Business Context and Reporting Period
Flexible Solutions International, Inc. develops, manufactures and markets specialty chemicals that reduce water evaporation, including HEAT$AVR and WATER$AVR, and biodegradable thermal polyaspartate polymers used in industrial, agricultural and consumer applications. The unaudited Form 10-Q covers the three and six months ended June 30, 2012, with comparisons to the corresponding 2011 periods.
The company operates through Energy and Water Conservation Products and biodegradable polymer products. Three customers represented 54% of six-month sales, and the three primary customers accounted for 57% of accounts receivable at June 30, 2012.
Key Financial Metrics
| Metric | Three months ended June 30, 2012 | Three months ended June 30, 2011 | Six months ended June 30, 2012 | Six months ended June 30, 2011 |
|---|---|---|---|---|
| Sales | $3.762 million | $3.930 million | $8.956 million | $8.288 million |
| Gross profit | $1.107 million | $1.683 million | $3.081 million | $3.467 million |
| Gross margin | 29.4% | 42.8% | 34.4% | 41.8% |
| Operating income (loss) | $(0.346) million | $0.470 million | $0.434 million before other items | $1.148 million before other items |
| Net income (loss) | $(0.466) million | $0.175 million | $(0.243) million | $0.533 million |
| Basic EPS | $(0.04) | $0.01 | $(0.02) | $0.04 |
Six-month cash flow from operations was $65,895, compared with cash used in operations of $1.361 million in 2011. Investing cash use was $85,532, primarily for equipment purchases. Financing activities provided $161,302, including $225,000 of additional short-term line-of-credit borrowings, partly offset by $63,698 of loan repayments. Cash increased from approximately $506,905 at year-end 2011 to $645,907 at June 30, 2012.
At June 30, 2012, current assets were $6.398 million and current liabilities were $2.485 million, resulting in working capital of $3.913 million. Accounts receivable were $2.355 million and inventory was $3.194 million.
Total borrowings were approximately $2.787 million, consisting of an $875,000 short-term revolving line, $308,111 of current long-term debt and $1.604 million of long-term loans. The revolving line was renewed and expanded in March 2012 to a maximum of $5.0 million, subject to borrowing-base limitations, at an annual interest rate of 3.75%. The company also obtained an additional secured loan facility of up to $1.4 million, with no amount outstanding at June 30, 2012.
Material Changes Versus the Prior Comparable Period
- Second-quarter sales decreased 4.3%, while six-month sales increased 8.1%.
- Gross margin declined materially, primarily because production began at the Taber plant, increasing depreciation, and higher oil prices increased aspartic acid costs.
- Second-quarter operating results shifted from $469,734 of income to a $345,995 loss. Six-month income before other items and taxes declined from $1.148 million to $434,083.
- The company reported a second-quarter net loss of $465,995 compared with net income of $174,734, and a six-month net loss of $243,339 compared with net income of $532,841.
- Energy and Water Conservation Products revenue declined to $548,333 from $686,567 for the first six months, while biodegradable polymer revenue increased to $8.407 million from $7.601 million.
- Six-month depreciation and amortization increased to approximately $611,786 from $163,345, primarily reflecting the commencement of depreciation on the Taber plant and equipment.
- Administrative salaries and benefits, consulting, professional fees and commissions increased. Professional fees included higher intellectual-property legal costs and arbitration-related costs.
- The company’s inventory increased 10.5% from year-end, with raw materials rising while completed goods declined.
Outlook, Risks, Contingencies and Unusual Items
Management stated that it expects to have sufficient cash resources for commitments and cash-flow requirements during the following year and identified no substantial cash commitments other than long-term loan repayments and approximately $212,997 of remaining lease obligations. The filing provides no formal revenue or earnings guidance.
Management expects the Taber plant to reduce raw-material costs, exposure to oil-price fluctuations and shipping costs over time by manufacturing aspartic acid from sugar, although the company expects to continue importing some aspartic acid from China.
Key risks include competition, weaker sales or customer loss, adverse economic conditions, higher borrowing costs or debt defaults, regulatory changes, insufficient funds for capital expenditures, operational inefficiencies, foreign-exchange movements and dependence on significant customers. European economic conditions pressured second-quarter biodegradable polymer sales.
The company disclosed increased legal costs related to intellectual-property protection, new patent filings and an arbitration proceeding. The filing does not provide a quantified arbitration exposure or state that a material loss has been accrued. The Taber facility and related equipment, inventory and receivables secure the AFSC loan. The company reported no impairment charges and stated that its disclosure controls were effective as of June 30, 2012.
Investor Verification Priorities
- Verify whether the sharp gross-margin decline is temporary or reflects a sustained increase in depreciation and raw-material costs.
- Assess the Taber plant’s production performance, cost savings and effect on future cash flow.
- Review borrowing-base availability, covenant compliance, interest costs and repayment schedules for the revolving line and secured loans.
- Investigate the status, potential exposure and accounting treatment of the arbitration proceeding and intellectual-property matters.
- Evaluate customer concentration and collectibility of receivables, given that three customers represented 54% of six-month sales.
- Monitor inventory growth, particularly raw materials, and its effect on working capital and liquidity.
- Reconcile the segment disclosures and confirm the reported biodegradable polymer segment designation and related revenue trends.