Fuel Tech, Inc. — Fiscal 2016 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2016; filing dated March 14, 2017. The filing also presents unaudited fourth-quarter results. Fuel Tech develops and sells air-pollution-control technologies, FUEL CHEM combustion-treatment programs, and development-stage Fuel Conversion products.
Business Context
- Air Pollution Control (APC): NOx-reduction, SCR/SNCR, burner, electrostatic precipitator, flue-gas-conditioning and related engineering services.
- FUEL CHEM: Specialty chemical injection programs intended to improve combustion efficiency and control slagging, fouling, corrosion, opacity and sulfur-trioxide-related issues.
- Fuel Conversion: Development-stage CARBONITE technology intended to produce engineered carbon feedstock products. No material commercial revenue had been generated.
- Demand is materially influenced by coal-fired generation, environmental regulations, utility capital spending, fuel switching and natural-gas prices. The company had 146 employees at December 31, 2016.
Financial Performance and Metrics
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Revenue | $55.2 million | $73.7 million | Down 25% |
| Gross profit | $18.8 million | $28.6 million | Down 34% |
| Gross margin | 34% | 39% | Down 5 percentage points |
| Operating loss | $14.8 million | $8.3 million | Loss increased |
| Net loss | $17.4 million | $12.4 million | Loss increased |
| Loss per diluted share | $0.74 | $0.54 | Loss increased |
| Cash flow from operations | $(2.7) million | $6.9 million | Declined $9.7 million |
- APC revenue was $34.1 million, down 22% from $43.5 million. APC gross margin was 25%, compared with 30% in 2015; excluding identified subcontractor-dispute and inventory-reserve charges, management stated the margin would have been approximately 28%.
- FUEL CHEM revenue was $21.1 million, down 30% from $30.2 million. Reported segment gross margin was 48%, compared with 52%; excluding the inventory-reserve impact, management stated the margin would have been approximately 51%.
- U.S. revenue declined 17% to $42.5 million, while international revenue declined 43% to $12.6 million. International revenue represented 23% of total revenue, versus 30% in 2015.
- Fourth-quarter revenue was $9.6 million, compared with $18.2 million in the prior-year quarter. Fourth-quarter net loss was $9.1 million, or $0.39 per diluted share, compared with a $9.1 million loss, or $0.39 per share, in fourth-quarter 2015.
- SG&A decreased to $25.6 million from $30.9 million. R&D increased to $4.6 million, including $2.8 million related to Fuel Conversion. Restructuring charges increased to $1.4 million from $0.2 million.
- 2016 included a $2.1 million impairment of APC finite-lived intangible assets, a $0.8 million excess and obsolete inventory reserve, and a $1.2 million settlement accrual related to an APC subcontractor dispute.
Liquidity, Capital Structure and Cash Flow
- Cash and cash equivalents were $11.8 million at year-end, compared with $21.7 million in 2015. Including $6.0 million of restricted cash, total cash was approximately $17.8 million.
- Working capital was $26.6 million, down from $35.9 million. Total assets were $57.8 million and total liabilities were $14.4 million.
- There were no cash borrowings under the domestic or China revolving facilities. Domestic availability was approximately $1.7 million after outstanding letters of credit; China availability was approximately $0.9 million.
- The domestic facility had been reduced to $5.0 million and became fully cash-collateralized. The facility was scheduled to mature June 30, 2017, and management stated that it intended to renew it.
- Operating activities used $2.7 million; investing activities used $0.9 million, primarily for equipment, patents and other intangible assets; financing activities used $6.2 million, primarily because $6.0 million was transferred to restricted cash.
- Outstanding performance-related commitments included $3.3 million of standby letters of credit and bank guarantees and $4.6 million of performance surety bonds. Future operating lease payments totaled $1.8 million.
Material Changes Versus 2015
- Revenue contracted sharply across both operating technology segments, with the largest decline in international APC activity and FUEL CHEM demand from major customers.
- Backlog fell to $8.0 million at December 31, 2016, from $22.2 million at December 31, 2015. A substantial portion was expected to convert to 2017 revenue, subject to project spending and timing.
- The company reported a larger net loss despite lower SG&A, reflecting lower revenue, weaker margins, restructuring costs, impairment charges and income tax expense.
- Cash generation deteriorated from $6.9 million provided by operations to $2.7 million used by operations.
- Management reduced the workforce in July 2016 and stated that cumulative headcount and operating-cost reductions over the prior two years had eliminated approximately $8 million of annualized expenses.
- The company established a full valuation allowance against deferred tax assets; net deferred tax assets were zero at December 31, 2016.
Outlook, Commentary, Risks and Unusual Items
- Management expected improved U.S. APC order flow in 2017 but acknowledged that new orders depend on customers’ capital-investment decisions and regulatory implementation. Foreign markets remained active bidding opportunities but had not offset U.S. weakness.
- Management believed cash and working capital were sufficient for the base APC and FUEL CHEM businesses, but not sufficient to fully develop Fuel Conversion. Outside funding would be required for full commercialization; availability and terms were uncertain.
- Key risks include continued declines in coal-fired generation, low natural-gas prices, delayed or reduced environmental enforcement, customer concentration, competition, pricing pressure, foreign-currency exposure, intellectual-property challenges and dependence on magnesium hydroxide supply. The primary supply agreement expires December 31, 2017.
- One customer represented 19% of 2016 consolidated revenue, compared with one customer representing 12% in 2015.
- The filing reported no litigation expected to have a material adverse effect. Performance guarantees and surety bonds were not accrued because management believed the related projects would be completed successfully.
- The independent auditor expressed an unqualified opinion on the consolidated financial statements. Management concluded that disclosure controls and internal control over financial reporting were effective as of December 31, 2016.
Important Facts for Investors to Verify
- Whether APC backlog of $8.0 million converts to revenue as expected and whether new 2017 orders improve from the depressed 2016 level.
- Customer concentration, including the identity, financial condition and expected spending of the customer contributing 19% of 2016 revenue.
- Available unrestricted liquidity after accounting for the $6.0 million restricted-cash requirement, foreign cash restrictions and future letters-of-credit collateral needs.
- Renewal terms and availability of the domestic and China credit facilities, both scheduled to mature in 2017.
- Progress, funding requirements and commercialization prospects of the Fuel Conversion business, which had no material commercial revenue.
- Resolution and cash impact of the $1.15 million APC subcontractor settlement, performance guarantees and surety bonds.
- Whether continuing operating losses, intangible-asset impairments and the full deferred-tax valuation allowance indicate further impairment or financing risk.