Devin Sullivan - Senior Vice President David S. Collins - Chief Financial Officer, Senior Vice President and Treasurer Douglas G. Bailey - Executive Chairman, Chief Executive Officer and President

Steven Charest - Divine Capital Markets LLC, Research Division Daniel J. Mannes - Avondale Partners, LLC, Research Division Derek Hernandez John Quealy - Canaccord Genuity, Research Division

Good day, ladies and gentlemen, and welcome to the Q2 2013 Fuel Tech, Inc. Earnings Conference Call. My name is Emily, and I will be your operator for today. [Operator Instructions] As a reminder, this conference call is being recorded for replay purposes. And now I would like to turn the call over to Devin Sullivan, Senior Vice President, The Equity Group. Please proceed.

Thank you, Emily. Good morning, and thank you for joining us for Fuel Tech's 2013 Second Quarter Conference Call. Yesterday after the close, we issued our press release, a copy of which is available on our website, www.ftek.com. Our speakers for today's call will be Doug Bailey, Chairman, President and Chief Executive Officer; and Dave Collins, Senior Vice President and Chief Financial Officer. Also joining us today is Bill Cahill, Fuel Tech's Corporate Controller. Before turning things over to Dave, I'd like to remind everyone that matters discussed in this call, except for historical information, are forward-looking statements that are subject to certain risks and uncertainties that could cause actual results to differ materially from those set forth in our forward-looking statements. The factors that could cause results to differ materially are included in our filings with the SEC. The information contained in this call is accurate only as of the date discussed, and investors should not assume that statements made in this call remain operative at a later date. Fuel Tech undertakes no obligation to update any information discussed in this call. And as a reminder, this call is being broadcast over the Internet and can be accessed at our website, www.ftek.com. With that said, I'd now like to turn the call over to Dave Collins, Fuel Tech's Chief Financial Officer. Dave, please go ahead. David S. Collins: Thank you, Devin, and good morning, everyone. Thank you for participating in today's call. Consolidated revenues for our second quarter increased $8.2 million to $29.1 million, a year-over-year increase of 39%. For the first 6 months of 2013, our consolidated revenues increased $5.5 million to $51.6 million, a year-over-year increase of 12%. Our bookings in the first half of this year, coupled with our substantial year-end backlog, have provided us good visibility for revenue growth in 2013. While our domestic revenue was flat in the quarter and down $10.8 million for the first 6 months of 2013, our foreign revenues have grown significantly due to our contract in Chile and our continued growth in China. Our U.S. domestic business is expected to pick up in the second half of 2013 as we work through our 2013 domestic bookings of $22 million. Our foreign revenues in the current quarter increased $8.9 million or 302% to $11.8 million. And for the first 6 months of 2013, our foreign revenues have grown $16.3 million to $21.5 million, a year-over-year increase of 302%. Consolidated gross margin for the second quarter was 41%, down from 43% in the prior year. For the first 6 months of 2013, our consolidated gross margin was 41%, down from 46% in the prior year. Consistent with our previous discussions, the decline in consolidated gross margin is attributable to higher -- to a higher concentration of foreign revenues, which carry a lower overall gross margin profile, principally due to our Chilean burner project. We expect to see the reduced gross margin continue on a comparative quarter basis through 2013 and through the first half of 2014 as we execute through this large project. Our selling, general and administrative expense for the current quarter increased $1.4 million over the prior year to $9.3 million. Approximately $500,000 of the quarterly SG&A increase is due to a discrete corporate consulting project contracted for and completed in the second quarter, which is not expected to recur in subsequent quarters. The remaining increase of $900,000 is principally associated with increased staffing levels and administrative functions for our growth in foreign locations. For the first 6 months, our SG&A expense was up $900,000 due to the reasons previously discussed. For the full year of 2013, we expect SG&A expense as a percentage of sales to decrease. Our research and development costs for the current quarter and year-to-date periods were down $539,000 and $112,000, respectively, from the prior year. While our current quarter expense was down due to the timing of project spending, we expect to see our full year R&D expense to approximate prior year levels as we have a number of critical projects that we are supporting. Longer term, we expect to continue supporting our R&D efforts as we believe this is a critical component for our future growth. Consolidated net income for the current quarter was $1.2 million or $0.05 per diluted share, and our adjusted EBITDA for the first 6 months of 2013 was $4.2 million. Now let's move on to a more in-depth discussion of our business segments. The APC segment reported quarterly revenues of $20.2 million, up $7.4 million or 58% from the prior year. For the first 6 months of 2013, our APC revenues have increased $4.6 million or 16% to $33.2 million. We continue to maintain a strong backlog figure of $45.1 million at June 30. And we expect to see continued order activity both domestically and foreign through the remainder of 2013. Consistent with our prior conference calls, we expect our second half APC segment revenue to be stronger than our first half due to the timing of project completion, work for both domestic and foreign orders. A little bit about our geographies. Our China-Pacific Rim business is continuing to grow, and we are adding resources to support that growth. For the first 6 months of 2013, our announced China-Pacific Rim bookings were up moderately to $7.7 million. Our comparable July and August booking activity has been slower in 2013, but we are seeing a continued interest in our product suite, which is expected to convert to new orders in the second half of 2013. Our Chilean business continues to work through its installation schedule, and we are effectively managing the project metrics. While there has been some shifts in outage schedule, we do not expect this to materially impact our revenues in 2013. The last installation of the 6 units included in the Chile contract takes place mid-2014. Our U.S. domestic bookings for the first 6 months totaled $21.3 million due to a number of state consent decrees issued, and we would look for these contracted projects to provide a lift for our second half U.S. domestic business. Our consolidated backlog at June 30 was $45.1 million, broken down as follows: U.S. domestic, $15.7 million; Chile, $20 million; China-Pacific Rim, $8.9 million; and Europe, Western Asia, $500,000. We expect to recognize the majority of this backlog in 2013 except for approximately $10 million to $12 million of our Chile backlog. For the first 6 months of 2013, we have announced $29 million in new orders, $21.3 million in U.S. domestic and Europe orders and $7.7 million in foreign orders, which are principally from China. Subsequent to the end of the quarter, we have announced an additional $6.4 million in new orders. Gross margin for the APC segment declined in the second quarter, from 35% -- to 35% from 38% in the prior year. Likewise, we saw a drop in our 6-month gross margin to 35% from 41% in the prior year. This drop was expected and is due to the higher mix of foreign revenues, which carry a lower overall gross margin profile. As we have previously discussed, we expect to see lower APC segment gross margins in the second half of 2013 for a couple of reasons. First, we realized higher gross margins in our China-Pacific Rim operations in the first half of 2013, due to specific projects which were sold at higher gross margin levels. We do not expect to see this trend continue in the second half of 2013. Additionally, we will continue to see a dilutive effect of our -- on our APC segment gross margins from the Chile project, which will contribute measurable revenues through the first half of 2014. Our blended gross margin and backlog at June 30 was 31%. Our FUEL CHEM segment reported Q2 revenues of $8.8 million, which was up slightly from the prior year. For the first 6 months, our FUEL CHEM segment revenue was $18.4 million, up $800,000 from the prior year. While we do not -- while we do have good growth opportunities in our FUEL CHEM business, we expect to see our current business activity levels in FUEL CHEM continue into 2014. Quarterly gross margin for our FUEL CHEM segment was 53%, which was also consistent with the prior year. We expect to see our gross margins range between 48% and 52% through 2013. Operating income for the second quarter and 6 months was $2.1 million and $2.2 million, respectively, in 2013. Our effective tax rate for Q2 was 38%, and our effective tax rate for the first 6 months was 39% due to the mix of forecasted domestic and international revenue and income levels. For the full year 2013, our expected annual tax rate should range between 38% and 40%. However, our quarterly rate may fluctuate based on geographic income levels and permanent items relative to the level of our consolidated pretax income. Cash and equivalents at June 30 was $23.1 million, and we remain substantially debt-free. Our working capital balance increased to $41.9 million as of June 30 from $38.9 million at year end. Cash used in operating activities for the first 6 months was $492,000, due principally to the status of billings and collections on our APC projects. Our spending on property and equipment totaled $1.3 million. And we advanced a small amount of debt in our China-Pacific Rim operations to fund current project needs. Through our strong cash flow, we continue to invest in our research and development activities and will continue to do so through the remainder of 2013. Now I'm going to turn the call over to Doug. Douglas G. Bailey: Good morning, everyone, and thank you for joining us today. Fuel Tech's second quarter results reflect the success of our strategy in developing and advancing an operating platform based on achieving geographically driven regulatory diversification. Our results for the second quarter are in line with our previously stated expectations. As many of you are aware, last year, we were faced with the task of growing our Air Pollution Control or APC business in a dramatically different regulatory environment, with the initial stay and eventual vacature [ph] of the Cross-State Air Pollution Rule or CSAPR by the D.C. Circuit Court of Appeals in August of 2012. The urgency within our domestic market that drove sales in 2011 all but disappeared. Many domestic utilities simply delayed their purchasing decisions, awaiting regulatory clarification. Thankfully, our deliberate and early focus on broadening our product offerings and building international sales allowed us to generate record 2012 APC bookings of $72.8 million, nearly 90% of which were generated in Latin America, China and Europe. Through June 30 of this year, we booked over $29 million of orders, with over $6 million of additional orders booked subsequent to quarter end, primarily driven by demand in China and in the U.S. by state-level consent decree activity. The U.S. Supreme Court announced on June 24, 2013, that it granted the Environmental Protection Agency's petition to now hear the case that involves the Cross-State Air Pollution Rule. This rule was EPA's latest regulatory attempt to reduce emissions in areas that contribute significantly to out-of-state air quality violations. CSAPR would have reduced the amount of air pollution crossing state lines by capping emissions of sulfur dioxide and nitrous oxides from industries in upwind states. At the present time, we do not know what this Supreme Court review might conclude, and we continue to actively quote domestic APC business that's driven by a number of other mandates. Turning to our international business. Work in Chile on the largest APC contract in our history is progressing in accordance with our customer's schedule requirements, and then we expect its completion by mid-2014. We've also recently quoted additional potential business in the Chilean market. In China, as Dave mentioned, we announced $7.7 million of bookings through June 30, 2013, consisting of ULTRA, SNCR, Flue Gas Conditioning and SCR technology solutions that are all being installed to comply with NOx reduction requirements under that nation's 12th Five-Year Plan. We anticipate that China will require continued efforts well beyond that plan to achieve healthy air quality in compliance with the standards it has set. Statistics released last week by China's Ministry of Environmental Protection reveals that air quality in Beijing was deemed unsafe for more than 60% of the days in the first half of 2013. The national average also failed to meet the safety standards in nearly half of the days in the same 6-month period. The Environment Minister, Zhou Shengxian, was quoted to say that, "China's air quality is grim, and the amount of pollution emissions far exceeds the environment's capacity." This past spring, new data released from the 2010 Global Burden of Disease Study revealed that China's outdoor pollution contributed to 1.2 million premature deaths in 2010, or 40% of the worldwide total. We therefore believe that there's a tremendous work program in the Chinese market for Fuel Tech to help that nation achieve levels of air quality comparable to what has been realized by other large industrialized economies. We will continue to support this marketplace with additional resources and investment as needed. Turning to our FUEL CHEM segment, revenues and margins moderately improved in the second quarter. This segment is still challenged by low natural gas prices and much lower capacity utilization at coal-fired power plants. Despite current market conditions, we continue to satisfy our customers by meeting their expectations as well as evolve our position in this market by developing new products that utilize the FUEL CHEM business model and provide demonstration program opportunities. Our R&D program remains on track, and we expect to commit up to 3% of annual revenue towards those endeavors in this area during 2013. As we discussed last quarter, we have a number of new products in various stages of laboratory, field and commercial testing for our APC and FUEL CHEM customers, and we are consciously continuing those programs. So I'd now like to ask the operator to please open the floor to questions. Thank you.

[Operator Instructions] Your next question comes from the line of Steven Charest of Divine Capital Markets. Steven Charest - Divine Capital Markets LLC, Research Division: Just wanted to clear up a small piece here on bookings for the quarter. You said it was $29 million through June 30? Douglas G. Bailey: Announced. Correct. Steven Charest - Divine Capital Markets LLC, Research Division: Okay. So I come up a little bit shy of that and let's call it rounding? David S. Collins: Yes. That's for the quarter. Douglas G. Bailey: Yes, it's for the -- that's for the year, Steve, year-to-date.

Your next question comes from the line of Dan Mannes for Avondale. Daniel J. Mannes - Avondale Partners, LLC, Research Division: A couple of questions, and I'm sorry, I dialed in a couple of minutes late. Relative to APC for the quarter, was the schedule a little bit different? Obviously, margins were a bit better than expected. Was the Chilean job a little bit more back-end loaded this year? Is that something you already commented on? David S. Collins: Yes. The margin -- we're seeing a little bit better margins coming out of China for the first half of this year, Dan. That's really the change from what was expected on our end. Daniel J. Mannes - Avondale Partners, LLC, Research Division: Okay. And is that something... David S. Collins: I mean, on Chile, we're on plan with that. So I don't know if there's anything significant. There's been a little bit of a delay on the outage schedules, but it's not expected to materially impact revenues. Douglas G. Bailey: My -- this is Doug. My recollection was that there may have been a little bit of timing difference for equipment deliveries from the first quarter to the second quarter, which might have given rise to some difficulty in predicting quarter-by-quarter revenue. Overall, the program remains substantially on timetable. Although there's a little adjustment in the outage schedules with the customer such that by about this time, approximately next year, we will complete that project. The... Daniel J. Mannes - Avondale Partners, LLC, Research Division: Okay. And then on the China side, what do you attribute the better margins to? I mean, obviously, you don't do your own manufacturing. Was it delivery timing? Was there -- what would be unique that would change the margin structure on some of these contracts in China? David S. Collins: Sure. Yes, we -- when we look out at China marketplace, we expect to see some competitive pressures there. And so when we think about modeling, we work some of that in. We just haven't seen it to date yet. But it is expected to impact us in the second half of this year. So but [indiscernible] with the carry-out margins, so [indiscernible] Daniel J. Mannes - Avondale Partners, LLC, Research Division: Right. But in the second quarter, I mean, this is business you... Douglas G. Bailey: [indiscernible] as we do more of these projects and better understand the requirements of that local marketplace, we're able to adjust the support manhours that are provided as you gain experience and replicate jobs. So that's allowed for some improvement in margins as engineering manhours have been able to be lowered against the delivery of subsequent bookings. Daniel J. Mannes - Avondale Partners, LLC, Research Division: Right. I was just saying in Q2, a competitive pressure shouldn't have played in because those -- that was work you'd already booked, in most cases, I would assume. But you're saying prospectively, as you look at new awards, you think you might see some pressure on pricing? Douglas G. Bailey: I think there have been competitive pressures certainly over the last 1.5 years. We don't own all of that market, and competitive pricing pressure does exist. Some of that would be baked into margin levels. Some of that is just associated with the development of this marketplace and what the delivered pricing on a competitive basis has to be. You respond to that by adjusting your price quotation, but you also respond to that by determining what you can do on the cost side. Daniel J. Mannes - Avondale Partners, LLC, Research Division: Understood. Douglas G. Bailey: I expect a little bit of maybe up-and-down possibilities in margins, particularly for somewhat customized work. Daniel J. Mannes - Avondale Partners, LLC, Research Division: Okay. Switching over to FUEL CHEM real quick. On the FUEL CHEM side, you did see a little bit better revenue than we would have thought in the quarter. Are you -- do you attribute that to higher usage by current customers? It looks like anything that would be a driver is just better power plant uptime, driving more usage or anything unique to your product or anything, maybe changing at the power plant level that might drive more usage? Douglas G. Bailey: Well, I certainly think quarter-to-quarter, usage does vary. We've seen -- if I look at, say, year-to-date 2013 versus year-to-date 2012 against a constant customer mix, some customers are up dramatically. Some are down a little bit as it relates to how they're operating those units. We've seen some go temporarily offline simply because they're not on a dispatch schedule. So you do see some lumpy changes on a unit-by-unit basis. But that has averaged out to a moderate increase. But in general, a number of the accounts are operating a little higher. Daniel J. Mannes - Avondale Partners, LLC, Research Division: Okay. That's a fair answer. Two other quick topics. You talked about the new products. This something we've been talking about for several quarters now. Any change in terms of, number one, your willingness to talk a little bit about -- more about what these new products are or number two, about the timing of introduction? Douglas G. Bailey: Sure. Products that aren't yet field or commercially -- fully proven, we'd have a little reluctance to do so until we're fully satisfied that we have all that we are seeking to understand determined. We are actively talking to customers about product offering. As I said before, that reduces acid gases. That's probably a little more near term in the commercialization. Obtaining field trials with customers is certainly a function of scheduling that might take many months to do. I hope we remain interested in the mercury control market, particularly as it relates to the -- solving the potential problem of reemissions of mercury. That's been heavily in development. These are challenging, by the way, emissions problems to solve. So I want to underscore the importance of significant laboratory and pilot phase testing required to be highly successful in these markets. Some of our development related to mitigating SO2, SO3. That kind of emissions problem is in development but also is in response to what we expect to see longer term regulatory requirements to spell out. Daniel J. Mannes - Avondale Partners, LLC, Research Division: Okay. And R&D expense is down sequentially. Is that more just the timing of some of these tests? Or are you... Douglas G. Bailey: Yes, that's right, Dan. The -- some of the biggest lumpy costs you see us incur are for field test programs. Some of these can occur at a test institute, but then they get larger in amount when you go out to a customer site. They're often run for 1 to 3 weeks. The timing of that is subject to the availability of these facilities. And so they could easily move from not only month-to-month but quarter-to-quarter as well. How we've scheduled ourselves those field tests and laboratory tests to be conducted are a bit bumpy over the course of the year. So it is primarily related to that, Dan. But on a full year basis, we're tracking pretty much to our planned expenditure level. And we have a portfolio of quite a number of projects, some of which carry larger expenditures than others. I might say that one of the things that we look at in our R&D project spending is we can certainly have out-of-pocket costs with third parties and material chemical consumption. But we also are utilizing our internal engineering talent, and we charge manhours. So often, in terms of some of those R&D expenditures, we're really absorbing payroll cost that we would otherwise have. And we do the same thing, of course, in our cost of sales on projects. So the accounting treatment's the same, and that's cost that's just shifting from SG&A to R&D, if you will. Daniel J. Mannes - Avondale Partners, LLC, Research Division: Okay. Last question. Sorry? Douglas G. Bailey: No, I think I answered your question. Daniel J. Mannes - Avondale Partners, LLC, Research Division: Yes. Last one, I guess, would be on the federal side. You mentioned CSAPR is going to be revisited by the Supreme Court. At the same time, CAIR is in effect. And then thirdly, EPA is now saying they're going to go back and perhaps revisit CSAPR. From your perspective, are you seeing any demand from these sort of transport rules domestically or it's pretty much all the domestic demand consent-driven at this point? Douglas G. Bailey: Well, we've seen a number of different drivers. We -- both in terms of what we've actually sold and what we have quoted. We're seeing certainly consent decrees, permit requirements, new units being sold, too, could be a plant expansion or load management issue. But CAIR remains in effect, as you indicated. We've actually had substantial SNCR sales. You probably recall that I'd mentioned in the past that in an environment like this, sometimes we'll turn -- be turning our attention to larger-scale projects that can translate into lumpier revenues. We certainly did that with respect to our Chilean project, and we continue to quote some larger projects. The decision to train for those projects is, therefore, necessarily longer. We measure our progress by having been awarded further engineering studies, whether that's a feasibility study or an initial design. Sometimes we come up against the actual contract award decision. You can win or you can lose. We have multiple competitors. But I do believe that we have some great product offerings. We're continuing to sell our solution of Advanced Selective Catalytic Reduction, which is lower in capital costs overall. The number of applications where that's possible is a little more limited in the United States. But nevertheless, we're finding opportunities, and I wouldn't be surprised to see our success in achieving those. So I continue to expect the APC environment, with the lack of a replacement for CSAPR or CAIR, to have a little lumpiness associated with it.

[Operator Instructions] Your next question comes from the line of Derek Hernandez for Brean Capital.

I guess you guys kind of worked through a number of the questions I had. But I was wondering in particular with regards to the Chilean project. You mentioned it continuing through the year. You had previously stated that a good chunk of it was going on in Q2. I guess I was wondering if that project in particular would continue at the run rate it had in Q2 through the rest of the year or if that was going to drop off a little bit or come up if it was still lumpy, I guess. David S. Collins: Yes. No. I would look for that to continue Q3, Q4 as it has been. We're going to roll about $10 million of that overall project into 2014. Our last installation is mid-2014. But if I look at modeling that project for Q3, Q4, I'd probably split it evenly between the 2.

I see. And then in general, you said that you expected bookings in the U.S. to increase. I was just wondering what kind of drivers you guys saw there and what was bringing customers to the table there? Douglas G. Bailey: I'm sorry, I didn't hear the question. It's -- could you repeat the question?

Yes, certainly. Douglas G. Bailey: Just a little bit louder, please.

Sure. I was saying that you guys commented that you expected bookings in the U.S. to increase. And I was just wondering if you guys had any particular drivers for that. Douglas G. Bailey: Well, as I mentioned, a lot of what we are quoting is related to things like consent decrees, permits. There are regional haze regulations in the Western states that we have provided some quotation activity to, not all of which we will win. But there's still a number of drivers even with CAIR being the only regulatory law that are still giving us a pretty full potential order book to quote from. But it's not at all like it was in 2011 when CSAPR was enacted and there was a surge of orders, particularly of our SNCR technology simply because the timeframe to meet a ruling like that was so short that you couldn't even begin to contemplate a large SCR-type installation. We do think that the market is moving more to Selective Catalytic Reduction-type technologies. And you know we have a group fully devoted to SCR catalyst technologies' efforts. So much of our quotation activity today centers on some of those opportunities. And those integrate in with our traditional programs to provide ASCR-type programs.

Your next question comes from the line of John Quealy for Canaccord. John Quealy - Canaccord Genuity, Research Division: First, I don't know if you touched on this, the competitive landscape -- we saw Nalco or Ecolab now finally get out of the Mobotec business at least on the cap equipment side. Can you talk about were they a major competitor or have they been? They had some interesting sorbent-based technologies a few years back. But can you comment on -- is -- do you think that's a major change in the competitive environment or not? Douglas G. Bailey: Well, we had some competitive activity with Nalco Mobotec, to be sure. I think there was some domestic business, for example, John, but they weren't against Fuel Tech. But to our belief, the margin attractiveness on the basis for which it was, one, was very, very modest, a level that we would not have bid. So I think that is sort of a telling sign that the desire to exit from that business was that it was not succeeding. Most of their activity, however, I would say, largely centered in Europe. They have shifted away from the domestic U.S. market and were concentrating much more on Poland and U.K. So we certainly saw them over there, and since the announcement of their divestiture of that activity, there's been a little bit more attention given to Fuel Tech's capabilities in Europe. Europe has never been a large market for us, but interestingly enough, there are some unique opportunities that we are certainly doing some early feasibility and engineering work on, that could put us in a more favorable position today than we were before to win and execute. So that's a true stay-tuned statement because it's going to unfold over several quarters ahead.

Okay. And then days on the model, I came in with some part answers, I think, from some other callers. But it sounds like some business gets pushed out of '13 into '14. Is that Latin America? And then also, on the margin profile generally for APC, we've known that some of the Asian business had lower margin. Are those trends still intact for the back half of the year? How should we think about that? David S. Collins: Yes, they are. Our blended margin in backlog at June 30 was 30%. So we are looking to see the overall APC margin drop a bit in the second half. And there's about $10 million of the Latin American contract that's going to move to 2014, so...

There are currently no further questions. And at this time, I'd now like to turn the call back to Mr. Bailey. Douglas G. Bailey: Okay. Well, thank you again for your participation on today's call and of course, for your continued interest in Fuel Tech. We remain excited, optimistic about our future, and we certainly look forward to keeping you apprised of our progress. For those who participated in today's call, we thank you very much. Bye, everyone.

Thank you for joining today's conference call. This concludes the presentation. You may now disconnect. Have a good day.