Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Results of Operations
Revenues for the three and six month periods ending June 30, 2020 and 2019 were $4,401 and $8,948 , $8,179 and $19,103 respectively, representing a decrease of $4,547 or 51% and $10,924 or 57% versus the same period last year.
The Air Pollution Control (APC) technology segment generated revenues of $1,937 and $3,133 for the three and six month periods ending June 30, 2020 , representing a decrease of $2,866 or 60% and $7,459 or 70% from the prior year amount of $4,803 and $10,592 . The decrease in APC revenue was principally related to timing of project execution and the decline in backlog of $9.7 million at December 31, 2019 versus $12.4 million at December 31, 2018 , resulting from lower new APC orders announced during 2019 and continuing through the first six months of 2020.
Consolidated APC backlog at June 30, 2020 was $8,321 versus backlog at December 31, 2019 of $9,671 . Our current backlog consists of U.S. domestic projects totaling $7,193 and international projects totaling $1,128 .
The FUEL CHEM ® technology segment generated revenues of $2,464 and $5,046 for the three and six months ended June 30, 2020 , representing a decrease of $1,681 or 41% and $3,465 or 41% from the prior year amounts of $4,145 and $8,511 . The decrease in FUEL CHEM revenue for the three and six months ended June 30, 2020 as compared to the same period of the prior year was due to a reduction in demand from power generation, extended unscheduled outages and significantly reduced operations which were largely impacted by the COVID-19 pandemic. We remain focused on attracting new customers in our FUEL CHEM business, for both coal and non-coal applications, and have recently announced a new order for equipment on three new coal-fired units.
Consolidated gross margin percentage for the three and six month periods ended June 30, 2020 and 2019 were 14% and 26% , and 44% and 41% , respectively. Gross margin for the comparable periods are significantly reduced due to the decline in revenues across the segments and the impact of product mix. The decrease in Fuel Chem margins to 40% from 50% and to 41% from 49% for the three and six month periods ended June 30, 2020 and 2019 was a direct result of the decrease in sales volume as several accounts remained offline due to soft electric demand, extended outages, and to the margin mix of customers generating revenue. The decrease in APC gross margin to ( 20% ) and 2% in the three and six months ending June 30, 2020 from 38% and 35% in 2019 is primarily due to $1,150 of charges incurred to remedy a non-conformance issues with a U.S. customer under a warranty provision of the contract.
Selling, general and administrative expenses (SG&A) were $2,755 and $6,641 , and $4,455 and $8,913 respectively for the three and six month periods ended June 30, 2020 and 2019 . For the three and six month periods ended June 30, 2020 the decrease of $1,700 and $2,272 is primarily the result of a reduction in administrative costs relating to foreign subsidiaries of $600 and $950 (largely driven by the suspension of the APC business operation in China), a reduction in administrative costs related to employees of $151 and $185, other administrative costs of $294 and $352 and professional and consulting services of $113 and $190. The reversal of a specific reserve of $499 for allowance of doubtful accounts related to the remedy of the aforementioned warranty nonconformity also contributed to this reduction. SG&A as a percentage of revenues increased to 63% and 81% from 50% and 47% in the three and six month periods ending June 30, 2020 and 2019 . The increase in SG&A percentage is primarily attributed
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to the decrease in revenues due to the timing of project execution as well as lower new APC orders announced during 2019 and 2020.
On January 18, 2019, the Company announced a planned suspension of its APC business operation in China. This action is part of Fuel Tech’s ongoing operational improvement initiatives designed to prioritize resource allocation, reduce costs, and drive profitability for the Company on a global basis. The Company recorded restructuring charges of $0 and $30 , and $0 and $625 for the three and six months ended June 30, 2020 and 2019 , respectively. The charge in the six months ended June 30, 2019 consisted primarily of one-time severance payments and the early termination penalty for our lease associated with the suspension of our APC business in China. For further information related to restructuring, refer to Note 4 - Restructuring Activities. The Company continues to engage in efforts to complete existing contracts.
Research and development expenses for the three and six -month periods ended June 30, 2020 was $271 and $595, and for the same periods in 2019 was $205 and $471 respectively. The expenditures in our research and development expenses were focused on new product development efforts in the pursuit of commercial applications for technologies outside of our traditional markets, and in the development and analysis of new technologies that could represent incremental market opportunities. This includes water treatment technologies and more specifically, our DGI™ Dissolved Gas Infusion Systems, an innovative alternative to current aeration technology. This technology has not yet met the criteria to be a separate operating segment under ASC 280 Segment Reporting. This infusion process has a variety of applications in the water and waste water industries, including remediation, treatment, biological activity and wastewater odor management. DGI technology benefits include reduced energy consumption, installation costs, and operating costs, while improving treatment performance.
Income tax expense for the three and six month periods ended June 30, 2020 and 2019 were $31 and $2 , and $149 and $2 respectively. The Company is projecting a consolidated effective tax rate of approximately 3% for 2020 which is lower than the federal income tax rate of 21% . The Company's effective tax rate differs from the statutory federal tax rate of 21% for the three and six months ended June 30, 2020 primarily due to a full valuation allowance recorded on our United States, China and Italy deferred tax assets since we cannot anticipate when or if we will have sufficient taxable income to utilize the deferred tax assets in the future. Further, our effective tax rate differs from the statutory federal tax rate due to state taxes, differences between U.S. and foreign tax rates, foreign losses incurred with no related tax benefit, non-deductible commissions, and non-deductible meals and entertainment expenses.
Liquidity and Sources of Capital
We have sustained losses from continuing operations during the six month period ended June 30, 2020 totaling $5,111 . Our cash used from continuing operations for this same period totaled $3,414 . We have taken measures to reduce our expense infrastructure and our ability to operate our base businesses prospectively is based on our ability to secure new orders in the APC business and our ability to successfully execute existing APC projects in line with our internal budgets.
Our cash balance as of June 30, 2020 totaled $11,257 (including restricted cash of $3,003 ), and our working capital totaled $12,133 . We have debt obligations of $1,556 from a Paycheck Protection Program (the “PPP”) loan, and we have outstanding letters of credit, under our current credit agreement does which not have any financial covenants as we are currently in a Cash Collateral Security agreement with our lender.
We continue to monitor our liquidity needs and in response to our continued losses have taken measures to reduce expenses and restructure operations which we feel are necessary to ensure we maintain sufficient working capital and liquidity to operate the business and invest in our future.
We have evaluated our ongoing business needs, and considered the cash requirements of our base business of Air Pollution Control and FUEL CHEM, as well as our efforts to wind-down our APC operations in China. This evaluation included consideration of the following: a) customer and revenue trends in our APC and FUEL CHEM business segments, b) current operating structure and expenditure levels, and c) the costs of winding down our APC operations in China as well as other research and development initiatives.
Based on this analysis, management believes that currently we have sufficient cash and working capital to operate our base APC and FUEL CHEM businesses.
On June 19, 2019, the Company entered into a Cash Collateral Security agreement with BMO Harris Bank, N.A. (the BMO Harris agreement) to use for the sole purpose of issuing standby letters of credit. The BMO Harris agreement requires us to pledge as cash collateral 105% of the aggregate face amount of outstanding standby letters of credit. The Company pays 250 basis points on the face values of outstanding letters of credit. There are no financial covenants set forth in the BMO Harris agreement. At June 30, 2020 , the Company had outstanding standby letters of credit totaling approximately $2,860 under the BMO Harris
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agreement. As of June 30, 2020 , the Company held $3,003 in a separate restricted use designated BMO Harris Bank N.A. deposit account. Fuel Tech is committed to reimbursing the issuing bank for any payments made by the bank under these instruments.
In connection with the transition to BMO Harris Bank N.A., the Company canceled its U.S. credit facility with JPMorgan Chase Bank, N.A. effective on September 25, 2019.
On April 15, 2020, the Company received $1,556 in loan proceeds from the Paycheck Protection Program (the “PPP”), established pursuant to the recently enacted Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) and administered by the U.S. Small Business Administration (“SBA”). The unsecured loan is evidenced by a promissory note of the Company dated April 15, 2020 (the “Note”) in the principal amount of $1,556, issued to BMO Harris Bank N.A. (the “Bank”), the lender.
Under the terms of the Note, interest will accrue on the outstanding principal at the rate of 1.0% per annum. The term of the Note is two years, though it may be payable sooner in connection with an event of default under the Note. To the extent the loan amount is not forgiven under the PPP, the Company is obligated to make equal monthly payments of principal and interest, beginning seven months from the date of the Note, until the maturity date. The Note contains covenants by the Company, including obtaining the written consent of the Bank prior to material changes in the management or ownership of the Company.
The CARES Act and the PPP provide a mechanism for forgiveness of up to the full amount borrowed. Under the PPP, the Company may apply for and be granted forgiveness for all or part of the PPP Loan. The amount of loan proceeds eligible for forgiveness is based on a formula that takes into account a number of factors, including the amount of loan proceeds used by the Company during the eight-week period after the loan origination for certain purposes including payroll costs, rent payments on certain leases, and certain qualified utility payments, provided that at least 75% of the loan amount is used for eligible payroll costs; maintaining or rehiring employees and maintaining salaries at certain levels; and other factors. Subject to the other requirements and limitations on loan forgiveness, only loan proceeds spent on payroll and other eligible costs during the covered eight-week period will qualify for forgiveness. The Company intends to use the entire PPP Loan amount for qualifying expenses, though no assurance is provided that the Company will obtain forgiveness of the PPP Loan in whole or in part.
The Note may be prepaid in part or in full, at any time, without penalty. The Note provides for certain customary events of default, including, but not limited to, failing to make a payment when due under the Note, failure to take actions required by the Note, the Company defaulting under certain agreements in favor of any third party, making false statements, the Company’s insolvency, and the commencement of creditor or forfeiture proceedings against the Company. Upon the occurrence of an event of default, the Bank has customary remedies and may, among other things, require immediate payment of all amounts owed under the Note, collect all amounts owing from the Company, and file suit and obtain judgment against the Company.
Contingencies and Contractual Obligations
Fuel Tech issues a standard product warranty with the sale of its products to customers as discussed in Note 13. There was no change in the warranty liability balance during the six months ended June 30, 2020 .
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains “forward-looking statements,” as defined in Section 21E of the Securities Exchange Act of 1934, as amended, which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and reflect Fuel Tech’s current expectations regarding future growth, results of operations, cash flows, performance and business prospects, and opportunities, as well as assumptions made by, and information currently available to, our management. Fuel Tech has tried to identify forward-looking statements by using words such as “anticipate,” “believe,” “plan,” “expect,” “estimate,” “intend,” “will,” and similar expressions, but these words are not the exclusive means of identifying forward-looking statements. These statements are based on information currently available to Fuel Tech and are subject to various risks, uncertainties, and other factors, including, but not limited to, those discussed in Fuel Tech’s Annual Report on Form 10-K for the year ended December 31, 2019 in Item 1A under the caption “Risk Factors,” which could cause Fuel Tech’s actual growth, results of operations, financial condition, cash flows, performance and business prospects and opportunities to differ materially from those expressed in, or implied by, these statements. Fuel Tech undertakes no obligation to update such factors or to publicly announce the results of any of the forward-looking statements contained herein to reflect future events, developments, or changed circumstances or for any other reason. Investors are cautioned that all forward-looking statements involve risks and uncertainties, including those detailed in Fuel Tech’s filings with the Securities and Exchange Commission.
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