Fuel Tech, Inc. 2011 Q3 Form 10-Q Summary
Business context and reporting period
Fuel Tech provides boiler optimization, efficiency improvement, and air-pollution-control technologies to utility and industrial customers worldwide. Its two reportable segments are Air Pollution Control (APC) and FUEL CHEM. This unaudited Form 10-Q covers the three and nine months ended September 30, 2011, with comparisons to the same periods of 2010.
Key financial metrics
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $24.023 million | $20.279 million | $65.666 million | $56.798 million |
| Gross profit | $10.973 million | $8.783 million | $30.597 million | $24.735 million |
| Gross margin | 45.7% | 43.3% | 46.6% | 43.5% |
| Operating income | $2.914 million | $1.479 million | $6.662 million | $1.622 million |
| Operating margin | 12.1% | 7.3% | 10.1% | 2.9% |
| Net income | $2.655 million | $0.817 million | $4.424 million | $0.722 million |
| Net margin | 11.0% | 4.0% | 6.7% | 1.3% |
| Diluted EPS | $0.11 | $0.03 | $0.18 | $0.03 |
Revenue increased 19% in the quarter and 16% year to date. APC revenue increased 19% in both periods, while FUEL CHEM revenue increased 18% in the quarter and 13% year to date. APC backlog was $22.890 million at September 30, 2011, compared with approximately $20.3 million a year earlier.
Cash and cash equivalents were $28.998 million at September 30, 2011, and marketable securities were $0.053 million. Working capital was $41.973 million, compared with $36.645 million at December 31, 2010. Nine-month operating cash flow was $3.064 million, investing cash flow was $(1.698) million, and financing cash flow was $(2.957) million. Capital expenditures and patent purchases totaled $1.700 million.
Short-term debt was $2.343 million, consisting of borrowings under the China facility. The domestic revolving facility had no borrowings and approximately $13.789 million of availability. Total standby letters of credit and bank guarantees were approximately $1.211 million. The company was in compliance with its debt covenants at September 30, 2011.
Material changes versus the prior comparable period
- Revenue growth reflected increased construction-project activity in APC and new and existing customer activity in FUEL CHEM.
- Gross margins improved because of a higher-margin APC project mix. Consolidated cost of sales declined to 54.3% of quarterly revenue from 56.7%, and to 53.4% year to date from 56.5%.
- Operating income benefited from higher revenue and gross profit, relatively stable quarterly SG&A, and the absence of the prior-year comparison issue described below.
- Research and development expense increased to $1.075 million year to date from $0.575 million as the company pursued new technologies and applications outside traditional markets.
- Accounts receivable increased to $27.920 million from $21.175 million at December 31, 2010. Unbilled receivables increased to approximately $10.682 million from $6.800 million.
- Fuel Tech repurchased 571,554 shares during the quarter for approximately $3.367 million, leaving approximately $2.633 million authorized for additional repurchases.
- The company amended its domestic revolving facility, extending maturity to June 30, 2013 while reducing the borrowing base from $25 million to $15 million, subject to a potential increase with lender approval.
Guidance, outlook, risks, contingencies, and unusual items
- Management expects APC demand to grow as increasingly stringent U.S. air-quality requirements, including CSAPR-related compliance, are phased in. Management also expects growth from utility-market penetration of TIFI technology and international expansion.
- Management expected an approximately 30% effective tax rate for 2011, with an ongoing rate excluding discrete items of approximately 38%.
- The company’s business is materially dependent on the continued existence and enforcement of worldwide air-quality regulations. Revenue timing for APC projects depends on project costs incurred and customer acceptance criteria.
- A $0.758 million gain was recorded in the second quarter from revaluation of the ACT acquisition contingent consideration liability; management concluded the 2011 earnout was not probable, leaving no remaining contingent liability. The prior-year period included a similar $0.768 million gain.
- FUEL CHEM 2011 revenue included a non-recurring $1.281 million pass-through sale. FUEL CHEM 2010 revenue included a $1.957 million risk-share payment with no offsetting costs.
- One contract in progress was identified as a loss contract, resulting in a $0.174 million provision in the third quarter.
- Product warranty liability was $0.445 million at September 30, 2011, compared with $0.202 million a year earlier. Outstanding customer guarantees expose the company to reimbursement obligations if issuing banks are required to pay.
- Cross-default provisions in the domestic and China credit facilities could permit acceleration or cancellation following a default. Foreign-currency and interest-rate exposures were considered immaterial by management, and the filing states that a hypothetical 100-basis-point adverse rate movement would not materially affect near-term interest expense.
- No legal proceedings were reported, and management stated that previously disclosed risk factors had not materially changed. Disclosure controls and procedures were deemed effective.
Important facts for investors to verify
- Whether APC backlog converts to revenue and cash flow on the expected schedule, particularly given the increase in unbilled receivables.
- The sustainability of improved gross margins and the impact of project mix on APC profitability.
- Whether expected regulatory-driven demand and TIFI customer adoption produce the projected revenue growth.
- Cash conversion, working-capital requirements, and the effect of share repurchases on liquidity.
- Compliance with the domestic and China credit-facility covenants and renewal of the China facility, which expires June 29, 2012.
- Warranty claims, customer performance guarantees, loss-contract provisions, and other contingent obligations.
- The effect of discrete tax items on the reported 2011 tax rate versus the ongoing expected rate.