Business Context and Reporting Period
Fuel Tech, Inc. filed this unaudited Form 10-Q for the three months ended March 31, 2012. The company provides boiler optimization, efficiency improvement, nitrogen oxide reduction, air pollution control, and FUEL CHEM chemical-treatment technologies to utility and industrial customers worldwide.
Reportable segments are Air Pollution Control (APC) and FUEL CHEM. The filing was signed on May 8, 2012.
Key Financial Metrics
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Revenue | $25.212 million | $22.622 million | 11% increase |
| Gross profit | $11.992 million | $11.156 million | 7% increase |
| Gross margin | 47.6% | 49.3% | Down approximately 170 bps |
| Operating income | $2.492 million | $2.803 million | 11% decrease |
| Operating margin | 9.9% | 12.4% | Down approximately 250 bps |
| Net income | $1.543 million | $1.339 million | 15% increase |
| Diluted EPS | $0.06 | $0.05 | Increase |
| Cash flow from operations | $5.475 million | $(1.929) million | Improved by $7.404 million |
Cash and cash equivalents were $31.055 million at March 31, 2012, compared with $28.229 million at December 31, 2011. Working capital was approximately $43.473 million at March 31, 2012, compared with $43.626 million at year-end 2011. The company used $0.788 million for capital expenditures and patent purchases and $1.889 million to repurchase common stock.
Total assets were $107.114 million and total liabilities were $18.188 million at March 31, 2012. Short-term debt was $1.188 million, consisting of borrowings by the company’s Beijing subsidiary. The domestic revolving credit facility had no cash borrowings, approximately $12.946 million available capacity, and $2.054 million of outstanding letters of credit and bank guarantees. The China facility had approximately $3.890 million available capacity, $1.188 million of borrowings, and $0.467 million of letters of credit and bank guarantees.
Material Changes Versus the Prior Comparable Period
- APC revenue increased 42% to $15.714 million, reflecting higher contract bookings in the third and fourth quarters of 2011 and progress on construction projects.
- FUEL CHEM revenue decreased 18% to $9.498 million. Management attributed the decline to customer attrition, soft electric demand, low natural-gas prices, unscheduled outages, and lower operating utilization. Q1 2011 also included approximately $1.0 million of nonrecurring, low-margin installation work.
- APC backlog increased to $22.2 million at March 31, 2012, from $14.5 million at March 31, 2011. Approximately $16.5 million was domestic and $5.7 million was international; most was expected to be recognized during 2012, subject to project execution and expense timing.
- Cost of sales increased to 52% of revenue from 51%, primarily because APC cost of sales increased to 56% from 50% due to product mix. FUEL CHEM cost of sales improved to 47% from 51%.
- SG&A increased 13% to $8.994 million, driven by employee costs, commissions and bonuses, and consulting and professional fees. These increases were partly offset by a $0.427 million decline in stock-based compensation.
- Operating income declined despite higher revenue because SG&A and research and development expenses grew faster than gross profit.
- Net income increased partly because income-tax expense declined to $0.945 million from $1.385 million. The effective tax rate decreased to 38.0% from 50.8%.
- Accounts receivable declined by approximately $8.0 million from year-end, contributing to operating cash flow. Unbilled receivables increased to $12.685 million from $7.262 million.
- The company completed its share repurchase program, buying 334,636 shares for $1.889 million during the quarter and 1,036,350 shares for approximately $6.0 million since program inception. Repurchased shares were retired.
Outlook, Risks, Contingencies, and Unusual Items
Management expected near-term growth to depend on adoption of FUEL CHEM TIFI technology in the utility market, compliance with domestic nitrogen-oxide regulations, and expansion of both segments internationally. The company projected a consolidated 2012 effective tax rate of 38.0% and expected liquidity needs to be met by operating results.
- APC demand depends materially on the continued existence and enforcement of air-quality regulations.
- FUEL CHEM results are sensitive to electric demand, natural-gas prices, plant utilization, customer retention, and unscheduled outages.
- The domestic facility matures June 30, 2013; the China facility expires June 29, 2012. Both facilities contain cross-default provisions. The company was in compliance with all financial covenants at March 31, 2012.
- One contract in progress was identified as a loss contract, resulting in a $38,000 provision during the quarter.
- Warranty liability was $333,000 at March 31, 2012, compared with $212,000 at March 31, 2011.
- Fuel Tech was involved in Chinese litigation concerning alleged unfair competition, trade-secret misappropriation, and patent ownership or validity. Management did not believe the matters would have a material adverse effect based on the information available.
- The company reported no material change in previously disclosed risk factors, no material litigation adverse outcome expected, and no indications of goodwill or intangible-asset impairment.
- Foreign-exchange exposure is not hedged because management considers the transactions immaterial. A hypothetical 100-basis-point adverse interest-rate movement was not expected to materially affect 2012 interest expense.
Important Facts for Investors to Verify
- Whether the $22.2 million APC backlog converts to revenue as expected during 2012 and whether project mix improves APC margins.
- Whether FUEL CHEM customer attrition and lower utility utilization persist, particularly in the context of electric demand and natural-gas prices.
- The renewal, replacement, or expiration status of the China credit facility after June 29, 2012.
- The ability to maintain covenant compliance while supporting letters of credit, bank guarantees, capital spending, and working-capital needs.
- The collectability and timing of the $12.685 million of unbilled receivables and the related percentage-of-completion estimates.
- Whether warranty claims, the loss-contract provision, Chinese litigation, or patent challenges produce costs above management’s current assessment.
- Whether the 38.0% projected 2012 effective tax rate is achieved and whether the company’s improved operating cash flow is sustainable.