FuelCell Energy's CEO Discusses Q2 2011 Results

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 1.08:1, primarily from improved product margins and lower commissioning of warranty costs compared to the prior year period. This met our expectations.

Research and development contract revenue was $1.9 million for the second quarter of 2011 compared to $3.6 million for the second quarter of 2010, decreasing due to lower activity under the Department of Energy solid oxide fuel cell development program. This program was extended in the quarter, and $8.2 million was added to backlog. The company's research and development backlog totaled $15.2 million as of April 30, 2011 compared to $9.9 million in the prior year.

Net loss to common shareholders was $12 million compared to $16.7 million for the prior year.

Turning to year-to-date operating results. For the 6 months ended April 30, 2011, the company reported revenue of $56.7 million compared to $31.2 million for the prior year period.

Product sales and revenues more than doubled to $52.4 million compared to $25.8 million for the prior year and corresponds to our increased production rates, which are now 56 megawatts annually.

Research and development contract revenue was $4.3 million compared to $5.4 million.

Margins for product sales and revenues improved by $7 million compared to the prior year period, and the product cost-to-revenue ratio improved to 1.08:1 from 1.44:1, primarily from increased revenue with higher product margin and lower commissioning and warranty costs.

Total liquidity was $57 million at April 30, including total cash and investments in U.S. treasury of $55 million and revolver availability of $2 million.

Total cash used for the 6 months ended April 30, 2011 was $17.3 million, including revolver borrowings of $3 million, compared to $21.1 million for the prior year, excluding net proceeds of $17.7 million from the registered direct offering of common stock in January 2011.

The payment terms for the recent POSCO Power order requires an initial down payment and a total of 40% of the order value by the time the first kits begin shipping in October 2011.

With the closing of the order from POSCO Power in the third quarter, the company expects full year cash use to be in the range of previously stated $6 million to $8 million per quarter, or $24 million to $32 million for the full year.

Capital spending for the second quarter was $500,000, and depreciation expense was $1.6 million. Our power plants are gross margin profitable on a unit basis. Higher product sales and service contracts combined with continued cost reductions will drive profitability. We continue to estimate that we can achieve company profitability at an annual production rate of 80 megawatts to 90 megawatts. Chip?

Arthur Bottone

Thank you, Joe. In our previous call, we spoke of our strategic priorities: driving growth, operational excellence and customer satisfaction. Let's talk about driving growth in support of our mission: meeting the world's energy needs today. With more than 80 power plants generating ultra-clean energy at more than 50 sites globally, FuelCell Energy is the market leader of megawatt-class fuel cells for clean and renewable baseload power generation.

Including the recent order received from POSCO, our installed base and backlog stands at a record 182 megawatts.

Our worldwide business is growing because, as in South Korea, our Direct FuelCell solutions excel at solving energy, environmental and business problems. Global demand for power is forecasted to increase 50% by 2025. Urban populations are increasing, making central generation difficult to site and costly.

Global communities need more energy but must mitigate the costs and adverse health effects of pollutants and greenhouse gas emissions.

Our DFC [Direct FuelCells] power plants are ultra-clean, efficient, reliable distributed generation solutions. Their high electrical efficiency proficiency results in more output for a given unit of fuel, reducing operating costs and emissions. Their low-emissions profile virtually eliminates pollutants and helps customers reach their sustainability goals.

DFC power plants provide power of use without additional investments in transmission and distribution.

To dimensionalize our power plant growth potential, we've analyzed our worldwide markets and quantified near-term and addressable market needs by country and by vertical market. We estimate the near-term global market potential for our solutions is $6 billion.

We sell into 2 primary markets. The first is ultra-clean energy, FuelCells operating primarily on natural gas across 7 distinct and diversified vertical markets. These vertical markets account for 162 megawatts of our installed base and backlog.

The second primary market is renewable energy, FuelCells operating on renewable biogas across 4 distinct and diversified vertical markets. 20 megawatts of our power plants operate on biogas are installed in our backlog.

As previously mentioned, POSCO Power placed a large order with FuelCell Energy for 70 megawatts of fuel cell kits, equipment and services valued at $129 million. This was a true team effort by our SCE associates. The largest order ever received by our company to date, it almost doubles our product and service backlog and illustrates the impact that farsighted legislation can have in driving the adoption of clean power generation while promoting local economic growth.

This 2-year order calls for FuelCell Energy to deliver 2.8 megawatts of fuel cell kits to POSCO every month, from October 2011 to October 2013. POSCO will use these kits to produce complete power plants in its facilities in South Korea.

POSCO Power has made major commitments to fuel cells in its relationship with FuelCell Energy, including the construction of a balance of plant facility and a new module assembly facility designed for up to 100 megawatts of production annually.

Under a license agreement with FuelCell Energy, POSCO will build fuel cell power plants in these facilities using our design and supplied components. This allows us to leverage our manufacturing capability while supporting and benefiting from South Korea's green economic policies.

In March, POSCO Power officially opened its new module assembly facility with a ribbon-cutting ceremony, which I attended with the Chairman of POSCO, our partner's parent company; the CEO of POSCO Power and South Korea's Vice Minister of Knowledge Economy, the equivalent of the U.S. Secretary of Energy.

Historically, South Korea has seized opportunities to create export-driven economies with technologies like automobiles, electronics and household appliances. In a short period of time, POSCO has developed nearly 70 megawatts of projects in South Korea and is engaged in developing an export market for fuel cells in Asia.

POSCO's large, multi-year order along with the completion of their new facility represents the next step in the evolution of our relationship. Our progress in South Korea is an excellent example of how the combination of strong market and a motivated local partner with significant resources can drive fuel cell adoption and revenue growth.

The South Korean power generation model is focused on clean distributed generation that is scalable, efficient and creates jobs. Scalable distributed generation allows power generation to be added in cost-effective increments and the point of use while minimizing costly investments in transmission and distribution.

Efficiency drives economics by generating more power from a given unit of fuel. Fuel cells are an ideal distributed baseload power solution for South Korea and other geographies as well, because they're ultra-clean, efficient, quiet and easily sited in highly dense areas. South Korea's clean distributed generation model is designed to drive economic growth and create local jobs, which is a model that is affable globally.

The outlook for project financing in the U.S. continues to improve, and we remain encouraged with the discussions we're having with financial institutions for project financing.

In Connecticut, we continue active discussions with financial institutions regarding the financing of a 43.5 megawatts of Department of Public Utility Control-approved projects. We are receiving strong project development interest and support from the state, and I'm optimistic that we will be able to close one or more of these projects soon.

Currently, most of our installations in California are in the growing renewable biogas market. Fuel cells are an ideal distributed generation solution for these markets because they excel at converting waste problems into clean energy solutions.

California leads the nation in the adoption of clean energy. Legislation was passed in April that increases the clean energy requirement of the state's renewable portfolio standard from 20% to 33%. Our California markets are gaining critical mass as customers gain experience with our products and make repeat purchases or service business references.

The new California administration continues to be supportive of clean and renewable energy distributed generation. The administration is developing plans to deploy 12,000 megawatts of distributed generation by 2020. We are participating in the process of determining strategies to realize this goal.

Globally, there's growing appreciation for clean distributed baseload generation. Power generation challenges in select areas of Asia and Europe illustrate the value proposition of Direct FuelCells. Our globalization strategy is moving forward in Europe as we continue our discussions with multiple prospective partners there.

Earlier this year, we marked our entry into England when The Crown Estates ordered a DFC power plant for its Quadrant 3 redevelopment project in Central London.

Our advanced technology programs are focused on areas of research and technologies that have strong prospects for commercialization. During the second quarter, we received an $11.7 million award from the Department of Energy for phase 3 of the Solid State Energy Conversion Alliance program, better known as the SECA program. We have also received 2 awards totaling $1.7 million under DOE program to demonstrate advanced biogas desulfurization technology that could lower operating costs for units running our renewable biogas.

The Environmental Protection Agency awarded us a contract to evaluate our fuel cell power plant's ability to separate CO2 from industrial emissions. In short, our power plants provide multiple value streams for our customers: ultra-clean power, high-quality, usable heat and hydrogen. CO2 separation would add a fourth value stream with a large market potential.

Operational excellence is the foundation of our path to company profitability. The cost per megawatt class products has been reduced by more than 60% since they were first commercialized in 2003, and our products are now profitable.

Our cost-to-ratio continues to improve and excluding the repair and upgrade program charge was 1.08:1 for the second quarter. Higher volumes will drive further cost reduction and expand sales opportunities within our markets.

During 2010, we increased our production rate by 50%, to 35 megawatts annually. We increased production another 60% again during our second quarter to 56 megawatts in response to increasing order flow. This is another great accomplishment by our SCE associates.

An added benefit of the recent POSCO order is our ability to plan level loading of the fuel cell kit production or plan [ph] the United States. This will yield manufacturing and supply-chain efficiencies, helping to further reduce our costs.

We have an ambitious but achievable vision: provide ultra-clean, efficient distributed generation baseload power to lessen the cost of grid-delivered electricity without incentives. We have reached grid parity in certain high-cost regions, and we believe by continuing to focus on cost reduction with reasonable volume expectations, we'll be able to achieve parity with grid pricing in the near term.

At the same time that our cost per kilowatt hour of DFC fuel cell power plants is decreasing, the cost per kilowatt hour essentially generated power is increasing because of the need for additional investment in new capacity and transmission infrastructure.

Finally, customer satisfaction has and will continue to be a key driver of our installed base growth, which has increased at the rate of over 40% annually over the last 4 years. A sizable segment of our growing backlog and service agreements of up to 20 years in duration, which all of our customers have executed. As our customer base continues to grow, this will generate other additional and adjacent services, giving us a large opportunity to build out our service model and grow this revenue stream.

Revenue from recurring services will smooth out quarter-to-quarter earnings while generating additional profit margin.

The pace of FuelCell Energy's growth is accelerating. We are globalizing our business, penetrating key markets and focusing on top line revenue growth.

Increasing at steady production volumes will allow us to achieve manufacturing, supply-chain efficiencies and organizational leverage. As new orders grow, our product and service backlog increased revenue will lead to company profitability.

Source: SeekingAlpha.com