Fuel Tech, Inc. — Form 10-Q Summary
Business Context and Reporting Period
Fuel Tech provides boiler optimization, efficiency improvement, and air-pollution-control technologies, primarily through its Air Pollution Control (APC) and FUEL CHEM segments. This unaudited quarterly report covers the three- and six-month periods ended June 30, 2012, compared with the corresponding 2011 periods.
Key Financial Metrics
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Revenue | $20.9 million | $19.0 million | $46.1 million | $41.6 million |
| Gross profit | $9.0 million | $8.5 million | $21.0 million | $19.6 million |
| Gross margin | 43.2% | 44.5% | 45.6% | 47.1% |
| Operating income | $0.2 million | $0.9 million | $2.7 million | $3.7 million |
| Net income | $0.1 million | $0.4 million | $1.6 million | $1.8 million |
| Diluted EPS | $0.00 | $0.02 | $0.07 | $0.07 |
| Net cash from operations | Not separately provided | Not separately provided | $5.3 million | $0.9 million |
Q2 operating margin was approximately 0.9%, versus 5.0% in the prior-year quarter. Six-month operating margin was approximately 5.8%, versus 9.0% in 2011. Income tax expense was $39 thousand in Q2 and $984 thousand for the six-month period; management projected a 38% consolidated effective tax rate for 2012.
- APC revenue increased 33% in Q2 and 38% year to date, to $12.8 million and $28.5 million, respectively. APC backlog was $20.1 million at June 30, 2012, including $7.7 million domestic and $12.4 million international projects.
- FUEL CHEM revenue decreased 14% in Q2 and 16% year to date, to $8.1 million and $17.6 million, respectively.
- Cash and cash equivalents totaled $24.7 million at June 30, 2012, compared with $28.2 million at December 31, 2011. Cash and short-term investments totaled $24.8 million, and working capital was $38.5 million versus $43.6 million at year-end.
- Total assets were $100.1 million and shareholders’ equity was $83.9 million at June 30, 2012.
- Short-term debt was $1.2 million, consisting of borrowings under the China facility. There were no domestic revolving-facility borrowings. Domestic and China facilities had approximately $13.0 million and $4.0 million, respectively, available for future borrowing.
Material Changes Versus the Prior Comparable Period
- Revenue increased 10% in Q2 and 11% for the six-month period, driven by APC construction projects and prior bookings.
- Overall profitability declined despite higher revenue. Cost of sales as a percentage of revenue increased to 57% from 55% in Q2 and to 54% from 53% year to date.
- APC margins weakened because of a greater proportion of lower-margin foreign projects. FUEL CHEM margins improved because of customer-order mix and the absence of certain low-margin installation work recognized in 2011.
- FUEL CHEM revenue was pressured by soft electric demand, fuel switching to lower-priced natural gas, unscheduled outages, and lower operating levels at coal-fired units. The 2011 comparison also included $2.7 million of non-recurring low-margin installation revenue.
- Research and development expense increased to $969 thousand in Q2 and $1.5 million year to date, compared with $315 thousand and $717 thousand, respectively.
- Prior-year results included a $758 thousand gain from revaluation of the ACT contingent consideration liability; no such gain occurred in 2012.
- The company repurchased 1.1 million shares for $5.3 million during Q2 and 2.2 million shares for $11.3 million cumulatively under its repurchase programs. Shares outstanding declined to 22.2 million at June 30, 2012.
Cash Flow, Debt, Liquidity, and Other Items
- Six-month operating cash flow of $5.3 million was primarily supported by $8.6 million of accounts-receivable collections, partly offset by $7.5 million of payments of accounts payable and accrued liabilities.
- Investing cash use was $1.7 million, principally for property, equipment, and patent purchases. Financing cash use was $7.2 million for share repurchases.
- The domestic unsecured revolving facility had a $15.0 million borrowing base, with maturity through June 30, 2013, and no cash borrowings at quarter-end. Standby letters of credit and bank guarantees totaled $2.0 million domestically and $0.4 million in China.
- The company was in compliance with its debt covenants at June 30, 2012. Cross-default provisions could permit acceleration if either facility were in default.
- One loss contract in progress had an estimated loss of $657 thousand. Product warranty liability increased to $515 thousand from $313 thousand at the beginning of 2012.
Guidance, Outlook, Commentary, and Risks
- Management expected APC demand to grow as U.S. and international air-quality compliance deadlines take effect over the next three years. A substantial portion of APC backlog was expected to be recognized in fiscal 2012, although timing depends on project cost incurrence.
- Near-term growth was expected to depend on adoption of TIFI technology, compliance with NOx regulations, and expansion in non-U.S. markets.
- Management expected liquidity requirements to be met by operating results. No formal revenue or earnings guidance was provided beyond the projected 38% effective tax rate.
- The business is materially dependent on the existence and enforcement of worldwide air-quality regulations. Other risks include project timing and margins, customer acceptance and performance guarantees, weak electric demand, fuel switching, foreign currency exposure, and interest-rate changes.
- Fuel Tech does not hedge foreign-currency exposure because management considers the transactions immaterial. A hypothetical 100-basis-point adverse interest-rate movement was not expected to materially affect 2012 interest expense.
- In China-related litigation, two patents associated with the ULTRA product line were invalidated by the Chinese Patent Review Board; Fuel Tech intended to appeal. Management did not then believe the proceedings would materially adversely affect the China business.
- Management reported effective disclosure controls, with no material change in internal control over financial reporting.
Important Facts for Investors to Verify
- Whether APC backlog converts to revenue and cash flow as expected during the remainder of 2012, particularly the $12.4 million international component.
- Whether FUEL CHEM customer attrition, low natural-gas prices, and reduced coal-unit utilization continue to pressure revenue.
- Whether APC project mix and foreign projects continue to reduce gross margins.
- The cash impact and remaining authorization of the share-repurchase program, which had $710 thousand remaining at June 30, 2012.
- Compliance with revolving-credit covenants and the potential effect of standby letters of credit, bank guarantees, and cross-default provisions.
- The outcome of the Chinese patent appeal and related litigation.
- The company’s ability to fund continued R&D, capital expenditures, and working-capital needs while maintaining liquidity.