.1% during the three and six months ended February 28, 2023 compared to the prior fiscal year periods primarily as a result of new opportunities with new and existing customers. NTIC anticipates that its sales of ZERUST® products and services into the oil and gas industry will continue to remain subject to significant volatility from quarter to quarter as sales are recognized, specifically due to the volatility of oil prices. Demand for oil and gas products around the world depends primarily on market acceptance and the reach of NTIC’s distribution network. Because of the typical size of individual orders and overall size of NTIC’s net sales derived from sales of oil and gas products, the timing of one or more orders can materially affect NTIC’s quarterly sales compared to prior fiscal year quarters.

During the three and six months ended February 28, 2023, 20.9% and 22.0% of NTIC’s consolidated net sales, respectively, were derived from sales of Natur-Tec® products, compared to 21.7% and 21.2% during the three and six months ended February 28, 2022, respectively. Sales of Natur-Tec® products increased 5.0% and 13.4% to $3,812,078 and $8,394,843 during the three and six months ended February 28, 2023, respectively, compared $3,630,862 and $7,400,490 during the three and six months ended February 28, 2022, respectively, as a result of increased global demand. COVID-19 adversely impacted demand for Natur-Tec® products from across the apparel industry, as well as many large users of bioplastics, including college campuses, stadiums, arenas, restaurants, and corporate office complexes. While NTIC has experienced a recovery in many of these areas to pre-pandemic levels, NTIC still expects some of these customers will be the last businesses to fully re-open and operate at full pre-pandemic capacities.

Cost of Goods Sold. Cost of goods sold increased 0.9% and 5.0% for the three and six months ended February 28, 2023, respectively, compared to the three and six months ended February 28, 2022 primarily as a result of the increase in net sales, as described above. Cost of goods sold as a percentage of net sales decreased to 65.0% and 66.6% for the three and six months ended February 28, 2023, compared to 70.2% and 69.4% for the three and six months ended February 28, 2022 primarily as a result of passing along price increases to customers and increased sales made to customers in the oil and gas industry, which products carry higher margins than our Zerust industrial products. Although NTIC has taken certain actions to address inflationary pressures and pass on related cost increases to its customers, it expects some of these inflationary pressures to persist through the end of fiscal 2023. Some improvements from these actions as well as some improvements in gross margin were realized in the six months ended February 28, 2023.

Equity in Income from Joint Ventures. NTIC’s equity in income from joint ventures increased 22.3% and 0.9% during the three and six months ended February 28, 2023, respectively, to $1,128,731 and $2,318,135, respectively, compared to $922,832 and $2,297,581 during the three and six months ended February 28, 2022, respectively. These increases were primarily due an improvement in gross margins and operating profits at the joint ventures. NTIC’s equity in income from joint ventures fluctuates based on net sales and profitability of the joint ventures during the respective periods. Of the total equity in income from joint ventures, NTIC had equity in income from joint ventures of $1,547,944 attributable to EXCOR during the six months ended February 28, 2023, compared to $1,499,821 attributable to EXCOR during the six months ended February 28, 2022. NTIC had equity in income from all other joint ventures of $770,191 during the six months ended February 28, 2023, compared to $797,760 during the six months ended February 28, 2022.

Fees for Services Provided to Joint Ventures. NTIC recognized fee income for services provided to joint ventures of $1,252,746 and $2,434,551 during the three and six months ended February 28, 2023, respectively, compared to $1,246,909 and $2,505,767 during the three and six months ended February 28, 2022, respectively, representing increases of 0.5% and a decrease of 2.8%, respectively. Fee income for services provided to joint ventures is traditionally a function of the sales made by NTIC’s joint ventures; however, at various joint ventures, the fee income for services is a fixed amount that does not fluctuate with the change in sales experienced by certain joint ventures. Net sales at the joint ventures increased 3.6% and decreased 2.7% to $25,482,590 and $50,212,879 during the three and six months ended February 28, 2023, respectively, compared to $24,601,767 and $51,624,762 during the three and six months ended February 28, 2022, respectively. Net sales of NTIC’s joint ventures are not included in NTIC’s product sales and are not included in NTIC’s consolidated financial statements. Of the total fee income for services provided to joint ventures, fees of $396,792 were attributable to EXCOR during the six months ended February 28, 2023, compared to $435,422 attributable to EXCOR during the six months ended February 28, 2022.

Selling Expenses. NTIC’s selling expenses increased 15.1% and 11.5% for the three and six months ended February 28, 2023, respectively, compared to the same respective periods in fiscal 2022 due primarily to an increase personnel expense during the current fiscal year period compared to the prior fiscal year period, and expenses incurred during the current fiscal year periods in connection with the startup of a new indirect, majority owned subsidiary formed to assume the operations of a former joint venture in Taiwan, partially offset by payroll tax credits. Selling expenses as a percentage of net sales increased to 18.7% and 18.1% for the three and six months ended February 28, 2023, respectively, from 17.7% and 17.8% for the three and six months ended February 28, 2022, respectively, primarily due to the increased selling expenses as noted above.

General and Administrative Expenses. NTIC’s general and administrative expenses increased 22.4% and 21.5% for the three and six months ended February 28, 2023, respectively, compared to the same respective periods in fiscal 2022 due primarily to increased professional services and travel and personnel expenses during the current fiscal year periods compared to the prior fiscal year periods, as well as expenses incurred during the current fiscal year periods in connection with the startup of a new indirect, majority owned subsidiary formed to assume the operations of a former joint venture in Taiwan, partially offset by payroll tax credits. As a percentage of net sales, general and administrative expenses increased to 16.9% and 16.3% for the three and six months ended February 28, 2023, respectively, from 15.0% and 14.6% for the same respective periods in fiscal 2022 primarily due to the increase in general and administrative expenses as noted above.

Research and Development Expenses. NTIC’s research and development expenses decreased 18.4% and 8.3% for the three and six months ended February 28, 2023, respectively, compared to the same respective periods in fiscal 2022 primarily due to decreases in expenses associated with development efforts.

Interest Income. NTIC’s interest income decreased to $3,451 and $9,619 during the three and six months ended February 28, 2023, respectively, compared to $9,909 and $20,852 during the three and six months ended February 28, 2022, respectively, due primarily to changes in the invested cash balances.

Interest Expense. NTIC’s interest expense increased to $115,144 and $206,475 during the three and six months ended February 28, 2023, respectively, compared to $7,404 and $10,295 during the three and six months ended February 28, 2022, respectively, due primarily to increased outstanding borrowings under the line of credit and increased interest rates, in each case during the current fiscal year periods compared to the prior fiscal year periods.

Remeasurement Gain on Acquisition of Equity Method Investee. Authoritative guidance on accounting for business combinations requires that an acquirer re-measure its previously held equity interest in the acquisition at its acquisition date fair value and recognize the resulting gain or loss in earnings. As such, since NTIC acquired the remaining 50% ownership interest of Zerust India effective September 1, 2021, NTIC recognized a gain of $3,951,550 during the six months ended February 28, 2022. This gain is included in “Remeasurement gain on acquisition of equity method investee” on NTIC’s consolidated statements of operations. There was no comparable gain during the current fiscal year period.

Income Before Income Tax Expense. NTIC had income before income tax expense of $1,175,614 and $1,920,027 for the three and six months ended February 28, 2023, respectively, compared to $447,728 and $5,673,941 for the three and six months ended February 28, 2022, respectively.

Income Tax Expense. Income tax expense was $181,795 and $292,528 for the three and six months ended February 28, 2023, respectively, compared to $151,743 and $656,123 during the three and six months ended February 28, 2022, respectively. Income tax expense was calculated based on management’s estimate of NTIC’s annual effective income tax rate.

NTIC considers the earnings of certain foreign joint ventures to be indefinitely invested outside the United States on the basis of estimates that NTIC’s future domestic cash generation will be sufficient to meet future domestic cash needs. As a result, U.S. income and foreign withholding taxes have not been recognized on the cumulative undistributed earnings of $20,493,861 and $21,256,923 as of February 28, 2023, and August 31, 2022, respectively. To the extent undistributed earnings of NTIC’s joint ventures are distributed in the future, they are not expected to result in any material additional income tax liability after the application of foreign tax credits.

Net Income Attributable to NTIC. Net income attributable to NTIC increased to $885,248, or $0.09 per diluted common share, for the three months ended February 28, 2023, compared to $182,847, or $0.02 per diluted common share, for the three months ended February 28, 2022. This increase was a result of the increase in gross profit and joint venture income contribution, partially offset by the increase in operating expenses. Net income attributable to NTIC decreased to $1,387,490, or $0.14 per diluted common share, for the six months ended February 28, 2023, compared to $4,676,606, or $0.48 per diluted common share, for the six months ended February 28, 2022. This decrease was primarily due to the $3,951,550 remeasurement gain on acquisition of equity method investee recognized during the prior fiscal year periods, which did not repeat this fiscal year, and to a lesser extent, the increase in operating expenses, partially offset by the increase in gross profit.

NTIC anticipates that its earnings will continue to be adversely affected to some extent by COVID-19, inflation and worldwide supply chain disruptions, among other factors. Additionally, NTIC anticipates that its quarterly net income will continue to remain subject to significant volatility primarily due to the financial performance of its subsidiaries and joint ventures, sales of its ZERUST® products and services into the oil and gas industry, and sales of its Natur-Tec® bioplastics products, which sales fluctuate more on a quarterly basis than the traditional ZERUST® business.

Other Comprehensive Income - Foreign Currency Translations Adjustment. The changes in the foreign currency translations adjustment were due to the fluctuation of the U.S. dollar compared to the Euro and other foreign currencies during the three and six months ended February 28, 2023 compared to the same periods in fiscal 2022.

Liquidity and Capital Resources

Sources of Cash and Working Capital. NTIC’s working capital, defined as current assets less current liabilities, was $23,998,313 as of February 28, 2023, including $5,451,111 in cash and cash equivalents, compared to $23,169,480 as of August 31, 2022, including $5,333,890 in cash and cash equivalents and $5,590 in available for sale securities.

On January 6, 2023, NTIC entered into a Credit Agreement (the “Credit Agreement”) with JPMorgan Chase Bank, N.A. (“JPM”), which provides NTIC with a senior secured revolving line of credit (the “Credit Facility”) of up to $10.0 million. The Credit Facility includes a $5.0 million sublimit for standby letters of credit. Borrowings of $7,100,000 were outstanding under the Credit Facility as of February 28, 2023.

Unless terminated earlier, the Credit Facility will mature on January 6, 2024, and the principal amount thereunder, together with all accrued unpaid interest and other amounts owing thereunder, if any, will be payable in full on such date. Borrowings under the Credit Agreement bear interest at a floating rate, at the option of NTIC, equal to either the CB Floating Rate or the Adjusted SOFR Rate. The term “CB Floating Rate” means the greater of the Prime Rate in the United States or 2.50%. The term “Adjusted SOFR Rate” means the term secured overnight financing rate for either one, three or six months (depending on the interest period selected by NTIC) plus 0.10% per annum. With respect to any borrowings using an Adjusted SOFR Rate, there is an applicable margin of 2.15% applied per annum. There is no applicable margin with respect to borrowings using a CB Floating Rate.

To secure the Credit Agreement, the Company assigned to JPM a continuing security interest in all of its right, title and interested in collateral made up for the assets of the Company.

The Credit Agreement contains customary affirmative and negative covenants, including, among other matters, limitations on NTIC’s ability to incur additional debt, grant liens, engage in certain business operations and transactions, make certain investments, modify its organizational documents or form any new subsidiaries, subject to certain exceptions. Further, the Credit Agreement contains a negative covenant that restricts the ability of NTIC to redeem or repurchase its common stock or pay dividends if the result of which would cause an event of default under the Credit Agreement. The Credit Agreement also requires the Company to maintain a Fixed Charge Coverage Ratio of at least 1.25 to 1.00. The term “Fixed Charge Coverage Ratio” means the ratio, computed for the NTIC on a consolidated basis, of net income plus income tax expense, plus amortization expense, plus depreciation expense, plus interest expense, and plus dividends received from joint ventures, minus unfinanced capital expenditures and equity in income from joint ventures, all computed for the twelve month period then ending, to scheduled principal payments made, plus scheduled finance lease payments made, plus interest expense paid, plus income tax expense paid, and plus cash distributions and dividends paid, all computed for the same twelve month period then ending.

The Credit Agreement also contains customary events of default, including, without limitation, payment defaults, material inaccuracy of representations and warranties, covenant defaults, bankruptcy and insolvency proceedings, cross-defaults to certain other agreements, breach of any financial covenant and change of control. Upon the occurrence and during the continuance of any event of default, JPM may accelerate the payment of the obligations thereunder and exercise various other customary default remedies. As of February 28, 2023, NTIC was in compliance with all debt covenants under the Credit Agreement.

In connection with the execution of the Credit Agreement described above, on January 6, 2023, the Amended and Restated Loan Agreement dated August 31, 2021 between Northern Technologies International Corporation and PNC Bank, National Association was terminated.

NTIC believes that a combination of its existing cash and cash equivalents, available for sale securities, forecasted cash flows from future operations, anticipated distributions of earnings, anticipated fees to NTIC for services provided to its joint ventures, and funds available through existing or anticipated financing arrangements will be adequate to fund its existing operations, investments in new or existing joint ventures or subsidiaries, capital expenditures, debt repayments, cash dividends, and any stock repurchases for at least the next 12 months. During the remainder of fiscal 2023, NTIC expects to continue to invest directly and through its use of working capital in Zerust India, NTIC China, Zerust Mexico, NTI Europe, its joint ventures, research and development, marketing efforts, resources for the application of its corrosion prevention technology in the oil and gas industry, and its Natur-Tec® bio-plastics business, although the amounts of these various investments are not known at this time.

NTIC also expects to use some of its capital resources to continue to transition some of its joint ventures as needed or appropriate, which may include additional acquisitions by NTIC of the remaining ownership interests of joint ventures not owned by NTIC, the formation of one or more new subsidiaries to assume the operations of a joint venture, and dissolutions or liquidations of one or more of its joint ventures. Some of these joint venture transitions may materially impact NTIC’s results of operations for a particular reporting period. For example, the formation of a new indirect, majority owned subsidiary of NTIC to assume the operations of a former joint venture increased NTIC’s operating expenses during the six months ended February 28, 2023.

NTIC traditionally has used the cash generated from its operations, distributions of earnings from joint ventures and fees for services provided to its joint ventures to fund NTIC’s new technology investments and capital contributions to new and existing subsidiaries and joint ventures. NTIC’s joint ventures traditionally have operated with little or no debt and have been self-financed with minimal initial capital investment and minimal additional capital investment from their respective owners. Therefore, NTIC believes there is limited exposure by NTIC’s joint ventures that could materially impact their respective operations and/or liquidity.

In order to take advantage of new product and market opportunities to expand its business and increase its revenues and assist with joint venture transitions, NTIC may decide to finance such opportunities by additional borrowing under its revolving line of credit or raising additional financing through the issuance of debt or equity securities. There is no assurance that any financing transaction will be available on terms acceptable to NTIC or at all or that any financing transaction will not be dilutive to NTIC’s current stockholders.

Uses of Cash and Cash Flows. Net cash provided by operating activities during the six months ended February 28, 2023 was $2,204,834, which resulted principally from NTIC’s net income, dividends received from joint ventures, depreciation and amortization expense, and stock-based compensation, partially offset by equity in income from joint ventures. Net cash provided by operating activities during the six months ended February 28, 2022 was $2,118,728, which resulted principally from NTIC’s net income, dividends received from joint ventures, deferred income tax, depreciation and amortization expense, and stock-based compensation, partially offset by the remeasurement gain on acquisition of equity method investee and equity in income from joint ventures.

NTIC’s cash flows from operations are impacted by significant changes in certain components of NTIC’s working capital, including inventory turnover and changes in receivables and payables. NTIC considers internal and external factors when assessing the use of its available working capital, specifically when determining inventory levels and credit terms of customers. Key internal factors include existing inventory levels, stock reorder points, customer forecasts and customer requested payment terms. Key external factors include the availability of primary raw materials and sub-contractor production lead times. NTIC’s typical contractual terms for trade receivables, excluding joint ventures, are traditionally 30 days and 90 days for trade receivables from its joint ventures. Before extending unsecured credit to customers, excluding NTIC’s joint ventures, NTIC reviews customers’ credit histories and will establish an allowance for uncollectible accounts based upon factors surrounding the credit risk of specific customers and other information. Accounts receivable over 30 days are considered past due for most customers. NTIC does not accrue interest on past due accounts receivable. If accounts receivables in excess of the provided allowance are determined uncollectible, they are charged to selling expense in the period that the determination is made. Accounts receivable are deemed uncollectible based on NTIC exhausting reasonable efforts to collect. NTIC’s typical contractual terms for receivables for services provided to its joint ventures are 90 days. NTIC records receivables for services provided to its joint ventures on an accrual basis, unless circumstances exist that make the collection of the balance uncertain, in which case the fee income will be recorded on a cash basis until there is consistency in payments. This determination is handled on a case-by-case basis.

NTIC experienced an increase in trade receivables and a decrease in inventory as of February 28, 2023, compared to August 31, 2022. Trade receivables, excluding joint ventures, as of February 28, 2023, increased $538,087 compared to August 31, 2022, primarily related to correlating increases to sales.

Outstanding trade receivables, excluding joint ventures balances, increased an average of 8 days to an average of 75 days from balances outstanding from these customers as of February 28, 2023 from an average of 67 days as of August 31, 2022.

Outstanding trade receivables from joint ventures as of February 28, 2023 increased $917,073 compared to August 31, 2022, primarily due to the timing of payments. Outstanding balances from trade receivables from joint ventures increased an average of 166 days to an average of 256 days from balances outstanding from these customers as of February 28, 2023 from an average of 90 days as of August 31, 2022. The significant increase in outstanding balances from trade receivables from joint ventures was due to the timing of a large order, that was subsequently collected. The average days outstanding of trade receivables from joint ventures as of February 28, 2023 were primarily due to the receivables balances at NTIC’s joint ventures in Sweden, France, South Korea and Thailand.

Outstanding receivables for services provided to joint ventures as of February 28, 2023 decreased $656,210 compared to August 31, 2022, and the average days to pay increased an average of 4 days to an average of 80 days from an average of 84 days as of August 31, 2022.

Net cash used in investing activities for the six months ended February 28, 2023 and 2022 was $1,923,336 and $5,792,833, respectively, which was primarily the result of the purchase of property and equipment, and investments in patents, and in the case of the prior year period, the purchase of the remaining 50% ownership interest in Zerust India.

Net cash used in financing activities for the six months ended February 28, 2023 was $111,605, which resulted from dividends paid to shareholders and dividends received by non-controlling interests, partially offset by proceeds from the exercise of stock options, borrowings under the line of credit and proceeds from NTIC’s employee stock purchase plan. Net cash used in financing activities for the six months ended February 28, 2022 was $2,786,371, which resulted from borrowings under the line of credit and proceeds from NTIC’s employee stock purchase plan and the exercise of stock options, partially offset by dividends paid to shareholders and dividends received by non-controlling interests.

Share Repurchase Plan. On January 15, 2015, NTIC’s Board of Directors authorized the repurchase of up to $3,000,000 in shares of NTIC common stock through open market purchases or unsolicited or solicited privately negotiated transactions. This program has no expiration date but may be terminated by NTIC’s Board of Directors at any time. No repurchases occurred during the six months ended February 28, 2023. As of February 28, 2023, up to $2,640,548 in shares of NTIC common stock remained available for repurchase under NTIC’s stock repurchase program.

Cash Dividends. During the six months ended February 28, 2023, NTIC’s Board of Directors declared cash dividends on the following dates in the following amounts to the following holders of NTIC’s common stock:

During the six months ended February 28, 2022, NTIC’s Board of Directors declared cash dividends on the following dates in the following amounts to the following holders of NTIC’s common stock:

The declaration of future dividends is not guaranteed and will be determined by NTIC’s Board of Directors in light of conditions then existing, including NTIC’s earnings, financial condition, cash requirements, restrictions in financing agreements, business conditions, and other factors, including without limitation the effect of COVID-19 on NTIC’s business, operating results and financial condition.

Capital Expenditures and Commitments. NTIC spent $1,871,903 on capital expenditures during the six months ended February 28, 2023, which related primarily to a new warehouse facility, equipment and facility improvements, including the purchase of the property immediately adjacent to NTIC’s headquarters in Circle Pines, Minnesota, which includes a 26,000 square foot industrial building, and related renovations. The building will be used primarily for warehousing space and light industrial production. NTIC expects to spend an aggregate of approximately $2,000,000 to $2,500,000 on capital expenditures during fiscal 2023, which it expects will relate primarily to the purchase of the new warehouse facility, equipment and facility improvements, including approximately $700,000 in renovations on the property and building described above.

Inflation and Seasonality

Although inflation in the United States and abroad historically has had little effect on NTIC, inflationary pressures adversely affected NTIC’s gross margins during the first six months of fiscal 2023 and are expected to persist into at least the third quarter of fiscal 2023. NTIC believes there is some seasonality in its business. NTIC’s net sales in the second fiscal quarter were adversely affected by the long Chinese New Year, the North American holiday season and overall less corrosion taking place at lower winter temperatures worldwide.

Market Risk

NTIC is exposed to some market risk stemming from changes in foreign currency exchange rates, commodity prices and interest rates.

Because the functional currency of NTIC’s foreign operations and investments in its foreign joint ventures is the applicable local currency, NTIC is exposed to foreign currency exchange rate risk arising from transactions in the normal course of business. NTIC’s principal exchange rate exposure is with the Euro, the Japanese Yen, the Indian Rupee, the Chinese Renminbi, the South Korean Won, and the English Pound against the U.S. Dollar. NTIC’s fees for services provided to joint ventures and dividend distributions from these foreign entities are paid in foreign currencies and, thus, fluctuations in foreign currency exchange rates could result in declines in NTIC’s reported net income. Since NTIC’s investments in its joint ventures are accounted for using the equity method, any changes in foreign currency exchange rates would be reflected as a foreign currency translation adjustment and would not change NTIC’s equity in income from joint ventures reflected in its consolidated statements of operations. NTIC does not hedge against its foreign currency exchange rate risk.

Some raw materials used in NTIC’s products are exposed to commodity price changes. The primary commodity price exposures are with a variety of plastic resins.

Any outstanding advances under NTIC’s Credit Facility with JPM bear interest at a floating rate, at the option of NTIC, equal to either the CB Floating Rate or the Adjusted SOFR Rate, as defined above. Borrowings of $7,100,000 were outstanding under the Credit Facility as of February 28, 2023.

Critical Accounting Policies and Estimates

There have been no material changes to NTIC’s critical accounting policies and estimates from the information provided in “Part II. Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates” included in NTIC’s annual report on Form 10-K for the fiscal year ended August 31, 2022.

Accounting Pronouncements

See Note 2 to NTIC’s consolidated financial statements for a discussion of accounting pronouncements.

Forward-Looking Statements

This quarterly report on Form 10-Q contains not only historical information, but also 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. These forward-looking statements are subject to the safe harbor created by those sections. In addition, NTIC or others on NTIC’s behalf may make forward-looking statements from time to time in oral presentations, including telephone conferences and/or web casts open to the public, in press releases or reports, on NTIC’s Internet web site, or otherwise. All statements other than statements of historical facts included in this report or expressed by NTIC orally from time to time that address activities, events, or developments that NTIC expects, believes, or anticipates will or may occur in the future are forward-looking statements, including, in particular, the statements about NTIC’s plans, objectives, strategies, and prospects regarding, among other things, NTIC’s financial condition, results of operations and business, the anticipated effect of COVID-19 and its acquisition of Zerust India on NTIC’s business, operating results and financial condition, the outcome of contingencies, such as legal proceedings. NTIC has identified some of these forward-looking statements in this report with words like “believe,” “can,” “may,” “could,” “would,” “might,” “forecast,” “possible,” “potential,” “project,” “will,” “should,” “expect,” “intend,” “plan,” “predict,” “anticipate,” “estimate,” “approximate,” or “continue” or the negative of these words or other words and terms of similar meaning. The use of future dates is also an indication of a forward-looking statement. Forward-looking statements may be contained in the notes to NTIC’s consolidated financial statements and elsewhere in this report, including under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Forward-looking statements are based on current expectations about future events affecting NTIC and are subject to uncertainties and factors that affect all businesses operating in a global market as well as matters specific to NTIC. These uncertainties and factors are difficult to predict, and many of them are beyond NTIC’s control. The following are some of the uncertainties and factors known to us that could cause NTIC’s actual results to differ materially from what NTIC has anticipated in its forward-looking statements:

• The effect of worldwide disruption in supply issues on NTIC’s business, operating results and financial condition, which will likely continue through the end of fiscal 2023, regardless of the status of COVID-19;
• The effect of COVID-19 on NTIC’s business, operating results and financial condition, including in particular in China, and disruption to our customers, suppliers and subcontractors, as well as the global economy and financial markets;
• The effect of current worldwide economic conditions, inflation, recessionary indicators and any turmoil and disruption in the global credit, financial and banking markets or the perception of adverse conditions on NTIC’s business and the business of NTIC’s customers, supplier, vendors and other third parties with whom NTIC conducts business;
• The effect of the ongoing war between Russia and Ukraine, and the effect of the war and the resulting sanctions by U.S. and European governments on commodity price fluctuations, which have decreased our margins and the margins of our joint ventures and resulted in decreased joint venture profitability, which will likely continue through the end of fiscal 2023;
• NTIC’s operations in China and the risks associated therewith, including trade or other issues that may result from increasing tensions between the U.S. and China;
• Variability in NTIC’s sales of ZERUST® products and services to the oil and gas industry and Natur-Tec® products and NTIC’s equity income of joint ventures, which variability in sales and equity in income from joint ventures, in turn, subject NTIC’s earnings to quarterly fluctuations;
• Risks associated with NTIC’s international operations and exposure to fluctuations in foreign currency exchange rates, import duties, taxes, and tariffs;
• The effect of the United Kingdom’s process to exit the European Union on NTIC’s operating results, including, in particular, future net sales of NTIC’s European and other joint ventures;
• The effect of the health of the U.S. automotive industry on NTIC’s business and the evolution of the automotive industry towards electric vehicles;
• NTIC’s dependence on the success of its joint ventures and fees and dividend distributions that NTIC receives from them;
• Risks associated with NTIC’s acquisition of the remaining 50% ownership interest in its Indian joint venture, Zerust India;
• NTIC’s relationships with its joint ventures and its ability to maintain those relationships, especially in light of anticipated succession planning issues, and risks associated with possible future acquisitions of the remaining ownership interests of certain joint ventures;
• Fluctuations in the cost and availability of raw materials, including resins and other commodities, including supply chain disruptions and weather related impacts;
• The success of and risks associated with NTIC’s emerging new businesses and products and services, including in particular NTIC’s ability and the ability of NTIC’s joint ventures to sell ZERUST® products and services to the oil and gas industry and Natur-Tec® products and the often lengthy and extensive sales process involved in selling such products and services;
• NTIC’s ability to introduce new products and services that respond to changing market conditions and customer demand;
• Market acceptance of NTIC’s existing and new products, especially in light of existing and new competitive products;
• Maturation of certain existing markets for NTIC’s ZERUST® products and services and NTIC’s ability to grow market share and succeed in penetrating other existing and new markets;
• Increased competition, especially with respect to NTIC’s ZERUST® products and services, and the effect of such competition on NTIC’s and its joint ventures’ pricing, net sales, and margins;
• NTIC’s reliance upon and its relationships with its distributors, independent sales representatives, and joint ventures;
• NTIC’s reliance upon suppliers;
• Oil prices, which may affect sales of NTIC’s ZERUST® products and services to the oil and gas industry, and which may be impacted by the ongoing war between Russia and Ukraine;
• The costs and effects of complying with laws and regulations and changes in tax, fiscal, government, and other regulatory policies, including rules relating to environmental, health, and safety matters;
• Unforeseen product quality or other problems in the development, production, and usage of new and existing products;
• Unforeseen production expenses incurred in connection with new customers and new products;
• Loss of or changes in executive management or key employees and the need to hire and train local support in a timely manner in order to support customer needs;
• Ability of management to manage around unplanned events;
• Pending and future litigation;
• NTIC’s reliance on its intellectual property rights and the absence of infringement of the intellectual property rights of others;
• NTIC’s ability to maintain effective internal control over financial reporting, especially in light of its joint venture arrangements;
• Changes in applicable laws or regulations and NTIC’s failure to comply with applicable laws, rules, and regulations;
• Changes in generally accepted accounting principles and the effect of new accounting pronouncements;
• Fluctuations in NTIC’s effective tax rate;
• The effect of extreme weather conditions on NTIC’s operating results; and
• NTIC’s reliance upon its management information systems.

For more information regarding these and other uncertainties and factors that could cause NTIC’s actual results to differ materially from what NTIC has anticipated in its forward-looking statements or otherwise could materially adversely affect its business, financial condition or operating results, see NTIC’s annual report on Form 10-K for the fiscal year ended August 31, 2022 under the heading “Part I. Item 1A. Risk Factors.”

All forward-looking statements included in this report are expressly qualified in their entirety by the foregoing cautionary statements. NTIC wishes to caution readers not to place undue reliance on any forward-looking statement that speaks only as of the date made and to recognize that forward-looking statements are predictions of future results, which may not occur as anticipated. Actual results could differ materially from those anticipated in the forward-looking statements and from historical results due to the uncertainties and factors described above and others that NTIC may consider immaterial or does not anticipate at this time. Although NTIC believes that the expectations reflected in its forward-looking statements are reasonable, NTIC does not know whether its expectations will prove correct. NTIC’s expectations reflected in its forward-looking statements can be affected by inaccurate assumptions NTIC might make or by known or unknown uncertainties and factors, including those described above. The risks and uncertainties described above are not exclusive, and further information concerning NTIC and its business, including factors that potentially could materially affect its financial results or condition, may emerge from time to time. NTIC assumes no obligation to update, amend, or clarify forward-looking statements to reflect actual results or changes in factors or assumptions affecting such forward-looking statements. NTIC advises you, however, to consult any further disclosures NTIC makes on related subjects in its annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K that NTIC files with or furnishes to the Securities and Exchange Commission.

NTIC is exposed to some market risk stemming from changes in foreign currency exchange rates, commodity prices and interest rates.

Because the functional currency of NTIC’s foreign operations and investments in its foreign joint ventures is the applicable local currency, NTIC is exposed to foreign currency exchange rate risk arising from transactions in the normal course of business. NTIC’s principal exchange rate exposure is with the Euro, the Japanese Yen, the Indian Rupee, the Chinese Renminbi, the South Korean Won, and the English Pound against the U.S. Dollar. NTIC’s fees for services provided to joint ventures and dividend distributions from these foreign entities are paid in foreign currencies, and, thus, fluctuations in foreign currency exchange rates could result in declines in NTIC’s reported net income. Since NTIC’s investments in its joint ventures are accounted for using the equity method, any changes in foreign currency exchange rates would be reflected as a foreign currency translation adjustment and would not change NTIC’s equity in income from joint ventures reflected in its consolidated statements of operations. NTIC does not hedge against its foreign currency exchange rate risk.

Some raw materials used in NTIC’s products are exposed to commodity price changes. The primary commodity price exposures are with a variety of plastic resins.

Any outstanding advances under NTIC’s Credit Facility with JPM bear interest at a floating rate, at the option of NTIC, equal to either the CB Floating Rate or the Adjusted SOFR Rate, as defined above. Borrowings of $7,100,000 were outstanding under the Credit Facility as of February 28, 2023.

Evaluation of Disclosure Controls and Procedures

NTIC maintains disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) that are designed to provide reasonable assurance that information required to be disclosed by NTIC in the reports it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to NTIC’s management, including NTIC’s principal executive officer and principal financial officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. NTIC’s management evaluated, with the participation of its Chief Executive Officer and its Chief Financial Officer, the effectiveness of the design and operation of NTIC’s disclosure controls and procedures as of the end of the period covered in this report. Based on that evaluation, NTIC’s Chief Executive Officer and Chief Financial Officer concluded that NTIC’s disclosure controls and procedures were effective as of the end of such period to provide reasonable assurance that information required to be disclosed in the reports that NTIC files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to NTIC’s management, including NTIC’s Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There was no change in NTIC’s internal control over financial reporting that occurred during the quarter ended February 28, 2023 that has materially affected or is reasonably likely to materially affect NTIC’s internal control over financial reporting, other than changes implemented to continue integrating Zerust India’s internal controls with NTIC’s internal controls.

Although Item 1A. is inapplicable to NTIC as a smaller reporting company, NTIC hereby discloses the following revised risk factor described in its annual report on Form 10-K for the fiscal year ended August 31, 2021:

The operations of NTIC China may be adversely affected by China’s evolving economic, political, and social conditions as well as increasing tensions between the United States and China.

The results of operations and future prospects of NTIC China may be adversely affected by, among other things, changes in China’s political, economic, and social conditions, changes in the relationship between China and its western trade partners, changes in policies of the Chinese government, changes in laws and regulations or in the interpretation of existing laws and regulations, changes in foreign exchange regulations, measures that may be introduced to control inflation, such as interest rate increases, changes in the rates or methods of taxation, and increasing tensions between the United States and China. In addition, changes in demand could result from increased competition with local Chinese manufacturers who have cost advantages or who may be preferred suppliers for Chinese end users. Also, Chinese commercial laws, regulations, and interpretations applicable to non-Chinese owned market participants, such as NTIC China, are continually changing, and such changes may require NTIC China to change how it conducts its business. These laws, regulations, and interpretations could impose restrictions on NTIC’s and NTIC China’s ownership or operations or NTIC’s interests in China and could adversely affect NTIC’s business, results of operations, and financial condition.

Local regulations in China related to the electric power shortage that began in 2021 may adversely affect NTIC China’s operations or the operations of our suppliers with facilities in China. For example, these regulations could result in partial or complete factory shutdowns due to a lack of continuous supply of electrical power. Additionally, the price of electric power may be increased, and peak-demand periods during which prices are higher may be extended by local governments. Certain of our resin suppliers with facilities in China were adversely impacted by these regulations, which contributed to constrained supply. Although NTIC China’s operations have not been significantly impacted by regulations related to electric power shortages to date, such regulations may in the future decrease or shut down production or increase product costs, which could adversely affect NTIC’s business, results of operations, and financial condition.