Fuel Tech Inc (FTEK) 2010 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the first quarter 2010 Fuel Tech Inc. earnings conference call. My name is Jasmine and I will be your operator for today. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. At this time I would like to turn the conference over to your host for today, Miss Tracy Krumme, Vice President, Investor Relations and Corporate Communications. Please proceed.

Thank you. Good morning, everyone, and thank you for participating on today's conference call to discuss our first quarter results. Joining me on the call this morning is Doug Bailey, Chairman and Interim President and Chief Executive Officer and Ellen Albrecht, Controller and acting Treasurer and 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, this conference call is being broadcast over the Internet and can be accessed at our Web site, www.ftek.com. With that said I would now like to turn the call over to Doug Bailey. Doug, please go ahead.

Thanks, Tracy, and good morning to everyone. We appreciate all of you joining us on this call. I realize I may have met only a few of you. So if I may, I would like to first briefly introduce myself. I have been associated with Fuel Tech for 12 years, commencing with the investment made in the company in 1998 by those of us affiliated with American Bailey Corporation. Over those 12 years I've continuously served as a director and thus have come to know the company quite well from that perspective. In January 2004 I was named Deputy Chairman of the Board and subsequently succeeded to the position of Chairman on January 1 of this year.

Approximately five weeks ago, I was subsequently appointed to the additional positions of Interim President and Chief Executive Officer at the time that the retirement of John Norris was announced. While we have commenced the search for my successor, I have dedicated my attention to carrying out all the duties of the President and CEO and will continue to do so, until that search is fully completed.

With me is Ellen Albrecht, our Controller and acting Treasurer and Chief Financial Officer, who similarly is carrying out the full duties of the CFO position on an interim basis. We are currently in the later stage of our search for a new CFO and we expect to successfully complete that search in due course. While I will provide you with an overview of our financial operating results, in a few minutes Ellen will discuss those results and our financial position in greater detail.

Our financial results for the first quarter included total revenues of $17.6 million, up 2% from the comparable prior year period. Net income for the quarter was $0.2 million or $0.01 per diluted share, which compares to a net loss of $1.6 million, or $0.06 a share in the same quarter a year ago. Our balance sheet remains exceptionally strong with cash and cash equivalents of $21.4 million and debt of only $2.9 million. At current revenue levels our business model generates positive cash flow that can be expected to increase measurably with top line growth. Let's begin by taking a closer look at the business behind these overall numbers.

As most of you know, Fuel Tech is a fully integrated company that uses an extensive suite of technologies to provide boiler optimization and efficiency improvements along with air pollution reduction and control solutions to utility and industrial customers worldwide. For reporting purposes, we broadly group those technologies into two principal business segments. One is a return on investment driven specialty chemical business for efficiency improvements that we call FUEL CHEM. The second is a regulatory-driven business for air pollution control, or APC, that consists of capital projects. So beginning with our FUEL CHEM business, segment revenues were $9.4 million for the quarter up 11% from the first quarter of 2009. Gross margins were 55% for the quarter, up from 41% in the same quarter last year.

This was primarily due to the one-time recognition of the $2 million risk share payment from a successful demonstration project at a domestic electric utility on one of the largest coal-fired boilers in the United States. However, excluding that risk share payment, gross margins for the FUEL CHEM segment would have been 43%. In 2009, the downturn in the US economy did have a significant impact on energy demand, and this situation continues today. In particular, electricity demand fell almost 4% last year while coal consumption and power generating stations declined over 10% marking the greatest annual decline in electricity generation since 1938.

This drop in demand has resulted in a dampening of electric generating loads, causing certain units to be run at reduced power levels or even shut down for periods of time. This has impacted the FUEL CHEM segment as certain clients scaled back or temporarily suspended chemical injection on units that utilize FUEL CHEM programs. To illustrate the significance of this impact, while we entered the quarter with FUEL CHEM systems in place on 40 coal-fired units and 51 units of fire other fuels, less than one half of those 40 coal-fired systems operated their FUEL CHEM systems in the first quarter.

Our realized growth rate was therefore moderated by these curtailments that resulted from reduced electrical demand. Realized gross margins, excluding the risk share, were limited by programs operating at partial loads and by contracted increases in our chemical and transportation costs. With electrical loads down significantly due to the economic environment, many of our customer units operated at reduced power levels or shut down for periods of time. When our customers operate at partial power levels, they experience significant reductions in slag-related problems and have reduced their need for FUEL CHEM programs. Thus, our revenues per unit are dramatically lower in many cases.

Additionally, our employees who operate and maintain equipment and provide on-site services remain part of our team and those salaries are generally the same regardless of load levels. Thus far this year, we announced the receipt of two commercial FUEL CHEM orders from an existing domestic electric utility customer. Our proprietary TIFI, or Targeted In-Furnace Injection technology, will be installed on a medium and large coal-fired boiler experiencing slagging problems associated with burning high sodium Powder River Basin coals. These were not the first FUEL CHEM orders from this valued client and we are pleased that it was able to proceed straight to commercial status without the need for a demonstration. We look forward to working closely with this customer and will explore opportunities of additional business on its extensive coal-fired fleet.

Worldwide demand for US Appalachian Coals, generally one of the fuels with the highest heat content and fewest operational issues, has again started to grow, which tightened availability while increasing prices relative to other fuels. This is therefore expected to create additional demand for Illinois Basin and Powder River Basin coals, fuels that can benefit from TIFI technology, given the slagging and fouling challenges caused by high levels of sodium found in PRB coals and iron and sulfur that are found in Illinois Basin coals. This ongoing shift in fuel preference should enable Fuel Tech to market its programs on an expanded basis of ILB and PRB coal users.

Turning to our air pollution control segment, we generated revenues of $8.2 million in the first quarter, down 7% from the comparable 2009 quarter. This decrease in APC revenues was the result of a slowdown of capital project orders for pollution control equipment from our customer base, primarily as a consequence of regulatory uncertainties and constrained capital spending. Gross margins were 36% in the quarter, up from 28% a year ago, and the margin increase reflects a sales mix with a higher percentage of equipment supply projects and a lower percentage of those large projects that involve additional installation services that typically have lower margins.

Our United States APC backlog for the quarter was $21 million, down slightly from the $22 million at the end of 2009. During the first quarter, we announced $4.6 million in new domestic APC contract awards. But this relatively low level of activity reflects the impact of deferred APC outlays by both electric utilities as well as industrial customers. Of most importance here is the state of the domestic market for NOx control specifically and pollution control in general. With lower electricity demand, emission levels at power plants are reduced.

With lower profits and cash flows, these utilities and industrials are less inclined to spend money on pollution controls, especially when the regulations with which they must comply are in a state of uncertainty. According to the White House Office of Management and Budget, the EPA submitted the revised Clean Air Interstate Rule, or CAIR, for review just within the last two weeks. States, industry and environmental groups might expect to see that proposed rule announced by midyear 2010. So while the details of what the EPA will propose are not yet publicly known, in order to comply with the court directives, the revised CAIR rule will likely allow significantly less trading of NOx allowances compared to the existing CAIR rule that is still currently in effect.

There's also a bill sponsored by Senators Carper and Alexander, I refer to that as the Carper/Alexander Bill, which would be a legislative fix and put to rest the questions of whether the EPA's current or revised CAIR rule properly addresses all of the legal requirements to comply with the existing Clean Air Act. This bill addresses NOx and SOx emissions on a national level with two separate trading zones and a cap on mercury emission with no trading through amendments to the Clean Air Act. If enacted, it would greatly clarify the rules within which emitters must operate and would allow facility owners to make more informed capital deployment decisions to reduce emissions.

The issuance of the new CAIR rule or the proposed Carper/Alexander Bill, either alone or in combination, should provide much-needed regulatory clarity, not to mention expected tighter NOx controls and compliance time lines which would greatly benefit Fuel Tech.

Right now, our customers are largely in the dark about what the rules will be and that generally lead to a wait and see approach. Thus the market is temporarily quite depressed and I see that continuing at least through the current second quarter of 2010.

While we cannot easily grow our market when such business conditions exist, what we can do is to position our company to achieve greater success when that market does re-emerge and that is precisely what we have done and are doing. We now have the most complete suite of NOx control technologies of any company we know, and we will use that suite to build competitive advantage. From the first step a customer takes to control NOx, Fuel Tech now offers a client one-stop shopping for its control needs. This includes systems such as low and ultra low NOx burners, along with over fire air systems that are designed to limit the initial creation of NOx in the combustion process.

We also offer an advanced selective catalytic reduction or ASCR system designed to reduce created NOx at a capital cost comparatively lower than other solutions. This capability is being recognized by customers in the US and abroad as evidenced by the alliance agreement with a major utility that we just announced in the current first quarter. This customer knows that we'll enjoy state-of-the-art NOx control at competitive costs at each and every unit. We've had alliance agreements with other utilities in the past and those agreements have worked well for both parties.

We anticipate that the next major installation opportunities for APC capital equipment will occur in the fall of this year and the spring of 2011 with equipment orders required four to six months prior to installation. Therefore, we expect to receive a few orders over the next two months and then a stronger order flow in the third and fourth quarters of this year. Orders for our ASCR or CASCADE systems require longer lead time to secure, so they will be less seasonal in their award timeline.

While utilities and industrials are uncertain as to what the ultimate rules will be, a number of them are beginning to deploy the first systems that they know they will need under any likely regulatory framework. Therefore, we expect to see a few other domestic project awards in the coming months, even before the rules are clarified. However, we do not expect to see the domestic NOx control market re-emerge in a significant way until after utilities, industrials have seen the proposed new regulations or change in law which should occur later this year.

Turning to the China market, we have seen the level of activity increase as five APC projects were announced since December 30, 2009. The most recent award was for our first low NOx burner and over fire air project in China as well as our third NOx control order and seventh unit award in Guangzhou City where the Asian games are scheduled to commence in November 2010. This province has supported Fuel Tech's NOx control opportunities as new environmental regulations were issued in preparation for these games, calling for the installation of systems to reduce NOx by as much as 80% by September 30, 2010.

While the pace is picking up in China for NOx control, this market will not emerge in a major way until the country is into its 12th, five-year plan which begins on January 1 of next year. The Chinese ministry of environmental protection, NOx control technology policy directive sets the framework for this five-year plan. And later this year, we expect to see specific regulations set forth at the level of the provinces which will implement that national policy.

It is of note that Fuel Tech's current suite of solution fits very nicely into the specific NOx control technologies called out in this policy for various plant situations that are based on size, age and coal consumed. So much work has gone into positioning Fuel Tech for this very important market and we expect to be quite successful in China over the next decade.

Now I would like to turn the call over to our Controller and acting Treasurer and Chief Financial Officer, Ellen Albrecht, to discuss in greater detail our financial results. Ellen.

Thank you, Doug. Good morning everyone. As Doug mentioned consolidated quarterly revenues for the quarter were $17.6 million, a 2% increase from the $17.3 million reported in the first quarter of 2009. This increase is due to favorable results from the FUEL CHEM side of the business which will be discussed in detail shortly. Net income for the quarter was $0.2 million or $0.01 per diluted share compared with a net loss of $1.6 million or a negative $0.06 per diluted share in the same quarter of 2009. Now let's talk in more depth about each of our business segments.

First quarter FUEL CHEM segment revenues were $9.4 million. The number is comprised of $8.7 million from coal units, an 18% increase versus the coal unit revenue reported in the first quarter of 2009 which totaled $7.4 million. This 18% increase is attributed to the recognition of a risk share payment, a successful demonstration program at a very large utility customer. For those of you who are not familiar with our risk share programs, these programs are applied on demonstrations in which the customer will receive a discounted price for the initial program with a contingent amount due at completion if the criteria for success are met. At the completion of the demonstration, the results will be evaluated against the program objectives and if successful the outstanding program discount will be paid in full.

If the success criteria are not met, the customer is not obligated to pay this contingent portion. The utility demonstration program previously mentioned included a 90-day trial at the customer's site in the second half of 2009, at which time the discounted program rate was charged. However, the contingent amount referred to as the risk share revenue was not recognized or received until the first quarter of 2010. Without this one-time risk share payment, overall coal revenues would be down almost 9% as several utilities have extended outages and temporarily discontinued use of their FUEL CHEM program. As of March 31, 2010, the Company did not have any contingent risk share payments outstanding.

Quarterly revenues from non-coal fired units of $0.7 million were down 37% versus the prior year quarter, primarily due to decreased usage on oil-fired units as a result of favorable natural gas prices. Overall FUEL CHEM segment revenues increased 11% versus the first quarter of 2009. Again, excluding the risk share payment I discussed earlier, overall segment revenues would have been down 12%. Despite the current economic environment we continue to have good market penetration for the FUEL CHEM segment. We have announced two new commercial FUEL CHEM programs thus far in 2010. It was especially encouraging that these programs did not require demonstration programs as they were additions to an existing customer's fleet and as a result went straight to commercial operation.

International FUEL CHEM demonstrations are ongoing despite current delays at customer sites. These delays are of customer origin and we remain ready to restart upon notification. Quarterly gross margins for the FUEL CHEM segment increased to 55% in the current quarter from 41% for the same period in 2009. The aforementioned risk share payment positively contributed 12% to the gross margins for the FUEL CHEM segment. Excluding the impact of the risk share payment, gross margin would have been 43% for the quarter.

Although this is still a 2% increase over the prior year comparable period, the decline in year-over-year base business revenue, coupled with fixed program expense at the customer sites not currently using the program, may adversely affect the overall margins. Gross margin percentage is down slightly from historical levels primarily due to the dilutive impact of fixed operating costs, such as personnel and depreciation that are still incurred at customer sites experiencing reduced chemical demand. This is not indicative of any other negative underlying trend. 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 quickly if possible on the receipt of new contracts.

Now let's move to the air pollution control segment. First quarter 2010 revenues for the air pollution control, or APC segment, were $8.2 million, a decrease of 7% from the first quarter last year which saw APC revenues of $8.8 million. Our APC backlog at the end of 2009 was $22 million, and we have announced $4.6 million of APC orders during the first quarter of 2010. Included in this amount are three awards from China as interest abroad remains steady. Backlog at the end of the quarter was $21 million, and is comprised of $14 million domestically, $6 million in China and $1 million in other countries.

While the current revenue recognition in this segment is depressed, there are signs of recovery. The majority of this backlog will be recognized in the current year. Additionally, we expect more announcements this quarter and a stronger level of awards in the latter half of the year. Quarterly segment gross margins were 36% compared with 28.4% a year ago. The margin increase for the period is attributed to a shift in overall project mix with increasing margins from our ancillary product line. Although historical levels have trended higher, gross margins for our core products, excluding the effects of installation work, remain strong.

On a consolidated basis, company gross margin percentages for the first quarter of 2010 were 46.1%, an increase of 34.3% reported in the first quarter of 2009. Excluding the impacts of the risk share revenue previously discussed, quarterly consolidated gross margins would have been 39.3%. The reasons for this have been previously discussed. Quarterly SG&A expenses, exclusive of R&D expenditures, were $7.5 million, a decrease of $0.8 million or 9% versus the first quarter of 2009. Of this decrease, $500,000 is due to the SG&A costs associated with the reduction and restructuring of the workforce that became effective in the latter half of 2009.

Also contributing to this decrease was a reduction in outside services of $434,000, some of which can be attributed to the acquisition of substantially all of the assets of Advanced Combustion Technology in January of 2009. Partially offsetting these amounts was an increase in expenses of $269,000 related to our China office, as overall business activity has increased significantly as evidenced by the multiple recently announced awards.

The Company has taken the prudent and responsible actions of curbing personnel costs and reducing near-term discretionary spending while still making the strategic investments required to grow our business globally. Even after considering these steps and other cost-saving measures taken, our financial and administrative infrastructure is capable of handling global revenue growth of an additional $40 million to $70 million with minimal additional investment. Due to this ability to leverage the fixed and semi-variable costs in SG&A, we feel a long-term SG&A expense as a percentage of revenues run rate of less than 20% of revenues is achievable.

Quarterly research and development expenses were $146,000 and were focused on developing and testing technologies with near-term market applications in both boiler optimization and air pollution control arenas. This amount is at the same level as the prior year comparable period. As always, we continue to watch the domestic and international regulatory landscape to ensure Fuel Tech is continually properly positioned to meet the emission control needs of our customers.

For emissions like mercury and CO2 we continue to evaluate various technologies to identify ones we feel are commercially viable. First quarter 2010 generated operating income of $491,000, compared to a $2.5 million operating loss reported in the prior year quarter. The risk share revenue recognition and shifting project mix, coupled with the reduction in overall expenses, were the primary drivers. We expect near-term operating results to be tempered due to the timing of revenue recognition on existing projects for the APC segment and to aforementioned reduced utilization of the FUEL CHEM program at multiple customer sites.

As we look to the rest of the year, we do however, expect stronger third and fourth quarter operating results as the current bid activity converts to contracts, especially in the APC segment. The increase in quarterly interest expense versus first quarter 2009 is due to increased borrowing on our China facility needed to support expanded operations. The change in other income and expense is driven by Foreign Exchange translation movements.

Due to the mix of forecasted domestic and international revenue and income levels presumed for the full year 2010, we have set the full year 2010 tax provision rates at 40% and we'll adjust quarterly as necessary. Net income for the quarter was $214,000 or $0.01 per diluted share. The effect of FAS 123R on after-tax net income was $887,000 or $0.04 per diluted share. Cash has increased to $21.4 million and other than our $2.9 million in debt in China, related to the start-up of the Beijing Fuel Tech office, we have no debt on our balance sheet.

A portion of this debt was paid back in early second quarter. Working capital at quarter end was a strong $32.4 million, and we have not seen any deterioration in payment patterns from our customers either domestically or abroad on APC or FUEL CHEM in the wake of the global financial situation. Quarterly operating cash flows totaled $685,000, cash used in investing activities of $182,000 was primary due to the purchase of equipment for FUEL CHEM demonstration or commercial programs.

Fuel Tech's domestic and international market interest and sales activity continues at a strong pace, especially in our APC business segment. While we are encouraged about our business prospects for 2010 and we believe we will win substantial new contracts this year, the timing of those awards during the year remains uncertain. Thus, we do not believe it prudent to provide any additional quantitative revenue or earnings guidance at this time.

Now I'd like to turn the call back to Doug.

Thank you, Ellen, for that analysis and full report. What I'd like to do now, Operator, is immediately open the line for questions. And so I turn it over to you. Thank you.

(Operator Instructions). Your first question comes from the line of John Quealy of Canaccord.

Good morning. A couple of questions. First, on the APC backlog, if I understood Ellen's comments, looks like to be recognized in the P&L, Q3, Q4 time frame. Can you talk about what other factors that vary it between Q3 and Q4? Is it summertime construction? Is it use it or lose it spending? Is it regulatory, CAIR related visibility? How should we think about the relative mix Q3, Q4 for that types of business?

Relating to the current backlog that we have and the timing of the revenue recognition on that, the revenue is recognized as costs are incurred. And for projects that will be installed and started up in the latter half of the year, we expect to see the majority of the project costs incurred in the third and fourth quarter, which will generate the offsetting revenue. On the domestic end, of the $14 million, $10 million is attributed to one large project that has a fall outage installation. So that project the majority of which will finish up in Q4.

Okay. That's very helpful. Going to fuel treatment again just for the numbers for a minute, if I understand it correctly, of the $11 million, about $2 million was that sort of one-time commissioning. If you strip that out, business was down a little bit. Or excuse me, down to $7 million from $9 million. Business was down about 10%, 11%, whatever the math was. Is that a decent rate looking into the Q2 period? And then I'm interested in a follow-up on the new customer there.

Yes. We reported segment revenues for FUEL CHEM at $9.4 million, but as we pointed out, $2 million of that was recognition of a risk share payment. So if you were to exclude that, that's $7.4 million. I think I noted that one of the most notable business environment situations is the reduced electrical load demands, and that clearly has affected how many of those units have chosen to operate or not operate the FUEL CHEM systems that are in place. So fewer than half of the systems on coal-fired units actually ran in the first quarter.

The negative of that, of course, is that we realized less revenue in that current quarter. The positive of that is that we have those systems in place, and if they were to switch to more slagging fuels or increased their load demands where slagging increases, those can be turned on immediately, and therefore the contribution from those increased revenues will benefit the company in a significant way. (Overlapping Speakers). Of underutilized capacity already in place and sold. But we must continuously resell what we provide to them to gear our solutions to their current immediate needs is the way they operate those units.

And Doug, I'm interested on the PRB-related boiler, yesterday or the day before, whenever it was, so that still suggests that folks are seeking out the solution in coal mix as an issue. Can you talk about the sales cycle for this particular boiler? How long have you known it? How have you sold it? Is it a coal purchase that caused them to go ahead, given all those things you said about the headwind? They still went ahead and ordered it? What were the factors there?

This specifically was a very long sales cycle. If you're talking about the very large unit that we realized, this involved a long demonstration program, competitive solutions were tested, our system met all the requirements. But the sales cycle is indeed quite long.

And then lastly, Doug, for you, on the executive recruiting, can you give us an update or relative expectations we should be looking for? Thanks.

Sure. As I mentioned, it's my belief that we are in the later stage on the Chief Financial Officer search. That search had been underway for some time. There was a little bit of a stand-by period as our transition in my position occurred. But we have continued that. And we believe that we'll have that position filled relatively soon.

On the other hand, it was only five weeks ago that I assumed my duties here. We have commenced that search. It typically takes a few months, could be three to four months to find the right individual. That could be sooner, could be longer. But I would suggest that, I think, the search processes for Chief Executive Officers and similar C-level positions are well understood to take that amount of time. So I imagine over the summer time frame, we will identify candidates whom we feel meet our position requirements, narrow that down, and expect to have that position filled hopefully sometime well into the third quarter.

Great. Thank you.

Your next question comes from the line of Graham Mattison with Lazard Capital Markets. Please proceed.

Hi. Good morning, everyone.

Good morning.

I wonder if you could touch on some of the opportunities you're seeing beyond China or outside of the US, in some of the other markets where you've had some traction and the potential for contribution to those later in 2010 and 2011.

Well, let me mentioned Europe. We've identified a number of opportunities, specifically opportunities in countries such as Poland and the UK. We are in the final stages of a large program that we expect to announce soon that will be a significant-sized project in Europe. Europe actually had its best year, last year. Ellen can provide the numbers, if you'd like to hear those. And so, while certain markets many years ago closed for Fuel Tech such as, for example, Germany, which went all SCR several years ago, we turned our attention to municipal solid waste plants and opportunities in other countries. So we do see sustained business opportunity and growth in Europe.

We've also turned our attention to countries such as Chile. We continue to develop our FUEL CHEM program in Mexico. We're realizing revenues there. Certainly the political process, the selling process varies country to country. This is a business with a long sales cycle no matter where you operate. And when you add local country environmental politics to layer on that, it simply can just take longer, shorter, depending on where you are selling.

Though we have presence well established in Europe, we are now selling into South America, and we intend to operate our business globally. There are certain countries that we've also entered, like India. But we may find that focusing our attention in one part of the world versus another part of the world might give us more immediate benefit. So while we'll continue to look at those opportunities, if they are too slow in coming we will shift our attention to where we can find business that fits our need.

Great. And then you spoke about that you guys are evaluating some acquisitions. Is this something that we might be able to see this year, or is that probably more of a 2011 after the new CEO is in place?

Well, you saw us do two of them with Advanced Combustion Technology and Tackticks, FlowTack. I can assure you that we are combing the landscape for more opportunities than we actually consummate. We've mentioned in the past that we are interested in the mercury control market. We've looked at a number of opportunities. We do our due diligence, we evaluate against important criteria, whether those will benefit the company and its shareholders. And so in some cases we turn them down. That was certainly the case with one pursuit in the mercury arena last year. Therefore, we will not go public with what we were looking at there.

But we believe that both internal development as well as external acquisition can afford the company growth opportunities. I think we did successfully round out our suite of technologies on the APC side, and what we are doing on the FUEL CHEM side is developing additional products that provide more specifically tailored solutions or more advanced performance from the systems that can be installed. Given our specific knowledge of the chemistry of the FUEL CHEM and TIFI program, I believe we are well-suited for research and development that will bring more of those products to market. So you'll see those products come about. Some have been announced and some are in later stages of development.

Personally, I believe that the success of this Company has been built on the foundation of solid research and development. We have a group of employees here, including many Ph.D.s and very experienced engineers, who have built the company's core technologies to be able to do what we are doing today, and I believe that our future does depend upon continued commitment in the development of advanced technologies. So while the current financial environment has caused us to curtail some of our spending in a prudent way on those, I've been seeing good ideas come to my desk, have approved some of those ideas for additional research and development. And we intend to continue to look for ways that we can increase our competitive advantage through internal development of what we do best and be able to enjoy the benefits of having those products and processes in the years ahead.

All right. Great. Very helpful. Thank you for the details. I'll jump back in queue.

Thank you. Next question?

Your next question comes from the line of Jeremy Sussman with Brean Murray and Company. Please proceed.

Hi. Good morning, everyone.

Good morning.

You mentioned in your opening remarks that the EPA had submitted a revised CAIR to the White House a couple of weeks ago. Any sort of sense of sort of what may be in there? Or if not, sort of -- I know you think we'll get something published in mid-2010, but ultimately sort of a timeline of how this is all going to play out?

Sure. I think I can answer your question in sufficient detail, although I'm not the regulatory expert and we have not seen the actual proposal. But what we do expect is that the EPA is going to take a dual approach to cap-and-trade. The fundamental issue is what will be decided on cap-and-trade. And what we expect that the EPA would set very few restrictions on intrastate trading, but impose significant restrictions on interstate trading. And therefore, if you're a unit operator in a large producing state, such as a Pennsylvania or an Ohio and that's where you operate only, you may very well have intrastate trading opportunities by buying NOx control allowances, or selling them, that would allow you to maybe do more limited investment on your own units. However, if you operate in a state where there are few other utilities, you're the principal operator, you will probably have to invest in command and control solutions that will heavily restrict on a timeline that will be increasingly more stringent on NOx control.

So either way, we think Fuel Tech will benefit, but what's needed is clarity in the regulations. The reason our customers are postponing those capital investments are primarily related to the lack of clear regulations. It's probably going to be a couple months before we publicly see what those are. But whether it's the revised CAIR, as promulgated by the EPA, or a legislative amendment such as Carper/Alexander, clarity is what we need the most. And either alone or both in combination should benefit our company. But the biggest question is what will be enacted relative to cap-and-trade.

Thank you.

That was the reason why CAIR was vacated, because there was objection that the cap-and-trade approach that was in place was not the right approach to solving the needs of the country.

Thank you very much. That was great color. Thanks.

Okay.

Your next question comes from the line of Aaron Husock with Lanexa Global. Please proceed.

Great. Thanks for taking my questions. On kind of China APC, specifically as it relates to the regulations that are now in place in Guangdong province, it seems like the prior management team had been expecting this to be a much larger opportunity. They'd talked about it being a $50 million APC market this year and that Fuel Tech might have a chance to get around half of that. But the bookings from Guangdong, year to date, have been relatively small. And it seems like we're now kind of at the end of when everyone has to have placed their orders to get things installed by September, as the regulations state. Can you just kind of talk about what changed in Guangdong versus the original expectations, kind of more competitors, more aggressive, was system pricing lower? Kind of why has this turned out to be a smaller market?

Well, I got my first keener understanding when I went to Beijing myself back in March. In fact, I'd asked one of our other directors to join me and therefore as a board member, I got to meet every member of our employee team in Beijing, visit with some of the government officials at different levels, and better understand the regulatory environment. What I walked away with was the clear understanding that it is this 12th five-year plan that will really drive fundamental growth.

That being said, we have had success in sales. We've sold different types of systems, ULTRA, our first low NOx burner system. Recall that our acquisition of ACT and what we've been doing in the area of combustion modification solutions closer to the burner level. One of the reasons we did that was to meet what we anticipated the needs of the China market would be early on. So a lot of the growth we think will come from those type solutions.

We have everything all the way to advanced SCR. And of course, we are going to be marketing -- continuing to market our FUEL CHEM systems. But the China market is primarily going to be an APC market near-term as opposed to FUEL CHEM. And it will also be one that is more devoted to burner modification approaches is our belief. That being said, we've recently complemented our solutions to have that offering and expect to market the full suite. But it's still a developing market that, I would say, while large in size is complex and requires having an infrastructure and a development process in place. So we've invested in that. We have a fine organization over there. We've re-evaluated our selling approaches. And as I said earlier, I believe that while we'll continue to penetrate the market moderately in 2010, realistically, I expect to see the growth occur after January 1 for regulatory reasons.

Okay, great. Maybe you could help us sort through some of the puts and takes in FUEL CHEM as we look at the June quarter. I guess it's my impression that it's a seasonally stronger quarter typically in FUEL CHEM, but at the same time you'll have that risk share going away. Is it your current kind of rough estimate that FUEL CHEM sales will be down in the June quarter compared to the March quarter?

Ellen I think would like to answer that question for you.

Well, historically Q3 is the biggest quarter for FUEL CHEM sales. We expect sales in Q2 to remain at a flat level compared to base business revenue for Q1.

Okay. Okay. So stripping out the $2 million we should think of it as flat?

Yes. [Overlapping Speakers].

Because we know what units are running and what are not. So realistically, we don't expect to see an immediate change in those operational levels.

Okay. Great. Thank you.

Your next question comes from the line of Scott Reynolds with Thomas Weisel. Please proceed.

Thanks for taking my question. All right. So of that $10 million that's supposed to be booked in the third quarter, I just wanted to confirm, that was part of the $12.7 million order for the over air fire and low NOx burners in the US, right?

Correct.

Correct.

Okay. So I'm just trying to get an idea of the mix on margins for those as I understand those are a bit lower margins than the historic low to mid margins of the segment. Is that true?

That is true.

Okay. So we should probably expect margins a little bit south of 40% on those then, right?

Yes. That is correct. (Overlapping Speakers). Certainly contributing and strategically reflect the positioning that the Company has taken in that product area.

And that project, the majority of the revenue will be recognized in the third and fourth quarters.

Okay. Excellent. And then just so we're all on the same page, we should probably expect a sequential down tick in APC revenue in the second quarter, correct?

Based on current activity and the contribution from our ancillary product line, we don't expect a significant downturn.

Okay. Okay. That's good. And then on SG&A, typically the second quarter is the high point for SG&A due to some stock comp expenses. Is that expected again this year?

I think the answer is yes.

Okay.

Ellen you would like to add some color?

No, that's primarily due to stock compensation expense related to directors' grants.

Okay. Very good. That's all I have. Thank you.

Your next question comes from the line of Steven Charest with Divine Capital. Please proceed.

Steven?

Yes, hi, can you hear me?

We can hear you. Go ahead with your question, please.

Two questions for you briefly. The first if you could qualify, with a little bit more detail some of the RFP activity going on with customers. You had briefly mentioned that a lot of customers are interested in deploying, at least initially, the minimum equipment they believe would be required when a new rule finally comes out. Is that something that would be more of the upstream products like over fired air, or is it a mix? And then the second question, competition, Nalco's acquisition of Mobotec, even in these depressed conditions, how much of a game changer is that for you?

With respect to your first question, larger customers, for example, that are operating multiple units, they can't do everything at once. And so they have the ability to choose those solutions that move them directionally where they fully anticipate regulations to go. I mean, we know that NOx emissions are only going to get tighter. For example, it's expected that the bill before Congress could mandate emissions of NOx be reduced from about 3 million tons in 2008 to 1.6 million tons in 2015. That's a 53% reduction. While the step-wise reduction may be so much in 2012, so much in 2013 and so forth, spending your capital prudently calls for choosing among alternative approaches that gets you there on the most efficient basis.

So one of the advantages Fuel Tech has, it has a range of offerings from NOxOUT SNCR that we've traditionally sold, now the low NOx burner offerings. Importantly, advanced SCR that on a capital basis is quite a bit more competitive with the traditional SCR solutions. So we're selling on all fronts. We're going to be customer-driven. What we think and what they think best serves their needs both immediately and long-term, which is quite honestly a multi-year proposition for them, we'll implement. Where we've announced an alliance agreement, for example, is a great way to orderly deploy those investments in a way that they know they're going to get good pricing, good cost, and good performance.

You asked about Nalco Mobotec, and while we won't specifically comment on the strengths and weaknesses of our competition, we believe that we are successfully selling against competition on many fronts. We've seen them enter the China market. We will continue to go up against them and what you will see is what our record is and what their record is. And I'd like to think that we will continue to focus on having advantages, not against any one particular competitor, but any who choose to enter the field.

We base that on the cost, the design of the systems that we currently sell as well as our long-term commitment to development of better products, better processes that will keep us competitive. Add to our intellectual property strengths and stay competitive on that basis as well.

So we probably have seen increasing competition in the APC segment where certain patents have expired and smaller companies have entered. Acquiring ACT was one way to take one of those competitors out. FUEL CHEM, we have a very significant intellectual property position. We are enforcing, by way of notice, those who might chose to intentionally infringe on that position, and we think that's the right responsible approach to take. But every time a market grows in size it attracts new competitors. There's no way you can have a market all to yourself. So as your market grows, to benefit yourself it will just naturally attract new competitors. It's my job, it's our job, to position the company to compete effectively against those, not just here in the US but in any market we choose to enter.

Okay. Thank you.

You bet.

Your last question comes from Dan Mannes with Avondale. Please proceed.

Thanks. Good morning.

Good morning.

Follow-up question on FUEL CHEM. I guess I was a little surprised with the first quarter results. Looking at overall trends in coal-fired generation, they were actually up dramatically -- not dramatically but they were actually up year over year in the first quarter given the weather. Was there sort of a behavioral change? You'd think with higher output year over year, you'd think the plants that have the systems would use more year over year. Was there a change at some point in '09 or in the first quarter where there was a decision made to shut down these units even though they were running a little bit harder?

That's a good question. One of the things you have to remember is when loads change, what's your inventory position in coal. So for example, if you have a large stockpile of a high-grade coal, you're going to work through that inventory before you switch. We've also seen, as you know in the last year with low natural gas prices, coal-fired units switch to natural gas. So in the pecking order it may very well be that natural gas over coal, over oil, is the choice of fuels.

Prices of coals in the different producing regions of the country dictate medium to longer-term switching. Coal is bought under contract. Therefore you may have some commitments that are out there for an extended period of time. So think of it as a long wave market response and not something that you can see occur within any one quarter. As I mentioned, as prices of central Appalachian coals rise, that might therefore cause a customer to reconsider an Illinois Basin coal or a PRB coal.

But overall, coal consumption did decrease because of reduced electrical demand and some switching to natural gas. And we're going to see a slow wave of recovery and growth in the coal. I'm a fundamental believer in the coal markets long-term. We've been associated with that industry, in my family all our lives. And so we understand the cycle dynamics and we've seen cycles rise and fall. But having the solutions that we have here at Fuel Tech to efficiently burn coals of a variety of qualities will still offer our customers the lowest-cost way to generate electricity and meet the emissions requirements of this country on a long-term basis. And we think long-term.

But I mean, is any part of this given that loads, that generation loads were so weak for most of 2009 at some point they made the decision to ramp down FUEL CHEM usage and maybe it's going to take time for them to make the decision to turn it back on? Even though load demand picked up a little bit in the first quarter, it may take sort of a sustained load demand to make that shift?

That's right. And in the past we've reported a number of units that we've sold and we're on. And that's a number approaching 100. But you know, even though we're on over 50 oil-fired units, they contribute a small percentage of our revenue stream because they simply have moved away from oil, but they bought FUEL CHEM because it solved the problem that they had.

Our attention should be focused on the coal-fired units. And as I pointed out, while many of those systems are in place, due to load demand or reduced power generation levels that simply mitigates the slagging problem, they don't need to pump continuously. I would look for a slow but steady recovery in our overall economy. I think we all know that we've gone through one of the greatest economic downturns in decades. And certainly this has affected our customers. And any realistic business person knows that that customer is facing decisions just as we are in operating our business as to how to prudently manage its cash, how to prudently operate its capacity. And so it's an unfortunate circumstances, but many of our FUEL CHEM systems are sitting there fully installed, ready to pump, but not running.

Got it. And then just one last question on the executive search. I mean, you guys started the search for a CFO when John Graham left. I mean, how much of a change did things happen when John Norris decided to retire, i.e., do you sort of have to change priorities pretty quickly? My impression is that it's difficult to hire a CFO when they don't know who their boss is, I guess is what I'm saying?

Good question. First of all, there was only a brief suspension of the search process, simply when there was the change of command, let's say. But that process was well underway. And at the time I was appointed Interim President and CEO, we were down to the finalist stage. As I came onboard, I could also see candidate opportunities and can add those to the mix to where I feel that I'm just going to stay over the course of the next few weeks. I believe we're going to find our individual and have that position filled.

On the CFO side?

On the CFO side. That being said, we haven't lost any ground. We've got a fine individual here in Ellen Albrecht. I've known her for 12 years now and she's been with the company 14 years. This is one hard-working individual, who knows everything about this Company. We have lost no momentum in operating the finance and accounting function.

Could she use a little help? Absolutely. And she's going to get it. Help is on the way. But I think it is important to carefully select that individual and I also believe that that individual, many of the qualified people can be fully prepared to make a decision to join the Company without knowing who the CEO is. We've got a fine management team here. Those that are incumbent in their position, they don't know who my successor is. If we had the CFO position filled that would have been an incumbent. And so I'm not going to lose any momentum by waiting to have my successor be the one to choose the CFO, if we've got the right person identified. And I believe we're close. And so if that's the case, then that person will come onboard and we'll move on to the other things we need to do.

Got it. I'm sorry. I didn't mean to cut you off.

I'm prepared to make that decision as I think the right candidate would be. So I think we're close.

Thanks. And I'm sorry. Just one last follow-on as it relates to the CEO search. Any specific background that you're looking for? I.e., given John Norris's exposure to the utility space, would you like to have someone else with a utility background or any other considerations in that search?

Well, with any CEO, I think the foundational strength you want is exceptionally strong leadership. John provided leadership. It's a rare individual who I think has every facet of background that any one company would like to have. But what's important here is a leader who recognizes the organizational strengths of our employees and can motivate them to accomplish that which is the mission of the Company, sets a clear vision, knows the purpose and direction the Company is taking.

In many of our directors' and managers' opinions, we're wanting someone who's very strong on a sales marketing-driven strength, background. Ideally, the candidate would have the kind of engineering or technical background because we are an engineering services company. But I think we first and foremost have to be a sales and market-driven company.

A good leader has to set strategy, understand his opportunities in the market place, the weaknesses the company has, what its strengths are, and develop and execute a business plan that provides the shareholders with the best return opportunity it can afford. That person may come from the utility industry, it might come from some other industry. But that individual will embrace what is the fundamental core strengths of this company, articulate that to the organization and to our customers, and position the company to achieve growth in a way that it's best suited to do.

That's helpful. Thank you very much.

You bet. Okay. I think we've heard all questions. Those are all good questions. Thank you very much. This was my first call with you folks. It's been a privilege to be here for five weeks. It's a company I dearly admire and have come to greatly respect over the last 12 years. I have a very unique opportunity to get to know the company in a more in-depth way.

Directors are supposed to let the management team manage the business. And I've done that. And yet now as I've done in the past with other companies that we've been associated with, I have my hand at the wheel, for at least that time period until my successor is named. That's one thing everybody knows is that I'm here for a short period of time. And my focus is on building the organization, its management, motivating the employees to do what we're good at doing.

We're in a weak economy. We're seeing turmoil in Europe, we've seen chaos in the banking, financial industries, the automobile industry. Everybody's read the news. You know, the one thing about this Company, is it's fared pretty well through a tough economic time. We're generating positive cash flow. Is it as much as we'd like to? Absolutely not. Will we be prudent in how we spend our money and where we direct our resources? Absolutely.

But I believe that the long-term landscape for Fuel Tech is good. I think we'll continue to put products and processes in place that afford us new opportunities. I think you've seen the company do that over the last couple of years. We're trying to operate the company on a global basis but with some careful consideration as to where those market priorities are best. So I am enjoying the position I have. I'm benefiting from an organization of very fine people who I think are renewing their enthusiasm for this business and quite committed to serving our customers and our shareholders in a way that they're glad to be here doing.

So it's a privilege to have this position. It's a privilege to work with Ellen, Tracy and all those around me who are working exceptionally hard to deliver good results. And I look forward to the next call and reporting on the progress, week by week, month by month. I think you'll see that progress unfold. And we're going to get through this economic downturn along with the best of them.

So thank you. I look forward to meeting some of you that I have not met individually when we have some face-to-face opportune time. And feel free to call me if you have any further questions. Okay. Thank you, everybody. I believe we're done. Very good questions. Thank you for your time. Have a good day.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.