Fuel Tech's (FTEK) CEO, Doug Bailey on Q1 2014 Results - Earnings Call Transcript

May.13.14 | About: Fuel Tech, (FTEK)

Fuel Tech Inc. (NASDAQ:FTEK)

Q1 2014 Earnings Conference Call

May 13, 2014 9:00 am ET

Executives

Doug Bailey – Chairman, President, Chief Executive Officer

Dave Collins – Senior Vice President, Chief Financial Officer

Analysts

Dan Mannes – Avondale Partners

Steven Charest – Divine Capital Markets

Operator

Good day ladies and gentlemen and welcome to the Q1 2014 Fuel Tech Incorporated Earnings conference call. My name is Steve and I’ll be your operator for today. At this time, all participants are in a listen-only mode. We will conduct a Q&A session towards the end of this conference. If at any time during the call you require assistance, please press star, zero and an operator will be happy to assist you. As a reminder, this call is being recorded for replay purposes.

Now I would like to turn the call over to Mr. Devin Sullivan, Senior Vice President of The Equity Group. Please proceed, sir.

Devin Sullivan

Thank you, Steve. Good morning everyone. Thank you for joining us for Fuel Tech’s 2014 First Quarter 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. Also on the call is Bill Cahill, Fuel Tech’s Corporate Controller.

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 during this 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, www.ftek.com.

With that said, we’ll now begin the call, and I’d like to turn things over to Doug Bailey, Fuel Tech’s Chairman and Chief Executive Officer. Please go ahead, Doug.

Doug Bailey

Good morning everyone and thank you all for joining us today. Before I turn things over to Dave, I wish to spend just a few minutes discussing some significant and very likely impactful developments at Fuel Tech that occurred over the last few weeks.

On the regulatory front, on April 29, 2014, just two weeks ago, the United States Supreme Court upheld the EPA’s cross-state air pollution rule, or CSAPR, which mandates that so-called upwind states reduce emissions from coal-fired power plants of sulfur dioxide and nitrogen oxide. By way of background, following the introduction of CSAPR on July 6, 2011, Fuel Tech experienced a surge in domestic orders for our SNCR technology as utility and industrial clients rushed to comply with the lower emissions standards set to take effect on January 1, 2012. For the third and fourth quarters of 2011, we recorded approximately $41 million of APC orders driven by CSAPR. SNCR was and still is an ideal low capital solution for these plants, reducing NOX emissions by 40 to 60% with minimal installation downtime and low energy consumption; however, this rule was short-lived and was stayed on December 30, 2011 by the U.S. Court of Appeals for the District of Columbia Circuit Court, causing a prompt disappearance in pressure to comply. Eventually, CSAPR was vacated by this same court on August 21, 2012, thus solidifying a more than two-year regulatory hiatus.

Since that time, our domestic APC business has operated under other existing regulations and state consent decrees. Although U.S. bookings continued, the pace of new domestic awards slowed and backlog declined as utilities delayed their purchases while awaiting the regulatory clarity that was ultimately delivered just two weeks ago. This dynamic was apparent in our first quarter results. The revival of CSAPR could prove to be a significant factor in driving the growth at our APC business segment. As the law was remanded, the timeline for utility compliance remains uncertain and it’s still quite unclear as to when EPA will be able to start CSAPR implementation. This is based on when it obtains a ruling from the DC circuit court on certain state implementation plans that were disapproved and once the EPA moves towards implementation of its federal implementation plan, there are questions as to how EPA views the timing to begin the compliance windows by source and state.

Last quarter, I noted that we do have visibility into near-term potential for well over $100 million in domestic APC project opportunities, over half of which are with utilities with the balance in industrial segments. We are waiting further clarity on our reimplementation of CSAPR to see how this pipeline will change. I do wish to point out that our decision to maintain Fuel Tech’s highly skilled internal resources during the judicial process has proven to be a sound one. We are prepared to respond quickly and our sales and marketing infrastructure will help ensure that we can secure a significant share of contract awards generated by CSAPR.

Secondly, on April 30, a day after CSAPR was upheld, we acquired two related private companies, collectively referred to as PECO-FGC, which provides particular control on flue gas conditioning solutions to coal-fired power plants and other solid fuel energy facilities. These acquisitions broaden Fuel Tech’s product portfolio by complementing our suite of NOX reduction technologies and provide us an avenue for revenues with customers striving to meet the EPA’s mercury and air toxic standard, or MATS. We acquired these companies for a total of $8.25 million in cash. In 2013, they combined to produce revenues of $10 million and had a year-end backlog of $14 million. Operating profitably, PECO-FGC is expected to immediately be accretive to our earnings.

Fuel Tech and PECO-FGC share a similar customer base which provides substantial cross-selling opportunities and a natural channel for potential follow-on business from those clients requiring multi-pollutant emission control solutions. We’re very excited to be working with the PECO-FGC team of talented professionals and now add Westlake, Ohio as our newest office location. While at that suburban Cleveland office last week, I was pleased to welcome everyone at PECO-FGC to the Fuel Tech family and we all look forward to a successful future together.

Particulate control is a fast-growing segment of the total air pollution control market. Adding the capabilities of PECO-FGC creates a substantial opportunity for Fuel Tech as operators of coal-fired power plants throughout the U.S. and abroad develop strategies to meet upcoming regulations. In the U.S., this includes the previously mentioned mercury air toxic standard and CSAPR for utility boilers, along with boiler maximum achievable control technology, or boiler MACT, rule for industrial boilers. Compliance dates for MATS and boiler MACT implementation include both 2015 to 2016 deadlines while the date for CSAPR is expected to become clear over the next few months.

I’ll be back in a few moments to touch on some other topics, but for now I’d like to turn the conversation over to Dave Collins, Fuel Tech’s Chief Financial Officer. Dave?

Dave Collins

Thank you, Doug, and good morning everyone. Thank you for participating in today’s call. We started off 2014 slower than we would have liked, but we expect the acquisition of PECO-FGC to contribute significantly to our results in 2014, and we are watching for EPA rule making after the Supreme Court ruling and will update everyone on our quarterly call as soon as we have clarity to this opportunity. Each of these opportunities have the ability to immediately contribute to our results of operations and we think the combination creates a compelling story for Fuel Tech. I will provide some overview comments later in my script regarding our outlook for 2014.

Our first quarter revenue was $18.6 million, which represents a decrease of $3.8 million or 17% from the prior year. This decrease was reflected in both segments and was geographically focused on our U.S. domestic business. We will discuss in a minute the segment results for the quarter. Our loss for the first quarter of 2014 totaled $1.1 million or $0.05 per diluted compared with a break-even quarter in the prior year. Our working capital decreased slightly by $394,000 and totaled $48.2 million at March 31. Our cash balance remains strong at $24.9 billion or $1.10 per diluted share.

Consolidated gross margin dollars for the first quarter totaled $7.9 million, down from $9.4 million in prior year. As a percentage of revenue, our gross margin was consistent in both years at 42%. Our selling, general and administrative expenses totaled $8.7 million for the first quarter of 2014. They were up slightly from prior year. This increase reflects higher quarterly costs for professional and consulting costs associated with our strategic planning and acquisition-related costs, offset by reduced employee costs. Our research and development for the first quarter of 2014 was down $689,000 from prior year. We remain committed to new product development initiatives and expect to continue spending between 2% to 3% of revenue on research and development projects.

Consolidated net loss for the first quarter of 2014 was $1.1 million or $0.05 per diluted share. Our adjusted EBITDA for the first quarter was a negative $43,000. These amounts are reflective of the lower top line revenue discussed previously. We booked a tax benefit for the first quarter of 2014 due to the consolidated loss. We currently expect our full-year effective tax rate to be 13% but our tax rate may change significantly due to the geographic mix of our income and the impact of permanent items on our overall effective tax rate.

Now let’s move on to a discussion of our business segments. Our APC segment reported first quarter revenues of $10.7 million, down $2.2 million or 17% from the prior year. As discussed previously, this decrease is principally driven by a drop in our U.S. domestic APC work. While we have recently experienced slower demand for our U.S. domestic APC projects, we see the recent Supreme Court ruling to be a significant event for our business and are awaiting a response from the EPA to clarify the timing and scope of the regulations. We believe that once this clarification takes place, we will see a renewed interest in our suite of NOX technologies which have been developed to achieve compliance with tightening emissions standards.

In our foreign APC markets, our China business increased slightly from the prior year and our Chile contract revenue in the first quarter declined by approximately $700,000 from prior year. We did see growth in our mainland China revenue during the first quarter, representing an increase of 32% over the prior year. Our consolidated backlog at December 31 was $15 million, broken down as follows: U.S. $2.4 million; Europe and Latin America, including Chile, $6.7 million; and China-Pacific Rim $5.9 million. Our consolidated gross margin for the APC segment was consistent with the prior year at approximately 34%.

Our fuel chem segment reported first quarter 2014 revenues of $7.9 million, which represents a decrease of $1.6 million or 17%. During the first quarter, we had a number of plants in outage which decreased our revenue in the first quarter. We expect our existing customer revenue to be consistent with the prior year amounts for the remainder of 2014. Additionally, we are looking at a number of (indiscernible) opportunities with both existing and new customers, which is encouraging. Over the past few years, we have worked hard to offset prior customer losses and feel that we have gained some momentum for building new business. Gross margin for our fuel chem segment was 53%, which was also consistent with the prior year.

Now we would like to provide some brief comments regarding the remainder of 2014 and specifically our new acquisition of PECO-FGC. For our APC business, we expect domestic APC NOX markets to be slower until the EPA provides clarification for reduction levels and timing for the new CSAPR regulations. Additionally, our recent PECO-FGC acquisition will bring us approximately $10 million to $12 million of U.S. domestic APC backlog as of the closing date and we would expect to recognize approximately $6 million to $7 million of that figure in 2014. We also have outstanding bids issued with rewards that double the acquired backlog figure.

We expect in a competitive marketplace, our gross margin (indiscernible) for this work will approximate 30% to 35% with lower margins reflected for installation and work components. With the CSAPR ruling and the PECO-FGC acquisitions, we believe there are significant opportunities for us in the U.S. domestic marketplace to fully leverage our infrastructure. That being said, we will look for a slower Q2 as we integrate PECO-FGC and look for clarification regarding CSAPR. Our selling, general and administrative expenses on a gross dollar basis are expected to increase approximately $2 million in 2014 over the prior year due to the acquisition of PECO-FGC.

In our fuel chem business, we realized a slower start to the first quarter of 2014 was due to a combination of things, including outages and customer demand. As previously discussed, we are actively engaged with new customer opportunities and will look to this new business, along with our existing customers, to support modest growth in our fuel chem business over the prior year.

Cash and cash equivalents at March 31 totaled $24.9 million and we have a small debt balance due on our foreign line of credit totaling $1.6 million. Our working capital balance remains strong and exceeds $48 million as of March 31.

Now I’d like to turn the call back over to Doug.

Doug Bailey

As Dave alluded to, our results for the first quarter reflect the lingering narrative of more than 2.5 years of regulatory gridlock here in the United States associated with defining our nation’s pollution control policies coupled with the changing generation mix and lower overall electricity consumption. Domestically, these factors produce lower revenues, fall bookings, and a diminished backlog. In response, we continued to expand our global markets and achieve greater geographic diversity particularly within our regulatory driven APC portfolio. As demonstrated over the last several years, this approach has produced significant increases in our international revenues, primarily in China. In the first quarter of 2014, international revenues represented 51% of total revenues compared to 43% in the same quarter last year. While acknowledging our results for the first quarter were disappointing, we do not view them as an indicator of our performance for the year. In fact, the revival of CSAPR and the PECO-FGC acquisitions have made the future for our APC business significantly more promising.

The solutions offered by PECO-FGC will also assist us in strengthening our already established presence in China where APC market conditions remain strong and Fuel Tech’s presence and revenues continue to increase. China plans to spend some $277 billion over the next five years preventing and controlling air pollution. Among its greater challenges is controlling PM2.5 fine particulates. Investment in China to control particulate emissions is expected to be somewhat larger than NOX controls. Pollution levels in China are hitting record highs, resulting in as many as half a million premature deaths each year according to the President and Chinese Medical Association. The Deputy Minister of Environmental Protection has observed that NOX emissions have only dropped by about 2% over the last three years. China is the world’s largest emitter of greenhouse gases and awareness is rising inside China and beyond its borders that it is exporting its pollution to neighboring countries in Asia and even the west coast of the United States.

Compounding these concerns is the likelihood that coal will remain the predominant fuel source in China for the foreseeable future. It is projected that approximately one-half of China’s power generation capacity to be built between 2012 and 2020 will be coal-fired. From a regional perspective, coal is estimated to generate nearly half of Southeast Asia’s electricity by 2035, up from less than a third at present. We continue to believe that we are and will growingly be uniquely positioned to assist China in addressing its current emissions challenges. Our Beijing office is now seven years old and we employ 35 full-time Chinese national employees. Fuel Tech has now installed more than 160 emission reduction systems in China, representing approximately 20% of our global install base. We are experiencing a broad new level of interest in our suite of emissions control solutions, to include our SDR, SNCR, and flue gas conditioning technologies. We do believe that the diverse nature of our NOX solution portfolio now combined with the particulate matter expertise at PECO-FGC provides us with a distinct advantage in this important market.

With respect to our business in Latin America, our project in Chile should be substantially completed by early 2015. Although Chile is a limited market, we continue to leverage the success of this project as the showcase that demonstrates our abilities with the goal of seeking additional business in this and other markets. In Mexico, we continue to demonstrate sound technical progress with improved comprehensive control of SO3 at customer units. This is evident by visible plume reduction and we are encouraged that this developing market continues to represent one in which Fuel Tech can establish a long-term leadership position.

I’d now like to ask the operator to please open the floor for questions from our analysts and institutional investors. Thank you.

Question and Answer Session

Operator

[Operator instructions]

Your first question is from the line of Dan Mannes from Avondale Partners. Please go ahead.

Dan Mannes – Avondale Partners

Hey, good morning guys. A couple quick follow-up questions. I appreciate the color on CSAPR. What I’m wondering here is when you look at how the U.S. market has evolved since CSAPR was stayed, and CSAPR was actually stayed at the implementation date. I guess I’m wondering as you talk to your clients, how much is still out there versus how many of the plants that might have looked like they’d be subject to CSAPR have subsequently been or are planned to be shutting down? I guess I’m just trying to figure out what the market opportunity is left under the rule.

Doug Bailey

Good question, Dan, and not easy to answer. Certainly I think the focus has to be on the upwind states, states like Texas, Missouri, Nebraska, Kansas, Louisiana. These were the ones that were over their emission budgets back in 2011. In some situations, they may be able to achieve these new limits with few or no additional controls. We haven’t had the opportunity to review each and every state budget and know the current emissions limits to know which sources within those states are specifically in need of further controls. In order to quantify an answer to your question, particularly since we’ve been on stay here for 2.5 years and the old compliance schedules are obviously out of date, one of the things we’ll need to know is what kind of compliance deadlines will be renewed. That can then determine which technologies might be employed and whether or not they can be implemented in those time frames. If they were very short timeframes, which I don’t necessarily expect, like we saw when CSAPR was first enacted, technologies like SNCR will be favored.

I think also you have to put into this mix the plant retirement strategies, the fuel switching strategies to determine which sources will continue to operate requiring controls and how much of those will require our technologies. So we await further clarification to really be able to quantify that, Dan.

Dan Mannes – Avondale Partners

Okay. Can I ask in an alternative fashion, given your marketing group and you talk to your clients, what so far has been the reaction from your clients? And I don’t know if you had a chance to listen to maybe any of the utilities who reported after CSAPR, but at least among the major coal utilities, the tone was fairly muted in terms of their view of the risk. I’m wondering if maybe you’re getting a different feel as you talk to their environmental guys.

Doug Bailey

Well with it being such a short timeframe since this announcement came out, I don’t particularly have a lot of color on this date, Dan, as to what the utilities are saying. I think probably—we think they probably view the need to deal with cross-state migration of pollution as a very real thing. I don’t think people expected that we would go on in the future with no regulation like CSAPR. It might have been redefined, but here we have it and I think it’s going to take certainly several months before the actual implementation plan is more clear.

I do not expect the announcement to make an immediate effect on us like it did in July 2011 over the course of two months where we saw a surge in orders, but I do expect it to be a favorable driver with winds at our back to grow our APC business domestically.

Dan Mannes – Avondale Partners

Okay, and then if I could just switch gears real quick and just ask about PECO-FGC, can you just spend a few minutes talking about what their scope of work is typically on an ESP upgrade, what do they bring to the table in terms of proprietary, and then how would they participate in China because I don’t believe they’re there now, and how would you be able to port their capabilities here, there? So kind of a three-part question on PECO-FGC.

Doug Bailey

You’re correct that they don’t participate in China right now, Dan, and that was one of the drivers of the business combination. It was also an orderly plan for the principal owners of PECO to enter retirement and logically put the organization with a company he knew well and we already had a good cultural fit. They have proven experience. They are not a patent protected type of technology, but they have well established, proven proprietary designs, methods that have consistently met or exceeded their performance guarantees. They have a lot of experience in optimizing ESP operations, a lot of stuff around refill work, and the market for refills is where a lot of the opportunities lie. They have knowledge in rebuild sequencing, being able to remove existing components, design and install new hardware controls, and to get overall ESP performance improvements. They also have significant modeling capabilities akin to the category of expertise that Fuel Tech uses every day in our NOX control work, so the ability to model, predict, improve ESP performance is one of their strengths.

We expect to be able to increase their revenues substantially. Part of that is because the market itself is larger than they’ve been able to penetrate. Some of that has been principally limited by their small size, being unable to necessarily bond larger projects in which the performance guarantees require such commitments. It’s something that Fuel Tech is quite able to do, so for example we’ve already bid on a couple of large projects that are of the scope and size in excess of their annual revenues to date and are waiting a determination of who will win those projects.

As far as the U.S. market, Dan, we see that market size over the next several years to be in the 250, $275 million range. Probably in the near term, 2014, ’15 and so forth, probably 60% of the work will be with utilities relative to retrofits; probably 40% or so will be with industrial ESP operators, and then the minor retrofit parts business represents probably an equal sized opportunity to the major retrofit business.

So there is going to be some turnkey installation work involved. This will involve typically slightly lower margins to execute these large projects, but the typical margins on the engineering and parts business of the business will be greater – you know, in that 30% to 40% range, 35% to 40%.

So when you look at the opportunity over the next several years, Fuel Tech by acquiring PECO can leverage its capabilities with our scale, and I think secure a significant share of a market that only has a handful of competitors. It’s not as diverse as some other markets such as burner markets.

The other thing is that the FGC side of the business, you may recall we license that technology and have been selling it in China, and we’ve sold a number of FGC projects in China using PECO-FGC employees traveling there with us, so that’s a pent-up market that’s being penetrated by Fuel Tech. When you look at particulate control, ESPs, fabric filters, the size of the market in China for all players is probably over a five-year period – you know, ’13 to ’18 – is expected to be on the order of $20 billion. So we’ll obviously need to establish local sourcing and capability, but that’s a market somewhat in excess of spend on NOX control and the air pollution that you see in China is every bit as much related to the inability to control plant particulates. We know by having PECO-FGC people over there that they are not operating their ESP the way they should, and we therefore have the combined expertise to help them achieve that over the years ahead.

So I see particulate control to be a very important market for Fuel Tech in China, but it’s also going to be driven by strong needs over the next several years here in the U.S.

Dan Mannes – Avondale Partners

Sounds good.

Doug Bailey

And again, we’ve worked with these people for quite a number of years. The fit is still good. When I walked into that office for the first time, it just felt like I was in a Fuel Tech office – the way they do their business and their engineering is just so akin to what we do that it’s a nice marriage. So we have to grow—we hope to grow it substantially.

Dan Mannes – Avondale Partners

Sounds good. Thanks Doug.

Operator

Your next question is from the line of Steven Charest from Divine Capital Markets. Please go ahead.

Steven Charest – Divine Capital Markets

Hey gentlemen, how are you today?

Doug Bailey

We’re fine, thank you.

Steven Charest – Divine Capital Markets

Excellent. Quick question on kind of the run rate of RFP, RFQ activity. We haven’t heard too much in that space with the expected Supreme Court gaming. Any color on that?

Doug Bailey

Good question. We’ve actually been incredibly busy in our proposals and sales groups, working on—and I’ve always said it, often these are lumpier, larger projects with the deadline for compliance still out there in time, so we haven’t had the pressure of regulatory driver in all cases to see a broad market of numerous commitments. We have met opportunities because there are consent decrees with certain operators with deadlines associated with that, and you’ve seen our ability to maintain a domestic business in light of no regulatory driver such as CSAPR being in place. That’s still going to be the case, so if you ask a salesperson, are you busy, they’ll say we’re extremely busy.

But the win rate is a little less frequent and the opportunity for those wins can be a little larger. I think that will remain true but accelerate in the particulate control market where we’re seeing quotations in the $10 million to $20 million range for (indiscernible) work. So I think lumpy is still an appropriate adjective to describe the market. The pipeline is out there and we’re hopeful that clarity on CSAPR will solidify the customer base to make their commitments and put the dollars in their capital budgets to enable us to carry out those programs.

We’ll turn it back to the operator for the next question, please.

Operator

There are no further questions at the moment, but if there are any questions from analysts and institutional investors, please press star, one.

There are no further questions. I would now like to send the call back over to Doug Bailey for closing remarks.

Doug Bailey

Thank you, Operator. Well, we do continue to be optimistic that Fuel Tech is well positioned to expand its presence as a leader in the global pollution control market. The year 2014 may very well be a breakpoint year in our history, and I’m excited to continue working towards our long-term objectives. As always, I wish to thank Fuel Tech’s team of professionals around the world for their dedication, resourcefulness and support, and we thank our shareholders. To you on the call, thank you for your participation and your continued interest in Fuel Tech. Thanks very much. Bye everybody.

Operator

That concludes your conference call for today. Have a great day. Thank you.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!