Update: Kelso Q3 Earnings

As expected, Kelso has a lackluster Q3 with revenues coming in at $4.4M which was very close to my expectation of $4.5M. However, I didn't expect a net income loss and severe gross margin compression. I still believe these are temporary issues. I will first start by listing the excerpts of significance from the MD&A and then I will give my comments.

  • Despite the poor economy Kelso is confident that the demand for its current products and new product offerings will continue to improve revenue gains in future periods. Indicators in the rail industry suggest that the demand for new tank car builds and mandatory retrofit activity will grow steadily during through 2018 and should provide Kelso with growth in sales revenue.
  • These factors have caused a significant slowdown in demand for our products in 2015. This trend is likely to extend into early 2016
  • The Company has experienced cost increases for raw materials, lo wer prices for competitive products and increased product liability insurance resulting in gross prof it returns of 16.9% for the three months ended September 30, 2015 compared to 47.25% for the three months ended September 30, 2014. The severe diminishments in gross profit results were expected due to the startup inefficiencies of our KKM production system. The Company is working on new production methods to minimize cost of goods sold and economies of larger production for KKM to improve overall profit margins.
  • Originally scheduled for January 2015 the delayed PHMSA regulations have proven problematic to the owners of rail tank cars. After much cost benefit analysis the retr ofit option for most owners is cost prohibitive and makes no financial sense. It appears that the retrofit “bonan za” will not occur as expected. Instead, there may be a new build boom on the horizon as the majority of existing DOT-111 tank cars will most likely be re-purposed or scrapped in favor of new tank cars. Both options are good for the long term benefit of the Company

  • In response to the emerging negative environment Kels o realigned its business model early in 2015 to weather this sharp downturn in tank car activity. Our research and product development initiatives and service trials remain on schedule. We are looking at measures to re duce operating costs without harming our effectiveness, performance and long-term profitability. When markets improve our goal is to be positioned to supply our customers with a broader range of products. Despite the negatives associated with deteriorating ge neral economic conditions and crippling oil prices our financial health and ability to conduct business remains strong. Our capital needs continue to be financed from operations and there is no interest bearing debt to service. Going forward we have positioned the Company to capitalize on many new business opportunities for our products. We will continue to develop our business capabilities to improve our financial performance as railway markets improve in the future

Based on the MD&A, I remain assured about the future success ahead of the company, but I acknowledge the fact that it will take time which is why I made the recommendation in the past to hold off on buying. Unfortunately, Kelso is part of a cyclical industry (the railroad industry obviously) and they can't avoid it's up and downs -- the can however reduce their dependence on it by getting into the trucking market, one of their current goals. Therefore, management is currently focusing on getting new products through their trials and focusing on R&D so that when the market improves they will be able to really capitalize on the opportunity. That's really the only thing they should be doing at this time anyways. They don't have any debt to service and their operations still fund their capital needs which is what matters. When the market will improve, the revenue growth should be explosive along with the profits, as has been shown in the past. Here's a quote from the MD&A which drives the point home about explosive revenue and profit growth in good times: "Management has successfully implemented its initia l business plans and established multi-million dollar sales of its products to North American ra il tank car manufacturer s (OEM) and retrofit/repair businesses. In accordance with the establis hed business development goals revenues have grown Kelso Technologies Inc. steadily over the last five audited year end periods as follows: $23,816,809 for the year ended December 31, 2014; $13,131,387 for the year ended December 31, 2013; $2,830,778 for the four month year ended December 31, 2012; $2,233,8 07 for the year ended August 31, 2012; and $1,326,024 for the year ended August 31, 2011".