Fuel Tech, Inc. 2018 Second-Quarter Form 10-Q Summary
Business context and reporting period
Fuel Tech provides engineered solutions for combustion optimization, including Air Pollution Control (APC) technologies that reduce nitrogen oxide emissions and the FUEL CHEM program, which uses chemical and modeling technologies to improve boiler efficiency and reliability. The filing covers the three and six months ended June 30, 2018. The company’s results are materially dependent on air-quality regulations, particularly in the United States.
Fuel Conversion operations were suspended in the second quarter of 2017 and are reported as discontinued operations. The company had 24.2 million common shares outstanding as of July 31, 2018.
Financial performance and position
| Metric | Three months ended June 30, 2018 | Three months ended June 30, 2017 | Six months ended June 30, 2018 | Six months ended June 30, 2017 |
|---|---|---|---|---|
| Revenue | $11.847 million | $9.741 million | $24.638 million | $18.232 million |
| Gross profit | $3.722 million | $3.625 million | $8.747 million | $7.347 million |
| Gross margin | 31% | 37% | 36% | 40% |
| Operating loss from continuing operations | $1.619 million | $5.601 million | $1.803 million | $7.378 million |
| Net loss | $1.753 million | $6.854 million | $1.969 million | $9.360 million |
| Basic and diluted loss per share | $0.07 | $0.29 | $0.08 | $0.39 |
APC revenue increased 52% in the quarter and 78% year to date, to $8.407 million and $16.990 million, respectively. FUEL CHEM revenue declined 18% in the quarter and 12% year to date, to $3.440 million and $7.648 million. Management attributed the APC increase primarily to project execution timing and the conversion of new orders announced during 2017. FUEL CHEM remained pressured by soft electric demand, low natural-gas prices, fuel switching, unscheduled outages and lower plant utilization.
Six-month cash flow from operations was an outflow of $3.512 million, including $3.469 million from continuing operations. Investing activities used $212 thousand, primarily for equipment and patents, and financing activities used $13 thousand for employee tax withholding related to vested equity awards. Total cash, cash equivalents and restricted cash declined from $14.386 million at December 31, 2017 to $10.432 million at June 30, 2018.
At June 30, 2018, unrestricted cash and cash equivalents were $3.912 million, restricted cash was $6.520 million, and working capital was $22.243 million. Total assets were $46.957 million and shareholders’ equity was $32.421 million. The company reported no outstanding borrowings under its domestic or China credit facilities.
The domestic facility provided up to $5.5 million through August 31, 2018 and $5.0 million thereafter through its June 28, 2019 maturity date. Approximately $4.936 million of standby letters of credit and bank guarantees were outstanding under the domestic facility, leaving approximately $564 thousand available for future borrowings. The China facility provided approximately $793 thousand, with $167 thousand of letters of credit and guarantees outstanding and approximately $626 thousand available.
Material changes versus the prior comparable period
- Revenue increased 22% in the second quarter and 35% for the first six months, driven by APC project activity.
- Gross margin declined because of business mix, project mix and project-execution timing. APC six-month margin was unchanged at 30%, while FUEL CHEM six-month margin decreased to 48% from 51%.
- SG&A declined 20% in the quarter and 13% year to date, primarily from lower employee-related costs. SG&A represented 40% of quarterly revenue and 39% of six-month revenue, compared with 61% in both prior-year periods.
- Operating and net losses improved substantially, partly because the prior-year periods included a $2.965 million building impairment charge, higher stock-based compensation and restructuring costs.
- Discontinued-operations losses decreased to $74 thousand in the quarter and $99 thousand year to date, compared with $1.269 million and $1.999 million, respectively, in 2017. The 2018 quarter included a $56 thousand impairment charge related to Carbonite patent assets.
- The company recorded a $317 thousand abandonment charge for international patent assets that it elected not to maintain because of limited business opportunities.
- APC backlog declined to $14.417 million at June 30, 2018 from $22.053 million at December 31, 2017. Approximately $12.652 million of remaining performance obligations was expected to be recognized over the following 12 months.
Guidance, outlook, risks and unusual items
Management projected a 0% consolidated effective tax rate for 2018 because of a full valuation allowance on deferred tax assets and the company’s inability to predict when sufficient taxable income will be available to use them. No specific revenue or earnings guidance was provided.
Management stated that current cash and working capital were sufficient to operate the APC and FUEL CHEM businesses, while noting that continued operations depend on securing new APC orders and executing existing APC projects within budget. The company has eliminated approximately $19 million of aggregate expenses over the prior three years through headcount and other operating-cost reductions.
A China project prime contractor received notice of a potential approximately $920 thousand liquidated-damages deduction related to project delays. The matter was in preliminary negotiations, and the company could not predict the outcome or estimate a loss range. Fuel Tech intends to pursue its rights if negotiations are unsuccessful.
Seven construction contracts were identified as loss contracts at June 30, 2018, with a $264 thousand provision recorded, compared with four contracts and a $117 thousand provision at December 31, 2017. The company also had $159 thousand of warranty liability, with no change during the first six months.
Fuel Tech adopted ASC 606 revenue recognition and the restricted-cash cash-flow standard on January 1, 2018. The ASC 606 adoption reduced other accrued liabilities by $205 thousand and increased accumulated deficit by the same amount at adoption. The filing states that prior periods were not adjusted, which may affect comparability.
Key risks include continued operating losses and negative operating cash flow, dependence on regulatory demand and APC order wins, lower FUEL CHEM utilization, project execution and performance-guarantee exposure, restricted cash collateral requirements, standby-letter-of-credit obligations, foreign-currency fluctuations and the potential impact of future lease accounting. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether APC backlog conversion and new orders can offset the decline from $22.053 million at year-end 2017 to $14.417 million at June 30, 2018.
- Whether the company can reduce or eliminate recurring operating cash burn while remaining dependent on APC project wins and execution.
- The status and potential financial exposure of the approximately $920 thousand China liquidated-damages claim.
- The liquidity impact of $6.520 million of restricted cash and approximately $5.103 million of outstanding domestic and China letters of credit and guarantees.
- Whether FUEL CHEM demand improves from conditions associated with low natural-gas prices, fuel switching and reduced power-plant utilization.
- The ultimate recoverability of assets held for sale and the remaining costs of winding down Fuel Conversion operations.
- The effect of ASC 606 adoption and non-comparable prior-period revenue presentation on reported trends.