Business Context and Reporting Period
Fuel Tech, Inc. filed its Form 10-K for the fiscal year ended December 31, 2013, filed March 10, 2014. The company develops and commercializes air-pollution-control and combustion-optimization technologies through two segments: Air Pollution Control (APC), including NOx-reduction systems, and FUEL CHEM, which uses specialty chemicals and targeted injection processes to improve combustion efficiency and control slagging, fouling, corrosion and sulfur-trioxide-related issues.
The filing is an annual report rather than a standalone fourth-quarter filing. Unaudited fourth-quarter 2013 revenue was $24.2 million and net income was $0.4 million, compared with fourth-quarter 2012 revenue of $26.6 million and a net loss of $0.03 million.
Key Financial Metrics
| Metric | 2013 | 2012 | Change |
|---|---|---|---|
| Revenue | $109.3 million | $97.6 million | Up 12% |
| APC revenue | $72.6 million | $62.4 million | Up 16% |
| FUEL CHEM revenue | $36.8 million | $35.2 million | Up 4% |
| Gross profit | $46.8 million | $40.7 million | Up 15% |
| Gross margin | 43% | 42% | Up 1 percentage point |
| Operating income | $8.0 million | $5.2 million | Up 54% |
| Net income | $5.1 million | $2.8 million | Up 84% |
| Diluted EPS | $0.23 | $0.12 | Up $0.11 |
| Cash flow from operations | $2.8 million | $8.7 million | Down $5.8 million |
| Capital expenditures and patent purchases | $1.8 million | $2.5 million | Down $0.8 million |
At December 31, 2013, cash and cash equivalents were $27.7 million, working capital was $48.6 million, total assets were $110.1 million, total liabilities were $21.4 million and stockholders’ equity was $88.6 million. Accounts receivable increased to $37.0 million from $30.2 million, including $12.6 million of unbilled receivables.
Debt was limited primarily to $1.6 million outstanding under the Chinese revolving facility. The company had no cash borrowings under its $15 million domestic revolving facility and approximately $11.5 million of domestic borrowing availability. The company was in compliance with its debt covenants.
Material Changes Versus the Prior Comparable Period
- Revenue growth was driven mainly by APC projects, particularly international orders and work progress in China and Chile. International revenue rose 69% to $46.1 million, representing 42% of consolidated revenue versus 28% in 2012.
- APC gross margin improved to 38% from 36%, principally because of three domestic projects with above-average margins. FUEL CHEM gross margin increased slightly to 53% from 52%.
- SG&A increased 11% to $36.4 million, reflecting international expansion, higher compensation and commissions, increased bad-debt expense and higher stock-based compensation.
- Income tax expense increased to $2.8 million from $2.3 million, while the effective tax rate declined to approximately 35% from 45%.
- Operating cash flow declined substantially because accounts receivable increased by $7.0 million and accounts payable declined by $3.0 million, despite higher net income.
- APC backlog declined to $22.4 million from $46.7 million. Management expected a substantial portion of the year-end 2013 backlog to be recognized in 2014, subject to project spending and timing.
- FUEL CHEM revenue increased modestly, but the segment continued to be affected by weak electric demand, low natural-gas prices, fuel switching and lower utilization of coal-fired units.
Guidance, Outlook, Risks and Unusual Items
Management did not provide quantitative revenue or earnings guidance. It expected near-term growth to depend on penetration of the coal-fired utility market, enforcement of NOx-reduction regulations and expansion in non-U.S. markets, particularly China and other international geographies. Management expected liquidity needs to be met by operating results.
- Regulatory dependence: Demand is materially dependent on adoption and enforcement of environmental regulations. Delays, amendments or reduced enforcement could reduce demand.
- Coal and fuel-transition risk: Fuel switching to natural gas, plant closures, reduced utilization or reduced reliance on fossil fuels could adversely affect both segments, particularly FUEL CHEM.
- Backlog and project execution: APC revenue is recognized partly under percentage-of-completion accounting. Three loss contracts were in progress at year-end, with a $68,000 loss provision.
- Customer concentration: Two customers represented 18% and 14% of 2013 revenue. The loss or reduction of a major customer could materially affect results.
- Receivables and credit risk: The allowance for doubtful accounts increased to $1.2 million from $0.5 million, and the filing identifies a $7.0 million increase in accounts receivable as a major use of operating cash.
- Performance obligations: Bank guarantees and letters of credit supporting construction contracts totaled $4.1 million. Management believed material payments were unlikely, and no liability was recorded.
- Supply risk: FUEL CHEM relies partly on magnesium hydroxide supplied under an agreement extended through December 31, 2016; supply outside the United States remains less certain.
- Foreign-exchange exposure: The company does not use foreign-currency hedging instruments. Foreign operations and currency movements affected results and comprehensive income.
- Intellectual property: The company reported 94 granted patents, six allowed Chinese utility-model patents and 88 pending applications. Certain patents expire beginning in 2014, and protection could be challenged or circumvented.
- Unusual and nonrecurring matters: No 2013 gain was recorded from the ACT contingent consideration liability; a $0.8 million gain had been recorded in 2011. The company also recorded $1.8 million of stock-based compensation expense in 2013.
The independent auditor issued an unqualified opinion on the consolidated financial statements and stated that internal control over financial reporting was effective as of December 31, 2013. No material litigation, unresolved SEC staff comments or other off-balance-sheet transactions were reported beyond the disclosed commitments and guarantees.
Important Facts for Investors to Verify
- Whether the sharply lower APC backlog converts to revenue and cash flow as expected during 2014.
- Collections on the increased accounts receivable balance and whether bad-debt expense remains elevated.
- The timing, renewal and utilization of the Chinese credit facility, which was scheduled to expire June 27, 2014.
- Exposure to coal-plant closures, natural-gas fuel switching and changes in U.S., Chinese and international air-quality regulations.
- Performance of the two large customers representing 32% of 2013 revenue in aggregate.
- Potential cash requirements arising from performance guarantees, letters of credit, warranties and loss-making construction contracts.
- The effect of customer concentration, foreign-exchange movements and the company’s inability to hedge currency exposure.
- The accuracy of percentage-of-completion estimates, goodwill assumptions and the recoverability of deferred tax assets, including the $1.8 million valuation allowance related to Italian tax losses.