Fuel Tech Inc

NASDAQ:FTEK

Earnings Call Analysis

Earnings Call Transcript 2023-Q3

[Operator]

Greetings, and welcome to the Fuel Tech, Inc. Third Quarter 2023 Financial Results Conference. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Devin Sullivan., Thank you, Devin. You may begin.

[Devin Sullivan]

Thank you, Kat, and good morning, everyone. Thank you for joining us today for Fuel Tech's Third Quarter 2023 Financial Results Conference Call. Yesterday, after the close, we issued a copy of our results. That release is available at the company's website at www.ftek.com. .

Our speakers for today will be Vince Arnone, Chairman, President and Chief Executive Officer; and Ellen Albrecht, company's Chief 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 made 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 of 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, Chairman, President and CEO of Fuel Tech. Vince, please go ahead.

[Vincent Arnone, executive]

Thank you, Devin. Good morning, and I'd like to thank everyone for joining us on the call today. Our results for the third quarter reflected continued double-digit revenue growth for our Air Pollution Control or APC segment with sales up 36% from last year's third quarter and an expected and welcomed rebound in revenue at FUEL CHEM, which saw revenue double from the immediately preceding second quarter of 2023, as program activity for this segment normalized following a period of reduced operation driven by unscheduled downtime and temporary maintenance on our installed units. We continued to maintain a conservative cost profile with SG&A expenses trending at or slightly below 2022 levels, secured new APC contracts and ended the quarter with over $33 million in total cash and investments and no long-term debt.

We believe that the future of our company lies not only on capitalizing on the opportunities offered by our existing products and end markets but also on developing and commercializing new product and market opportunities. To that end, the continuing development of our Dissolved Gas Infusion technology, or DGI, remains as a high priority. In following up on our discussion from our Q2 earnings conference call regarding DGI, we are very pleased to have completed the on-site deployment and pilot testing of our DGI technology in an aquaculture setting in the Western United States.

Over the 100-day demonstration, the DGI technology delivered and consistently controls the dissolved oxygen levels [ in a man ] between 9 and 12 milligrams per liter, which is approximately 150% of atmospheric saturation. Based on an analysis of the results and post-study consultation with the client, the DGI technology not only met the pilot study expectations and parameters, but in many cases, exceeded them, for consistent delivery of high-quality dissolved oxygen on demand. The client reported excellent results from taste tests by local chefs, including an absence of trimethylamines within the harvest. Results from this study will be published in an abstract and presented at the Aquaculture America Conference in February of 2024.

We are currently in negotiations with this client to deploy our DGI system at their location for both their next growth cycle and their larger-scale development plans. In addition to this demonstration, we are continuing our conversations with other potential channel partners as we look to deploy DGI in other end markets either late this year or early in 2024.

DGI is best described as a technology that involves the efficient transfer of high concentrations of gas into a body of water to drive chemical or biological reactions such as wastewater treatment or for process improvements such as industrial applications or aquaculture. Our DGI system is a 2-step technological process where first, a slip stream of processed water is pressurized and infused with oxygen using Fuel Tech's patented saturator, and secondly, this oxygen laden slipstream is returned to the process basin through a patent-pending injection array for optimal distribution and gas residence time.

At present, we are utilizing DGI to deploy oxygen into bodies of water. However, we do believe that DGI can be applicable for other gases as well such as ozone. DGI's benefits include the precise control of dissolved oxygen levels for all process applications and ability to extend plant capacity without major expansion or capital outlay, order reduction and minimal bubble formation for extended residence time. We believe that DGI is applicable across several end markets, including pulp and paper, food and beverage, chemical or petrochemical, water and wastewater treatment and aquaculture.

Now let's please spend a few minutes discussing our APC and FUEL CHEM business segments. Our FUEL CHEM business segment benefited from the return of our larger scale customer units to more normalized levels of usage after experiencing extended downtime in the second quarter associated with reduced dispatch driven by weather-related demand and unscheduled maintenance outages. We expect FUEL CHEM's performance in the fourth quarter of this year to be at a reduced level from the $4.1 million reported in last year's fourth quarter, due primarily to a reduction in program utilization levels at our primary accounts from the very high levels experienced in 2022. This will result in lower annual revenues at FUEL CHEM when compared to full year 2022.

With respect to international opportunities for the FUEL CHEM segment, we are continuing to follow the opportunity to expand the provision of our chemical technology in Mexico, our partner in that country, to address the emissions created by the burning of high sulfur fuel oil, which is being undertaken without the necessary environmental remediation and at the expense of the health of surrounding communities.

Earlier this year, we executed a 2-year extension to the program that we currently have in place at 1 facility, and we do believe that political pressure is building in favor of the implementation of our FUEL CHEM program at additional facilities in this country. Our partner is currently in discussions with the state-owned utility, CFE, regarding the application of our technology at several units.

For the APC segment, revenue rose by 36% to $3.7 million from last year's third quarter, driven primarily by the timing of project awards and the commencement of work on contracts announced during 2022 and continuing through the first 9 months of 2023. These projects involved our SCR, SNCR and ULTRA emissions control solutions at natural gas and coal-fired units in the U.S., Europe and the Pacific Rim.

As previously announced, we have secured $2.2 million of new project awards during the third quarter. And earlier this week, we announced an additional $2.6 million of new awards. Based on our visibility to projects that are in development, we expect a minimum of $3 million to $4 million in additional awards before the end of this year.

Last quarter, we discussed the U.S. Environmental Protection Agency's issuance of a rule finalizing requirements that obligate 23 states to reduce emissions of nitrogen oxides from power plants in certain industrial facilities. According to the EPA, this action was designed to tighten nitrogen oxide emission requirements by updating the Cross-State Air Pollution Control Rule to meet the good neighbor requirements of the Clean Air Act. The good neighbor rule has currently been stayed by several circuit ports covering sources and upwind states. Within the past few weeks, sources in effected downwind states have petitioned the Supreme Court to proceed with the rule. For the near term, upwind sources will likely not be required to reduce their nitrogen oxide emission levels until the requirements and timing of the final rule have been resolved.

We continue to believe that this new federal rule will serve as a catalyst for new APC orders over the next several years, as utility and industrial customers explore ways to further reduce NOx emissions. In fact, it is important to note that we have received and responded to several requests for budgetary proposals as customers prepare to address the upcoming compliance requirements as part of their capital budgeting requirements for 2024 and beyond. We will provide further analysis and commentary on this regulation as more information becomes available in the future.

Through the first 9 months of 2023, APC revenues have already exceeded the revenue recognized for the entirety of 2022. Based on our effective backlog at quarter end, the business development activities we are pursuing and our previously noted expectations for FUEL CHEM, we expect that total revenues for 2023 will increase modestly to between $27 million and $28 million, up from $26.9 million in 2022. This base case outlook excludes any material contributions from DGI as we are still in the early stages of commercialization and any significant contributions to APC from the EPA rule earlier this year.

In closing, I want to once again thank the Fuel Tech team for their ongoing continued hard work and dedication and our shareholders for their continued support, as we continue to evolve our operations and expand our presence as a global supplier of technologies that enable clean air and pure water.

With that said, I'm going to turn the discussion over to Ellen. Ellen, please go ahead.

[Ellen Albrecht, executive]

Thank you, Vince, and good morning, everyone. We are pleased with our third quarter results, reflecting higher net income, a significant revenue improvement in our FUEL CHEM segment compared to the immediately preceding second quarter of 2023 and continued strength in our balance sheet.

For the quarter, consolidated revenues were flat at $8 million compared to last year's third quarter driven by improved results year-over-year in our APC business segment. Consolidated revenues for the 2023 9-month period rose to $20.8 million from $19.9 million in the same period last year.

APC segment revenues for the quarter increased 36% to $3.7 million from $2.7 million in the prior year period driven by the timing of project execution and the recognition of ancillary APC orders. This increase was offset by a decline in FUEL CHEM product revenue for the quarter that was the result of lower dispatch electrical generation demand and changes in product and fuel usage at certain accounts. As noted, FUEL CHEM revenue more than doubled from Q2 2023 when this segment was affected by customer-driven maintenance outages.

Consolidated gross margin for the third quarter was 45% of revenues as compared to 46% of revenues from the prior year period. Although APC gross margin rose to 40% from 34% in last year's third quarter due to a change in project and project mix, lower revenues for the FUEL CHEM segment impacted margins on a consolidated basis. Third quarter 2023 gross margin for the FUEL CHEM segment returned to historical levels of right around 50%.

Consolidated APC segment backlog as of September 30, 2023, was $5.6 million, down sequentially from $6.6 million at June 30, 2023, and $8.2 million as of December 31, 2022. Backlog at quarter end consisted of $2.4 million of domestically delivered project backlog and $3.4 million of foreign-delivered project backlog. As Vince noted, we have recently announced new contracts -- new contract awards and expect to add this to the backlog balance prior to the end of the year.

We continue to maintain an expense discipline across our enterprise. SG&A expenses for the third quarter decreased to $3 million from $3.3 million last year. This decrease was primarily due to timing of certain employee-related expenses. For the full year 2023, we expect SG&A expenses to range between $12.8 million and $13.2 million as we strategically invest in resources to support current business initiatives.

Research and development expenses for the third quarter increased to $513,000 from $207,000 in last year's third quarter. This increase was primarily due to continuing investments in our DGI water treatment technologies and in support of our pilot testing initiatives. We will continue to invest as needed in our R&D efforts in support of our commercialization of our DGI technology and to actively pursue commercial applications for technologies outside of our traditional markets.

We continue to take advantage of the favorable interest rate environment and as of September 30, 2023, have invested in excess of $30 million in held-to-maturity debt securities and money market funds. This generated $322,000 of interest income in the third quarter and nearly $1 million of interest income for the 2023 9-month period, up from just $100,000 in the same period last year. We continue to expect that interest income for 2023, barring any unusual cash deployments to grow the business will approximate $1.3 million.

Net income for the third quarter was $459,000 or $0.02 per share compared to net income of $314,000 or $0.01 per share in the same period 1 year ago. Adjusted EBITDA was $352,000 compared to an adjusted EBITDA of $421,000 in the prior year period.

We continue to maintain a strong financial position. As of September 30, 2023, we had cash and cash equivalents of $13.5 million and short and long-term investments of $19.7 million. Working capital was $31.9 million or $1.05 per share. Stockholders' equity was $44.1 million or $1.45 per share, and the company continues to have no outstanding debt.

We are confident in our ability to fund our ongoing growth initiatives, pursue new product and market opportunities and maintain our strong financial position, which we view as an important competitive advantage.

Thank you for your time, and I'll turn the call back over to Vince.

[Vincent Arnone, executive]

Thanks very much, Ellen. Operator, let's please now open the line for questions.

[Operator]

[Operator Instructions] Amit Dayal is our first question from H.C. Wainwright.

[Amit Dayal, analyst]

Just with respect to DGI, I mean, it looks like the pilot is working pretty well. You're seeing the results better than expected. With these type of now like how quickly -- and the balance sheet that you give, how quickly can you move this to just expanded efforts with other pilot stage opportunities and even, I know, you may be a little bit dependent on the customer itself from commercializing with this client who has had the pilot. But how should we think about revenues from this coming through for you guys? How quickly could that happen now that you have seen these results?

[Vincent Arnone, executive]

Right. No, thanks for the question, Amit. With respect to this particular customer, our next step here is probably going to be engaging in an equipment lease or rental arrangement with them for their next growth cycle, which will likely start before the end of this year, early next year. But with this small system that we're using there, we're not expecting material revenues.

Relative to your, call it, your more broad question on how quickly we can get perhaps more systems out in a commercial environment, premature for me to talk about any sort of revenue level for 2024. But what we are going to be doing now that we do have some, call it, pilot or demonstration success in our hands, as I noted in my commentary, we're going to take this information out publicly via conferences and look to expand knowledge about DGI in marketplaces. So that is going to be our next step.

Yes, we have a solid balance sheet. As you know, we've been using our funds carefully regarding how we do invest in DGI. But with each step, it's providing us more impetus, if you will, to further invest to pick the pace up a little bit regarding commercialization. So that's something we're evaluating right now as we're looking to end '23 and move into 2024, but we're going to be looking at some resource enhancements, human resource enhancements. We're going to be looking at perhaps adding additional DGI systems to have on hand as inventory for a potential sale or demonstration. That's everything that's in process right now.

When we look to have our first call in 2024, which will be in that early March time frame, obviously, I'll have more to talk about regarding the development of DGI at that point in time. But suffice it to say, between now and then, we are expecting to have additional demonstrations, and we are expecting to have some small level of commercial revenue.

[Amit Dayal, analyst]

Just looking ahead a little bit into 2024, maybe it's a little early, but how do you feel about sort of your setup with respect to the visibility you have right now for 2024, could that be another sort of year-over-year period for you or revenue growth period for you? I mean any color on how you are positioned for sort of in the next 12 months would be helpful. And the reason I ask this question, Vince, is you have cash per share, $1.45 roughly, and the stock is trading well below that. I'm just trying to understand where the disconnect is, I mean what investors may or may not be thinking about the opportunities in front of you?

[Vincent Arnone, executive]

Amit, completely understand, and I share your sentiment regarding where we're trading today vis-a-vis our cash value per share. Visibility, in terms of me sitting here and providing guidance on '24, it is premature. However, I will tell you that I would be disappointed as CEO of the company if we would not be targeting another year of revenue increase in 2024 over 2023. So that's the statement that I'll make today. I think that the disconnect on valuation, I think as we are able to provide more positive information to the public and more -- make more people aware of what Fuel Tech is actually providing both as an environmental solutions company to the world today. And also from a pure value perspective, I think, hopefully, we'll see that disconnect in valuation change as we move into 2024.

[Operator]

Our next question comes from Marc Silk at Silk Investment Advisories.

[Marc Silk, analyst]

So in the October 9 edition of Barron's, there was an article discussing Europe's first ever carbon-based tariff. So some of the highlights were, "The imports to Europe will now face attacks based on carbon emissions caused by manufacturing. The goal of the legislation is to encourage more countries to write laws that reduce emissions and make sure that European manufacturers stay competitive with rivals operating in director -- in dirtier jurisdictions. So this could reconfigure international trade flows over the next 5 years and potentially result in new carbon fees going into effect in more countries. So taxes will start being collected in 2026 and will increase gradually until they are equal to EU carbon prices in 2034."

So I have a few questions. So you've done a great job controlling expenses relative to revenues. And something like this can really accelerate growth for Fuel Tech. So since you have the technology and expertise to mitigate this risk for many companies and industries, can you discuss maybe cost-effective strategies that would allow you to participate in this opportunity? So for instance, Fuel Tech could pursue resellers and partnerships around the world where you provide the solutions and they can supply the sales force so this could be a revenue sharing agreement without you incurring start-up costs, et cetera, but would lead only to variable costs in relation to increased sales.

[Vincent Arnone, executive]

Marc, thanks for the question. I appreciate it. And actually for everyone's benefit, Marc did actually share the commentary on the European carbon tariff with me. And I have done a little bit of reading on that myself. So Marc, thanks for that. It's a monumental undertaking what the EU was actually looking to put in place today. To your point, they put the requirement out. It's in a transitional phase as we sit here today. Evidently, they're willing to start to try to gather some data on carbon credit/tariffs, if you will, starting in 2024.

Now Marc, as you know, the -- right now, the targeted industries are the -- call it, the highest level polluters on the planet. It's cement, it's iron, steel, aluminum electricity and hydrogen. So these are many of the end markets that Fuel Tech addresses today with our technology base via addressing European customers or via addressing customers in different parts of the world.

So from our perspective, we need to see how this tariff program is going to develop, obviously. But as companies around the world are looking to reduce their carbon footprints, we worked very closely with the steel industry over many, many years and have good relationship with steel, particularly in the U.S., not as strong in the EU as we sit here today. So we'd have some work there to do.

With some of the other industries, I think where we're going to continue to look to capitalize on helping those industries reduce their carbon footprint by applying our nitrogen oxide technologies on their facilities, as we have the opportunities to work with them prospectively. So it's difficult to call this out is what I would call a specific targeted opportunity because we have been dealing with these industries historically, and we will continue to try to capitalize on any attempts that these industries are looking to make to reduce their carbon footprint.

As we get more information on this regulation in particular and better understand how companies are looking to address it. We'll gather more information on our end, and I'll be happy to share that on next earnings conference call as well.

[Marc Silk, analyst]

Yes, because one of the thoughts is that where the U.S. is reducing their dependence on coal, that's not necessarily the case for other countries.

[Vincent Arnone, executive]

Correct.

[Marc Silk, analyst]

So I mean, what's interesting about this is, this could really change the prospects for your product from a regulatory requirement to an economical one in order to avoid basically recurring taxes, i.e., expenses. Is that -- would that -- is that correct?

[Vincent Arnone, executive]

Under a cap and trade type system, that's exactly how it would work.

[Marc Silk, analyst]

All right. I mean the positive is, obviously, this doesn't make sense to pursue now as your company is trading below cash. But it just I think, brings awareness that it's an interesting investment and potential takeover target, but you don't have to comment on that. Let's switch to DGI for a second. So congratulations on the success of the pilot. So have you in Mr. Decker discovered maybe any areas in this industry of low-hanging fruit for this product?

[Vincent Arnone, executive]

Bill has a couple of thoughts in mind where there will be low-hanging fruit, we believe. I think our next demonstration is likely going to be one of those areas that we are going to be targeting, but it's not something that I can speak to at this point in time. But it is a demonstration of where we're looking to engage in as we move into the first quarter of next year. But Bill has been working diligently across his body of relationships in multiple industries to indeed do just that, find those areas that could be an immediate fit for DGI. To be honest, aquaculture came as a little bit of a surprise to us. But as we found out, it's an area that is really perfectly suited for the DGI application. But Bill has some other targets in mind as well.

[Marc Silk, analyst]

So also some of the areas that aren't low-hanging fruit, but it makes sense to concentrate on, i.e., lucrative future deals. Would those be mixed with reasonable sales cycles? Or it's going to be another one of these 100-day type of experiments or just because you already showed success in this, maybe it shortens the time frame?

[Vincent Arnone, executive]

Yes. I -- if past practice relative to how Fuel Tech has done business, it comes [ through ] with DGI, we'll probably need to have more demonstrations than not, particularly still at the beginning of the commercialization of the product because everyone is going to want to see proof of concept at "their facility" as opposed to just making the assumption it's going to work immediately. But as we do have, what I would call, repetitive business in specific end markets, I think that should diminish over time.

[Marc Silk, analyst]

The other question is, just in general, have you looked into like some areas that you could potentially have some recurring revenues as that would probably, knowing as you open the doors every year that there's money coming in the door could definitely help the valuation of your stock?

[Vincent Arnone, executive]

Referring to DGI specifically or?

[Marc Silk, analyst]

Just any part of the business?

[Vincent Arnone, executive]

Yes. We -- obviously, we have really been fortunate to enjoy the recurring revenue that we've had from our Chemtech business, unfortunately, that has diminished over the past decade or so with the heavy focus on reducing the utilization of coal. However, that being said, we are looking at trying to find other ways whereby we can enhance our recurring revenue platform, whether it be spare parts and services for our systems or anything otherwise because recurring revenues are obviously fabulous to have in hand and typically the higher gross margin than our typical system sales. So it's something that we are working on as a company.

[Marc Silk, analyst]

Great. And lastly, I appreciate you buying stock after last quarter's earnings around $1.20. It will be nice to see more insight of buying from the Board and upper management to give shareholders a confirmation that you believe in the future growth of the company.

[Operator]

Our next question comes from Jim McIlree from Dawson James.

[James McIlree, analyst]

Can you discuss the gross margin outlook for Q4, given the revenue outlook, it sounds like there might be a little bit of decline, particularly -- well, actually, it seems like there might be a little bit of gross margin decline for both businesses in Q4 relative to Q3. Do I have that right or about right?

[Vincent Arnone, executive]

I would say, Jim, that for Q4 for APC, likely to see a little bit of a downtick there. We did have the favorable impact of a, call it, an ancillary revenue scenario, if you will, in Q3 that did give us a little bit of a bump up on the APC margin side. So I would think that would revert back to more traditional 35-ish percent levels in Q4. And Chemtech, given the fact that we are looking at a little bit of a reduction in revenue in Q4 from Q3, I'd say, flat to a little bit lower for Chemtech. So on a weighted average basis yes, yes, down, down from Q3.

[James McIlree, analyst]

Got it. And then as far as -- I know you're reluctant to talk too much about 2024, but at least conceptually as DGI ramps up next year, will that require a significant or a meaningful increase in either R&D or sales and marketing in order to support that business?

[Vincent Arnone, executive]

I definitely envision that we are going to be adding some resources for DGI in 2024. The pace of business opportunity will drive the level of that resource add. Right now, Jim, I wouldn't call it a material number as I see it today. A couple $300,000 on an annualized basis relative to how it would roll out and impact 2024, somewhere in that range as we would look to add a couple of individuals throughout the year. We'd be looking at some field resources, perhaps some sales resources as well to support that business development.

[James McIlree, analyst]

Is it fair to think of it as success-based or success-based with maybe a couple of month lag?

[Vincent Arnone, executive]

I would say it's very fair, yes.

[James McIlree, analyst]

Okay. Okay. Great. And then my last question is, can you discuss the maturity of your investment portfolio? Just broad brush, are you extended out a long period of time? Or is it call it, 18, 24 months for portfolio?

[Vincent Arnone, executive]

Yes. When we -- understood, when we first started putting our portfolio in place, we had laddered the investments from a minimum of 90 days, maximum of 36 months. And so as they've expired, we've reinvested, but trying to keep a similar, call it, range of exploration window. So some of the earlier maturities that we had, obviously, were at -- when we put them in place originally, we're at some of the lower rates. But we've replaced them with maturities coming at this point in time, averaging 5% or a little more than 5% on some of those items as well.

So today, we're probably a weighted average of somewhere in the 4%, maybe a little bit more range. But as we have some of those early maturities start to drop off I think that our weighted average is going to pop up as we move throughout 2024.

[James McIlree, analyst]

And with the recent decline in long-term rates, do you have to mark to market any of those? Or as long as you have indicated they're going to be held to maturity, you don't have to market to market.

[Vincent Arnone, executive]

Yes. Held to maturity is basically how we're accounting for these, so we do not mark to market.

[Operator]

This concludes our question-and-answer session. I would like to turn the floor back over to Vince Arnone for closing comments.

[Vincent Arnone, executive]

Thank you, Kat. I'd like to thank everyone for joining us on the call today. We were pleased with our third quarter performance here in 2023. Looking forward to what's hopefully going to be a strong end of 2023 and an excellent beginning to 2024 since we won't have our next conference call until approximately early March of '24. Again, thank everyone for joining to our shareholders and investors, other stakeholders. A good holiday season to everyone, and thanks for your support. Fuel Tech appreciates it. Thank you.

[Operator]

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.