Greetings, and welcome to the Fuel Tech 2019 Second Quarter Financial Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Devin Sullivan, Senior Vice President of The Equity Group. Thank you. You may begin..

Thank you, Jesse. Good morning, everyone. Thank you for joining us today for Fuel Tech’s 2019 second quarter financial results conference call. Yesterday, after the close, we issued a copy of the release, which is available at the Company’s website, www.ftek.com.

The speakers on today’s call will be Vince Arnone, Chairman, President and Chief Executive Officer; and Jim Pach, the Company’s Principal Financial Officer. After prepared remarks, we will open the call for questions from our analysts and investors.

Before turning things over to Vince, I’d like to remind everyone that matters discussed in this call, except for historical information, are forward-looking statements as defined in Section 21E of the Securities Exchange Act of 1934, as amended, which are pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 and reflect Fuel Tech’s current expectations regarding future growth, results of operations, cash flows, performance and business prospects and opportunities as well as assumptions made by and information currently available to our Company’s management.

Fuel Tech has tried to identify forward-looking statements by using words such as anticipate, believe, plan, expect, estimate, intend, will and similar expressions, but these words are not the exclusive means of identifying forward-looking statements.

These statements are based on information currently available to Fuel Tech and are subject to various risks, uncertainties and other factors, including, but not limited to, those discussed in Fuel Tech’s Annual Report on Form 10-K in Item 1A under the caption Risk Factors and subsequent filings under the Securities Exchange Act of 1934, as amended, which could cause Fuel Tech’s actual growth, results of operations, financial condition, cash flows, performance and business prospects and opportunities to differ materially from those expressed in or implied by these statements.

Fuel Tech undertakes no obligation to update such factors or to publicly announce the results of any forward-looking statements contained herein to reflect future events, developments or changed circumstances or for any other reason.

Investors are cautioned that all forward-looking statements involve risks and uncertainties, including those detailed in the Company’s filings with the SEC. With that said, I’d now like to turn the call over to Vince Arnone. Vince, Please go ahead..

total suspended solids; hydrogen sulfide and metals removal; along with keeping basins aerobic over time. With respect to pulp and paper. We are actively engaged in data analysis and application review for a midsized paper production facility in the Midwest U.S.

And we are also engaged with a long-standing customer of ours in the same industry, where we are focused on incorporating DGI technology as part of the customers’ new water treatment facility, which is currently in the planning and engineering phase. In closing, I want to thank you once again for your ongoing interest in Fuel Tech.

One year ago, we were struggling financially. Our available operating cash was diminishing, and we had $10.4 million in global cash at the end of the second quarter of 2018. Additionally, we were uncertain as to the source of bookings for the remainder of 2018, and we were on the verge of taking the decision to wind down our operation in China.

Today, liquidity has stabilized. We ended the second quarter of 2019 with approximately $15 million in global cash, and our balance sheet remains strong. The wind down of our China operation has gone successfully thus far.

We will have eliminated approximately $2 million in annual operating losses from our profit and loss statement, and we are likely to have $2 million to $3 million in cash available to repatriate.

We successfully installed FUEL CHEM at two new coal-fired units this year and demand and weather permitting, these units will run for a good portion of the summer and winter months. Lastly, in general, the U.S. economy remains favorable for the further expansion of business, and the U.S.

regulatory landscape has become modestly more favorable for fossil fuels. All of that said, we recognize and accept the near-term challenges that we have at our APC business, but we remain confident in a longer-term opportunity landscape.

For 2019, although our outlook for generating income from continuing operations this year has shifted as a result of our APC performance, the operating leverage that we have created via our restructuring efforts over these past few years, will enable us to weather our current delay in orders.

Our goal as a company and as a team is the generation of sustained profitability and cash flow, and I remain confident that the Fuel Tech team will be successful in the achievement of this goal. Now, I’ll turn things over to Jim for a discussion of our financial results. Jim, please go ahead..

Thanks, Vince, and good morning, everyone. As Vince noted, our Q2 results were impacted by losses at our China operations, totaling $540,000 and slower-than-expected new APC award activity during the first half of this year. Excluding China, our consolidated loss from continuing operations was approximately $0.3 million.

With respect to the top line, second quarter revenues declined to $8.9 million from $11.8 million, reflecting a $3.6 million revenue decline at APC, partially offset by a $0.7 million increase in revenues at FUEL CHEM as compared to last year’s second quarter.

Lower APC revenues were the result of a decline in backlog entering the second quarter and slower-than-expected new APC contract awards. As Vince note – has noted and mentioned, we are pursuing several avenues for new APC business in the U.S.

Consolidated gross margin was 43.6% of revenues compared to 31.4% of revenues in Q2 2018, primarily due to mix in revenues between APC and FUEL CHEM. APC gross margin was $1.8 million or 38.1% of revenues as compared to $2.1 million or 24.7% in Q2 2018.

APC results for Q2 2019 included no revenues from Beijing Fuel Tech and an operating loss of $0.5 million. In Q2 2018, revenues from Beijing Fuel Tech were approximately $0.7 million with an operating loss of approximately $0.6 million.

FUEL CHEM’s segment revenues improved to $4.1 million from $3.4 million in Q2 2018, reflecting the addition of a new coal-fired unit during the second quarter that included an approximately $0.9 million order for equipment and installation that was recognized as revenue. Segment gross margin was 49.9% in Q2 2019 and $47.8 million in Q2 2018.

For the full year 2019, we are targeting a blended gross margin of APC and FUEL CHEM of between 35% and 40%, excluding the impact of China. We continue to focus on cost control, and our SG&A for Q2 reflects that. SG&A for Q2 2019 was $4.5 million, a decline of 6.5% from Q2 2018.

We are on track to meet our full year 2019 objective of SG&A ranging between $15 million and $16 million, which includes China – which excludes China SG&A and restructuring costs of approximately $1.4 million, which we expect to report as discontinued operations following the anticipated completion of the suspension of our APC activities in that geography.

R&D expenses of $0.2 million were slightly lower than last year’s second quarter. R&D for 2019 is expected to be comparable to $1.1 million we reported in 2018, with higher spending driven in a large part by our development of the Dissolved Gas Infusion technology.

Our net loss from continuing operations was $936,000 or $0.04 per diluted share compared to a net loss from continuing operations of $1.7 million or $0.07 per diluted share in last year’s second quarter. Net loss from continuing operations in Q2 2018 included a non-cash intangible assets abandonment charge of approximately $317,000.

Excluding the impact of operating losses at Beijing Fuel Tech, Fuel Tech’s net loss from continuing operations for Q2 2019 was $0.4 million or $0.02 per diluted share.

Given our cumulative net operating losses of $28.2 million at June 30, 2019, which covers several geographies, we continue to expect that our income tax expense for 2019 will be at or near $0. And this figure includes China NOLs, which we will maintain, given that we are preserving the legal entity in China.

Our balance sheet at June 30, 2019, remained debt free, and we had cash and cash equivalents of $14.9 million, including restricted cash of $3.3 million. During the second quarter, we entered into a cash collateral agreement with BMO Harris to facilitate the issuance of our standby orders of credit for our EPC business.

This agreement requires us to provide cash collateral of 105% of the aggregate face value of our outstanding standby letters of credit. Upon signing this arrangement, we reduced our JP Morgan Chase facility in half to $2.75 million, resulting in the reduction of the restricted cash during the quarter.

We anticipate migrating the outstanding letters of credit with JP Morgan to BMO Harris during the third quarter, and we’ll terminate our facility with JP Morgan.

The overall reduction of restricted cash since December 31, 2018, is a reduction of this new – is a reflection of this new banking arrangement as well as the reductions in our outstanding letters of credit with existing customers.

Our working capital balance at June 30, 2019, was $21.2 million, which will continue to support our ongoing operating needs of the business. In China, we currently have $3.1 million of trade accounts receivable outstanding at June 30, 2019, down from $5.5 million of trade accounts receivable outstanding as of March 31.

Receivables at June 30, 2019, are in offset by a valuation allowance of $1.1 million. We reduced our trade accounts receivable balance in China by a $2.4 million during the quarter, which in – is comprised of cash collection activities, offset by invoicing activity on the remaining projects in that geography.

We continue to actively pursue cash collections in China through a variety of means with our recently announced suspension in that geography. With respect to valuation, our book value per share was $1.32. Our tangible book value per share was $1.20, and our working capital per share was $0.88 at June 30, 2019.

In addition, we have approximately $0.69 per share in deferred tax liabilities for the U.S. and Italy, which have been fully reserved and are not included in any of the per share amounts quoted above. With that, I would like to turn the call back over to Vince..

Thank you, Jim. Operator, let’s please go ahead and open the line for Q&A. Thank you very much..

Thank you. [Operator Instructions] Our first question comes from the line of Amit Dyal with H.C. Wainwright. Please proceed with your question..

Thank you. Good morning, everyone..

Hey, good morning, Amit..

Hi, guys..

Hi, how are you?.

So with respect to Air Pollution Control business, you highlighted various initiatives to, sort of, revive growth over here.

What is the time line you think some of these efforts will take to begin reflecting? Even in the backlog or in the financials?.

Right. From a time line perspective, Amit, obviously, right now, we’re in the middle of the Q3 time frame, right? As I noted in my comment here, we are expecting some contract bookings to come our way here in Q3 and before the end of the year.

Difficult to project a dollar value on those items, but what we’ve seen largely as a push towards, what I would call, some of our larger dollar value contract opportunities, a push towards late this year or into early 2020 time frame. So we are going to see a little bit of a push of revenue generation from APC from 2019 into 2020 time frame.

At least that’s the way we’re looking at it right now..

Got it, understood..

But the – again, the opportunity landscape that we are seeing is still robust. So we’re not concerned by some of the timing delays that we’re seeing thus far. However, there are delays..

Understood. And your comments regarding sort of losing certain bids.

I mean how should we read into this? Is there sort of a more price sensitive environment in the industry right now? Or are competitors, like, just trying to digest whatever margins they can and just to – win on pricing basis? Like how should we read into some of these bids not coming through for you guys?.

Understood. And Amit, I would read it as not solely that issue. It’s actually a little bit of a mix, what I would call, specifically to Fuel Tech. One example I’ll give you is that one of the larger projects that we were actually targeting to win and to have significant impact on 2019 was actually a larger ESP retrofit project bid.

And ultimately, what transpired here was the plant owners that are making a decision to go with a nonunion bid for a union plant as opposed to taking a union contractor bid for that union plant.

And so it was completely, basically, a surprise to us in terms of how that ended up coming down because we were well aligned with the, what I would call, the primary union contractor for the facility, okay? So it’s not like we were going up on an apples-to-apples basis with competitor for this particular bid.

It was a completely different choice in terms of how that customer chose to move forward with their selection of a contractor. So that was – that’ one example, but that’s actually a larger contract value item. In Europe, we have come across at least one situation whereby the competitive pricing issue was something that we had to address.

And we found – again, in certain markets, you will find this, on certain bids you will find this. Whereby competitors in a marketplace solely to bring work in-house will put price points out there that are either at cost or below cost.

And we’re not in a position here today whereby we’re looking to go ahead and – engaged at projects that were cost or below cost. It’s just not worth our effort to pursue that sort of work. So we’ll take decisions on a project-by-project basis.

If we think a project is strategic to us relative to maintaining a long-term relationship with a customer or developing a new relationship with a customer, but just on a project-by-project basis, independent of a strategic reason, we’re not going to be bidding at zero or below zero gross margin..

Fair enough. I mean it makes sense. Yes. This $8 million in backlog, Vince.

Is this to be recognized before the end of the year? Or what’s the time frame on delivering this backlog?.

I would say, about three quarters of that is going to come into 2019, Amit..

Okay, understood..

And then obviously, we have to replenish..

Right. And just finally on the FUEL CHEM side.

This $4 million sort of run rate levels for the quarter, is this what we should expect? I know you’ve previously highlighted that, that depends on consumption on the consumer – on the customer side, but is this where you think, at least on a quarterly basis, around $4 million is a steady state for you now?.

Actually, the FUEL CHEM business is seasonal. We see better performance in Q3 and in Q1 just into the temperature extremes, if you will.

So generally speaking, what we saw as an annualized revenue run rate in that $17 million to $18 million range is what we would expect to continue with some higher revenue in Q3 and in Q1, slightly lower in Q2 and Q4, okay? So yes, we would expect to see, for Q3 as an example, we would expect to see a number larger than the $4 million number in Q3 versus what we experienced in Q2..

Can you remind us how many customers on the FUEL CHEM side do we have right now?.

In terms of, what I would call, active feeding customers today, I’d say approximately 15 active feeding customers today..

Understood. I think, that’s all I have, Vince. I will step back in queue. Thank you..

Thank you very much..

Thank you. Our next question comes from Pete Enderlin with MAZ Partners. Please proceed with your question..

Good morning, Vince and Jim..

Hey, good morning, Pete.

How are you?.

Good. How are you? So the first question is, sort of simplistically speaking, why did it take so long to close the China operations? It’s still not closed quite.

And in another words, what would have been the downside of just basically, abruptly shutting it down? I’m sure there was some downsides, but can you explain that a little more?.

Absolutely, Pete. Obviously, Beijing Fuel Tech was an active, viable business. Full employee team engaging in sales, project execution and various administrative expenses.

So our objective was to take a systematic way of winding down the business, whereby we still had to meet our customer requirements that were under contract, so we had to complete work there. Point number two, we had been caring a sizable accounts receivable balance for our China business for quite some time.

So very important for us, not to strand those receivables there and put active effort forced to go ahead and collect as much as we can before completely looking to shut down the operation. And thirdly, ensuring that we did take care of our longer-term Beijing Fuel Tech employees in the proper way.

So three factors, but it wasn’t as simple as saying, as of x date, we’re going to look to close down the operations, shut down the legal entity because we had contract exposure, legal requirement to fill contract requirements, significant outstanding accounts receivable that we were not going to leave stranded.

And so we wanted to make sure that we wound this down in the correct way. So that’s why it’s taken a little bit longer than one might think.

Does that help?.

Are those – the remaining receivables, any of those at risk at this point?.

Of the $3 million that Jim mentioned that we have outstanding today, we actually do have a reserve on that $3 million of about third of that amount, okay? So net-net balance of what’s outstanding is around USD 2 million.

Today, we have collection efforts in place that I had mentioned in my script whereby we’re looking to have, what I would call, access or remaining cash in China of somewhere in the $2 million to $3 million range.

So we’re pursuing efforts to collect as much of that outstanding AR, including what – some pieces of what we have reserved before we stop our efforts fully on the AR collection side..

Yes. You lost some competing bids in the APC pipeline.

To whom? Can you give us some explanation or details on that?.

Without giving specific names, we have obviously – we have multiple competitors for our different technologies. As I was just mentioning in my previous response to Amit’s question on this ESP project award. We have two or three competitors that do ESP retrofit work in this country, and we see them on a recurring basis on bids.

And sometimes they win, sometimes we win. So that’s not unusual. This particular bid that I was talking about was a little bit unique from our perspective in terms of how the bid ended up being awarded okay? In Europe, there are a handful of companies that will provide SCR or SNCR technology to that customer base. And so it’s some of the same names.

It – and again, typically, it’s the case whereby the awards will go back and forth across that comparative basis. There are a large number of competitors. We have seen a reduction in the competitive landscape over this past two, three years, generally, as the focus on fossil fuel has declined.

So generally, it’s a smaller competitive landscape, but we still have competition..

Is it primarily or somewhat more in the ESP area rather than the emissions area, other than electrostatic?.

Generally in the U.S. I would say yes. Although, there is still competition for SCR and SNCR. In Europe, where we have to find, in general, a little bit more overall competition, in general..

On the $80 million to $100 million pipeline, can you give a little – sort of a overall breakdown or maybe even some detail on how that looks by verticals? Also between coal and gas? And maybe geographically as well? Anything you can give us that would help us to understand the potential out there?.

Right. So when we talk about pipeline, it’s basically a list of project opportunities that will cover a – that actually goes out to immediate term to a sort of a five-year landscape of opportunity. And it will still largely be a domestic U.S.-dominated pipeline of projects because still, the majority of our business is here.

It covers all of our technology landscape and both power generation and a variety of industries as well, as we look out over this, call it, immediate term to five-year time horizon. So difficult to give much more details than that, Pete..

Okay.

Can you help us understand the current state of play with respect to the clean air rules and modification by the EPA for power plants? You said there’s some sort of easing going on, but – expand on that a little bit?.

Yes. Generally speaking the – what happened a couple of months ago was the former Clean Power Plan that was put in place was actually removed from being effective. New government is actually putting in regulation that is – it’s generally more fossil fuel favorable, generally speaking.

Now I can’t say specifically that it’s going to drive a material uptick in business. When I make the comment – I make the comment to be able to say that, it’s not going to detract us from future business opportunities, okay? So that’s just a general trend, at least within this current governmental regime..

And does it, in any way possibly, improve the prospect or decrease the rate of decline for coal as opposed to natural gas?.

Yes. That’s a – I wish I had a better answer, a more specific answer to that, Pete. It’s difficult to predict, right? Coal has gone through a very significant impact over this five to eight-year time horizon.

And even though, there might be a, call it, a favorable regulatory landscape, that doesn’t mean that there’s still isn’t going to be a pressure on coal specifically, right? We’ve seen a significant fundamental change towards basically natural gas now being used at levels as a power generation source that were only seen by coal five to eight years ago.

Now natural gas is being used at, call it, 45% fuel utilization rate for power gen. Coal is now back down to the upper 20s or around 30%, and the renewables are providing the remainder. So we’ve gone through a fundamental shift already. Natural gas prices are still extremely low.

Absent something that changes the outlook on natural gas from a pricing perspective, I’m not so sure we see anything change on the coal side, Pete..

Okay. And then one last one.

What would it take to dramatically accelerate the pace of development of your water technology? In other words, sort of like what is the main limiting factor right now?.

My perspective, Pete, it’s having in our hands our first or second successful internal demonstration that we can use then as a basis for expanding into specific market applications.

Once we have in our hands and we better understand, call it, the application base, it’ll give us the impetus to go ahead and look to invest more in the expansion of the proliferation of the technology across different industries, right? Today, we’re not trying to attack multiple industries. There’s too much there for us to be able to focus on.

So just focusing on pulp and paper, oil and gas, it – that’s a lot for us to handle today based on how we’re structured. But we took a – took the approach with our investment in water that we were going to invest modestly.

Particularly, given our – the financial condition that we’ve been in here in the recent near term, but our investment has been modest. We have not hired outside individuals to go ahead and move this forward yet. We’ve purchased demonstration systems that will enable us to go to market and improve our technology, and that’s all we’ve done thus far.

There are additional investments that we can make to help this move forward faster as well. I mentioned very specific industry-related subject matter experts that, we believe, will help us be more expedient in market penetration.

Those we were looking at – we are looking at right now, and we’re going to have one to two individuals onboard here that will be market specific by the end of Q3 or early in Q4, but they will help us expedite the penetration of markets.

We’ve realized that we need to move water along more expediently, and we’re going to do everything that we can, given our financial situation to make that happen..

Okay. Thank you very much..

Thank you, Pete..

Thanks, Pete..

Thank you. And the next question is from the line of William Bremer with Vanquish Capital. Please proceed with your question..

Good morning, Vince.

How are you?.

Hey, Bill.

How are you doing?.

Good.

My first question, I’d like to get a sense of what percent of the backlog of that $8 million is from your direct sales force versus your distribution partners?.

It’s all from our direct sales force from my perspective. We don’t have – our representative network is solely contact-based. Our direct sales force handles all of the sales execution activity and the relationship, ultimately. So I’d say, 100% of that amount is related to direct sales force, and that’s the way we’ve operated, historically..

Okay.

So given the bookings or, I should say, limited bookings at this point that we have seen for quite some time, what changes have you been making primarily on your sales force?.

As we sit here today, I have every confidence in the world that sales force we have in-house is going to be able to go ahead and bring in the bookings that we need to move forward and revitalize our backlog. As we’re sitting here today, we’re looking at perhaps changing out a sales rep or two or adding a sales rep or two in specific areas.

But relative to internal direct sales force, no changes planned..

Can you give us an idea of how many sales individuals at this time this company has?.

Okay. Off the top of my head right now, it’s at – the number I’m going to give you is eight. And that includes APC and FUEL CHEM sales. It’s seven or eight..

All right. You definitely need to pick up as we’ve seen the figures and the stock is definitely reflecting that lack of initiative. We need to close some deal too. Next question is on the Dissolved Gas Infusion.

Can you give us a sense of what on the technology side still needs to be done? And are we still at one trailer? Or do we have possibly another in fabrication? Give us an update there..

Right. Today, we still have one demonstration trailer, okay? That’s outfitted and ready to go.

From a technology development perspective, Bill, from my viewpoint, the only thing incremental that we could be doing today, call it, in advanced of actually getting customer business, would be to put our heads together on what would I – what I would call, an upscaled system or upscaled systems.

Systems that have significantly greater capacity to go ahead and surveys larger bodies of water, okay? Prior to doing that, okay, we wanted to get that first demonstration done first. But our internal team is giving thought to how that upscaled system might look and function as well.

So – but technically, that’s, what I would call, the next focus as we sit here right now..

Okay.

And I’m assuming based upon larger bodies of water, you’re going to need multiple modular units at different spots, correct?.

That is a correct statement. In most cases we will be modular, and we will have multiple units. However, to be cost conscious, as we do look at some of the larger applications, which are more than likely to come our way based upon our discussions with current customer base opportunities.

We are still going to have to upscale from what we have in hand today, and we’ll be able to do that. It will still be modular. We will still require multiple units, but the units will be just much larger than we have in terms of a setup versus our demonstration system today..

Yes, no. That’s my point.

Do we have sufficient in a demonstration and pilot stage at this time to really have proof of concept?.

We do. We believe we do..

Okay.

Wouldn’t it be advantageous for us to realize the balance sheet and have multiple pilots proceeding almost immediately?.

If – Bill, if we have a chance to move forward with a couple of customers that are willing to go ahead and do demonstrations, we can have another system fabricated and ready to go within an 8 to 10-week time frame. It’s not going to hold us back. We’re not going to let that hold us back.

If we have the opportunity to spend money and do a demonstration, we’re going to spend the money. We won’t hesitate. Okay..

Okay, thank you..

Thank you, Bill..

Thank you. [Operator Instructions] Thank you. It appears we have no additional questions at this time. So I’d like to pass the floor back over to Mr. Arnone for any additional, concluding comments..

Thank you very much. I’d like to thank everyone for joining on the call today and for your interest in Fuel Tech.

As I mentioned in my closing comments, I would like to reiterate that yes, we have been through a little bit of a slower period in APC bookings, however, I have every confidence in this Fuel Tech team that we’re going to rebolster our APC project backlog here in the near term.

I said our goals were sustained profitability and cash flow, and I’m confident that we will achieve that. Thanks everybody. Have a great day..

Ladies and gentlemen, this does conclude today’s teleconference. Again, we thank you for your participation, and you may disconnect your lines at this time..