Flexible Solutions International, Inc. — Form 10-Q Summary
Reporting period: Three and six months ended June 30, 2011; filed August 15, 2011. The unaudited consolidated statements are presented in U.S. dollars and should be read with the company’s December 31, 2010 Form 10-K.
Business Context
The company 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. Operations are reported in two segments: Energy and Water Conservation Products and biodegradable polymers.
Financial Performance and Position
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Sales | $3.93 million | $2.83 million | $8.29 million | $6.22 million |
| Gross profit | $1.68 million | $1.24 million | $3.47 million | $2.77 million |
| Gross margin | 42.8% | 43.8% | 41.8% | 44.6% |
| Operating income | $469,734 | $279,490 | $1.15 million | $864,162 |
| Operating margin | 12.0% | 9.9% | 13.9% | 13.9% |
| Net income | $174,734 | $(133,590) | $532,841 | $382,082 |
| Basic EPS | $0.01 | $(0.01) | $0.04 | $0.03 |
- Second-quarter sales increased approximately 39%, while six-month sales increased approximately 33%. Management attributed the increase to more normal customer inventory levels for the energy and water conservation products and stronger marketing across markets for polymer products.
- Six-month revenue consisted of $7.60 million from biodegradable polymers and $686,567 from energy and water conservation products. The polymer segment generated $1.40 million of segment profit, while the energy and water conservation segment generated a $868,823 loss.
- Six-month operating expenses rose to $2.32 million from $1.91 million. Increases included wages, administrative costs related to the new facility, professional fees for patent and litigation matters, and commissions.
- Cash used in operating activities was $1.36 million for the first six months, compared with $13,233 used in the prior-year period. The principal working-capital uses were increases in accounts receivable of $1.74 million and inventory of $652,391.
- Investing cash use was $619,253, primarily for construction and equipment. Cash used in financing was $592,815, including the $1.03 million repurchase of 792,576 common shares, partly offset by a $500,000 revolving line-of-credit draw.
- Cash and cash equivalents declined to $197,618 at June 30, 2011 from $2.76 million at December 31, 2010. Working capital was $4.07 million, compared with $5.12 million at December 31, 2010.
- Total debt was approximately $2.84 million, consisting of $500,000 under a revolving line of credit and $2.34 million of long-term debt, of which $336,924 was classified as current.
- Total assets were $15.49 million and stockholders’ equity was $11.01 million at June 30, 2011. Accounts receivable were $2.95 million and inventory was $3.21 million.
Material Changes Versus Prior Comparable Period
- Revenue growth produced higher gross profit and operating income, but gross margins declined from 43.8% to 42.8% in the quarter and from 44.6% to 41.8% for the six-month period.
- Net income improved from a second-quarter loss of $133,590 to income of $174,734. Six-month net income increased approximately 39% to $532,841.
- Liquidity weakened materially because of operating working-capital investment, capital expenditures and the share repurchase. Management obtained a $500,000 revolving credit facility in February 2011.
- Property, equipment and leaseholds increased to $8.51 million from $7.87 million, including $5.82 million of plant-under-construction and equipment related to the Taber, Alberta facility.
- Shares outstanding declined to 13,169,991 from 13,962,567 following the February 2011 repurchase and cancellation.
Guidance, Outlook, Risks and Unusual Items
- Management expected the Taber plant to begin commercial production in 2011 and expected approximately $50,000 of additional spending before production. The plant is intended to manufacture aspartic acid using sugar-based raw materials, potentially reducing raw-material, oil-price and shipping exposure.
- Management stated that available cash resources were sufficient for commitments and anticipated cash-flow requirements for the following year, although the filing also reports only $197,618 of cash at quarter-end and negative operating cash flow for the six-month period.
- The revolving credit facility permits borrowings up to the lesser of $1.5 million or an advance-rate formula based on eligible receivables and inventory. Borrowings bear interest at prime plus 0.75% and mature February 28, 2012. The facility is secured by substantially all assets of NanoChem Solutions, excluding intellectual property, and contains financial and operating covenants.
- On June 29, 2011, a former WATER$AVR distributor filed an arbitration dispute asserting multiple claims. The company denies the allegations and intends to defend the matter; the amount and outcome were indeterminable at the filing date.
- Three customers represented 55% of six-month sales, and the three primary customers represented 57% of accounts receivable at June 30, 2011, creating customer-concentration and collection risk.
- Other identified risks include competition, economic weakness, customer or sales losses, borrowing costs or debt defaults, regulatory changes, foreign-exchange exposure, operational inefficiencies and the availability of funds for capital expenditures.
- No impairment charges were recorded. The company stated that its disclosure controls and procedures were effective as of June 30, 2011 and that no material change occurred in internal control over financial reporting during the quarter.
Facts Investors Should Verify
- Whether the Taber facility commenced commercial production in 2011 and whether the expected $50,000 remaining expenditure was accurate.
- Subsequent operating cash flow, receivables collection, inventory levels and the company’s ability to maintain liquidity after the sharp cash decline.
- Compliance with the revolving credit facility’s borrowing-base and financial covenants, and the February 28, 2012 maturity or refinancing of the facility.
- The resolution, cost and potential financial impact of the WATER$AVR distributor arbitration.
- The sustainability of polymer-segment growth and the continuing losses in the energy and water conservation segment.
- The impact of customer concentration, raw-material sourcing, foreign-exchange movements and increased legal and facility-startup costs on future margins.