Business Context and Reporting Period
Flexible Solutions International, Inc. develops and markets specialty chemicals for water and energy conservation, including HEATSAVR and WATERSAVR, and biodegradable thermal polyaspartate polymers used in industrial, petroleum, utility, mining, detergent and agricultural applications. The company reports Energy and Water Conservation Products and TPA products as its two segments. This unaudited Form 10-Q covers the three and nine months ended September 30, 2019, with comparative periods ended September 30, 2018. The EnP Investments acquisition, consolidated at 65%, materially expanded the TPA business.
Financial Highlights
| Metric | Three Months Ended September 30 | Nine Months Ended September 30 |
|---|---|---|
| Sales | $7.4 million, versus $3.8 million | $22.6 million, versus $12.2 million |
| Gross profit | $2.4 million, versus $1.0 million | $7.3 million, versus $4.5 million |
| Gross margin | 32.1%, versus 25.1% | 32.3%, versus 36.7% |
| Operating income | $819,000, versus an operating loss of $199,000 | $2.1 million, versus $1.4 million |
| Net income attributable to controlling interest | $412,000, versus a net loss of $145,000 | $1.4 million, versus $2.7 million |
| EPS | $0.03, versus $(0.01) | $0.12, versus $0.23 |
| Operating cash flow | Not separately reported | $4.0 million, versus $(465,000) |
Third-quarter operating margin was approximately 11.1% and net margin attributable to the controlling interest was approximately 5.6%. Nine-month operating margin was approximately 9.4% and net margin attributable to the controlling interest was approximately 6.2%.
- TPA revenue was $7.3 million in the third quarter and $22.3 million for the nine months, compared with $3.7 million and $11.9 million, respectively, in the prior-year periods.
- Energy and Water Conservation Products revenue was $92,000 in the third quarter and $375,000 for the nine months. The segment remained loss-making, with a nine-month segment loss of $473,000.
- Nine-month operating expenses increased to $5.2 million from $3.1 million, including higher wages, advertising, interest, professional fees, travel, currency exchange expense and a $232,000 bad debt expense.
- Gain on investment was $342,000 for the nine months, compared with $5,000 in the prior-year period. The 2018 nine-month results also included a $1.7 million gain from insurance proceeds related to the 2017 Taber plant fire.
Liquidity, Cash Flow and Capitalization
- September 30, 2019 cash and cash equivalents were $6.0 million; restricted cash was $1.0 million, producing total cash, cash equivalents and restricted cash of $7.0 million.
- Working capital was $12.7 million, down from $15.1 million at December 31, 2018. Total assets were $33.5 million and total stockholders’ equity was $20.9 million.
- Cash provided by operations of $4.0 million was more than offset by $2.6 million of investing outflows and $2.3 million of financing outflows, resulting in an $857,000 decrease in cash and cash equivalents before the restricted-cash presentation.
- Investing outflows included $1.2 million invested in an equity-method fertilizer-additives venture and $1.4 million of property and equipment purchases.
- Financing uses included $1.5 million of dividends, $1.0 million of short-term line-of-credit repayments and $916,000 of loan repayments. Loan proceeds totaled approximately $1.1 million.
- Debt included $1.8 million outstanding under a short-term line of credit, $4.5 million of long-term debt, and a $500,000 convertible note payable. The convertible note was reduced from $1.0 million after conversion of $500,000 into 200,000 common shares.
- The company stated that it was in compliance with all loan covenants and had sufficient cash resources for its expected commitments and cash-flow requirements over the following year.
Material Changes, Outlook and Risks
- Sales growth reflected increased customer orders, growth across most TPA product lines and the EnP acquisition. Management reported that three customers represented 45% of nine-month sales, compared with 47% in the prior-year period, indicating significant customer concentration.
- Nine-month gross margin declined because of higher raw-material costs, new tariffs and the company’s inability to pass additional costs through to customers. The company identified imported aspartic acid costs, tariffs, oil and gas activity and drought conditions as important operating factors.
- Interest expense rose substantially because of acquisition and equipment-related debt. The company also adopted ASC 842 on January 1, 2019, recognizing operating lease right-of-use assets and liabilities; management stated that the adoption did not materially affect operating results or cash flows.
- The company invested $1.0 million in a Florida fertilizer-additives LLC and placed an additional $1.0 million in restricted cash, to be released upon achievement of an EBITDA milestone. Additional payments of $1.0 million and $500,000 may become due if further milestones are reached.
- Management identified competition, interest rates and debt covenant compliance, economic conditions, regulation, tariffs, customer losses, sales execution, capital availability and distribution inefficiencies as risks. The company does not hedge its foreign-exchange exposure.
- No impairment charges were recorded for goodwill, indefinite-lived intangible assets or other long-lived assets during the periods presented. Disclosure controls and procedures were assessed as effective as of September 30, 2019.
Investor Verification Items
- Verify the sustainability of sales growth and profitability following the EnP acquisition, particularly the concentration in TPA products and reliance on three major customers.
- Assess the effect of tariffs, raw-material pricing and the company’s ability to recover higher costs through customer pricing.
- Review debt maturities, variable interest rates, borrowing-base availability and covenant compliance, including the EnP-related financing.
- Evaluate the $1.0 million restricted-cash milestone and potential additional payments of up to $1.5 million related to the fertilizer-additives investment.
- Reconcile cash generation with capital expenditures, dividends, partnership distributions and continued investment requirements.
- Monitor the persistently loss-making Energy and Water Conservation Products segment and the company’s plans, if any, to improve its performance.
- Confirm the treatment of non-controlling interests, which reduced nine-month net income attributable to the controlling interest by $528,000.