Flexible Solutions International, Inc. (FSI) Q2 2022 Earnings Report, Transcript and Summary

Good day, everyone and welcome to today’s Flexible Solutions International Second Quarter 2022 Financial Results Conference Call. Please note, this call is being recorded. And now it is my pleasure to turn the conference over to Mr. Dan O’Brien. Please go ahead, sir. Daniel O’Brien: Thank you, Jess. 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 Q2 conference call. I'd like to update our company condition and our product lines, along with what, in our opinion, might occur in the third and fourth quarters of 2022. Then I'll comment on our financials. For the COVID virus, we are not experiencing problems due to the virus other than mild cases in our employee ranks and shipping delays when Asian ports experienced lockdowns. Our NanoChem division, NCS, represents more than half the revenue of FSI. This division makes thermal polyaspartic acid called TPA for short, a biodegradable polymer with many valuable uses. NCS also manufactures SUN 27 and N Savr 30 which are used to reduce nitrogen fertilizer loss from soil. In 2022, NCS started toll operations using the spray dryer we installed over the last several years. TPA, it's used in agriculture to significantly increase crop yield. It acts by slowing crystal growth between fertilizer ions and other ions in the soil, resulting in the fertilizer remaining available longer for the plant to use. TPA is a biodegradable way of treating oilfield water, prevent pipes from plugging with mineral scale. TPA's attack is that it prevents the scaling out of minerals that are part of the water fraction of oil as it exits the rock formation. Scale must be prevented to keep the oil recovery pipes from clogging. TPA is sold as a biodegradable ingredient in cleaning products and also as a water treatment chemical. SUN 27 and N Savr 30 are nitrogen conservation products. Nitrogen is a critical fertilizer that can be lost through bacterial breakdown, evaporation and soil runoff. SUN 27 is used to conserve nitrogen from attack by soil bacterial enzymes that cause into evaporation while N Savr 30 is effective at reducing nitrogen loss through leaching. Our ENP division; ENP represents most of our other revenue. ENP is focused on sales into the greenhouse, turf and golf markets compared to our NCS sales which are into row crop agriculture. The opening of the economy after the pandemic has affected ENP sales into the home gardening market, especially home cannabis in a negative manner. We now expect 2022 sales to be similar to 2021. Programs we have put in place to reinvigorate growth at ENP will take until the end of the year to take effect. The Florida, LLC investment. Once again, this investment was profitable. The company is focused on international sales into multiple countries, all of which face different issues and respond in varied ways. Sales have been very strong in Q1 and Q2 this year and we see this continually in the second half. However, the LLC is exposed to high cost of goods while experiencing difficulty passing all the costs onward to customers. As a result, margins are compressed and earnings may not reach historical levels until raw material prices abate. Strategic investment in Lygos; in December 2020, FSI invested $500,000 in Lygos in return for equity. We made a second investment of $500,000 in June 2021. Lygos is using the investment to develop a microbial route to aspartic acid using sugar as a feedstock. FSI will be the major user of aspartic acid derived this way and believes that sustainable aspartic acid will allow us to obtain large new customers and develop valuable new products. Lygos' scientific team have already successfully developed other organic assets from sustainable feedstock and are recognized as one of the world leaders in synthetic biology by their peers in industry and academia. We have high confidence in their ability to achieve sustainable aspartic acid through a fermentation. Once this route is fully developed, we plan to work with Lygos to build capacity and produce aspartic acid which we can then polymerize into sustainable polyaspartates. The merger with Lygos. On April 18, FSI and Lygos announced their intent to merge, subject to shareholder approval. Details of this plan are included in the news release from that date. The companies have filed an even more detailed document with the Securities Commission called an S-4. This document is publicly available at www.sec.gov. If you have questions regarding the merger, please consult the S-4. Q3 and Q4; TPA, SUN 27 and N Savr 30 for agricultural use have peak uptake in Q1 and Q2. This year was somewhat different due to high crop prices and fertilizer prices. We saw increased interest in our products and stronger ordering. Maintaining inventory to service customers remains key to maximizing sales. And as one would expect, shipping days -- delays are not helping. To date, our preordering of inventory made sure that no sales have been lost. If historical behaviors recur in second half 2022, we would expect slightly lower revenue compared to the first half but continued increases compared to year-earlier periods. Oil, gas and industrial sales of TPA experienced increased sales through late 20 -- Q4 '21 and into Q1 and Q2 2022. This was driven by shortfalls of competing products and high oil prices. It continued throughout Q2 and is evident in Q3 so far. We don't consider this a permanent effect. Tariffs; on September 30, 2018, several of our raw materials imported from China have included a 10% additional tariff which rose to 25% in 2019. International customers are not charged with tariffs because we've applied for the export rebates available to cover the tariffs. The accumulating tariff payments to the government are affecting our cost of goods, our cash flow and our profits negatively till the rebates are received. Rebates can take many years to arrive. We submitted our initial applications more than 3.5 years ago. Total dollar due -- amount due back now exceeds $7 million and it's continuing to increase. The rebates will increase profitability and cash flow while decreasing cost of goods for future quarters in which rebates are received. We learned 9.5 months ago that our application had been sent to a government lab so that our formula-based calculations could be verified. We were promised a 30-day response period about 90 days ago. Shipping in inventory; ocean shipping from Asia to the U.S. and ocean shipments from the U.S. to international ports are slightly quicker than Q1 but still very slow. Prices per container remain more than triple than normal. Land transport inside the United States is also taking much longer than usual and pricing is extremely high. We're doing our best to cope with shipping issues by ordering far ahead but we have warned that some disruption will be unavoidable. Some of the extra costs will have to be borne by us in order to retain customers. Raw material prices have also increased substantially over the last 12 months. Passing price increases along to customers can take several months and result in temporarily constrained margins. Just as we finished raising customer prices related to raw materials increases from Q4 '21 and Q1 '22, new increases were imposed on us. And we're working with our customers on pricing again. We still expect revenue, operating cash flow profit to grow as fast or faster than it did in 2021. But inflationary forces may keep us in a position where selling prices lag cost increases most of the time. Highlights of the financial results; we're very pleased with the results for Q2. Year-over-year revenue and operating cash flow were all up significantly. Net profit also exceeded the comparable 2021 and it was a quarterly record. During Q2, we also incurred about $350,000 in merger activity costs due to professional fees. If these costs were not present, our Q2 profits would have been approximately $0.02 per share higher. Merger costs are expected to be much lower in Q3. We estimate that year-over-year growth in revenue, cash flow and profits will continue in Q3 and Q4. Sales for the quarter increased 31% to $11.17 million compared with $8.54 million for Q2 '21. Profits; the result -- the profit of $1.66 million or $0.13 per share in 2022, up from a gain of $1.18 million or $0.10 a share in the 2021 period. Operating cash flow is a non-GAAP number but it's useful to show our progress with noncash items removed for clarity. For Q1 and Q2, it was $4.56 million or $0.37 per share, up from $3.29 million or $0.27 a share in Q1, Q2 combined 2021 period. Long-term debt; we continue to pay down our long-term debt according to the terms of the loans. However, we have consolidated all our debt for ENP and NCS with Stock Yards Bank. This has resulted in increased lines of credit with lower interest rates and reduced interest rates on our term debt. At the same time, we bought all the units we did not already own in ENP Peru Investments, LLC and guaranteed the mortgage held by the LLC. This LLC owns the 5 acres and 60,000 square foot building on the southwest corner of our Peru, Illinois factory. The action returns full ownership of the 20-acre parcel to FSI and the mortgages at favorable terms. Funds to pay the mortgage are obtained by charging NCS and ENP rent on the building. Working capital; it is adequate for all our purposes and is increasing continuously as we book retained profit from sales. We have lines of credit with Stock Yards Bank for the ENP and NCS subsidiaries. We're confident that we can execute our plans with our existing capital. The equity investment in Lygos was made on cash on hand through FSL, our Canadian operating company. Text of this speech will be available as an 8-K filing on www.sec.gov by Wednesday, August 17. E-mail or fax copies can be requested from Jason Bloom, jason@flexiblesolutions.com. Thank you. The floor is open for questions. And Jess, would you prepare everybody for that. Thanks.

Our first question comes from William Gregozeski at Greenridge Global.

Dan, great quarter. In regards to the Florida, LLC, what percent -- I know you don’t like giving too many specifics on this but I was under the impression most of their product was purchased from FSI. And you mentioned that they were having trouble with their higher cost of goods. So I’m trying to reconcile what that issue might be for them, if they’re just having a hard time passing their price increases on that they’re getting from you guys or if it’s something else? Daniel O’Brien: Actually, you hit the nail on the head. We manufacture for them under contract. And our contract allows us to raise prices as our input costs go up. They are having trouble passing that along to their customers. And I mean, they have raised prices as far as they can but there are -- there is stress in their selling and we are working with them to the best of our abilities inside the contract but I'd be giving money to .

Okay. So at least for the near future, I mean, the low 20 gross margin range is probably going to be continued for them on their results? Daniel O’Brien: Yes. I would say that's probably correct. That's absent another bout of amazing inflation. If inflation in raw material cost stops or backs off, they'll be able to increase their margins again. But at the moment, earned margin is probably what you'll see.

Okay. And there's been all kinds of news about the droughts in the Western U.S. Is there any interest in using WaterSavr to help with that problem? And obviously, it would be a fix for it. But is anybody pursuing that? Daniel O’Brien: We have a part-time salesman handling all of the inquiries. But Bill, this is the crazy situation here. We've been pitching WaterSavr to Western America for 20 years and prove that it works. 20 years ago, there was 100 feet more water in those dams. And that's when they should have started using it because this WaterSavr does not generate water, it only saves it. And there's not a lot of water left to save. So, I guess I’ve got a case of schadenfreude but it’s really not the answer to their problems now. The answer to their problem is to get their reservoirs full again.

We'll move next to Tim Clarkson with Van Clemens Capital.

Dan, just wanted to know when do you think this -- is it Lygos investment, when do you think that will be completed? Daniel O’Brien: Yes. On the merger agreement, this is an agreement that has its contracts. The contract states that the merger must be complete by September 30. If it is not complete by September 30, it has to be either extended or it goes away. So I guess what I'm saying is that expect it to be completed by September 30 or not to be completed.

Okay. And in terms of now the -- what was the kind of the logic of doing this deal again? Is it -- go ahead. Daniel O’Brien: Yes. No, it's a good question because although it hasn't been well received by the market, the logic is pretty solid. The opportunities in a combined company that can start with corn sugar grown in the United States, ferment that into aspartic acid at a price lower than the current oil price of aspartic acid and then utilize it to make quite a variety of polyaspartate and other chemistries at the Flexible Solutions factories results in a value-added specialty chemical platform that is specifically attractive to the detergent companies to start with, who are trying to become 100% sustainable. And these groups of the detergent companies -- really can't name names but they're all the big ones, they are trying to go completely sustainable. And the need is for hundreds of thousands of metric tons of finished products from a company just like the Flexible Solutions-Lygos combination. Now obviously, it's a big project to -- getting to hundreds of thousands of tons from 5s of thousands of tons but that's the logic behind this is to not make a generic chemical like aspartic acid but to make a specialty chemical from aspartic acid and to control the entire roof from sugar all the way to the specialty chemicals. So that was -- that's the theory behind it and it's a good business plan.

Right. Now what -- I mean, is this reasonable that this would all turn profitable in 2 years or 5 years? Or maybe you don’t even know. Daniel O’Brien: Well, this is a point where I have to say to you, please read the S-4 because there are forward-looking statements in the S-4. It's -- sadly, it's a 500-page document which I have not memorized yet. But yes, there are forward-looking statements. There's a point where profitability is expected. I'm pretty sure it's inside 5 years but please, I can't be quoted on that.

Sure. And just looking at -- again, I’m a big picture guy. What’s the biggest risk? I mean, it doesn’t sound like the risk is whether there’s demand for the product. It sounds like the risk is whether you can create -- do it on a bigger scale, right? Daniel O’Brien: Yes, it's an execution risk.

Okay. Okay. And obviously, you must believe that based on some of the execution successes on a smaller scale that already demonstrate at least a reasonable probability that they’re going to be able to do it, right? Daniel O’Brien: Yes.

Otherwise, it’d be kind of a foolish venture. So -- right? I mean, that’s kind of the obvious but obviously has to be stated out loud.. Daniel O’Brien: Yes, you're right. It's -- we believe it's a reasonable opportunity and...

And Flexible Solutions, the fact that Flexible Solutions just coming into this is because you already give these guys a good-sized market and can help facilitate them getting up to the scale. Is that the piece that Flexible Solutions brings to it? Daniel O’Brien: Yes, that's the piece we bring is a route to market at a much higher price. If they just make -- if Lygos went ahead on their own and made aspartic acid, they would get 1 price per ton because it would be more or less a commodity organic asset. By owning Flexible Solutions and having the route to the specialty chemical sector that Flexible Solutions services, the selling price per ton more than doubles and the margin increases dramatically as well.

Right. And you’ve done some -- raised enough, what these bond raises and stuff that at least for the reasonable foreseeable future, you’ve got enough money to try to make this happen. Daniel O’Brien: That would be accurate. That's -- it might not be as much as some of the synthetic chemistry companies have raised or synthetic biochem. But the fact that the Flexible Solutions plant already exists ready to do the second half of the processing is a pretty significant benefit compared to what other companies in the sector face.

Right. Right now just leaving off the detergent application, I mean, is there a sizable market just for the proven fertilizer application if the product was more available? Daniel O’Brien: Yes. There's also markets that we've never addressed but one of them is actually the international market for aspartame. Aspartame, you may have personal feelings about it. But if it were made from sustainable chemicals, it would at least be somewhat safer than making it from oil-based chemicals.

Yes. I’m sure that would appeal to a lot of people of all kinds of beliefs about nutritional items that may or may not be based on science but sounds -- which is a big part of that game. So anyhow, well, I appreciate it. I mean, I’m very hopeful that this is going to -- off and I’m watching it and got still some money in it and really admire what you're doing. So keep at it.

Our next question comes from .

Congratulations on a beautiful quarter. My question is pretty simple. I spent a number of hours, like you said, going through that S-4 which was very, very lengthy. One question I couldn't get answered is, how close are they to commercialization? Daniel O’Brien: Yes. And it's probably not a question I should answer.

Well, it’s a pretty important question quite honestly. Daniel O’Brien: Yes. I can have an opinion that they are...

That’s close enough for me. I would like your opinion, yes. Daniel O’Brien: I think my opinion is -- yes -- my opinion is that it's the full commercialization is within 5 years and how much earlier than that, I'm not certain.

Okay. Yes, because I mean, we’re taking a beautiful company like FSI which is growing, profitable and we turn them into an R&D company where with even $160 million, like you just stated your sector peers, biochem tried to do a synthetic stuff. One company I follow, they spent over $1 billion and still not profitable. So $160 million sounds like a lot of money but when you start getting into this, it might not be enough money. Daniel O’Brien: Might not but here's a theory that I have in this world. Going back to the very beginning of Flexible Solutions, my father and I funded the original private company with $500. And the point was there is no more money coming, make it work. Sometimes bootstrapping and being forced to work inside a tight budget is better for a company than having unlimited funds. I don't know.

I see the -- I’d certainly see the benefit in that. Absolutely. And the potential -- discounting the benefit -- the potential -- the potential is ginormous. I don’t think anybody questions that. The question is, are we going to become a disaster because it’s going to take 7 years or 8 years and we’ve got to raise another couple of hundred million. And all along, we’re going to become a money-losing R&D company. Daniel O’Brien: Well, Dennis, unfortunately, that's stuff I really can't comment on because it would be forward stuff that I actually don't know the answers to. And I really don't want to put us in legal jeopardy along with financials.

No, no. I wouldn’t want you to do that as well. Listen, again, a beautiful quarter. We have still a lot of reservations going forward. But again, I appreciate you taking the time. Daniel O’Brien: You're welcome, Dennis and not over till the shareholder meeting. So we'll keep working and we'll keep showing you why it's a good idea.

Mr. O’Brien, at this time, I do not have any other questions holding. I will turn the conference back to you for any additional or closing comments. Daniel O’Brien: Thank you, Jess. Everybody, thanks very much for listening in today and for your questions. Hopefully, we’ll be talking again at the end of third quarter and thank you very much.

Ladies and gentlemen, that will conclude today's program. We thank you for your participation. You may disconnect at this time.