FutureFuel Corp.: Form 10-Q/A for the period ended Sep 30, 2023

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations of FutureFuel Corp. (“FutureFuel”, “the Company”, “we”, or “our”) should be read together with our consolidated financial statements, including the notes thereto, set forth herein. This discussion contains forward-looking statements that reflect our current views with respect to future events and financial performance. Actual results may differ materially from those anticipated in these forward-looking statements. See “Forward-Looking Information” below for additional discussion regarding risks associated with forward-looking statements.

Effect of Restatement

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations reflects correction of the errors described in the Explanatory Note with respect to the statement of cash flows included in the Original Form 10-Q. For additional information and a detailed discussion of the corrected errors, refer to the Explanatory Note and the Background of the Restatement.

Unless otherwise stated, all dollar amounts are in thousands.

Overview

Our Company is managed and reported in two reporting segments: chemicals and biofuels. Within the chemical segment are two product groupings: custom chemicals and performance chemicals. The custom product group is composed of specialty chemicals manufactured for a single customer whereas the performance product group is composed of chemicals manufactured for multiple customers. The biofuel segment is composed of one product group. Management believes that the diversity of each segment strengthens the company in the ability to utilize resources and is committed to growing each segment.

Within the United States Environmental Protection Agency (EPA) Renewable Fuel Standard (RFS), we generate 1.5 Renewable Identification Numbers (RINs) for each gallon of biodiesel sold in the United States with a classification of a D4 or D6 RIN. RINs are used to monitor the level of renewable fuel traded in a given year in accordance with RFS 2 within the EPA moderated transaction system (EMTS). We do not assign cost of goods sold to the generation of RINs as the physical fuel generates the full cost. As of September 30, 2023, we held 4.2 million D4 and D6 RINs with a fair market value of $6,971. Comparatively, as of September 30, 2022, we held 8.1 million RINs with a fair market value of $12,752.

Summary of Financial Results

Set forth below is a summary of certain consolidated financial information for the periods indicated.

* Adjusted EBITDA restated for the three and nine months of 2022 consistent with 2023 reporting to exclude cash (realized) gains and losses on derivative instruments.

We use adjusted EBITDA as a key operating metric to measure both performance and liquidity. Adjusted EBITDA is a non-GAAP financial measure. Adjusted EBITDA is not a substitute for operating income, net income, or cash flow from operating activities (each as determined in accordance with GAAP) as a measure of performance or liquidity. Adjusted EBITDA has limitations as an analytical tool and should not be considered in isolation or as a substitute for analysis of results as reported under GAAP. We define adjusted EBITDA as net income before interest, income taxes, depreciation, and amortization expenses, excluding, when applicable, non-cash stock-based compensation expenses, public offering expenses, acquisition-related transaction costs, purchase accounting adjustments, losses on disposal of property and equipment, non-cash gains or losses on derivative instruments, and other non-operating income or expenses. Information relating to adjusted EBITDA is provided so that investors have the same data that we employ in assessing the overall operation and liquidity of our business. Our calculation of adjusted EBITDA may be different from similarly titled measures used by other companies; therefore, the results of our calculation are not necessarily comparable to the results of other companies.

Adjusted EBITDA allows our chief operating decision makers to assess the performance and liquidity of our business on a consolidated basis to assess the ability of our operating segments to produce operating cash flow to fund working capital needs, to fund capital expenditures, and to pay dividends. In particular, our management believes that adjusted EBITDA permits a comparative assessment of our operating performance and liquidity, relative to a performance and liquidity based on GAAP results. This measure isolates the effects of certain items, including depreciation and amortization (which may vary among our operating segments without any correlation to their underlying operating performance), non-cash stock-based compensation expense (which is a non-cash expense that varies widely among similar companies), and non-cash gains and losses on derivative instruments (which can cause net income to appear volatile from period to period relative to the sale of the underlying physical product).

We utilize commodity derivative instruments primarily to protect our operations from downward movements in commodity prices, and to provide greater certainty of cash flows associated with sales of our commodities. We enter into hedges, and we utilize mark-to-market accounting to account for these instruments. Thus, our results in any given period can be impacted, and sometimes significantly, by changes in market prices relative to our contract price along with the timing of the valuation change in the derivative instruments relative to the sale of biofuel. We include the mark-to-market or non-cash portion of this item as an adjustment as we believe it provides a relevant indicator of the underlying performance of our business in a given period.

Additionally, we held marketable securities of certain debt securities (trust preferred stock) and in preferred stock and other equity instruments during the nine months ended September 30, 2023, (but sold all investments during the three months ended June 30, 2023). The realized and unrealized gains and losses on these marketable securities fluctuated from period to period. We included this item as an adjustment as we believed it provided a relevant indicator of the underlying performance of our business in a given period.

The following table reconciles net income, the most directly comparable GAAP performance financial measure, with adjusted EBITDA.

The following table reconciles cash flows from operations, the most directly comparable GAAP liquidity financial measure, with adjusted EBITDA.

* Adjusted EBITDA restated for the three and nine months of 2022 consistent with 2023 reporting to exclude cash (realized) gains and losses on derivative instruments.

Results of Operations

Consolidated

Consolidated revenue in the three and nine months ended September 30, 2023 decreased $1,389 and $1,957 compared to the three and nine months ended September 30, 2022, respectively. In the three- and nine-month periods ended September 30,2023, chemical segment sales volumes declined $3,763 and $2,294, respectively, on weakened glycerin markets and the timing of recognition of capital recovery. Partially improving chemical sales in both the three- and nine-month comparison periods was a favorable product mix and revenue from new custom chemical contracts. Biofuel segment net sales increased $2,270 and $820, respectively, in the three- and nine-month comparison periods on higher sales volumes mostly offset by lower average prices. D4 RIN prices dropped significantly during the quarter as renewable diesel volumes increased in the market.

Gross profit in the three months ended September 30, 2023 decreased $16,115 as compared to the same period of 2022, from: (i) the spread in biofuel price and feedstock price narrowed (inclusive of the effect of the D4 RIN price decline); (ii) the change in the activity in derivative instruments with a realized loss of $7,286 in the current three-month period as compared to a realized gain of $4,023 in the same three-months of the prior year; (iii) the change in the mark-to-market derivative position which was an unrealized loss of $6,782 as compared to an unrealized gain of $665 in the three months ended September 30, 2023 and 2022, respectively; (iv) the reduction from the timing of recognition of capital recovery; and (v) the change in the adjustment in the carrying value of our inventory as determined utilizing the LIFO method of inventory accounting. The adjustment in item (v) increased gross profit $2,528 in the three months ended September 30, 2023 as compared to $6,133 in 2022. These contrasting results in items (i) and (ii) reflect the impact of price movements in the biodiesel market during the course of each year compared to when we committed to our feedstock acquisition. In 2022, prices rose sharply as a consequence of the conflict in Ukraine and we recorded mark-to-market losses on the derivative instruments we use to hedge our biodiesel margins. The losses were then offset by significant gains in physical sales in the period. In 2023, biodiesel prices fell in the first half of the year and then rose in the third quarter. This generated derivative gains for the first half of the year and now mark-to-market losses in the third quarter against committed sales in the fourth quarter.

Gross profit for the nine months ended September 30, 2023 was $16,901 as compared to $13,807 in the nine months ended September 30, 2022. This increase resulted from (i) the change in our realized derivative gains of $2,150 in the current nine-month period as compared to realized losses of $24,970 in the prior nine-month period given the explanation noted in the three-month comparative period, and (ii) the change in the adjustment in the carrying value of our inventory as determined utilizing the LIFO method of inventory accounting. This adjustment increased gross profit $6,023 in the current nine-month period as compared to $1,308 in the prior nine-month period.

Operating expenses

Operating expenses increased $478 and $1,897 in the three and nine months ended September 30, 2023, as compared to the three and nine months ended September 30, 2022. This increase was primarily from increased compensation and legal expense.

Other income (expense)

Other income (expense) increased income $1,904 and $12,502 in the three and nine months ended September 30, 2023, respectively, as compared to the same periods of 2022. In the current three-month period interest income was $2,527 as compared to dividend and interest income of $1,210 and a loss of $590 on marketable securities in the same period of 2022. In the current nine-month period, marketable securities were sold with realized gains of $575 and interest income was $6,595 as compared to unrealized losses on marketable securities of $7,366 and interest and dividends income of $2,621, in the same period of 2022.

Income tax provision (benefit)

The Company’s income tax provision for the three and nine months ended September 30, 2023 comprises only small amounts of current state taxes. No deferred tax benefits on ongoing tax losses have been recognized, reflecting management’s determination that none of the net deferred tax assets generated on its 2023 tax losses are more likely than not to be realized. The three-month period in 2022 similarly reflected immaterial state taxes and miscellaneous items, while the nine-month period included the cumulative impact of valuation allowances recorded against certain existing deferred tax assets.

The Company evaluates its deferred tax assets quarterly and records a valuation allowance to reduce these assets to the amount that is more likely than not to be realized.

Chemical Segment

Chemical revenue in the three and nine months ended September 30, 2023 decreased 17.0% or $3,659 and 4.5% or $2,777, respectively, compared to the same comparative periods of 2022. Revenue for our custom chemicals (unique chemicals produced under contract for specific customers) for the three and nine months ended September 30, 2023 totaled $14,454 and $46,650, a decrease of $1,593 and an increase of $2,622 from the same periods in 2022, respectively. Custom chemicals sales revenue was reduced in the current reporting periods as compared to the prior year periods from the timing of recognition of upfront capital reimbursements from customers. The reduction in sales revenue from the recognition of deferred revenue was $1,978 and $3,174 in the three and nine months ended September 30, 2023 as compared to the same periods of 2022. (See Note 3 to our consolidated financial statements). Also reducing sales revenue were lower volumes of chemicals sold into the energy market. Partially offsetting these reductions were sales from two new contracts in the agricultural market. Performance chemicals (composed of multi-customer products which are sold to the open market based on specification) revenue was $3,393 and $11,834, a decrease of $2,066 and $5,399 from the three and nine months ended September 30, 2022, respectively. This decrease was mostly from lower sales of glycerin as markets softened on increased imports.

Gross profit for the chemical segment for the three months ended September 30, 2023, decreased $1,484 when compared to the same period of 2022. This decrease was primarily from: (i) the timing of recognition of upfront capital payments as noted above; (ii) reduced glycerin sales; and (iii) the change in the adjustment in the carrying value of our inventory as determined utilizing the LIFO method of inventory accounting. This adjustment increased gross profit $234 as compared to $710 in the same period of 2022.

Gross profit for the chemical segment for the nine months ended September 30, 2023 increased $3,941 when compared to the same period of 2022 from: (i) product mix, and (ii) the change in the adjustment in the carrying value of our inventory as determined utilizing the LIFO method of inventory accounting. This adjustment increased gross profit $1,105 in the nine months ended September 30, 2023 as compared to a decrease in gross profit of $463 in the same comparative period of 2022. Partially reducing this increase in gross profit was the timing of recognition of upfront capital payments as noted above.

Biofuel Segment

Biofuels revenue in the three and nine months ended September 30, 2023 increased $2,270 and $820, respectively, as compared to the same periods of 2022. These increases resulted from increased sales volumes of 14% and 21%, mostly offset by reduced average prices of 12% and 21%, respectively. The lower prices were driven in part by the reduction in D4 RIN prices which according to S&P Global (September 29, 2023 authored by Phillip Herring and Melvin Lee), dropped 44.5% in 2023 due to an increase of renewable diesel production and a decline in biodiesel margins.

A significant portion of our biodiesel sold was to four major refiners/blenders in the three months ended September 30, 2023 and to two major refiners in the three months ended September 30, 2022 and in the nine months ended 2023 and 2022. No assurances can be given that we will continue to sell to such major refiners, or, if we do sell, the volume we will sell or the profit margin we will realize. We do not believe that the loss of these customers would have a material adverse effect on our biofuels segment or on us as a whole because: (i) we believe that we could readily sell our biodiesel to other customers on equivalent terms as potential demand from other customers for biodiesel exceeds our production capacity; (ii) our sales to these customers are not under fixed terms and the customers have no fixed obligation to purchase any minimum quantities except as stipulated by short-term purchase orders; and (iii) the prices we receive from these customers are based upon then-market rates, as would be the case with sales of this commodity to other customers.

Biofuels gross loss was $3,008 and $5,016 in the three and nine months ended September 30, 2023, respectively, a decrease in gross profit of $14,631 in the three-month comparative period, and an increased loss of $847 in the nine-month comparative period of 2022. In the current three months of 2023, the change in the activity in derivative instruments was a realized loss of $7,286 as compared to a realized gain of $4,023 in the same three months of the prior year. Also increasing gross losses was the change in the mark-to-market derivative position which was an unrealized loss of $6,782 as compared to an unrealized gain of $665 in the three months ended September 30, 2023 and 2022, respectively. As described previously, heating oil futures prices rose in the three months ended September 30, 2023 whereas they had fallen overall for the first six months of the year. This moved our derivatives position from a gain to a loss position that will be offset by sales later in the year. In addition to this, there has been a decline in margins driven by the effect of the D4 RIN price decline as previously noted and increases in feedstock prices.

Reducing gross profit in the three months ended September 30, 2023 was the change in the adjustment in the carrying value of our inventory as determined utilizing the LIFO method of inventory accounting. This adjustment increased gross profit $2,294 in the three months ended September 30, 2023 as compared to $5,423 in the same comparative period of 2022. For the nine months ended September 30, 2023, the change increased gross profit $6,023 as compared to $1,771 in the same comparative period of 2022.

In regards to our derivative activity, we recognize all derivative instruments as either assets or liabilities at fair value in our consolidated balance sheets. The realized and unrealized derivative gains and losses are recorded as cost of goods sold. Our derivative instruments do not qualify for hedge accounting under the specific guidelines of Topic 815, Derivatives and Hedging. None of the derivative instruments are designated and accounted for as hedges primarily due to the extensive record keeping requirements.

The volumes and carrying values of our derivative instruments were as follows:

*All derivative instruments are entered into with the standard contract terms and conditions in accordance with major trading authorities of the New York Mercantile Exchange.

Critical Accounting Estimates

Revenue Recognition

The Company recognizes revenue under Topic 606, Revenue from Contracts with Customers. Certain long-term contracts had upfront non-cancellable payments considered material rights. The Company applied the renewal option approach in allocating the transaction price to the material rights. For each of these contracts, the Company estimated the expected contractual volumes to be sold at the most likely expected sales price as a basis for allocating the transaction price to the material right. Estimates are updated quarterly on a prospective basis. These custom chemical contracts have payment terms of 30 days. See Note 3 to our consolidated financial statements.

For most product sales, revenue is recognized when product is shipped from our facilities and risk of loss and title have passed to the customer, which is in accordance with our customer contracts and the stated shipping terms. Nearly all custom manufactured products are manufactured under written master service agreements. Performance chemicals and biodiesel are generally sold pursuant to the terms of written purchase orders. In general, customers do not have any rights of return, except for quality disputes. All of our products are tested for quality before shipment, and historically returns have been inconsequential. We do not offer rebates, except those related to the BTC.

Biodiesel selling prices can at times fluctuate based on the timing of unsold, internally generated RINs. From time to time, sales of biodiesel are on a “RINs-free” basis. Such method of selling results in applicable RINs being held. The value of the RINs is not reflected in revenue until such time as the RIN sale has been completed.

Revenue from bill-and-hold transactions in which a performance obligation exists is recognized when the total performance obligation has been met and control of the product has transferred. Bill-and-hold transactions for the three and nine months ended September 30, 2023 and 2022 were related to custom chemicals customers whereby revenue was recognized in accordance with contractual agreements based upon product being produced and ready for use by the customer. These sales were subject to written monthly purchase orders with agreement that production was reasonable. The product was custom manufactured and stored at the customer’s request and could not be sold to another buyer. Credit and payment terms for bill-and-hold customers are similar to other custom chemicals customers. Revenues under bill-and-hold arrangements were $10,149 and $31,504 for the three and nine months ended September 30, 2023, respectively.

Liquidity and Capital Resources

Our net cash from operating activities, investing activities, and financing activities for the nine months ended September 30, 2023 and 2022 are set forth in the following table.

We believe that existing cash balances and cash flow to be generated from operating activities and borrowing capacity under the amended and restated credit agreement will be sufficient to fund operations, product development, cash dividends, and capital requirements for the foreseeable future.

Operating Activities

Cash provided by operating activities was $8,458 in the nine months ended September 30, 2023 as compared to $44,127 in the same period of 2022. This decrease in cash was primarily attributable to the change in accounts payable, including accounts payable - related parties, demonstrating a cash outflow of $25,305, primarily from the timing of vendor payments, the change in fair value of equity securities of $11,057, the change in inventory demonstrating a cash outflow of $9,672, and the change in accounts receivable, including accounts receivable - related parties, demonstrating a cash outflow of $8,933. Partially offsetting these cash outflows was the change in net income of $13,720.

Investing Activities

Cash provided by investing activities was $29,716 in the nine months ended September 30, 2023 as compared to cash used in investing activities of $2,503 in the nine months ended September 30, 2022. Of the $32,219 change, $37,438 was the result of increased proceeds from the sale of marketable securities. Offsetting this increase in cash was an increase in cash out flow in the collateralization of derivative instruments of $3,856 and in capital expenditures of 1,302.

Financing Activities

Cash used in financing activities was $7,891 and $7,877 in the nine months ended September 30, 2023 and 2022, respectively, primarily for payments of dividends on our common stock.

Credit Facility

We have a credit agreement, as amended on March 30, 2020, with a syndicated group of commercial banks for $100,000. The loan is a revolving facility, the proceeds of which may be used for our working capital, capital expenditures, and general corporate purposes. The facility terminates on March 30, 2025. See Note 9 to our consolidated financial statements for additional information regarding our credit agreement.

We intend to fund future capital requirements for our businesses from cash flow as well as from existing cash, cash investments, and, if the need should arise, borrowings under our credit facility. We do not believe there will be a need to issue any securities to fund such capital requirements.

Dividends

In the first three quarters of 2023 and 2022, we paid a regular quarterly cash dividend in the amount of $0.06 per share on our common stock. The regular cash dividend amounted to $2,626 in each of the quarters of 2023 and 2022. The declaration of these regular quarterly cash dividends was made in the three months ended December 31, 2022 and March 31, 2022, respectively.

Capital Management

As a result of our initial equity offering, our subsequent positive operating results, the exercise of warrants, and the issuance of shares in our at-the-market offering, we accumulated excess working capital. Some of this excess working capital has been paid out as special and regular cash dividends. Additionally, regular dividends will be paid in 2023, as previously reported. Third parties have not placed significant restrictions on our working capital management decisions.

A significant portion of these funds was held in cash or cash equivalents at multiple financial institutions. In the period ended December 31, 2022, we also had investments in certain preferred stock, debt securities, and other equity instruments. We classified these investments as current assets in the accompanying consolidated balance sheets and designated the debt securities as being “available-for-sale.” Accordingly, the debt securities were recorded at fair value, with the unrealized gains and losses, net of taxes, reported as a component of stockholders’ equity. We also held equity securities with readily available market values. These equity instruments were recorded at fair value, with the unrealized gains and losses reported as a component of net income. We sold all marketable securities in the nine months ended September 30, 2023. The fair value of the debt securities and equity instruments totaled $0 and $37,126 at September 30, 2023 and December 31, 2022, respectively.

Lastly, we maintain depositary accounts such as checking accounts, money market accounts, and other similar accounts at selected financial institutions.

Off- Balance Sheet Arrangements

We engage in two types of hedging transactions. First, we hedge our biofuels sales through the purchase and sale of futures contracts and options on futures contracts of energy commodities. This activity was captured in our consolidated balance sheets at September 30, 2023 and December 31, 2022. Second, we hedge our biofuels feedstock through the execution of purchase contracts and supply agreements with certain vendors or they meet the normal purchase and normal sales exception of ASC 815 Derivatives and Hedging. These hedging transactions are recognized in earnings and were not recorded in our consolidated balance sheets at September 30, 2023 or December 31, 2022 because they do not meet the definition of a hedge instrument as defined under GAAP. The purchase of biofuels feedstock generally involves two risk components: basis and price. Basis covers any refining or processing required as well as transportation. Price covers the purchases of the actual agricultural commodity. Both basis and price fluctuate over time. A supply agreement with a vendor constitutes a hedge when we have committed to a certain volume of feedstock in a future period and have fixed the basis for that volume.

Management’s Evaluation of our Disclosure Controls and Procedures

Under the supervision and with the participation of our chief executive officer and our principal financial officer and other senior management personnel, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15(d)-15(e)) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this report. Based on that evaluation, our chief executive officer and our principal financial officer concluded at the time the Original Form 10-Q was filed that these disclosure controls and procedures at September 30, 2023 were effective to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms.

Subsequent to that evaluation, our chief executive officer and our principal financial officer concluded that our disclosure controls and procedures were not effective as of September 30, 2023, because of a material weakness in our internal control over financial reporting discussed below.

Material Weakness in Internal Control over Financial Reporting

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statement will not be prevented or detected on a timely basis. Management identified a material weakness in our internal control over financial reporting due to a deficiency in our review control over cash flows from investments within the statements of cash flows in accordance with applicable accounting guidance at the three months ended June 30, 2023 and September 30, 2023 and at the year-end December 31, 2023. Therefore, the Company has an ineffective financial reporting control over the review of the statement of cash flow. The control did not operate at a level precise enough to detect material errors in calculations and formulas and as a result did not detect material differences between the operating and investing sections of the statement of cash flow.

Remediation Plan

The Company’s management, under the oversight from the Audit Committee, is implementing additional review procedures to enhance our internal control over financial reporting with respect to the statement of cash flows. These review procedures include the development of a review checklist to ensure that we will apply the applicable accounting guidance under ASC 230, Statement of Cash Flows.

Notwithstanding the identified material weakness, management believes that the consolidated financial statements included in this Quarterly Report on Form 10-Q present fairly in all material respects our consolidated financial position, results of operations and cash flows for the period presented.

Changes in Internal Control over Financial Reporting

Except as described above, there were no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during the quarter ended September 30, 2023 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.