Flexible Solutions International Inc (FSI) 2020 Q2 法說會逐字稿

Good day, and welcome to the Flexible Solutions International Second Quarter 2020 Financial Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Dan O'Brien. Please go ahead, sir.

Thank you, Madison. 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 onward-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 the 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 2020 Q2 call. Prior to addressing our financials, I'd like to talk about our corporate condition and product lines, along with what, in our opinion, might occur over the next 2 quarters. COVID virus, the NanoChem subsidiary, the ENP subsidiary and the Florida, LLC investment are all engaged in producing for the agriculture and/or the cleaning products sectors. Therefore, we are considered essential services and likely to remain so if restrictions are reinstated.

Productions and sales are continuing to meet customer orders. We continue to shrink our inventory and increase our cash position in Q2 by ordering less inventory than we consumed. This tactic has been successful, and we feel that we now have the right level of inventory to suit the risks of COVID, while still having the ability to service our customers.

Our NanoChem division, NCS, represents more than 1/2 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.

TPA is used in agriculture to significantly increase crop yield. The method of action is by slowing crystal growth between fertilizer ions and other ions in the soil, resulting in the fertilizer remaining available longer for the plants to use. 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 normally grow steadily but slowly. A simple explanation of TPA's effect 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.

SUN 27 and N Savr 30 are our nitrogen conservation products. Nitrogen is a critical fertilizer but subject to loss through bacterial breakdown, evaporation and soil runoff. SUN 27 is used to conserve nitrogen from attack by soil bacterial enzymes, while N Savr 30 is directed towards reducing nitrogen loss through leaching and evaporation.

ENP, the October 2018 acquisition. ENP is focused on sales into the greenhouse, turf and golf markets, while our NCS sales are into row crop agriculture, 2 very distinct markets. The strong quarters for ENP are 2 and 3 to match the U.S. spring and summer. Q1 was stronger than the year earlier period, and Q2 repeated the feat. ENP expects moderate growth in the second half of 2020 with a caution that Q4 early buy orders could be affected if the virus causes customers to keep inventory very low.

The LLC investment announced in January 2019. This investment was profitable again. The company we invested in sold more in Q2 2020 than it did in Q2 2019. The company is focused on international sales and into multiple countries, all of which are facing different COVID issues and responding in varied ways. The large number of variables prevents any useful prediction for second half 2020 other than results similar to 2019.

Q3 and the rest of the year. TPA, SUN 27 and N Savr 30 for agricultural use had peak uptake in Q1 and Q2, with Q2 showing quite strongly. Early buy orders in Q4 could be reduced if our customers decide to use just-in-time strategies.

Oil, gas and industrial sales of TPA are expected to be flat or mildly down in Q3 compared to the previous year while predictions regarding Q4 are not possible under the circumstances. Like agriculture, our sales to cleaning products and water treatment are considered essential, leaving only oil and gas as a market vertical at significant risk. The risk in O&G is not permanent loss of business, rather it's the possibility of some wells shutting down for maintenance while oil prices are low.

Tariffs. Since September 30, 2018, many of our raw materials imported from China have included a 10% additional tariff, which rose to 25% in '19. U.S. customers have received price increases from us as this inventory entered production. International customers have not been charged with tariffs because we're applying for the export rebates available to recover the tariffs. As a result, the accumulating tariff payments to the government are affecting our cost of goods, our cash flow and our profits negatively until the rebates are received.

Rebates are very complicated to apply for and take many months to arrive. The total dollar amount due back to us has become significant and continues to increase. The rebates will increase profitability and cash flow will help decreasing cost of goods in future orders during which the rebates are received. In my last speech, I expressed comfort that we would begin to see rebates in Q2 or early in Q3. I base this on the fact that we filed our templates and requests for our first rebate in mid-May. As of August 14, there has been no response from the government, except an excuse that employees are not in the office. Because there is a 30-day payment delay even after approval, we no longer expect rebates in Q3.

Highlights of the financial results. Our sales for the quarter increased 14% to $7.71 million compared with $6.77 million in Q2 2019. The result is a gain of $1.3 million or $0.09 a share in the 2020 period compared to a loss of 28,000 or $0.00 a share in 2019. We attribute the improvement to: a, increased sales; b, reduced expenses; c, better product mix; and d, no repeat of the bad debt recognized in Q2 2019.

Working capital is adequate for all our purposes and is increasing during 2020 as we book retained profits from sales. Effort will be made to minimize inventory and accounts receivable while increasing cash until the effects of the virus become more predictable. We also have a line of credit with BMO Harris Bank in Chicago. We're confident that we can execute our plans with the existing capital.

The purchase of ENP in 2019 was funded by a term loan from Harris Bank and a $1 million convertible debenture taken by the seller. 1/2 of the debenture was converted to 200,000 FSI shares in 2019, while the remaining $500,000 was retired for cash in Q2. The term loan is approaching half repayment. And finally, in this area of my speech, the LLC investment in January '19 was made with cash on hand provided by FSL, our Canadian operating company.

The text of this speech will be available as an 8-K filing on www.sec.gov later today, Monday, August 17. E-mail or fax copies can be requested from Jason Bloom at jason@flexiblesolutions.com.

Thank you. The floor is open for questions. And Madison, will you please give the instructions and set everything up for the Q&A.

(Operator Instructions) We can go ahead and take our first question.

Dan, it looks like the Florida, LLC is doing very well so far this year. Are you able to talk at all about what's driving their top line growth and if the margins are going to be anywhere near where they were in the second quarter?

Bill, good to hear from you. The Florida, LLC had issues last year in Q1 and Q2 that were related to international currency, specifically the Brazil, I believe, it's the real. Those have not been repeated and the customers that were normally serviced ordered on time and in the volumes expected rather than playing games with running down inventory.

Definitely, the margins are likely to remain similar. They won't be increasing, but similar to down a little bit depending on our cost of goods, which is, of course, because we manufacture many of the products for the LLC, our cost of goods flows through to their cost of goods and to their margin as well. So I would say, as a decent prediction, we are tracking in a normal canyon right now, but I can't promise that something won't kick us out.

Okay. So I mean, even though like a net margin and over 10% is something that we can expect possibly going forward from this?

I would think so. That's something that our company showed in in Q1 and again in Q2 as a whole. And that would be something we would aim for, excluding extraordinary circumstances.

Okay. All right. And then last question, you spent about $0.5 million on CapEx. What was that for? And then do you have any other expenditures planned for the rest of this year or next year?

Yes. We have been -- over the past 1.5 years, we've been installing new equipment in our plants in Peru. I don't want to disclose what the equipment is for, for fear of leading competitors to the same conclusion we have, which is this equipment is going to be very profitable over time.

But it is nearly finished installation. We expect it to go live by the end of the year. And the CapEx will then be allowed to be expensed by the end of the year according to the Trump tax changes. So yes, that's what we're up to. There's about another -- my guess, maybe another $500,000 before we go live.

Okay. And then what's that new equipment then? I know you don't want to talk about it, but is there any kind of -- I mean, should we be expecting gross margin improvement because of that?

Small gross margin improvement because it will reduce our cost of doing certain products. And then over future time, we will use it for both toll manufacturing. And for the expansion of certain products that were not possible to expand without access -- direct access to this machinery. Until now, we've been using toll manufacturers and by moving away from that, we are going to be able to expand certain products that just didn't make sense with the toll.

(Operator Instructions) We can go ahead and take our next question.

Dan, congrats on a great quarter.

Thank you.

So just to kind of follow up on your tariff comments. So kind of wanted to confirm that the amount that you guys are expecting, roughly $0.5 million to $1 million, was that amount per quarter in terms of the reduction in total gross -- total profit goods? Is that what you guys are sort of expecting?

No. Here's what has happened. Over the almost 2 years that these -- that we've been pursuing these rebates, the accumulated amount is between $500,000 and $1 million that we expect back. And that material or that amount of money is likely to come back across a 1- to 2-quarter period, whenever it starts, those historic ones should come back across 1 to 2 quarters. But let's also remember that every pound of raw material we're buying out of China continues to have a tariff applied.

So what we're trying to do here with the first set of rebates is get back into a situation where we don't have historical rebates due to us. We only have the last quarter or the last 4 months perhaps. So we want to get into a position where instead of having a very large chunk of historical rebates due to us. We only have the 3 months -- the most recent 3 months that we've been paying. And we are frustrated, I can imagine U.S. shareholders are frustrated and I imagine even the government is frustrated that they can't get organized enough to rubber stamp our application and let this go forward. But that's what's happening.

So expect at some point to have 1 to 2 quarters where there's an extra $500 million -- or sorry, $500,000 to $1 million. And then normal period thereafter where we put out a couple of hundred thousand dollars in tariffs in 1 quarter, but get the previous quarter's tariff rebates back. Do I make a lot of sense or not?

No. That's helpful. No, that's super helpful. I appreciate the color. And just as a last question, noticed that the waters -- kind of the -- you guys break out the 2 segments in your filing. Noticed in the WaterSavr kind of segment, you guys kind of broke even in terms of profitability and you guys have lost kind of an immaterial amount in previous quarters, but have actually shown profitability. Is that something you can kind of expect going forward?

Our focus on that division, because of the intense difficulty of selling to governments who essentially have shown, over 15 years, that they are not interested in our product, even though it works; we have been left with small sales into swimming pools and small sales into the oil and gas industry in North America who are using it to keep water in their fracking ponds and very happy with the water conservation.

We don't want to give up the product line, but we are not going to expand capital trying to grow it. So I think what you can expect to see is similar results, where the revenue exceeds the cost of goods and the cost of keeping the divisions open is actually a value to us because it does support employees who have secondary responsibilities in accounting and other areas of our company. So it's going to be valuable. It's going to defray costs, but it's not going to be a focus going forward.

That makes sense. And on the TPA side, it seems like, kind of looking at the environment, the planting kind of season is a lot better because of weather. Is that something you guys are seeing that's probably helping you guys on the NanoChem side of things?

Yes. A normalized spring is always better. Customers and our customers' customers will find themselves in predicaments where they don't know what -- if it's an odd spring with floods or other weather events, they won't know when to order something and then some things just don't get ordered and used that year. So this year has been much more favorable.

The same thing could be said -- Bill asked earlier about our LLC investment. That has -- when it's normalized, which it was this year, that's very beneficial to us as well because the planting seasons internationally are far different from North America, and there is even a second planting season in the fall for South America. For many of the acres, they get 2 crops a year. So there's a second planting season in South America that's getting ready to begin now.

We can go ahead and take our next question.

Dan?

Yes. I'm here with you.

It's [Greg Hillman]. A couple of questions. About the Florida, LLC, there was like an earn-out of like, I think, $1 million a year for a couple of years. Have those been payments? Did they hit the targets? And were those payments made?

Yes. The first term payment was made. The next one's coming up in December. The first one was earned and then some. And the second one looks as though it will be earned, although there's only 6 months. I'm confident that they will earn-out their position and very pleased that they will.

Okay. Good. And the question about resuming the dividend and your relationship with the bank, I think your bank told you to hold off on it. What's your thoughts on the dividend on a go-forward basis?

Well, as well as the bank, I think we all have to recognize that COVID has become more of a long-term problem than it was expected in February and March. And that all of us are waiting for a reliable vaccine or a guaranteed cure, if you get it. So -- and I read 2 very instructive magazines weekly. It's Chemical & Engineering News and The Economist. My understanding is that we are at least a year away from a reliable vaccine applied to enough human beings that normalized operations across the world will take place.

The FSI board is feeling very strongly that no resumption of a dividend should happen until that vaccine or, let's be honest, maybe vaccine is never achieved, but a reliable cure for people who get sick is in place. So we're going to be quite conservative. If the world hadn't changed back in February, we obviously would have had enough money and capacity to continue a dividend. But we would not want to be in a situation of paying out our cash and then discovering that for some reason or other, our bank loans were no longer available, and we didn't have the cash to repay them.

Okay, good. And it seems that your most recent M&A activity, the Florida, LLC and that other company, ENP, have done pretty well and they are good acquisitions. But could you just maybe give me a sense about basically the adoption of TPA and the nitrogen stabilizers? How is that occurring domestically and worldwide? And what do you need to do to speed that up either through acquisitions or internal marketing efforts?

Okay. Well, that's a good question. I like these ones. The adoption of nitrogen stabilizers in the North American market is about 20% to 25% of nitrogen fertilizer use right now and growing reasonably rapidly. So we expect to earn our share in that market. Internationally, which is another reason why we made the Florida acquisition. It's only 10%. And certain countries are much greater than that, but certain countries are much less. So internationally, there is an even bigger opportunity than there is in the United States.

Nitrogen stabilizes aren't just about yield anymore. They're also about the amount of urea and other nitrogen products that end up in our ground water and in our river systems. If you really want to scare yourself some time, have a look at algae blooms in the Gulf of Mexico that are 45% due to nitrogen fertilizer runoff from the corn and soybean producing states.

I mean, obviously, we have to produce food, but we should be doing a better job of making sure that the fertilizers we need to produce the amount of food we want to eat are staying where we put them. And so over time, nitrogen stabilizers, we expect them to be mandated, but waiting for government action is not our plan.

And I'll just move -- before talking about sales techniques, I'll move to the TPA project. TPA is less of a pollution solution and more of a yield enhancer. So that one will take more sales effort and has taken more sales effort over the years. But it's a great product, great margins on it. And it works virtually for every farmer that tries it.

So we're now backing up to the -- the first stage of your question, we will look to organic growth just over the next few quarters to make sure we understand exactly what we're doing. One of the reasons for the 2 very specific acquisitions after 15 years of doing nothing was people. Each of these acquisitions brought with us people, we believe, are part of the next phase of Flexible Solutions and its growth. We've lowered our average age. We've increased our average IQ and we've got to our company what I feel is an increased exuberance and optimism.

So we want to -- we would love to acquire more companies, but it has to match a very harsh set of rules for us. One, it doesn't end up on my shoulders running the new group. I have enough on my shareholders. Two, it's accretive immediately. Three, it's reasonably priced. And four, it brings to our company, people that can be part of the next-generation because we don't want to make our job harder, we want to make it more fun. If we find acquisitions that suit all of that, we will make them. If we can't find them, we will find ways to grow organically. Sorry about the long answer.

Okay. Great. And then you mentioned government. Is there anything that the government could do to accelerate your sales? You mentioned the thing about the algae blooms and things like that, but that would be one thing. But what's your take on anything that government might do and...

Well, sometimes, it's -- and I just -- I don't know how -- if you've done much reading on nudge economy. But it's often just making it better for the farmer to do the right thing rather than beating them up with a new set of regulations. If I were king of the world, perhaps I'd be trying something like saying, there is a green credit of some type for reducing the amount of nitrogen that you apply to your fields through the use of nitrogen stabilizers. That's just a -- that's the sort of thing that I think would work with growers. Farmers are pretty tough individuals and threatening them with stuff usually just means they go around you.

Okay. That's really helpful. And actually, Dan, just one other thing. The form of TPA, the nitrogen stabilizer, are those both available in granules and liquids?

The nitrogen stabilizers are liquid only, and they are applied to the nitrogen, either liquid nitrogen UAN or to urea pellets. TPA is available in a powder form as well as a liquid form. The powder form is quite a bit more expensive, and it doesn't sell normally into the agriculture industry.

We'll go ahead and take our next question.

It's [Raymond Hao]. How are you?

I'm fine, Simon.

Question for you. I'm trying not to make too much of the prepared comments in your press release, but you said something to effect of you were busy making products for essential services in agriculture and cleaning products; and combined with normal operations, very strong quarter. Should I read anything into the combined with normal operations? Was there a new consumer care product related to COVID that was in there?

No. I'm turning a fine line. It's arrogant and obnoxious to brag during a world pandemic. And we did possibly see some of our customers ordering more than they would have. So if -- I'm sorry if it was misunderstood.

For instance, in cleaning products, we have seen a small rise. And I'm sure it's because people are washing their hands more and washing their dishes and their laundry. And we supply products that go into all those finished goods. Likewise, in agriculture, perhaps there were increased orders. I doubt that in agriculture. I think we just saw just-in-time and perhaps something that wasn't ordered in fourth quarter last year got ordered in the second quarter.

Got it. And all in all, is your supply chain still functioning smoothly?

It is. It's a little slower, but we always carry 3 to 4 months of inventory for most of our products. So a 3- to 4-week delay in deliveries really just played into our hands to reduce a 6-month inventory to a 4-month.

Got you. And last question for me. A small item, but Trio Opportunity Corp., what do they do?

Interesting company. I know of them because one of our Directors is also a director in their corporation. It's a private Seattle-based company with an international arm. We invested in the international arm. They lease houses -- lease-to-own houses in the United States. And in 3 or 4 of the states, they're doing very well. They pay an 8% interest, which, of course, because it's being paid in into our Cayman subsidiary, has a tax advantage. They've been growing rapidly, and we're very pleased with our investment. Every month, we get the interest. And yes, highly recommended.

All right. It appears there are no further questions. Actually, we just got 1 more. Let's go ahead and take our next question.

Dan, for the Florida, LLC or one of the companies you just bought, what's the ornamental agriculture?

Turf and ornamentals. Ornamental part is plants and lawns and small trees. All of the things that you see around the mall or in a property development.

Okay. Got it. They sell into that market, like for fertilizers and things that help them. Okay. Okay.

Absolutely. That's their focus: Golf, turf and the ornamental which is the things that are bigger than grass.

And I take it that's growing faster than the economy. That has a decent growth rate, that market?

As a market, I think it's probably growing faster than the economy, but our skill set and the person that we acquired in that acquisition, man named George Murray, they are good at gaining market share as well.

All right. Now there appears to be no further questions. Mr. O'Brien, I'd like to turn the conference back to you for any additional or closing remarks.

Thanks, Madison. Well, everybody, thank you for joining us. And hopefully, you'll be back again and in 3 months for the next conference call. Until then, thanks very much for your attention. Bye.

This concludes today's call. Thank you for your participation. You may now disconnect.