Fuel Tech's (FTEK) CEO Vincent Arnone on Q2 2016 Results - Earnings Call Transcript

| About: Fuel Tech, (FTEK)

Fuel Tech, Inc. (NASDAQ:FTEK)

Q2 2016 Earnings Conference Call

August 10, 2016, 09:00 AM ET

Executives

Devin Sullivan - SVP, The Equity Group

Vincent Arnone - President and CEO

David Collins - SVP and CFO

Analysts

John Quealy - Canaccord Genuity

Operator

Greetings, and welcome to the Fuel Tech Inc. Reports 2016 Second Quarter Financial Results Call.

At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host Mr. Devin Sullivan. Thank you. Your may begin.

Devin Sullivan

Thank you. Good morning, everyone, and thank you for joining us for Fuel Tech’s 2016 second quarter financial results conference call. Yesterday after the close, we issued a copy of the release, which is available on our 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 from our analysts and investors.

Before turning things over to Vince, I would like to remind everyone that matters discussed on 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 is 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 during 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, President and Chief Executive Officer of Fuel Tech. Vince, please go ahead.

Vincent Arnone

Thank you, Devin. Good morning and thank you everyone for joining us on the call today.

First, I would like to spend some time discussing the significant activities and developments since our last call in May. With respect to our financial results in the second quarter, revenue for the company as a whole was $15.2 million, versus $18.7 million in the second quarter of 2015.

However, our operating results was effectively the same. We're beginning to realize the impact of the cost reduction activities that we first initiated in the second quarter of 2015 and that we have continued since that date.

Our SG&A expenses are down $1.6 million and $2.4 million respectively for the second quarter and first half of the year from the comparable periods in 2015. I'll discuss our cost reduction initiatives in more detail in a few minutes.

In this past several months, I've stated that our company is focusing on three fundamental initiatives during this near term period in order to reposition ourselves for the future.

First in order to ensure that we continue to advance for generating positive cash flow, we're aligning our organizational infrastructure and related cost with the current revenue generation capability of our base business segments, which are Air Pollution Control and FUEL CHEM.

Second, we're enhancing the revenue generation capability of our base business segments via partnership opportunities where we bring Fuel Tech's existing suite of products and technologies to market through a partner sales channels or we bring a partner's product and technologies to market through Fuel Tech's existing sales channels.

And lastly, we're looking to making measured investments in new products and technologies that will represent the future of Fuel Tech.

Our Fuel Conversion business segment is one of these investments and we'll look to be making others in the future. Now let's review our business segment performance in more detail.

Year-to-date, we've announced $17 million in new APC project order. The $17 million in new orders are from customers in the U.S., China and Europe for our ESP, SNCR, A SNCR, SCR, Combustion and ULTRA technology solutions. Of the $17 million in new project awards, slightly more than 50% were from customers outside of the U.S.

At June 30 of this year, the capital project's backlog in the APC segment was approximately $11.6 million. When including the $2.3 million of new orders announced thus far in Q3, our pro forma backlog as of today is approximately $14 million.

In terms of our sales pipeline, we are pursuing a number of promising new projects in all geographies and are encouraged about our prospects for additional project bookings throughout the remainder of this year.

Today, our sales pipeline of opportunities exceeds $100 million on a global basis and this is consistent with activity levels that we've realized in prior years.

Although we do not provide specific guidance based on our existing project backlog and our current sales pipeline, we believe that worldwide APC revenue will approximate the same level in 2016 versus 2015 with contributions coming from all of our targeted geographies.

In the U.S. market, demand for coal and overall energy used are both down and there is a lack of finalized domestic regulatory initiatives that could potentially accelerate APC sales.

However, with that said, we continue to position ourselves to take advantage of the evolving regulatory landscape over both the near and longer term. Our focus remains on MATS, boiler MATS and maintenance drivers for ESP upgrades, ULTRA and SCRs for industrial applications and SNCR for units requiring compliance with CSAPR, the Cross-State Air Pollution Rule.

For utility MATS and industrial boiler MATS rules, we continue to see bidding opportunities to address particular matter control. Our near-term efforts include establishing business relationships with multinational industrial entities that will require compliance with regulatory standards and partnering with companies that require our technology portfolio to complete a broad bid package.

In Europe, we remain optimistic about the business environment in 2016, driven by increasing customer interest in our internally developed Advanced SNCR technology, as power generation facilities seek to comply with the European Union’s Industrial Emissions Directive.

In the U.K., we are continuing to pursue coal-fired units that are converting to biomass in order to benefit from government subsidies.

Through the use of strategic partners with local presence and project execution capability, we are also continuing to strengthen business ties with local entities in Spain, Turkey, Poland and the Czech Republic to take advantage of project opportunities in these geographies.

In China the introduction of more stringent NOx reduction standards for select high population areas will continue to drive revenues in the near-term. Today, there’s a large install base of current SCR systems that will not be able to meet this new target as presently configured.

Upgrading the existing SCR systems will require a parallel upgrade to the ammonia production and delivery technology tied to those SCRs.

For FUEL TECH, this presents an opportunity to convert our large install base of ULTRA systems to higher capacity systems. Additionally, SNCR working in tandem with SCR has become an accepted technology for meeting more stringent emissions requirement.

SNCR reduces the inlet NOx emission level to the SCR, which will then enable the SCR to meet the tighter emission standard. As an example of our partnering initiatives for the India market, in June we announced an exclusive licensing agreement for our SNCR technology with ISGEC Heavy Engineering Limited, one of India’s leading engineering and construction companies.

ISGEC will offer our SNCR solution and projects throughout India where coal remains a primary and growing source of fuel. In late 2015, the Indian Central Government issued regulations governing emissions requirements for coal-fired thermal power plants, which take effect starting in 2017.

Our SNCR technology is a proven cost effective way to allow utility and industrial client to comply with these rules. This agreement with ISGEC will cost effectively monetize our proven emissions control technology in the India market.

We announced our first sale with ISGEC in late July and we will report on our progress in this market on a recurring basis as we see further development.

In contrast to APC, revenue with FUEL CHEM declined in the quarter, continuing the trend that began in 2015. FUEL CHEM continues to face headwinds due to reductions in coal-fired generation driven by the abundance of low priced natural gas and resulting coal-to-gas conversion.

In the first half of this year, we were also impacted by mild weather, which served to further suppress energy demand in key markets. In combination these factors have created an environment where there is simply less demand for our product in traditional end markets. We are pleased however that margins that remained consistent with historical performance.

We are continuing to pursue a variety of means to introduce our power chemical technologies to new customers in the U.S. and overseas. In the U.S. we are seeking to help our customers adapt to the changing manner in which coal-fired units are being dispatched. As coal units are required to reduce their load profiles, many of them are having difficulty running at these load levels.

More specifically, there is equipment on a boiler that will impede the unit from running at lower outlet levels without a specific change in operation and we believe the FUEL CHEM technology can provide benefit in this instance.

In Europe, we are excited about the opportunity to offer our FUEL CHEM program to the operators of biomass fired units, and municipal solid waste units both of which are known to have severe and costly slagging and fouling issues and we are targeting to demonstrate our capabilities in 2016.

On a worldwide basis, we are expanding our industrial reach into the pulp and paper industry, where FUEL CHEM can address the issue of slagging and fouling in black liquor recovery boilers.

In the U.S., we have solidify a technology demonstration with a large multinational company that will commence in the third quarter. Additionally as part of our partnering efforts, in Asia, we’ve identified a company that currently manufactures and sells a variety of industry-specific chemicals to greater than 350 pulp and paper units on their continent.

We are very close to finalizing an agreement with this company whereby it will be an implementer of the technology in Asia. It is our goal to have successful technology demonstrations in the U.S. and in Asia in 2016 as a springboard towards accelerating business activity thereafter.

With respect to Fuel Conversion, as we reported previously, we created a separate business segment for this new initiative in the fourth quarter of 2015 for financial reporting purposes in order to be able to provide greater transparency regarding our actions and results in this segment.

We continue to advance this developing business, which converts low-cost carbon-based feedstocks into high-value engineered carbon products. As planned, we completed our primary engineering efforts in 2015, and began to focus on specific commercial development activities in 2016.

In the current calendar year, we have been evaluating various build-out strategies and potential site selection opportunities with engineering refinements continuing through all aspects of the development phase.

During the second quarter, we targeted an available industrial site in the Central Appalachian area that is located in proximity to both desired feedstocks and potential customers. We are currently performing due diligence on their site.

Our work continues in refining markets scenarios, production plans, operating and maintenance cost estimates and capital requirements to support our plant build out schedule. We have also initiated certain environmental permitting work and are engaged with the local economic development authorities.

The need for quality carbon feetstocks in the industry is significant and we remain in contact with several end users interested in testing our engineered carbon products on a larger scale. This testing is conducted through a collaborative effort to improve product performance.

We continue to gain insight into our targeted markets and are refining the engineering aspects of both the process and plant design. As we continue through 2016 with a forge reporting our further progress on this important initiative.

Regarding our other new product and business development efforts and as further evidence of our strategic emphasis on partnering, I’m very pleased to announce that Fuel Tech has recently executed in-licensing agreements with two companies that will further expand the breadth of Fuel Tech's product offerings.

With over 1,000 installations of our technology solutions, in-licensing opportunities allow Fuel Tech to act as a reseller of complimentary products, offering partners access to an established global channel of high quality utility and industrial commercial clients.

The first agreement is with Redox Technology Group also known as Redox Solutions. Redox is a specialty chemical manufacturer that produces chemical for mercury remediation in a variety of end market.

Redox desires to expand the distribution of its products to the coal-fired utility generation market, via use of Fuel Tech's sales channel, business relationships and knowledge of chemical delivery and distribution.

Redox has a patented approach utilizing a ferrous sulphides product to enhance the total mercury removal capabilities, a wet FTD scrubber systems. The market driver for this application is the MATS regulation.

The agreement is five years in length and Fuel Tech will be an exclusive reseller of the Redox product to a specific targeted customer base.

We are excited to be working with the Redox team on this initiative and as well as on joint technology development efforts in the future.

Additionally we have established an exclusive global agreement with PowerPlus Cleaning Systems, for the Impulse Cleaning Technology. The Impulse System uses supersonic combustion pulse technology to create a controlled and repeated shockwave to remove slag in deposits and enhance boiler operation without damaging heat transfer services.

The Impulse System minimizes high maintenance expenses, associated with traditional clean methods such as [boiling] and water washing. The combination of PowerPlus' impulse cleaning technology and Fuel Tech's industry-proven Targeted In-Furnace Injection Process creates a compelling cleaning solution, which effectively removes slag and ash build-up within the boiler.

The technology has been proven effective on utility and industrial units and is also been effective on areas downstream of the furnace including the economizer and air free heater. Additionally, impulse technology has also been utilized on natural gas fired units where combustion byproducts can reduce the efficiency of heat recovery boilers.

In closing, we are now more than half way through the year and I'm confident in stating that, we have made some excellent progress on the three fundamental initiatives that I had noted at the beginning of my commentary.

We have made significant modifications in our organizational structure in 2015 and in 2016. The impact of these actions can be clearly seen in our SG&A costs which have declined significantly and through June 30, 2016, represented annualized savings of just under $5 million.

Most recently, at the end of last month, we took further actions that will reduce our annual SG&A cost by an additional $3 million. We will begin to see the benefit from these actions in the fourth quarter of this year. With this last modification, our infrastructure will be well balanced with our base revenues.

Next, our focus on business partnerships continues to grow and we look forward to realizing the financial impact of these mutually beneficial relationships in the near term and lastly, we are very excited about creating our future landscape as a company. The investments that we're making in new products and technologies today will represent the future of Fuel Tech.

We are excited about the opportunity for our fuel conversion business segments and we look forward to investigating and pursuing other products and technologies in the near future. Our repositioning as a company has begun and I remain excited about our future.

And with that, I will turn the call over to Dave for some comments. Thanks Dave.

David Collins

Thanks Vince. Good morning, everyone, we remain focused on cash management and are watching our balance sheet movements and working capital closely as we continue to execute on business strategies that Vince mentioned.

At the end of June, our balance sheet remains strong with cash of $19.4 million, working capital of $33.1 million and we remain debt free. Consolidated revenues for the first six months of 2016 was consistent with the prior year $33 million versus $33.8 million in 2015, reflecting increases in our Air Pollution Control segment offset by decreases in our FUEL CHEM segment.

Our second quarter revenue of $15.2 million was down from $18.7 million in the prior year, reflecting decreases in revenue in both segments. I'll touch on these in more detail during our segment discussion.

For the current quarter and six month periods, our foreign revenues decreased while our U.S. revenues increased versus the same period for the prior year. Our gross margin percentage of 37% for the current quarter was down slightly from the prior year.

For the first six months of 2016, our gross margin percentage declined to 35% from 41%. The changes in our gross margin are reflective of the mix of APC and FUEL CHEM segment revenues with our higher margin FUEL CHEM revenues declining and our lower margin APC revenues increasing as a percentage of total revenues.

Our selling, general and administrative expense for the current quarter totaled $6.8 million, down $1.6 million or 20% from the prior year mark of $8.4 million. For the first six months, our SG&A expense totaled $14.2 million, down $2.4 million or 14% from the prior year mark of $16.6 million.

As Vince discussed, we're continuing to evaluate our cost structure and have taken a number of measures to reduce our spending and we'll continue to evaluate and make needed improvements as current business conditions continue to evolve.

Our research and development cost for the current quarter totaled $1.1 million, an increase of $140,000 over the prior year and for the first six months totaled $2.3 million, an increase of $426,000 over the prior year.

We're continuing to invest in the development of new technologies and products and expect as we continue spending in R&D cost through the remainder of the 2016.

Our net loss for the current quarter and year-to-date periods total $2.6 million, 11% per diluted share and $5.3 million or $0.23 per diluted share respectively. Our adjusted EBITDA for the first six months of 2016 was a negative $2.5 million.

Now let's move on to a more in-depth discussion of our APC and FUEL CHEM segment. Our APC segment reported current quarter revenues of $10 million, down slightly from the prior year total of $11.1 million. For the first six months of 2016, our APC revenues totaled $23 million, up $5.1 million from the prior year total of $17.9 million.

Our backlog at June 30, 2016, was $11.6 million, down from $22.2 at December 31, 2015 and this does exclude the $2.3 million of new orders announced during Q3 that Vince referenced.

Our APC segment gross margins declined to 28.7% from the prior year period amount of 29.9%. For the six-month period, our APC segment gross margins had declined 4.1% through 28.5% from 32.6%.

Our APC segment gross margin is dependent on the mix of products sold in future periods across all geographies. Our FUEL CHEM segment reported current quarter revenues of $5.1 million, which is down $2.5 million from the prior year total of $7.6 million, but up slightly from Q1 of 2016.

For the first six months of 2016, our FUEL CHEM segment revenue totaled $10 million, which is down $5.8 million from the prior total of $15.8 million. Our current quarter gross margin for the FUEL CHEM segment of 52.5% was up from the prior year percentage of 50.3% and our six months gross margin for our FUEL CHEM segment was in line with the prior year percentage of 50.9%.

Gross margin for the remainder of 2016 should range between 48% and 52%, which is consistent with previous guidance. Our tax expense for the current quarter and year-to-date periods was nominal. During the fourth quarter of 2015 we established a full valuation allowance against our U.S. domestic and European deferred tax assets, which effectively eliminated our tax provision for the results of operations and no taxing jurisdictions.

We expect to continue booking in nominal tax provision for the remainder of 2016.

With that, I would like to turn the call back over to Vince.

Vincent Arnone

Thank you, Dave. I would like to in fact now open the conference call for questions, please operator, let's open the lines.

Question-and-Answer Session

Operator

Thank you. At this time we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of John Quealy with Canaccord. Please state your question.

John Quealy

Hey, good morning guys. Can you hear me okay?

Vincent Arnone

Yes we can, John. Good morning to you as well. How are you?

John Quealy

I am doing well. Thanks Vince. So a couple of questions. First, on the new initiatives on the REC selling and things like that, are these the only two third party or strategic relationships you've got going on right now or can you talk about how you narrated down for these?

Obviously there seems like there is good overlap on this particular venture with your existing customer base on the coal-fired side and having that expertise in geography on the station level and then also talk about how you evaluated the other reselling agreements on chemical to third parties?

Vincent Arnone

Understood, thanks for the question John, are these the only two call it partnering type arrangements that we have in place? The answer of that is, no. We have others that we simply don’t disclose publicly.

These two are little more unique in nature, because we are obviously bringing our partner's product to our new marketplace, two markets that we know very well and that we are looking to serve with our existing channels.

To your point both of these products are an excellent fit with what we do as a company today and with our capabilities to bring product to market. So we are very, very pleased to be working with Redox and PowerPlus.

And strategically John, these are initiatives that we're putting more and more emphasis on as it relates to using what we've created as a brand name for 20 to 30 years as a company and utilizing that brand name and the channels that we have and relations that we've build to bring other folk's products to marketplace.

So we’re excited about these two. I expect that we will look to have more in the future as well. Again these are in-licensing examples of us, working with partners externally. Obviously ISGEC and India is one, very specifically targeted that we have been working on for a couple of years.

And then we are working with at least two to three to four other companies domestically and internationally, as companies that can bring our suite of technologies into specific market spaces whether they be industry-specific or they be geography specific.

So this is the way the future for Fuel Tech as we do look to reposition and as we look to redefine ourselves for the future.

John Quealy

And in terms of the exact licensing agreements or commission agreement, is this certain minimum where you would start to receive or pay out commissions or royalties, is this the rev share, how generally from a monitoring perspective these arrangement set up?

Vincent Arnone

Right, with the arrangements that we have with both Redox and PowerPlus, these effectively are marketing and product supply. These are reseller agreements whereby we're going to be buying product from those two companies and reselling into markets, okay. So no license or commission or anything along those lines associated with those agreements.

With ISGEC in India that is more call it your -- more of your pure licensing type of relationship. However, in addition to receiving a royalty on their sales into targeted markets, we will also be selling some quality smart and/or services to ISGEC as part of that relationship. So we will have call it a dual means of generating income from the relationship.

John Quealy

Okay. And then off to FUEL CHEM, if we could for a little bit, so good to see I know pressure on revs and margins, but overall, the margin profile and range staying intact, can you guys talk about when you look at the term FUEL CHEM customer base, who else potentially, is that risk or de-rating volume or shutting down on spark spread?

How do you think about the future risk Vince or Dave to the business on some of these macro issues we've been dealing with for quite some time?

Vincent Arnone

Right. As the macro issues are there as you just noted and they're not going away here anytime soon. The remaining customer base that we have now, from our perspective at least as we see it today John and obviously the discontinues in the future, as we see things changed rapidly in prior situations.

But the remaining customer base we have today we're obviously watching very, very closely and we think the customer -- with regard to the major customers that comprise the majority of the revenues that are generated in FUEL CHEM.

We think it's pretty stable as we sit here right now. The first half of the year, the run rate was just $10 million in revenues. We would expect to see something along those lines in the second half of this year and then we’re watching closely as we move in 2017.

There are still going to be coal-fired generation in this country for quite some time. However is it going to be little back, sure it is. Is there going to be a need for FUEL CHEM in the future for coal-fired generation in this country, we do believe there is, but in all likelihood to your point, we will probably see a decline in FUEL CHEM revenues domestically as we move into the future, but I don’t know how, how far into the future that’s going to be as I sit here today. So I can't even make an assumption here, but all I can say John, is we're watching that really, really closely.

And on the FUEL CHEM side, the technology is great technology. We know that it does work, but it is also applicable to other industrial areas, the pulp and paper industry being one very specific area that we think that we can help and it’s a viable industry.

If you look at some of the macroeconomics on paper, demand on a global basis, it's growing and so we can get ourselves aligned with that industry more specifically in this country.

And then as I noted in my script, we’re looking at nice relationship with a company that services 350 clients in Asia, that’s the direction we need to go with FUEL CHEM. Its expanding the markets that we're serving with that technology.

John Quealy

And just a broader comment around milestones, so with all these initiatives they take time to get the piece of paper in place and they get the people in the field. So are we looking for tangible progress on these initiatives in the beginning of '17, is that a decent timeframe or how are you calibrating to your people and to your alliance partner's results?

Vincent Arnone

Right, to be honest, it's going to vary with each of the partners depending on the technology that’s going in the marketplace. As I sit here today, I would make the comment that we're expecting anything material here for the remainder of 2016, but I do expect contribution as we move into '17 without question.

Now that doesn’t mean that as we sit here today, we are not making aggressive plans to go ahead and visit our customer base for both the Redox and PowerPlus technologies. In fact those activities are going on as we speak right now.

And in fact on the PowerPlus, case we’ve actually had one very nice commercial arrangement that we solidified already for their technology. So that is in process. Material revenues not likely until '17 but we will talk more about that as we work through Q3 and have a Q3 conference call, while we're better prepared to talk about what we've experienced relative to our investigative selling processes in the target markets.

John Quealy

Okay. Great, I will leave it there. Thanks guys.

Vincent Arnone

Thank you, John.

Operator

That does conclude our Q&A session. So I will turn it back to Mr. Arnone for closing remarks.

Vincent Arnone

Well thank you very much everyone. I appreciate you taking the time for the call today. Thank you for your interest in Fuel Tech. We are working through a repositioning of our company today. I'm very excited about it. Our employee team is excited about it and we are very, very pleased to bring on our new partners in Redox Technologies and also PowerPlus.

In fact we issued a more detailed press release about 45 minutes ago about both of those partner relationships. So thank you everyone for your time today and look forward to talking in the future. Thank you.

Operator

This concludes today's conference. Thank you for participation. You may disconnect your lines at this time.

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