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Tuesday, February 21, 2006

Epolin Inc. (EPLN) 10-K

EPLN (sec, website)

For the full year ending Feb 28, 2005.
Incorporated in NJ, 1984, went public in 1989.

11.8 million shares on May 10, 2005

358-364 Adams St
Newark, NJ 07105

They manufacture, market, research, develop dyes and dye formulations, mostly near infra-red and laser absorbing dyes. They started out in specialty organic chemical products, but focused on near infrared dyes since 1991. They still do other specialty products on a custom basis (additives for plastics, thermochromic materials for paints), but this business will not grow over time.
To management's knowledge, and based upon its review of the web sites of the Company's known competition, management believes that the Company has one of the most extensive assortment of near infrared ("NIR") dyes in the world by offering the customer a varied assortment of dyes absorbing in the NIR region of the spectrum (from 700 to 1600NM). Nevertheless, the Company is not aware of any statistical evidence available to support its belief regarding its position in the industry.
Epolin Holding Corp, incorp in NJ as a real estate holding company, become wholely owned in 1998. This holding company owns the 19.5K sq ft of manufacturing and warehouse and admin space in NJ.

Applications for infrared dyes:
The dyes are used in protective goggles against laser light. An early product was a dye to absorb neodynium-YAG laser light, typically used in military range finders. This extended to other customers. The dyes are also used in welding goggles.

Some competitors would only sell dyes if the customer also bought resin from them as well. New welding specifications require shields to absorb specific levels of infrared (based on recent studies of eye damage and early cataracts). EPLN now offers a line of dyes whic absorb the entire range of welding radiation. Management expects the welding market to grow significantly due to the new specifications and the use of lasers in welding.

Security inks. This is a new business for the company. These inks absorb very little visible light and thus seem invisible in low concentrations. But a mechanical reader can detect them. Useful for authenticating food and drug labels, documents, credit cards. So far the main use has been for credit cards.

Specialty filters. This is a potential new market for instrument makers who use glass filters currently containing rare earth oxides. These are brittle. EPLN is looking into a cheap plastic filter to do the same thing.

Dyes for sun protection. This market isn't very active and the company doesn't expect much.

Dyes for heat shields. These would block much of the solar heat, but still allow visibility. The company is doing R&D in this area. It needs to last 7 years before deteriorating from the sunlight, results are "elusive".

Dyes for interlayer and laminates. Similar to heat shields plus they're shatterproof for auto applications. Needs to last even longer than 7 years.

Look, why are you guys telling me about all these wannabe applications??? Stick to the here and now.

Specialty chemical products (mentioned above). Custom products for companies that sell into the adhesives, plastics, aerospace, pharm, flavor, and fragrance industries. Typically these are intermediate products. Small quantities make it inefficient for customers to do it themselves. Not more than 10% of profits or losses.

Lots of government regulation in this business. The New Jersey Industrial Site Recovery Act requires EPLN to get approval before relocating or changing control of the company. The property is subject to inspection for compliance. EPLN registers all new and proprietary products with the Toxic Substances Control Agency (oddly enough, can't really find it on the web). In 2004 and 2005, compliance with environmental laws cost $18,000 [this is why a country must be either wealthy or unpopulated in order to have a clean environment].

Raw materials come from several large chemical manufacturers. EPLN only uses a few of them, but potential suppliers is large. No problems in getting materials in 2005.

R&D. New applications under development: credit card heat blocking films, laser eye protection related to night vision for military, document verification for the military, welding and laser eye protection, medical devices, tagants, hot melt additives. These are usually done for a specific customer to lower the risk. R&D costs were $374K in 2004 and $408K in 2005.

Competition. Other dye companies do not seem to have the broad range of products that EPLN has nor the level of technical service and customer support. Competition is limited.

The IR dyes of the major part of the companies revenues haven't changed since 1976 (which is good), but there is always a lot of activity.

No patents.

Customer concentration: 50% of sales were to 3 customers (which is actually down from 65% in 2004). Two customers were 44% of sales (up from 42%). One customer was 24% (14% for near infrared dyes, 10% for security inks). One customer was 20%, all for near infrared dyes.

Only 10 full-time employees (8 in 2004). No unions. There's a lot of reliance on Dr. Murray S. Cohen who is Chairman (and stepped down as CEO to allow the new marketing guy to run the business, which I view as a very good move).

The company has been subleasing 2K sq ft of space ($36K/year) to a non-related party to operate an optics and security inks lab.

No material legal proceedings. Legal settlement caused a net expense of $86K in 2005, lawsuit by a former director and also a former employee.
In December 2000, two individuals (each a former director and former employee of the Company) instituted suit... alleging claims pursuant to their past employment as well as a derivative claim.... included breach of contract, civil rights, age discrimination, wrongful termination, infliction of emotional distress and a shareholder derivative claim. In June 2003, the Company... settled the lawsuit.... a lump sum payment... of $312,000. In addition, the Company agreed to buy back 126,500 shares... for... $69,575 ($0.55 per share).... During the quarter ended November 30, 2003, the Company was reimbursed a portion of the settlement payments from its insurance company in the amount of $118,560.
Only 282 stockholders of record, meaning they could go dark.

They had been paying dividends in 2002, 2003, and 2004, but stopped in 2005 to expand.

Stock option grants:
2003: 25K
2004: 162K
2005: 100K

Gross margins:
Q3 2006: 71.6%
[Q3 2005: 62.5%]
2005: 60%
2004: 66%

Operating margins:
Q3 2006: 39.5%
[Q3 2005: 28.6%] probably low due to lawsuit
2005: 28.2%, low due to lawsuit settlement of $86K (see above)
2004: 33.5%

Net margins:
Q3 2006: 25.8%
[Q3 2005: 15.6%] probably low due to lawsuit
2005: 17.5%, low due to the lawsuit (see above)
2004: 21.7%

Revenues increased 5.3% in 2005 (to an all-time record) due to inceased sales of dyes for security inks, partly offset by a decrease in traditional markets.

My favorite section (which I'm taking from the Q3 2006 release, which may differ from the 10-K version) is:
We are currently going through a period of reassessing our direction in order to increase value for our shareholders. Our business, though reasonably healthy, has not recently grown to the degree management anticipated.... Based upon these observations, we tried to learn what could be done to stimulate growth and recapture the promise of our early years. Our first task was to draw up a business plan. We believe this highlighted our one major weakness and that was in sales and marketing. For years we felt it to be unnecessary to go out and reach our customers. We believed that our web site was sufficiently explicit to attract anyone interested in near infrared light management to come to us because we were the "only game in town". We now realize that the customer has alternatives which do not include the use of Epolin dyes. We believe the business plan made clear the necessity of hiring a Sales/Marketing executive (which was accomplished with the hiring of Greg Amato) along with back up technical service help (which has also been accomplished). In order to cover the cost of these additional personnel and place a greater emphasis on company growth, we suspended in fiscal 2005 the cash dividends program which we had been in place during fiscal 2002, 2003 and 2004. We believed that it was in the long term best interest of the shareholders for us to reinvest profits for future growth. However, as a result of our current cash position, we declared and paid a $0.02 cash dividend in August 2005. Although there can be no assurance, we currently anticipate declaring another dividend in the early part of the new upcoming fiscal year which will begin March 1, 2006.
They also talk about the importance of management succession. Murray S. Cohen agreed to step down as CEO (but remaining Chairman). This happened in January 2006 and Greg Amato (the marketing guy) became CEO. This is a great move. It give Amato a chance to run things while Cohen is still Chairman and can take over again, if needed.

This letter from October 20, 2005 goes into more detail.
The facility we occupy dates back to the early decade of last century. It is in a building that let us get started as a public company but one that seriously needed rehabilitation. When we purchased the property in 1999, we began to make improvements to the property. Such investments in its upgrade have accelerated in the last few years which have in itself impacted company profitability.The business we are in is fundamentally a high-tech business. Our early efforts to manufacture and sell near infrared dyes required support of sophisticated analytical equipment in order to produce quality products. For example, our first spectrophotometer, leased in 1996, reached the end of its dependable life and was replaced by a new machine this year. Our other instrumentation was also replaced. However, the major expenditures made since then has been the direct result of our new business plan
It talks about how sales growth will come at a price of reduced profitability. They believe higher profits will be seen by the end of fiscal 2007. They needed closer ties with outside companies to create the full formulated resin (not just dyes) and they now have these business arrangements.

FIFO used for inventory. Straight line depreciation for inventory. Asset and liability for taxes. Revenue recognition is standard. They repurchased 50K shares at 59.5 cents per share in 2005 (they've always repurchased a small amount each year since 2002). No off-balance sheet arrangements.

Murray S. Cohen, 79, Chairman and CEO, director since 1984, $266K salary, $40K bonus, owns 16% of the stock
Cohen was Director of Research from Jan 1978 through May 1983. VP and Technical Director of Borg-Warner Chemicals 1973-1978. BS from U of Missouri in 1949, PhD in Organic Chemistry from Missouri in 1953.

James Ivchenko, 65, President and Director, director since 1993, $246K salary, $35K bonus, owns 12.4% of the stock
Worked at Ungerer & Co. as Plant Manager for the Totowa, NJ and Bethleham, PA plants from 1988 to 1991. 30 years experience in the flavor, fragrance, and pharm intermediate industry. BA, MS, and MBA from Fairleigh Dickinson University in NJ.

Morris Dunkel, 76, Director since 1984, owns 2.1% of the stock
VP and Technical Director of Elan Chemical Inc. Worked at Tenneco Chemicals 1976-1983. BS 1950 Long Island U. MS Brooklyn College 1954. PhD in Organic Chem from U of Arkansas 1956.

James R. Torpey, Jr., 55 [the spring chicken of the group], Director since 2001
President of Madison Energy Consultants. 1995-2002 Director of Technology Initiatives at First Energy/GPU, Chairman of Solar Electric Power Assoc, President and board member of GPU Solar. Member of US Dept of Energy Solar Industry Advisor Board. MBA Rutgers 1991.

Greg Amato, 48, started with the company in 2004 as VP Sales and Marketing.
1993-2004 worked at Elementis, PLC, a specialty chemical mfgr, as VP Specialty Markets of Elementis in Hightstown, NJ in 2000-2004. BE Georgia Tech 1978.

Claire Bluestein (former director) owns 8.4% of the stock. She was president and sole shareholder of Captan Associates, developing materials for commercial applications of radiation curing technology. BA from UP in '47. MS and PhD in Organic from U of Illinois.

From 1996 10-K:
Abdelhamid A.H. Ramadan, now 66, was manager of research, process development and QA since 1993. Before that he was production manager at Celgene Corp and senior chemist and chemical hygene officer. Also a production dept. head at Tenneco. BS Chem 1963 from Ain Shams University in Cairo. In 1998 he owned 3% of the stock. He left the company in 2000. and he owned 3.5% of the stock in 2001. He disappeared (no mention why) as a director in 2002 replaced by Peter Kenny.

Peter Kenny started as a director in 2001. He was senior VP at Independence Community Bank (ICBC, sec, FDIC #16018) (he was in a bank acquired by them, he doesn't show up in ICBC sec docs). Looking at the FDIC database, back in 2001, the bank had 1,213 employees, $7.6 million in assets (now $18 million). They were performing very well back then (and now). In 2005, he was gone. It says in the 2004 10-K that he resigned after the end of fiscal 2004 for personal reasons.

No audit committee, no audit expert (not a listed company so they can get away with it).

Of the people listed, only Cohen and Ivchenko have options. Total of 90K options.

Amato has 100K restricted shares after 1 year.

Ivchenko and Cohen have a substantial employment contract including 1.5% and 2% of gross revenues (limited at $3 million) and that increases by 0.25% each year for 10 years.

Executives and Directors own 30.7% of the stock. Another 12% is owned by Santa Monica Partners and also Sandra Lifschitz. The directors' stock contains rights of refusal.

Chester C. Swasey, 53, was VP of sales and marketing back in 1996. He came from Fairmount Chemical Company and Union Carbide. He came from Fairleigh Dickenson University (same school as Ivchenko).

Weismann Associates LLC of Livingston, NJ. No website, but they're listed on the PCAOB list.

Audit fees:
no other audit related fees
$3K tax fees

Weismann Associates also audited:

Boonton Electronics (sec) although that was Polakoff Weismann Leen LLC of Livingston, NJ back in Jan 2000. Boonton's net loss for 1999 was almost as large as their entire equity. PWL didn't give them a "going concern" qualifier. But then Boonton was acquired by Wireless Telecom Group.

It looks like that's about it.

Weismann Associates gave EPLN an unqualified audit for 2005 and 2004 in this document.

On August 16, 2001, they dismissed Polokoff Weismann Leen and engaged IWA Financial Consulting LLC (which was a brand new accounting firm). IWA had no qualification in 2003.

Here they claim to have audited the financial statements for 2002 and 2003. But in the next year, they claim to have only reviewed 2002 and 2003. Later on, they issue a 10-K/A that has been audited.

In 2005, they switched to Weismann Associates with no warning or explanation that I can find.

visual display
Balance Sheet:
Net Cash        ************** $696K (nearly 6 cents/share)

Cash ************************
AR ***********
Inventories ***************
prepaid *
Current assets ****************************************************

PP&E (gross) ****************************
Depreciation ---------------
tax assets ****
life insur ****
other assets ********

accrued expens ***** (mostly employment agreement)
Current liab *****
Deferred comp *****
Total Liabil. **********
Equity **************************************************************

Income Statement:
Revenue            *****************************
Cost of sales ************
SG&A *********
taxes ***.
net income ***** $504K (3.94 cents/share)

net income / non-current assets = 48%
net income / non-depreciated PP&E = 36%
net margin = 17.5% (low due to legal settlement)
net margin in 2004 = 21.7%

Cash Flow Statement:

Free Cash Flow ***********************************

Net Income *************************
depreciation ++
deferred tax ++
deferred comp oblig +
AR +++++
prepaid tax ++++
accrued expenses +++

capex ----
life insur policy --

treasury stock pur -

Net increase **********************************

They had $1.1 million in one bank (or brokerage) and $448K in another (way beyond FDIC guarantees). They claim to evaluate the stability of the financial institutions periodically. I wish they'd include the FDIC numbers of banks so I could check for msyelf.

Epolin: assets=$3.6 million, revenues=$2.9 million, net income=$394K
Epolin holding company: assets=$834K, revenues=$134K, net income=$109K

All straight-line depreciation
building: 39 years
machinery and equipment: 5-7 years
furniture and fixtures: 7 years
leasehold improvements: 10-39 years

Major work is capitalized, repairs and maintenance are expensed.

Revenue recognition seems fairly standard.

322K options from the 1998 stock option plan were outstanding, ave strike price 30 cents.
458K options could be granted in the future.
200K shares are associated with specific compensation plans (see above).

Fully diluted shares = 12.3 million shares
Totally diluted shares = 12.78 million shares

US: 84% of revenues
Asia: 13% of revenues
Europe: 5% of revenues

US: 90% of revenues
Asia: 6% of revenues
Europe: 4% of revenues

Max lease obligation per year is $97K.

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