Flexible Solutions International, Inc. (FSI) Q3 2014 Earnings Report, Transcript and Summary

Good day and welcome to the Flexible Solutions International Third Quarter 2014 Financials Conference Call. Today’s call is being recorded. At this time, I would like to turn the conference over to Dan O’Brien, Chief Executive Officer of Flexible Solutions. Please go ahead, sir. Dan O’Brien - Chief Executive Officer: Thank you, Tim. 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 third quarter conference call. Before concentrating on the financials, I’d like to talk about where we are in our product lines and what we think may occur over the next several quarters. The NanoChem division represents most of the revenue of FSI. This division makes polyaspartic acid, called TPA for short, 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 and other ions in the soil. When embryonic crystals are prevented from transforming into fully crystalline form by TPA, the fertilizer remains available to plants further into the growing season. The firm, but light attraction between the TPA and fertilizer ions also reduces fertilizer runoff. Keeping fertilizer easily available to crops results in better yield with the same level of fertilization. In North America alone, the wholesale market is estimated at over $2 billion a year and most crops are able to use TPA very profitably. TPA in agriculture has a unique economic situation for all links in the sales to end user chain. FSI earns a fair profit on manufacturing. Distribution earns a strong profit selling to dealers. Dealers make good profits selling to growers and yet the grower still earns a great profit from the extra crops he produces with the same land and the same fertilizer program. More than 350 trials over the last 15 years have demonstrated that investing $10 to $15 per acre in TPA can pay back $30 to $100 or more. We believe this is an excellent basis for long-term growth in sales as more growers become aware of this improvement to best practices. TPA is also a biodegradable way of treating oil-filled water to prevent pipes from plugging with mineral scale. Our sales into this market are well established and growing steadily, but can be subject to temporary reductions when production is cut back or when platforms are shut down for reconditioning. The simple explanation of TPA is the fact is that it prevents the scaling out of minerals that are part of the water fraction of oil as it exits the rock formation. The scale must be prevented to keep the pipes from clogging. Used as a biodegradable additive in fracking fluid, TPA has the same effect on the pipes, but is also known to reduce scale plugging of rock force thus increasing the flow of oil and gas to the pipes from the rock. Many alternative chemicals are used to prevent floor plugging, TPA is the biodegradable choice. SUN 27, this product is ready for full scale production and we are actively pursuing orders. It’s a fertilizer additive that reduces the speed of nitrogen fertilizer degradation in soil. Most soils contain the protein urease, which is an enzyme that degrades nitrogen fertilizer. Up to half the nitrogen applied to a field can be lost to urease activity. This is a significant cost to the grower and has negative environmental side effects. Sales of SUN 27 began in first quarter 2014 and are expected to accelerate in late 2014 or early 2015 as growers and distributors make their nitrogen conservation plans for the 2015 season. The size of the potential market for urease in addition is very large given the nitrogen in various formats that can be protected by SUN 27 is applied to millions of acres of crop land worldwide each year, and that nitrogen lost through urease enzyme activity destroys large amounts of expensive nitrogen fertilizer. SUN 27 is equal to or better than competing products, and pricing is set to be very competitive at both wholesale and retail levels. SUN 27 has a lower freezing point than competing urease inhibitors, resulting in reduced storage problems. We make SUN 27 here in the United States and it’s sold by the NanoChem subsidiary. We have multi-truck load volumes available. DCD as a result of our inventive work to develop SUN 27 we became expert enough in nitrogen conservation chemistry to formulate a solution to the second major cause of nitrogen fertilizer loss, denitrification. This is also caused by bacterial activity in soil. Warm wet soils are the most prone resulting in oxygen being stripped from the fertilizer to leave nitrogen gas. The gas can’t be used by the plants and escapes to the atmosphere. The gold standard for reducing denitrification is the DCD solution. And we have developed an excellent version. We have organized multi-truck load capacity and are actively seeking orders for Q1 2015. At this time we will be manufacturing for the distribution under trade names owned by the distributors and have not yet chosen a trademark for our DCD product. WatrSavr is included in the main part of my speech for the first time in several years. We are continuing our efforts in the USA, Turkey, Morocco, Chile, parts of East Asia, and in Australia. The successful trial in 2012 on Lake Sahara in Las Vegas has provided concrete evidence that WatrSavr works safely in the U.S. Southwest and saves water at low cost to the water owner. The Lake Sahara project, the AWWA Journal article that resulted from the project and the hard work over the last decade at sites around the world have led to the pilot program which completed this fall in Wichita Falls, Texas. There were no problems encountered during the pilot and we feel comfortable that we have the equipment and skills to protect even larger lakes from evaporative loss. The results of the pilot program are being tabulated and assessed. They will be leased by the Texas authorities when they feel it’s appropriate. Because the unofficial results appear to be positive, possibly 18% water savings on a 5,700 acre reservoir, we are hopeful that a larger contract for 2015 may be available. The pilot was watched with extreme interest by water management groups throughout the U.S. and internationally. We hope that the Wichita Falls pilot will be the tipping point that results in mainstream uses of WatrSavr.

SUN 27, the first nitrogen conservation product for agriculture that we introduced this year is entering a full season of sales which is normally Q4 and Q1. Our second product for nitrogen conservation DCD is also a Q4 and Q1 purchase decision. The drop in crop prices in the last year has not changed the business pace for using our agriculture products, but it has reduced early purchase decisions. We don’t know if this will effect our Q4 sales. Growth in oil field use of TPA is likely but with the caveat that the recent fall in oil prices may cause customers to schedule maintenance shutdowns that cause temporarily reduced uptake. WatrSavr does not expect sales in Q4 because of the Northern Hemisphere winter. It’s possible that small orders may occur in Q1 for use in the summer of 2015, but our expectation is that the significant sales if they occur will be in Q2 and Q3 ‘15. We are not able to provide specific growth predictions, because even with loyal growing customers and new sales opportunities in multiple markets, our sales are purchase order by purchase order rather than long-term uptake contracts. It’s unrealistic to give numerical guidance under these conditions. We are comfortable predicting that full year 2015 revenue will be higher than 2014. In Q4 2014, we may see faster growth year-over-year due to preordering of agricultural TPA and SUN 27 for the 2015 season. Throughout 2015, we expect additional growth in revenue with the usual lumpy quarterly numbers, because of customer behavior, weather, crop pricing, oil platform maintenance and the other variables of our business. Highlights of the financial results. Sales for the quarter increased 29% to $3.85 million compared to $2.98 million for Q3 2013. The result is a gain of $177,000 or $0.01 a share in the ‘14 period compared to a loss of $682,000 or $0.05 a share in 2013. Our working capital is very adequate. The company’s growth is supported by its line of credit with a Chicago-based bank. FSI also provides a non-GAAP measure useful for judging year-over-year success. Operating cash flow has arrived at by removing depreciation option expenses and one-time items from the statement of operations. For the nine months ending September 2014, operating cash flow was $1.024 million and that’s $0.08 a share compared to $590,000 and $0.04 a share in the same period 2013. Detailed information on how to reconcile GAAP with non-GAAP numbers is included in our news release from Friday, November 15. Our other product line, swimming pool products, is being emphasized less than the NanoChem and WatrSavr divisions. While maintaining the long-term opportunities and limiting the cash and management costs, swimming pool products have been impacted by competition this past year and we have formulated responses, which will not show success or failure until summer of 2015. The text of this speech will be available on our website by Tuesday, November 18. E-mail and fax copies can be requested from Jason Bloom at 1-800-661-3560, his e-mail jason@flexiblesolutions.com. Thank you. The floor is open for questions. And Tim, will you please give the instructions? Thank you.

[Operator Instructions] We will take our first question from Greg Hillman with First Wilshire Securities Management.

Yes, good morning. Could you talk about the awareness of your products in the nitrogen area, how many farmers – what percentage of the farmers in the United States have heard of it and what kind of missionary effort you need to introduce it in terms of the sales cycle, I mean, can the channels educate people to the product or what was your thoughts on that? Dan O’Brien: Hi, good morning Greg.

Hi. Dan O’Brien: I wouldn’t know the percentage of farmers that would be using nitrogen conservation products, but these products are well established in the marketplace and the difficulty is not in a missionary work direct to the growers. It is more an issue of will your product be chosen by distribution as the one or a slate of one several that they present to their growers who are interested in nitrogen conservation. There are several other companies in this field. Our business plan is to be the best quality product at the lowest price. And we are continuing to follow through on that business plan which means that our – most of our efforts go to educating the distribution that we already have for our other products that we have a nitrogen – actually two nitrogen conservation products that are available as well.

Okay. Are they sold in internet communities together and they are two separate products with two different application notes? Dan O’Brien: Two separate products. The reason for that is because the SUN 27 product will find much more use in dry land, dry farm soils because that’s where the urease enzyme gets its best crack at destroying the nitrogen before the plants can get it. In warm and wet soils the DCD product is more effective and of course no farmer is likely to have both warm and wet soils and cold and dry soils at the same time unless he is operating in multiple different geographical areas in which case he will buy both products and use them separately.

Okay. And do you have distributors lined up by right now that created material increases in sales for these nitrogen products? Dan O’Brien: I won’t say lined up, I will say that we have pitched to several large distributors who if they choose our products it will have a material effect.

Okay. And you are not going directly to markets to the farmers you are going through the channels? Dan O’Brien: We are going through channels. See the direct to farm market is an expensive proposition we don’t believe we have the employee base or the cash to do it that way at this time.

Okay. Thanks. I will get back in the queue. Dan O’Brien: Thank you, Greg.

[Operator Instructions] It appears there are no other questions at this time. And I am sorry we do have a follow-up from Greg Hillman [First Wilshire Securities Management].

Yes. In the – so the WatrSavr area, for the rest of waters do you have – how many tons is it applied during the year to have the effect, this would have to be 5 multiple times or how good is one application, how much time is when that – how good is one application or in terms of the benefits of it? Dan O’Brien: Okay. WatrSavr has to be applied at least once every three days and we often recommend applying a third of a dose everyday because it’s more efficient for employee scheduling and it also means that if a huge wind comes up or it rains heavily you have only lost a third of a dose rather than a whole dose which is three days worth. We highly recommend to our customer base that first they treat the three to four months of highest evaporation losses in any given year which of course in the Southwest is May, June, July and August. If they have cash available, we then recommend that they would treat the two shoulder months April and September. And some places who are in extreme water problems might choose to go to 8 or even 10 months a year. The daily treatment is required because this is a fully biodegradable product. It is broken down by ultraviolet light from sunshine and if you don’t reapply it, it’s gone in three to four days. Now this is both a curse and a blessing if you don’t like the product it’s gone in four days, if you like the product you have to reapply within three days.

Okay. And then the cost, do you withstand our cost or can you just make our associated price with the community for what the cost is? Dan O’Brien: We have a standard price in North America of $2.50 a pound and that normally will result in the water that is safe having a cost in the range of $100 to $130 an acre foot. Now, that is more than farmers pay in California, but it’s a order of magnitude less than municipal people pay in the same state. So, definitely, there is a marketplace and there is a huge opportunity for water to be saved and then sold to the highest priced user.

So that would be like the wildcard for the company, the WatrSavr business for the state? Dan O’Brien: This is a wildcard. It won’t take much more sales before that division breaks even, but it will take – there is a huge market opportunity if we can find a way to use both political and bureaucratic pressures to cause people to save water rather than trying to find new sources all the time.

And then in terms of the regulatory front affecting your company, is there any regulatory actions in light that are pending that would affect any of the divisions of your company, in particular, fracking with your comments on having say for fracking fluids? Is there any pending regulations that could affect oil division of your company or other divisions for that matter? Dan O’Brien: At this time, we are not aware of anything that would affect us either positively or negatively. There seems to be a more observation going on between governments and oil companies to do what they can to reduce their environmental footprint. That is an area where over time we expect more companies to incorporate TPA in their fracking fluids, but the oil industry takes enough risk with drilling that they often are very conservative in the aftermarket and we are not going to point to this as something that is going to be a huge jump forward in our sales. We expect it more to be a slow, steady growth that’s amassed quite a bit over time.

Okay. And just your cost of the aspartic acid for China, how has that changed or how has that cost change over the last 3 years or what’s the trend of that right now? What’s your reporting? Dan O’Brien: The trend is not a trend. Sorry, to be suspicious there, but the moving pieces are oil prices, shipping costs, Chinese labor and the Chinese U.S. currency exchange rates. And what we are noticing is that although there is a slight trend upwards, it gets moved around dramatically by all the variables and it is not something that is causing us any trouble at this point in time.

Okay, that’s great. And as the headcount of your company increased, are you adding more people in Illinois? Dan O’Brien: We have added sales over the last year and a half in the Denver, Colorado area. We have added small amounts of employees in the factory as our tonnage has grown. The decrease in cost has come from mothballing the Taber factory and that has reduced our headcount in total.

Okay, in the last quarter. Were there any abnormal expenses in the quarter you just reported? Dan O’Brien: Nothing.

Okay, good. Thanks. Dan O’Brien: Thank you, Greg.

And we will take our next question from Gary Schwab with Valley Forge Capital Management.

Yes, hi, Dan. Dan O’Brien: Hi, Gary.

Question for you on the WatrSavr product, now that we are starting to look at that again, prior to the Arrowhead Lake Texas reservoir, were you getting any calls on WatrSavr and how has that changed after that test for quotes, the interest quotes? Dan O’Brien: Yes, okay. First, a correction here that was not a test at Lake Arrowhead that was a pilot program, it really was intended to and did save significant amounts of water for the City of Wichita Falls. Our success in getting the Wichita Falls contract was driven by the success in Las Vegas at Lake Sahara. Our sales team in the WatrSavr division, which includes me by the way. We have received dozens if not scores of enquiries on a quarterly basis and they have been increasing steadily since the first of the Lake Sahara since that information was first available in 2012 Wichita Falls has increased it even further. And I think it has had the beneficial effect of showing people that it’s not just for little acreages, this is something that can be done on any sized body of water in the world that you want to conserve. And I think that’s really what we have got from Wichita Falls is the final key to anyone who is looking at this logically. If you are looking at this logically Wichita Falls proves that there isn’t a problem as it scales up and that’s been the huge value.

So when you get a call for quote can you quote them or you have to go out send somebody out to the reservoir to look at the physical geography layout of the reservoir to figure out what an application would be, in other words or can you just give them a quote if they would tell you so many acres you give them a quote? Dan O’Brien: Actually, we even check what they say about their acres Google is a wonderful toy. We can go there. We can look at the most recent shot of their reservoir. We can calculate the acreage ourselves from that. And if it’s changed radically or it differs from their suggestion we will get back to them say well look are you sure about that. We then can tell them how much per month of product they would use and we can give them a rough estimate of what we think the spreading costs might be if they wish to contract the spreading, we can also introduce them to a company who will give them a firm quote on spreading application and that will be true for North America. Overseas we are less likely to want to make a firm quote for spreading costs, but we are happy to make a firm quote for the products used and offer training for the – for implementation of a spreading program.

So you will be offering training if they don’t contract out a spreader company from you? Dan O’Brien: That’s correct. We have discovered that many people who say they understand powder distribution or our speaking of powders that are different from WatrSavr, different enough that we find that we have to at least sell them some of our specialized equipment to get them going, because the standard systems of just dumping it in a hopper and hoping that it will come out the far end of whatever system you have got is not realistic.

So, are you manufacturing the equipment or is somebody making that for you, how expensive is that, is it least or is it bought by the…? Dan O’Brien: We are doing a mixture of everything. We have some things we will contract the parts of and assemble for resale. We have a contractor who will put together entire boat mounted spreading systems. We are looking at and we will have completed by the end of the winter a full turnkey boat solution that can be leased or bought through us but not from us.

And as far as gearing up for waters that you don’t hope, if you are going to get because you are getting, you said you are getting a lot of interest but you don’t know all of a sudden people start placing orders, it’s very short season and if waters did start coming in, it’s tough to decide whether you make the product in advance and then you don’t get the orders or you wait for the orders to make the product and then the season is over before you can deliver it, how are you handling all of that? Dan O’Brien: Well, we have tried to make the order and hold it attitude and we aren’t satisfied with the amount of inventory that puts in our system. There are routes to having the components of the product that have a long fuse that takes several weeks to arrive. We can have those components in stock and at a much, much lower inventory cost and under the circumstance of orders coming in quicker than expected, we have our total manufacturer prepared and ready to do his best to get the most product out the door by when the order comes in, we have got the hard to source raw materials in stock with the toll manufacturer at our cost and the easy to access products will be ordered overnight and arrive in the short order. As long as our toll manufacturer has capacity, we should define under those circumstances. We have a maximum of 50 tons a week with a single toll manufacturer and we have access to others. So, I think we are fine, but you are right, Gary, there is a little bit of a gamble there. We will have to deal with it each season based on the previous season.

What is the season? What is the application season? Is it July and August, is it August and September, is it July, August, September, well, what do you think…. Dan O’Brien: Well, it’s variable. If you are in the Austin, Texas, it might be April, May, June, July, August, September and possibly even October, because we were still obtaining good results in Wichita Falls in October. It’s going to be dependent on how much your budget is and if your budget is small, you will pick June and July. If your budget is slightly larger, you will pick May, June, July and August. And if your budget is unlimited, you will go 8 to 10 months a year.

So, if we are just talking about summer season, which is the peak, when does this stuff have to be ordered? What are you telling your respective clients you must give us an order by such….. Dan O’Brien: Well, we have been – it will be so wonderful if we could tell them anything. We ask that they make their order as soon as possible and we say that if you don’t make an early order, we can’t guarantee delivery, we will only guarantee a delivery date once we have received the purchase order. So, that is the weakness, but it’s also the way that a small company has to operate and in fact a big company needs to operate that way too, because you can’t allow what ifs and hopeful….

Yes, of course not. Dan O’Brien: Yes.

I used to be in the retail business and when you are ordering for Christmas sometimes, you had to say I am giving you a commitment in advance so that you have product for me, something like that, can you do anything like that? I mean, what you talked right now, you don’t have that problem, but…. Dan O’Brien: We have all the tools in our quiver to deal with that problem when it occurs and we don’t know when it will occur, if it will occur and what magnitude will be involved. If it’s a 100 ton order, we can always slip it in. If it’s a 1,000 ton order, which is by the way in the range of $4 million, we will still trying to find a way. And if the customer is simply can’t be serviced, what we will do is find a way to service their highest evaporation months so that in the following year, their satisfied customers who will make an early purchase order to be sure of getting the shoulder months as well. Obviously, Gary, we are just going to do what it takes to get as much revenue as we can.

Great, okay. And so just rule of thumb, you are like pound an acre every other day? Dan O’Brien: Every 3 days, so one-third of one pound per day.

Very good. Alright, Dan thanks a lot. Dan O’Brien: Thanks, Gary.

And we will take our next question from Greg Hillman with First Wilshire Securities Management.

Yes. Dan, just to follow-up, I think I heard that you had EPA approval for WatrSavr. Did they actually test it for its safety or what was involved in getting out approval and/or do any other products like WatrSavr like products have that approval? Dan O’Brien: Well, I am okay. First, I have got to correct something. WatrSavr itself is not controlled by EPA. WatrSavr is controlled by NSF, the National Sanitation Foundation under Schedule 60. And yes, we have full approval for drinking water from NSF. EPA regulated our combination of WatrSavr and the BTI pesticide for mosquito control. When you are working in the pesticide field, EPA is the controlling group. We received approval for WatrSavr combined with BTI and attempted to sell that product for 1 to 2 years. We were not successful in getting the product into the sales program and it has been discontinued. As a result, the EPA approval of WatrSavr with BTI is discontinued, but we – our sales force still lets people know that we have successfully navigated the EPA route when necessary and could do so again. So that’s a slight misunderstanding. We do not currently have EPA approval and we do not need it.

Okay, the approval of the National Sanitation Foundation? Dan O’Brien: National Sanitation Foundation and they are the group that is required to oversee drinking water chemicals.

Okay, got it. Thanks. Dan O’Brien: Thank you.

And at this time, there are no other questions in queue. Dan O’Brien - Chief Executive Officer: Thank you very much for joining us. Interesting questions today. I appreciate your time everyone and I look forward to speaking with you at the next conference call. Tim, can you close this down? Thank you.

And that concludes today’s conference call. We appreciate your participation.