Fuel Tech Inc (FTEK) 2006 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2006 Fuel-Tech Incorporated earnings conference call. My name is [Tawanda], and I will be your coordinator for today.

[OPERATOR INSTRUCTIONS.]

As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the call over to your host for today's call, Ms. Tracy Krumme, Director of Investor Relations.

Thank you, and good morning, everyone. 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 203-425-9830 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, 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. 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 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, the conference 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 this morning.

We are very pleased to report another outstanding record-breaking quarter for Fuel Tech. Our quarterly revenues were another all-time record high at 20.2 million, up 57% from the third quarter of '05. Pretax income for the quarter was 3.7 million or $0.15 a share, up 87% over last year's third quarter.

For the first nine months ended September 30, our revenue was 57.1 million, up 56% over the first nine months of last year. Our pretax income for the nine months ended September 30 was 9.4 million, or $0.39 a share, almost double last year's 4.8 million, or $0.21 a share. Our year-to-date revenues pretax income have already surpassed results for all of 2005, which was our previous best full year.

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 various tax and other charges, such as 123(R) 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 over $25 million.

Now I'd like to tell you about the company business behind these outstanding 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 improvement 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, capital projects product line. Again, this quarter we have both product lines generating significant growth in revenues while margins have remained excellent.

Our APC capital projects business sector saw revenues increase 68% for the quarter and 60% for the nine months ended September 30 over 2005. Gross margins at 44% were down a bit for the quarter and nine months ended September 30 from last year, but are stable and in line with our expectations for this 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 at booking and fulfilling orders from a variety of domestic utility and industrial customers.

The Selective Non-Catalytic Reduction, or SNCR systems, for our Chinese projects are on schedule for deliveries and installation this year and in the first part of 2007. 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 the demonstration of this 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 substance to transport, offload and store for use with an SCR system at power plants.

Our backlog at the end of the third quarter was 14 million, and that's down from 19 million at the end of the second quarter, but we quickly replenished that backlog shortly into the fourth quarter as we have already announced 6.3 million in new contracts since the end of September. As you know, our capital projects purchase orders are somewhat seasonal and are not uniformly distributed in neat quarterly segments.

To date in 2006 we have announced 28.5 million in new business. We expect this business sector to grow, and we anticipate significant new orders in this business sector before the end of the year.

Our Fuel Chem specialty chemical product line also had a great third quarter, with revenues of 9 million, up 46% over last year, and with nine months revenues of 20.3 million, up 49% 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 3.4 million during the first nine months of this year relative to 2005, as the high cost of oil has kept those units offline most of the time this year.

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 product in reducing slag problems and especially in reducing SO3 plume issues utilities are encountering as they install SCRs to control NOx.

Nine-month revenues from coal-fired units on Fuel Chem are three times the comparable period in 2005. This is exactly the market we have worked so hard to gain acceptance in. Our Fuel Chem products are now installed on 23 coal utility units, and we expect continued growth in this area. And at 57% for the first nine months of the year, our margins in this business sector are up a good bit and continue to be very strong.

We also anticipate significant new orders in this business sector in the very near future. As we look at the geographic breakdown of our revenues, we note that our international revenues, at 15.5 million for the first nine months of 2006, now make up 27% of our total revenues. Now, this international number is up over 150% versus the nine months 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 clients there, especially for Ultras. This is an important market for us, and we certainly hope our efforts and anticipate our efforts will be rewarded with new projects there this year.

Other key international markets for us are Mexico and India. Our Punta Prieta project in Mexico should start operation this quarter and will hopefully demonstrate the very positive results in mitigating their serious SO3 plume issues. In India there was much interest in our Fuel Chem program to mitigate slag and SO3 plume and for CO2 reasons. We are in India this quarter trying to bring home a first order in that important market.

Finally, we continue to work on new products and services in our R&D area, and some of those appear to hold much promise. Our recent announcement regarding our new targeted corrosion inhibition technology, which is aimed at the municipal solid waste boiler market, is but one of a series of exciting new technologies we've been working on. Our goal is to have a very broad suite of products and services that can address a broad spectrum of client needs within the general areas of boiler optimization and pollution control, which are our core expertise areas.

Now I'd 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.

As John mentioned, net sales for the third quarter increased 57% to 20.2 million, up 7.4 million from the prior year. This was our fifth consecutive record quarter for net sales. Pretax income totaled 3.7 million in the quarter, or $0.15 per diluted share, up 87% from 2 million, or $0.08 per diluted share in the prior year. Net income totaled 2.1 million, or $0.09 per diluted share, compared with 1 million, or $0.05 per diluted share, in the prior year.

Net sales for the nine months rose 56% to 57.1 million, up 20.4 million from the prior year. Pretax income totals 9.4 million, or $0.39 per diluted share, up 97% from 4.8 million, or $0.21 per diluted share on the prior year. Net income for the nine months totaled 5.4 million, or $0.22 per diluted share, compared with 5 million, or $0.22 per diluted share in the prior year.

The third quarter and year-to-date results include .3 million and 1.4 million respectively in stock-based compensation expense, reflecting the January 1, 2006 adoption of Statement 123(R), Share-Based Payment. Additionally, the third quarter and year-to-date results reflect 1.6 million and 4.1 million in income tax expense, virtually all of which is non-cash.

Net income for the third quarter and first nine months of 2005 was favorably affected by the one-time recording of a 2.2 million non-cash tax benefit related to the anticipated utilization of net operating loss carry-forwards. This benefited the prior year to the tune of about $0.10 per diluted share.

The increases in net sales for the quarter and nine-months periods were driven by strong growth in both technology segments. Net sales for the nitrogen oxide technology segment were 11.2 million and 36.7 million respectively for the third quarter and nine months ended September 30, 2006, the latter representing a 60% increase over the prior year.

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. This segment continues to experience a high level of order activity, as utilities and industrial facilities that are impacted by the Environmental Protection Agency's state implementation plan call regulation and other recently introduced regulatory mandates continue to utilize Fuel-Tech's technology as an important element of their ongoing regulatory compliance strategy. Fuel-Tech continues to work towards developing alliance agreements with selected customers.

Quarterly and nine-month sales for the fuel treatment chemicals technology segment were 9 million and 20.3 million respectively, the latter representing a 49% increase over the prior year. This technology segment's gains 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 previously, partially offsetting these gains was the adverse effects of rising crude oil prices, which has limited chemical applications by some domestic utility customers with oil-fired generating units. Fuel-Tech's oil fired revenues for the first nine months of the year were down 3.4 million versus the prior year.

The outlook for the fuel treatment chemical product line is 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 coals, such as those from the Powder River and Illinois Basin areas, and the emergence of the important SO3 mitigation market, bodes well for incremental domestic growth in the near future and, as John mentioned, the opportunity for international expansion into Mexico, India and China looks promising.

The gross margin percentage for Fuel-Tech for the quarters ended September 30, 2006 and 2005 was 50%. The gross margin for the third quarter for the NOx reduction business decreased to 44% from 51% 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 third quarter of 2006 from 49% in 2005. The increase is due in part to the timing of revenue recognition on cost share demonstrations, which depressed the prior year margin percentage.

The gross margin percentage for Fuel-Tech for the nine months ended September 30, 2006 and 2005 was 49% and 48% respectively. The gross margin percentage for the NOx reduction business decreased to 44% from 49% for the same reason noted previously. And for the fuel treatment and chemical business, the gross margin percentage increased to 57% for this period from 48% in the prior year, again for the same reason noted previously.

SG&A expenses for the three months ended September 30, '06 and '05 were 6.1 million and 4.1 million respectively. While these expenses for the nine months ended September 30, '06 and '05 were 17.6 million and 11.9 million respectively. This $5.7 million increase for the nine-month period is attributable to the following.

Fuel-Tech reported 1.1 million in stock compensation expense in accordance with Statement 123(R), as discussed previously.

Fuel-Tech realized an increase in the revenue-related expenses in the amount of $1.6 million as both technology segments had significantly improved revenue growth versus the prior year.

Lastly, Fuel-Tech recorded an increase in human resource-related expenses of approximately 1.7 million as staffing levels were increased in several areas in anticipation of overall business growth.

One final contributor, actually, was an increase in incremental expenses related to audit, tax, consulting and recruiting fees, a portion of which reflects our recent domestication to a U.S. company.

R&D expenses for the three months ended September 30, '06 and '05 were .6 million and .3 million respectively, while these expenses for the nine months ended September '06 and '05 were 1.5 million and .9 million respectively. Fuel-Tech has established a more focused approach in the pursuit of commercial applications for its technologies outside of its traditional markets and in the development and analysis of new technologies that could represent incremental market opportunities.

The increase in other income and expense for the third quarter and nine months ended September 30 versus the 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 third quarter and nine months ended September 30 of '06 reflects 1.6 million and 4.1 million in income tax expense, virtually all of which is non-cash.

The balance sheet continues to show increased strength resulting from the leverage of Fuel-Tech's business model. At September 30, 2006, Fuel-Tech had cash and cash equivalents and short-term investments of 25.7 million and working capital of 33.1 million versus 16.4 million and 19.6 million at the end of 2005. Operating activities provided 3.4 million of cash in the first nine months of the year primarily due to the favorable operating results of the business segments.

Investing activities used cash of 5.7 million during the first nine months of the year as short-term investments were increased by 4 million and 1.7 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 during this period generated cash related to the exercise of stock options in the amount of 7.5 million. Of this amount, 3.1 million represents proceeds from Fuel-Tech's stock options exercise in the first nine months of 2006, while 4.4 million represents the excess tax benefits realized from the exercise of these stock options.

Overall business activity continues to trend favorably for both business segments. We expect to announce additional business, both domestically and abroad, in the near-term as a result of our strong results through September 30, 2006. Full year revenues are expected to be 70 to $74 million, an increase from prior guidance of 68 to $72 million. The NOx reduction technology segment is expected to generate 43 to 45 million in revenue, and the Fuel Chem technology segment is expected to generate 27 to 29 million in revenue.

Our pretax net income for this revenue range before the impact of Statement 123(R) is expected to fall between $0.50 and $0.53 per diluted share, an increase from prior guidance, which was $0.48 to $0.51 per diluted share. The impact of Statement 123(R) on Fuel-Tech's income statement for 2006 on a full-year basis is expected to be $0.06 to $0.07 per diluted share.

Now, with that, I'd like to turn the call back over to John.

Thanks, Vince.

In summary, we are very excited about the record results that have been achieved, as well as the significant growth opportunities ahead of us.

With that said, Operator, can you please open the line for questions? Operator?

[OPERATOR INSTRUCTIONS.]

John Quealy with Canaccord Adams.

A couple questions. If we can just focus on Fuel Chem first, so you did about 9 million in the quarter, and 1 million I guess is offline due to oil-fired stuff. Is that right, for the quarter?

In terms of impact on the quarter, I'd say that's approximately right, John.

Okay. So--but, if you look at this point forward, 9 million, I know you folks have said in the past that you haven't lost a Fuel Chem customer. Is a $9 million point a good run rate for this business? And I know you just gave us the sort of full-year Fuel Chem number, but is 9 million a good number to start with moving forward, not just for Q4 but in '07?

There's two factors in getting that answer. First, John, we haven't seen yet a full quarter of all of the units that are online and that will be online. Next, however, it is somewhat seasonal, and I think we're headed in this kind of direction. Is it that or is it better? We'll know probably with one more quarter under our belt. I don't think this is a temporary spike up, if that helps. I really think it'll be this kind of number and, hopefully, better going forward.

And John, maybe to your point in terms of seasonality and having these units online altogether, what's the relative standard deviation? Is it $1 million high or low with this mix of business currently before we talk about new order flow? Or what's your comfort range on how that business performs quarter to quarter?

We don't know fully yet, John. We had a number of units that came off, for example, in September for outages that were on, and we've got some that were in trial that are just now coming on. But, that's always going to be the case outside of the very middle of the summer or across the winter. So, right now I think this is probably as good a number as we've got right now going forward. I think the fourth quarter we have some units that were in outages in October. Outages tend to occur over September and October, and we had a number of units that were in outages in October. So, whether the fourth quarter will reflect quite this good I'm not sure but, in general, once we have units on, we expect this kind of business sector to generate numbers like this going forward for '07.

And if I can push a little bit on '07, you've had ...

--John, we haven't even gotten our business plan. We're going to meet offsite here soon and start putting those together.

I know you're hesitant to do it but, if we can talk qualitatively, you had some pretty bullish comments, I thought, in your commentary about Fuel Chem's significant new order flow. When you talk about that, can you give us a range of it, just sort of one to two to three customer sites that you're looking at, or what's the sort of order flow magnitude that you mentioned, threefold up this time next year? Is this 10, 15 potential units, or how do we handicap this?

I don't know that you can right at this moment, but I will say our policy is not to announce actual orders until they're signed and in hand. Well, we have never had so many negotiations going on with clients in our history.

And my last question on Fuel Chem and I'll leave it. In terms of the number of individual customers you have over those 23 facilities, can you talk about the pace of penetration of existing customer assets and how those expectations are for you folks, moving forward?

It's starting to pick up as we -- and again, you'll see announcements as they come out when we get signed orders. But, we do have a number of clients who have tried us on one unit that are now in discussions with us about expanding that to other units. That's exactly what we had talked about in the past that we want to do, and those are beginning to come to fruition. But, it's like a chicken and an egg. You can't count him until he's hatched.

That's fair. If I can go to APC for a moment, in terms of the business there and China opportunities, can you talk about, again, an order of magnitude? How many orders on APC we're trying to track down in China, and can you talk about relative win-loss percentage? You've been relatively quiet in the last quarter or so in terms of posted wins about China. But, can you talk about how that market's developing for you?

The market, as you've heard us in presentations over the past several months, the near-term market in China, the major near-term market in China, is Ultra for us, and Fuel Chem. The Chinese are putting in a lot of SCRs, the big, expensive catalyst.

Their construction costs in China aren't nearly what ours are. So, for new units that are going in, they're trying to control NOx in anticipation of the Olympics. They're also putting stringent controls on the use of any sort of hazardous substance, like anhydrous ammonia, in and around their major cities, especially again leading up to the Olympics. That is putting a lot of emphasis at the Chinese utilities on switching to urea-based ammonia supplies, which our Ultra does.

We've never had so many bids out there right now. They move not always at a pace that anybody would like in the negotiations, but we're very optimistic about that market. And that I think, John, through about 2010, the market there is probably going to be heavily Ultras and Fuel Chem. The Chinese will address the retrofit, which is an enormous market, way over 1,800 coal units, that are existing already, and I think their preferred technology, if our national demonstration projects work well, is probably going to be SNCRs.

So, we're very hopeful about what the future bodes there. In the near-term, they're also pretty interested in Fuel Chem, especially for its SO3 slag and, really, the CO2 benefits, because we can get about a percent or so efficiency gain with that. So, there is actually a lot going on but, again, the fruit is in the actual signed contracts. We are very hopeful, as I said in my announcement, for near-term success there.

Just a couple quantitative questions. First, on the margin side, APC margins basically in line. Fuel Chem, much higher than we thought on some startup accounting. Can you actually just walk us through why that number creeps upward when you start a project, if I understand that properly?

Well, early on it isn't up. We usually do -- our standard approach with a client is to go in and do a demonstration period, where we, on our nickel, put in the system after it's been modeled, and then we split with the client the cost of the program 50-50, the chemical costs for the first period, 60, 90 days. At the end of that time, if we've met their expectations and they want to go forward with us, then they pay us the other half of that part we split, and then we go commercial. If not, we pack up our equipment and go home.

We've not actually ever been asked to pack up our equipment and go home after a trial run. So, during that first period, 60, 90 days, sometimes with an outage or two, that's operational days. Sometimes that can run longer and, during that period, we're only collecting half of those costs. If it's successful, we'll get it after that.

We're also I think seeing -- you're seeing the margins. We've said all along that we need a little more track record with major coal customers and a larger coal base before we can accurately predict what those margins are going to be going forward longer-term in that business. And I think we're still in that period. I feel very pleased and highly optimistic about our future, given the trends are upward.

John, just one more point on that that I'll make, as well. There is a little bit of what I would call a project mix impact there on the Fuel Chem side, as well. The oil-fired business has traditionally been a bit of a lower margin business relative to the coal-fired units, so we're feeling a little bit of a benefit on the margin side as a result of the reduction of the oil-fired business.

And one addition to John's point. We talk about the business, or we have talked about the business on the Fuel Chem side as averaging approximately $1 million per unit per year for a coal-fired unit. As that number does increase in actuality per unit, we will realize some leverage on the fixed cost of sales that relate to the Fuel Chem business. So, we're seeing a couple of factors going on right now. And to John's point, until we get a little bit more history and what I would call an increase in the base of Fuel Chem business, it's going to be difficult for us to predict exactly where that Fuel Chem margin number's going to actually end up.

We've been quoting mid-50s to slightly below that, and I think that's still our target at this point in time.

My last question maybe for you, Vince, looks like you did about 4 million in operating cash flow this quarter. What are your thoughts for Q4 and how you end up the year?

Right now I would anticipate definitely adding some additional cash prior to the end of the year. Our year-end position ends up being contingent upon, really, collections as it relates to the air pollution control side of the business. So, timing is sometimes difficult to predict along that end. But, independent of anything else, without any surprises, favorable or unfavorable, I would expect our cash balance to be in a range of, say, 27 to $27 million at the end of the year. That's the range I would give.

John, one more item. You didn't ask, but I think we'll note that we had said earlier that we had hoped to start showing improvement in our operating margins, and I think it's neat to note that we made improvements not only on the quarter but on the first nine months up to the kinds of range that we think we can get to in the future. We expect to continue on that.

Michael Molnar with Goldman Sachs.

On Fuel Chem, can you walk us through the trends in the units under contract in the last four quarters? I just want to make sure I have my numbers right, just for coal-fired.

Yes, I think we're on right now 23 coal-fired units, utility units. I tend to break those out because there are some industrial units. Twenty-three utility coal-fired units, 21 of which is in the U.S., two of which are in Italy.

Now, how did that trend? Was it 23 last quarter? What was it the quarter before? I'm trying to see how the units have ramped up.

Michael, let me walk you from -- let's start with the end of the third quarter of prior year.

There we go. Perfect.

Okay, does that work for you?

That's great.

Thirteen at the end of the third quarter of prior year. Okay, I'm just going to talk about domestic units. I'm not going to factor in the two international ones, okay? Thirteen, 18 at the end of the fourth quarter of '05, 19 at the end of the first quarter, 20 at the end of the second quarter, 21 now at the end of the third quarter of '06.

When you guys look at the addressable market, how do you think about it for Fuel Chem? You have a number of boilers in the U.S., but all those boilers wouldn't be your addressable market. Can you help us break that down into how you think what could be the market for Fuel Chem in the U.S., let's start with?

Yes. [John], there's 1,527 or so coal-fired utility units in the United States. Of that, there's 40-some-odd lignite units. I used to discount those. I no longer discount those. Those may actually be a market for us.

Of that 1,500, if you look at the reasons people can use us, in the past we thought of it that Fuel Chem was primarily a slag reduction kind of thing, so you look for issues around high-slag coals, PRB, Illinois Basin and others. That's really, we're finding out as we looked at the benefits of Fuel Chem, not a sole focus on that technology. It's very useful for those kinds of issues.

SO3 mitigation, especially when you put on an SCR, is a huge issue, and we're extremely effective. Our recent test results there are very positive. As you look at mercury reduction for non-SCR units, the principal technology there is activated carbon injection. Recent data, especially that was presented at the MEGA Mercury conference a month or so ago, show that SO3 blinds activated carbon to a greater degree and prevents it from being very effective in removing mercury. Our Fuel Chem technology we believe is the solution for that.

So, I would tell you that, of that 1,500 units, any of those units could absolutely have a need for our services today. Now, you're not going to win all 1,500 plus of those units in any market. Nobody gets 100 % of anything. But, if you just took off 500 of that just because you can't win them all, that's still 1,000 units that, over $1 million each, that we could be in an addressable market.

So, I think for the company, could we be a $1 billion a year company in Fuel Chem? Yes. Now, that's all talk when you're a $70 million-something company until you get there, but we are looking at technology applications and new technologies that are derivatives of our Fuel Chem, which that targeted corrosion inhibition technology was one such example that can broaden that market.

The TCI alone is a Fuel Chem kind of application that's really targeted after municipal solid waste. Now, there's 100 or so of those units in the U.S., but there's 600-some units like that worldwide, 400 of which are in Europe. That's a pretty neat market in Europe, and that's a neat technology addition for us. So, we're looking at tweaking that to expand our customer base around those Fuel Chem and Fuel Chem-related technologies.

And if I could just ask one more, just want to make sure I understand your comments on the SO3 and mercury. It's not that the Fuel Chem will reduce mercury. It's the fact that, if you have SO3, activated carbon won't work. Is that right?

That's exactly right, and we suppress SO3.

Graham Madison with First Albany Capital.

Just looking at the international market, you seem to be gaining quite a bit of traction in your key markets. And I know you work in about 18 or so countries. Where else do you see as target markets beyond India and China and Mexico?

There's a lot of places, Graham. The biggest issue is you've got to focus. Now, you may see us do an odd project here and there because we are getting requests for our technology in other non-targeted countries and, to the extent we can enter there easily without a lot of effort, because the sale is basically already done, we will do that.

We're trying to focus right now on a few key markets, because you can't be all. We're a small company. We will grow and we will expand those. But we have those countries right now, Europe, India, China and Mexico that we're heavily focused on, but you may see something come out of us in countries that are not targeted. Just know that, if you see something like that from us, it will be because they actually came to us and we were able to work out a way to go in there easily enough.

In terms of the margins, are the margins about the same overseas or a little bit better?

We don't know good yet. We don't have a good enough track record yet to answer that question, especially on the Fuel Chem side. So, give us a bit more time to win some and establish a track record. Right now anything I would tell you would be a guess until you actually do it.

Right. the first projects that we have here in China, the first couple of projects that we've actually been in the process of completing, are all U.S.-based contracts, U.S.-based supply. So, the margins on those have been comparable to domestic projects. To John's point, we just don't have the history, nor experience, to be able to forecast that right now.

On the Fuel Chem side, obviously the market opportunity is huge there. what do you see is the biggest challenge, going forward, in terms of what might limit your growth?

The biggest challenge on Fuel Chem domestically is market acceptance that our product can do what we say it can do and what our clients know it can do who've tried us. there have been decades of people out there that utilities laughingly refer to as "Snake-oil salesmen." Heck, I used to call them "Snake-oil salesmen" when I was leading a couple of major utility generation efforts.

And that really is the issue. Utilities are pretty jaundiced about adding chemicals to do the kinds of stuff that we're accomplishing with Fuel Chem. Once you get that ball rolling, though, Graham, I think you'll see that we won't actually have to necessarily be calling on every client. We'll get some of those folks calling on us. And we just had the barest nibbles of that starting to happen now, but that will be really knowing when the market is accepting.

Now, overseas, I think once they see the U.S. market accept Fuel Chem for what it can do, that makes it a lot easier. A lot of overseas utilities look not to what salesmen say, because a lot of people say a lot of things. But, they're looking at what do utilities in the U.S. do. There's a lot of bias towards listening to their fellow utility brethren, and so as we see success in the U.S., we'll see much better success overseas.

[Paul Chang] with ThinkEquity.

Just wanted to confirm some numbers. I think you had said that backlog at the end of the quarter was 14.2 versus 19 last quarter. Did I get that right?

Yes, and that we had added 6.3 since then.

If you could just kind of help us understand and drill down on, when you have an increase in backlog, typically how is that recognized over the -- either current quarter and upcoming quarters?

Well, backlog, by our definition, is the unrecognized revenue associated with signed and executed contracts and purchase orders.

When we have a contract for a $2 million installation and we're working through that, the first part of that might be modeling, and then there's engineering and construction of the equipment, and there's progress payment. As we recognize those revenues, that backlog comes down because, as you're recognizing it, it's no longer unrecognized.

Projects on the capital projects side don't fall neatly into quarters, and we are in negotiations, and have been for the ones that we've announced, for example, the $6 million-plus in orders, with a number of utilities and customers, and they will execute those purchase orders and execute those contracts to fit their schedule and their outages, typically spring or fall, but they also want us to fit their budget items. Some of the utilities are on fiscal year budgets, and a lot of them are on calendar year budgets. And oftentimes, they won't sign a contract and start down a process until they're getting close to the start of their budget year when they're going to actually spend those funds.

But, you work through the projects, and so you've got to keep winning more to build that backlog.

Thanks.

Does that help?

Yes. We may come back to you offline for more, but I think that's it for now.

Sure, Paul.

Again, the reduction to 14, I mean, sure, it would be neat to have had those announcements a couple of weeks earlier that we were in negotiations for a long time, and that way we'd have over 20 million out there in the third quarter. But, we've never been more excited. We wouldn't be putting the estimates out for the end of the year and stuff about our APC product line if we had doubts about that.

[Rich Levelowski] with Fidelity and Company.

Over the past year, year and a half, we've been talking about mostly transportation and then, next year, Peabody was talking about differences in production out of the PRB. Can you talk about your expectations for that situation, if it's going to have a measurable effect on your business?

I think two things are probably going to happen. I think, before all kinds of good economic reasons, the PRB production and the rail transportation issues are going to get better. But, on the flip side, I don't see that as being the key driver for our Fuel Chem business any longer. I think its' a great market for us, and it'll be a key market for us, but other issues, SO3 issues especially, are huge out there in the industry, and growing.

Our biggest customer on Fuel Chem today does not use Powder River Basin or Illinois Basin coal. They use Appalachian coal. All coals have slag, more or less, and people who are using high-slag coals can see an enormous in-furnace benefit from slag reduction. And early on, that was the most apparent benefit, because you could actually see it. You could see the slag being cleaned off of those tubes, and that slag problem being reduced.

As we have further refined the numerous benefits of our Fuel Chem program, that market has expanded a lot. So, I think expansion of PRB will only help, but it's not the key driver for our business like it was a year or two ago.

You mentioned you have 21 domestic [inaudible] units on the coal-fired and a number within demonstration. Are those counted with the 23?

Those are in the 23 and, since we tend to keep clients, we just announce it at the demonstration. We don't announce when a person has transitioned from demo to commercial.

How much in that initial batch of APC orders for the customers in China do you have left to recognize?

We probably have approximately 2.5 to 4 million left to go on those contracts, somewhere in that range.

The domicile change that you announced, what kind of effect is that going to have on the tax rate either in 4Q or in 2007, the effective tax rate?

Yes. In 2007 and going forward, you're going to see our effective tax rate go out to 38 percent on a going-forward basis. Don't expect any impact on the fourth quarter at this point in time.

[Jessie Herrick] with MCS.

Just a quick question on the Fuel Chem demo units. You were talking about a 60 to 90-day demo period. When you actually make the announcement, has that demo period started, or are you starting the mapping and modeling for that?

Typically we get a purchase order to go do the demo, and the mapping is included in that purchase order. There are rare occasions when they might ask for a map. We're typically not -- announce just the mapping for Fuel Chem. But, typically, they're going down that path.

But, as soon as they sign a purchase order to -- and paying for the mapping, and then we're going to go ahead. All of that occurs within about five or six weeks from the time we get a purchase order. We do the modeling and then have the equipment delivered and installed. Typically about six weeks is what it takes us.

About six weeks after the announcement?

After the announcement, although sometimes if we've been in negotiations, we may have pre-positioned the equipment, and we can shorten that time frame.

Moving on to your tax charges, you mentioned that a lot of those are non-cash charges.

They're basically all non-cash, Jessie.

And wondering about how much runway we have left on non-cash charges going forward, if you guy have any sort of estimate on that.

We came into the year with about 6.5 million in net operating losses to begin 2006. 1.1 million of that is set to expire if we don't use it here in 2006. The dynamic that we have going on here is, earlier in the year, we had extensive stock option exercise activity, which is just a positive thing for the company overall. But, that generated some tax deductions, some current-year tax deductions, that we can use to offset our current year taxable income.

At the end of the day, what I'll tell you is that, starting in 2007, I would expect to have effectively about -- I'll give you a range, say 9 to 12 million in tax-deductible assets, if you will, that can shelter taxable income going into 2007, somewhere in that range.

And then just moving on to the guidance that you guys just bumped up. I guess looking at how much you've had over the nine-month period and then the guidance, it looks like, quarter-over-quarter, you'll be going down slightly as far as your revenue. I'm just wondering if that is mainly a function of just the lumpiness in the APC contracts.

There are several functions out there at work here. One, we try not to go out on a limb with grandiose forecasts that we can't meet. The other part is there's some seasonality to some of this as we have a number of our units on the Fuel Chem side, for example, in outages, that were in some pretty major outages in October. They're coming out of those now, but how that will affect our revenues is -- we don't know yet.

And oftentimes in the fourth quarter, especially if winter doesn't hit too early, utilities will take outages all the way up through Thanksgiving, and then the holidays tend to be a little bit of a depressed -- our sales on our Fuel Chem side are going to track utility power sales, to be honest, because you're going to have the chemical on when they've got the units on.

Right. So, you said that some of the units are in October outages, and some of those are actually still going through right now?

Oh, yes. And they'll start -- be coming out of those now. You can't take your whole fleet off if you're a utility. You have to phase it. You tend to do outages in the spring and fall, and you'll also try, because you don't have a workforce that can take that kind of surge, and there's a pretty tight labor market. So, they'll phase them down starting in September, but it'll run well through November.

Do you have a percentage of the units that are offline?

I don't have that, Jessie. I don't.

Debra Fiakas with Crystal Equity Research.

Just to clarify the cash flow from operations in this quarter, you mentioned it was a net use of 5.1 million. Did that include, or was that excluding, the excess tax benefit on the stock option exercises?

There was a net use of 5.1 million, Debra? I'm not sure ...

I'm asking what was the cash flow from operations. Just wanted to clarify the remark you made.

On a year-to-date basis it's 3.4 million, on a year-to-date basis.

On net usage?

No, net increase, cash provided by operating cash flows of 3.4 million.

Excellent. And that included the tax benefit from ...

No, it did not. It did not.

Okay, that's excluding it. Excellent.

And then, just to turn to the APC segment, and maybe you could talk about your target margins in that segment, as well.

I think those margins that we have down there, as we said over the past several months, we expect that kind of 44% range to be about right. We'll see what the international business margins will end up being. We need a little more track record on that. But, I think we're settled into about the margin range that we're going to expect on our APC line now. So, as we said in the remarks, those are in line with -- where we are right now is in line with our expectations going forward.

And then, also you've been talking about the number of potential target customers for the Fuel Chem segment. I wondered how many salespeople you have assigned to that segment, or how you have your salespeople organized to pursue those 1,500 utilities.

Over 1,500 utilities, there's obviously not that many utilities. So, once you can get in to demonstrate on a significant utility, then hopefully they will see those results, and it's a lot easier to expand that to other units within that same utility. So, it's not like our sales force has to call on necessarily every one of those, but we will be out there trying to call on as many of those as we can. We have about 12 to 15 in-house salespeople and about that many reps, and all of our people sell all of our products.

And I guess that's really what I was aiming for, is they're going out with an entire portfolio of products. They're not necessarily going out and talking only about Fuel Chem.

And then, just to get an idea of how many actual customer groups we'd be talking to, what's the average number of units per utility?

That really runs the whole gauntlet. A smaller utility would have eight units, for example. A large utility, when I was running AEP's fleet, I think I had 152, 150-something.

So, it's quite a wide range.

It's quite a wide range.

[Michael Carboy] with [Signal Bill Capital.]

A question for you on the issue of establishing credibility and confidence with prospective customers. I was hoping you might elaborate a little bit on what you think leads to that confidence. Is it simply monitoring for the tests for a while, or does it require a full tear-down of the units for a detailed inspection?

Oh, no. The benefits are oftentimes readily apparent, and I told a story of one of our customers. The plant manager was -- they actually used us primarily for SO3 plume mitigation and, looking through his observation window 10 days into the demo, saw the tubes now clean that were covered in slag, and said, "I've seen enough. Let's go forward with the other unit."

Proof is in the pudding there.

So, you can see a lot of benefits just looking through it. Now, there are other benefits out there that sometimes take the 60 to 90 days, and they look at their numbers, like efficiency gains, NOx reduction. Although they see it right away, they like to look at trends.

And you'll get typically some NOx reduction, maybe up to 10 percent, with the Fuel Chem. Some longer-term maintenance issues around SO3 mitigation, especially air heater, are just now being realized by our folks because they do take an outage to go in and take a look at that.

But, you can normally see it pretty quick. The real issue is getting utility users to be willing to talk about their experiences. Utilities like to talk to their brethren utilities, and they put a lot of confidence in what a fellow plant manager somewhere else says, and especially if they're able to go visit that plant. Now, utilities used to be a brotherhood. Now they're in competition with each other in the wholesale market. But, we have, just in the past few months, had a number of our key clients been willing to host visits from other utilities to come in and take a look at their operations, and I can tell you for a fact that's having a huge impression on potential clients.

And then, just a follow-up on another question that had come up earlier. Vince, you had said that there had been no circumstances wherein a trial had not been converted into a full install. Then, I believe later, in a response to a question, you said typically you keep a trial, and there's a subtle difference there in wording.

It was not intended to be a subtle difference in words.

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Tom Bishop with BI Research.

I had a question here on whether the sales effort -- I mean, given that you've never been asked to not keep your Fuel Chem equipment there, that's a pretty good thing that you can strut about.

So, I am surprised that the number of units has only gone up by one each quarter since the beginning of the year, and wondering if maybe you need more sales effort or if there's -- there's a disconnect there between 100% satisfaction and adding one unit a quarter.

Yes. I think you're going to see the pace of that pick up substantially. Two or three things. Only recently, Tom, as I've just said to Michael, only recently have some of our utility customers been willing to host others in there to take a look at it.

Yes, I was pretty excited to hear you say that.

And on a bigger deal, we actually have a number of utilities who are pretty interested but are waiting to put it in next year's budget and to get that budget in there, because there is -- the up front, there is an O&M cost for them putting the chemical in, before they start seeing those benefits. Now, they'll see a great return once that gets going but, unless they're getting a fuel cost pass-through, the plant manager's got to get that typically in their budget. Right now, utilities are submitting their budgets up through their eldership. Typically, budgets are approved in utilities, just like everybody else, but--typical in that Board meeting in the first quarter.

Now, you just touched on my second question, which is, when you put in a Fuel Chem unit, and say the guy's looking at $1 million worth of cost annually to spray this stuff in there, can you just run us through the benefits in terms of what it costs to de-slag a unit, that sort of thing? And then, [inaudible] in efficiency, and I know there's SO3 that you maybe can't even put a dollar amount on.

Well, that's true. Walk through the benefits on Fuel Chem, if you will, very briefly, Fuel Chem. If you have an SO3 problem, mitigation of that is not a return on investment kind of issue, it's a, "You've got to fix it" kind of issue. And when we apply our Fuel Chem program, the blue plume goes away. And that's the requirement for that.

For slag kinds of benefits, you will start to see that quickly, and the benefits will occur by not having to de-rate the unit. Oftentimes, units have to be de-rated. Typically, like 20 megawatts out of a 500-megawatt unit, 20 or 25 megawatt de-rate because they can't get the heat transfer because slag is preventing that.

So, the power sales part of the utility over in their wholesale trading group will see a benefit to extra power sales. You will also have fewer times when the unit has to be brought down in load to fire air or water cannons in there to knock the slag off. And there will be a minor cost reduction in fewer shotgun shells of trying to use 12-gauges to knock the slag off.

Can't imagine doing that.

So, you see some of those kind of benefits. Again, the major benefit there is increased power sales, which the plant manager doesn't see in his budget. That's over in the wholesale sales group. The ability to use higher slagging coals, which are typically cheaper, like PRB, typically much cheaper if you could use it, and has lower SO2, typically, which there's a cost for SO2 emissions in the credits. Again, that's going to be seen by the fuel purchasing guys in the utility, not the plant manager.

The plant manager's going to see a reduction in outage cost when he has his annual or 18-month outage, because he's not going to have to go in and de-slag, and it's going to be a shorter outage. Typically, de-slagging is one of those critical path items, and that's increased power sales, but it's also a decreased O&M budget for him. He will see decreased maintenance and capital expenditures in the air heaters, of having to change out the air heater baskets. But, that will be on a 12-month to 18-month kind of cycle.

And in the future, and in some countries now in the present, the 1% efficiency gain not only helps the coal but also will help on the CO2. So, there's a lot of benefits of this stuff. The plant manager just in a typical utility doesn't see them all in his budget. That will come together, though, at a senior VP level.

That's probably a longer dissertation, but I hope that helps answer your question.

It does. And just one last question here about the number of units using Fuel Chem. You keep mentioning the 23 coal-fired units, but I thought there was a bunch of oil ones, too.

There are. Because the coal utility units tend to be the larger units and more substantial, we're on I think four domestic industrial coal units and 13 oil units, and five other, like waste energy. I think those are the current totals.

Preeti Dubey with Thomas Weisel.

I have actually just a few questions. First, on Fuel Chem, are you seeing a higher usage of your Fuel Chem chemical bio-installed base of coal-fired boilers, especially if you compare it to what the usage for, say, last year?

Yes, because the mix -- as Vince pointed out, typical revenue from an oil unit is going to be in the hundreds of thousands. We're right now saying that you should use $1 million a unit on coal, but we're still working on that track record to refine that. many of our coal customers are well more than $1 million a year per unit.

Just one follow-up question on that. Is the amount of the Fuel Chem chemical that a customer uses, is that dependent upon the size of the boiler?

It is dependent on the size of the boiler and the needs that they're looking for. The size of the boiler really does impact. As you can imagine, you're trying to spray our chemical and get full coverage in the boiler so that, if a boiler is much bigger, you're going to have to have more nozzles and you're going to have to be injecting a bit more to achieve those results.

But, the benefits also are huge. If you're a 1,000 megawatt, or the largest unit in the world is 1,300 megawatts, and we have one of those as our customer, that's a 5% power recovery from de-rate is huge on a unit like that versus a 300-megawatt unit.

And also one question on your new corrosion control technology. Can you tell us when do you expect to start commercializing it, and when can we expect the first revenue to come out of it?

Well, we'll get our first revenue when we get our first customer with it, and we've got some keen interest. We just announced it, and so that'll--I mean, you'll see the first revenue when we announce the first customer. But, we're marketing that right now heavily, but just very recently. We really like to not make claims on stuff until we demonstrate it, and we actually do run tests on utility boilers on some of our R&D stuff that utilities that really believe in us and like us will allow us to run an R&D. And we have not made announcements for those kinds of test runs when we're trying to test out a new product. and we're in some of those test runs on new stuff now with different boilers and, as we get and certify the results and we become convinced that it's something we're going to put our name behind, then we'll got to market with it and we'll make an announcement about it. But, there's a lot of neat stuff.

Yes. I think what's critical to note about the corrosion control technology is the fact that it's truly what I would call the first step as part of a reorganization of the effort of our R&D group internally to go ahead and focus on bringing some new developments quickly to market.

John reorganized the R&D group in a more focused manner earlier this year with the intent of focusing on specific customer needs and then being able to bring a solution to market as quickly as possible. While the corrosion control market is not going to be what I would call a huge marketplace for us, our R&D team is looking at some other opportunities which could have larger impacts overall.

And just one question on your international operations. Based on the leads that you have and your ongoing negotiations in your international market, do you think you can repeat your performance of 2005 in terms of generating new orders in the APC segment in 2007?

I hope it's better than that.

Okay. Well, definitely the potential is there. Do you think so?

Yes. My clear expectations, and it's all talk until you do it, but my clear expectation is that would be a yes.

You have over $25 million in cash, and you have said that your goal is to have a broad suite of products. I would think that acquisitions would be an important part of it. And can you just tell us what are your plans as using your cash, and also if you are looking at acquisitions, any specific areas that you can elaborate on?

Yes, we have said that, and yes, we do have that cash, and it is building, as Vince said. We are looking out there. We have nothing right now, but an acquisition is not the only way to accomplish gaining the capability to offer clients a multi-pollutant control suite. There are other ways that might even be cheaper than an acquisition, joint efforts and joint projects.

I kind of like the quicker, cheaper approach if we can do that, and I have actually pretty high confidence that we'll be able to do something along those lines to enhance our products and services, maybe in a quicker, cheaper way than just spending shareholder cash.

[Quint Slattery] with [Symmetry Peak] Management.

Just in terms of the previous question, is there any chance that, if you guys are going to pursue some acquisitions or partnerships, you might raise some additional cash to bolster the balance sheet?

I don't know. I can't really answer where the Board might want to take the company in that regard. We do have, and I will say that, for those of you who didn't know how hard of work, but Vince did a great job, and we do have a $25 million unsecured line of credit that's currently available in addition to our $25 million in cash out there, and that war chest is building, as Vince said.

What our options are and what we might need to do in the future we haven't clearly defined.

And just in terms of going on the road, are you guys going to attend any conferences or go on the road any time in Q4 or Q1?

Yes. We've got the next-generation conference that's held by Merriman, Curhan, Ford & Company in May in New York City, and we're also presenting at the Roth Capital Conference in February in California.

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And at this time, there are no further questions in queue. I would now like to turn the call back over to Management for closing remarks.

Well, thank you very much. We're real happy with the quarter we've had, and we think this is only the beginning. We've got a really bright future ahead of us. Our job is to make it a reality.

Thank you for your interest, and have a great day.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect, and have a great day.