Flexible Solutions International Inc. — Q1 2017 Form 10-Q
Business context and reporting period
The company develops and sells specialty chemicals for water and energy conservation and biodegradable polymers and chemical additives. The filing covers the three months ended March 31, 2017, with comparative results for the three months ended March 31, 2016. The interim financial statements are unaudited.
Key financial metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Sales | $4.664 million | $5.313 million | Down 12.2% |
| Gross profit | $2.094 million | $2.239 million | Down 6.5% |
| Gross margin | 44.9% | 42.1% | Up 2.8 percentage points |
| Income before other items and tax | $1.052 million | $1.300 million | Down 19.1% |
| Net income | $3.253 million | $0.742 million | Up $2.511 million |
| Net margin | 69.7% | 14.0% | Improved primarily from fire-related gain |
| Basic and diluted EPS | $0.28 | $0.06 | Increased |
| Cash used by operating activities | $(1.894) million | $0.186 million provided | Declined |
| Ending cash | $4.869 million | $1.249 million | Increased |
At March 31, 2017, total assets were $18.976 million, including $14.554 million of current assets. Current liabilities were $2.892 million, producing reported working capital of $11.662 million. Total debt consisted of a $0.700 million revolving line of credit, $0.201 million of current long-term debt and $0.302 million of long-term debt. The revolving line bears interest at 4.0% and had $0.700 million outstanding against availability determined by eligible receivables and inventory. Management stated that all debt covenants were satisfied.
Cash from investing activities was $4.030 million, principally reflecting $4.054 million of insurance proceeds. Financing activities provided $0.402 million, including $0.450 million of additional line-of-credit borrowings, partly offset by $0.050 million of loan repayment. Capital expenditures were $0.030 million.
Material changes versus the prior comparable period
- Sales declined because the Taber, Alberta manufacturing facility was destroyed by fire and because of lower customer orders for biodegradable polymer and chemical additive products.
- Energy and water conservation product revenue declined to $0.248 million from $0.328 million. Biodegradable polymer and chemical additive revenue declined to $4.416 million from $4.985 million.
- Gross margin improved because lower oil prices reduced aspartic acid input costs.
- Operating expenses increased to $1.042 million from $0.939 million, including higher administrative salaries and benefits, rent, and professional fees. Commissions decreased as uncommissioned sales increased.
- Net income included a $2.572 million gain on involuntary disposition related to the fire and a $0.051 million inventory write-down. These items make the reported earnings increase nonrecurring in nature.
- Operating cash flow turned negative, primarily because of increases in accounts receivable and inventory. Accounts receivable rose to $3.393 million and inventory to $4.539 million from $3.008 million and $3.786 million, respectively, at December 31, 2016.
- The company issued 3,000 shares upon employee stock-option exercises during the quarter. Shares outstanding were 11,460,991 as of May 15, 2017.
Guidance, outlook, risks and unusual items
The filing does not provide quantitative revenue or earnings guidance. Management stated that it had sufficient cash resources for the coming year and did not anticipate material capital requirements other than disclosed commitments. Lease commitments total approximately $0.883 million through 2021.
The February 2017 fire destroyed the Taber plant and related building and equipment with a reported carrying value of approximately $1.937 million, as well as inventory. The company received approval for interim insurance proceeds of $4.208 million, of which $1.571 million was receivable at March 31 and collected after quarter-end. The final insurance recovery and the effect of the plant loss on future operations should be verified.
Management identified crude oil prices, oil and gas industry activity, and drought conditions as factors that could materially affect future results. Additional risks include competition, interest rates and borrowing costs, economic conditions, regulation, customer concentration, sales weakness, funding for capital expenditures, foreign-exchange fluctuations and operational inefficiencies. Three customers represented 57% of Q1 sales and 56% of accounts receivable at March 31, 2017. The company does not hedge foreign-exchange exposure.
The company stated that disclosure controls and procedures were effective as of March 31, 2017 and that no material change occurred in internal control over financial reporting during the quarter.
Investor verification points
- Verify the final insurance settlement, timing of remaining proceeds and whether the Taber facility will be rebuilt, replaced or permanently removed from operations.
- Assess the sustainability of earnings excluding the $2.572 million fire-related gain and related insurance effects.
- Monitor customer concentration, order trends and the decline in revenue, particularly among biodegradable polymer and chemical additive customers.
- Reconcile negative operating cash flow with reported net income and track receivables and inventory conversion.
- Confirm available borrowing capacity, interest rates, covenant compliance and repayment obligations under the revolving line and long-term debt.
- Evaluate exposure to crude oil prices, oil and gas activity, drought conditions, foreign exchange and unhedged customer credit risk.