Flexible Solutions International, Inc. (FSI) Q2 2012 Earnings Report, Transcript and Summary

Welcome to the Second Quarter Financial Conference Call on the 15th of August 2012. I will now hand the conference over to Daniel O'Brien. Please go ahead, sir. Daniel O’Brien: Thank you, Patricia. Good morning. I'm 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 regard 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 FSI Conference Call for Second Quarter 2012. Prior to commenting specifically on the financials, I'd like to speak about where we are on our projects and what we expect for the next few quarters. Revenue is down slightly in second quarter 2012 compared to 2011, but up for the half-year. We believe this is caused by macroeconomic conditions, especially in Europe. Our first quarter was strong due to increasing agricultural sales that are not repeated in Q2 because the inputs for crops are already determined. Weakness overseas coincided with seasonal sales in the U.S., resulting in a rare year-over-year decline in quarterly revenue. Our NanoChem division is now more than 90% of revenue and has become the main sales and profit driver for our company for the next several years. This division makes polyaspartic acid, called TPA for short, a biodegradable protein with many valuable uses. 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 increases in quantity, efficiency and quality. Aspartic acid from that Taber plant is shipped to our Peru, Illinois plant where it is converted to polyaspartic acid. One of the primary potential customers for renewably sourced TPA is the dish and laundry detergent market. The market opportunity for our product in detergents is estimated as greater than $350 million per year. TPA is a biodegradable substitute for the part of detergent that prevents dirt from redepositing on clothes or dishes before it can be rinsed away. 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 their fully crystalline form by TPA, the fertilizer remains available to the plants further into the growing season. Keeping fertilizer easily available to crops, results in better yield with the same level of fertilization. In North America, the wholesale market is estimated at over $2 billion a year and almost all crops are able to use TPA profitably. Sales into agricultural grew quickly grew in 2011 and that strength carried forward into 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 larger than a year ago. They are focused on supporting our best distributors, helping the others improve their performance and identifying additional distribution opportunities. TPA in agriculture is a unique economic situation for all links in the sales and user chain. With many products, the economic value is good for several parties but one, prominently the end user is asked to accept the soft value such as convenience instead of the profit that accrues to all the other parties. It's not so for TPA. FSI earns a fair profit on manufacturing, distribution earns a strong profit selling to dealers, dealers make good profits selling to growers. Yet the growers still earns a profit from the extra crops he produces with the same land and fertilizer program. In fact, the grower can make several times his TPA investment in extra profit when crop prices are high. We believe this is an excellent basis for our long-term growth in sales. 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 and growing steadily, but they can be subject to temporary reductions when production is cut back or when platforms are shut for reconditioning. Q3, Q4 and the start of 2013, we're optimistic but cautious. Our products are the best in the class, and in less volatile economic conditions, we have forecast sales based on past results. But until we're more comfortable about the world economy, we've decided not to provide specific growth predictions. It's too difficult and unrealistic to be accurate with our guidance. We still expect full year 2012 revenue to be higher than 2011. Our best estimate is that Q3 will resemble Q2, and that in Q4, we will see a resumption of year-over-year growth due to the pre-ordering of agricultural TPA for the 2013 season. The drought in the U.S. and Russia has caused crop prices to increase dramatically recently. Our crop prices give growers incentive to increase their yield by using TPA. We think this will have a very significant positive effect on Q1 2013 revenue. On to the highlights of the financial results. Sales for the quarter decreased 4% to $3.6 million compared to $3.93 million in Q2 of 2011. The result is a loss of $466,000 or $0.04 a share in the '12 period compared to a profit of $175,000 or $0.01 a share in '11. Now that the Alberta factory is operating, a biomass expense is no longer given in the news release. Instead, due to the generation of revenue from that facility, expenses are included in operations. In addition, depreciation of the factory has begun, and this results in a significantly higher depreciation expenses in the financials compared with the year earlier quarters. Our working capital is very accurate -- 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 unused $6.4 million line of credit with a Chicago-based bank. Now 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 half of 2012, operating cash flow was $1.17 million, $0.09 a share compared to $1.42 million and $0.11 a share in 2011. We're pleased with these results, and the detailed information on how to reconcile GAAP with the non-GAAP numbers is included in our news release of August 14. And last, our other product lines. WaterSavr and swimming pools are emphasized less than the NanoChem division, while maintaining the long-term opportunities and limiting cash and management costs. Swimming pools sales decreased compared to the same quarter of 2011. We believe that this is a continuation of better-than-usual early buy orders from Q4 2011, distributor resistance to midseason reorders and competitors chasing sales at any price. WaterSavr sales are difficult to predict. We continue our efforts in Turkey, Morocco, Senegal, parts of East Asia, and Australia. We expect some small sales during the year. The drought this summer has revived interest in the Western U.S. and several trials have been requested. Successful trials this year could result in sales during 2013. The text of this speech will be available on our website by Thursday, tomorrow. And e-mail copies can be requested from Jason Bloom at (800) 661-3560 or jason@flexiblesolutions.com. Thank you. The floor is now open for questions. Patricia, would you please explain the question-and-answer system.

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

My first question actually you made a comment about the drought in the Midwest affecting -- actually, positively affecting TPA sales. And you were talking about that in the first quarter of 2013. But you still have agricultural sales in Q3 and Q4. I know at a lesser demand for it in those quarters, but how do you think this drought would play out as far as Q3 and Q4 is concerned with TPA sales in the agricultural market? Daniel O’Brien: It's a little bit difficult. The Q3 sales are usually into the southeast and the very south of the west and into irrigated land. So the question would be, is there a significant effects of a drought or not? And I would say that the more significant effect will be latter part of Q4 with pre-order sales, if that does drive increased pre-orders. But as I noted, the first time that we're relatively sure that it will positively impact us is in the first quarter when we're supplying people in the American Midwest who are the greatest planters of corn and soybeans.

Okay, of course, the drought situation could be much different if not over at that time? Daniel O’Brien: We hope it will be over and...

I hope so, yes. And how much did European sales impact the quarter? Daniel O’Brien: I would say they were responsible for the difference between a small growth and the very small reduction in revenue we had. So in the range of $200,000 or $300,000.

$200,000 to $300,000? Okay, I mean, it wasn't really that significant. Daniel O’Brien: No. And, in fact, I like to be quite positive. The speech is one thing, but when we speak in the Q&A or one-on-one, I like to be very positive. I mean, we're not seeing that the damage to the economies in Europe is destroying our business. What it's doing is removing our visibility of how quickly we'll grow or whether we'll grow one quarter and not the next and then revert to growth the one following. It's more a visibility issue than a loss of business, either -- even occasionally temporarily, but in the long term, having products like ours that are environmentally responsible and that work as well at nearly the same cost as dirty chemicals is going to serve us well in Europe. So we have temporary issues, much the way the Europeans have temporary issues. And as they solve their problems, so will ours change for the positive.

And I know you that you won't disclose actual numbers, but could you say that sugar-based TPA sales have actually increased in the second quarter over the first quarter. Because I believe the first quarter you really just started to produce samples. So I'm assuming that sales TPA -- sugar-based TPA were up over Q1, can I safely say that? Daniel O’Brien: You can safely say that. I'm not going to go into the numbers.

Okay. Significant amount going Q2... Daniel O’Brien: No, sorry. Please don't drag me into this, thank you.

I'm sorry. I realize I shouldn't get into that area. I always try but -- all right, well at least they were up over at Q1, but I'm sure Q1 was a very small base to start with there. And just one final question, I was surprised the gross margins, they dropped below 30%. In your opinion, what would you say was the biggest factor in that reduction of gross margins? I mean, if I look even from last year's quarter, it was over 40% and even in the first quarter of this year, you had a 38% gross margin. So it kind of took me by surprise to see it drop below 30%. Daniel O’Brien: I will comment on that and just say that our product mix varies dramatically. We had very high ratios of agricultural sales, which have our best margins in Q1, and relatively low in Q2. So product mix is a big one. Another one is the price of oil increased and decreased several times this spring. We don't track oil prices daily or even monthly, but what we do find is that whenever possible, our aspartic acid suppliers raise prices early and keep prices high longer, and we are not able to force them to lower their prices until they are ready to. And we have been surprised at how strong and how well aspartic acid prices have held up this year. So the combination of product mix and raw materials cost have, I would say, are the cause for the decrease in margin. And whenever we have strong agriculture sales, our margins will increase. And whenever we can get aspartic acid at lower prices, our margins will increase.

I mean, you made mention that Q1 was a high agricultural mix, which is kind of understood the seasonality in your business. Q2 should also be a high agricultural mix , too, that's why I saw that -- or you're saying that the agricultural [indiscernible]. Daniel O’Brien: It wasn't this year. It wasn't this year, John. And we don't know -- I mean, we've had -- we're tracking higher in agricultural all year but not in second quarter. What it probably means is that our customer base accurately predicted their needs, ordered it in the first quarter and didn't have to reorder in the second quarter. But again, we don't -- we do not have long-term contracts with people, so we're subject to the vagaries of the marketplace.

Okay. So I'll look at a 6-month total to kind of get a feel for the agricultural mix or the overall total sales. Daniel O’Brien: Yes. 6 months is always going to be a little bit more accurate than 3 months with small companies.

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

Yes, could you talk about -- you said TPA is used in the North Sea in offshore oil rigs there. And I was wondering whether it's going to be used in the Gulf or any other parts of the world or mandate it any time soon, including the United States? Daniel O’Brien: Well, it's interesting. I would have my doubts about significant uptake in the Gulf of Mexico. There is no regulation that would cause the oil companies or the oil service companies to increase their cost even the 4% or 5% that our product entails, the 4% or 5% on a tiny fraction of their total cost. But where we do see some forward opportunity is onshore in the United States. The hydraulic fracturing industry has tested our products, and they have tested out really quite well. They have a couple of advantages. They allow recovered water to be much easier to treat because the -- of course, the polyaspartates biodegrade within 28 days and they also work relatively well inside the formations. If you know, and I'm sure you do know fracturing quite well, you have to pump down lubricants, you have to pump down water, of course. And then there's proppants which are usually, especially shaped sand. And then the other thing you need is something to keep the formation of water from coating the rock and clogging the pores, and that's where TPA can be part of the system. And we are hoping that we will continue to gain traction here. And I'm not saying we have any significant sales into the fracturing market, but we have some positive outlook and we're pushing quite hard through our scientific sales staff.

Okay. That's really good. And moving on to the detergent's side, what's the name of the product, detergent product that uses TPA currently, of the end product to consumer? Daniel O’Brien: Oh, well, if you're looking to buy our product, you could buy from Ecover , is one name. Another is Method Home, and a third is Seventh Gen. So our products are available to the household home cleaner through those 3 products.

And are those products gaining traction? I mean, are they increasing sales over time? Daniel O’Brien: They're buying more product from us. I really shouldn't comment on their business.

[Operator Instructions] This concludes the second quarter financial call. Thank you for participating. You may now disconnect. Daniel O’Brien: Thank you, Patricia. That was well done.