Flexible Solutions International Inc. — 2020 Q1 Form 10-Q Summary
Business context and reporting period
Flexible Solutions International develops, manufactures and markets specialty chemicals that reduce water evaporation, biodegradable polymers and chemical additives for water treatment, petroleum, mining, utility and agricultural applications. The company operates through Energy and Water Conservation Products (EWCP) and Thermal Polyaspartate biopolymers and additives (TPA) segments.
This unaudited Form 10-Q covers the three months ended March 31, 2020, with comparisons to the three months ended March 31, 2019. The company reported 12,240,545 common shares outstanding as of May 15, 2020.
Key financial metrics
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Sales | $8.429 million | $8.471 million | Down $0.042 million |
| Gross profit | $2.950 million | $2.776 million | Up $0.174 million |
| Gross margin | 35.0% | 32.8% | Up 2.2 percentage points |
| Operating income | $1.567 million | $1.047 million | Up $0.520 million |
| Operating margin | 18.6% | 12.4% | Up 6.2 percentage points |
| Net income attributable to controlling interest | $1.265 million | $1.011 million | Up $0.254 million |
| Basic and diluted EPS | $0.10 | $0.09 | Increased |
| Cash used in operating activities | $(1.255) million | $(1.694) million | Improved by $0.439 million |
TPA generated $8.340 million, or approximately 99% of total revenue, while EWCP generated $89,928 and recorded a segment loss of $60,255. Three customers represented approximately 44% to 48% of sales, depending on the disclosure section.
At March 31, 2020, cash and cash equivalents were $3.412 million, accounts receivable were $7.672 million, inventories were $8.903 million and total current assets were $20.290 million. Total assets were $34.820 million and total stockholders’ equity was $21.605 million.
Current liabilities were $8.362 million, producing reported working capital of approximately $11.928 million. The filing states that the company had sufficient cash resources for the coming year, although one MD&A reference incorrectly labels the March 31 working-capital date as March 31, 2019.
Debt included $3.556 million outstanding under short-term lines of credit, $4.179 million of long-term debt, $0.500 million of convertible notes and $0.706 million of operating lease liabilities. The company was in compliance with its debt covenants at March 31, 2020. The short-term credit facilities had stated interest rates of 3.25% and 5.0445% at quarter-end.
Cash declined by $1.222 million during the quarter to $3.412 million. Operating cash use was $1.255 million, investing cash use was $0.818 million and financing activities provided $0.847 million, primarily from additional line-of-credit borrowings. Accounts receivable increased by $3.203 million during the quarter and was the principal working-capital use of cash.
Material changes versus the prior comparable period
- Sales decreased modestly, primarily because of lower EWCP customer orders; TPA sales were broadly stable.
- Gross profit increased 6.3%, and gross margin improved from 32.8% to 35.0%.
- Operating expenses decreased 20.0% to $1.383 million. The filing attributes the change to lower professional fees, reduced travel, lower Canadian-dollar administrative costs, lower commissions and a favorable currency-exchange impact, partly offset by higher advertising and promotion.
- Operating income increased 49.7%, and net income attributable to the controlling interest increased 25.1%.
- Operating cash use improved but remained negative, largely because of the increase in accounts receivable.
- Capital expenditures declined to $96,280 from $1.276 million in the prior-year quarter.
- No dividends were paid in Q1 2020. On March 19, 2020, the company suspended its annual dividend until further notice because of COVID-19 uncertainty.
- The company issued 25,000 shares upon exercise of stock options. Options outstanding at March 31, 2020 totaled 600,000.
Guidance, outlook, risks and unusual items
The filing provides no quantitative revenue or earnings guidance. Management identifies crude-oil prices, the cost of aspartic acid imported from China, oil and gas industry activity, drought conditions, customer demand and COVID-19 as key factors affecting future results.
Management stated that it had sufficient cash resources to meet commitments and cash-flow requirements for the coming year and did not anticipate material capital requirements during the twelve months ending December 31, 2020, apart from disclosed lease and debt obligations. However, the company continued to consume cash from operations and relied on revolving credit borrowings during the quarter.
COVID-19 may cause staff shortages, lower customer demand, increased government intervention and other disruptions. The duration and severity of the effects could not be reliably estimated as of the filing date. The company also faces customer concentration, foreign-exchange exposure, competition, regulatory changes, interest-rate and borrowing risks, potential tariffs on Chinese raw materials and dependence on operating performance in the oil, gas and agricultural markets.
The company’s investment in a Florida fertilizer-additives LLC increased to $2.031 million at March 31, 2020. A previously restricted $1.000 million deposit was released in January 2020. Additional payments of up to $1.500 million may become due if specified EBITDA milestones are achieved.
In April 2020, the holder of the remaining $500,000 convertible note elected to receive cash. The filing reports no impairment charges for goodwill, indefinite-lived intangible assets or other long-lived assets during the quarter. The company recognized a $199,529 gain on investments and a $98,928 foreign-currency translation loss in other comprehensive income.
Management concluded that disclosure controls and procedures were effective as of March 31, 2020, and that no material change occurred in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether negative operating cash flow and the $3.203 million quarterly increase in receivables persist or reverse.
- The effect of COVID-19 on TPA demand, EWCP orders, manufacturing operations, staffing and collections.
- Availability and covenant headroom under the revolving credit facilities, particularly as borrowings increased.
- The cash payment and balance-sheet impact of the $500,000 convertible note redemption in April 2020.
- Concentration risk from the three major customers and the company’s dependence on TPA revenue.
- Potential additional payments of $1.000 million and $0.500 million tied to milestones for the Florida investment.
- The timing and conditions for resumption of the suspended dividend.
- Exposure to Chinese raw-material tariffs, crude-oil prices, foreign-exchange movements and oil-and-gas industry conditions.
- The filing’s inconsistent customer-concentration percentages and the apparent March 31, 2019 labeling error in the working-capital discussion.