Flexible Solutions International Inc. — Form 10-Q Summary
Business Context and Reporting Period
Quarterly report for the three and six months ended June 30, 2016, filed August 12, 2016. The company develops and sells water- and energy-conservation chemicals, including HEATSAVR and WATERSAVR, and biodegradable polymers and chemical additives used primarily in petroleum, chemical, utility, mining, agriculture, detergent and consumer-care applications.
The company operates in two reportable segments: Energy and Water Conservation Products (EWCP) and Biodegradable Polymers and Chemical Additives (BPCA). The financial statements are unaudited and prepared under U.S. GAAP.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2016 | Three Months Ended June 30, 2015 | Six Months Ended June 30, 2016 | Six Months Ended June 30, 2015 |
|---|---|---|---|---|
| Sales | $3.733 million | $3.901 million | $9.046 million | $8.865 million |
| Gross profit | $1.983 million | $1.627 million | $4.222 million | $3.526 million |
| Gross margin | 53.1% | 41.7% | 46.7% | 39.8% |
| Operating expenses | $1.054 million | $1.022 million | $1.993 million | $1.988 million |
| Net income | $561,237 | $318,671 | $1.303 million | $822,936 |
| Net margin | 15.0% | 8.2% | 14.4% | 9.3% |
| Basic diluted EPS | $0.05 | $0.02 | $0.11 | $0.06 |
For the six months, operating cash flow was $1.248 million versus $779,357 in the prior-year period. Investing cash flow was $(80,100), including $79,750 of equipment purchases. Financing cash flow was $(1.126) million, primarily reflecting the $1.575 million repurchase of common stock, partially offset by $550,000 of additional line-of-credit borrowings. Ending cash and cash equivalents were $2.581 million, compared with $1.126 million at June 30, 2015.
At June 30, 2016, current assets were $8.633 million and current liabilities were $2.225 million. Reported working capital was $6.408 million. Debt consisted of $750,000 outstanding under the short-term revolving line of credit and $653,879 of long-term debt, including its current portion. The company reported compliance with all loan covenants.
Total assets were $14.392 million, total liabilities were $2.667 million and stockholders’ equity was $11.714 million. The company had $2.006 million of accounts receivable and $3.221 million of inventory. Three customers represented 58% of six-month sales and 58% of accounts receivable at June 30, 2016.
Material Changes Versus the Prior Comparable Period
- Six-month sales increased 2.0%, while second-quarter sales decreased 4.3%. The six-month increase was driven principally by higher EWCP sales from new customers; second-quarter BPCA sales declined because of lower customer orders.
- Gross profit increased 19.7% for the six months and 21.9% for the quarter. Management attributed the margin improvement primarily to lower aspartic acid costs resulting from lower oil prices.
- Six-month net income increased 58.3%; quarterly net income increased 76.1%. The improvement reflected higher gross profit, lower interest expense, and a $1,914 gain on equipment sales compared with losses in the prior-year periods.
- Operating expenses were broadly stable for the six months. Lower rent, consulting, professional fees, interest and utilities were partly offset by higher office and miscellaneous costs, travel, research and commissions.
- The company repurchased and cancelled 1.75 million common shares on January 6, 2016 for $1.575 million at $0.90 per share, reducing shares outstanding and capital in excess of par value.
- The short-term line of credit balance increased to $750,000 from $200,000 at December 31, 2015. The line permits borrowings up to the lesser of $3.0 million or specified percentages of eligible receivables and inventory and bears interest at 4.0%.
- Long-term debt decreased to $653,879 from $754,475 at December 31, 2015 through scheduled repayments.
Outlook, Commentary, Risks and Unusual Items
- The Taber, Alberta, aspartic-acid plant remains suspended. Management is seeking a partner to complete process development and reach profitable production levels. The suspension is expected to save approximately $800,000 annually in plant operating and general and administrative costs.
- Management identified crude-oil prices, activity in the oil and gas industry, and drought conditions as factors that may materially affect future results. The company also expects future client-building efforts and regulatory-compliance research to affect expenses.
- Management stated that existing cash resources are sufficient for expected commitments and cash-flow requirements for the coming year and that no significant capital requirements are anticipated through December 31, 2016, other than disclosed commitments.
- Lease commitments total approximately $303,963 through December 31, 2020. The company also has scheduled debt repayments, including $100,598 in 2016, $201,193 in 2017, $201,193 in 2018 and $150,895 in 2019.
- A $500,000 short-term note receivable issued June 22, 2016 at 5% annual interest was repaid with interest on July 25, 2016.
- Three customers accounted for 52% of second-quarter sales and 58% of six-month sales. Customer concentration creates exposure to customer loss, order reductions and collection risk.
- Other risks include competition, economic conditions, interest rates and borrowing costs, regulatory changes, sales weakness, inability to achieve projected operating results, limited capital availability, operational inefficiencies, foreign-exchange fluctuations and dependence on oil-and-gas and agricultural markets. The company does not hedge foreign-exchange exposure.
- Management concluded that disclosure controls and procedures were effective as of June 30, 2016, and reported no material change in internal control over financial reporting during the quarter.
- The company adopted specified stock-compensation and consolidation guidance without material impact. It was evaluating the future effects of new revenue-recognition, lease and stock-compensation standards.
Investor Verification Items
- Verify the sustainability of the improved gross margin and the extent to which lower oil prices, rather than volume or structural efficiency, drove the improvement.
- Assess BPCA customer concentration, order trends and the effect of oil-and-gas industry activity on future revenue.
- Monitor the $750,000 revolving-credit balance, borrowing-base availability, interest costs and compliance with financial covenants.
- Reconcile the reported share counts: the balance sheet states 11,427,991 shares outstanding at June 30, 2016, while the filing cover page appears to show a different figure.
- Evaluate the commercial prospects and funding requirements for the suspended Taber plant and the likelihood of securing a development partner.
- Review accounts receivable concentration, inventory levels and cash conversion, particularly because three customers represented 58% of receivables.
- Confirm the subsequent repayment and interest on the $500,000 note receivable and the August 2016 issuance of 9,000 shares upon employee stock-option exercise.