Fuel Tech Inc (FTEK) 2003 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to your Q3 2003 Fuel Tech NV earnings conference call. My name is Jean, and I will be your conference coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a Q&A session towards the end of the conference. If at any time during the call you require assistance, please press star followed by 0, and a coordinator will be happy to assist you. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today’s call, Ms. Tracy Krumme, Director Investor Relations. Please proceed.

Thank you, Jean. Welcome to Fuel Tech’s third-quarter conference call. By now, all of you should have received a copy of today’s release. If you have not, please call us at 203-425-9830, and we will be happy to send you one.

Joining me on the call this morning is Steve Argabright, President and Chief Operating Officer, and Scott Schecter, Chief Financial Officer. As a reminder, the matters discussed in this conference 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. These factors that could cause results to differ are included in our filings with the SEC.

It is important to note that 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 time. Fuel Tech undertakes no obligation to update any information discussed in this call and, as a reminder, this call is being broadcast over the internet, and can be accessed at our website, www.fueltechnv.com

With that said, I would now like to turn the call over to Steve. Steve, please go ahead.

Thank you, Tracy, and good morning, everyone. Thank you for joining us today to review our financial and operating results for the third quarter. Upfront I want to apologize for my voice – I have a pretty bad cold, so I will try to get through this in a professional way.

We are pleased with our results for the third quarter. As we reported, Q3 earnings were 6 cents per diluted share, compared to 2 cents per diluted share for Q3 last year. Net sales in Q3 increased 27% to $10.2m, compared to $8m in Q3 last year. Net sales for the nine months were $28.2m, up 32% over last year.

Q3 was a record quarter for Fuel Chem, our fuel treatment chemical business, with revenues up 90% from last year. This was attributable to our increased penetration of the western coal fuel utility market, as well as an increase in our more traditional oil-fired business. As expected, sales have slowed somewhat due to scheduled outages and lower loads at this time of year.

We continue to be extremely excited about the growth opportunities in our Fuel Chem business. In the last 60 days, plant managers from two large utilities and a regional co-op have visited our successful targeted in-furnace injection application at Western Farmers’ Hugo Station, a 475MW Powder River basin coal-fueled unit in Oklahoma.

Having these utilities visit the station has been invaluable, because plant managers can both see the results first hand, and discuss the benefits with plant personnel. The two large utilities that visited Hugo are among the top prospects that we have identified as being important in achieving critical mass.

We continue to make progress at these, as well as other, utilities, and expect that we will have additional units operating and others committed to demonstrations by the end of Q1. Successful demonstrations at these major utilities will lead to increased penetration of our technology both within these utilities and at new customers. We will be disappointed if this does not result in a year over year increase in excess of 75% for 2004.

We continue to market to the major coal companies, and to seek new business opportunities outside the utility industry as well. We believe our alliance announced last quarter with Peabody Coal, the world’s largest coal company, has enhanced our credibility, and gives us another avenue for penetrating the market. During the quarter we started up two new large coal-fueled industrial units, and are pursuing others. In addition, we continue our discussions with EPRI, the Electric Power Research Institute, about working together on a project, and are heavily involved in all the important trade organizations, including the American Coal Council.

We have been getting very good press, lately, which we think will also add to our visibility. Power Magazine, a well-respected periodical in the utility industry, mentioned our Fuel Chem business in September’s issue, and the most recent, October, issue, which has just hit newsstands, was dedicated to Powder River basin coal. In this issue our Fuel Chem business was featured in a two-page article discussing our technology, its ability to inhibit slag, and the benefits we provide in efficiency and production gains. This article should give us additional exposure in the market.

Additionally, Winslow Environmental News, a monthly newsletter published by Winslow Management, highlighted us as its feature company in the October issue, with the title “Making Coal Cleaner – Fuel Tech at the Forefront”. Anyone interested in seeing copies of these articles can contact Tracy in our Stamford office. Additionally, we will post these stories to our website.

Our fuel-oil fired business continues to do well, because gas prices are high relative to oil prices. Unlike coal applications, it is not an unsold market, but our technology has proven to be superior to our competitors’.

On September 30th we acquired Martin Marietta’s fuel treatment chemical business and signed a long term supply agreement for their magnesia-based chemical products used in our Fuel Chem business.

Martin Marietta is the leading US producer of these chemicals and, as a result, this agreement will allow us to continue to provide our customers with the highest quality chemicals at favorable prices. We will also benefit from additional revenue, market intelligence, and contacts gained in their oil-fired customer base, which we can leverage with our technology.

Turning to our air pollution control business, revenues for the quarter were up 8% from last year - less than we had internally projected, as a result of the current environment. As we mentioned in our last press release, a combination of the recent rulings on New Source Review, financial issues and constraints at utility companies, and mild summer and winter weather, have all led to a slowing in our air pollution control business.

We expect the easing of the New Source Review regulations to benefit us in the long run, because our lower cost non-catalytic reduction technology may be considered for units that previously would have required the installation of the competing and much more capital intensive selected catalytic reduction, or SCR, technology. But in the short run the new ruling, coupled with the outcome of some litigation relative to the old rule, was causing utilities to step back and reassess their compliance plans, and re-calculate how to meet their NOx limit in the most cost-effective manner.

2004 NOx allowances are currently trading for about $2,500 a ton, only a slight premium to 2003 allowances. Several factors are contributing to the low prices, including the projected availability of relatively low cost power.

Another factor contributing to lower allowance pricing is the result of a Supreme Court ruling three years ago that extended the SIP Call deadline by 13 months, from May 1st 2003 to May 31st 2004. The ozone season runs from May 1st through September 30th, so for 2004, and only for 2004, the ozone season will run for four months rather than five, but the affected sources will receive NOx emission allowances at a full season’s rate. These excess allowances translate into lower allowance pricing, again providing utilities with a short term temporary alternative for meeting SIP Call requirements.

In summary, these factors have caused a slowing in our APC business. We have done our best to get customers to book orders, and it has only really been in the last month that we have learned that two of our projects in progress will be delayed due to NSR issues, and that a major utility will not release a multiple unit equipment order this year, as expected, due to capital restraints.

However, allowances for 2005 are currently trading about 25% higher than those for 2004, confirming our belief that bookings and equipment releases will pick up in the second half of next year, and be strong into 2005 and 2006. As we have said before, these revenues are not going away – they are merely being postponed.

We recently announced orders for air pollution control projects totaling $2.2m, a large utility placed multiple design engineering orders totaling $1.2m for the future installation of NOxOut systems. Additionally, two NOxOut demonstrations were booked for very large coal-fueled boilers, both of which will expand our market penetration.

Design engineering orders were also received for two additional utility units and two industrial units. These orders are particularly important, as a high percentage, historically it's been around 90%, become converted to equipment releases and will translate into future revenue.

In Europe, we recently received orders for the installation of a NOxOut system on a municipal solid waste incinerator in Spain, a demonstration at a cement plant, and design engineering orders for industrial units. Our Italian company continues to penetrate the NOx reduction markets in Spain, the UK, France, and Italy.

We continue to pursue commercial applications, and look for alliances and strategic partners for Acuitiv software, our computational fluid dynamic visualization package. We recently announced a distribution channel partnership with Unified Technologies, a leading reseller and software distributor in Singapore and South East Asia. Additionally, we created an alliance with Ascension Technology, a leading manufacturer of motion tracking devices. We believe these alliances will help broaden our market and enable us to further enhance our opportunities.

I will now turn the call over to Scott for the financial overview.

Thanks, Steve, and good morning. As Steve mentioned, reported net sales for the three months ended September 30th were $10.2m, versus $8m in the same period last year. Net sales for the nine months were $28.2m, up 32% from $21.3m last year. The growth in our Q3 sales was driven primarily by strong Fuel Chem revenues, which, as Steve said, were up 90% in Q3 versus last year, and up 45% in the nine month period. This was due to our strong performance at Western coal-fueled utilities, as well as an increase in our oil-fired business.

Net income for the quarter increased 248%, to $1.3m, or 6 cents per diluted share, compared to $379,000, or 2 cents per diluted share in the same quarter last year. Gross margins in Q3 were 45%, up from last quarter’s 36%, due primarily to two factors. First, as I discussed on our last conference call, we completed most of our turnkey NOxOut projects at the end of Q2, and although these projects, which include the installation scope, have a higher contract value, their gross margins are significantly lower than contracts that include just our traditional scope.

Secondly, product mix was a factor, as Fuel Chem, which, as you know, has gross margins approaching 60%, comprised 34% of our revenues in Q3, versus only 22% in Q2.

In Q3 SG&A and R&D expenses increased to $3.3m from $3.1m in Q3 last year, and while R&D costs were down, SG&A costs this quarter were higher, up $244,000 from last year. This is attributable to the addition of sales resources for the Fuel Chem business late last year, as well as to a lesser extent, some additional resources allocated to support the marketing and commercialization of our Acuitiv advanced visualization software.

Going forward, we anticipate that our SG&A costs will increase as higher sales volumes, particularly in Fuel Chem, lead to increased selling costs, mainly from commissions. As we have stated before, our market penetration of the targeted in-furnace injection technology is a strategic priority.

We continue to have a strong balance sheet. We ended the quarter with $5.8m in cash, working capital of $12.5m, and no debt. The decline in cash from year end is driven by the repayment of almost $2m in debt, a reduction in accounts payable and accrued expenses, and the purchase of Martin Marietta’s fuel treatment chemical business, which was for $1.3m. As Steve mentioned, this acquisition will benefit us, because we can leverage our technology with our new customers, providing them with improved results, and us with increased revenue. Additionally, we will benefit from favorable pricing, while maintaining product quality on a long term supply agreement we signed for our fuel treatment chemicals.

Also, getting back to the debt repayment, keep in mind that although we repaid $1.8m in debt, that does increase the availability we have on our credit facility by the same amount. Current backlog stands at approximately $4.1m.

As Steve discussed in detail, we have seen a slowing in our air pollution control business, and this is likely to last through the first half of next year. Although we expect to receive new contracts during this slow period, revenues from our air pollution control business will temporarily be affected. Because of this, we expect Q4 results to range between a slight loss and a slight gain.

We do think, however, that 2004 will be a year in which we start to see the dramatic growth that we expect our Fuel Chem business to give us for many years. Later in the year, as I have said before, we expect to see a recovery in the air pollution control business, and that will continue into a strong 2005 and 2006.

With that, I would like to turn the call back to Steve for closing remarks.

Thanks, Scott. In summary, I want to reiterate how excited we are about the near term prospects of our Fuel Chem business. Significant progress has been made toward initiating our targeted in-furnace injection technology at several key utilities, which will provide us with the critical mass we need to grow at an accelerated rate in 2004 and beyond. The successful application at Western Farmers’ Hugo Station has been particularly helpful in this regard.

Although our air pollution control business has weakened in the short term, we expect that trend to reverse in the second half of next year, and to be strong in 2005 and 2006. With that said, I would like to open the call for questions.

Thank you, sir. Ladies and gentlemen, if you wish to ask a question, please press star followed by 1, on your touch-tone telephone, if your question has been answered or if you wish to withdraw your question, press star followed by 2. Questions will be taken in the order they are received. Please press star 1 to begin. Please wait while we collect our questions.

Your first question comes from Robert Kirkpatrick (ph) of Cardinal Capital.

Good morning. Could you take a little bit of time and review in a bit more detail what it is you have actually acquired from Martin Marietta, and also go in to some more detail as to your long term chemical supply agreement, what that exactly covers in your Fuel Chem process, and how much of that you use? And then I have some follow-up questions.

Steve, because of your voice, why don’t I take a shot and fill in where needed?

Basically, we acquired intangibles from Martin Marietta – their customer list and their business. There were really minimal assets involved in this deal, so it was really just an acquisition of the customer list and their commitment to support us obviously in the transition and going forward.

As far as the chemical supply agreement, long term agreement is concerned, as Steve mentioned earlier, the favorable pricing improves as volume increases, so as we capitalize on the opportunity that faces us on Fuel Chem, that pricing should go down, or will go down considerably. For us, it is a big win. The business that we did acquire was on the oil-fired side and, again, as Steve mentioned, we get a lot of market intelligence and other contacts, and we can truly leverage our proprietary technology with their customer base. And we do see increased revenues from the existing customers and additional penetration into this market by doing this deal.

The revenues are $0.5m a year? $5m a year?

In between. In the $1.5-$2m range.

Should this be highly profitable on an incremental basis, this business?

Initially, no, because those customers are using a product line that we are going to –- over the next year our intent is to transition many of them to our own product line, and the margins on the existing product line are considerably lower, so there will be a transition period there, and for those that we keep on the existing product line we will find a new source for that supply.

And when you say you're going to -- so you will start selling then Fuel Chem products – is that correct?

Yes, our own Fuel Chem products. The goal is to transition these guys to our existing product line, using our proprietary technology.

How many customers are we talking about? 20? 50? 500?

It is about 20.

I was going to say about 20.

You have to understand too, that the supply agreement is for the raw material or the base product, either one, that covers the great majority of our business – I would say probably 80-90%.

How long an agreement is it? 3 years? 5 years? 10 years?

In excess of five.

That’s great. Thank you so much.

Your next question comes from Cheryl Bullnick (ph) of Fulcrum.

Do me a favor, Scott, and just remind me what the backlog was at the end of Q2?

I believe -- I’ll check as we're on the phone, I believe it was in the --. Hold on, instead of just believing, I’ll give it to you. It was $9.3m.

And obviously, the difference being that you realized revenue out of backlog for the NOx contracts in this quarter by and large, and that is not going to be there for next quarter –

Let me just interrupt – the $4.1m that I gave on my chat was the current backlog number.

So that was not the backlog inclusive of the – let me ask it positively. The backlog of $4.1m includes whatever you have put into backlog from the $2.2m of contracts that you announced recently?

Correct.

That is a good backlog number to be going off of. That does not reflect the changes between June 30th and September 30th.

Well, it reflects the changes between June 30th and today.

But it does not stop at September 30th – a minor point. In a broader sense, it is pretty obvious that folks are much more excited about the long term opportunity of Fuel Chem, and it sounds like you are on plan, based on what you said before, Steve, that you expect to have these things in place -- then it was nine months and now it is six months from the end of Q3, so by the end of Q1.

Can you go through how you think this might roll out in terms of you will get a contract, presumably from one of the two major utilities, or the third utility that went down there to visit Hugo, then you get a contract. When does the revenue begin to hit your income statement? When do you begin work? How is the revenue versus the expenses going to work through your income statement and affect the cash flows of the company?

Let me start by just explaining a typical sales progress. The first step, once the sale has been made, is to get a purchase order for the computational fluid dynamic model, which tells us where to place the injectors, and so forth, to do the job that is required to be done. That is, again, a very small amount of money, in the $20,000 range. Then it's sit down with the customer, make sure that the locations we have chosen are realistic from an installation perspective, and then decide when they're going to take a shutdown – again, it could be a normal outage, it only takes a day or two to install our system.

Then, typically, you have a 60-90 day ‘trial,’ where we have been given certain requirements to be successful. In other words, a reduction in slag formation, a reduction in scheduled -- in unscheduled outages, several other operational issues, a reduction in SIP flowing. Once those successful criteria are made, then the idea is to proceed with a multi-year contract.

Now the revenue starts flowing as soon as we ship chemical for the test. Sometimes there is a risk share, where we will reduce the price of the chemical to share risk during the trial period, and then recover that reduction when the trial has been deemed a success, and then proceed on multi-year contract. So revenue starts flowing as soon as the first load of chemical is shipped. From an expense perspective, really you are only talking – usually, we service those with part-time people that we hire locally.

So that is not going to be a big deal then.

No.

What I think I’m hearing you say is when you talk about a 75-100% increase in Fuel Chem revenues for next year, it sounds like the bulk of that comes Q2 and beyond, rather than Q1.

I think that’s realistic.

That's fair enough. Now on The APC part of the business, if I could just turn to that for a second. You said something that interested me, that the allowance prices are actually up 25%. I think when we last talked about that, Scott, it sounded like the allowance prices for the NOx had been kind of flattish. What has happened in the market that has, all of a sudden, if I am correct, led to an increase in the allowance price?

What is up 25% is allowance prices in ’05, versus ‘04 and ’03, which again lends more credence to what we were talking about in terms of a recovery, that those -- Based on various factors – having a five month season versus a four month season, anticipated demand, etc. etc. – those prices are higher.

The utilities are already planning out to ‘05 of how much they are going to actually take care of through the allowances and getting it up now, so that does make sense. Fair enough. Thanks very much.

Your next question comes from David Faundry (ph) of Heartland Funds.

Good morning. Could you -- I think you said, in relation to Fuel Chem, that there are also two coal-fired industrial units that were being considered. Could you give us some more color on that?

We haven’t really stopped calling on the industrial system, in fact – industrial units, in fact our very first targeted in-furnace injection system was a paper mill in Canada, and that is still running after about six years. So that market is still important to us, and we just sold two large industrial furnaces burning coal in the US. These are at a paper mill, but it’s coal-fired rather than black liquor production oriented fired. Similar problems with slagging, and that sort of thing. We are not turning our back on that market. It is not insignificant.

The two that you mentioned -- those are potential –

No, they are operating.

They are operating?

They are operating as we speak. Those were sold early in Q3 and they are operating.

So that should give you some kind of stable base load for Fuel Chem sales.

Right. They are not as large as a typical utility furnace, but they are certainly not insignificant.

Coming back and following up some of this Fuel Chem trial business, is it reasonable to expect –- are the trials with these utilities, are these utilities single unit locations, or would they have multiple units, so that if you do a trial at one, it may lead to a trial, assuming that it works in the one and they are happy, do they have multiple units they might expand to?

Absolutely. In fact, single unit stations are quite rare. It happens that a utility like Western Farmers, for example, a smaller co-op utility, is a single coal-fired unit, but that is the exception rather than the rule. Most of the utilities are multi-unit stations. You could expand within the same station.

So that the two large utilities you are talking to and the regional co-op that you are speaking of, is it fair to say in all three cases there are multiple unit opportunities as opposed to a single unit?

Two out of three. The regional co-op is very similar in size to Western Farmers, but certainly the two other large utilities and the great majority of people we call on -- multiple units.

Can you give us a little bit of an update as to whether or not you have seen any traction out of the Peabody relationship, and whether or not you have established relationships with any other coal-producing companies?

From a traction perspective, there has been joint calls made. There has not been -- I can't say that there's been a successful sale as a result of that particular arrangement, but there has been new contacts made at higher levels in some utilities that they have very good relationships with. Other coal companies, there has not been anything formal, but there still is significant discussions going on with three or four others.

Is the Peabody relationship progressing as you would have expected? Are you getting as many joint calls, or is it still in its infancy?

I would say it is in its infancy. As expected, I would like to see a lot more activity on all of them. But it is progressing nicely, but not as fast as certainly I would like to see it progress.

Lastly, going back to this acquired business, if you have to convert them to the new fuel -- chem fuel -- Fuel Chem, do you have to put in new equipment in order to do that, or is it just switching them over to the new fuel?

In most cases, depending on the problems associated with the particular customer we are taking over, we would want to convert them to the target in-furnace injection technology, because that is where the real benefits for them come from. So in that case, where that is something that makes sense from a requirement situation, then yes, it would be new equipment. So you are talking again in the range we have said before, $50,000-$100,000 worth of capital on our behalf.

What was the reason that the seller wanted to close? Why did Martin Marietta want to get out of this business? Was it too small for them?

They did not want to be in the retail -- quote-unquote retail business any more. In other words, they didn't want to sell direct to the end user. This business that they sold used to be much larger. It is just something that as heavy fuel oil use has gone down in the States, they have changed their priorities on what their business model looks like, and this is no longer part of it.

Do you feel that there are expanded opportunities outside the 20 customers that they are calling on?

Yes. Absolutely. Because again, that industry was something that the oil-fired part of the utility industry was something we'd been familiar with, but now we have a lot more information on what is out there, particularly outside the country in Canada. They had quite a bit of business in Canada that we are going to expand.

So yes, I think it is going to be helpful, not only from converting their existing customers, but also expanding customers that we have met as a result of this agreement.

Last question -- could you give us a little bit of an update on the software business?

Unfortunately, we have not received a lot of new licenses. We have remained very excited about the technology, but we are in a position where we need to see some revenues.

How long do you continue to fund that if you do not see some traction in it?

That decision, per se, has not been made definitively, but there will certainly be discussions within the next quarter.

Your next question comes from Robert Kirkpatrick of Cardinal Capital.

Steve, you mentioned during your prepared remarks that litigation on the air pollution control side under the old rule had also made utilities rethink their strategy. Could you shed a little more light on that, and what has gone on there?

There's been one utility was “found guilty” of exceeding NSR regulations under the old administration. These lawsuits, I think there were 7 or 8 of them filed 3 or 4 years ago – and most of them are ongoing, some have been settled, but most of them are still going on. That utility -- when that news broke, so to speak, it threw other utilities in a quandary of, well, geez, we got the same potential situation.

It is all about regulatory certainty, or a lack thereof. What do we really need to do? And NSR means, the old rule basically said that it was a case by case situation where you have to put on the best available control technology, which means selected catalytic reduction for NOx, if you perform non-routine maintenance other than day to day repair type things, whereas the new one basically says that when you perform equipment maintenance, that no new pollution controls are required if replacement components are functionally equivalent to existing components. That is if there was no change to basic design or to emitting capacity.

The new one also set a cost that it has to be above 20% of replacement cost. In other words, the improvements, or quote-unquote whatever your maintenance is has to be more than 20% of replacement cost for the equipment. So there's -- the new rule, in our opinion, is good, because it would give regulatory certainty, and that is what all these utilities are looking for. How do they make huge capital investments, especially in the situation they are in, without fully understanding and completely understanding what the requirements are? That is the issue.

Thank you. Could you review just how many coal-fired units you started the period with, and how many you ended the period with, that were used in the Fuel Chem business?

We started with six and we still have six.

Thank you so much.

Again, ladies and gentlemen, it is star 1 to ask a question. You have a question from Jim Colgan (ph) of Frontier Capital.

Could you just tell me what the revenue for Fuel Chem is going to be in '03, or what you expect?

We have said that we expect it in the $10m range in the past, and that really has not changed in a material way.

How much of that is coming from the actual chemicals themselves?

Principally all of it. Materially all of it. You do have modeling revenue in there, but materially all of it is the chemical.

Thank you very much.

Your next question comes from David Faundry of Heartland Funds.

I think you mentioned that some of the units that were using the Fuel Chem were taking offline, or are expected to be taken offline?

This time of year is the classic time for outages, when major repairs are made. Loads are low in fall and spring, and that is when utilities take their scheduled shutdowns to do work, and loads are lower because demand for power is lower.

I think there were three utilities -- utility -- three units -- Pacific, Northwest or something -- that were using Fuel Chem, that sometimes, depending upon the quality of the coal that they were getting were using more or less Fuel Chem.

That's correct.

What is the status – are they still using –

It is the same situation where it is intermittent based on the requirements. In other words, when they detect that there are some slagging issues, then they turn on the pump.

Thank you.

Press star 1 for questions, ladies and gentlemen. Sir, I have no questions at this time.

Again, I want to thank you for joining our Q3 conference call and your interest in Fuel Tech. Thank you.

Thank you for participating in today’s conference. This concludes the presentation. You may now disconnect.