Fuel Tech Inc (FTEK) 2006 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2006 Fuel-Tech N.V. earnings conference call. (OPERATOR INSTRUCTIONS). 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 of Investor Relations.

Thank you. Good morning, everyone, and welcome to Fuel Tech's second quarter conference call. By know all of you should have received (technical difficulty) if you have not (technical difficulty) call 203 (technical difficulty) 9830 and we will be happy to send you one.

Joining me on the call this morning is John Norris, President and Chief Executive Officer, and Vince Arnone, Senior Vice President, Chief Financial Officer and Treasurer.

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. 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 the statements made in 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, 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 John Norris. John, please go ahead.

Thanks, Tracy, and good morning to everyone. We appreciate all of you joining us on this call. We are very pleased to report another outstanding record-breaking quarter for Fuel Tech. Our quarterly revenues were another all-time record high at 19.8 million, up 68% from the second quarter of '05. Pre-tax income for the quarter was 3.4 million, or $0.14 a share, up 112% over last year's second quarter.

For the first half of the year our revenue was 36.9 million, up 55% over the first half of last year. This six-month revenue amount for Fuel Tech is higher than any full-year revenue amount prior to '05. Our pre-tax income for the first half was 5.8 million, or $0.24 a share, more than double last year's 2.8 million, or $0.12 a share.

Our CFO, Vince Arnone, will discuss our financial results in much greater detail in a few minutes, including a discussion of the after-tax earnings and the impacts of the various tax and other charges, such as the 123R stock compensation expenses, which affect year-over-year income comparisons. Vince will also cover our balance sheet in detail, but it remains exceptionally strong, with cash, cash equivalents, and short-term investments increasing to now over $20 million. It is clear that the second-quarter results have built onto our strong first-quarter results to yield a record-breaking first half.

Now I would like to tell you about the Company's business behind those outstanding financial numbers.

As most of you know, Fuel Tech is a fully integrated company that uses a suite of technologies to provide boiler optimization and efficiency improvements and air pollution reduction and control solutions to utility and industrial customers worldwide. For reporting purposes, we broadly group these technologies into two product lines -- a specialty chemical business we call FUEL CHEM; and our Air Pollution Control, or APC product line. Again, this quarter, we had both product lines generating significant growth in revenues while margins have remained excellent.

Our APC business sector saw revenues increase 64% for the quarter and 56% for the half over 2005. Gross margins at 45% are down slightly for the quarter and half from last year, but are stable, and in line with our expectations for this capital projects business sector going forward.

The revenue growth in this business sector benefited from work on our two major projects in the People's Republic of China and from ongoing progress in booking and fulfilling orders from a variety of domestic and utility and industrial customers.

The Selective Noncatalytic Reduction, or SNCR, systems for our Chinese projects are on schedule for deliveries this year. This technology continues to have success in the marketplace as clients look for cost-effective means to reduce nitrogen oxide, or NOx, emissions.

In addition, our first NOxOUT CASCADE hybrid system is due to be installed this fall, and we are very pleased that our client has recently been awarded a major Department of Energy grant to help fund a demonstration of this important new technology application.

Also, our ULTRA technology, which converts urea to ammonia for use with Selective Catalytic Reduction, or SCR, systems, is getting much interest from utilities, especially in the U.S. and China. Our ULTRA system allows clients to avoid the use of anhydrous or aqueous ammonia, which are very hazardous substances, to transport offload and store for use with an SCR system at power plant.

Our FUEL CHEM specialty chemical product line also had a great second quarter, with revenues of 6.6 million, up 75% over last year, and with first-half revenues of 11.4 million, up 51% over last year. The growth in revenues is especially remarkable when you take into consideration that shipments to our U.S. utility oil-fired customers are down 1.5 million in the first half relative to '05, as the high cost of oil has kept those units off-line most of the time.

The surge in FUEL CHEM revenues is from U.S. utility coal-fired power plant customers, and reflects the rapidly growing market acceptance of our products in reducing slag problems in boilers, and in reducing SO3 plume issues utilities are encountering as they install SCRs to control NOx. This is exactly the market we've worked so hard to gain acceptance in. Our FUEL CHEM programs, which provide an annuity revenue stream, are now installed on 23 coal utility units, up from 11 in the first half of '05, and six in the first half of '04. And at 57% for the first half of the year, our margins in this business sector are up a good bit and continue to be very strong.

As we look at the geographic breakdown of our revenues, we note that our international revenues, at 10.7 million for the first half of '06, now make up 29% of our total revenues. This international revenue number is up over 150% versus the first half of last year. While our European revenues for the first half are up some from the first half of last year, the major portion of this revenue growth is from Asia, especially our China projects.

Our marketing efforts in China continue in earnest, with much interest being shown by potential new customers there. This is an important market for us and we certainly hope our efforts will be rewarded with new projects there this year.

Other key international markets for us are Mexico and India. Our [Punta Plieta] project in Mexico should start up this quarter, and we'll hopefully demonstrate the very positive results we expect in mitigating their SO3 plume issues.

In India, there is much interest in our FUEL CHEM program there to mitigate slag and SO3 plume problems. We will be in India this quarter to try to bring home the first order in that important market.

Finally, we continue to work on new products and services in our R&D area, and some of these appear to hold much promise. Our goal is to have a very broad suite of products and services that can address a broad spectrum of client problems within the general areas of boiler optimization and pollution controls, which are our core expertise areas.

Now I would like to turn the call over to our Chief Financial Officer, Vince Arnone, to further discuss the financial details of our results.

Thank you, John, and good morning, everyone. As John mentioned, net sales for the second quarter increased 68% to 19.8 million, up 8 million from the prior year. This was our third consecutive record quarter for net sales.

Pre-tax income totaled 3.4 million in the quarter, or $0.14 per diluted share, up 112% from 1.6 million, or $0.07 per diluted share in the prior year. Net income totaled 2 million, or $0.08 per diluted share, compared with 3.2 million, or $0.14 per diluted share in the prior year.

Net sales for the six months rose 55% to 36.9 million, up 13 million from the prior year. Pre-tax income totaled 5.8 million, or $0.24 per diluted share, up 105% from 2.8 million, or $0.12 per diluted share in the prior year.

Net income for the six months totaled 3.3 million, or $0.14 per diluted share, compared with 3.9 million, or $0.17 per diluted share in the prior year.

The second quarter and year-to-date results include $0.8 million and $1.1 million in stock-based compensation expense, reflecting the January 1, 2006 adoption of Statement 123R, Share-Based Payments.

Additionally, the second-quarter and year-to-date results reflect 1.4 million and 2.5 million in income tax expense, virtually all of which is non-cash.

In contrast, net income for the second quarter and first six months of 2005 was favorably affected by the onetime recording of a $2.2 million non-cash tax benefit related to the anticipated utilization of net operating loss carryforwards. This benefit added $0.10 per diluted share to the net income line in 2005.

The increases in net sales for the quarter and six-month periods were driven by strong growth in both technology segments. Net sales for the nitrogen oxide reduction technology segment were 13.2 and 25.5 million for the second quarter and six months ended June 30th, 2006, the latter representing a 56% increase over the prior year.

As John noted, this segment benefited from revenues associated with two projects to be installed in the People's Republic of China, and from ongoing progress in booking and fulfilling orders from a variety of domestic utility and industrial customers.

The NOx reduction segment continues to experience a high level of order activity, as utilities and industrial facilities that are impacted by the Environmental Protection Agency's SIP Call regulation continue to utilize Fuel Tech's technology as an important element of their ongoing regulatory compliance strategy. The backlog in this segment is approximately 19 million at the end of the second quarter, up from 17 million at the same time last year.

Quarterly and six-month sales for the fuel treatment chemicals technology segment were 6.6 and 11.4 million, the latter representing a 51% increase over the prior year. This technology segment's growth versus a year ago are principally the result of new customer accounts at major coal-fired Midwestern and Southeastern U.S. utility plants.

As John noted, partially offsetting these gains was the adverse effect of rising crude oil prices, which is limiting chemical application by some domestic utility customers with oil-fired generating units. Fuel Tech's oil-fired revenues for the first half of the year were down 1.5 million versus prior year.

The outlook for the fuel treatment chemical product line is extremely exciting. Today, 23 coal-fired utility units are being serviced by FUEL CHEM programs -- 21 domestically and two internationally. The increased utilization of higher-slagging Powder River and Illinois Basin coals bodes well for incremental domestic growth in the near future. And as John mentioned, the opportunity for international expansion into Mexico and India looks promising.

The gross margin percentage for Fuel Tech for the quarters ended June 30th '06 and '05 was 49%. The gross margin for the second quarter for the NOx reduction business decreased to 45%, from 50% in the prior year, due to the mix of project business. For the fuel treatment chemical business, the gross margin increased to 58% in the second quarter of 2006, from 49% in 2005. The increase is due to the timing of revenue recognition on cost share demonstrations.

The gross margin percentage for Fuel Tech for the six months ended June 30th '06 and '05 was 48%. The gross margin percentage for the NOx reduction business again decreased to 45%, from 49% in the prior year, for the same reason noted previously. For the fuel treatment chemical business, the gross margin percentage increased to 57% for this period, from 47%, again, for the same reason just noted previously.

SG&A expenses for the quarter ended June 30th '06 and '05 were 6 million and 3.8 million, while these expenses for the six months ended June 30th '06 and '05 were 11.5 million and 7.8 million.

The $3.7 million increase for the six-month period ended June 30th '06 is attributable to the following.

As mentioned previously, Fuel Tech recorded 1.1 million in stock compensation expense in accordance with Statement 123R. Next, Fuel Tech realized an increase in the revenue-related expenses in the amount of $900,000, as both technology segments had significantly improved revenue growth versus the prior year. Further, Fuel Tech recorded an increase in human resource-related expenses of approximately 1.5 million, as staffing levels and related expenses were increased in several areas to meet growing customer requirements. Finally, Fuel Tech realized incremental expenses related to audit, tax, consulting and recruiting fees, all in support of furthering business growth. Of particular note were expenses incurred to achieve the previously-announced plans to domesticate Fuel-Tech N.V., currently a Netherlands Antilles company, as a Delaware corporation.

R&D expenses for the quarter ended June 30th '06 and '05 were 499,000 and 326,000, while these expenses for the six months ended June 30th '06 and '05 were 850,000 and 660,000. Fuel Tech has established a more focused approach in pursuit of commercial applications for its existing technologies and in the development and analysis of new technologies that could represent incremental market opportunities.

The increase in other income and expense for the second quarter and six months versus prior year is due principally to an increase in interest income, driven by higher average cash balances and market interest rates. As noted previously, the second quarter and first six months of '06 reflects 1.4 million and 2.5 million in income tax expense, virtually all of which is non-cash.

As John noted, the balance sheet continues to show increased strength, resulting from the leverage of Fuel Tech's business model. At June 30th '06, Fuel Tech had cash and cash equivalents and short-term investments of 20.1 million and working capital of 28.9 million, versus 16.4 million and 19.6 million at the end of 2005.

Operating activities used (indiscernible) million of cash in the first half of the year due to the changing -- change in working capital from the end of 2005. Investing activities used cash of 11.5 million during the first half of the year, as short-term investments were increased by 10 million, and $1.3 million was invested to support and enhance the operations of the business, principally for equipment related to the fuel treatment chemical product line.

Financing activities generated cash related to the exercise of stock options in the amount of $5.7 million. Of this amount, 2.9 million represents proceeds from Fuel Tech stock options exercised in the first half of 2006, while 2.8 million represents the excess tax benefits realized from the exercise of these stock options.

On a very positive note, we are pleased to mention that we finalized a $25 million unsecured credit facility with Wachovia Bank. We look forward to a mutually beneficial long-term relationship with this reputable financial institution. Our previous line was in the amount of $15 million and was secured by all assets of the Company.

Overall business activity continued to trend favorably for both technology segments. We expect to announce additional business both domestically and abroad in the near term.

As a result of our strong first-half results, full-year revenues are expected to be in the 68 to $72 million range, and increase from prior guidance of 65 to 70 million. The NOx reduction technology segment is expected to generate 42 to 44 million in revenue, and the FUEL CHEM technology segment is expected to generate 26 to 28 million in revenue.

Our pre-tax net income for this revenue range, before the impact of statement 123R, is expected to fall between $0.48 and $0.51 per diluted share, an increase from prior guidance, which was $0.45 to $0.50 per diluted share. Of note is the fact that the impact of 123R on Fuel Tech's income statement is expected to be $0.06 to $0.07 per diluted share on a full-year basis.

With that positive information, I now turn the call back over to John.

Thanks, Vince. In summary, we are real excited about the record results that have been achieved, as well as the significant growth opportunities before us. With that said, operator, can you open up the lines for questions, please?

(OPERATOR INSTRUCTIONS). John Quealy, Canaccord Adams.

Congratulations on a great quarter. A couple of questions here. First, on the $16 million order out of China that's working its way through, can you comment on how -- how far we're done and how much is left here as we go to the back half of the year?

Right now at the end of the second quarter, we're about -- in terms of percentage of revenue recognized -- somewhere in that 55 to 60% range of that $15 million total. And then the remainder of that 15 million is going to come into our revenue line, the great majority of which will fall into 2006. But there will be a piece in 2007. Right now the remaining units for those two projects are scheduled to be shipped prior to the end of this year, but then we will have some startup activities which will require some on-site engineering assistance in 2007. So that's where those projects stand right now.

If we can talk more broadly, I know you folks had the successful Chinese conference in the last quarter, and I think I heard John correctly on the call that you folks were looking for some indications of success or order flow by the end of the calendar year. That's a little bit faster than I would have expected. I was expecting more like an '07 idea of what sort of order flow could come out of that opportunity. Can you just go into that a little bit more for us?

Sure. We had a great reception to our conference that we had last quarter. And coming out of that, especially for our ULTRA business, is a lot of interest by the clients over there.

A little bit about China that really would help, I think, everybody. China operates on five-year plans, and they're in the middle of -- or just started one that will run through 2010. That five-year plan doesn't really address a lot of the retrofit market, but does start addressing some of the new plant markets. So, for the retrofit market, of the 350,000 megawatts that are out there, the significant orders for those are probably going to come next decade. And that's actually pretty exciting for that kind of opportunity continuing.

In the near term, however, there's a lot of power plants. There's 250,000-some megawatts being built. They are requiring pollution control equipment on that for SOx, and now for NOx. The Chinese market has also recognized the dangers of anhydrous and aqueous ammonia. I think in a 90-mile radius around Beijing, they have now prohibited all ammonia storage and shipments in that area. So those customers are now looking for urea to ammonia alternatives, and ours, we think, is the best out there. There's a lot of interest in that. I have high hopes that that market will actually play out a bit quicker than we had first anticipated. All of that is talk until you actually bring it in, but we've got a lot of bids out there right now that look pretty promising.

Great. In terms of -- I know last quarter we have the dedicated salesperson -- I think Linda is her name -- that's actually done a great job of getting orders, but we're also going with some third-party folks to supplement her efforts. Can we talk about, if you can, how many folks you're using, Have they been fully versed in the Fuel Tech product -- that sort of thing?

Dr. Linda Lin is our Vice President for Asia-Pacific, and she has done an outstanding job. Dr. Lin holds 20, 25 patents in the air pollution area. She is one of the most renowned experts in the world and happens to be Chinese and working for us.

She has an arrangement that has distributorships and alliance agreements now with a number of the AE firms, the major AE firms in China. When you're dealing with ULTRAs, upfront, you really want to market to both the utility customers, but especially the AEs, because they are involved in the design and construction of these SCRs and scrubbers.

I think we had -- Vince, was it -- a dozen different agreements with different companies over there. I won't go into specific details due to some competitive reasons, but we are multiplying our effective marketing capability quite well, I think. So it's not the numbers of people per se, but how we're approaching it. We feel pretty good about this right now.

One more thing I'll add is that John mentioned these cooperation agreements, and yes, we have between 10 to 15 of such -- such of these agreements in place. We supplement that with what are more traditional sales agency agreements as well with a handful of sales agents job is purely to help sell our products out in China right now.

The last point is the fact that we are looking very seriously about our entree into China via the initiation of some sort of legal entity arrangement. We're looking into that very diligently at this point in time; nothing in place, obviously, right now. But just to point out that, obviously, we're taking this market very, very seriously, and we're looking at being able to capitalize using any and all resources that we can.

Great. Just a couple more points. On the -- domestically on APC, by the numbers it looks like business is going quite well. Can you talk about how utilities are dealing with SIP Call and how that's going, and also some folks trying to do some prospecting for some other regulations, whether it's the CAIR or what have you? Can you talk about what folks are doing?

Sure. As you know, the SIP Call kind of started it, and it's still in play as utilities and more over industrials are still working on their compliance. A lot of them -- utilities built SCRs early in that region and kind of overcomplied but are now having to pick up with some of the smaller units. Especially true, a number of utilities delayed doing anything on the smaller units because they actually, quite frankly, thought they were going to be phased out in favor of natural gas plants. With the price of gas having gone up the way it did, those expectations have changed, and a lot of the small coal units are deeply in the money, and they are now getting the kind of controls. That will last for a number of years.

But the new regulations -- CAIR, which basically takes everything east of the Mississippi and applies NOx and SOx controls, and then the Clean Air Visibility rules will take the rest of the country. So there's a whole market of the rest of the Company just now opening up, and those compliance early dates are still a few years out.

A number of utilities are looking at SNCRs for that. But equally, John, they are looking at ULTRA where they're going to put SCRs. And people are becoming cognizant of the dangers around anhydrous and aqueous ammonia, and they're looking for alternatives. As they put on SCRs, they also encounter the problem of SO3 plume, which happens across an SCR if you have any significant sulfur in the coal. That's a great application for our TIFI, our FUEL CHEM.

So, to be honest with you, whether it's a big unit and they put an SCR, that's wonderful for us, because we [will] try to sell them an ULTRA, and it really opens up more opportunities for us on our FUEL CHEM side. If there's a small unit, then an NCR from us would work real nice. So we want to capitalize on any unit out there, and that's the way the market is starting to play out, too.

Just a final last couple ones. On FUEL CHEM, Mexico sounds like it's going to get kicked off this calendar quarter. I know a couple of quarters ago we were thinking about the total addressable opportunity in the couple dozen range out there. Number one, can you comment on the addressable market in Mexico for FUEL CHEM on the oil-fired units? And two, timing. Obviously this is a long leadtime business -- if you can give us a yardstick to measure (multiple speakers)

Mexico has about 17,000 megawatts of heavy oil-fired generation, and if you were to use an average unit size -- they're usually not this big, but I will use that for illustration -- of 500 MW size, then that's about 34 500 MW units. If you used our rule of thumb of about $1 million per unit for an oil-fired unit that size per year, then that opportunity is about a $34-ish million per year number.

We think we can capture -- we think we've got a technology that can apply to most of that. How much we end up capturing depends on a lot of things. Getting stuff done in country takes more time than it would typically here in the U.S. But I think once they see the results -- the results they saw in the lab were so good that they actually ran the test three times because they couldn't believe how good they were. That's what got us so far to where we are, and we have high hopes for this market.

In the last one, I think you said FUEL CHEM revenues were down 1.5 million year-on-year first half.

No. FUEL CHEM revenues are way up. (multiple speakers) absolutely.

I'm sorry; the oil-fired business.

The oil-fired -- the oil-fired units -- units are dispatched according to how -- their cost in the market. And an oil-fired unit at, say, 10,000 [heat] rate with a $75 per barrel price of oil has a price into the market probably in the $75 to $80 range. Through the first and second quarters, especially in the second quarter, most of those units were off-line just because they're out of the money. Now, since July the 1st, with this heat wave, units have been starting up all over, those oil units. So actually we think that's going to pick up a little bit in the third quarter.

Let me rephrase it a little bit. For oil-fired units for FUEL CHEM, can you give us how -- the number of how many are off-line due to the high oil prices?

Let's see -- hold it a second -- I don't know -- we've got, I think, nine oil-fired units here in the U.S. that are utility. I don't know how many are off-line. I would have said probably seven of those. That was in the last quarter. I think a whole bunch of those have restarted now.

Great quarter.

[Pricid Depri], Thomas Weisel.

Actually I missed the last part of Vince's comments, where he was mentioning something about the EPS guidance. I just want to know if you have revised your EPS guidance or you're keeping it unchanged?

The EPS guidance -- did you catch the revenue guidance?

Yes, I got that.

The EPS guidance, we're basically increasing it pre-123R to $0.48 to $0.51 per diluted share, pre-123R impact, and the 123R impact is $0.06 to $0.07 per diluted share.

That's up from, what, (multiple speakers)

Up from $0.48 to $0.50 -- sorry -- from $0.45 to $0.50 per diluted share.

Okay. Next question -- actually, you mentioned in your comments that about your first NOx CASCADE product to be installed this fall. I just want to know some more information about this particular installation, what kind of customer it is, and is that an existing customer? And also if you could give a profile of prospective customers for the NOx CASCADE products -- again, the type of customer, the size, whether it's a utility or an industrial customer, or it's an existing customer, whatever information you can provide.

The customer I don't think we've actually announced. We've had business with this customer before, absolutely. The customer just -- it's a utility customer. It's a smaller, between 100 and 200 MW, coal unit. This CASCADE is -- it's a SNCR with a small SCR, and it holds the promise of getting 50 to 70% reduction for a pretty modest capital range.

On this project it's being coupled with a fluid bed scrubber that can take out SO2, and DOE is funding it to demonstrate state-of-the-art technologies that could be applicable to a smaller coal unit that couldn't afford to put an SCR on it or a limestone scrubber. And we have very high hopes for this. Our equipment delivery is in progress, been working on it for a while, and we announced it earlier in the year. We just didn't go into the recent DOE grant that was pretty significant for the utility. They had been hoping for this.

This is -- again, we are really trying not to be a one or two or three-trick pony here. We're trying to have a whole suite of technologies that, no matter what a person's decision is with regard to their environmental compliance, that we have a product or service that can be of benefit. We think that that offers our best chance of success and allows us to go with the flow as regulations change.

Okay. Also, actually, I have one more question. I noticed that the gross margins in the FUEL CHEM business were much higher this quarter as compared to earlier quarters, and I just want to know if that's a one-quarter event and we should expect gross margins to decline in the FUEL CHEM segment going forward?

A portion of the increase is what I would call onetime in nature. We have realized the benefit of about $600,000 in revenue here in the first half of the year that was related to cost share demonstrations for shipments of chemical actually in 2005. In other words, we have $600,000 in revenue and 600,000 in gross margin that fell into the first half of this year that related to '05. The impact of that is approximately 3% on the gross margin overall. So that would put us more on an equalized basis in the 53% to 54% range. And it looks like right now that that 53% to 54% range is the margin level that's going to be recurring here in the near term.

My last question -- when I looked at your announced orders in this quarter, in the second quarter and also in the first quarter of 2006, they were pretty much at the same level, at around 8 to $8.5 million in both quarters. What I want to know is what do you think will be the catalyst that can take your new orders to a level that is much higher than 8 to $8.5 million per quarter? Is that going to be mostly international revenues, or do you see some catalyst in the domestic market which will help you drive your new order growth?

We were giving year-over-year, where we were really up a couple of million on the APC side over the first quarter -- the first half of last year. We get a lot of orders in the third and fourth quarters, typically third quarter, as utilities look to comply for next year's NOx season. It usually takes six to nine months for us to do an SNCR project, and NOx season starts May the 1st. So a lot of utility orders tend to happen in that kind of timeframe. People wait until the last minute to do stuff. That's on the capital project side, and we have high hopes of having a great year in that area. On the FUEL CHEM side, we've never announced this as much as we've been doing this year so far. So it's been a really good first half.

(OPERATOR INSTRUCTIONS). [Sue Desnu], Aragon Capital

Congratulations on the quarter. I just wanted to ask about FUEL CHEM and the rate base recovery issue. I understand that as many as seven states have now approved a pass-through for the chemical costs. I just wanted to confirm that in fact the number of states is that high. And if so, how many FUEL CHEM boilers are in these states?

I can't confirm that seven-state number. You're getting better data than -- or higher data than we have. We know of two states that have it, and one that is three-quarters or 80% of the way to having it that would be a major benefit.

That is important. It would make it a lot easier. But we're finding clients are moving forward once they try our product -- and more and more of them are trying it -- moving forward regardless of that. Now, that would help immensely, but that's really not stopping us any more. And especially as people put on SCRs and have plume issues, they have to solve those. They can't operate. And we can solve those, and reduce their costs overall. So we continue to work real hard on that issue, but I don't have -- you're quoting numbers that are about twice what I know of. If they're right, that would be awesome. But I don't have those numbers.

I know that you don't have a lot of control over this, but how confident are you that additional states might actually approve a pass-through over the next six months to a year?

You're asking me about politics, which is where these get into. Technically, a whole bunch more ought to move forward with that, because it's clearly -- and especially where there's an SO3 plume issue, that's clearly in the fuel -- cost of fuel and pollution abatement areas. But these things are driven not only by technical issues, but by politics. And I can't give you a really good and -- any better estimate than you can on that.

Debra Fiakas, Crystal Equity Research.

In your guidance, I was just sort of jotting down a few numbers here on the back of an envelope, and I appreciate those numbers. I just wondered, it doesn't seem like there's a lot of room for expansion in spending for marketing purposes, and yet you've got lots of plans to penetrate further into China and to go into India. I wondered what you're spending plans were there, or just how you plan to go about moving into those markets. Is it going to take additional staffing? Will you need offices and facilities in each of those markets?

First, thank you for your coverage. It's appreciated. The marketing and R&D expenditures, to be honest with you, are -- while we have a budget for it, we're going to do what's necessary to go after those markets. If I thought we needed to add a new marketer here in some region in the U.S., we'll add that in a heartbeat. If we need to add new people in our international efforts, we'll do that. We have a pretty substantial office in Milan, Italy, as an example. And we're probably going to go use the Milan -- the Italian folks. The leader there has had a lot of experience in India, probably use them to go lead our efforts into India. That has a couple of advantages; not only his experience there, but also there's the possibility of taking advantage of European CO2 credits under Kyoto. To take advantage of that, you have to be a European office company that's doing that.

So our current structure offers us -- that's just one example of a lot of the kinds of stuff we're working on. We are not limited by some budgeted amount that we're locked into. We want to be a very flexible Company. We want to grow earnings fast and on an accelerated pace with profit. And whatever it takes to do that, we'll do it.

Right. And that's one of the reasons why we increased our credit line. Obviously, as we look at the cash balance that we have on hand, which we expect it to continue to grow, we're going to use those funds to capitalize on some of these markets that are potentially huge for us. And if we do have to spend the additional dollars, we definitely will do that.

To comment relative to a lot of room in the guidance, in the way we see things panning out today and for the remaining five months of this year, we don't anticipate several hundreds of thousands of dollars of incremental spending happening between now and the end of the year. If that happens to happen, obviously, we'll talk to you about that on our next conference call, and we'll have good reasons for doing that, obviously. But today we just don't see that level of magnitude of spending happening between now and the end of the year.

We're really trying to leverage better the resources we have. I think there's some opportunity there on our engineering side and on our sales and marketing side. We took -- we used to operate as two different divisions. We've pulled all of that together. We're one integrated team now, and cross-training our sales reps. And we think that that combination is going to allow us to get a lot more coverage for the same amount of people.

I'm sorry if this is something of a repeat of previous questions -- my attention was diverted for a short time to another conference call -- but I wanted to go back to the gross margin. You gave a range of 52% to 54%. Is that gross margin range contingent on a continuation of the product mix that we saw in the second quarter, or will we see more NOx business relative to FUEL CHEM in the second half of the year? I was just trying to get an idea of what's your guidance range, if that's fixed on a certain mix of business.

The 52 to 54% was only the specialty chemical technology segment only.

Okay; I'm sorry.

On an overall basis, for the Company as a whole, we're currently at 48% weighted average basis. And I think that's a pretty good number. I think that's a sustainable number. Again, it would be contingent on the business mix that we have, the capital projects business and the specialty chemical business at 48%, assuming a similar mix of business between those segments is a good number.

The 52 to 54% for the specialty chemical business is a number that we think is sustainable. And obviously our numbers today are primarily driven by the domestic marketplace. As we -- as we expand FUEL CHEM internationally, we'll have to get a better feel for how that will impact gross margins as we go forward. Today we just don't have a good deal of experience with that to talk to.

Thank you. I appreciate you going over that, because I was -- I came back into the call as you were saying those numbers. And I can tell you, it got my attention.

We'd like to be at 52 to 54% overall, but we'll see how things develop.

(OPERATOR INSTRUCTIONS). John Quealy, Canaccord Adams.

Actually, just coming back to this issue on FUEL CHEM, I know in prior calls I think you folks are talking about sustained gross margins in FUEL CHEM in the sort of 52 to 53% range. I realize there's some moving pieces in the first half of this year, but it certainly seems like you folks are saying potentially run rates are 53 to 54%, depending on mix and traction. Is that a correct assumption? And if so, what has really changed the difference in the outlook there over the last several quarters?

52, 53, 54 -- somewhere in that range is the number that we expect to be able to recur. I don't think we have realized a fundamental change in our expectations necessarily. We do have some leverage that just comes from the incremental revenue dollar, but I wouldn't call that necessarily significant as it relates to gross margin. And again, in the year-to-date figure, at 57% gross margin, there is what I would call a onetime benefit of around 3 -- what I'd call 3%, 3.5%, due to some realization of cost share revenues.

And, John, while we don't -- we don't and can't tell you the exact units that we put on, because clients want the confidentiality, because they really do view that as a competitive advantage. I will say that the units that we've been signing on recently this half have been a lot larger in nature. And when you've got fixed costs with regard to the equipment and the staff, if you've got a larger unit and you're pumping more, your margins for that unit hopefully are going to go up just slightly. So there's a lot of things in play, but I think the numbers are all -- we can't guess a whole lot tighter than that 52, 53, 54% range.

Lastly, competition on FUEL CHEM, it hasn't really been an issue in the past. Competitors still sort of, I'd say, taking a back-seat role in this industry, or what's your characterization, John?

They're trying. You can't have a market that we view as exciting as this and not have people trying to come in there. The good part is that there's nobody out there performing as well as we have, and the client testimonials have been awesome. And as we get more and more acceptance, you know, we get a few clients who are willing to let people talk to them and to let us quote them, and that's turning the tide.

We have had demonstrations going head to head with competitors in different technologies -- our approach is patented -- and we like those, because every time we do those, the competitor's equipment gets taken off and sent home, and we are in there. So we think we've got a good product, but we're trying to enhance that product. We're looking at different chemical combinations that can do different things for different client needs, kind of a cocktail mixture, if you will, that offers a suite of solutions for clients. And those efforts are starting to pan out.

Tom Bishop, BI Research.

I had a question on the number of units where FUEL CHEM is being used, and especially with -- the number with TIFI. And also, the number of pollution control units outside of that around the world. I think I recall a figure over 300.

I think it's 375 or something like that. That's exactly right.

So you've installed pollution control equipment on 375 units around the world?

Yes.

On the FUEL CHEM?

Total -- hold it a second here, there's -- right now -- just to give you a rundown -- I think total coal -- this is utilities and industrial -- are 27 installed, total oil is -- worldwide is 13 units, and other industrial stuff that burns different things like municipal waste, five units. I think that's the current number (multiple speakers) first half.

Apparently, TIFI is not always used as the way to get the job done with FUEL CHEM.

You're going to have to explain that one.

Well, is every single one of these units applied with TIFI?

No, there's a couple of the oil units where you can actually mix the chemical in with the oil, and we call that in-body. So there's some of the oil units that are out there. Oil tends to be a lower revenue kind of dollar, which is why we focus on the coal.

But with coal you have to use TIFI?

With coal, competitors try a spray-on; it doesn't work. So yes, you need to use Targeted-In-Furnace Injection.

If I could just ask another question. How does the 2.8 million tax benefit from the exercise of stock options, which is a big number relative to the 5 million or so that was generated from the stock option conversions -- how does that figure into the tax calculation on the income statement, which you say is largely non-cash for GAAP purposes? Is it not part of it, or how does that work?

FAS 123R is a very complex accounting statement.

That's why I'm asking.

Again, maybe -- that's a question maybe we can also talk about off-line as well. But very briefly, our income tax expense for the first six months of the year is $2.5 million. All of that is non-cash in nature, and the reason that is non-cash is because all of our taxable income in the first half of this year has been sheltered by tax-deductible stock compensation expense.

The stock options that were exercised by employees or directors, whomever, generated the tax deduction. And that tax deduction is sheltering our taxable income during the first half of the year. So that's where that 2.5, $2.8 million number is coming from. You get a benefit on the cash flow statement because that expense is non-cash, obviously. And so that's why you see that as an addback on the cash flow statement.

So there's no NOL involved here?

Not at this point in time, no. (multiple speakers). We're generating current-period tax deductions. There's an ordering methodology that's utilized here. Current-period tax deductions are used first, prior to your NOLs. So right now we're using tax deductions that were generated from our stock option exercise activity.

The NOLs total what?

$6.5 million coming into 2006.

Sorry; I missed that.

$6.5 million coming into 2006.

So it's possible by the time we get to 2008, or even late 2007, that the tax expense will become more cash (multiple speakers)

That is correct. Exactly.

(OPERATOR INSTRUCTIONS). At this time there are no further questions. I would like to turn the call over to Mr. John Norris for closing remarks. Please proceed, sir.

Thank you very much, and thanks, everybody, on the line for your interest in Fuel Tech. It's been an exciting first half and we look forward to talking to you at the next quarter. We're hoping for a really good year. Take care and have a good day. Bye bye.

Thank you.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a wonderful day.