Flexible Solutions International Inc (FSI) 2011 Q2 法說會逐字稿

Ladies and gentlemen, welcome to the second-quarter financial conference call on Tuesday, 16th of August, 2011. Throughout today's presentation all participants will be in a listen-only mode. After the presentation, there will be an opportunity to ask questions. (Operator instructions).

I will now hand the conference over to your host, Dan O'Brien. Please go ahead, sir.

Thank you, Kristin. Good morning. This is Dan O'Brien, CEO of Flexible Solutions. The 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 with the Securities and Exchange Commission.

Welcome to the second-quarter conference call. Before going over the financials, I would like to speak about where we are in our major projects and what we are expecting for the next few quarters.

(technical difficulty) record revenue was booked in the second quarter, and it was based on increased volume of product. Our sugar to aspartic acid plant in Alberta received its steam permit a few weeks ago and is in the stage of high-volume testing before production can begin. Production from the Alberta plants will allow (technical difficulty) by the only renewably based polyaspartic acid in the world. This will allow access to customers who demand this level of environmentally sound material as well as insulating the Company from future oil price shocks.

One of the primary potential customers for this grade of material is the dish and laundry detergent market. The market opportunity for our product in detergents is estimated as greater than $350 million per year. FSI considers the start of commercial production at the Alberta plant a material event, and we will provide a news release when the event occurs.

The NanoChem division now represents more than 90% of revenue and has become the main sales and profit driver for our Company for the next few years. This division makes polyaspartic acid, TPA, a biodegradable protein with many valuable uses. Along with the detergents mentioned above, TPA is used in agriculture to increase crop yield. In North America alone, the wholesale market is over $2 billion a year, potentially and most crops are able to use TPA profitably. Sales into agriculture were strong in 2010, and that strength carried forward into Q1 2011 and now to Q2.

Our internal sales team has identified additional distributors who may be able to accelerate this success in new regions, so we hope to be able to report more expansion of our distribution network in the rest of 2011 and increase sales from both established and new distribution in 2012.

The way TPA works in agriculture is by slowing the inevitable crystallization of fertilizer ions with oppositely charged ions naturally present in soil. This results in fertilizer remaining bioavailable for plant growth through more of the season, and yield is increased. It's important to realize (technical difficulty) quantity of fertilizer. A grower can actually make each acre of his land more efficient and more profitable by including TPA as well as the recommended fertilizer load for his particular soil.

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 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.

Q3, Q4 and early 2012 -- we are optimistic. Swimming pool sales continue to increase compared to 2010, which, in turn, was up from the depths of 2009, and inventories are low in that industry. Macroeconomic trends in crop prices remain positive, which increases interest in TPA for agriculture. More quarters of rapid growth in agriculture sales are quite likely.

The oil sector is providing us with new chances to grow. And of course, when we get the Alberta plant to commercial status, significant detergent contracts become possible. In revenue numbers, we estimate that in 2011 we will exceed all comparable quarters by 15% or more. Since we have already had 29% and 39% increases in Q1 and Q2, respectively, meeting our predicted 15% increases in the second half of 2011 will result in very strong revenue growth for the full year.

Minor GAAP losses are possible in Q3 and Q4, since these are our smaller revenue quarters. However, we expect of Q3 and Q4 to be cash flow positive, leading to a very strong full-year operating cash flow and full-year GAAP profitability. Our only caution is that high oil prices are increasing aspartic acid prices. This increases our cost of goods and affects margins until the production at the Alberta plant can relieve the pressure.

However, in Q1 2012 we revolve into our stronger half-year and expect the Alberta plant to be in operation. With these potential conditions in place we have a very positive outlook for Q1 2012 and beyond.

Here are the highlights of the financial results. Sales for the quarter increased 39% to $3.93 million compared to $2.83 million in 2010. The result is a profit of $175,000 or $0.01 a share in the '11 period compared to a profit of $134,000, also $0.01 a share in '010. It must be stated that increased cost of raw material coupled with strong resistance to price increases in the oil service industry has reduced our margins in '11 compared to the same quarter of '10. We are proud of the record revenue achieved again this quarter, and revenue is expected to increase for the rest of the year, as I have mentioned earlier, at 15% rates or higher compared to year-earlier numbers. And I will update the forecast at each conference call.

Because of the outsize effects of depreciation, stock option expenses and one-time items on the financials of small companies, FSI also provides a non-GAAP measure that is useful for judging our year-over-year success. Operating cash flow is arrived at by removing depreciation, option expenses and one-time items from the statement of operations. Please note that our definition of one-time items also includes expenses at the Alberta plant until the day it begins commercial production. Once Alberta is producing, it's expenses will be excluded from our non-GAAP calculations and the disparity between GAAP and non-GAAP numbers will decrease as Alberta increases output. The Alberta operations have a significant tax loss to date that will shelter Alberta earnings for several quarters.

In first half 2011, operating cash flow was $1.83 million or $0.14 per share compared to $1.52 million and $0.11 share a in the first half of 2010. We are pleased with these results, but the pressure on margins from raw materials is evident in this metric too. Detailed information on how to reconcile GAAP with non-GAAP numbers is included in our news release of August 15.

We would like to remind investors of two actions from earlier in 2011 that have continued bearing on our financial condition. First, we bought back and canceled nearly 800,000 shares, which significantly reduced our stock outstanding. Second, to recover the working capital position reduced by this cash used for stock repurchase, we negotiated a line of credit for up to $1.5 million at 4%, secured against inventory and receivables at the NanoChem division. The result of these two actions is less dilution per share, of course, and slightly higher total funds available for operations.

Finally to our other product lines -- WaterSavr and swimming pools are being emphasized less than the NanoChem division while maintaining the long-term opportunities and limiting our cash and management costs for those product lines. Swimming pool sales are back to pre-recession levels, and we are planning for the resumption of the growth through this year and into 2012.

WaterSavr sales are much more difficult to predict. We are continuing our efforts in Turkey, Morocco, the Middle East, parts of East Asia, Australia and Spain. Small sales are expected at intervals through the year.

The text of his speech will be available on our website by Thursday, August 18, and e-mailed copies can be requested from Jason Bloom at 1-800-661-3560, and his e-mail is jason@flexiblesolutions.com.

Thank you, the floor is open for questions, and, Kirsten, will you give me instructions, please?

(Operator instructions) John Nobile.

I just was hoping I could -- you could pinpoint an actual date on the Taber plant or give a range for the time when you anticipate commercial production to be started. And how long after you start production there do you think it would take to fully ramp up?

I can't give you an exact date because it depends on testing which is ongoing. And I'm also not going to provide ramp-up data and output data on the plant because we consider that trade secret information, and it will have to remain that way because it is too difficult to compete in this global environment if we are providing people with detailed information on a new plant that doesn't exist anywhere else on earth.

I really am sorry not to be able to be more transparent with investors, but this is going to be our standard procedure once commercial production starts there.

I guess I will have to just wait and see, if and when it does. But I was hoping -- not an exact date, but if you could give a rough estimate as to when you anticipate commercial production starting at Taber. Even if it was within like a few-week range, that would be fine, just to get an idea.

Okay, well then let me say that it's weeks, not months. And I'm very much hoping to be making that news release this quarter.

Okay, fair enough. And actually, on the balance sheet, a couple of financial statement questions I had -- accounts receivable, it was up significantly, I think about 150% since the close of last year. I was just wondering how you felt about the collectability of that. I know that I looked at the allowance for doubtful accounts. It really didn't increase much; I think it was like a 2% or 3% increase. However, we are looking at a 150% increase in accounts receivable. So just to get a feel for the collectability, obviously if you didn't increase it that much I would guess that you feel that most of that would be collected?

We feel that all of it will be collected. And our auditors have worked with us for 10 years now. They have seen our bed debt situation over the years, and they are comfortable and happy to -- with our allowance for receivables.

So what I would just suggest to you is that the increase in sales has increased our receivables. It has also increased our total amount of money we've got in play. As we go into the slower half of the year, I think you will see that our receivables reposition themselves much closer down to our total growth for the year. And as always, we believe that we are dealing with reliable, honorable customers and that our bad debt will stay where it is, close to zero.

All right, because I know -- I looked at the cash from operations, and it was actually a negative for the six months. But the bulk of that really was because of the increase in the accounts receivable. So I would imagine, within a quarter or two, we should see that change somewhat significantly, then?

Yes, and we are working on it. We are making sure that there's no -- there will be no glitches.

Okay, and actually on Q1, I had asked you, and it's probably the same but I just wanted to make sure. The drop in gross margins on the increase in sales -- I think you said really it was 100% related to the price of oil. I just wanted to make sure that this also, this quarter, was really just pinned on oil and not some other factors. I was hoping you could just talk a little bit about that.

There are no other factors, John.

Particularly oil.

It's cost of goods sold, and that's being -- that was majorly affected by the run-up in oil prices.

Okay, and a couple more financial questions -- the professional fees, that was a significant increase in the quarter, because when I looked back quarter over quarter over quarter, it was pretty stable. But this quarter, hold on, I think it was -- you know, it went up significantly to about $174,000. And I'm just curious if this is a level that we can anticipate going forward or if this was something that might have been an anomaly for the quarter.

Professional fees increased. We have mounted a patent infringement suit against Mr. Larry [Cosgan] and the legal fees on that are increasing. We also filed some new patents for new technology in the polyaspartic field that will protect us going out the next 17 or 18 years. The litigation probably will have another few months to run at current levels, but we are expecting to win that case fairly soon. And the patent filings are more expensive than the patent maintenance, but there will be some increase in our professional fees because of these two items, not at these continuing levels, though.

Okay, but some increase compared to like quarter over quarter, if I was to look at Q3 or Q4, but not looking at like $174,000 level. I think you have had maybe $50,000 levels in the past.

Yes. We have not taken off on a new tangent here. We just protect our assets, and when we have something that must be patented, we patent it.

Okay, fair enough. And just final question, financial, the tax rate, because it looked like it was pretty high at 62.8% for this quarter. And I think last quarter it was the same situation. So just to get an idea, especially since in some modeling numbers here, going forward, what can I safely use as a tax rate? I think you had mentioned 40%, but -- and this quarter I was surprised to see it's still at a high level. So going forward, what you would anticipate on a quarterly basis and even through 2012, a tax rate?

At the end of each year we expect our tax to be normalized out at 40% combined between federal and Illinois tax. I'm not -- I don't have the ability to do this in my head over the phone. So if we have to go into it much further, let's do it privately, John. But if we have overpaid our taxes in the first half, we will end up with an adjustment, a positive adjustment in the second half. We think we may have paid a little bit over, and we are happier to be that way than last year, where we had to make a negative adjustment which looked rather poorly. So we think we are close, but we believe we are over rather than under.

Okay, so --

And the number for the full year is always 40%.

Okay, so for Q3 and Q4 we will see that get into line to bring the annual to about a 40% rate, which means it will be a little more favorable tax treatment than the high rates that I've seen in the first half.

Correct, and this is our strategy to avoid being caught on the short side, which is much more embarrassing than being caught on the high side.

I understand. I think you've covered that, obviously, in the first half. All right, well, thank you.

[CJ Popejoy].

Well, I had the tax question also. But can you give me some idea what the cost advantage on your products is going to be when your plant opens as opposed to oil?

Only that it's substantial. Once again, trade secret --

I understand.

-- Is preventing us from being open. Yes, thank you.

But -- and how can you ramp that up? Have you built your plant so that you can meet future needs fairly quickly?

Yes. We have the ability, once we are in production, to increase very quickly over time. We have to purchase and install new reactors, but we have a streamlined method for achieving that now, and we have also found a streamlined method for making sure that we will never be held up by a steam permit again.

So you are pretty much on the edge of doing this, right?

We are going to do it and we are almost open, and it's a matter of not if but when.

I mean technologically, you are pretty much on the edge. Right?

Yes, oh, yes. There is no problem with the technology. It works.

Well, yes, but you are one of the first to do this?

We are the only people who have never done it, and we wanted to stay ahead of everyone else. That's why the trade secret.

Well, you have a very good story. Who can argue against saving water?

Thank you very much. I appreciate that.

Gary Schwab.

Good quarter, thanks. Did you do any Ecosavr -- did your Ecosavr division include any WaterSavr sales in Q2 versus last year?

Very minor sales. I don't have a number for you and we never break it out, Gary. But, no, WaterSavr didn't do very well in second quarter.

So it was mostly Ecosavr?

Mostly our swimming pool products.

Okay. Now, you said in your presentation that Taber would go commercial in 2012. But you also said, when you were talking to John, that you hope to be able to announce something in Q3. Is there going to be any additional development expense at Taber?

Well, there may be some -- well, obviously, Gary, we are in the middle of high-volume testing. There's always the possibility of negative information from that. I don't have any right now. I don't expect any significant CapEx as a result of the testing. I did talk about the production dates for Alberta twice in my speech, but the second time where I mentioned the date 2012, that was in specific reference to being in production at the time when we turn into our larger half of the year. That doesn't change the fact that I expect to announce that we are commercial long before then.

Okay, because I know in the first quarter you said something like four to six weeks of testing should be able to do it, and that's still a reasonable --

That is still a reasonable expectation.

-- Time estimate, yes. Okay. Now, as far as oil goes, if oil prices average -- right now, we are back down in the 80s again. If we stay in the 80s for Q3 and Q4, do you expect that to increase your margins on aspartic acid for TPA in the second half of the year?

Yes. Middle 80s is a better number for us than $100 plus. One thing to recognize, though, is that our aspartic acid is shipped to us from China and there has been a disconnect between North Sea Brent prices and West Texas Intermediate prices. I was discussing that internally this morning, that I haven't kept track of that disconnect. But the Chinese groups are certainly not paying West Texas Intermediate. So we may see less advantage from that, we may see more.

Frankly, I'm going to say we will not see as much price pressure in the second half of the year. We should see better margins, but I don't want to predict a number. It wouldn't be accurate.

And what about -- can you give us an update on your high-temperature TPA, that down-hole squeeze product?

Those products are being tested. We don't have any major sales in it yet. We do have strong hopes that that will be forthcoming. And I -- of course, that's driven by the customer, who is also driven by their customer. So my timing estimates would be not accurate.

And lastly, I know you mentioned something about this lawsuit by Noranth Ventures, your ex-Singapore distributor. Do you have to set aside funds for that, excess fees as a -- sort of in an escrow account or anything as a protection?

No; we consider that -- I was speaking of -- earlier in the question period with Mr. John Nobile, I was speaking about a patent infringement suit that we have filed against Global Green Solutions of Chicago. The suit that we consider -- well, I'm not supposed to comment. We don't consider the Singapore suit significant. It's also an arbitration suit that will be done in New York; it's not a lawsuit, it goes to arbitration. And at the appropriate time we will be making our own counterclaims that make the entire thing a lot clearer.

But at this point I have to stick with my legal advice, which is no further comment.

(Operator instructions) Hans Kummerfeld.

You did mention the BT business to save us from mosquitoes. Is that kind of on a back-back burner or off the table now or -- ?

We have taken that off the table because we can't find the right partner, and we certainly do not have the right sales force to take a product like that to market.

Yes, thank you.

I can't say anything more succinct than that.

Sure, and obviously when you found the right people for the ag business that made a huge, huge difference. So --

It did.

Yes, so there we go. At the Illinois plant, once you get the Taber plan going will you be cutting back hours or throughput here in the states at a 40% kind of tax rate? Would you be switching more up to Taber, I guess?

No, actually. Your question gives me the opportunity to reinforce something. Taber makes the raw materials for Illinois, so we are backwardly integrating. No; all it does is it makes -- it changes the tax payable. When we make material in Alberta for sale to our Illinois company, it gets transferred across the border at world prices. So Illinois will still pay world prices for aspartic acid, but the Alberta plant will make the profit. Both plants will operate as fast as we can and sell as much as we can to our final customers, but there's just a change in our supply system that makes it possible for us to earn the profits of making aspartic acid instead of paying them to companies overseas.

Okay, very good, thank you.

Bill Gregozeski.

You mentioned that the water product sales were up, but it looks like in the second quarter they were quite a bit below the second quarter last year. I know you don't like the quarter-over-quarter comparisons, but how do you see the second half of the year looking for the water product sales?

Well, I see them at, year-over-year, an increase. And I can't remember the exact numbers; I think we were around 0.975 last year. I think water products will be in the 15% upward range, 10% to 15%. Very difficult to know what's going to happen with restocking in the swimming pool industry, and I think that I've beaten this almost to death, but the swimming pool industry is a vicious area where there's very little growth and everyone is trying to poach each other's customers.

We are taking the high road as far as we can and expecting growth. But the more you grow, the more people take potshots at you. If we get WaterSavr sales in the second half of the year, then there will be significant increase in the water division. So it's really a matter of we can hold our own and grow a little bit with swimming pools. If we get WaterSavr contracts, we grow dramatically.

And with your gross margins, it looks like they kind of bounce around a bit. Is there anything that determines that margin, or is it really just the fluctuations in oil? Like is there a higher margin on a product versus like the oil product, or is it pretty similar across the board product wise?

We have different margins into virtually every market vertical, and product mix does determine our margins. The other two things -- one has been identified, oil. And the second variant that is quite high is currency. It's Chinese currency versus US dollar, Canadian currency versus US dollar. And that's enough moving parts that I shouldn't try and make predictions, but I will say that when the Chinese currency is rising, our margins are shrinking. When the Canadian dollar is rising, our margins are shrinking. If either of those two things go the opposite direction, our margins increase. And of course, our margins increase with oil prices dropping and decrease with oil prices rising.

Okay, and then my last question is, what is your current borrowing capacity under that line of credit.

$1.5 million.

Okay, so it's the full amount?

No. How much have we got, taken, or -- how much do we have?

How it sounded in the Q was you can borrow based on your receivables.

Oh, yes, we can borrow up to the full amount right now.

Okay, all right, that's all I have, thanks Dan.

William Phillips.

Congratulations on a very solid quarter. A question with regards to a major distributor in the southwest -- I know you made mention of the possibility, I believe it was last quarter, with regards to consummating some sort of agreement. Any -- can you flesh out any progress on that particular distributor?

Continuing progress, no signed contract at this point because there is a wait for results from the growing season. I think that's realistic from the other party's point of view. They are pretty big, and they would like to be sure that they are putting their name on something that works. Obviously, we know what works because it has been working for 15 years. But everyone should do their due diligence.

So they are looking at what's going on as far as the spring crop is concerned right now; is that correct?

There is also some winter wheat usage. And in the Midwest there is a tradition for many farmers to take their profits from their crops and prepay for their fertilizer needs for the following year. We will see some fourth-quarter sales into that arena.

Thank you for clarifying.

Gary Schwab.

Yes, Dan, just one more thing on your detergent business. I assume that you have a lot of potential customers that are just as anxious as we are, waiting for this Taber to go commercial. Do you have any contingent detergent like memorandums of understanding that they will place an order once this thing is commercial?

I do not have any signed documentation from any detergent majors. We have significant interest, and we also have significant industrial sales into the detergent industry already with smaller companies. So if you are trying -- and I try and tell everyone this. Please, each of you who are investors, if you have the opportunity to buy Method home detergent or Seventh Generation detergent, I highly recommend that you do so because you will be doing the environment a service and yourselves a service.

Are there detergent customers who are buying your product but they are under contract with other people for the non-biodegradable product or whatever, and that once those contracts are completed with this other party, then they can come and fill that --.

I don't know. That would be trade secret in somebody else's company, and I certainly wouldn't know that. And if I had that knowledge I would be under an NDA. I simply can't go there.

So basically you've got to go out now and sell this, once you go commercial?

Well, certainly. That's the life.

Yes. No, no, no. Okay, I didn't know if there was anything like waiting in the wings that you were working against there. That was all.

Okay, well, I can't give you any comfort there, Gary.

Okay, all right, thanks Dan.

(Operator instructions) CJ Popejoy.

Yes. With fracturing taking hold all over the country down here in the states and even worldwide, do you have any products that go into the nat gas exploration business, with the worry over the water tables and all that business?

That's a good question. Hydraulic fracturing -- and I hope everybody can hear me well; there's a little bit of fuss on the incoming line to me. But the question about hydraulic fracturing is an excellent question. We have sampled several exploration service companies with material for adding to their hydraulic fracturing. We believe and in fact know that polyaspartates can be used in this field and that our TPAs are the best ones for that purpose.

I think that we will find over the next several years that there's a very good business for us there. It will depend to a large extent on what individual governments do in terms of regulating fracking materials and making sure that the regulations are followed. We do strongly believe that if the regulations require that people treat their water and remove all nonbiodegradables from the recovery water and if that governments insist on disclosure of the chemistry used, that there will be a movement towards our biodegradable products for fracking. It's not a significant part of our business, but it's a significant interest to us at this time.

Thank you very much.

William Phillips.

I just wanted to ask the same question again but in a slightly different way with regards to the possibility of major contracts in the detergent industry. There's -- as you said, there's interest out there from some very large people with regards to you being a major source, possibly a major source, from them. Are they looking for milestones in terms of the Taber plant, i.e., you are going to go up and get commercial production? And then there's the ramp-up period in terms of processing at a full capacity on a continuous basis. Are they looking for those kind of milestones before they are, in fact, willing to put pen to ink as far as a major agreement in terms of you being a supplier?

Okay, that's a well-put redefinition. Absolutely; large companies do not like to make statements such as we have a renewable source of biodegradable product and then discover that the small company they are dealing with has managed to trip over their pointy shoes. We believe that nothing can accelerate, nothing can transpire until we are in production there and can document that to a potential large contract.

Understood. Have they given you any guidelines as far as what broad-brush milestones they need to see you accomplish before they are willing to sign a contract? Can you give us -- can you flesh that? Can you give me an answer on that basis?

The type of discussions we have indicate that, if we can confirm that we are in full production in Alberta, then we can begin serious talks. But beyond that, there is nothing in writing.

Okay, how long are they looking for you to be in continuous production before they are saying, okay, Flexible Solutions as a company can be a reliable supplier. Therefore, we are pulling to put pen to ink. Any kind of indication (multiple speakers)?

I don't have any number on that, none whatsoever. That will be their internal decision, and it's a moving target.

Have they indicated anything of that nature?

No.

Okay, thank you.

Thank you, sir. We appear to have no further questions at this time. Please continue with any further points you wish to raise. We have no questions, sir. Please continue.

Thank you, Kirsten. And thank each and every one of you for joining me today. I appreciate it and -- for all the good questions. I look forward to third quarter and having another positive conference call and another set of interesting questions to answer. Thank you very much. Goodbye.

Ladies and gentlemen, this concludes today's second quarter financial conference call. Thank you for participating. You may now disconnect.