FuelCell CEO Discusses Q3 2010 Results - Earnings Call Transcript

Operator

Good day, ladies and gentlemen. And welcome to the FuelCell Energy Reports Third Quarter 2010 results conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time.

I would now like to introduce your host for today's conference, Kurt Goddard, Vice President of Investor Relations.

Kurt Goddard

Good morning and welcome to the third quarter earning call for FuelCell Energy. Delivering remarks today will be R. Daniel Brdar, Chairman and Chief Executive Officer; and Joseph G. 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 two 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 FuelCell 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 call -- turn the call over to Dan Brdar. Dan?

R. Daniel Brdar

Thank you, Kurt and thank you for joining us this morning. Policy makers, power producers and energy consumers worldwide are turning to FuelCell because their unique attributes allow them to solve acute energy, environmental and business problems that other technologies cannot.

Our FuelCell technology helps South Korea achieve their low carbon green energy goals, allows agriculture and municipal customers to transform waste problems into renewable energy solutions and generates reliable secure power for commercial and government facilities.

We are the world's only manufacturer of commercial megawatt-class fuel cells for base load power generation. Our products provide energy solution because they use a variety of fuels like renewable biogas or plentiful natural gas to generate ultra clean base load electric power where it is needed. They do this more cleanly, quietly and efficiently than combustion-based technologies and they produce power continuously unlike wind and solar.

Beginning in 2012, South Korea's renewable portfolio standard mandates close to 6,000 megawatts of additional renewable energy over the next decade. POSCO Power, our partner in South Korea, is expanding their facilities and we expect to capture a large share of this market. In the U.S., the problem solving abilities of fuel cells, Government incentives and loosening credit markets contribute to expansion in key vertical markets and multiple orders.

We received three orders totaling 3.4 megawatts in the third quarter followed by three more orders in August totaling 2.6 megawatts for a total of 6 megawatts of products for commercial, government and utility projects.

These actions point to increase in order volume in the near term as projects in our growing sales pipeline move to closure and we are taking steps now to preserve for producing higher volumes of our products.

I’ll get into more detail about our results after, Joe Mahler, our Chief Financial Officer reviews the financials for the quarter. Joe?

Joseph G. Mahler

Thank you, Dan, and good morning, everyone. FuelCell Energy reported total revenues for the third quarter of 2010 of $18.9 million compared to $23 million in the same period last year. Product sales and revenue in the third quarter were $16.2 million compared to $18.7 million in the prior year quarter and $13 million for the second quarter of 2010.

Revenues increased over the second quarter on U.S. order flow. The company's product sales backlog including long-term service agreements totaled $79.8 million as of July 31, 2010 compared to $104.8 million as of July 31, 2009 and $75.5 million as of April 30, 2010. Orders received to date in the fourth quarter of 2010 will add $13.1 million to product revenue backlog.

Product margins measured on a dollar basis improved over the prior year quarter by $3.7 million driven by sales of higher margin megawatt-class modules. The product cost-to-revenue ratio of 1.24 to 1 in the third quarter compared to 1.4 in the third quarter of 2009 and 1.47 in the second quarter of 2010. This improvement in the cost profile reflects continuing success in reducing product and manufacturing costs while enhancing the technology.

Research and Development contract revenue was $2.7 million for the third quarter of 2010 compared to $4.3 million for the third quarter of 2009. The company's research and development backlog totaled $7.4 million as of July 31, 2010 compared to $15.3 million as of July 31, 2009 and $9.9 million as of April 30, 2010.

The company has a number of DOE research and development awards worth about $5 million in contract negotiations and is currently proposing Phase III of the solid oxide contract to DOE with an estimated total value of approximately $30 million.

Total cash and investments in U.S. treasuries were $67.8 million as of July 31, 2010. Net cash used for the third quarter was $8 million excluding net proceeds of $32.1 million from the public offering of common stock. Net cash used for the second quarter of 2010 for comparison purposes was $13.8 million, cash used benefited from lower expenditures and higher receipts from new orders received in the quarter.

Capital spending for the third quarter was $300,000 and depreciation expense was $1.8 million. For the nine months ended July 31, 2010, FuelCell Energy reported revenue of $50.1 million compared to $67.6 million for the comparable prior year period. The product sales and revenues were $42 million compared to $57.1 million for the comparable prior year period as the sales mix shifted to FuelCell components from complete power plants.

Net loss to common shareholders for the nine months improved by $10.4 million. The primary driver with that margin for product sales and revenue improved by $11.6 million over the prior year period due to sales of higher margin megawatt-class products.

On the order and financing front, customers are telling us that their access to capital is improving and recent orders, contracts and negotiations in our pipeline indicate this. We are in active discussions with several parties on the Connecticut projects and also with the department of energy on our Phase II loan application.

We see creative financial solutions employing tax free bonding in California as well as customers deploying their own capital to solve business problems with our fuel cells. Our products help to solve business, economic and environmental issues and we see effort in the marketplace to get FuelCell projects done. We are working these to closure.

Before I close, I would like to re-enforce our message that we are at the inflection point where volume alone will enable company profitability. Our costs are on target and we are focused on closing the orders in our pipeline. Dan?

R. Daniel Brdar

Thank you, Joe. As we prepare for higher production rates on our path to profitability, FuelCell Energy’s business strategy is focused on driving product costs down while growing our key geographic and vertical markets. Our cost reduction program has successfully reduced the unit cost of our megawatt-class products by more than 60% and this is reflected in the improving margins in our financials.

The confluence of both policy initiatives like the South Korean RPS and active and growing order pipeline in the U.S. and expansion in key vertical markets will drive orders and higher manufacturing volumes.

In South Korea, our largest market, the RPS passed in March by the national assembly has created a strong market for fuel cells. Due to the high cost of imported fuel and the poor wind and solar profiles of the Korean peninsula, fuel cell has an excellent green energy solution for South Korea and the Government has designated fuel cells as a key economic driver.

To accelerate the adoption of renewable energy alternatives, the South Korean legislature adopted a far sided and aggressive renewable portfolio standard. The RPS requires 350 megawatts of additional renewable energy per year for 2016 and 700 megawatts per year for 2022, accumulative target of nearly 6000 megawatts.

Fuel cells fully qualify under the Korean RPS because they're extremely clean, highly efficient and can operate on natural gas or renewable bio gas. Our product transforms these fuels into electricity with up to twice the efficiency of conventional technologies resulting in significantly lower green house gas submissions because they do not combus fuel, our fuel cells emit virtually no harmful pollutions unlike combustion-based distributed generation.

An ideal form of distributed generation, our products are easily sited due to the small footprint quiet operation and competitive costs compared with large conventional power plants and their associated transmission lines. Our byproduct heat can be used for commercial or industrial purposes and combined heat and power applications where system efficiencies can reach 90% depending on the application.

FuelCell Energy has a major presence in this market already. POSCO has purchased approximately 59 megawatts of our power plants and fuel cell components today. Our South Korean strategy is based on a long-term licensing agreement with POSCO under which they assemble power plants using fuel cell components supplied by FuelCell Energy.

This strategy allows us to leverage our manufacturing capacity and capture overseas market opportunities. POSCO build a balance-of-plant facility in Pohang. It is now constructing an adjacent fuel cell module facility that is on schedule to be completed by year end. These facilities will have an annual capacity of 100 megawatts.

In support of this project, we are procuring fuel cell stack module assembly and conditioning equipment for POSCO, demonstrating its confidence in the market for FuelCell Power in South Korea and a solid commitment to our long-term partnership. POSCO has invested more than $100 million in their FuelCell facilities and business.

The South Korean RPS will drive orders as POSCO seeks to fully utilize its expanding capacity. We are currently in discussions with POSCO on their order for 2011 deliveries and expect a detail of the Korean RPS pricing mechanism to be finalized by the Korean Government in the very near term.

In the U.S., we received two orders totaling 3.1 megawatts during the third quarter and subsequently received another three orders totaling 2.6 megawatts. These orders demonstrate our customer satisfaction with our products and the growing understanding that fuel cells can solve problems for utilities, agricultural operations, municipalities, food and beverage processors, military installations and other customers needing ultra clean distributed power.

California is setting the pace for clean energy policy in the U.S. In April, the California public utility commission authorized 5.6 megawatts of FuelCell projects to be sited at four state universities. These projects will be the first megawatt-class utility owned fuel cells in the U.S.

In May, following the commission's decision, Pacific Gas and Electric ordered two 1.4 megawatt DFC1500 power plants for Cal State University East Bay and San Francisco State University.

These units will be operational early next year and both power plant also be configured to use the byproduct heat from the fuel cells for facility and swimming pool heating. These units will provide a first-hand opportunity for U.S. utility to become knowledgeable about large scale stationary fuel cells and the problems they can solve for utilities.

These power plants will operate on clean natural gas which is plentiful here in North America. Because of their low emissions, high efficiency and quite operation, these units are an excellent example of how utilities in California and other states can use clean distributed generation to meet their clean air and green house gas emission targets, enhance the reliability of the transmission and distribution systems and relieve grid congestion.

Additionally, we are discussing -- discussions regarding the installation of 2.8 megawatts of FuelCell Power plants at the other two university campuses approved by the California public utility commission. In August, we announced two orders for Fuel Cell Power plants in California.

G3 Power Systems ordered a 1.4 megawatt DFC1500 to be installed at Olivera Egg Ranch located in California. The power plant will run on renewable biogas obtained from ranch operations that will convert a significant agricultural waste problem into clean energy solutions.

The waste from the agricultural operations emit ammonia, methane and other gases creating acute environmental and disposable challenges. All of their egg ranch will install an anaerobic digester in which heat and micro-organism will reduce the volume of waste and create a methane-rich biogas as a byproduct. The power plant will utilize 100% of the methane-rich biogas and fill nearly all of the ranches power needs.

The by-product heat of the fuel cells will used by the anaerobic digester eliminating the need for a combustion boiler. Our fuel cells are well suited for agriculture and food and beverage processing as proven by other installations in California such as the Sierra Nevada Brewerie and Gill's Onions, a food processor.

Olivera is our first animal waste agricultural project and chose how fuel cells can be applied to cell multiple business, energy and environmental problems. They lower the owners’ power costs and insure reliable supply of renewable power while reducing green house gas emissions and virtually eliminating the emission of pollutants.

At the same time, they solve a significant waste disposal problem for the agricultural operation. The problems associated with agricultural waste are significant challenge in many parts of the country.

In California, dairy production alone is estimated to generate several hundred megawatts of waste each year that can be converted to ultra clean renewable energy employing the same approach being used at Oliver Egg Ranch. We now have multiple projects in our sales pipeline based on the same concept.

In August, Eastern Municipal Water District in southern California ordered two 300-kilowatt DFC300 FuelCell power plants for the Perris Valley Regional Water Reclamation Facility in Riverside County.

Following Eastern Municipal’s prior purchase of three DFC300 power plants in 2007 for its Moreno Valley facility, this order demonstrates the customer satisfaction with our products.

These power plants will operate on renewable biogas obtained from the waste water treatment plant in a highly efficient combined heat and power configuration, typical of wastewater treatment facilities.

Our fuel cells are helping Eastern Municipal meet the stringent emission standards of the South Coast Air Quality Management District, the agency responsible for a region that they consider to be the smoggiest in the country.

The use of anaerobic digesters combined with our ultra-clean fuel cells allowed Eastern Municipal and other wastewater treatment facilities to dramatically reduce the volume of waste from their facilities and generate renewable base load power at the same time.

As a result, we have a growing number of wastewater treatment projects in our sales pipeline, moving through the closure process. We expect wastewater in particular and biogas applications in general to be one of our fastest growing market segments, as we become the preferred solution to help these facilities solve their waste problems and power generation needs.

In Connecticut, we received two orders from customers demanding reliable and secure distributed energy. In July, we announced the sale of a 300-kilowatt DFC300 fuel cell power plant to LOGANEnergy, a dedicated fuel cell energy services company that will install the power plant at Carla’s Pasta, a frozen food processing facility in South Windsor.

The plant will provide 60% of the customers power requirements with the byproduct heat used for space heating and production processes. The high efficiency of the fuel cell power plant lowers fuel and electric cost for Carla’s Pasta, while reducing the company's carbon footprint.

Food processing operations like Carla’s Pasta needs reliable power to keep their food processing and cold storage equipment operating around the clock. In August, we also announced the sale of two 300-kilowatt DFC300 fuel cell power plants also the LOGANEnergy to be installed at the U.S. Naval Submarine Base New London in Groton.

The primary home of the U.S. submarine fleet, the base must have secure highly reliable sources of energy. The power plants will be installed near the existing energy plant and will provide base load electricity with the by-product heat being dedicated to the MG plant boiler, reducing fuel costs and carbon emissions.

In addition to the U.S. Navy, we’ve supplied fuel cell power plants to other branches of the U.S. military including the Air Force and Marine Corp helping our arm forces become more energy independent, efficient and secure.

As Joe mentioned earlier, we are in active discussions on multiple financing paths, where the 43.5 megawatts fuel cell projects approved by the Connecticut of Public Utility Control, including commercial financing sources and with the U.S. Department of Energy for a loan guarantee for 27 megawatts of these projects. While both the commercial financing and the loan guarantee process have been slow, our recent discussions on both approaches leave us optimistic about a successful outcome.

In Europe, discussions with perspective customers are progressing well. Europe has always been a leader in green energy and is an untapped market for fuel cells. The European continent is very diverse marketplace geographically and politically. And we anticipate partnering with multiple entities. We are in active negotiations with what we believe will be our, the first of several partnerships for the European market.

And our research and development work, we are demonstrating enormous potential of fuel cells. Our hydrogen co-production concept, the DFC-H2, has been installed as part of a state-of-the art hydrogen vehicle fueling station at the Orange County stations, wastewater facility in California.

It will start up on natural gas and then switch to biogas generated by the wastewater treatment plant and begin co-producing Hydrogen for vehicles early next year. A truly cutting edge technology, the DFC-H2 produces not one but three integrated value streams for customers, electric power, hydrogen for vehicles and heat.

With our partner, Versa Power Systems, we have been meeting the cost and performance objectives of Phase II of a 30.2 million department of energy contract to develop large scale coal-based solid oxide fuel cells.

The ultimate objective of the program is to develop megawatt class solid oxide fuel cell power plants that run on coal-derived syngas thereby reducing greenhouse emissions from coal by 90%. The company is currently in discussions with the DOE for the third phase of the program. And expect a decision from DOE by the end of this year.

With growing momentum in our sales pipeline and order flow in our key markets, we created a Chief Operating Officer position in July. This roll will help position the company for growth as we ramp up production and will insure close integration between manufacturing operations, product development, our quality initiatives and our supply chain.

Tony Rauseo, formerly Vice President of Engineering and Chief Engineer was appointed to fill the position. His strong operational, manufacturing and engineering background will allow us to insure a smooth production ramp.

Fuel cells are an ideal solution for today's energy challenges. In many cases they're the only solution. Fuel cells stationary -- FuelCell Energy stationary fuel cells are helping customers meet clean energy standards, transform waste into renewable energy and generate power, cleanly, quietly, reliablely and securely wherever it is needed around the world.

Fuel cells can solve future energy problem too, co-producing hydrogen for vehicles and extracting clean energy from coal. As a result of the ability of fuel cells to solve a diverse array of problems, we see several significant near-term catalysts for our business.

We anticipate receiving our next order from POSCO Power to support their 2011 needs, now that the South Korean RPS is being finalized. We anticipate a successful conclusion of the next phase of the DOE loan guarantee process or third party financing for some, or all of the projects approved in Connecticut.

And we expect continued order flow from California similar to our recent announcements, as the remaining approved utility projects and the numerous wastewater food and beverage processing and agriculture waste projects in our pipeline are closed.

Increasing order flow from our target markets and a growing recognition of the ability of stationary fuel cells to solve energy and environmental problems, for our customers positions us well to ramp production and move to profitability.

Operator, at this time, we are pleased to take questions from our listening audience.

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