Flexible Solutions International, Inc. (FSI) Q1 2012 Earnings Report, Transcript and Summary

Ladies and gentlemen, welcome to the Flexible Solutions International Conference Call. The first quarter financials on the 16th of May 2012. [Operator Instructions] I would now like to hand the conference over to Daniel O'Brien. Please go ahead, sir. Daniel O’Brien: Thank you. Good morning. This is Dan O'Brien, CEO of Flexible Solutions. Safe Harbor provision. The Private Securities Litigation Reform Act of 1995 provides a Safe Harbor for forward-looking statements. Certain of the statements contained herein, which are not historical facts, are forward-looking statements with respect to events, the occurrence of which involve risks and uncertainties. These forward-looking statements may be impacted, either positively or negatively, by various factors. Information concerning potential factors that could affect the company is detailed from time to time in the company's reports filed with the Securities and Exchange Commission. Welcome to the conference call for first quarter 2012. Prior to commenting specifically on the financials, I'd like to speak about where we are on our major projects, and what we expect for the next quarters. Growth continued in most of our market verticals during Q1. Record revenue was booked in the first quarter and continues to be based on increased volume of product rather than merely increasing price per unit of volume. Our sugar to aspartic acid plant in Alberta is now in operation. We do not provide volume information or details of production. However, revenue generation has started. Depreciation of the factory has begun, and the Taber production team is focused on continuous increase in quality, quantity and efficiency. One of the many primary potential customers for this grade of material is the dish and laundry detergent market. The market opportunity for our products in detergents is estimated as greater than $350 million per year. The NanoChem division now represents more than 90% of revenue and has become the main sales and profit driver of our company for the next several years. This division makes polyaspartic acid, TPA is the acronym, a biodegradable protein with many valuable uses. TPA is used in agriculture to increase crop yield. The method of action is through limiting crystal embryo growth between fertilizer ions in the soil. When embryonic crystals are prevented from transforming into a fully crystalline form by TPA, the fertilizer remains available to plants further into the growing season. Keeping fertilizer easily available to crops results in better yield with the same level of fertilizer. In North America alone, the wholesale market is estimated at over $2 billion a year, most crops are able to use TPA profitably. Sales into the agriculture grew very quickly in 2011, and that strength has carried forward into Q1 2012. The distributor we were so pleased to find in late 2009 has shown remarkable ability to grow sales and increase interest in our products. Our internal sales team is fully engaged in supporting our best distributors and helping the others improve their performance. TPA is also a biodegradable way of treating oilfield water to prevent pipes from plugging with mineral scale. Our sales into this market are well-established. They're growing steadily. They can be subject to temporary reductions when production is cut back or when platforms are shut down for reconditioning. In some areas, including many Nordic countries and companies operating in the North Sea, the use of TPA is mandated as part of environmental regulation. Second quarter and the rest of 2012. Well, we're optimistic, but we're cautious. Our products are best in their class and in normal economic conditions, we can attempt to forecast sales based on past results. However, given the news of an accelerating world economic slowdown, particularly in Europe and the Far East, we've decided not to provide specific growth predictions. It's simply too difficult and unrealistic to give accurate guidance at this time. We still expect full year revenue 2012 to be higher than 2011, and we will revise to our best ability each quarter. We hope to succeed even during difficult times, and we will do our best to provide upside surprises. Swimming pool sales were the only product sector that did not increase compared to the same quarter of 2011. We suspect that this is a combination of better than usual early buy orders in Q4 2011 and other customers waiting for Q2 to place their orders. Agriculture is strong. Our best distributor has shown another quarter of rapid growth. The oil sector is providing us with lots of new chances to grow and, of course, when we get the Alberta plant to significant volume levels, large detergent contracts become possible. We continue to caution that the continuous high oil prices have increased aspartic acid prices. This increases our cost of goods and affects our margins until production gains at the Alberta plant can relieve the pressure. Some highlights of the financial results. Sales for the quarter increased 19% to $5.19 million, compared with $4.36 million in 2011. The result is a profit of $223,000 or $0.02 a share in the '12 period, compared to a profit of $358,000 or $0.03 a share in 2011. Now that the Alberta factory is operating, a biomass expense is no longer given in our news releases. Instead, due to the generation of revenue from that facility, depreciation of the factory has begun. This results in significantly higher depreciation expense in the financials compared to previous quarters. Working capital is more than adequate. FSI sales tend to be larger during the first half of the year, resulting in higher accounts receivable, lower cash and lower inventory. The company's growth is supported by its mostly untapped $6.4 million line of credit with a Chicago-based bank. Because of the outsized effects of depreciation, stock option expenses and onetime items on the financials of small companies, FSI also provides a non-GAAP measure useful for judging our year-over-year success. Operating cash flow is arrived at by removing depreciation, option expenses and onetime items. For the first quarter of '12, operating cash flow was $1.12 million, $0.08 a share, compared to $800,000 or $0.06 a share in 2011. We're pleased with these results, but the pressure on margins from raw material cost is evident in this metric too. Detailed information on how to reconcile GAAP with non-GAAP numbers is included in our news release yesterday. And onto our other product lines. WaterSavr in swimming pools are being emphasized less than the NanoChem division, while maintaining the long term opportunities and limiting cash and management cost. Swimming pools and their sales are back to pre-recession levels, and we plan to see some growth in the division through 2012. WaterSavr sales are more difficult to predict. We're continuing efforts in Turkey, Morocco, parts of East Asia, Australia and Spain. Small sales through the year, especially in the mining industry, can be expected. The text of this speech will be available on our website by Thursday, May 17. E-mail copies can be requested from Jason Bloom at 1 (800) 661-3560 or on the Internet jason@flexiblesolutions.com. Thank you. And the floor is now open for questions.

[Operator Instructions] The first question comes from John Nobile from Taglich Brothers.

I'll try not to probe too much into a number that I know you probably won't disclose, but I have a few other questions, hopefully you could shed some light on, in particular TPA and water treatment. Now that's a very large market, but I'm curious if you have -- currently have any sales in this market and what are you actively looking to penetrate this market? Daniel O’Brien: Water treatment sales are an interesting area. They're quite fragmented. It is a huge market, as you say. We have sales into the market. They are usually driven by the customer finding us. The reason for this is that the distribution and the pricing of water treatment chemicals is very low. We're not great distributors. We sell large quantities and don't have a huge distribution system or a distributor network. So water treatment is one of the most difficult markets for us to penetrate profitably, and we do focus on profits. So at this time, we do not focus on the marketplace even though we know it's very large, because we believe that even if we were successful, we would find ourselves with extremely low margins.

Okay. But in particular like the first quarter that just closed, if you can throw a percentage of sales, like the TPA sales, that were generated from this market? Daniel O’Brien: I wouldn't even know that number. It's small, and we concentrate on agriculture, oilfield and cleaning products.

Okay. And in detergents, how does sugar-based TPA product compare in terms of price to polyacrylic acid? Daniel O’Brien: Well, in today's world, I think we could reach polyacrylic acid pricing. Whether we chose to or not, that would be a decision to be made at the time. And it would be highly dependent on whether we were able to sell as much product as we wanted or as much product as we could produce into other marketplaces at higher margins.

Okay. So in that regard, the detergent market, because I know you had mentioned that you're looking at possibly multimillion dollar contracts with a sustainable source, which the sugar-based would be. Okay, that would be sufficient enough for them to maybe pay a higher price over polyacrylic acid in terms of additive? Daniel O’Brien: Yes, we would hope so. There is very little appetite in the world for paying extra for green. Normally, the process in these big deals is, no, we'd like to pay the same as the dirty products, and we'll take full advantage of the sustainable and green marketing opportunity, but unless you can match industry prices, we'll continue in our normal behavior. I guess, what I'm saying is that we want that business, but we want it at the right time for the company. And the right time is when we can choose to take a long-term contract at a lower price than we would otherwise be able to get in other marketplaces, but it would give us some comfort over multiple years. We aren't ready to take that contract. We haven't got production to that level yet. So I have the luxury of thinking about strategy and not actually having to pull any triggers at this point.

Okay. And if I could just ask, on the financials, the tax rate, obviously, over the quarters, it should drop closer to a rate of -- well, a combination of a 40% U.S. rate, and I believe Alberta is 25%, so maybe there's a mix in there, but... Daniel O’Brien: The tax rate is going to be right in the 38% to 39% range until well, until further notice.

And then trying to get an idea, obviously, I model out quarter-by-quarter and trying to get an idea, obviously, when we can turn profitable in Alberta, which should drop that tax rate dramatically. But right now, you can't offset that loss, so the rate -- actually, what was it in the quarter? It was quite high, 72% tax rate in the quarter. So going forward, if I could even ask into Q2, should I model something in the 38% to 39% range or is it going to take a little bit more time before we approach that, given the Alberta ramp up? Daniel O’Brien: It's going to take more time. This tax issue is troubling to us. We find it unfortunate that we have to work this way. I think that you'll just have to look at it quarter-by-quarter.

Okay. But could you kind of have some kind of an idea as to when it will get closer to a typical tax rate? Approximately, how many more quarters? Are we looking at maybe a whole year out or within a few quarters? Daniel O’Brien: It could be a whole year. It could be several quarters. I mean, this is not something that I'm comfortable predicting because then you're asking me to predict production levels at Alberta, and that is something that I refuse to go into because I can't accurately predict it.

Okay. That's what I was trying to get to. Daniel O’Brien: I know. You're always trying to go around behind my back, John.

Okay, all right, well, I'll leave that. Just one more, one last question and I'll leave that. In the press release, the revenue forecast was dropped. You're not providing it obviously this quarter, citing Europe and the Far East, and I know in particular Europe has their problems, and I think the forecast with a negative growth and maybe slight growth next year is bad, but from your fiscal 2011 numbers or even the first quarter, what percentage of total revenue does Europe in particularly generate for you, just to get an idea of how that might impact you? Daniel O’Brien: Our European sales are between 50% and 60%. I don't keep a number, an accurate number in my head, but I know it's in that range.

Okay. So it's very significant. But looking at your numbers in light of the European economy, it doesn't look like -- either it did have a big effect, but other regions are more than offsetting that because the numbers are pretty robust on the sales end, but I would imagine... Daniel O’Brien: Yes, they are. But John, those are historical sales now. We don't want to be trapped in a situation of hubris and saying, well, we did that last year, or last quarter, we're just going to keep going up. The changes that have happened just in the last 6 weeks are enormous. The price of oil has dropped dramatically. That's a benefit for us going forward. But it also -- remember in my speech, when oil prices are low that might be a time, and we don't have any evidence to base this yet. But this is -- we think about these things. Oil price is low. What a good time to close a platform for renovation in the North Sea. These things can be very significant to us. Europe is going into yet another recession. Will the detergent-buying public continue buying green or will they buy cheap? We don't know the answers to this. We have customers who order from us on a monthly, a weekly, quarterly basis. We don't control our customers. So we don't control our future in terms of being able to predict our revenue in scrambled times. And that's why we are just not comfortable giving a number and being probably wrong one way or the other.

Okay. I guess, we'll see how the second quarter shakes out as far as total sales and in particular to Europe is a concern obviously, with their problems over there.

The next question comes from Gary Schwab from Valley Forge Capital Management.

I was surprised when you just said that -- when you said European sales could be to 60%. So I assume that you're talking about oil service and detergent. Aren't most of your ag sales are U.S correct? Daniel O’Brien: Correct. Yes. We don't break out our sales. I mean, that's why I gave some -- the numbers. I'm not going to give you accurate numbers when we don't break them out on the financials either.

Okay. But going forward, how was your ag business doing? I think I remember last year, you said that there were 2 big distributors who said they could possibly double their ag sales in 2012, somebody said that. Now obviously, I guess, that hasn't happened, but it's still early in 2012. But what's going on with those 2 big distributors? Daniel O’Brien: As far as we know, they bought substantially in the first quarter and presumably they're selling it onto their customers. Second quarter is only half finished. I haven't seen any numbers for May. I saw April, so I won't comment. We are expecting that there will be growth in -- serious growth in agriculture. Now I wouldn't want to be trapped in into predicting 100%, but it's -- it was definitely up very significantly in first quarter, and we'll see how many of the other 3 quarters that occurs in. So yes, we're very satisfied with agriculture.

Would you think that by 2013, your ag business would surpass the other 2 divisions? Daniel O’Brien: Well, I mean, that gets me into trying to predict growth rates. There are a number of moving parts. Certainly, we will be much closer to oilfield sales in agriculture with another year of the kind of growth we had last year. So yes it's getting close to being our biggest division, but again, it's not something we really want to break out because it gives an awful lot of information to potential competitors if they can see where we're doing what and how much money we're making at it.

Okay. I wasn't on the last conference call, but I had a question regarding last -- the December quarter's earnings at NanoChem -- well, not earnings, but revenues. There was a large sequential drop in the biopolymer division between September when you did like -- almost $3.7 million to December, where you did about $3.2 million. You had about a $500,000 drop between the third and fourth quarter. Was this something that was normal or was there something that slowed down? Daniel O’Brien: Well, those are not -- I'll do my best, Gary. Those aren't numbers that I've got on my desk in front of me, but it's normal to compare December 2011 -- or sorry, 2010 with 2011, because our quarters have different mixtures. The 2010 to 2011 comparison was a change -- upward change of 30-some percent, if I remember correctly. And the year as a whole was up 30-some percent. So what can happen, and I'm not saying this did happen, but there is an early buy program for agriculture, and that occurs in September and October, and the deliveries occur at different stages. I don't know what went out on September 30 and what went out on October 1. I also don't know what shipped in the last 2 weeks of the December and didn't -- or didn't ship and as a result went out in the first 2 weeks of January. I don't think a $500,000 variance between quarters, when you're measuring consecutive quarters rather than year-over-year quarters, is something to be worried about.

Okay. Because also I think you said last year that, that ag business, which is normally in the first and second quarter, you said you were seeing continued orders in the third quarter and then you get pre-orders in the fourth quarter. Daniel O’Brien: All true.

And you didn't know if that would continue in the second half of 2012, but does it -- do you have any better feel for that now? Daniel O’Brien: Definitely, we have a more organized buying group at the other end in terms of Southern United States that have a fall season are buying more and that is contributing to third quarter and early buys for the following year are contributing to both third quarter and fourth quarter. We don't see any reason why that would change but, of course, they're not bankable orders until we receive them.

Okay. And another thing, you split your revenues into 2 geographic categories, U.S. and abroad and then Canada. What makes up your Canadian revenues? Is it only product that you sell to Canadian customers? Or what makes up Canadian revenues? Daniel O’Brien: Products sold to Canadian customers in the swimming pool division or agriculture or detergent or oilfield customers in Canada from the United States from the NanoChem division.

So what about Taber sales when you sell to Peru. Are those going to be considered U.S. revenues or they can be consider Canadian revenues? Daniel O’Brien: I can't answer that. It's never been asked before, and I will have to ask the auditors. The customer is in the United States and the manufacturer is in Canada, I'm suspecting it will be American sales, but I don't actually know.

Okay. Maybe Jason could find out or you could find out, and I'll give Jason a call on that? Daniel O’Brien: Yes, give Jason a call.

Yes, okay. And then lastly, I know you don't want to talk about production figures available, you said. I realize this is for competitive purposes. But you've gotten a lot more cautious, and there's been a lot of selling over the last couple of months. I think the stock was up around $2.50 back in March. I know the market has come down, but your stock never came down like that, that quickly without any news. I don't know if it's a problem. It's a problem for me. I don't know if it's a problem with shareholders, but if feel that people are worried that your progress in Alberta is not going well. Can you at least talk about the volume output that has been increasing since you first announced that you've gone commercial, that you haven't come into a roadblock, that your bioreactor has not stopped or that there's a problem with what you're doing? Can you tell us that this is not... Daniel O’Brien: I can tell you point blank that the process works, that the equipment is running and that volume is increasing.

So volume has been increasing? Daniel O’Brien: And that's as far as I intend to go.

Okay. Okay. Daniel O’Brien: Can I comment on one other thing as well?

Sure. Daniel O’Brien: And that might be that the company has always -- I mean, I want to get this out in a really positive spin manner. This company will be highly successful, with or without Taber. It will be even more spectacularly successful with Taber, which is why we have put so much energy into getting control of our raw material stream. So as you can see by the constantly growing operating cash flow, we have one of those little companies that can. And yes, Taber has taken longer and cost a little more than expected, but if you were to go back -- go out into the chemical industry and measure the dollars per ton of production we spent on Taber, we spent about $6 million, instead of the $5 million we were hoping for, but we've got a 5,000 metric ton nameplate capacity there and when you compare that to what you see in the other chemical engineering news, we've done a spectacular job of getting a low-cost operation into operation and yes, the cost was a couple of years, but keeping your cash under control is how you stay in business and eventually become the winner.

Well, okay, I mean, that sounds good. And I've always had faith in you. And the fact that you have a nameplate 5,000 metric ton plant, I heard that you'd still need further steam engine, steam engineer and provincial approvals to get to that nameplate output. Do you plan to or have you done anything, spoken to any agencies or whatever in advance to prepare for that next step up approval? Daniel O’Brien: We have a route to approval that will not take anywhere near the time that the previous one did. Yes, we can provide preliminary drawings and get approvals on that. We can do everything we need to do. I'm not even certain that we will need. They're doing well. There are levels of approval. We won't need the same level of approval we had last time. Extensions of steam lines are very different from approving new vessels.

The next question comes from Gregg Hillman from the company, First Wilshire Securities Management.

I just wanted to ask you if you'd done the deal trials for frac-ing and whether you have actually demonstrated proof of increased production by using your aspartic acid in the field? Daniel O’Brien: Okay. That's hydraulic fracturing for tight gas or tight oil, right?

Exactly. Daniel O’Brien: We have had our product used by several companies in North America as an ingredient in frac-ing fluid, and it works equally well to the nonbiodegradable competitors. So say, asking me if it improves recovery? That's not a fair question. It equals the current standards of other people's products. And this actually is a great opportunity maybe for others to hear what TPA does in frac-ing fluids. When you fracture the rock, you have to prevent your frac-ing fluids and your flowback water. The water in the -- and the water in the formation from depositing scale on the rock surfaces and ruining the porosity because when that porosity is gone, you don't get any more oil or gas out of the structure. TPA, just as it keeps scale from growing on the inside of oil recovery pipes in the North Sea, can also prevent that scale from forming on the pores of a frac structure. So if it's used properly in the right amounts, it's as good as the industry standards for nonbiodegradables, but it's a biodegradable, which means that your recovered water is going to be easier to treat and your -- how would you say it, your political correctness factor is going to go up. So that's what's been done in frac-ing. We don't know how fast this opportunity will grow for us, but we are working steadily with groups, and we're hoping to gain more business in that field.

And Dan, have any states -- so it's not required to adhere to for -- by any states in the United States? Daniel O’Brien: No, it's not a required product. We are only just in the first stages, correct me if I'm wrong, but we're in the first stages of legislation that is simply saying you must disclose the materials in your frac-ing fluids. I think after that, lawmakers will start to look at which things are allowable and which things aren't, but until they know what's in there, they probably won't make any rulings on what should be in there.

Have you aligned yourself with a really good distributor for oilfield chemicals like for example Multi-Chem, a company that was just bought by Halliburton. Have you aligned yourselves with one of the top oilfield chemical companies in a way that your selling force is excited about it? Daniel O’Brien: That would be an unusual situation for us. We have in our -- inside our company, we have the world experts on TPA. And we sell to -- I'm not allowed to name them, but we sell to virtually every oilfield service company of any size that operates in North America or Europe. And we do direct technical sales into their technical team system. So rather than a distributor who has to explain our product, we actually have our senior scientist explain our products and how they work with the oilfield service company who's actually going to utilize the product. The reason for doing this is that almost all oilfields downhole liquids are mixtures of things bought from several companies and put together by the service company to make what they feel is the best product for the purpose. And TPA is only one of many things in there. There will also be corrosion inhibitors. There may be wax buildup inhibitors. There may be gas hydrate inhibitors. So we need to be working directly with the technicians in the service companies to make sure that they know what our product can do and that they use it for the right purposes. And if they have trouble, they can come directly back to the scientist who invented the product and work with them until the solution is found. That would be extremely difficult in a distribution system.

The next question comes once again from John Nobile from Taglich Brothers.

Just one more question. I know that you are currently shipping in aspartic acid from China. I believe the majority of that is coming in from China. Now I'm just curious in the past, you had mentioned that about 90% you're looking to actually produce from your Alberta plant sugar-based, which I believe sugar is in abundance in that area. So just the perspective from annual shipping cost getting 90% from the Alberta plant versus shipping it in from China, what do you believe that would actually save you in annual shipping cost? Daniel O’Brien: I can't give you a dollar number, but I would say that it drops the shipping cost per ton by between 50% and 60%. And it may be possible to drop it further than that. That's based on truck shipping, which is the most expensive out of Alberta. We are working towards rail shipment. It's not as easy as it looks on the map, as I'm sure you know, but when we get solid numbers on there, I'm guessing that we can get close to a 75% reduction in shipping.

I mean, it sounds very significant. I was just hoping to get a little more quantitative in the actual shipping. I mean... Daniel O’Brien: Shipping is roughly $150 a ton right now from China, and I think I'm correct. I mean, this is getting little deep into the figures for me, but I think it's about $150 a ton to Chicago and perhaps another $50 Chicago to our plant in Peru, 100 miles out of Chicago core. So we're seeing dropping our shipping by $100 a ton and as much as $150 a ton if everything works out perfectly.

Okay, and how much tonnage would you say in a particular year just to kind of quantify it? Daniel O’Brien: Well, you see that's the problem as I can't give you that number because then everybody who's competing with us can work out our selling prices from our revenue stream. So one of the things we've always had to keep secret is either our total tonnage or our revenue, and the SEC doesn't let you keep your revenues a secret.

Thank you. There seem to be no further questions at this moment. Please go ahead with any other points you wish to raise. Daniel O’Brien: Gentlemen, thank you for joining us today. I am pleased with all your questions, and I hope to be back to hear from you in 3 months and that the world will be better, and we will be talking about all good things again. But thank you very much, and I will continue to do my very best to make this a great company. Goodbye.