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Friday, May 26, 2006

Epolin (EPLN) 10-K

Epolin 2005 10-K

Full year ending Feb 28, 2006
11,966,355 shares on May 1, 2006. 557K options outstanding. 413K for future granting. Assume 13 million totally diluted shares.
Based upon our years of experience in the specialty dye
business, we believe that the Company possesses the largest
offering of near infrared (NIR) dyes in the world.
Expenses due to compliance with environmental laws increased from $18K to $21K.
R&D costs increased somewhat to $447K from $408K.
Limited competition (EPLN has a very broad range of dyes and a very high level of technical service).
Still no patents.

2006: Two customers were 30% of sales. Two other customers were 14.3%.
2005: Two customers were 44% of sales. One customer was 6.4%.

Still 10 employees.

Same properties. The sublease (at $18K vs $36K) is still going on, ends Halloween 2007.

Regular dividend of 2 cents (which we saw earlier).

200K stock options granted at 54 cents per share. Also the 162K 2004 stock options were cancelled and reissued at 41 cents per share (up from 35 cents). 5 and 10 year expirations.

5000 shares were repurchased at 72 cents.
                                                  Years Ended

February 28, February 28, February 29,
2006 2005 2004

Revenue change +28.5% +5.3% +1.6%

Sales 100% 100% 100%
Cost of sales 38.9 40.1 30.3

Gross Profit 61.1 59.9 69.7
Selling, general and administrative 37.3 31.7 29.1

Operating Income 23.8 28.2 40.6

Income before taxes 25.4 29.7 42.1

Net income (after taxes) 16.1 17.5 21.7
Revenues increased in all products except specialty chemicals (which decreased). Strong increases in newer product areas such as security inks and coatings. Also overseas sales increased in Japan, Korea, Taiwan, Europe.

(Note that 2004 looked good due to the elimination of a deferred compensation liability)

85% increase in sales in Asia.
115% increase in sales in Europe.
11% increase in North America.

US: 73% of revenues
Asia: 15% of revenues
Europe: 9% of revenues

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

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

Traditional markets (welding dyes, eye protection) sales were flat. More emphasis now on technical service which has added new customers and new applications.

Gross margins increased only slightly due to increased material and overhead costs (I like a company that apologizes for not having bigger increases in gross margins due to material costs).

SG&A increased due to: 1) officers' salaries, 2) employee benefits, 3) cosmission expenses, 4) professional fees. The commission fee structure has changed and will be lower in the future.

Other income dropped due to the decrease in sublease rate (which will impact next year slightly more) more than offset by by greater interest income ($30K vs $8K).

Net income is $594K or 4.57 cents per totally diluted share. A P/E of 15 would only be 68.6 cents. I was willing to pay a higher price for Epolin because of several factors. I'm increasingly believing that it was worth it.

FIFO inventory.

Auditors: Weismann Associates, Livingston, NJ, same as last year. Unqualified opinion.

Balance Sheet
Cash ***************
AR *******
Inventories ******
Total Current Assets ****************************

PP&E ********........
Non-current deferred tax assets **
Life insurance policy **
Total Assets ****************************************

Accrued expenses ***
Total current liabilities ***

Other liabilities ***

Common stock equity ***********************************

Net Cash ********* $882K, 6.8 cents per totally diluted share

Income Statement for Q4
                      Q4 2006                 Q4 2005
Sales increased 22%
Sales $ 1,068,776 100% 873,116 100%
Cost of sales 477,836 45% 448,830 51%
SG&A 482,105 45% 281,208 32%

Operating income 108,835 10% 143,078 16%

Rental income 4,500 0% 9,000 1%
Interest income 17,908 2% 2,516 0%

Income taxes 42,965 4% 63,156 7%

Net income 88,278 8% 91,438 10%
The increased SG&A caused the decrease in net income. SG&A is largely set based on projected future revenue. If sales grows another 22%, then SG&A might shrink to 37% of sales and net income might grow to 9% of sales. However, notice that net margins for the full year are twice this much. That means the increase in SG&A in Q4 of each of the years has an exagerated impact on the Q4 bottom line.

Equity Statement

130K stock options exercised. 5K shares repurchased. $594K net income. Simple stuff.

Cash Flow Statement

AR is up. Inventories are down. There's some accrued but unpaid expenses. Cash flow from ops was $704K.

Capex was $182K. Free cash flow is a bit lower than earnings, but some of that could well be investment beyond maintenance capex, considering depreciation was only $47K.

Dividends paid was $236K. And that's about it for cash flow. Clear and simple.


Three customers are 44.5% of accounts receivable.

Depreciation schedule is unchanged from last year.

Advertising costs:
2006: $19,304
2005: $18,861

Inventory makeup is about the same as last year.

Pension plan: company matches 3-5% after 1 year of service.
2006: $49,940
2005: $40,119

Stock options granted:
2005: 0
2006: 200K
Balance on Feb 28, 2006: 457K (an additional 100K is in, probably CEO's, employment contract)
Average strike price is 42 cents.
413K available for future grants.

The vast majority of accrued expenses ($195K of $307K) is due to employment agreement.

CEO gets 10% of any increases in net income. So far, the accrued bonus is $10K.

R&D costs:
2006: $447K
2005: $408K


Let's say that net margins going forward are only 15% while revenue increases by 40% over the next few years. This would result in net income of $777K or 6 cents per totally diluted share and the stock might be worth 90 cents (plus you might add in half of the net cash) which is about where it's selling now. Clearly this stock isn't cheap. That's why I stopped buying it as the price was going up. However, if the revenue increases by 70% and net margins return to 17%, then it might be worth $1.23. That's about the value I had in mind when I bought the stock and that's still about the value I consider it to be worth. But I don't recommend buying the stock for anything more than 75 cents.

[June 5, 2006: However, if you were going to make EPLN say 3% of a highly diversified portfolio consisting of stuff like mutual funds, then EPLN would be a fine addition considering that the S&P 500 is now priced at about full value and EPLN is an above-average business in terms of return on equity, return on assets.]

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