Fuel Tech, Inc. (FTEK) Q3 2015 Earnings Report, Transcript and Summary

Greetings, and welcome to the Fuel Tech Third Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] It is now my pleasure to introduce your host, Devin Sullivan with The Equity Group. Please go ahead, sir.

Thank you, Kevin. Good morning everyone and thank you for joining us for Fuel Tech's 2015 third quarter financial results conference call. Yesterday after the close, we issued a copy of 3Q release, which is available on website www.ftek.com. The speakers on today's call will be Vince Arnone, President and Chief Executive Officer and Dave Collins, Senior Vice President and Chief Financial Officer. After prepared remarks, we will open the call for questions for our Investors. Before turning things over to Vince, I would like to remind everyone that matters discussed in 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 forward-looking statements. The factors that could cause results to differ materially are included in our filings with the SEC. The information contained in this call was accurate only as of the date discussed, and investors should not assume that statements made during the call remain operative at a later date. Fuel Tech undertakes no obligation to update any information discussed in this call. And as a reminder, the call is being broadcast over the Internet and can be accessed at the Company's website. With that said, I'd now like to turn the call over to Vince Arnone. Vince, please go ahead.

Thanks, Devin. Good morning and thank you everyone for joining us on the call today. During our first and second quarter conference calls, we anticipated that many of the same teams that impacted us in 2014 would continue to impact us as we entered into 2014, especially with respect to our APC business. And we expected that we would deliver sequential financial improvements in the second quarter – from the first quarter of this year and at the second half of 2015, which have improved financial performance versus the first half. With that said, our third quarter results met our expectations as revenues of $21.7 million represented an increase of 16% from the second quarter. Further, in the third quarter we returned to generating positive adjusted EBITDA and cash flow from operations. This was a potential financial result for our Company. We are encouraged by the improvement in financial performance from the first half of the year and expect that our financial results for the fourth quarter of 2015 will be an improvement over the third and as a result, our second half performance in 2015 is expected to improve over the first. As many of our long term investors know, we continue to operate in a very challenging environment in the domestic marketplace driven primarily by lingering regulatory uncertainties and migration of fuel sourcing from coals and natural gas. We are specifically addressing this fundamental structural shift in the power generation industry via modifications and our approach towards business development activities, cost structure and overall corporate strategy. We have noted previously and that it was our specific intent over these past two years, to expand our geographical presence and our air pollution control product lines to ensure that we would not be dependent on any one markets, nor product in any point in time. Including our announcement at this morning, year-to-date we have now announced approximately $30 million of new orders for customers in the U.S., China, Latin America and Europe for our ESP, SNCR, ASNCR, SCR, Combustion and ULTRA technology solutions. At quarter end, the capital projects backlog in the APC segment was approximately $70 million. This figure excludes post Q3 order announcements totaling nearly $13 million giving us an adjusted APC backlog of approximately $30 million as of this morning. During our second quarter conference call, we noted that we had visibility to an incremental $20 million in project orders that we expected to book before our third quarter conference call and I am very pleased that we were able to achieve this goal. We continue to pursue additional APC contract awards in a variety of geographies around the world and believe that we are well positioned to win additional awards prior to the end of this year and into the first quarter of 2016. The domestic market will likely remain challenging and so there is further clarity on the regulatory front and we will address the regulatory environment in a moment. However, we do see opportunities continue into develop in other parts of the world. First, in Europe, we are excited about the acceptance of our advanced SNCR technology which is an internally developed next generation SNCR Solution. On the deals of the four unit contract that we announced earlier this year at the largest power generation facility in the U.K., we believe that ASNCR can provide benefit to the installed base of power generation facilities in Europe that are seeking to comply with the European Unions, industrial emissions directive which requires information dates commencing in 2016. In China, the market dynamics remain complex and local competition remains engaged and strong. Project bidding activity is robust and we believe that it will continue at this high level in the near term as many power generation unit owners in highly concentrated regions look to comply with more stringent in MATS reduction standards. Just recently, Chinese environmental regulatory body set a 50 milligram NOx emission target to select high population areas that is going to effect in 2016. There is a large installed base of current SCR systems in China that will not be able to meet this new target as configured. Upgrading the existing SCR systems will require a parallel upgrade to the ammonia production and delivery technology at SCR. For Fuel Tech this presents an opportunity to convert the large installed base of ULTRA systems to higher capacity systems. We look forward to install in our latest generation of this internally developed technology in the Chinese market effective immediately and we are confident that we will see an improvement in our business performance in the near term. Moving on let's briefly discuss the current regulatory landscape in the U.S. First with respect to CASPR, Phase 1 implementation commenced on January 1, 2015 and Phase 2 is yet to start in 2017. CASPR mandates non emissions controls for states that are down win from pollution sources. We have received increase for our SNCR systems to help or direct any shortfalls in emissions, reductions under Phase 2. While we may not see material business in 2016 directly related to this regulation, we are very encouraged by the increase that we are receiving which indicates that union owners in specific states are planning for capital project spending in late 2016 and 2017. In addition to SNCR, we will also address this opportunity with our advanced SNCR, FCR or our layer technology approach. In October, EPA finalized the new National Ambient Air Quality Standards also known as NAAQS who always go on a mission. NOx emissions are one of the flue gas pollutants that contribute to ground level ozone and this new ambient requirement of 70 parts per billion is expected to create the need for sources to reduce NOx in the next several years. The current NAAQS for ozone is 75 parts per billion which has been effect since 2008. It is important to note that CASPR with an EPA rule for sources trying to meet ozone NAAQS standards that will set even before the 2008 ozone standard. The 2015 NAAQS standards are expected to generate future opportunities that are in 2017. Another recent regulatory development was EPA finalizing its new rule for greenhouse gases from existing power plants which is known as the Clean Power Plant. This final rule which we issued in August and finally published officially in October, covers CO2 and methane pollutants and includes a requirement to improve efficiency at existing sources with the compliance base of 2022 and 2030. States must have their final compliance plans completed by September 2016 which can be extended until September 2018 if required. There are already a number of legal challenges to plan including a request of the rules that we state with varying reports of 23 to 26 states being involved. Many experts believe that the future of the plan will likely give result before the extension date is reached. If the Clean Power Plant does not survive the legal challenges, it is important to note that the future number of units affected by the 2015 natural or NAAQS control will increase substantially. This would apply to a combination of utility and industrial sources since the Clean Power Plant projections expect 49 gigawatts of power generation to be taken offline. But this number of units remaining in service deeper NOx reductions from more sources will be required to meet the NAAQS standard. Continuing, the MATS rule was written to address hazardous air pollutants under the guidance of the Clean Air Act Amendments and specifically addresses emissions of particulate matter, mercury and hydrogen chloride from electricity generating units. The rule originally had an effective date of April 2015 with an extension allowed under certain circumstances to April 2016. This rule is an importance to Fuel Tech because generating units will need to add mercury and hydrogen chloride abatement technologies to their current operating environments in order to comply with this rule. The addition of these technologies can overload most existing particulate matter control systems primarily Electrostatic Precipitator and may require that these systems be retrofitted to reach compliance levels. Here I would like to highlight the performance of PECO-FGC, a Electrostatic Precipitator business that we acquired in April 2014 for approximately $8 million. Fuel Tech purchases business in 2014 in order to help industrial and utility customers achieve stricter emissions compliance under MATS. Thus far our investment thesis has proven accurate as since April 2014, total post transaction orders have exceeded $20 million. Moreover, PECO-FGC continues to maintain a strong project pipeline. As announced last month, we received significant orders for our ESP solutions from separate Midwest customers. The first was for ESP upgrade to reduce articulated emission from a large coal fired utility boiler and the second was for an ESP retrofit on a coal fired unit. With respect to boiler MATS which is very similar to MATS in terms of the pollutants covered but with applicability to industrial units as oppose to a electric generating units, all our argument are schedule to begin in December 2015 following reconsideration late last year. The original compliant state was January of 2015. However as suggested by Industry sources, it is likely that this reconsideration will delay the compliance stake. Fuel Tech has been a Solutions provider to industrial unit owners for more than 30 years. And we believe that we are well positioned to provide our particular control technology expertise to industrial unit owners that will need to comply with this rule. In summary, while the domestic regulatory environment is complex, we believe that our technologies will serve both utility and industrial customers well, as they look to comply with these regulations along with other required sources of compliance including consent degrees, permitting issues with industrial plant expansions and Regional Haze requirements. We have seen growing that need for new industrial gas fired unit which must install FCR technology to meet the best available control technology requirement and their operating permits. The timing of compliance and the overall volume of business for us however remain uncertain. Turning to our Fuel CHEM business segment, revenues were down slightly from prior year periods, while gross margins remain historically strong and consistence. As we have noted on prior calls, this business continues to face headwinds due to reductions in coal fired generation combined with coals to gas conversations and we continue to believe that full year [2005] [ph] revenues will be below the level of the prior year. Gross margins however should remain at the level of prior years. This revenue decline is primarily due to lower Chemical usage at existing customers. However, we have been able to partially mitigate a full impact of this usage decline to get the addition of business our new customers and through the development of alternative strategies to assist our customer base with new issues that they are addressing as they experience dramatic changes and how they need to operate the boilers. Fuel CHEM has proven effective in helping coal fire boilers operate at lower loads thus allowing unit owners to improve their power generation and dispatch capability. As we discussed last quarter, FUEL CHEM has the potential role in helping power plants comply with EPA’s new Clean Power Plant which seems to reduce CO2 and methane pollutants and include the requirement to improve efficiency at existing sources with compliance Phase of 2022 and 2030. By promoting boiler efficiency, the FUEL CHEM technology should be able to help operators of generating units, reduce CO2 emission by approving their heat rates. FUEL CHEM can help contribute to the 2% to 4% boiler efficiency improvement target for coal fired boilers to find in the Clean Power Plant. During the third quarter, we realized the full benefit of our previously announced $1.5 million cost reduction program. We continue to monitor our cost structure and are prepared to take further action as necessary in order to maximize our execution efficiencies and overall profitability. We remain committed to our investment in research and development as a means to involve our business. We invested 3.4 million in R&D through the first nine months of 2015 with the majority of the spending being devoted to our fuel conversion initiative. We are continuing to advance this initiative which converts low cost carbon based feed stocks into high value engineered carbon products. The Phase 2 engineering work that commenced at the beginning of Q3, will be completed this month providing design details for the construction of our production facility. As part of the commercial development activity, we have provided certain potential customers with test quantities of products tailor to meet their needs and have received very positive feedback. We repeatedly hear how high quality carbon is a fundamental and important element in the diverse manufacturing sectors of our economy for making both industrial and consumer products. Further, we continue to gain insights into the target markets and refine the engineering aspects of both the process and plant design. As we near the end of 2015, we are moving closer to the site selection and commercial development phases of positioning business and expect to report further progress in early 2016. So in summary, we remain very active in pursuing a number of initiatives to advance our growth objectives. Challenges do remain for the opportunities are quite exciting and we remain optimistic about our long term future. I want to thank you for your attention and now I’m going to turn the discussion over to Dave for a review of our financial results. Go ahead Dave.

Thank you, Vince, and good morning everyone. Consolidated revenues for our second quarter totaled $21.7 million compared to $21.5 million in the prior year. The first nine months of 2015, our consolidated revenues totaled $55.5 million compared to $60.3 million in the prior year. Our gross margin percentage for the current quarter was 36% reflecting a decrease from our prior year gross margin of 46%. For the first nine months of 2015 our gross margin percentage was 39% reflecting a decrease from our prior year growth margin of 44%. The decline in gross margins for both the current quarter and year-to-date periods is principally associated with the mix of technology sales and project margins in our APC segment. Our selling, general and administrative expense for the current quarter totaled $7.1 million, down 958,000 or 12% from the prior year amount of $8.1 million. For the first nine months, our SG&A expense totaled $23.7 million, down $2.1 million or 8% from the prior year amount of $25.8 million. These reductions are reflective of cost saving measures implemented in 2015. Our research and development cost for the current quarter and nine months totaled $1.5 million and $3.4 million reflecting increases over the prior year of $1.1 million and $2.5 million respectively. Given the sales of current R&D projects and the outlook for the remainder of 2015, we believe our current quarter expense levels for R&D spending will continue through the fourth quarter of 2015. Longer term we expect to continue supporting our R&D efforts as we believe this is a critical component for our future growth. Our net loss for the current quarter and year-to-date periods totaled 289,000, $0.01 per diluted share and $3.3 million or $0.14 per diluted share respectively. Our adjusted EBITDA for the current quarter and first nine months of 2015 was 638,000 and a negative $1.2 million respectively. The APC segment reported current quarter revenues of $13.1 million as slightly from the prior year total of $11.1 million. For the first nine months of 2015, our APC revenues totaled $31million down $2.2 million from the prior year total of $33.2 million. Our backlog at September 30 2015 was $16.9 million. As discussed in Vince's commentary, we have booked an additional 13 million of new orders, subsequent to the quarter close bringing our adjusted backlog up to approximately $30 million. Our APC segment gross margins in the current quarter totaled 23%, down from 41% in the prior year. For the first nine months our APC segment gross margins totaled 29% down from 36% in the prior year. As we have previously commented on this trend and expect to see APC margins around 30% for the remainder of 2015. Our Fuel CHEM segment reported current quarter revenues at $8.6 million down from $1.7 million from the prior year total of $10.3 million. For the first nine months of 2015, our Fuel CHEM segment revenue totaled $24.4 million down $2.7 million from the prior total of $27.2 million. Our current quarter gross margin for our Fuel CHEM segment of 56% was up 4% from the year margin at 52%.Our nine months gross margin for our Fuel CHEM segment totaled 52% which is consistent with our prior year gross margin of 53%. We expect to see our gross margin for the remainder of 2000 range between 50% and 53% which is consistent with previous guidance. Effective tax rate for the quarter and nine months varies due to discreet items and mix of geographic income. For the full year 2015 we expect our effective tax rate to approximate 40% through the geographic mix of incumbent losses. Our effective tax rate could change based on the mix of income and tax reporting within specific geographies, as well as the level of pre-tax net income compared to permanent add back items. Cash and equivalence at September 30, 2014 totaled $14.4 million and we remain debt free. Our working capital balances remain consistent through the first nine months and totaled $39.2 million at September 30 versus $39.7 million at our prior year end. Cash used in operating activities for the first six months was $1.1 million due principally to our nine months loss in status of our APC segment contracts and our spending on property and equipment totaled $523,000. We will continue to monitor our balance sheet position and operating profile to ensure we maintain a strong financial position as we work through our market opportunities. Now, I would like to turn the call back over to Vince.

Okay. We'd like to open the call for the questions at this point in time.

[Operator Instructions] Our first question today is coming from John Quealy from Canaccord Genuity. Please proceed with your questions.

Good morning, folks. So can we dive into the carbon a little bit, talk about some of your stocks and obviously I understand competitively you don’t want to give away everything, but talk about the ability, how you only been thinking about it, the time frame to actual commercialize, I mean you gave us a little hand, but if you could just dive deeper that would be great.

Yes John, we can give you little bit more information at this point in time but we realistically we'll need to comments we looked into 2016. But we are encouraged by what we are seeing as we are working through the development process with our fuel conversion business. This is engineered carbon, this is taking a very exciting process and applying to very inexpensive feedstocks and running those feedstocks into value added product that can be used in the variety of business segments. I can tell you a little bit about the segments that we are targeting, as I noted we are looking to post some industrial and consumer segments we are looking at foundry industries, iron and steel, we are looking in steel, alloy and silicone alloy producers and then some consumer product variance as well. So it's been a joint effort on both the quality - the process/technology development side, as well as testing the commercial development opportunities as well for this new initiative. We are excited about what we see that's why we are continuing to invest at this point in time. And as I said, there will be a lot more to comment when we move into 2016. We are moving at a very structured pace relative to how we're evaluating our incremental investment if you will, and as we move through those - across those milestones, that's how we take decisions in terms of whether or not we take that next step, as I noted in my commentary we're coming close to those next steps for buy – where we will consider looking at investing and how we're actually going to manufacture product and put them in the marketplace. So that's where we stand today.

Great, thank you.

You're welcome.

Thank you. Our next question today is coming from [indiscernible]. Please proceed with your question. Q – Unidentified Analyst: Thank you. Good morning. Just a follow up a little bit on the question about the fuel conversion, you're obviously looking at a lot of potential markets, but can you give us some sense of how big some of these markets could be, I mean what is the potential addressable market for some of them? I mean I guess the leading months as you look at the development of the program because you'd have to be selective to start with I think. So, what kind of market size could we be looking at?

Yeah, first of all I'll answer your second comment first. Yes, we are being selective in our approach because we need to obviously -- we need to prove out the efficacy of the processing and the technology, that's first step. And yes, we will target very specific market to do that first. Relative to market size, [Pete], it's difficult for me to go ahead and pull figures at this point in time that I would be comfortable with. All I can say right now is the fact that we believe very strongly that the market opportunities are going to be -- I'll use the word material, without putting numbers on that today. We'll know more as we move into 2016, and come to a point whereby we're looking to invest in actual manufacturing facility operation and we can talk a little bit more about specifically putting commercial product into market, and what those market sizes are going to be as we look at both industrial and consumer markets but today all I'm really comfortable saying is that we're seeing very, very positive indications from both technical efficacy and market acceptance and we are encouraged not to go ahead and look at these next steps of investment. And so that's where we are today, I wish I can give you a little bit more but that will come in the future. Q – Unidentified Analyst: Okay. And can you talk a little bit about where these products would fall sort of in terms of spectrum between commodity and highly technical or engineered products?

Yeah, I mean our intent is to actually move all the way towards the end of the spectrum whereby they are technically engineered products and not commodity products. We are actually looking to supplant commodity products. That's our intent. That's our expertise within Fuel Tech's is applying our engineering knowledge to be able to create something that's value added in the marketplace. We're now looking to create a commoditize product. Q – Unidentified Analyst: Okay. And then changing gears and looking from a high level, I guess the Chinese electrical generation market is probably slow, 80% coal or something like that, and it should be a huge potential given the severity of their pollution problems and I think they're planning to spend $300 billion and it could be should be probably a lot more than that over a period of time. Can you give us some sense of what the addressable market for your APC products is, going to that market primarily with ULTRA at this point I guess, but I don't understand why you can't have a broader approach in China and what limits your ability to fully capitalize on the whole market opportunity over there?

Yeah, I can help a little bit with that Pete, and yes of course, the Chinese marketplace is utilizing 75% to 80% coal as their fuel source for power generation. And I've seen recent articles that have actually understated their utilization of coal and so those percentages could possibly be higher than that as we sit here today. We've been in the Chinese marketplace since 2007, and on overall basis I'm pleased with what we've developed and built in that marketplace. What we found just like what many other companies have found when they've gone to move into China to do business, is we've found a very complex cultural business environment, we found highly competitive local Chinese suppliers that are really willing to do pretty much anything to win work. We've also found that compliance means something a little bit different in the China marketplace versus other markets in the world whereby the Chinese market still doesn't have today an ongoing internal enforcement mechanism for compliance with some other regulations. So, that creates a dynamic that is very different than other parts of the world. And that is actually what prevents us from being as pervasive with all of our technology portfolio as we would like to be, okay? ULTRA has been our largest selling technology there, we expect that to continue and that's because we really have a unique solution for converting urea to ammonia for all of their installed base of FCRs, and we believe we have a leg up on that technology in the marketplace. But as we know, new technologies don't stay very new long in that marketplace. So we've done well, I expect to still continue to do some good business in the China marketplace. We will look to see if we can bring other technologies to that market but as I mentioned there is a large number of local Chinese competition that's already there and supplying many of these technology to that market already. So, we're progressing as well I think we can at this point in time but we always look to improve. Q – Unidentified Analyst: And what do you think the trend of your business in China is likely to be this year overall?

I think from this year to next year I see a little bit of an uptick in business. 2015 has been a little bit of a downturn in the overall opportunity just because in 2015 we've really felt the impact of a large influx of competition, but we have developed -- we believe we've developed means to make ourselves a little bit more competitive with some of the local Chinese competition particularly with respect to ULTRA And that combined with the fact that there are going to be some lower emissions reduction levels that need to be met as we move into 2016 and 2017, and there's a huge market that needs to be served, that gives us indication that we should see an uptick in business in 2016 from 2015. Q – Unidentified Analyst: All right, and do you think that the competitive impact or competitive pressures on your mainstream business over there is really more sort of a cultural thing or is it because your cost structure is little bit too high for that market?

In reality it's a combination of both. It's a combination of both and we're looking to address, the cost structure issue that's where we can. Some of the other cultural business practice issues, that's a little bit more difficult for us to deal with is public company and so we'll focus on the cost structure. Q – Unidentified Analyst: Okay. Thank you very much.

You're welcome.

Thank you. We've reached the end of our question-and-answer session. I'd like to turn the call back to the Management for any further closing comments.

Thank you everyone for joining us on the whole call today. We appreciate your interest in Fuel Tech. As I noted, we're very pleased with our third quarter results. We expect better in the fourth and we're optimistic about our outlook for our existing product and technology suite, as well as looking forward toward some contributions from the technologies that we are investing in today. Thanks again everyone and we look forward to meeting hopefully some of you. Next week, Dave and I, will be presenting at Drexel conference in New York City, so if you happen to be there, please stop by and say hello. Thanks everyone.

Thank you. That does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today.