FuelCell Energy, Inc.
Q2 2011 Earnings Call Transcript

Published: 7 Jun 2011

[Operator:]

Good day, ladies and gentlemen, and welcome to the FuelCell Energy Reports Second Quarter 2011 Results Conference. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host today, Kurt Goddard, Vice President, Investor Relations. Please begin.

[Kurt Goddard:]

Good morning, and welcome to the Second Quarter 2011 Earnings Call for FuelCell Energy. Delivering remarks today will be Chip Bottone, President and Chief Executive Officer, and Joseph Mahler, Senior Vice President and Chief Financial Officer. The earnings release is posted on our website at www.fuelcellenergy.com, and a replay of this call will be posted 2 hours after its conclusion. The telephone numbers for the replay are listed in the press release. Before proceeding with the call, I would like to remind everyone that this call is being recorded and that the discussion today will contain forward-looking statements, including the company's plans and expectations for the continuing development and commercialization of our Fuel Cell Technology. I would like to direct listeners to read the company's cautionary statement on forward-looking information and other risk factors in our filings with the U.S. Securities and Exchange Commission. Now I would like to turn the call over to Chip Bottone. Chip?

[Arthur Bottone:]

Thank you, Kurt. Good morning, everyone, and welcome. FuelCell Energy is entering an exciting phase as the pace of growth accelerates, our fuel cell power plants providing solutions for our customers' energy, environmental and business challenges worldwide. As energy demand grows, we are intensifying the globalization of our business and the penetration of our key markets. We are focused on driving top line revenue growth. Our products are performing well and are profitable, while products and services backlog is the highest in our company's history. POSCO Power, our Korean partner, recently ordered 70 megawatts of fuel cell kits, equipments and services that we will deliver over a 2-year period. Valued at $129 million, this order represents initial demand under South Korea's renewable portfolio standard. We increased our production levels during the second quarter to 56 megawatts annually, and this large order from POSCO Power enables us to sustain these higher production levels. Service agreements executed with all of our customers are also contributing to revenue growth as our installed base grows and we move toward near-term profitability. I will discuss these and other results after Joe Mahler, our Chief Financial Officer, reviews our financial results for the quarter. Joe?

[Joseph Mahler:]

Thank you, Chip, and good morning, everyone. FuelCell Energy reported total revenues for the second quarter of 2011 of $28.6 million compared to $16.6 million in the same period last year. Product sales and revenues in the second quarter were $26.7 million, almost double the $13 million reported in the prior year quarter. The company's product sales and service backlog totaled $135.5 million as of April 30 compared to $75.5 million as of April 30, 2010. For the second quarter of 2011, product order backlog totaled $60.4 million, and backlog for long-term service agreements totaled $75.1 million. The POSCO Power order, valued at an estimated $129 million, almost doubled our backlog, to more than $250 million, the highest in the company's history. In the quarter, we incurred a onetime charge of $8.8 million due to our repair and upgrade program for a select group of 1.2-megawatt fuel cell modules produced between 2007 and early 2009. No additional charges are expected under this program, and the cash impact will be spread out over 12 months with an expected cash impact of $3 million to $5 million during fiscal year 2011. The charge was accounted for as an increase to cost of goods sold. During the second quarter of 2011, the accounting classification of the Series I preferred shares was adjusted to reflect a change in the timing of payments due under the instrument. There was no material change in the future cash flows, although the revaluation of the instrument resulted in a onetime noncash charge of $9 million to additional paid in capital. The reason for the change in the valuation of the obligation was that the original obligation had been accounted for under purchase price accounting at the time of the acquisition of Global Thermoelectric in 2003. Under the new valuation under debt accounting, the future estimated cash flows were discounted using a dividend rate in the modified agreement and the current foreign exchange rate, resulting in the adjustment. This accounting accelerates the prior accretion model for the instrument. My discussion of the financials from this point will exclude the repair and upgrade charge and a noncash charge related to the Series I preferred. Please note that a non-GAAP reconciliation is included at the end of the earnings release that illustrates financial results for the second quarter of 2011 and year to date, excluding the repair and upgrade charge and the charge to revalue the preferred shares. Margins for product sales and revenues improved by $4.1 million compared to the second quarter of 2010, and the "product cost to revenue" ratio improved to 1.08

[Arthur Bottone:]

Thank you, Joe. In our previous call, we spoke of our strategic priorities

[Operator:]

[Operator Instructions] Our first question comes from Walter Nasdeo with Ardour Capital.

[Walter Nasdeo:]

Chip, this is a kind of a nice order for you to kick your tenure off there as the head of FuelCell. I was wondering if it's possible for you to go ahead and kind of discuss a little bit with us what your kind of global sales and marketing strategy is. I think you mentioned that you're kind of going into global markets, but how are you planning on penetrating those? And what's going to be your kind of focus for growth going forward?

[Arthur Bottone:]

You started in Asia with the order for POSCO, so let me kind of start there. Kind of globally, POSCO has done a great job in Korea. We're working with them, obviously, now to continue the penetration within their own market, they have several opportunities, but also to encourage them to focus on export opportunities as well. We're starting primarily with Southeast Asia. We are having with them some discussions on perhaps what to do in Japan, and there are some other markets to penetrate. But clearly, strong partner relationship-building from where we are is our solution in Asia. In Europe, I mentioned in my comments that we are having discussions, Walter, with some potential partners right now, and I expect to have something soon. Again, the key strategy there is we need the right partner, much like POSCO has been the right partner, well capitalized, understands the power generation business and can really execute. Back in the U.S., we're deploying more of a direct model. Activity so far has been, as you know, on the West Coast in California, the East Coast primarily in Connecticut. We had a pretty strong fourth quarter last year, which carried over into the first quarter, where we did almost 20 megawatts of new-order business, which is a record for us in California last year. We're now building and shipping that, and I expect that that kind of number will continue going forward with our team out there. And we are seeing the Connecticut projects -- I know people have heard this before, but some positive movement there, and I mentioned in my remarks that we should see some progress there. So I think that's the beginning of that. There's broader interest in the East. And that's kind of the path forward to kind of get to a sustainable run rate that gets us on the path of that 90 megawatts of profitability.

[Operator:]

Our next question comes from Sanjay Shrestha with Lazard Capital.

[Sanjay Shrestha:]

A couple of quick questions. First, how should we think about the gross margin in your backlog right now for the product as well as sort of the consolidated gross margins from the cost-to-revenue perspective? What sort of an improvement are we going to see going forward because of that backlog and embedded profitability within that?

[Joseph Mahler:]

Sanjay, this is Joe Mahler. I think the gross margin in the backlog is clearly positive. You should continue to see our cost ratio improve as we push that volume through. Higher volume will reduce it even faster, so as we add more orders on top of this, that will actually accelerate the reduction of the cost ratio and actually move us first to gross margin profitability, and then, at 80 to 90 megawatts, to company profitability.

[Sanjay Shrestha:]

Okay. And that "80 to 90 megawatt" comment is really the scale benefits that you need to sort of get that operating expense covered from a gross profitability standpoint?

[Joseph Mahler:]

Yes, that's full profitability for the company.

[Sanjay Shrestha:]

Okay. Now a few more follow-ups, if I may. So in terms of this charge that you guys took in this quarter, what exactly were they related to? And were they actually the products that you guys have shipped to POSCO in the past, and there are some tweaks you had to make and then as part of the evolution of the company, and it is kind of what it is, sort of -- what exactly was that?

[Joseph Mahler:]

The charge is, in effect, we shipped units -- and you're correct, Sanjay. I think there were 16 modules in play, and I think 14 of them were in Korea. And in the period of '07 to early '09, we shipped modules out into the marketplace. And there was a flaw in the design that effectively shortened the life. And what happened is we observed that, and then it was in our interest to immediately take action on that. We actually worked a plan -- POSCO had most of the modules. So we worked a plan with POSCO to solve that situation. That situation only exists in those modules. It doesn't affect a later module version, which we call our C1400. It does not affect that, and it did not affect any of the sub-megawatts. So as you said, Sanjay, it's just one of those things -- it was what it was, or it is what it is. But that's the action we took, and we worked very closely with POSCO, and POSCO worked with us very aggressively on this program. And the other aspect of the program is that we are able -- once we saw the issue, if you capture it early in the life, you actually retain a lot of the life of the original modules.

[Sanjay Shrestha:]

Perfect. I have few more questions, if I can, actually. So the fact that it was such a big repeat order from POSCO clearly should be viewed that this issue is now completely behind the company, right?

[Joseph Mahler:]

Absolutely.

[Sanjay Shrestha:]

Okay. Two more...

[Arthur Bottone:]

They wouldn't have spent $130 million more, Sanjay. I mean, I sat with them face to face with the Chairman, and he said, "Look, we understand these things come up and go from--" We're moving forward, So they fully are on board, yes.

[Sanjay Shrestha:]

I think that's what I was trying to get at. So market questions, if I may. So, Chip, when you talk about sort of project financing activity getting better for this already-approved Connecticut project, can you go into some more detail on that as to what type of entities you're talking to? Because in the past, it was a potential concern, stack replacement after 5 years. Can you talk about that a little bit more? And second part of my question is, now with this big order from Korea, is it one of those where South Korea is at least a 70- to 100-megawatt kind of an annual opportunity for you guys going forward?

[Arthur Bottone:]

Okay. Let me answer the financing question first. What's different? I think we're seeing -- clearly in Connecticut, we're seeing some of the smaller, more regional banks in terms of the debt side. We're also seeing, Sanjay, some more reasonable, attractive terms. Both the expectation on returns, I wouldn't say it's lower, but I would say the cost of money and the kind of risk-return profile has certainly improved to be much more attractive, both for the lender and for us, frankly. So I think maybe that's just time healing the markets in general. Or I think the other thing is, if you kind of look at our backlog and also the kind of positive things people are saying, "Okay, you guys are going to be here." As far as the different instruments, we've also seen that change a little bit. We were looking at -- some people have put 100% equity in these deals. Some people have a mix of debt and equity. Some of the debt is tax-free bonds, like in California. So we're seeing also some creative -- creative is probably the wrong word, but some new instruments that I think have been helpful to attract both the lenders and the equity folks. So I think maybe that's a little bit post-2008 financial crisis. But I think it's also -- we've been here longer now. We've got more products out in the field, and people's confidence level is growing.

[Sanjay Shrestha:]

Okay. And in terms of POSCO?

[Arthur Bottone:]

POSCO's opportunity, that's a great question. Certainly, we've made public that the RPS numbers are 6,000 megawatts in total over, roughly, a 10-year period. And POSCO is starting, obviously, with addressing the RPS needs with basically 2 orders. 70 megawatts is roughly 35 megawatts a year. They expect, we expect that number to grow. We can support them in doing that in the same method. As we've mentioned, their facilities are built for 100 megawatts themselves with the balance in flat module assembly. But they're also looking at other things. I mean, we've got some other development programs with them for other projects. So they're all in with the technology of fuel cells powering not just power generation, but other things as well. So I think the export piece also represents upside. But I do not want to get too far ahead of ourselves. We're focusing on what we're doing right now and continue to support other efforts.

[Operator:]

[Operator Instructions] Our next question comes from Matthew Crews with Noble Financial.

[Matthew Crews:]

I wanted to talk maybe just a minute about the pipeline, both in California -- we already discussed Connecticut here, but also in South Korea. Could you describe sort of what you have in the near-term visibility in the pipeline in California? That would be part one of the question.

[Arthur Bottone:]

We've got about 130 megawatts -- we look at our pipeline every month or more. But we've got about 130 megawatts just in California alone in what we call our pipeline. I bring people back to the fact that we did over the last probably 6 to 9 months, we've done about 20 megawatts in California, which from a go-forward basis, 20 megawatts, 30 megawatts a year is a good number in California. Even with that backlog, there's a certain maturity period and things like that in execution to get that stuff over the line. So I think that's still there. There's been a new administration, which has been positive in terms of direction of things that, obviously, we're in favor of. But any new administration comes in and says, " I got to put my stamp on things." So we've had a little bit of slowdown in terms of conversion just due to some changing rules. The direction doesn't change. The incentives might move around a little bit, but directionally, it's the same path. And then I would say that we still continue to work on beyond the current tools that we have, SGIP and others, things like the feed-in tariffs and things like that, obviously, in Southern California last month. And some of these things have been on the table a while. But that's kind of the process, but I expect that we're on the back end of that tail rather than the front or the earlier end that we were in the past couple of years.

[Matthew Crews:]

Okay. And on South Korea, I think there's been discussion or at least in some type of reports out there of size of power plants up to 60 megawatts in size. We've seen you folks talk about the 20-megawatt power plant sizes. But in terms of POSCO's 30-megawatt sort of annual order flow from you guys and comparing that to sort of what the size of the plants are out there, I'm just curious on sort of the pipeline that POSCO has made available to you to discuss or what you see there in terms of what types of plants or how many plants that they're looking to build out?

[Arthur Bottone:]

Yes, it's a good question. I'll give you a little more clarity on that. Yes, the largest power plant that we have under construction, and it'd probably started at the end of this year, is 11 megawatts. That happens to be in Korea. But we are seeing bigger and bigger plants. I mean, here in the U.S. alone, we have one for 15 megawatts, and POSCO is talking about 11-megawatt and 20-megawatt plants. They do that for lots of different reasons, scale reasons. They're trying to power bigger blocks of growth in highly densely populated areas and things like that. POSCO has signed a number of memorandums of understanding with both local utilities and independent power producers in the country, probably between 60 and 80 megawatts of different contracts. So that obviously changes every week. So there's clearly interest, there's clearly belief that they have to do this. And frankly, as the RPS in Korea comes to fruition, really in 2012, where they start to hit some of these objectives, there's really not too many other solutions people can do, because all these projects take a long time to site and get permitted for. So they have a pretty active pipeline. We're in touch with some of their customers. We understand that from a return-on-equity perspective and things like that, these projects work. So it's a question, I think, of just starting to execute some of these projects as they tee them up.

[Matthew Crews:]

And the base, one look at the POSCO Power order sort of 30-megawatt size annual and sort of a base, they could come back to you in 6 to 9 months and say, "Listen, that might have been a little low. We need a follow-on order." I mean, is that the type of...

[Arthur Bottone:]

Yes, that door is open, frankly. I mean, our operations guys have done a great job in increasing over a fairly short period of time our run rate. So I think we can react fairly quickly to these guys. I think we've laid that out for them as well. And bear in mind that this RPS, which is what we got these orders for, is just one piece of what they're working on. There's a building application program we're working on, and they're talking about other things as well, exports. I don't want to try to guarantee anything, but certainly, they are aggressively pursuing things beyond the order they gave us, which is really just to support the RPS.

[Matthew Crews:]

Okay. And just one last question for Joe. There was a comment in the earnings -- or the release regarding cash collection, the timing of order closure. Could you give a little more detail on what order or where that order was going or the revenue associated with it?

[Joseph Mahler:]

Yes. In the comments that I just talked to, Matt, I talked to the POSCO order. So in the last few calls, I've been talking about $6 million to $8 million quarterly cash burn. And that was our, in effect, our guidance for the year. And what happens with the POSCO order, the POSCO order is loaded on the front end for working capital. We get about 40% of the order value before October 31. That brings us right back in line with that guidance. So on an annual basis, our cash will be somewhere between $24 million and $32 million, is our current estimate.

[Matthew Crews:]

Okay. So that was what the number is regarding.

[Operator:]

[Operator Instructions] Our next question comes from with Steven Athridge [ph] with BMO.

[Unknown Analyst -:]

The POSCO orders. Are any of them going to be used for biogas applications in the next while?

[Arthur Bottone:]

This is Chip. Potentially. I mean, we ship them kits, the balance-of-plant portion of the overall plant is modified if you do biogas slightly -- it's modified slightly if you do biogas versus natural gas. So potentially, some of that could actually be done. I don't know off the top of my head if they have any orders specifically for that. But certainly, they have installations in biogas right now. And so some of those 2-year order there, 70 megawatts, that certainly could be earmarked for biogas applications.

[Unknown Analyst -:]

Okay. The other question I've got for you, you've got improved sealants now for your Direct FuelCells. Can those sealants get used in the solid oxide area that you're working on with Versa?

[Arthur Bottone:]

In theory, yes. It's a different design. I probably can't go into those details here. But if you look at molten carbonate, we have cell stacks, 400 cells that are stacked high, and they're a certain width. With solid oxide, it's a little different design, whereas you don't have as wide a cell stack. So perhaps it could be. We've had good results so far with our solid oxide program. But really, where that comes into play, I think, is when you start to scale it up from where it is now, 15 or so kilowatts into 60 kilowatts and beyond. Good learnings to have, you're exactly right.

[Unknown Analyst -:]

And when could we expect to see real revenues come from solid oxide fuel cells for you? I mean, Bloom Energy is out there apparently marketing something now.

[Arthur Bottone:]

I mean, right now, our revenue comes from the R&D portion of our solid oxide program. We have a design that is different from Bloom's. We do both heat and power. Our folks would argue that it's a generation or 2 ahead of theirs. And of course -- so that's going to be several years for us to basically have a product in the range that would be for commercial operation.

[Operator:]

I'd like to turn it back over for closing comments. I'm not showing any other questions in the queue.

[Arthur Bottone:]

Okay. Well, if there's no further questions, let me thank everybody for joining today. Thank you for your support, and we look forward to talking to you on the next call for the third quarter results. Have a great day. Thank you.

[Operator:]

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the conference. You may now disconnect. Good day.