Fuel Tech, Inc. (FTEK) Q2 2014 Earnings Report, Transcript and Summary

Good day to you, ladies and gentlemen, and welcome to your Fuel Tech Second Quarter 2014 Financial Results Conference Call, which is hosted today by your Senior Vice President, Mr. Devin Sullivan, President of the Equality Group. My name is Kathy, and I'm your event coordinator during the call. [Operator Instructions] And this call is being recorded for replay purposes. And now, I'd like to hand over to Mr. Sullivan. Please go ahead.

Thank you. Good morning, everyone, and thank you for joining us for Fuel Tech's 2014 Second Quarter Financial Results Conference Call. Yesterday after the close, we issued a copy of our press release. A copy of which is available at www.ftek.com. Our speakers for today's call will be Doug Bailey, Chairman, President and Chief Executive Officer; and Dave Collins, Senior Vice President and Chief Financial Officer. Before turning things over to Doug and Dave, I'd like to remind everyone that matters discussed during this call, except for historical information, are forward-looking statements that are subject to certain risks and uncertainties that could cause actual results to differ materially from those set forth in our forward-looking statements. The factors that could cause results to differ materially are included in Fuel Tech's filings with the Securities and Exchange Commission. The information contained in this call is accurate only as of the date discussed, and investors should not assume that statements made in this call remain operative at a later date. Fuel Tech undertakes no obligation to update any information discussed during this call. And as a reminder, the call is being broadcast over the Internet and can be accessed at company's website at www.ftek.com. With that said, we'll now begin the call, and I'd like to turn things -- the call over to Dave Collins, Fuel Tech's Chief Executive Officer. Dave, please go ahead.

Thank you, Devin, and good morning, everyone. Thank you for participating in today's call. Our current quarter and year-to-date results remain sluggish due to a continuing slow pace of bookings within our APC segment business. This trend has been observed in both our U.S. and our foreign APC markets. While we wait for clarity from the EPA regarding the impact of the favorable ruling from the U.S. Supreme Court on CSAPR, we will continue to look to our foreign markets for growth opportunities. Offsetting the slower APC market revenues is a pickup in new customer activity within our FUEL CHEM segment, which we believe will contribute incremental revenues through the second half of 2014 and into 2015. While the initial revenue pickup is expected to be modest, we do have the potential to gain significant new incremental FUEL CHEM revenues based on these new orders. Consolidated revenues for our second quarter decreased $8.9 million to $20.2 million, a year-over-year decrease of 31%. For the first 6 months of 2014, our consolidated revenue decreased $12.7 million to $38.9 million, a year-over-year decrease of 25%. The decrease in revenue for both the current quarter and year-to-date periods is focused on our APC segment. The decline in foreign revenue is due in part to the further completion of our project in Chile. Our foreign revenues in the current quarter decreased by $0.4 million or 46% to $6.5 million and for the first 6 months of 2014, our foreign revenues have decreased $5.6 million or 26% to $15.9 million. Our U.S. revenue decreased $3.5 million or 20% to $13.7 million and for the first 6 months of 2014, our U.S. revenue has decreased $7.1 million or 24% to $23 million. I will speak more in depth in a moment about our segment and geographic results. Our gross margin for the current quarter and first 6 months has remained consistent at 42%, up slightly from 41% in the respective prior year periods. Our margin performance for the current quarter and 6 months has been consistent with prior year results, with the APC segment margins of around 33% and FUEL CHEM margins of around 53%. Our selling, general and administrative expense for the current quarter decreased by $348,000 or 4% from the prior year to $9 million. For the first 6 months, our SG&A expense was flat with the prior year at $17.7 million. Our research and development cost for the current quarter and year-to-date periods were down $205,000 and $894,000, respectively, from the prior year and totaled $225,000 and $469,000 for the 3- and 6-month periods ended June 30, 2014. Given the status of current R&D projects and the outlook for the remainder of 2014, we believe our current quarter expense level for R&D spending will continue for the third and fourth quarters of 2014. Longer term we expect to continue supporting our R&D efforts, as we believe this is a critical component to our future growth. Our net loss for the current quarter and year-to-date periods was $720,000 and $1.8 million or $0.03 and $0.08 per diluted share, respectively. Our adjusted EBITDA for the first 6 months of 2013 was $699,000. Now let's take a more in-depth look at our business segments. The APC segment reported quarterly revenues of $11.3 million, down $8.9 million or 44% from the prior year. For the first 6 months of 2014, our APC revenues totaled $22 million, down $11.1 million or 34% from the prior year. Our backlog at June 30, 2014 was $17.7 million, down from $22.4 million at December 31, 2013 and $45.1 million at June 30, 2013. A little bit about our geographies. Our China-Pacific Rim business was slower in the first half of 2014 due to a slower than expected booking activity. We believe this is only timing related and we'll look for improvement in bookings in the second half of this year, as we remain active in bidding new work. We are, however, seeing increasing competition in our China markets, but to-date we have been able to maintain our margin profile and have been successful winning new work in that markets. For the first 6 months of 2014, our China-Pacific Rim bookings totaled $3.2 million, down from $6.7 million in the previous year. Our China-Pacific Rim backlog at June 30, 2014 totaled $4 million. Our Chile contract is essentially complete for the first 5 units and our final installation for unit 6 is scheduled to take place in the second quarter of 2015. Our Chile backlog at June 30, 2014 totaled $4 million. We expect to carryover approximately $2.5 million of the Chile backlog into 2015, with the remainder being recognized evenly in Q3 and Q4 of this year. Bookings for our NOx suite of technologies in the U.S. APC market remained sluggish, despite the Supreme Court review on CSAPR, which ruled in favor of the EPA on all key points. We will look to constructively evaluate our domestic APC business opportunities over the next couple of quarters, and remain positive that we will have good market opportunities to deliver tailored NOx solutions to our customers that are impacted by CSAPR during the latter half of 2014 and into 2015. In the meantime, we will continue to pursue opportunities in the U.S. marketplace driven by other NOx emission standards. Our recent acquisition of PECO-FGC contributed favorably in the current quarter with revenues of $2.6 million and gross margins in excess of 45%. The margin result was benefited by a cancellation fee of approximately $680,000 in the current quarter, and we would expect our forward margin profile in this business to decrease in future quarters to a more normalized figure of around 30%. The order cancellation was for a project in backlog at the date of acquisition totaling about $6.8 million. This project was scheduled for 2015. We remain optimistic that the particulate business for which PECO-FGC offers solutions will continue to contribute positively to our results for the remainder of 2014 and into 2015. Our U.S. backlog at June 30, 2014 was totaled $9 million. Our APC segment gross margins have been between 33% and 35% for all reported periods in 2013 and '14, which is reflective of the reduced gross margin profile of the Chile projects and is consistent with prior discussions. We expect to see some margin improvement in the APC segment as the Chile project revenue is replaced by new work, but the margin profile will be dependent on the mix of future product technology orders. Our FUEL CHEM segment reported Q2 revenues of $8.9 million, which was up slightly from the prior year. For the first 6 months of 2014, our FUEL CHEM segment revenue was $16.8 million, down $1.6 million from the prior year. As previously discussed, this decline was observed in the first quarter of 2014 related to customer outage schedules. Our customer listing remains strong, and we have a number of new business opportunities that we think will deliver year-over-year growth for the remaining 2 quarters of 2014. Our current quarter and year-to-date gross margins for our FUEL CHEM segment were 55% and 54%, which is consistent with the prior year. We expect to see our gross margin continue to range between 40% to 52%. Our effective tax rate for the current quarter was low due to the mix of income loss geographies and the tax reporting within each of those jurisdictions, as well as the level of pretax net income compared with permanent add-back items. We continue to expect to see a long-term effective tax rate between 30% and 43%, but we'll look for the remainder of 2014 to be low due to the income levels reported. Cash and equivalents at June 30, 2014 were $17 million and we carry a short-term debt balance of $2.4 million from our China-Pacific Rim operations. Our working capital balance has decreased $8.1 million to $40.5 million for the first 6 months of 2014 through the PECO-FGC acquisition. Cash used in operating activities for the first 6 months was $1.9 million, due principally to our 6-month loss. Our spending on property and equipment totaled $1.1 million, and we've been to small amount of debt in our China-Pacific Rim operations to fund term project needs. Now, I'd like to turn the call over to Doug.

Good morning, everyone, and thank you, all, for joining us today. We issued our results for the second quarter yesterday afternoon, and they were to a large degree as expected. Our FUEL CHEM business segment maintained its overall revenue profile as compared to last year and continued to post good margin results. Our APC business segment, as we stated on our last quarterly call, has witnessed a slower pace of domestic bookings as utilities have delayed purchases, while awaiting regulatory clarity around EPA's cross state air pollution rule over CSAPR. As you will recall, that rule was stayed at the end of 2011 and ultimately vacated 2 years ago by the U.S. Court of Appeals for the District of Columbia Circuit Court. It was not until April 29 of this year, 1 month into the second quarter, that the Supreme Court upheld CSAPR and remanded it back to the D.C. circuit. Our APC segment recognized lower year-over-year quarterly revenues, principally as a result of this slower domestic market, coupled with lessening activity in Chile, as our large project there matures closer to completion. I'd like to briefly comment on the regulatory environment. We continue to expect that a revived CSAPR will be a growth driver for our domestic APC business once start dates and timeline for utility compliance are finalized. In the month of June, following our last call, EPA asked the D.C. Circuit to lift the stay on CSAPR and allow the agency to implement the first phase of the program for 2015 and the second phase in 2017. The Court of Appeals subsequently gave parties until August 22 or 10 days from now to file motions in support of EPA's motion to lift that stay. However, industry groups in several states have since asked the D.C. Circuit to delay the implementation of CSAPR. Our view is that all pending litigation should be resolved before the law takes effect. We therefore maintained somewhat tempered expectations as to the ultimate timing of the reimplementation of CSAPR. Also on June 2, EPA proposed new guidelines for states to follow in developing plans to address greenhouse gas emissions from existing fossil fuel fired electric generating units. Specifically, EPA proposed state-specific rate base goals for carbon dioxide emissions from power sector, as well as guidelines for states to follow in developing plans to achieve those state-specific goals. At least 4 states have sued EPA in response, and we anticipate that this issue too will be heavily debated for a much longer time to come. So in our APC business, we're tracking a number of significant trends and adopting both short and long-term strategies to capitalize on a clearly changing environment. First of all, as we await reimplementation of CSAPR, state consent decrees and other existing regulations continue to spur our APC bidding activity. In the near term, even after taking into account the trends in coal fire power plant retirements and fuel switching, we continue to track a large pipeline of near-term domestic utility and industrial APC project opportunities. On the industrial side, these include manufacturers of carbon black, fertilizer plants, chemical and refinery plants and pulp, paper and biomass facilities. Secondly, as our markets are transforming, we continue to look for selective acquisition over in-licensing opportunities to complement our present portfolio of engineered solutions. This was evidenced by our April 2014 acquisition of PECO-FGC that added capabilities for particulate control and Flue Gas Conditioning. Unlike CSAPR, the regulations driving PECO-FGC's growth in the market for electrostatic precipitated products and services are a bit more predictable in their near-term trajectory. EPA's Mercury and Air Toxic Standards rule and the Boiler Maximum Achievable Control Technology rule for industrial boilers have compliance dates that include 2015 and 2016 deadlines. Because of its smaller size and previous limited bonding capacity prior to our acquisition, the PECO-FGC organization has since been able to bid on several large projects simply because of the resources Fuel Tech brings to the relationship. We've been pleased with the performance and contribution of this business over the few months that it's been part of Fuel Tech and believe that it'll be an important contributor of future growth. Our third strategy for growth has centered on international expansion. This has been evidenced by early presence in China, where the market for air pollution control systems is more than twice as large as the U.S. market was at its peak. As we expand our product offerings, we believe that we can leverage our international presence by bringing those added solutions to market. For example, the controlled particulate matter is becoming a critical issue of growing public and political concern in China. We believe that China's investments to control particulate emissions will likely considerably exceed its recent focus on NOx control. Fuel Tech continues to focus on opportunities to strengthen our position in this important Asian market. We also continue to pursue opportunities in other parts of the world, most notably, Latin America, where our project in Chile should be substantially complete by mid-2015. In Mexico, we're demonstrating sound technical progress with improved comprehensive control of SO3 investment units that are strengthening our reputation through our presence in that country. Our fourth strategy for long-term growth centers on the new product development initiatives created through both cash and expected future expenditures. Through our research and development, in-licensing and acquisition programs, we are focusing on developed opportunities into control multiple pollutants such as mercury, acid gases and oxides and sulfur nitrogen. We're consciously seeking new solutions that trend our overall business mixed towards a higher level of recurring revenues. In particular, we aim to transform our APC business over time to be less dependent upon one-time customer capital projects to become more akin to our FUEL CHEM business model by developing recurring revenue chemistry solutions. While we're not yet ready to discuss these opportunities in any detail, I'm comfortable in saying that they are substantial in size, scope and potential financial contribution. With respect to our FUEL CHEM business, I am pleased to report that we've seen renewed interest in our technology from a number of new domestic utility customers, operating generating units in the 600- to 700-megawatt size range, burning both Eastern and Western coals. The decision drivers expressed by these customers are varied and include slag remediation, fuel switching and tax credits capture. The commencement dates for these new programs, many of which involve Fuel-Tech's TIFI on demand solution, vary over the months of May through September 2014. And we expect that this interest will translate into added new account revenue during the second half of 2014 and at a margin that is consistent with the 50% plus traditionally generated by FUEL CHEM. In summary, we continue to focus on organic sales growth, prepare for cash reduced market opportunities, seek acquisition and in-licensing opportunities to leverage our assets and our abilities, expand our international presence and remain committed to new product development initiatives. Our efforts in China are progressing and we seek to expand our very established presence at this promising market. The overarching themes of business transformation and recurring revenue will continue to drive the future development. Over time, we expect to transform Fuel Tech's operating business by capitalizing our core competencies of engineering, modeling, knowledge of complex combustion and reactive flow processes. Above all, our focus remains on creating long-term shareholder value and we appreciate your continued confidence in our ability to deliver. So I'd now like to ask the operator to please open the floor for questions from our analysts and our institutional investors.

[Operator Instructions] We have your first question and that comes from Mr. Lucas Pipes from Brean Capital.

So my first question is just on the APC side. You mentioned in the press release that you have visibility into a pipeline of domestic APC projects. I wondered if it was possible for you to kind of thread in sort of frame of reference regarding the magnitude of those projects.

Well, as I said in the past, and that continues to be the case, many of these, Lucas, are somewhat lumpy in size. They have relatively long-term sales cycles. They are largely driven by, as I said, consent decrees, permits. We are beginning to see some varied opportunities outside the utility sector in growing number for industrial projects, as I commented. I would say overall, with the current state of regulatory uncertainty, you're probably seeing a more competitive bidding environment for these projects. So while the pipeline might be large, the competition for wins is still relatively intense. We are seeking work that can support good traditional margins. We have passed on work that has gone at pricing that we believe is much too close to cost level. So I would say that the overall domestic market has been a smaller market, it's still large enough opportunities, but we are going to be a bit selective in what we choose to win. And that's reflected in the decision of our bid processes.

Okay. But, so is it maybe a reflection of 2011 activity or any sort of frame of reference in terms of going back to prior years, what it could look like?

I can't compare it to 2011, which was really -- had quite a acceleration of activity, when CSAPR was first enacted in the summer of that year. I think we booked over $40 million of orders in the following 2 quarters. Our bidding activity is high. It's not necessarily fast in terms of award decisions, simply because of the regulatory hiatus. That was a very different environment once CSAPR was enacted and had a compliance deadline that loomed not much more than 6 months later. Right now, they're continuing to debate the compliance timeframe of the renewed CSAPR enforcement. I expect it to be a little bit more reasonable and yet, I do expect to see projects requiring execution in 2015. So in the meantime, we continue to pursue non-CSAPR related opportunities.

That's helpful. And on that note, could you maybe share with us what the China contribution was to revenue in the second quarter, and kind of how you expect that to grow over the coming year or years to come?

Sure. China, for the second quarter, was little bit shy of $4 million. And that's down year-over-year and it's down because our first 6-month period of bookings was slower. Again, we don't see that as a continuing trend. We think it's timing related. We're still active in that marketplace. But when the orders are signed up can differ year-over-year, so we would expect the back half of this year to be comparable with prior periods and continue to look for that market to deliver growth to the company.

That being said, Lucas, it has evolved into a more competitive market, so we've seen emerging competition. We've seen there, as well as with here, similar efforts to win business at what we would view to be lower margin tendered bids. So it's more important for us to dedicate our resources to better margin projects. So we continue to expect order announcements in China, but we're also aiming to preserve margins at the same time.

No, that makes perfect sense. And if I could maybe squeeze in 1 last question. Very happy to see the acquisition on April 30. When I look at the backlog of PECO-FGC, if I noticed it correctly that there's a little bit of the decline over the most recent quarter to 3.7 million tons of backlog. Is that kind of the normal figure? Was it a little elevated before? How should we think about kind of the recurring contribution from that business?

2 factors, Lucas. There was 1 order that was in the backlog, when we acquired the company. That was a planned project in late 2015, at the very fourth quarter. That was an order that had been booked in early 2013. It was expected that, that would go forward and now, its -- plans are underway to convert those units to natural gas, part of an overall trend. There is possible plans to continue another unit on coal but -- and if that remains a fact, that contract could restart. But it carried about a 10% cancellation fee, Dave mentioned about $680,000 that went straight to bottom line. So that was a $6.8 million contract with equipment deliveries like around November 2015. So while we're sorry to see it go, its margin would have been a little bit better if we monetized the value of it today. On the other hand, we have won some domestic business, in particular, $5 million plus contract being awarded this quarter and expect to be complete second quarter of 2015, I believe. And we are working on a fairly large project pipeline. The pipeline of ESP projects that we are looking at is in excess of $25 million. The award dates vary from the current quarter that we're in to dates in 2015, and they also vary in size from about $0.5 million to $5 million, $6 million in contract size. So generally, we're pleased with the prospects of the PECO-FGC acquisition. But like all of our project activity in the APC segment, it is subject to puts and takes on contract execution or cancellation.

[Operator Instructions] And your next question comes from Mr. Dan Mannes from Avondale Partners.

This is Stefan on for Dan. Just real quick, I wanted to get your thoughts going back to CSAPR, you noted in the press release and just a minute ago that you expect to kind of a long-term pickup in orders. Do you have any commentary regarding what the EPA mentioned in their petition that CSAPR may have limited effect given that there's -- we're already near compliance on the original emission levels?

The commentary I can say is this. I'm not the expert, but I am aware that since you saw a more than 2.5 years delay, there has been progress on attainment over the previous baseline. So where we are today in 2014 may very well be different than where we were in 2011. And so the states and various groups are looking for an update to the starting point as it relates to what percentage improvements are needed. As you know, the CSAPR is all about the upwind states contributing to pollution and the downwind states for sulfur dioxides and NOx emissions. And so the current baseline measurements are probably going to be refreshed, I would say, as it relates to determining what improvements are needed.

All right. Also talking about FUEL CHEM, you noted the increase in demand for new domestic orders and I think you said kind of one of the catalysts for that, maybe I misheard you, was for tax reasons. Could you expand on it a little bit? That seems to be pretty new.

That was only in the case of 1 particular customer, who used a refined fuel. We don't see that as a primary driver to our FUEL CHEM business, but it has been in the case of that 1 particular customer.

And we have been engaged with that customer on another unit, so we've proven out the effectiveness of the program. So we're not expanding that across our fleet, so.

Okay. All right, great. And also on FUEL CHEM, I think you noted in your release that you were seeing some international opportunities, as well. I know you guys have tried that before and found the costs were a little difficult. Can you comment on any opportunities you're seeing there, as far as FUEL CHEM is concerned?

Well, we are seeing some opportunities in Europe. We've done a demonstration over there and a program that began at the end of March. We're tracking about a half a dozen opportunities in different countries, Italy, Netherlands, Switzerland, Finland, Poland, all of which represent interesting incremental opportunities. We see nearest short-term opportunities over there in black liquor recovery boilers, waste incinerators, pulp and paper industry. But I'll add that the -- probably the biggest international opportunity that we have is still in China. As you know, China is an air pollution control market, for us, today. But we've come to recognize and hear growing customer interest and possibly partnering interest for FUEL CHEM. We have actually done a lot of work in analyzing slag samples from various Chinese coals. We've developed localized sources of supply and we aim to commence some demonstration programs over there later this year and into next year. That being said, that business is at its embryonic stage, but could emerge to be a very important opportunity for Fuel Tech, and we certainly aim to capitalize on that. I'll also add that we made an even earlier commitment to the Mexican market. There, the fuel that's burned is Pemex oil. It's very problematic. It results in significant SO3 emissions and we've been working with the 1 and only state Utility CFE, and have a local partner in Mexico and established Pemex supply there with local content. And we've been able to overcome some very significant technical challenges to be able to remove SO3. So we're very optimistic that over time that we can become the leader in that market. That is a royalty generating income stream for Fuel-Tech because of our partnering relationship as opposed to a traditional top line revenue that we have here in the United States. It remains to be seen how we construct the business model in China, but I think it probably is reasonable to say that the partnering solution will be sought in order to get larger market access.

Okay, perfect. And then 1 last quick 1 on the SG&A line. Can you give us any idea of how much acquisition costs were included in that for the quarter?

Yes, it was minimal at about $50,000. So acquisition-related was minimal. We brought on in the quarter about $400,000 of costs associated with that business, that would be personnel and overhead-related costs and that showed up in the quarter.

But I will add that, as part of our strategic development, we're pursuing other opportunities, which have not been consummated and those necessarily involve planning and pre-acquisition SG&A costs.

We have no other questions, so I would now like to hand back to Doug Bailey for closing remarks.

Okay. Thank you very much. Here at Fuel Tech, we continue to believe that we're progressing as a leader on global markets for air pollution control and energy efficiency solutions. We have a really great dedicated team of professionals that's working around the world to achieve both immediate near-term and very importantly, our long-term objectives. And so we thank you, all, for joining us on today's call, and we certainly appreciate your continued interest in Fuel Tech. Thank you, operator, and thank you those of you who joined the call today. Bye, everyone.

Thank you, ladies and gentlemen. And that concludes your conference call for today. You all may now disconnect, and thank you for joining.