UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark one)
|X| Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006.
|_| Transition Report Under Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the transition period from to .
--------------- --------------
Commission File Number 000-29649
-------------------
FLEXIBLE SOLUTIONS INTERNATIONAL, INC.
(Name of Small Business Issuer as Specified in Its Charter)
NEVADA 91-1922863
(State of Incorporation) (IRS Employer Identification No.)
615 DISCOVERY STREET
VICTORIA, BRITISH COLUMBIA, CANADA V8T 5G4
(Address of Principal Executive Offices) (Zip Code)
(250) 477-9969
(Issuer's Telephone Number, Including Area Code)
-------------------
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes |X| No
|_|
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X|
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date: The Company had 12,981,316
shares of Common Stock, par value $0.001 per share, outstanding as of April 30,
2006.
Transitional Small Business Disclosure Format (check one): Yes |_|
No |X|
FORM 10-QSB
Index
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.............................................. 1
(a) Unaudited Consolidated Balance Sheets at March 31, 2006....... 1
(b) Unaudited Consolidated Statements of Operations for the Three
Months Ended March 31, 2006 and 2005.......................... 2
(c) Unaudited Consolidated Statements of Cash Flows for the Three
Months Ended March 31, 2006 and 2005.......................... 3
(d) Notes to Unaudited Consolidated Financial Statements for the
Period Ended March 31, 2006................................... 4
Item 2. Management's Discussion and Analysis or Plan of Operation........ 16
Item 3. Controls and Procedures.......................................... 20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................ 21
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds...... 23
Item 3. Defaults Upon Senior Securities.................................. 23
Item 4. Submission of Matters to a Vote of Security Holders.............. 23
Item 5. Other Information................................................ 23
Item 6. Exhibits......................................................... 23
SIGNATURES................................................................. 24
i
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This document contains "forward-looking statements" within the meaning
of the Private Securities Litigation Reform Act of 1995. All statements other
that statements of historical fact are "forward-looking statements" for the
purposes of the federal and state securities laws, including, but not limited to
any projections of earnings, revenue or other financials items; any statements
of the plans, strategies and objectives of management for future operations; any
statements concerning proposed new services or developments; any statements
regarding future economic conditions or performance; any statements regarding
future economic conditions or performance; any statements of belief; and any
statements of assumptions underlying any of the foregoing.
Forward-looking statements may include the words "may," "could,"
"will," "estimate," "intend," "continue," "believe," "expect" or "anticipate" or
other similar words. These forward-looking statements present our estimates and
assumptions only as of the date of this report. Except for our ongoing
obligation to disclose material information as required by the federal
securities laws, we do not intend, and undertake no obligation, to update any
forward-looking statement.
Although we believe that the expectations reflected in any of our
forward-looking statements are reasonable, actual results could differ
materially from those projected or assumed in any of our forward-looking
statements. Our future financial condition and results of operations, as well as
any forward-looking statements, are subject to change and inherent risks and
uncertainties. The factors impacting these risks and uncertainties include but
are not limited to:
o Increased competitive pressures from existing competitors and new
entrants;
o Increases in interest rate or our cost of borrowing or a default
under any material debt agreement;
o Deterioration in general or regional economic conditions;
o Adverse state or federal legislation or regulation that increases
the costs of compliance, or adverse findings by a regulator with
respect to existing operations;
o Loss of customers or sales weakness;
o Inability to achieve future sales levels or other operating
results;
o The unavailability of funds for capital expenditures; and
o Operational inefficiencies in distribution or other systems.
For a detailed description of these and other factors that could cause
actual results to differ materially from those expressed in any forward-looking
statement, please see "Risk Factors" in our Annual Report on Form 10-KSB for the
year ended December 31, 2005.
ii
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
FLEXIBLE SOLUTIONS INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
AT MARCH 31, 2006
(U.S. DOLLARS)
MARCH 31,
2006 DECEMBER 31,
(UNAUDITED) 2005
----------------- -----------------
ASSETS
CURRENT
Cash and cash equivalents $ 518,334 $ 526,292
Accounts receivable 1,933,500 758,463
Income tax - 28,918
Loan receivable 35,321 35,228
Inventory 1,687,021 2,314,979
Prepaid expenses 92,115 137,315
----------------- -----------------
4,266,291 3,801,195
PROPERTY, EQUIPMENT AND LEASEHOLDS 4,514,364 4,657,383
PATENTS 137,478 143,822
----------------- -----------------
INVESTMENT 369,000 369,000
----------------- -----------------
$ 9,287,133 $ 8,971,400
================= =================
LIABILITIES
CURRENT
Accounts payable and accrued liabilities $ 649,476 $ 691,105
----------------- -----------------
649,476 691,105
----------------- -----------------
STOCKHOLDERS' EQUITY
CAPITAL STOCK
Authorized
50,000,000 Common shares with a par value of $0.001 each
1,000,000 Preferred shares with a par value of $0.01 each
Issued and outstanding
12,981,316 (2005: 12,981,316) common shares 12,981 12,981
CAPITAL IN EXCESS OF PAR VALUE 11,574,182 11,422,219
OTHER COMPREHENSIVE INCOME 149,323 153,254
DEFICIT (3,098,829) (3,308,158)
----------------- -----------------
TOTAL STOCKHOLDERS' EQUITY 8,637,657 8,280,295
----------------- -----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 9,287,133 $ 8,971,400
================= =================
COMMITMENTS AND CONTINGENCIES (NOTES 14 & 15)
-- See Notes to Unaudited Consolidated Financial Statements --
1
FLEXIBLE SOLUTIONS INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005
(U.S. DOLLARS -- UNAUDITED)
THREE MONTHS ENDED MARCH 31,
----------------------------------------
2005
2006 (RESTATED)
SEE NOTE 3
------------------- -----------------
SALES $ 2,508,445 $ 2,019,581
COST OF SALES 1,339,060 1,078,301
------------------- -----------------
GROSS PROFIT 1,169,386 941,280
------------------- -----------------
OPERATING EXPENSES
Wages 276,400 234,436
Administrative salaries and benefits 160,949 38,005
Advertising and promotion 18,947 31,271
Investor relations and transfer agent fee 32,298 24,638
Office and miscellaneous 23,920 41,457
Insurance 42,494 28,318
Interest expense 1,044 37,674
Rent 58,533 55,806
Consulting 87,801 44,252
Professional fees 92,935 60,843
Travel 18,753 37,765
Telecommunications 6,997 10,288
Shipping 13,466 12,639
Research 37,603 15,508
Commissions 57,225 40,925
Bad debt expense (recovery) 589 --
Currency exchange 5,515 718
Utilities 4,992 7,166
Depreciation 147,621 168,103
------------------- -----------------
1,088,080 889,812
------------------- -----------------
INCOME (LOSS) BEFORE OTHER ITEMS AND INCOME TAX 81,305 51,468
INTEREST INCOME 945 2,730
------------------- -----------------
INCOME (LOSS) BEFORE INCOME TAX 82,250 54,198
INCOME TAX (RECOVERY) (127,079) --
------------------- -----------------
NET INCOME (LOSS) 209,329 54,198
DEFICIT, BEGINNING (3,308,158) (2,131,407)
------------------- -----------------
DEFICIT, ENDING $ (3,098,829) $ (2,077,209)
NET INCOME (LOSS) PER SHARE $ 0.02 $ 0.00
------------------- -----------------
WEIGHTED AVERAGE NUMBER OF SHARES 12,981,316 11,831,916
------------------- -----------------
-- See Notes to Unaudited Consolidated Financial Statements --
2
FLEXIBLE SOLUTIONS INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005
(U.S. DOLLARS -- UNAUDITED)
THREE MONTHS ENDED MARCH 31,
----------------------------------------
2005
2006 (RESTATED)
SEE NOTE 3
------------------ -----------------
OPERATING ACTIVITIES
Net income (loss) $ 209,329 $ 54,198
Stock compensation expense 204,118 23,400
Depreciation 147,621 168,103
------------------ -----------------
561,067 245,701
------------------ -----------------
Changes in non-cash working capital items:
(Increase) Decrease in accounts receivable (1,175,037) (610,002)
(Increase) Decrease in inventory 627,958 (239,302)
(Increase) Decrease in prepaid expenses 45,200 34,516
Increase (Decrease) in accounts payable (41,647) 38,945
Increase (Decrease) in Income taxes 28,918 65,164
------------------ -----------------
CASH (USED IN) OPERATING ACTIVITIES 46,477 (514,977)
------------------ -----------------
INVESTING ACTIVITIES
Short-term investments - 559,440
Investments - (54,000)
Loan receivable (93) (81)
Development of patents 6,344
Acquisition of property and equipment (4,602) (40,099)
------------------ -----------------
CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 1,649 465,260
------------------ -----------------
FINANCING ACTIVITIES
Proceeds from issuance of common stock (52,154) -
------------------ -----------------
CASH PROVIDED BY FINANCING ACTIVITIES (52,154) -
------------------ -----------------
Effect of exchange rate changes on cash (3,931) (13,559)
------------------ -----------------
INFLOW (OUTFLOW) OF CASH (7,958) (63,276)
Cash and cash equivalents, beginning 526,292 558,795
------------------ -----------------
CASH AND CASH EQUIVALENTS, ENDING $ 518,334 $ 495,520
------------------ -----------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest received $ 945 $ 2,730
------------------ -----------------
-- See Notes to Unaudited Consolidated Financial Statements --
3
FLEXIBLE SOLUTIONS INTERNATIONAL INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE PERIOD ENDED MARCH 31, 2006
(U.S. DOLLARS)
1. BASIS OF PRESENTATION.
These unaudited consolidated financial statements of Flexible Solutions
International, Inc (the "Company") have been prepared in accordance with
accounting principles generally accepted in the United States for interim
financial information. These financial statements are condensed and do not
include all disclosures required for annual financial statements. The
organization and business of the Company, accounting policies followed by the
Company and other information are contained in the notes to the Company's
audited consolidated financial statements filed as part of the Company's
December 31, 2005 Annual Report on Form 10-KSB. This quarterly report should be
read in conjunction with such annual report.
In the opinion of the Company's management, these consolidated
financial statements reflect all adjustments necessary to present fairly the
Company's consolidated financial position at March 31, 2006, and the
consolidated results of operations and the consolidated statements of cash flows
for the three months ended March 31, 2006 and 2005. The results of operations
for the three months ended March 31, 2006 are not necessarily indicative of the
results to be expected for the entire fiscal year.
These consolidated financial statements include the accounts of the
Company, and its wholly-owned subsidiaries Flexible Solutions, Ltd. ("Flexible
Ltd."), NanoChem Solutions Inc., WaterSavr Global Solutions Inc., Nano Detect
Technologies Inc., and Seahorse Systems Inc. All inter-company balances and
transactions have been eliminated. The Company was incorporated May 12, 1998 in
the State of Nevada and had no operations until June 30, 1998, as described
below.
On June 30, 1998, the Company completed the acquisition of all of the
shares of Flexible Ltd. The acquisition was effected through the issuance of
7,000,000 shares of common stock by the Company, with the former shareholders of
Flexible Ltd. receiving all of the shares then issued and outstanding of the
Company. The transaction has been accounted for as a reverse-takeover. Flexible
Ltd. is accounted for as the acquiring party and the surviving entity. As
Flexible Ltd. is the accounting survivor, the consolidated financial statements
presented for all periods are those of Flexible Ltd. The shares issued by the
Company pursuant to the acquisition have been accounted for as if those shares
had been issued upon the organization of Flexible Ltd.
On May 2, 2002, the Company established WaterSavr Global Solutions Inc.
through the issuance of 100 shares of its common stock.
Pursuant to a purchase agreement dated May 26, 2004, the Company
acquired the assets of Donlar Corporation on June 9, 2004 and created a new
company, NanoChem Solutions Inc. The purchase price of the transaction was
$6,150,000, with consideration being a combination of cash and debt. Under the
purchase agreement and as part of the consideration, the Company issued a
promissory note bearing interest at 4% to satisfy $3,150,000 of the purchase
price. This note was due June 2, 2005 and upon payment, all former Donlar assets
that were pledged as security were released from their mortgage.
4
The following table summarizes the estimated fair value of the assets
acquired at the date of acquisition (at June 9, 2004):
----------------------------------------------------- -------------
Current assets $ 1,126,805
Property and equipment 5,023,195
-------------
6,150,000
Acquisition costs assigned to property and equipment 314,724
----------------------------------------------------- -------------
Total assets acquired $ 6,464,724
----------------------------------------------------- -------------
The acquisition costs assigned to property and equipment are all direct
costs incurred by the Company to purchase the assets. These costs include due
diligence fees paid to outside parties investigating and identifying the assets,
legal costs directly attributable to the purchase of the assets, plus applicable
transfer taxes. These costs have been assigned to the individual assets based on
their proportional fair values and will be amortized based on the rates
associated with the related assets.
On February 7, 2005, the Company established Nano Detect Technologies
Inc. through the issuance of 1,000 shares of common stock from Nano Detect
Technologies Inc. to the Company.
On June 21, 2005, the Company established Seahorse Systems Inc. through
the issuance of 1,000 shares of common stock from Seahorse Systems Inc. to the
Company.
2. SIGNIFICANT ACCOUNTING POLICIES.
These consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States
applicable to a going concern and reflect the policies outlined below.
(a) Cash and Cash Equivalents.
The Company considers all highly liquid investments purchased with an
original or remaining maturity of less than three months at the date of purchase
to be cash equivalents. Cash and cash equivalents are maintained with several
financial institutions.
(b) Inventory and Cost of Sales.
The Company has four major classes of inventory: finished goods, works
in progress, raw materials and supplies. In all classes, inventory is valued at
the lower of cost and net realizable value. Cost is determined on a first-in,
first-out basis. Cost of sales includes all expenditures incurred in bringing
the goods to the point of sale. Inventorial costs and costs of sales include
direct costs of the raw material, inbound freight charges, warehousing costs,
handling costs (receiving and purchasing) and utilities and overhead expenses
related to the Company's manufacturing and processing facilities.
(c) Property, Equipment and Leaseholds.
The following assets are recorded at cost and depreciated using the
following methods using the following annual rates:
------------------------- -----------------------------
Computer hardware 30% Declining balance
Furniture and fixtures 20% Declining balance
Manufacturing equipment 20% Declining balance
Office equipment 20% Declining balance
Building 10% Declining balance
Leasehold improvements Straight-line over lease term
------------------------- -----------------------------
5
Property and equipment are written down to net realizable value when
management determines there has been a change in circumstances which indicates
its carrying amount may not be recoverable. No write-downs have been necessary
to date.
(d) Impairment of Long Lived Assets.
The Company assesses the recoverability of its long lived assets by
determining whether the carrying value of the long lived assets can be recovered
over their remaining lives through undiscounted future operating cash flows
using a discount rate reflecting the Company's average cost of funds. The
assessment of the recoverability will be impacted if estimated future operating
cash flows are not achieved. For the quarters ended March 31, 2006 and 2005, no
impairment charges have been recognized.
(e) Investments.
Investment in corporations subject to significant influence and
investments in partnerships are recorded using the equity method of accounting.
On this basis, the Company's share of income and losses of the corporations and
partnerships is included in earnings and the Company's investment therein
adjusted by a like amount. Dividends received from these entities reduce the
investment accounts. Portfolio investments not subject to significant influence
are recorded using the cost method.
The fair value of a cost method investment is not estimated if there
are no identified events or changes in circumstances that may have a significant
adverse effect on the fair value of the investment.
The Company currently does not have any investments that require use of
the equity method of accounting.
(f) Foreign Currency.
The functional currency of the Company is the Canadian Dollar. The
translation of the Canadian Dollar to the reporting currency of the U.S. Dollar
is performed for assets and liabilities using exchange rates in effect at the
balance sheet date. Revenue and expense transactions are translated using
average exchange rates prevailing during the year. Translation adjustments
arising on conversion of the financial statements from the Company's functional
currency, Canadian Dollars, into the reporting currency, U.S. Dollars, are
excluded from the determination of income and are disclosed as other
comprehensive income (loss) in stockholders' equity.
Foreign exchange gains and losses relating to transactions not
denominated in the applicable local currency are included in income if realized
during the year and in comprehensive income if they remain unrealized at the end
of the year.
(g) Revenue Recognition.
Revenue from product sales is recognized at the time the
product is shipped since title and risk of loss is transferred to the purchaser
upon delivery to the carrier. Shipments are made F.O.B. shipping point. The
Company recognizes revenue when there is persuasive evidence of an arrangement,
delivery has occurred, the fee is fixed or determinable, collectibility is
reasonably assured and there are no significant remaining performance
obligations. When significant post-delivery obligations exist, revenue is
deferred until such obligations are fulfilled.
Provisions are made at the time the related revenue is
recognized for estimated product returns. Since the Company's inception, product
returns have been insignificant; therefore no provision has been established for
estimated product returns.
6
(h) Stock Issued in Exchange for Services.
The valuation of the Company's common stock issued in exchange for
services is valued at an estimated fair market value as determined by officers
and directors of the Company based upon trading prices of the Company's common
stock on the dates of the stock transactions.
(i) Stock-based Compensation.
In December 2004, the Financial Accounting Standards Board ("FASB")
issued revised FAS No. 123(R), Share-Based Payment, which replaces FAS No. 123,
Accounting for Stock-Based Compensation, which superseded APB Opinion No. 25,
Accounting for Stock Issued to Employees. FAS No. 123(R) requires the cost of
all share-based payment transactions to be recognized in an entity's financial
statements, establishes fair value as the measurement objective and requires
entities to apply a fair-value-based measurement method in accounting for
share-based payment transactions. FAS No. 123(R) applies to all awards granted,
modified, repurchased or cancelled after July 1, 2005, and unvested portions of
previously issued and outstanding awards. The Company has adopted this statement
for its first quarter starting January 1, 2006 and will continue to evaluate the
impact of adopting this statement
(j) Comprehensive Income.
Other comprehensive income refers to revenues, expenses, gains and
losses that under generally accepted accounting principles are included in
comprehensive income, but are excluded from net income as these amounts are
recorded directly as an adjustment to stockholders' equity. The Company's other
comprehensive income is primarily comprised of unrealized foreign exchange gains
and losses.
(k) Income (Loss) Per Share.
Income (loss) per share is calculated by dividing net income (loss) by
the weighted average number of shares outstanding. Diluted loss per share is
computed by giving effect to all potential dilutive options that were
outstanding during the year. For the years ended December 31, 2005, 2004 and
2003, all outstanding options were anti-dilutive.
(l) Use of Estimates.
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities at the date of the consolidated financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates and would impact the results of
operations and cash flows.
(m) Financial Instruments.
The fair market value of the Company's financial instruments comprising
cash, short-term investment, accounts receivable, income tax recoverable, loan
receivable, accounts payable and accrued liabilities and amounts due to
shareholders were estimated to approximate their carrying values due to
immediate or short-term maturity of these financial instruments.
The Company is exposed to foreign exchange and interest rate risk to
the extent that market value rate fluctuations materially differ from financial
assets and liabilities, subject to fixed long-term rates.
3. RESTATEMENTS AS A RESULT OF CORRECTING STOCK COMPENSATION EXPENSE.
In October 2005, while completing a registration statement for
securities issued in the second quarter of 2005, the Company determined that
certain disclosures made in connection with its stock-based compensation expense
required adjustment. In September 2002, the Company entered into a distribution
agreement with Ondeo Nalco Company ("Ondeo") whereby Ondeo agreed to serve as
the exclusive
7
distributor of the Company's WATER$AVR(R) products for so long as
Ondeo maintained a certain threshold sales level as defined in the agreement. As
consideration for signing the agreement, Ondeo was granted an option to purchase
2,000,000 shares of the Company's common stock. Half of the option for one
million shares was exercisable immediately at an exercise price of $4.25 for
each common share. The remaining half of the option for 1,000,000 shares was
exercisable after certain threshold sales targets were achieved at a price of
$5.50 for each common share.
In determining the stock-based compensation expense for the nine months
ended September 30, 2002, the Company expensed the entire fair value of the
stock option believing that the option fully vested upon the signing of the
agreement. In its October 2005 review, however, the Company determined that: (i)
first, as stated above, half of the option to purchase 1,000,000 shares of
common stock did not vest and was not exercisable until the threshold sales
target had been met, which would not be until five years after the signing of
the distribution agreement; and (ii) second, the Company did not consider
Emerging Issues Task Force ("EITF") No. 96-18, Accounting for Equity Instruments
That are Issued to Other Than Employees for Acquiring, or in Conjunction with
Selling Goods or Services; EITF No. 00-18, Accounting Recognition for Certain
Transactions involving Equity Instruments Granted to Other Than Employees; and
EITF No. 01-9, Accounting for Consideration Given by a Vendor to a Customer.
To correctly account for the stock options granted to Ondeo, the
stock-based compensation expense, included in consulting expenses, should have
been measured at the date the performance obligation was complete and then
recognized on a rational and systematic manner in relation to the sales achieved
by Ondeo. Had the Company correctly accounted for these stock options,
stock-based compensation expense for the quarter would have been nil as no sales
had yet been achieved. Instead, the Company recorded a stock-based compensation
expense of $2,704,000 for the quarter.
During the three months ended March 31, 2003, Ondeo achieved the first
threshold sales target, and, accordingly, the Company should have recorded a
corresponding stock-based compensation expense of $54,080. However, since the
entire stock-based compensation expense had been recorded in the September 30,
2002 interim financial statements and in the year ended December 31, 2002, the
Company did not record any additional stock-based compensation expense as a
result of the attained first threshold level.
In the fourth quarter of the year ended December 31, 2003, it was
determined that Ondeo was not going to attain the minimum sales targets
stipulated in the exclusive distributorship agreement. Consequently the
exclusive distributorship agreement and corresponding stock options were
cancelled. The Company accounted for the cancellation of the stock options in
accordance with FAS No. 123 similar to a forfeiture of stock options and
reversed $2,480,200 of the stock compensation expense previously recorded in
2002. Had the Company accounted for the cancellation of the stock options
correctly, it would have reversed the stock-based compensation expense of
$54,080 that was recorded in the first quarter ended March 31, 2003.
The following presents the effect on the company's previously issued
financial statements for the three months ended March 31, 2005:
Balance sheet as at March 31, 2005 -
--------------------------------------------------------------------------------------------------------------
Previously Increase
Reported (Decrease) Restated
----------------------------------------------------------------------
Capital in excess of par value $ 7,686,820) $ (223,800 ) $ 7,463,020
Accumulated deficiency (2,301,009) 223,800 (2,077,209)
--------------------------------------------------------------------------------------------------------------
8
Statement of operations for the three months ended March 31, 2005 -
--------------------------------------------------------------------------------------------------------------
Previously Increase
Reported (Decrease) Restated
----------------------------------------------------------------------
Deficit, beginning $ (2,355,207) $ 223,800 $ (2,131,407)
Deficit, ending (2,301,009) 223,800 (2,077,209)
--------------------------------------------------------------------------------------------------------------
4. LOAN RECEIVABLE.
------------------------------------------------- -------------------
2006 2005
--------------- -------------------
5% loan receivable due on demand $ 35,321 $ 35,228
------------------------------------------------- -------------------
5. PREPAID EXPENSES.
------------------------------------------------- -------------------
2006 2005
--------------- -------------------
Security deposit and prepaids $ 92,115 $ 137,315
------------------------------------------------- -------------------
6. PROPERTY, EQUIPMENT AND LEASEHOLDS.
--------------------------------------------------------------------------------
Accumulated 2006 2005
Cost Amortization Net Net
------------ ----------- ------------ -----------
Buildings $3,144,259 $ 523,126 $2,621,133 $2,688,341
Computer hardware 54,397 26,477 27,920 29,962
Furniture and fixtures 17,516 6,833 10,683 10,965
Office equipment 29,492 15,206 14,286 15,081
Manufacturing equipment 2,183,600 765,610 1,417,990 1,488,208
Trailer 1,986 1,221 765 831
Leasehold improvements 39,430 20,123 19,307 21,362
Trade show booth 7,440 3,345 4,095 4,447
Land 398,186 - 398,186 398,186
------------ ----------- ------------ -----------
$6,013,784 $1,361,941 $4,514,365 $4,657,383
--------------------------------------------------------------------------------
7. PATENTS
In fiscal 2005 and 2006, the Company started the patent process for
additional WATER$AVR(R) products. As the patent process is not yet completed,
amortization has not yet been recognized. Patents are amortized over their
useful lives once granted.
------------------------------------------- ------------- ----------
2006 2005
------------- ----------
Patents $ 137,478 143,822
------------------------------------------- ------------- ----------
8. INVESTMENT.
--------------------------------------------- ---------- ----------
2006 2005
---------- ----------
Tatko Inc. $ 271,000 $ 271,000
Air Water Interface Delivery & Detection Inc. $ 98,000 98,000
---------- ----------
$ 369,000 $ 369,000
--------------------------------------------- ---------- ----------
On May 31, 2003, the Company acquired an option to purchase a 20%
interest in the outstanding shares of Tatko Inc. ("Tatko") for consideration of
the issuance of 100,000 shares of our common stock. The option to purchase the
shares of Taiko expires on May 31, 2008. The cost of the investment has been
9
accounted for based on the original fair market value of our common stock on May
31, 2003. See Contingencies (Note 12).
In 2005, NanoDetect purchased 32.7 shares of equity in Air Water
Interface Delivery and Detection Inc. ("AWD") for a total cost of $98,000. This
investment represents only 3.3% of the issued and outstanding shares of AWD and,
accordingly, will be accounted for under the cost method.
9. STOCK OPTIONS.
The Company may issue stock options and stock bonuses for our common
stock to provide incentives to directors, key employees and other persons who
contribute to our success. The exercise price of all incentive options are
issued for not less than fair market value.
The following table summarizes stock option activity for the years
ended December 31, 2005 and 2004 and the three months ended March 31, 2006:
----------------------------------------------------------------------------
Number Exercise price Weighted average
of shares per share Exercise price
--------------------------------- --------- --------------- -------
Balance, December 31, 2003 1,711,000 $1.00 - $4.25 $2.84
Granted 572,740 $3.00 - $4.60 $3.46
Exercised (37,000 ) $1.00 - $2.50 $1.55
Expired (5,000 ) $4.25 $4.25
Cancelled 1,000,000 ) $1.50 - $3.50 $2.50
--------------------------------- --------- --------------- -------
Balance, December 31, 2004 1,241,740 $1.00 - $4.60 $2.87
Granted 30,000 $3.58 - $4.40 $4.17
Exercised (162,000 ) $1.40 $1.40
Expired (49,000 ) $3.00 - $4.25 $3.52
--------------------------------- --------- --------------- -------
Balance, December 31, 2005 1,060,740 $1.00 - $4.55 $3.44
Granted 1,080,000 $3.25 $3.25
Cancelled (15,000 ) $1.20 - $4.25 $2.05
Balance, March 31,2006 2,125,740 $1.00 - 4.55 $3.36
--------------------------------- --------- --------------- -------
The fair value of each option grant is calculated using the following
weighted average assumptions:
----------------------------- -------------- -------------- -------------
2005 2004 2003
-------------- -------------- -------------
Expected life - years 5.0 5.0 5.0
Interest rate 3.65% 3.5 2.87
Volatility 52.0% 49.0% 49.0
Dividend yield - % - % - %
----------------------------- -------------- -------------- -------------
During the three months ended March 31, 2006, the Company granted
405,000 options to purchase common stock to consultants and has applied FAS No.
123(R) using the Black-Scholes option-pricing model, which resulted in
additional expenses of $78,163 this quarter. During the same period, the Company
granted 675,000 options to employees, resulting in an additional $125,955 in
wages and administrative expenses. During the year ended December 31, 2005, the
Company granted 30,000 (2004 - 275,400) stock options to consultants and has
applied FAS No. 123 using the Black-Scholes option-pricing model, which resulted
in additional expenses of $9,350 (2004 - $299,345). During the year ended
December 31, 2005, the Company recognized $93,600 in expenses for 90,000 options
granted in the year
10
ended December 31, 2004, but which vested in the year ended
December 31, 2005. During the year ended December 31, 2005, 250,000 options,
which were granted in 2004, vested according to the fulfillment of certain
milestones, which resulted in additional expenses of $422,500.
10. WARRANTS
On April 14, 2005, the Company announced that it had raised $3,375,000
pursuant to a private placement of up to 1,800,000 shares of its common stock.
The investors collectively purchased 900,000 shares of the Company's common
stock at a per share purchase price of $3.75, together with warrants to purchase
up to 900,000 additional shares of the Company's common stock. The warrants have
a four-year term and are immediately exercisable at a price of $4.50 per share.
On June 8, 2005, the Company announced that it had raised an additional
$327,750 pursuant to a private placement of up to 174,800 shares of its common
stock. An investor purchased 87,400 shares of the Company's common stock at a
per share price of $3.75, together with a warrant to purchase up to 87,400
additional shares of the Company's common stock. The warrant has a four-year
term and is immediately exercisable at a price of $4.50 per share.
The following table summarizes the Company's warrant option activity
for the year ended December 31, 2005 (no prior or subsequent activity):
-----------------------------------------------------------------------------
Exercise price Weighted average
Number of shares per share exercise price
---------------- -------------- ----------------
Balance, December 31, 2004 -- -- --
Granted 987,400 $4.50 $4.50
Exercised -- -- --
Cancelled -- -- --
---------------- -------------- ------------
Balance, December 31, 2005 987,400 $4.50 $4.50
------------------------------------------- -------------- ------------
11. CAPITAL STOCK.
No stock was issued in the quarter ending March 31, 2006.
On April 14, 2005, the Company announced that it had raised $3,375,000
pursuant to a private placement of up to 1,800,000 shares of its common stock.
The investors collectively purchased 900,000 shares of the Company's common
stock at a per share purchase price of $3.75, together with warrants to purchase
up to 900,000 additional shares of the Company's common stock. The warrants have
a four-year term and are immediately exercisable at a price of $4.50 per share.
On June 8, 2005, the Company announced that it had raised an additional
$327,750 pursuant to a private placement of up to 174,800 shares of its common
stock. An investor purchased 87,400 shares of the Company's common stock at a
per share price of $3.75, together with a warrant to purchase up to 87,400
additional shares of the Company's common stock. The warrant has a four-year
term and is immediately exercisable at a price of $4.50 per share.
The purpose of these transactions was to provide sufficient working
capital for the Company to retire the debt remaining from its acquisition of
certain assets from Donlar Corporation in June 2004. Costs associated with these
two capital raises were $523,407, making the net proceeds $3,179,343.
During the year ended December 31, 2005 the Company issued 162,000
shares of common stock at $1.40 per share upon exercise of stock options.
11
12. SEGMENTED, SIGNIFICANT CUSTOMER INFORMATION AND ECONOMIC DEPENDENCY.
The Company operates in two segments:
(a) Development and marketing of two lines of energy and water
conservation products (as shown under the column heading "EWCP" below), which
consists of a (i) liquid swimming pool blanket which saves energy and water by
storing evaporation from the pool surface, and (ii) food-safe powdered form of
the active ingredient within the liquid blanket and is designed to be used in
still or slow moving drinking water sources.
(b) Manufacture of biodegradable polymers and chemical additives used
within the petroleum, chemical, utility and mining industries to prevent
corrosion and scaling in water piping (as shown under the column heading "BPCA"
below). Chemical additives are manufactured for use in laundry and dish
detergents, as well as in products to reduce levels of insecticides, herbicides
and fungicides.
The accounting policies of the segments are the same as those described
in Note 2 to these Consolidated Financial Statements (Significant Accounting
Policies). The Company evaluates performance based on profit or loss from
operations before income taxes, not including nonrecurring gains and losses and
foreign exchange gains and losses.
The Company's reportable segments are strategic business units that
offer different, but synergistic products and services. They are managed
separately because each business requires different technology and marketing
strategies.
12
-------------------------------------------------------------------
Quarters Ended March 31st
2006 2005
--------------------------------
Revenue
EWCP $ 613,782 $ 430,895
BPCA 1,894,663 1,588,686
--------------------------------
Consolidated 2,508,445 2,019,581
Interest revenue
EWCP 945 2,673
BPCA 0 57
--------------------------------
Consolidated 945 2,730
Interest expense
EWCP 0 6,606
BPCA 1,044 31,068
--------------------------------
Consolidated 1,044 37,674
Depreciation and amortization
EWCP 13,832 13,760
BPCA 133,789 154,343
--------------------------------
Consolidated 147,621 168,103
Segment profit (loss)
EWCP 154,905 (283,969)
BPCA 179,584 338,167
--------------------------------
Consolidated 334,489 54,198
Segment assets
EWCP 373,362 262,123
BPCA 4,278,480 4,860,218
--------------------------------
Consolidated 4,651,842 5,122,341
Expenditures for segment assets
EWCP (6,929) 40,099
BPCA 5,187 -
--------------------------------
Consolidated (1,742) 40,099
-------------------------------------------------------------------
The EWCP shows a reduction in expenditures for segment assets due to a
credit being issued on costs associated with development of new patents.
The sales generated in the United States of America and Canada are as
follows:
-------------------------------------------------------------------------
2006 2005
----------- -----------
Canada $ 83,012 $ 424,112
United States and abroad 2,425,433 1,595,649
------------------------------------------------- ----------- -----------
Total $ 2,508,445 $ 2,019,581
------------------------------------------------- ----------- -----------
The Company's long-lived assets are located in Canada and the United
States as follows:
------------------------------------------------- ----------- -----------
2006 2005
----------- -----------
Canada $ 361,074 $ 254,579
United States 4,290,769 4,867,762
------------------------------------------------- ----------- -----------
Total $ 4,651,843 $ 5,122,341
------------------------------------------------- ----------- -----------
13
13. COMMITMENTS.
The Company is committed to minimum rental payments for property and
premises aggregating approximately $296,867 over the term of four leases, the
last expiring on June 30, 2009.
Commitments in each of the next five years are approximately as
follows:
------------ ---------------
2006 $ 154,855
2007 58,078
2008 55,956
2009 27,978
------------ ---------------
14. CONTINGENCIES.
On May 1, 2003, the Company filed a lawsuit in the Supreme Court of
British Columbia, Canada, against John Wells and Equity Trust, S.A. seeking the
return of 100,000 shares of the Company's common stock and the repayment of a
$25,000 loan, which were provided to defendants for investment banking services
consisting of securing a $5 million loan and a $25 million stock offering. Such
services were not performed and in the proceeding the Company seeks return of
such shares after defendant's failure to both return the shares voluntarily and
repay the note. On May 7, 2003, the Company obtained an injunction freezing the
transfer of the shares. On May 24, 2004, there was a hearing on defendant's
motion to set aside the injunction, which motion was denied by the trial court
on May 29, 2004. On the date of issuance, the share transaction was recorded as
shares issued for services at fair market value, a value of $0.80 per share. No
amounts have been recorded as receivable in the Company's consolidated financial
statements as the outcome of this claim is not determinable.
On November 13, 2003, Patrick Grant, an ex-employee, filed a lawsuit in
the Circuit Court of Cook County, Illinois against the Company, WaterSavr Global
Solutions Inc. ("WGS"), the wholly-owned subsidiary of the Company, and Daniel
B. O'Brien, the Company's Chief Executive Officer. The plaintiff claims damages
for breach of contract, tortious interference with an agreement and various
wrongful discharge claims. The plaintiff seeks monetary damages in excess of
$1,020,000 for the breach of contract and tortious interference claims and
unspecified compensatory and punitive damages in the wrongful discharge claims.
The parties completed mandatory mediation ordered by the Circuit Court and will
next appear in court for case management, at which time the court will set
discovery deadlines. The Company considers the case without merit and is
vigorously disputing the claims. In addition, the Company intends to file
counterclaims against the plaintiff for failure to repay financial obligations
owed to the Company of almost $40,000, as well as unspecified damages arising
out of the plaintiff's disclosure of confidential information to a client during
his employment at WGS. No amounts have been recorded as receivable and no
accrual has been made for any loss in the Company's consolidated financial
statements as the outcome of the claim filed by the plaintiff is not
determinable
On May 28, 2004, Sun Solar Energy Technologies, Inc. ("Sun Solar"),
filed a lawsuit in the Federal Court of Canada, against the Company, Flexible
Ltd., and Mr. O'Brien. Sun Solar is seeking: (a) a declaration that the
trademark "Tropical Fish" is available for use by Sun Solar; (b) injunctive
relief against further use of the "Tropical Fish" trademark by the Company; and
(c) monetary damages exceeding $7,000,000 for the alleged infringement by the
Company, Flexible Ltd. and Mr. O'Brien of the "Tropical Fish" trademark, as well
as any other "confusingly similar trademarks" or proprietary trade dresses. On
August 9, 2004, the Company, Flexible Ltd. and Mr. O'Brien filed their defense
and filed a counterclaim against Sun Solar. The counterclaim seeks: (x)
injunctive relief against further use of the "Tropical Fish" trademark by Sun
Solar; (y) a declaration that the "Tropical Fish" trademark is owned by
14
the Company, or, in the alternative, is not distinctive and should be struck
from the trademark registry; and (z) monetary damages exceeding $50,000. The
parties have completed documentary discovery and examinations for discovery of
all parties. No amounts have been recorded as receivable in the Company's
consolidated financial statements and no amounts have been accrued as potential
losses as the outcome of this claim is not determinable.
On July 23, 2004, the Company filed a breach of contract suit in the
Circuit Court of Cook County, Illinois against Tatko. The action arises out of a
joint product development agreement entered into between the Company and Tatko
in which the Company agreed to invest $10,000 toward the product development
venture and granted to Tatko 100,000 shares of the Company's restricted common
stock. In return, Tatko granted the Company a five-year option to purchase 20%
of Tatko's outstanding capital stock. Tatko has since refused to collaborate on
the agreement and the Company seeks declaratory relief stating that Tatko is not
entitled to the 100,000 shares of the Company's restricted common stock. The
litigation is still pending at this time.
In addition, Tatko filed its own suit on September 24, 2004 in the
Circuit Court of Cook County, Illinois seeking declaratory relief of its
entitlement to the Company's restricted common stock. On May 23, 2005, the Tatko
suit was dismissed with prejudice by the Circuit Court. No amounts have been
recorded as receivable in the Company's consolidated financial statements and no
amount has been accrued as a loss as the outcome of the claim against Tatko is
not determinable.
On January 12, 2005, the Company filed a lawsuit in the Court of the
Queen's Bench of Alberta, in which our subsidiary, Flexible Ltd., is
inter-provincially registered. We are seeking indeterminate damages resulting
from a breach of contract by Calgary Diecast Corporation ("CDC"). The contract
at issue was never completed and our raw materials remain in the possession of
CDC. On April 25, 2005, the court ordered a judgment in our favor in the amount
of $47,495 and we intend to collect on this judgment using all available means.
15. COMPARATIVE FIGURES.
Certain of the comparative figures have been reclassified to conform
with the current year's presentation.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
OVERVIEW
Flexible Solutions International, Inc. ("we," "us," and "our")
develops, manufactures and markets specialty chemicals that slow down the
evaporation of water. Our initial product, HEAT$AVR(R), is marketed for use in
swimming pools and spas where its use, by slowing the evaporation of water,
allows the water to retain a higher temperature for a longer period of time and
thereby reduces the energy required to maintain the desired temperature of the
water in the pool. Our newest product, WATER$AVR(R), is marketed for water
conservation in irrigation canals, aquaculture, and reservoirs where its use
slows down water loss due to evaporation. We also make and sell dispensers which
automate the deployment of our chemical products.
RESULTS OF OPERATIONS
The following analysis and discussion pertains to our results of
operations for the three months ended March 31, 2006, as compared to the results
of operations for the three months ended March 31, 2005, and to changes in our
financial condition from December 31, 2005 to March 31, 2006.
THREE MONTHS ENDED MARCH 31, 2006 AND 2005
Separate financial data for each of our operating segments is provided
below. We evaluate the performance of our operating segments based on the
following:
--------------------------------------------------------------------------------------------------------------------------
Three Months Ended March 31, % Change % Change
----------------------------------------------------------
Sales 2006 2005 2004 2006-2005 2005-2004
---- ---- ---- --------- ---------
Energy Segment $ 613,782 $ 430,895 $ 488,110 42% (12%)
Polymer Segment $ 1,894,663 1,588,686 * 19% *
------------------------------------------------------------------------------------------------
Consolidated $ 2,508,445 $ 2,019,581 $ 488,110 24% 314%
Gross Profit
Energy Segment $ 468,569 $ 123,920 $ 121,010 278% 2%)
Polymer Segment $ 700,817 817,360 * (14%) *
------------------------------------------------------------------------------------------------
Consolidated $ 1,169,386 $ 941,280 $ 121,010 24% 67%
SG&A
Energy Segment $ 550,147 $ 410,562 $ 374,987 34% 9%
Polymer Segment $ 537,933 479,250 * 12% *
------------------------------------------------------------------------------------------------
Consolidated $ 1,088,080 $ 889,812 $ 374,987 22% 137%
Interest Income
Energy Segment $ 945 $ 2,673 $ 3,116 (65%) (14%)
Polymer Segment $ 0 57 * * *
------------------------------------------------------------------------------------------------
Consolidated $ 945 $ 2,730 $ 3,116 (65%) (12%)
Write-down of
Investments
Energy Segment -- -- -- -- --
Polymer Segment -- -- * * *
------------------------------------------------------------------------------------------------
Consolidated -- -- -- -- --
--------------------------------------------------------------------------------------------------------------------------
Net Income (Loss) $ 209,329 $ 54,198 $ (250,861) (286%) (122%)
--------------------------------------------------------------------------------------------------------------------------
* Polymer segment data is not available as indicated. Our polymer segment was
formed after the acquisition of certain assets of the Donlar Corporation in June
2004.
16
For the three months ended March 31, 2006, we experienced a net profit
of $209,329, as compared to a net profit of $54,198 for the three months ended
March 31, 2005. Increased brand recognition, increased sales of our residential
swimming pool product, ECO$AVR(R), and increased sales from our NanoChem
division resulted in sales of $2,508,445 in the three months ended March 31,
2006, as compared to $2,019,581 in the three months ended March 31, 2005. Our
Energy segment had sales of $613,782 for the three months ended March 31, 2006,
as compared to $430,895 for the three months ended March 31, 2005. Our Polymer
segment had sales of $1,894,663 for the three months ended March 31, 2006, as
compared to sales of $1,588,686 for the three months ended March 31, 2005.
Our management is satisfied with the effect of the acquisition of
assets from Donlar Corporation ("Donlar"), as the NanoChem division (which is
comprised of the former Donlar assets) has contributed greatly to sales and cash
flow and is starting to replace the capital expended to acquire the assets. In
addition, opportunities to synergistically cross-sell all of our divisions'
products have already generated leads to new business and the swimming pool
division has discovered ways to help NanoChem increase utilization of its Peru,
Illinois factory, while decreasing our costs as a whole. We maintained
expenditures in the areas of WATER$AVR(R) product sales and marketing costs and
production equipment development costs. The major factors that contributed to
our increased revenue were greater sales from our HEAT$AVR(R) and ECO$AVR(R)
swimming pool division into new overseas markets and an increase in sales from
our newly-formed NanoChem division. NanoChem sales are much less seasonal than
those of our WATER$AVR(R) product and HEAT$AVR(R) and ECO$AVR(R) products
divisions. As Nanochem sales increase, we anticipate that we will experience a
reduction in the volatility of our sales over time.
Gross profit margin represents sales less cost of sales and producing.
The major categories of costs included in cost of sales and producing are cost
of goods, distribution costs, and costs of our buying department. Distribution
costs consist of all warehouse receiving and inspection costs, warehousing
costs, all transportation costs associated with shipping goods from our
facilities to our customers, and other costs of distribution. We do not exclude
any portion of distribution costs from cost of sales. Our gross margins may not
be comparable to those of other entities because some entities include all of
the costs related to their overhead in cost of sales. However, we exclude a
portion of cost of sales from gross profit and instead include such costs as a
line item in operating expenses.
Our operating expenses were $1,088,080 for the three months ended March
31, 2006, an increase of $198,268 over the three months ended March 31, 2005. We
continued our sales and marketing efforts for our WATER$AVR(R) product line,
with the objective of closing our first major sales as soon as possible. The
largest increases in operating expenses were in the areas of wages ($276,400 for
the three months ended March 31, 2006, as compared to $234,436 in the three
months ended March 31, 2005), administrative salaries ($160,949 for the three
months ended March 31, 2006, as compared to $38,005 in the three months ended
March 31, 2005), research ($37,603 in the three months ended March 31, 2006, as
compared to $15,508 in the three months ended March 31, 2005), and commissions
($57,225 in the three months ended March 31, 2006, as compared to $40,295 in the
three months ended March 31, 2005). The increase in wages and administrative
salaries are in part due to the application of SFAS 123 (R) that now requires
companies to apply a fair value based measurement method to employee stock
options. After applying SFAS 123(R) to employee granted stock options, the
company recognized an additional $125,955 in expenses this quarter. These
increases are also partially accounted for by the increase in sales and
represent a permanent increase in operating costs related to the new level of
sales. The increase in investor relations ($32,298 for the three months ended
March 31, 2006, as compared to $24,318 in the three months ended March 31, 2005)
and consulting ($87,801 for the three months ended March 31, 2006, as compared
to $44,252 in the three months ended March 31, 2005) are a result of stock
option expenses. Our decreases in advertising and promotion ($18,947 for the
three months ended March 31, 2006, as compared to $31,271 in the three months
ended March 31, 2005), travel ($18,753 for the three months ended March 31,
2006, as compared to $37,765 in the three months ended March 31, 2005) and
office and miscellaneous ($23,920 for the three months ended March 31, 2006, as
compared to $41,457 in
17
the three months ended March 31, 2005) are the result of better cost-control in
these areas instituted by management over the past year. The decrease in
interest expense ($1,044 for the three months ended March 31, 2006, as compared
to $37,674 in the three months ended March 31, 2005) is a direct result of the
Company paying off the short-term loan used for the purchase of assets to create
the NanoChem division. Our professional fees increased to $92,935 in the three
months ended March 31, 2006, as compared to $60,843 in the three months ended
March 31, 2005. This is the result of costs incurred in intellectual property
prosecution and protection.
Our Energy segment generated $550,147 in operating expenses in the
three months ended March 31, 2006, an increase from $410,562 for the three
months ended March 31, 2005. This 34 percent increase is attributable to our
increases in commissions and professional fees as well as to application of SFAS
123(R). Our Polymer segment generated $537,933 in operating expenses in the
three months ended March 31, 2006, an increase of $58,683. This 12% increase is
attributable to the nineteen percent increase in sales as well as the
application of SFAS 123(R).
Our net profit for the three months ended March 31, 2006 was $209,329,
an increase from our net profit of $54,198 in the three months ended March 31,
2005. The increase in net profit it attributable to increased sales in our
swimming pool products division, as compared to the three months ended March 31,
2005, augmented by positive operating cash from our NanoChem division. Our
Energy segment's net profit for the three months ended March 31, 2006 was
$46,446, an increase from our net loss of $283,969 in the three months ended
March 31, 2005, which is attributable to our increased brand recognition and
sales. Our Polymer segment's net profit for the three months ended March 31,
2006 was $162,883, a decrease over the net profit of $338,167 for the three
months ended March 31, 2005. This reduction in profits is attributable to higher
cost of goods sold, a result of the rise in oil prices worldwide.
Our profit per share was $0.02 for the three months ended March 31,
2006, as compared to $0.00 per share for the three months ended March 31, 2005.
LIQUIDITY AND CAPITAL RESOURCES
The following section discusses the effects of changes in our balance
sheet and cash flow on our liquidity and capital resources. The following table
summarizes our cash, cash equivalents and working capital that directly have an
impact on our immediate and future cash needs and sources.
----------------------------------------------------------------------------------------------------------------
March 31, 2006 December 31, 2005 Increase (Decrease)
--------------------- ------------------------- -----------------------------
Cash and cash equivalents $ 518,334 $ 526,292 $ (7,958)
Working capital 3,616,814 3,110,090 506,724
----------------------------------------------------------------------------------------------------------------
We have cash on hand of $518,334 as of March 31, 2006, as compared to
cash on hand of $526,292 at December 31, 2005. The overall decrease in cash and
cash equivalents was primarily a result of cash used to introduce and market our
WATER$AVR(R) product, which has not yet attained significant sales to maintain
positive cash flow.
As of March 31, 2006, we had working capital of $3,616,814, as compared
to working capital of $3,101,090 on December 31, 2005. The increase in working
capital is the result of increased sales and profits.
We expect that cash provided by operating activities may fluctuate in
future periods as a result of a number of factors, including the fluctuations in
our operating results, shipments, accounts receivable
18
collections, and inventory management. As our sales continue to build, our
accounts receivable will increase and our overall inventory levels will also
increase.
Because we repaid the short-term loan due in June 2005 (incurred in
connection with our purchase of the Donlar assets, used to create the NanoChem
division), we have no other commitments or guarantees in the next 12 months that
will materially affect our cash position or needs. We believe we have sufficient
capital to support our business and operations for at least the next 12 months.
We anticipate utilizing approximately $500,000 in the next twelve months
attempting to close sales in California, Spain and Australia and to extend
certain core U.S. patents to select other countries. Approximately 80% of such
expenditures are related to expanding sales for our WATER$AVR(R) product.
There can be no assurance that any of the expenditures will result in
additional sales revenues. In the event that our capital resources are not
sufficient for the continued expansion of the Company, new capital will be
needed or marketing expenses will have to be curtailed until capital is
available. There is no guarantee that capital will be available on terms
acceptable to the Company or at all. We have no investment banking agreements in
place at this time.
SUBSEQUENT EVENTS
On April 19th, 2006, Flexible Solutions Ltd. re-signed their lease for
the Calgary, AB factory for a further three years, through till September 30,
2009.
RESTATEMENT OF FINANCIAL STATEMENTS
The accompanying financial statements have been restated to revise
certain stock-based compensation expense. In October 2005, while completing a
registration statement for securities issued in the second quarter of 2005, we
determined that certain disclosures made in connection with our stock-based
compensation expense required adjustment. In September 2002, we entered into a
distribution agreement with Ondeo Nalco Company ("Ondeo") whereby Ondeo agreed
to serve as the exclusive distributor of our WATER$AVR(R) products for so long
as Ondeo maintained a certain threshold sales level as defined in the agreement.
As consideration for signing the agreement, Ondeo was granted an option to
purchase 2,000,000 shares of our common stock. Half of the option for one
million shares was exercisable immediately at an exercise price of $4.25 for
each common share. The remaining half of the option for 1,000,000 shares was
exercisable after certain threshold sales targets were achieved at a price of
$5.50 for each common share.
In determining the stock-based compensation expense for the nine months
ended September 30, 2002, we expensed the entire fair value of the stock option
believing that the option fully vested upon the signing of the agreement. In our
October 2005 review, however, we determined that: (i) first, as stated above,
half of the option to purchase 1,000,000 shares of common stock did not vest and
was not exercisable until the threshold sales target had been met, which would
not be until five years after the signing of the distribution agreement; and
(ii) second, we did not consider Emerging Issues Task Force ("EITF") No. 96-18,
Accounting for Equity Instruments That are Issued to Other Than Employees for
Acquiring, or in Conjunction with Selling Goods or Services; EITF No. 00-18,
Accounting Recognition for Certain Transactions involving Equity Instruments
Granted to Other Than Employees; and EITF No. 01-9, Accounting for Consideration
Given by a Vendor to a Customer.
During the three months ended March 31, 2003, Ondeo achieved the first
threshold sales target, and accordingly, we should have recorded a corresponding
stock-based compensation expense of $54,080. However, since the entire
stock-based compensation expense had been recorded in the September 30, 2002
interim financial statements and in the year ended December 31, 2002, we did not
record any additional stock-based compensation expense as a result of the
attained first threshold level.
19
In the fourth quarter of the year ended December 31, 2003, we
determined that Ondeo was not going to attain the minimum sales targets
stipulated in the agreement. Consequently, the agreement and corresponding stock
option was cancelled. We accounted for the cancellation of the stock option in
accordance with Statement of Financial Accounting Standard No. 123 similar to a
forfeiture of stock options and reversed $2,480,200 of the stock compensation
expense previously recorded in fiscal 2002. Had we accounted for the
cancellation of the stock option correctly, we would have reversed the amended
stock-based compensation expense of $54,080 that was recorded in the first
quarter ended March 31, 2003.
In light of the above, the net effect of the adjustments to the
financial statements is as follows:
1. Approximately $2,704,000 in stock compensation expense recorded in
September 2002 has been reversed;
2. Approximately $54,080 in stock-based compensation expense has been
recorded in the quarter ended March 31, 2003, as Ondeo met the first sales
threshold under the agreement;
3. Approximately $54,080 in stock-based compensation expense has been
reversed in the year ended December 31, 2003, as Ondeo failed to meet subsequent
sales thresholds under the agreement, resulting in the cancellation of the stock
option;
4. As stated above, we recorded a stock-based compensation expense of
$2,704,000 in December 2002. As a result of canceling the stock option, we
previously recorded a recovery of $2,480,000 of stock compensation expense at
December 31, 2003. This $2,480,000 recovery has been reversed, in conjunction
with the reversal of $2,704,000 in stock compensation expense originally
recorded; and
5. For the periods ended March 31, 2004 to June 30, 2005, the net
effect of these adjustments is to decrease capital in excess of par value by
approximately $223,800 and increase retained earnings by approximately $223,800.
We are presently unaware of any evidence that the restatements
described above are due to any material noncompliance by us, as a result of
misconduct, with any financial reporting requirement under the federal
securities laws. Our audit committee of the board of directors is working with
our management and our accountants to assure that we are taking the appropriate
approach to resolving the issues related to the restatements, as well as any
further issues that may be identified during the course of review.
ITEM 3. CONTROLS AND PROCEDURES.
Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to
ensure that information required to be disclosed in our periodic reports to the
Securities and Exchange Commission ("SEC") is recorded, processed, summarized
and reported within the time periods specified in the SEC's rules and
regulations, and that such information is accumulated and communicated to our
management, including our principal executive officer and principal financial
officer, as appropriate, to allow timely decisions regarding required
disclosure. Our disclosure controls and procedures are designed to provide a
reasonable level of assurance of reaching our desired disclosure control
objectives.
As of the end of the period covered by this Quarterly Report, we
carried out an evaluation, under the supervision and with the participation of
management, including our principal executive officer and principal financial
officer, of the effectiveness of the design and operation of our disclosure
controls and
20
procedures (as defined under Rules 13a-15(e) and 15d-15(e) under
the Securities Exchange Act of 1934, as amended). Based upon that evaluation,
our principal executive officer and principal financial officer concluded that
our disclosure controls and procedures are effective in timely alerting them to
material information relating to us (including our consolidated subsidiaries)
that is required to be included in our periodic reports.
The prior accounting treatment of our stock-based compensation expense
was done in consultation and in accordance with the advice of our independent
accountants. Accordingly, management does not believe that this restatement of
our Quarterly Report indicates or results from a material weakness with respect
to our disclosure controls and procedures or our internal controls over
financial reporting.
Changes in Internal Control Over Financial Reporting
During the first quarter of 2006, upon recommendation of our audit
committee, we implemented a new internal control protocol related to inventory
counts.
As part of the Company's internal control protocols our senior
management selects for review in the next reporting period various numerical
data from the previous period. During the compilation of data to be used in the
financial statements contained in the our Annual Report for the year ended
December 31, 2005, senior management discovered that the number assigned to
inventory for the quarter ended September 30, 2005 appeared to be suspect and
immediately investigated the issue. Within fifteen days of senior management's
review, a mis-transcription in the inventory number was identified and
corrected.
Our investigation revealed that, due to a clerical error in
transferring the inventory floor count to computerized spreadsheets, certain
inventory data was misreported. After correction and disclosure, management
referred this matter to the audit committee of our board of directors for
review, and determination as to whether a change to our inventory control
protocol was necessary or advisable. On January 25, 2006, the audit committee of
the board of directors recommended a change to our internal controls related to
inventory counts, which now requires that quarterly and annual inventory counts
be conducted by plant managers, accompanied by either an equal or more senior
level executive from a division reporting directly to our head office, or by an
independent accountant reporting in the same manner. This change was implemented
and made effective during the first quarter of 2006.
Although we modified our internal control procedures related to
inventory matters in the first quarter of 2006, management, our board of
directors, including its audit committee, and our independent auditor each
concluded that no change in the assessment of the effectiveness of our internal
controls was necessary based on an isolated event of human error. We believe
that such errors are uncommon and that it is not possible to design a system of
internal controls that absolutely prevents against human error. Nonetheless, we
have implemented the protocol changes described above in an effort to further
bolster the accuracy of our inventory data compilation.
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
On November 13, 2003, Patrick Grant, an ex-employee, filed a lawsuit in
the Circuit Court of Cook County, Illinois against us, WaterSavr Global
Solutions Inc. ("WGS"), our wholly-owned subsidiary, and Daniel B. O'Brien, our
Chief Executive Officer. The plaintiff claims damages for breach of contract,
tortious interference with an agreement and various wrongful discharge claims.
The plaintiff seeks monetary damages in excess of $1,020,000 for the breach of
contract and tortious interference claims and unspecified compensatory and
punitive damages in the wrongful discharge claims. The
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parties completed mandatory mediation ordered by the Circuit Court and will next
appear in court for case management, at which time the court will set discovery
deadlines. We consider the case to be without merit and are planning to dispute
the matter vigorously. In addition, we intend to file counterclaims against the
plaintiff for failure to repay financial obligations owed to us of almost
$40,000, as well as unspecified damages arising out of the plaintiff's
disclosure of confidential information to a client during his employment at WGS.
No amounts have been recorded as receivable and no accrual has been made for any
loss in our consolidated financial statements as the outcome of the claim filed
by the plaintiff is not determinable.
On May 1, 2003, we filed a lawsuit in the Supreme Court of British
Columbia, Canada, against John Wells and Equity Trust, S.A., seeking the return
of 100,000 shares of our common stock and the repayment of a $25,000 loan, which
were provided to defendants for investment banking services consisting of
securing a $5 million loan and a $25 million stock offering. Such services were
not performed and in the proceeding we seek the return of such shares after
defendants' failure to both return the shares voluntarily and repay the note. On
May 7, 2003, we obtained an injunction freezing the transfer of the shares. On
May 24, 2004, there was a hearing on defendants' motion to set aside the
injunction, which motion was denied by the trial court on May 29, 2004. On the
date of issuance, the share transaction was recorded as shares issued for
services at fair market value, a value of $0.80 per share. No amounts have been
recorded as receivable in our consolidated financial statements as the outcome
of this claim is not determinable.
On May 28, 2004, Sun Solar Energy Technologies, Inc. ("Sun Solar"),
filed a lawsuit in the Federal Court of Canada, against us, Flexible Ltd., and
Mr. O'Brien. Sun Solar is seeking: (a) a declaration that the trademark
"Tropical Fish" is available for use by Sun Solar; (b) injunctive relief against
further use of the "Tropical Fish" trademark by us; and (c) monetary damages
exceeding $7,000,000 for the alleged infringement by us, Flexible Ltd. and Mr.
O'Brien of the "Tropical Fish" trademark, as well as any other "confusingly
similar trademarks" or proprietary trade dresses. On August 9, 2004, we filed
our defenses and filed a counterclaim against Sun Solar. The counterclaim seeks:
(x) injunctive relief against further use of the "Tropical Fish" trademark by
Sun Solar; (y) a declaration that the "Tropical Fish" trademark is owned by us,
or, in the alternative, is not distinctive and should be struck from the
trademark registry; and (z) monetary damages exceeding $50,000. The parties have
completed documentary discovery and examinations for discovery of all parties.
No amounts have been recorded as receivable in the Company's consolidated
financial statements and no amounts have been accrued as potential losses as the
outcome of this claim is not determinable.
On July 23, 2004, the Company filed a breach of contract suit in the
Circuit Court of Cook County, Illinois against Tatko. The action arises out of a
joint product development agreement entered into between the Company and Tatko
in which the Company agreed to invest $10,000 toward the product development
venture and granted to Tatko 100,000 shares of the Company's restricted common
stock. In return, Tatko granted the Company a five-year option to purchase 20%
of Tatko's outstanding capital stock. Tatko has since refused to collaborate on
the agreement and the Company seeks declaratory relief stating that Tatko is not
entitled to the 100,000 shares of the Company's restricted common stock. The
litigation is still pending at this time.
In addition, Tatko filed its own suit on September 24, 2004 in the
Circuit Court of Cook County, Illinois seeking declaratory relief of its
entitlement to the Company's restricted common stock. On May 23, 2005, the Tatko
suit was dismissed with prejudice by the Circuit Court. No amounts have been
recorded as receivable in the Company's consolidated financial statements and no
amount has been accrued as a loss as the outcome of the claim against Tatko is
not determinable.
On January 12, 2005, we filed a lawsuit in the Court of the Queen's
Bench of Alberta, in which our subsidiary, Flexible Ltd., is inter-provincially
registered. We are seeking indeterminate damages resulting from a breach of
contract by Calgary Diecast Corporation ("CDC"). The contract at issue was
22
never completed and our raw materials remain in the possession of CDC. On April
25, 2005, the court ordered a judgment in our favor in the amount of $47,495 and
we intend to collect on this judgment using all available means.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS.
The following exhibits are attached hereto and filed herewith:
NUMBER DESCRIPTION
------ -----------
3.1 Amended and Restated Certificate of Incorporation of the registrant.
(1)
3.2 Bylaws of the registrant. (1)
31.1 Certification of Principal Executive Officer Pursuant to ss.302 of the
Sarbanes-Oxley Act of 2002.*
31.2 Certification of Principal Financial Officer Pursuant to ss.302 of the
Sarbanes-Oxley Act of 2002.*
32.1 Certification of Principal Executive Officer Pursuant to 18 U.S.C.
ss.1350 and ss.906 of the Sarbanes-Oxley Act of 2002.*
32.2 Certification of Principal Financial Officer Pursuant to 18 U.S.C.
ss.1350 and ss.906 of the Sarbanes-Oxley Act of 2002.*
--------------
* Filed herewith.
(1) Incorporated by reference to the registrant's Registration
Statement on Form 10-SB (SEC File. No. 000-29649) filed February 22, 2000.
23
SIGNATURES
In accordance with the requirements of Section 13 or 15(d) of the
Exchange Act, the registrant caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
Dated: May 15, 2006.
FLEXIBLE SOLUTIONS INTERNATIONAL, INC.
By: /s/ DANIEL B. O'BRIEN
-----------------------
Name: Daniel B. O'Brien
Title: President and Chief Executive Officer
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