Fuel Tech, Inc. — Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2014. The unaudited results cover Fuel Tech’s Air Pollution Control (APC) and FUEL CHEM technology segments. Fuel Tech provides boiler optimization, efficiency improvement, and air-pollution-control solutions worldwide. Amounts are in thousands, except per-share data.
Financial Results and Position
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Revenue | $21,482 | $33,555 | $60,333 | $85,131 |
| Operating income (loss) | $1,441 | $5,335 | $(367) | $7,504 |
| Net income (loss) | $1,192 | $3,480 | $(614) | $4,695 |
| Diluted EPS | $0.05 | $0.15 | $(0.03) | $0.21 |
| Gross margin | 46% | 44% | 45% | 43% |
- Revenue: Q3 revenue declined 36% year over year; nine-month revenue declined 29%.
- Segment revenue: APC revenue was $11,140 in Q3 and $33,178 for nine months, down 52% and 41%, respectively. FUEL CHEM revenue was $10,342 in Q3, up 2%, and $27,155 for nine months, down 5%.
- Profitability: Q3 operating income fell to $1,441 from $5,335, while nine-month operations produced a $367 loss compared with $7,504 of operating income in the prior-year period. SG&A declined in dollars but increased to 38% of Q3 revenue and 43% of nine-month revenue because of lower sales.
- Cash flow: Operating activities generated $1,403 in the first nine months, compared with $616 used in the prior-year period. Investing activities used $13,230, including $8,079 for acquisitions, $3,010 for Carbonite intellectual property, and $2,141 for equipment and patents.
- Liquidity: Cash and cash equivalents were $15,543 at September 30, down from $27,738 at December 31, 2013. Including marketable securities, liquidity was $15,578. Working capital was $39,446 versus $48,619 at year-end.
- Debt and credit: Short-term debt was $1,624, consisting of borrowings by the Beijing subsidiary. There were no borrowings under the domestic revolving facility. Approximately $6,738 remained available domestically and $3,635 under the China facility. The company was in compliance with all financial covenants.
- Balance sheet: Total assets were $109,942 and shareholders’ equity was $89,233 at September 30. Goodwill increased to $26,139 and other intangible assets to $10,616, primarily from acquisitions and purchased intellectual property.
Material Changes Versus Prior Comparable Period
- APC revenue and backlog weakened materially. APC backlog was $19,557 at September 30, 2014, versus $33,389 a year earlier, comprising $12,788 of domestic and $6,769 of international projects.
- FUEL CHEM revenue was comparatively stable in the quarter but remained pressured over nine months by soft electricity demand, low natural-gas prices, fuel switching, unscheduled outages, and lower plant utilization.
- Gross margins improved on a consolidated basis, but APC nine-month gross margin declined to 36% from 38%; FUEL CHEM nine-month gross margin remained 53%.
- Fuel Tech acquired PECO and FGC on April 30, 2014 for net cash consideration of $8,079. The businesses contributed $3,493 of revenue and $837 of pretax income after acquisition through September 30. Purchase-price allocations remained preliminary.
- On September 18, 2014, Fuel Tech purchased Carbonite fuel-conversion intellectual property and know-how for $3,010.
- Foreign-currency translation reduced comprehensive results by $493 for the nine-month period, compared with a $439 benefit in the prior-year period.
Guidance, Outlook, Risks, and Unusual Items
- Management projected a consolidated 2014 effective tax rate of approximately 20%, below the 34% federal statutory rate because of credits, permanent items, and foreign losses without related tax benefits.
- Management expects to continue developing new commercial applications and technologies, but the filing does not provide revenue, earnings, or backlog guidance.
- The business is materially dependent on worldwide air-quality regulations and enforcement. Demand is also affected by utility operating levels, electricity demand, natural-gas prices, fuel switching, and project timing.
- Acquisition accounting for PECO and FGC was provisional. Final valuations could materially change goodwill, identifiable intangible assets, liabilities, amortization, and future results.
- Domestic and China facilities contain cross-default provisions. Letters of credit and bank guarantees totaled approximately $8,262 domestically and $427 in China at September 30; Fuel Tech must reimburse issuing banks for payments under these instruments.
- One contract in progress was identified as a loss contract, with a $16 provision recorded. Unbilled receivables were approximately $11,458.
- Warranty liability declined to $432 from $596 at year-end. No material litigation was reported, and management stated that risk factors had not materially changed from the 2013 Form 10-K.
- Disclosure controls were deemed effective. The company continued modifying control documentation and procedures following implementation of new Epicor ERP modules.
Investor Verification Items
- Verify the sustainability and conversion of the reduced APC backlog and the timing of new project awards.
- Assess whether the PECO and FGC acquisitions deliver expected synergies and whether the preliminary purchase-price allocation changes.
- Monitor cash usage following acquisitions, intellectual-property purchases, and capital expenditures.
- Review the maturity and covenant terms of the domestic and China credit facilities, including guarantees and cross-default exposure.
- Evaluate the effect of low natural-gas prices, weak electricity demand, fuel switching, and utility outages on FUEL CHEM demand.
- Confirm the final 2014 effective tax rate and any effects from foreign losses, tax credits, and unrecognized tax benefits.
- Reconcile reported margins and profitability with the company’s percentage-of-completion and completed-contract revenue recognition policies.