Fuel Tech, Inc. — Form 10-Q Summary
Business Context and Reporting Period
Fuel Tech provides air-pollution-control, boiler-optimization, efficiency-improvement, and combustion-chemical solutions through its Air Pollution Control (APC) and FUEL CHEM technology segments. This unaudited Form 10-Q covers the three and nine months ended September 30, 2013, filed November 12, 2013. The company had 22.4 million common shares outstanding as of November 12, 2013.
Key Financial Metrics
| Metric | Three Months Ended September 30, 2013 | Prior Year | Nine Months Ended September 30, 2013 | Prior Year |
|---|---|---|---|---|
| Revenue | $33.6 million | $24.9 million | $85.1 million | $71.0 million |
| Gross profit | $15.1 million | $10.2 million | $36.4 million | $31.3 million |
| Gross margin | 45% | 41% | 43% | 44% |
| Operating income | $5.3 million | $1.6 million | $7.5 million | $4.3 million |
| Operating margin | 15.9% | 6.4% | 8.8% | 6.0% |
| Net income | $3.5 million | $1.2 million | $4.7 million | $2.8 million |
| Diluted EPS | $0.15 | $0.05 | $0.21 | $0.12 |
APC revenue was $23.4 million in the quarter and $56.6 million year to date, while FUEL CHEM revenue was $10.1 million and $28.5 million, respectively. The APC segment benefited from progress on international and domestic projects, particularly a large Chilean project.
Operating cash flow was negative $0.6 million for the first nine months, compared with positive $6.5 million in the prior-year period. The principal use of cash was a $13.3 million increase in accounts receivable. Capital expenditures and patent purchases used $1.6 million. Ending cash and cash equivalents were $23.7 million, compared with $24.5 million at December 31, 2012; cash plus short-term investments was approximately $23.7 million.
Working capital was $46.4 million at September 30, 2013, compared with $38.9 million at year-end 2012. Accounts receivable increased to $43.4 million from $30.2 million, including $22.6 million of unbilled receivables related to percentage-of-completion contracts.
Total debt was $1.6 million, consisting of borrowings under the China facility. The domestic revolving facility had no cash borrowings, approximately $8.1 million of availability, and $6.9 million of outstanding standby letters of credit and bank guarantees. The China facility had approximately $3.3 million of availability and $0.8 million of standby letters of credit and guarantees. The company reported compliance with all financial covenants.
Material Changes Versus the Prior Comparable Period
- Third-quarter revenue increased 35%; nine-month revenue increased 20%.
- Third-quarter operating income increased to $5.3 million from $1.6 million, and net income increased to $3.5 million from $1.2 million.
- APC revenue increased 52% in the quarter and 29% year to date, while FUEL CHEM revenue increased 7% and 5%, respectively.
- Third-quarter consolidated gross margin improved to 45% from 41%, primarily because of a greater concentration of higher-margin domestic APC projects. Year-to-date gross margin declined to 43% from 44% because of a greater proportion of lower-margin foreign projects.
- SG&A increased in dollars but declined as a percentage of revenue to 28% from 32% in the quarter and to 32% from 35% year to date.
- APC backlog declined to $33.4 million from $52.3 million at September 30, 2012; current backlog included $7.7 million of U.S. projects and $25.7 million of international projects.
- Operating cash flow shifted from positive $6.5 million to negative $0.6 million, principally due to higher receivables.
- The company amended its domestic revolving credit facility to extend maturity through June 30, 2015 and initiated a new China revolving facility that replaced the prior facility.
Guidance, Outlook, Risks, and Unusual Items
Management projected a consolidated effective tax rate of approximately 35% for 2013. The filing does not provide specific revenue or earnings guidance. Management expected continued research and development focused on commercial applications outside traditional markets and new technology opportunities.
- FUEL CHEM demand remained affected by soft electricity demand, low natural-gas prices, fuel switching, unscheduled outages, and lower utilization of coal-fired units.
- The business is materially dependent on the continued existence and enforcement of worldwide air-quality regulations.
- APC contracts generally run eight to sixteen months and use percentage-of-completion accounting, creating exposure to project execution, estimated-cost revisions, customer acceptance, performance guarantees, and collection timing.
- The company recognized a $0.5 million bad-debt expense for the first nine months and had materially higher unbilled receivables.
- The company increased its accrual for unrecognized tax benefits from $42,000 at December 31, 2012 to $104,000, related to an uncertain 2012 R&D tax-credit position.
- A property owner asserted that environmental conditions may exist at a Connecticut industrial property previously leased by the company and a subsidiary. Fuel Tech had not accrued a liability because it could not assess the likelihood or amount of a potential loss.
- Product warranty liability increased to $0.9 million from $0.8 million at year-end.
- Cross-default provisions apply between the domestic and China credit facilities. A covenant breach and acceleration could adversely affect liquidity.
- Foreign-currency exposure exists, but the company does not use hedging contracts because management considers the transactions immaterial. A hypothetical 100-basis-point interest-rate increase was not expected to materially affect near-term interest expense.
Investor Verification Points
- Verify collection and aging of the $43.4 million accounts receivable balance, including $22.6 million of unbilled receivables.
- Assess whether the $33.4 million APC backlog and large Chilean project can support revenue and margin levels after 2013.
- Monitor FUEL CHEM exposure to low natural-gas prices, coal-plant utilization, and electricity demand.
- Review performance guarantees, standby letters of credit, bank guarantees, warranty reserves, and potential environmental liabilities.
- Confirm compliance with revolving-credit covenants and the availability of domestic and China borrowing capacity.
- Evaluate the sustainability of reported margins given the mix shift toward international APC projects.