Fuel Tech Inc (FTEK) 2009 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2009 Fuel Tech earnings conference call. My name is Fab, and I'll be your coordinator for today. At this time, all participants are in listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to Tracy Krumme, Vice President, Investor Relations and Corporate Communications at Fuel Tech. Please proceed.

Thank you, Fab. Good morning, everyone and thank you for participating on today's conference call to discuss our third quarter 2009 results. Joining me on the call is John Norris, President and CEO, John Graham, Senior Vice President and CFO, and Ellen Albrecht, Vice President and Controller.

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, this call is being broadcast over the Internet and can be accessed at our website, www.ftek.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, everyone. We appreciate all you joining us on this call. Our results for the third quarter of this year include revenues of $16.5 million, down 30% from the third quarter of last year. Net income for the quarter was a loss of $698,000 or $0.03 a share, versus a profit of $2.1 million or $0.09 a share in the third quarter of 2008.

The results this quarter were heavily weighed down by weak revenue recognition and our Air Pollution Control, or APC portion of our business due to the timing of project milestones for contracts that were being executed and due to anemic APC domestic sales in the first nine months of the year.

In a few minutes, our Chief Financial Officer, John Graham, will discuss our financial operating results in much greater detail. John will also cover our balance sheet in detail, but it remains exceptionally strong with very little debt and with a strong and growing cash balance. Of note, our cash, our net cash provided by operating activities for the first nine months of this year is $7.5 million, which includes $2.8 million generated during the third quarter of this year and represents the second largest cash flow from operations at this point in the year in our corporate history, despite the worldwide economic crisis and our weak operating results.

Now let's take a look, a closer look to better understand the business state of our company. 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 targeted injection business for efficiency improvement that we call FUEL CHEM, and our Air Pollution Control, or APC, capital projects product lines.

Let's take a look at the results in both areas. First, our APC capital projects business sector where we saw revenues of just $6.2 million, down 54% from the third quarter of last year. Of this $6.2 million, only $3.9 million was from domestic APC projects, down 62% from the $10.3 million in domestic APC revenues in the third quarter of 2008. Year-to-date APC revenues for 2009 were $24.2 million, down 32% from $35.7 million during the same period in 2008. We recognized only a little of our June 30th backlog and added $2.9 million and announced new contracts during the quarter. So our APC backlog at the end of the third quarter of this year was a respectable $11.1 million. But only $3.6 million of that was for domestic projects.

The primary weak area of our business this year thus far has been our domestic APC business, and that is clearly shown in the third quarter results. Now, the really good news is that the market is finally starting to open up as evidenced by the $17.1 million in contract awards announced last week, almost all of which was for domestic customer projects. Included in that was the largest single APC contract award ever received by our company at $12.7 million.

Both of the announcements last week involve technologies that we acquired in January, so it is clear to see the very strategic worth of the acquisitions we made over the past year, and that will be even more clear in the not-so-distant future.

The weak APC revenue results for the quarter, to a certain extent, reflect the timing of various equipment orders in our existing backlog, such that not much of our back -- prior backlog was worked off in a quarter. Most of the work we did in the quarter involved in front-end modeling and engineering or in backend startup activities.

In addition, with a decreased overall workload, we took the opportunity to deploy more of our engineers and technicians on startups of projects employing our new advanced combustion technologies so they could learn the new technologies with hands-on experience. This caused some more time to be charged to the startup activities.

In addition, SG&A costs go up as more time is charged to training and admin and less time is absorbed by project-specific work. And that is reflected in our cost-of-sales figure. Since the equipment part of the order typically yields the highest revenue generation, and with most of our activities this quarter involved in front-end activities and system startups at client sites, we saw depressed revenues and the higher cost depressed margins in the sector down to 33.9% versus our more typical margins in the lower 40s. Those revenues that are still in the backlog will be recognized in the future quarters and the margin should recover to more typical levels as those existing projects are executed and as our overall business picks up.

The domestic APC business is driven by regulations, and those have been and still are in a state of flux in the US. Many US utilities have been waiting until they see what the new NOx regulations are going to be before they deploy expensive systems to clean up the air. The EPA is under court order to issue a new Clean Air Interstate Rule, and they're expected to issue that revised rule in the first part of 2010 with the final rule expected later next year. This new rule is expected to be significantly tougher than the current rule and is not likely to include a cap-and-trade approach for NOx, which was one of the court's major faults with the existing rule. All of this should bode well for our APC business for a number of years in the future.

Overseas, the picture is brighter in the APC sector. In Europe, the APC revenues for the quarter were up 201% over last year. And for the first nine months, the APC revenues are up 162% over the same period in 2008. These 2009 results are all-time record highs for our European office. We see expanded markets in Europe for our NOx reduction suite of technologies, especially in Poland where they must reduce NOx as part of their entry into the European Union.

In Latin America, we see Chile as an emerging market for NOx reduction technologies. We have one project there now and are pursuing a number of other opportunities. In China, our revenues for the quarter and the year-to-date lag last year, while our backlog of work is in adequate shape, representing more than half of the $11.1 million total company backlog.

But the real story is in the bid and contract negotiation area where there is much activity, and we expect that to yield a number of signed contracts over the next few months of this year and into 2010. Most of the current bid activity is in the Guangdong Province and especially around Guangzhou City, where new NOx regulations call for strict NOx control measures to be put into place before the Asian Games there next fall. Most of the current China backlog and most of the relatively near-term expected orders are for work that will be fully executed in 2010.

In our FUEL CHEM business sector, the third quarter of the year saw revenues of $10.3 million, an all-time record high for our company, surpassing the prior record set in the third quarter of last year just before the economic crisis hit. This is also the best first nine months of revenues at $28.5 million for FUEL CHEM, in our company history, surpassing last year's record of $27.2 million. This is particularly noteworthy, given the fact that a large number of our domestic utility clients are experiencing significant reductions in demand and have throttled back their power plants in response. When the utility clients run at reduced loads or shut down the units altogether, then our services are curtailed or stopped while they're offline. The reduced load operations of our utility clients is one of the reasons our margins in this sector are down to 42% for the quarter and the year.

We have some fixed costs, both people and equipment, at each plant. And with reduced utilization of our injections, then there is less revenue to cover those costs. I suspect that we may see this effect even more pronounced in the fourth quarter of this year as mild weather combined with a stalled economy keep a large number of our utility and industrial customers at reduced power operations or even offline for the quarter.

Getting back to the third quarter of this year. We had a one-time expense charge of about $425,000 for equipment related to our three new Mexican FUEL CHEM units due to the way that equipment is treated in the contracts. Those units will start up early next year on our FUEL CHEM program and should generate significant revenues and profits for us in the future.

The final major reason for the reduced margins in this sector, for the quarter and for the year-to-date, is the very large amount of risk share month we have outstanding from our existing current demonstration projects. At the end of the third quarter, we had 2.7 million in risk share outstanding, the largest amount in our company history by far. As you may know, we typically operate our risk share period at about break even and only bill the client for the difference if and when the project goes commercial. We are awaiting those demonstrations to be complete, and, hopefully, the results will be commercial projects and we can then bill and collect this money.

Internationally, we still see significant FUEL CHEM opportunities in Mexico, China, India, and now in Chile. In China we're in discussions with a number of potential customers for new demonstration programs. In India, we hope to restart soon the demonstration that was disrupted last year by riots in Mumbai. Chile also appears to be a viable market now for us for FUEL CHEM and we're working to get a demonstration program going there soon.

Turning to the list of FUEL CHEM customer units that we included in the press release, you will note that we made a few changes to keep the list current as of each earnings call. We have removed three coal units from the domestic demonstration column. One of those was a large unit installed, and they installed the equipment but never ran the demo due to dramatically reduced load on the unit and a change in coal. If that demo isn't started, we hope to move that equipment to another station with that same customer in the not-so-distant future.

We removed one medium size unit that partially ran a demo but stopped when the utility developed cash flow problems combined with dramatic load reduction such that they decided not to run the rest of the demo at this time. If and when that is restarted, as conditions change, then we'll add them back as they complete the demo.

Finally, we removed a small utility unit that completed a successful demo and paid the risk share so they're out of the demo column on our list. But low load conditions, combined with a contract for some better quality coal, have delayed starting the commercial phase of our program. So even though the equipment's there and ready to go, we're not going to add them to the commercial column until they restart the program.

From the commercial column in the US coal units, we removed one small industrial unit as the plant has permanently shut down due to the economic conditions in the country.

Internationally we removed two medium size coal units from Italy who stopped using us, as the economy there has caused reduced loads too, and they do not currently require us with the coal they're burning. These two Italian units have only generated a few hundred thousand dollars a year, in total, combined revenue in the past couple of years. So this will not cause a significant financial impact. Interestingly, we continue to be actively used on the two units burning olive pits in Italy.

In the non-coal area, we removed three oil-fired units that have been totally shut down due to the economy and the high oil prices.

As a reminder, our goal with this list is to provide analysts and investors data to help model our FUEL CHEM business, and we will make changes at each earnings call to provide updates to help in that endeavor. Given that we are setting all-time record revenues so far this year from this business segment, we may have to revisit in the future our rough guidance regarding revenues per unit for the coal units, since using that guidance results in numbers well below our current actuals. But for now our guidance will remain unchanged.

Finally, in China, our combined FUEL CHEM and NOxOUT selective noncatalytic reduction or SNCR modular system for small district heating units is finally being installed and will operate this winter season. As you may recall, this is a project jointly funded by the US Trade Development Agency and is to help these small units improve efficiency and reduce pollution. While the plants are small, there are over 550,000 such units in China. And, to date, there has been no effective system to accomplish these goals. We hope to be the first to market in this vast market opportunity area. We anticipate that we'll use something like our FUEL CHEM business model in this endeavor.

Now I'd like to turn the call over to our CFO, John Graham, to further discuss the details of our financial results.

Thanks, John. Good morning, everyone. As John mentioned, consolidated revenues for the third quarter ended 9/30 were $16.5 million, a decrease of 30% from the third quarter of 2008. Despite a record quarter for FUEL CHEM revenues, the lower APC revenue base, driven mainly by a suppressed domestic backlog related to reduced power operations to meet lower demand and continued uncertainty over the ultimate outcome of the Clean Air Interstate Rule, or CARE, restricted the flow of orders through 9/30, and thus APC revenue recognition for nitrogen oxide control systems.

Given the near-term fixed component of our SG&A expenses, which includes the incremental expenses from our three recent acquisitions and the amortization of identifiable and intangible assets, the gross margin dollars generated in the quarter were insufficient to fully cover SG&A expenses and resulted in a net loss of $698,000 or ($0.03) per diluted share compared to a net income of $2.1 million or $0.09 per diluted share in the same year-ago quarter.

Now let's go through each of the segments in a little bit more detail. In the FUEL CHEM segment, third quarter segment revenues were $10.3 million, an increase of 2% versus the third quarter of 2008. Revenue gains associated with new customer commercial units and demonstration programs were largely offset by the shutdown or scaling back of chemical injection at certain client units experiencing depressed electricity demand. Even so, the third quarter of 2009 saw the highest quarterly FUEL CHEM revenue amount ever recorded in Fuel Tech's history, and was also a record through the first three quarters of any year.

Of the $10.3 million in segment revenues, approximately $9.5 million was from coal-fired units, an 8% increase versus the coal unit revenue reported in the third quarter of 2008. Quarterly revenues from non-coal-fired units of $830,000 were 39% -- were down 39% versus the prior year quarter, primarily due to milder summer temperatures, reduced industrial loads, and the high cost of oil which reduced its use as a fuel source.

Despite the economic recession, we continue to have a very strong market penetration for new FUEL CHEM demonstrations both in the US and abroad. Year-to-date, we have announced 10 additional FUEL CHEM orders, many of them went or will be going straight into commercial status, thus avoiding the traditional break-even multi-month demonstration phase. This will also avoid some of the gross margin dilution normally associated with a new order that involves a demonstration period. These orders have been received from the US, China, Korea, and Mexico, thus lending further substance to the global applicability and market potential for the FUEL CHEM program.

Quarterly gross margins for the FUEL CHEM segment declined from 47.6% in the third quarter of last year to 42.2% this year. The joint result of larger demonstration programs under way, a one-time equipment sale at a nominal price to support the startup of a Mexican-based FUEL CHEM program, and the impact of local fixed cost to client sites spread over a suppressed average revenue base which diluted the overall segment margins.

The sale of the FUEL CHEM equipment to a Mexico-based client was done under a one-time contractual obligation to secure a substantial piece of business through our licensee. Excluding the dilutive margin impact of demonstration programs and the one-time Mexican sale, the base FUEL CHEM business generated a gross margin of approximately 48%. While this is down slightly from historical levels, it is primarily due to the dilutive impact of fixed operating costs such as personnel and depreciation that, when taken as a percentage of revenue at client sites experiencing reduced chemical demand, dilutes the underlying gross margin percentage. This is not indicative of any other negative trend in our business.

Year-to-date FUEL CHEM segment gross margins for our base business revenues was approximately 46%.

At present, we have eight FUEL CHEM units currently in demonstration with each designed to prove the effectiveness of the TIFI application. FUEL CHEM and -- excuse me. Fuel Tech and the customer normally share in the demonstration program's expenses, and the customer typically transitions into commercial status once that program's value has been demonstrated.

As John mentioned, we currently have approximately $2.7 million in outstanding risk share revenue, the largest aggregate balance in our history, that will be paid to us once the related FUEL CHEM programs are deemed a success.

From an operational standpoint, we continue to keep an adequate supply of FUEL CHEM systems ready to deploy in the United States, with additional units stationed in China so as to be able to install them as quickly as possible upon the receipt of new contracts.

Now, in the Air Pollution Control segment, third quarter 2009 revenues were $6.2 million, a decrease from third quarter of 2008, which saw APC revenues of $10.3 million. Including the orders received during the quarter, the APC backlog amount at 9/30 was $11.1 million. Since then we've announced over $17 million in additional APC orders, including the largest order in our history of $12.7 million for multiple low NOx burners in an over-fire air system for a single coal-fired unit.

While the near-term revenue recognition in this segment is suppressed, the signs of recovery are solid, as indicated by the ever increasing bid activity, especially in the US and China, and the recent domestic APC orders received.

Quarterly segment gross margins were 33.9% compared with 43.2% for the prior quarter -- excuse me -- prior year quarter. The significant reduction versus the prior year is primarily due to a pass-through catalyst sale at a nominal gross margin percentage and the timing of project milestones for other contracts that primarily involved lower margin, revenue generating activities such as initial engineering design and project startup activities in support of APC projects. Absent these items, gross margins were still on-par with historical levels, reflecting the strength of the APC core business.

On a consolidated basis, company gross margin percentages for the second quarter of 2009 were 39.1%, a decrease from the 45.1% reported in the third quarter of 2008.

Quarterly SG&A expenses, excluding R&D expenditures, were $8 million, an increase of $1.2 million versus the third quarter of 2008. The year-over-year increase was driven primarily by sales commission expense, predominantly on record FUEL CHEM segment revenues associated with a new sales commission plan initiated January 1st, 2009, by additional salaries and benefits arising principally from the acquisition of substantially all of the assets of Flow Tack, Tackticks, and advanced combustion technology and by under-absorbed engineering waiver expenses.

When our workload is lower due to few APC projects, then more time is charged by our engineers and technicians to non-project areas such as training and admin. As our project workload increases, more of these expenses will be absorbed into cost of sales with a corresponding decrease in SG&A expenses. Approximately 5% to 10% of our current SGA expense is comprised of unabsorbed engineering costs due to under-utilized technical personnel. The Tackticks and Flow Tack acquisitions will annualize in the fourth quarter of 2009, and the ACT acquisition will annualize in the first quarter of 2010.

A detailed explanation of the quarterly and year-to-date SG&A increases more specifically by individual accounts is included in our form 10Q that was filed last night.

For modeling purposes, the 9/30 year-to-date amortization expense related to identifiable and tangible assets from the three recent acquisitions was $972,000 and the year-to-date FASB and -- excuse this new term -- ASC-718, which used to be FAS 123R, stock-based compensation expense, was $4.6 million on a pre-tax basis.

As of 9/30/09, the amount recognized for the continued consideration arrangement, the range of outcomes, and assumptions used to develop the estimates of change for fiscal '09. We ran the earn-out calculation projection for fiscal '09 for ACT and concluded that its earn-out payment is not probable this year primarily due to the suppressed year-to-date APC revenues. Thus, the company recorded a one-time gain of $781,000 from the elimination of the contingent liability that related to 2009. The remaining amounts related to the 2010 and 2011 earn-out liabilities remain as an accrual on our balance sheet and we'll evaluate those in those years.

Quarterly R&D expenses were $160,000 and were centered upon developing and testing technologies with near-term market applications in both boiler optimization and air pollution control arenas. The decline versus the third quarter of 2008 is due to the company moderating its near-term R&D expenditures in the wake of the economic downturn. However, we have maintained our focused approach in the pursuit of commercial applications for our technologies outside of traditional markets, and in the development and analysis of new technologies that could represent incremental market opportunities.

As always, we continue to watch the domestic and international emission regulatory landscape to ensure Fuel Tech is continually and properly positioned to meet the emission control needs of our customers. For emissions like mercury and CO2 we continue to examine and develop various technology products and solutions to identify ones we feel will be commercially viable.

The third quarter 2009 net loss of $698,000 was below the $2.1 million net income reported in the prior year quarter. The suppressed APC revenue based, coupled with the dilutive impact of the Mexico FUEL CHEM equipment sale and the timing of risk share revenue receipts, resulted in insufficient gross margin dollars to fully cover the incrementally higher SG&A expenses. Even with the surge in APC orders the past few weeks and the healthy size of the APC backlog as of today, we do expect fourth quarter operating results to be somewhat suppressed due to the timing of those contracts available to be worked off prior to December 31st, 2009.

The year-over-year decline in quarterly interest income is due to the reduced cash balance available for investment, as we have spent over $26 million for the acquisition of three strategically significant companies in October '08 and January '09. We also bought our building in 2008, with the down payment in 2007. That total expenditure was around $11 million.

The change in other income expense is driven by foreign exchange translation movement only. Due to the mix of forecasted domestic and international revenue and income levels presume for full year 2009, we have adjusted the full year 2009 tax provision rate down from 40% to 37% on a year-to-date basis. To effectuate this adjustment, the third quarter provision rate was made at 27.4% to yield a year-to-date rate of 37%. While any further material adjustments are unlikely, we may make a final adjustment to this rate at year end if necessary.

The quarterly net loss of $698,000, or ($0.03) per diluted share, embedded in that number I want to give you two figures for modeling purposes. The Mexican FUEL CHEM equipment sale was dilutive to that number by about $0.01 per share, while the gain from the revaluation of contingent performance obligation was accretive to that number by about $0.02 per share.

Even after considering the cash outlays for the three recent acquisitions and the funding -- and funding the purchase of a new corporate headquarters building, our balance sheet does, in fact, remain very strong. Cash, including restricted cash, has increased to above $14 million, and other than our $2.2 million in debt in China related to the startup of the Beijing Fuel Tech office, we have no other debt on the balance sheet.

Working capital at quarter end was a strong $27.9 million, and we have not seen any deterioration in payment patterns from our customers, either domestically or abroad, APC or FUEL CHEM, in the wake of the global financial situation.

The restricted cash of $5.5 million present on our June 30th balance sheet, related to the collateralization of outstanding letters of credit in bank guarantees while we transitioned out of Wachovia and to J.P. Morgan Chase Bank, has been reduced to $881,000 as of 9/30, as we're wrapping up the transfer of these instruments over to Chase. Restricted cash should be at or near zero by year end.

Recall that Fuel Tech entered into a domestic $25 million revolving credit facility with J.P. Morgan Chase as of 6/30/09. This facility contained, among other items, a covenant that required us to achieve a minimum net income for the third quarter of '09 of $750,000. This covenant was not achieved. We have worked with the bank and received a waiver for this breach and have appropriately adjusted certain other future relevant covenants to as to avoid this from repeating. We have attached the amendment to the credit facility outlining these items in more detail to our third quarter form 10Q.

Finally, on the statement of cash flows, year-to-date operating cash flows were $7.5 million, an increase of $2.8 million during the quarter, driven by the add-backs of the non-cash items including depreciation, amortization, and stock compensation expense. Cash used in investing activity of $22.8 million was primarily for the ACT acquisition made in January of '09. Maintenance CapEx will remain well below 2% of consolidated revenues, and the majority of all CapEx will be to support and enhance the operations of the FUEL CHEM technology segment. John.

Thanks, John. Before we open the call the questions, we'd like to address the subject of guidance. Now, while we have -- both John and I indicated in this call that we do not expect a strong fourth quarter, we have decided not to give end-of-year quantitative guidance this year, given the uncertainty in the economy and with the turbulence in Congress over new laws that could profoundly affect the outlook that businesses have going forward with any new investments.

We have gone this long in the year without such quantitative guidance and with our policy on contract announcements, backlog definition, and our FUEL CHEM list updates, we believe that investors have sufficient insight into our future business projects with that information. We will revisit this policy at our end-of-year call next spring.

Now, Operator, I'd like to open up the line for questions.

Thank you. (Operator Instructions) And your first question comes from the line of Rick Hoss from Roth Capital Partners. Please proceed.

Hi. Good morning, everybody.

Hi, Rick.

Morning, Rick.

First on FUEL CHEM, you talked about -- you gave directional expectations for gross margin in the fourth quarter. I was hoping to narrow it down a little bit. For gross margins FUEL CHEM fourth quarter, do we expect it to be flat or even down from the third quarter?

Well, it depends. If we were to get a couple of the big demonstration programs to be declared operational in the fourth quarter, then the gross margins, for whatever revenues we have in the fourth quarter, would go up maybe dramatically. Absent those decisions, Rick, and I don't know which way that frog's going to jump, absent those decisions, I would not expect a change in gross margin for FUEL CHEM in the fourth quarter.

Okay. That's fair.

I don't think -- I will be shocked if revenues were remotely as strong, because this is the outage period and a lot of folks are going into outages on there. So I don't expect -- the third quarter's always our strongest quarter for FUEL CHEM revenues. But for whatever revenues we have in the fourth quarter, I think our gross margins are probably going to be roughly the same this year.

Okay. That's fair. And then can you give us an update on the initial China FUEL CHEM demo that was announced, well, it's probably 20 months ago at this point, maybe 22?

Yes. The -- I can, it's -- but it's unchanged. We're still in negotiations. The plant likes us. The parent has been taking a longer look at it. They've assigned a person as lead to come back. While we had third-party review that was very favorable to the whole project, all of that happened and came about right as this global economic prices hit. Now, while the Chinese are recovering from that faster, everything over there takes longer because they do a very collaborative approach to every decision. That's still in the review at the parent level, and that's where that is.

Okay. And what part does ITOCHU play in that final negotiation? I know it's the profit share arrangement, and I realize that's part of it. But are they there negotiating alongside of you?

Yes, Rick. That's a -- that is done together. We have a shared management board for those joint activities. We have extended that ITOCHU arrangement through the end of February of next year. And we'll see how and where that goes after that. But the -- on any of those kind of negotiations, those are jointly done, regardless of whether both parties are at the table at the time, we have a position going in and those positions don't change unless we agree with it.

Okay. And then on the APC side of things, your discussion in your prepared remarks implied a greater revenue recognition in the fourth quarter versus the third. It sounded like --

No -- well, it shouldn't have. We're looking at, what happened with our projects, even our existing ones, the client shoved back outages in next year and their completion dates. Now, most of the stuff that we have in backlog and almost all of the stuff, if not all of the recent contracts we sign, are going to be worked off in 2010. But the reality is that most of those equipment orders and everything are going to be placed in the first quarter of 2010.

Okay. And that's on that existing 11.1 backlog that --

It's on the whole amount really, the new 17 and the existing.

Okay.

But there'll be some of it, I'm giving a broad brush, there'll be some recognition, but not like we would see -- not like we saw like in the fourth quarter of 2007, where we had this huge surge, the contracts were awarded and we could immediately go to equipment manufacturing. We've shortened our delivery times for our equipment and that works against us on moving early on some of this stuff.

Okay. And I understand that with respect to the orders that have been announced in the last four quarters. But I'm really looking for the back --

Well, the majority --

-- at the end of the third quarter, that's still the majority? That is still going to be recognized in 2010?

Yes, the majority of that backlog is in China.

Okay.

And that China projects are to be -- the orders will -- for the equipment are going to come in the first part of 2010.

Okay. Okay. I understand. And then last question, SG&A, flat from a fixed cost standpoint. I'm assuming no more restructuring or evaluations as far as looking at internal modifications?

Right. The -- as John indicated in his remarks, there's a good bit of that SG&A, 5% to 10%, so if you're looking at a half a million to three-quarters or maybe more of that SG&A we see at our current levels per quarter, is really variable. And as you get more work, that SG&A's going to come down as those employees become fully utilized on project work. We did not, when we made the cuts in personnel back in the second quarter, we didn't cut down to the very nubbies because they we couldn't have grown. We would have -- a whole lot of our technology would have walked out the door. And right now at this anemic level of projects, those folks are just underutilized.

But we got the right mix. We got the right numbers of folks. We've pared that down. But we need to get our APC revenue recognition level up to that $10 million a quarter level and you'll see SG&A dropping significantly and you'll see profit margins going way up.

Okay. Thank you for taking my questions.

Thanks, Rick.

Thanks, Rick.

Your next question will come from the line of John Quealy from Canaccord Adams.

Hi. Good morning, guys.

Good morning, John.

Morning, John.

Couple questions. First of all, I realize the regulatory issues are slowing down the entire market. But for the $17 million that came in, and I realize they're different geographies, can you comment on the sales cycle? Did you have visibility and contact with these folks before the credit crunch hit? Or can you just walk us through how it happened and how they're tracking versus your previous expectations?

These -- most of these folks, we've been working with these projects. We were working with these clients late last year or early this year. So this is not something that popped up all of a sudden. These clients, the majority of this work is going forward because of their obligation to meet requirements under the Clean Air Visibility Rule, or it's also called the Regional Haze Rule. You have a number of states that have to get their NOx levels down regardless of CARE. So you've got a couple of regulations coming after them. These, and you'll notice most of these projects, John, are for low-NOx burners and over-fire air. That's what the vast majority of that $17 million is for. That's the first thing somebody does, and then they'll see how well they do with that before they would put on post-combustion NOx controls like SNCRs and SCRs and that sort of stuff.

So they're doing those first things. We're seeing that a lot more in a number of clients where they're taking the low capital -- lower capital, obviously $17 million, or -- it's not a low capital on a couple of major projects. But they're lower capital approaches on doing this stuff they're -- they know they're going to have to do eventually. Does that help?

Yes. No, it does. Thanks, John. And just staying with the revenues for a minute. Looking through '10, I mean, obviously you got some good APC business, sounds like it's clearly more geared for the back half of '10. My guess is I know you're not giving qualitative guidance. But APC, is it unreasonable to think that it stays at this level, even degrades a little bit for the next couple quarters, or is that not a -- is that too conservative an expectation?

I think it's too conservative. I think the fourth quarter is going to be weak. But I would expect this to pick up rather dramatically in 2010. The -- not only domestically, because we'll have to get really rolling on most of the equipment on even this large job will be ordered in that first part of the year, the recent contract. But the China projects that most -- that we have and that we're in the process of having, are going to -- are going to happen in 2010. Most of the Chinese bid opportunities and contracts we're in negotiation for, they're all for projects that have to be installed and in place before the fall of 2010, before those Asian Games. So, John, I expect the first half of 2010 to actually be much stronger on the APC side.

And then in FUEL CHEM, is there any movement with regard to inclusion in rate basis and things like that? Are we still -- is the landscape still very sporadic and heterogeneous with regards to ROIs and things like that?

No, there is some movement. In fact, one of our demonstrations is, as far as the client's concerned, it's very successfully done, and they've demonstrated the cost. What they did was their -- they now paused the demonstration and they're in front of a rate case right now that we have high expectations that that's going to get included in the cost of fuel. And if it does, then they'll go commercial right away.

So the savings on fuel can be really dramatic and the clients are, at least that client, is being, I think effective in their discussions with the Public Utilities Commission to show them that we can only get this savings if we use FUEL CHEM and, thus, it's a -- it ought to be a pass-through to the people who are going to benefit, which are the customers.

So there is some movement certainly in one state. And the biggest single issue in FUEL CHEM right now, though, John, is the dramatic load reductions. Even down in Santee Cooper, they've had most of the -- they've had one of those four units offline most of the time recently just cause they're not needed for base load work. When they're offline, we're offline on that unit.

So that is, by far, the biggest single impact across the nation on us is -- and it's running at reduced power. It also has, by the way, an impact on the APC. When you're running at half load, you're not generating the NOx levels that you normally generate. So you can run it at partial power and generate a heck of a lot less NOx and have fewer credits to have to buy in the market. So it's a double whammy on us when the electric load for the nation is down.

And then my last question, and I apologize, I don't know if I got all of it from your previous answering Q&A with the previous caller. But from SG&A perspective, I realize the leverage that comes in from a cost of sales perspective. But from an SG&A perspective, are we going to be in this sort of 8 million run-rate area for a while do you think? Or what are the -- what are the issues we need to deal with as we go into Q4 and to Q1 next year?

Yes. John, I think what you're seeing here is it's a bit of a bottoming out of the absolute dollar value of SG&A, topping out, however you want to look at it, for a couple of reasons. You are seeing now, we're through the one-time charges at the May RIF had. We're now experiencing those savings. As we've talked before, the foundation base of personnel is set. So as revenues grow, you'll see a very nominal increase to absolute SG&A dollars and a diluted percentage of SG&A as a percentage of revenue.

Embedded in this $8 million, if revenues stayed where they were, that's your run-rate number. But as revenues increase, you will see significant dollars pull out of SG&A and back up into cost of sales as the workload increases on the utilization of engineering talent and other technical staff also gets absorbed up in the cost of sales. So on a more traditional level of work, I would look for that, that quarterly run rate to drop into the mid-$7 million range and then extend that out to something, give or take around $30 million on an annual basis.

All right. Great. Thanks very much, guys.

Your next question will come from the line of Jeremy Sussman from Brean Murray.

Hi. Good morning.

Good morning.

Hi, Jeremy.

Hey. The $17 million in new business that you announced since the end of the quarter, you mention how that's mostly domestic and the results, largely the result of the successful acquisitions that you made, and that we can also kind of expect to hear more on this front. Kind of on that latter part, are you speaking more domestically, international, or really just across the broad spectrum?

The bigger push is domestically on those technologies. However, it is true that we're bidding in a number of opportunities in China that involve low-NOx burners and over-fire air. And we've got some work that we're bidding down in Latin America that is also in that low-NOx burner, over-fire air.

And I don't want to throw off -- and we've mentioned the technologies coming out of ACT. I will tell you that we are also engaged in a number of opportunity discussions and various bid levels of technologies that really came out of Tackticks and Flow Tack to the catalyst and the technologies associated with our new advanced SCR which is kind of a modified cascade.

So really all of those new technologies really are helping us. Thank goodness we did the deals.

No, that sounds great. And then just as a follow-up. You gave us some good color on Guangdong kind of driving your APC business, sounds like, in the first few quarters, at least of next year. Can you give us a sense of kind of how much -- how many bids you still have outstanding? Or maybe not that quantitative, but just a sense of kind of what type of magnitude can we expect to kind of hear about over the next few months?

I will hedge, but try to give you a little color on that. I wouldn't have mentioned it if it was one, two, three, or four kinds of opportunities. These -- they're not going to be as large as, obviously, a $12.7 million, at least most of them aren't in that kind of category. But we have a lot of -- we have a lot of bids out there. Now, how many of those we win we'll see. Our success rate has been pretty good in the past, but that doesn't always predict for the future.

There really is a scramble going on in that province to meet those NOx regs. And there is a -- there is a -- there's more than a couple of dozen out there. But whether -- how much of that that we win, we'll see. And you're going to know, because when we -- when we win them, we're going to announce them right away. Some of these, there's times when you're already -- you've already been announced in China as the low bidder and they expect you to already start work, but you can't charge it to the projects because you don't have a contract. They tend to get around to contracting sometimes a couple of months after the award's even announced publicly. So we are -- we're highly hopeful for a good 2010 in China.

We also expect that China, by the way, I didn't mention it, but that's when two thousand -- next year is when the regs should come out going into their 12th five year plan which starts January of 2011. So I think you'll see in the second half of 2010, as that 12th five year plan is unveiled, we should see orders pick up throughout the rest of China.

That sounds great. Thank you.

Your next question will come from the line of Jeff Osborne from Thomas Weisel Partners.

Great. Thank you. Just two questions on margins. John, you seemed to hint that the gross margins would be depressed in the FUEL CHEM business in the fourth quarter. And I was just curious if that's sequentially down from the reported 42.2 or the kind of X demo 48 number.

Well, Jeff, it's a good question, and I'll tell you why I can't give you a good answer on this one. It really depends. If we don't get the risk shares, the declaration, and I'm not saying I think we're going to lose the commercial declaration. But if they're not declared commercial and agree to the risk share in the fourth quarter -- that happens in the first quarter of next year, then we wouldn't see those revenues come in.

Without those risk share revenues, I suspect that FUEL CHEM overall revenues are going to be depressed in the fourth quarter due to the number of outages that people are going into to take advantage of the mild weather and the reduced electrical load right now. When you do that, we still have the cost of our personnel and equipment there. So I would not be surprised if our margins don't dip some in the fourth quarter of this year on FUEL CHEM. But it'll only be -- that would be a one-quarter kind of event.

Understand. And then maybe just touching on the Guangdong Province. I think you've mentioned in the past there's over 20 units there and you highlighted that it's definitely a competitive bidding process. But two questions around that. Can you just talk about the alternative solutions that your competitors are proposing for those units? And then given the degree of competition and how strategic it is for Fuel Tech, is it fair to say that the initial APC margins for that business might be a little bit lower than what you would see in the US or Mexico historic?

Right now, based on our current bids, I don't expect a significant margin erosion on our current bids. But when you're in negotiations, we'll see. We tend to have -- be teamed on these bids with multiple engineer constructor, so that we're bid with two or three or four of -- four or five bidders, and to try to increase our chances of winning.

When it's like a -- the bid is for low-NOx burners and over-fire air, there are some of the original equipment suppliers, the BMW, the Austins that are in there bidding their version of burners against our version of burners. When it comes down to SNCRs, post-combustion NOx control technologies, there's less competition there. You have a little bit, but we don't see as much and we tend to be more of the bidders. So it depends on exactly what the client is trying to do.

Those are the major technologies being bid. There's a few ultras out there. But most of the major technologies being bid are in that combustion zone and in the -- and what you can do post-combustion in basically one year. You can't usually build an SCR in one year, even in China. So does that help.

That does. Thank you for the details. Appreciate it.

Your next question will come from the line of Rich Wesolowski from Sidoti.

Thanks. Good morning.

Good morning, Rich.

Hi, Rich.

It seems that of the two big reasons why your FUEL CHEM margins have remained below your plan in the high 40s, maybe even 50%, the demonstrations significantly outweigh the effect of the economy and the operating leverage. If you continue to sell new demos, how will that margin re-attain that high 40s level?

Well, one thing, part of our demonstrations here are on some extraordinarily large units. And the revenues and the -- and, likewise, the risk share, are much higher than we've ever, ever seen. So I -- hopefully we'll get more opportunities on units in this kind of range and we might see that. But I think you'll see the risk share on a quarterly kind of basis outstanding, get down more. More typical is to -- our total risk share to be around $1 million, maybe a little bit over.

The other item to consider in the business model, Rich, is, as we grow the base FUEL CHEM business and still increase the number of demonstrations, but as the base business grows, the demos will naturally have a less dilutive impact as we apply them across a larger base revenue business.

So right now you're sitting in sort of the perfect storm of FUEL CHEM revenue -- excuse me -- margin depression in that you've got average loads down, you've got a very higher, anomalously high risk share balance out there, and, quite frankly, a very strong demonstration in terms of both size and quantity of them ongoing, which bodes well for their future, but, in near term, can't have the suppressive effect. That's why we give the base business some margins to show that other than the fact that the average client revenue was down a little bit and it has a little bit of a dilutive impact because you have to cover those fixed costs, there's really nothing inherently the matter with the core business, other than the fact that we have these larger items outstanding, which we'll take those all day because of the prospective and probable future business they represent.

Okay. That makes sense. And then, secondly, as far as your Chinese APC activity, it seems centered around Guangdong and the regulations, the Asia Games, et cetera. Would you expect this is a temporary burst of demand that may dissipate after the end of next year? Or is there evidence to suggest that there's some other regulatory stick that's going to propel that business beyond that?

Good question. There is a burst, that's clear, in Guangdong, that is not evident everywhere else right now. But as we have seen in the drafts of the regulations for all of China, which will be put out before they're -- at least that's what they've told us, they're going to put them out before the 12th five year plan goes into effect at the end of next year, that'll affect everybody. And I think you're going to see a burst of activity across all of China. They can't do everything at once. So I think you're looking at when those come out, a process that's going to take five to eight to 10 years, better part of a decade to go back and retrofit those thousands of units that they have. And that'll all start when they come out with those regs next year.

Thanks.

(Operator Instructions) And your next question will come from the line of Brian Shore from Avondale Partners. Please proceed.

Thanks. Good morning, everybody. Thanks for taking my questions.

Hey, Brian.

Most of them have been answered. I guess just a follow-up, John, on the APC side. In looking at the margins, you guys provided a pretty good explanation for the softer margins in the quarter. Looking forward, and given, I think in the past, that you've mentioned that some of the business related to ACT may be a little bit lower margin than your traditional business, on the new orders you got and looking even past that, is it fair to assume that margins may be down from historical norms or should we return back to those levels?

It'll be a mixed bag, Brian, to be honest with you. On the $12.7 million award, there's a lot of construction in that. And that overall margin on that piece of work will be lower than our traditional if you look at the overall project, because we took the turnkey rap on all of that. So our overall profit margin on that will be below our normal low 40s.

The other contract that we signed, though, is in that more typical range. I'd like to have more of the 12, $12 million kind of lump contracts. But those don't come every day. Most of all of our bids that we have going forward in the US and most of them in China, are for the normal kinds of margin ranges. This 12.7 one will be depressed from that because of the amount of construction work that's in it.

Okay. Great. And then following up on one of the other questions that was touching on competition. And I wanted to I guess turn to the US market. I mean, obviously, the lack of a regulation is pressured interest in bidding activity. But for those awards that are out there to be won, I mean, are you guys seeing an increase or more aggressive competition from peers who are just trying to win the business and may be willing to live -- give a little on margin?

Brian, I think, and, John, correct me if I'm wrong on this. But I think so far this year, of all the projects we know about that we bid on, we've lost one small project this year due to competition. We're really -- we're not losing to competition because very few people offer that full scope now that we have. ACT was our principal competitor out there in this -- in the front part of this. So it's really not the competition. It's just that there hadn't been a lot of work to compete on.

Yes. Our biggest competitive hurdle right now is something that the market cannot control, and that is the continued delay around exactly what is the revised CARE ruling going to look like when it comes to those states affected and those utilities affected for NOx control. Once that clarity comes out, we've bid a lot of jobs with clients in anticipation of the ruling going one way or the other. But until they know exactly how much they have to control relative to where the new rule is, when they'll have to have it under control, and whether or not there's going to be a cap-and-trade system, all three of those will dictate their NOx control deployment strategies. And until they know or have a very good feeling of which way all those are going to impact them, it would be irresponsible for them to issue orders against that. That's why we're watching so closely the timing of the revised CARE ruling scheduled now for publishing first part of 2010.

The other part of that, people will go forward with the stuff they know they have to do.

Right.

They're going to do the low-NOx burners, over-fire air, and some of them will do SNCRs. They know they're going to have to go there and they can't -- they've got to smooth out their capital. It's really on the -- on trying to sell cascades and any of the big projects that are really taking a hit right now.

I don't know whether you saw that Senator Carper put in to the Kerry-Boxer CO2 tax bill, a provision that really would fix CARE now. And it divides the country into two zones, zone one and zone two, and has different levels. It does allow cap and trade within the zone which would be helpful. It does not use a heat input level for the -- for getting like pounds of NOx per million BTU. That twist would hurt coal plants typically, and would cause them to have to put on more controls than otherwise.

So it remains to be seen whether that'll pass. Absent legislation, the EPA's going to have to come out, as John said, with a rule, and their rule won't be able to have cap and trade, per the court. So either way stronger regulations are coming, it's just a matter of when.

And I think in that explanation, I think you actually answered a couple more of my questions, John, just about, I guess what a -- what potential legislation could look like or I guess what you're expecting it to look like and whether you're keeping in touch with customers in advance of the -- in advance of any legislation and/or an EPA rule. So I think you touched on both of those. So thanks a bunch, guys.

Thanks, Brian.

We are heavily engaged in following that process, as you might well imagine.

And there are no further questions in the queue. I would now like to turn the call back over to Mr. John Norris for closing comments.

Well, thank you very much for your interest and for your questions. We look forward to better performance going forward, hopefully, especially in 2010. Take care. Bye-bye.

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