FuelCell Energy's (FCEL) CEO Chip Bottone on Q2 2016 Results - Earnings Call Transcript

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FuelCell Energy, Inc. (NASDAQ:FCEL) Q2 2016 Earnings Conference Call June 9, 2016 10:00 AM ET


Kurt Goddard - Vice President Investor Relations

Chip Bottone - President and Chief Executive Officer

Michael Bishop - Senior Vice President, Chief Financial Officer, Treasurer and Corporate Secretary


Eric Stine - Craig-Hallum Capital Group LLC

Sven Eenmaa - Stifel, Nicolaus and Company

Carter Driscoll - FBR Capital Markets

Jeff Osborne - Cowen and Company

Craig Irwin - ROTH Capital Partners

Anne Crow - Edison


Good day, ladies and gentlemen, and welcome to the FuelCell Energy reports second quarter 2016 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. [Operator Instructions]

I would like to introduce your host for today's conference, Mr. Kurt Goddard, Vice President, Investor Relations. Sir, you may begin.

Kurt Goddard

Good morning and welcome to the second quarter 2016 earnings call for FuelCell Energy. Yesterday evening, FuelCell Energy released financial results for the second quarter of 2016. The earnings release as well as a presentation that will be referenced during this earnings call is available on the Investor Relations section of the company Web site at www.fuelcellenergy.com. A replay of this call will be available two hours after its conclusion on the company Web site.

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 US Securities and Exchange Commission.

Delivering remarks today will be Chip Bottone, President and Chief Executive Officer, and Mike Bishop, Senior Vice President and Chief Financial Officer.

Now, I would like to turn the call over to Chip Bottone. Chip?

Chip Bottone

Thank you, Kurt. Good morning, everyone, and welcome. Please turn to slide four, Q2 2016 highlights. One key aspect of our strategy is to seek relationships with the leading and largest companies in our markets, whether as strategic partners or customers. While this may be challenging at times and requires patience, it builds credibility and is very productive in the long run.

Our May 5 joint announcement with ExxonMobil is an excellent example of this strategy. By aligning with the global leader in sequestration, economical and efficient carbon capture using fuel cells is a potential game-changing development.

ExxonMobil possesses world-class research and development capabilities as well as global reach and extensive resources. We are understandably excited about the prospects for advancing our fuel cell carbon capture solution with ExxonMobil.

Our project development team has been advancing numerous multi-megawatt projects. As a result, more than 125 MW of projects have been bid competitively into various RFPs. Also, we anticipate additional multi-megawatt projects will be bid this summer. I will address this very active and attractive pipeline in detail later in the call.

Recently, we completed the commissioning of a high-efficiency, hybrid fuel cell power plant and a natural gas pressure let-down station. The power plant and let-down station is owned by our peak customer, United Illuminating, now a subsidiary of AVANGRID.

Combining its fuel cell plant with an energy recovery generator, the system showcases the versatility and efficiency of our proprietary designs and our value proposition for gas pipeline operators. Engineer to recover energy that would normally be lost during the gas let-down pressure reduction process, our solution provides electrical efficiencies of 60% or higher by converting under-used energy into electricity.

During the second quarter, we continued to optimize our installed base. As we will discuss in more detail later in the call, we do not expect any further charges from actions like this in 2016. As our company grows, certain projects undertaken for sound reasons years ago may no longer make sense today. These optimization actions address changing customer circumstances and position us for future expected margin expansion in our services business.

We’re moving forward with the first phase of our planned two-phase expansion of our North American manufacturing facility. This prudently timed and financed capacity expansion provides near-term operating cost reductions as well as ensures that we meet future demand forecasted to arise from RFP awards and the potential for global applications.

To support our growth, we’re continuing to strengthen and diversify our capital structure. This was illustrated by the recent announcement that we closed a long-term loan facility with Hercules Capital, a leading debt provider.

I will update you our activity and markets in greater detail after Mike reviews our financial results for the quarter. Mike?

Michael Bishop

Thank you, Chip. Good morning and thank you for joining our call today. Please turn to slide five titled financial summary.

FuelCell Energy reported total revenues for the second quarter of 2016 of $28.6 million comparable to the prior year period. For the second quarter of 2016, a gross loss of $200,000 was incurred compared to a gross profit of $2 million for the same period last year. Higher service expense recognized in the quarter and lower Advanced Technology activity in this period negatively impacted margins.

Financial results include two non-recurring charges totaling approximately $2 million related to service agreements for legacy projects. One charge was related to the early termination of a sub-megawatt installation that we chose to exit. The original waste gas solution at this installation was no longer possible, so exiting the sub-megawatt site made sense at this time.

The other charge was also related to a legacy project involving a final extension of the service contract at the customer's option. The customer likes this project, although the service agreement profitability profile is not consistent with our current agreement. These actions reflect continued initiatives to optimize the service business and expand future market potential.

Operating expenses totaled $12.6 million for the second quarter of 2016 compared to $10.8 million for the prior year period. Extensive project development activities combined with targeted and accelerated R&D expenditures to further enhance our product offerings drove this year-over-year increase.

Net loss to common shareholders for the second quarter was $16.2 million or $0.56 per basic and diluted share. This compares to $10.7 million or $0.44 per basic and diluted share in the second quarter of 2015. The company’s cash, restricted cash, and financing availability totaled $169 million at April 30, 2016.

Backlog increased sequentially for the fourth consecutive quarter, totaling approximately $411 million. Service backlog totaled $295 million. Product backlog totaled $51 million or 24 MW. And Advanced Technology contract backlog totaled $65 million. These numbers do not include the Beacon Falls project or other projects bid into request for proposals or notices of awards that have been received for which we have not yet executed definitive agreements.

Turning to the inventory and project assets graph towards the right of the slide, inventory remained relatively flat from fiscal year-end, while both short and long-term project assets increased with continued construction of projects. Long-term project assets includes two projects under construction that we anticipate financing under the PNC Energy Capital facility later this year once the power plants are operational as well as UCI project which closed financing and entered commercial operations earlier this year.

Short-term project assets primarily reflect the Pfizer project, which is under construction and expected to enter commercial operations in our fourth fiscal quarter. With strong project asset inventory and cash balances, the total assets on our balance sheet as of April 30, 2016 exceeded $300 million.

During second quarter of 2016, we closed on an additional debt facility extended by Hercules Capital. We now have several financing facilities highlighted on the bottom of the slide that support project development, each targeting different project ownership structures. The Hercules facility is structured as working capital financing supporting potential projects such as Beacon Falls where we are selling fuel cell power plants to the project developer. The extensive underwriting diligence performed by Hercules is an additional point of validation of our business model.

The multiyear committed NRG facility is designed for construction period financing for projects that we are developing. Once the plants are operational, the project can continue to be financed under this facility by NRG or sold to a project investor.

The PNC Energy Capital facility in essence provides 100% loan-to-value financing for projects we developed and may choose to retain and recognize high-margin electricity revenue over the life of the underlying power purchase agreement or PPA.

And finally, we have financial support from the State of Connecticut for the phased capacity expansion that we are undertaking. The state extended debt facilities are up to 50% forgivable upon reaching certain job creation and retention targets.

So to summarize, access to capital supports our project development activities and positions us for near-term growth.

Please turn to slide six titled financial targets. Previously, we had forecasted fiscal 2016 revenue to be in the range of $170 million to 210 million. Additive to this range is the PNC Energy Capital $30 million tax equity facility which was forecasted to be fully utilized and resultant recognizing electricity revenue over the life of the project. Due to the pace of potential bid award announcements in 2016, full year 2016 revenue is now forecasted to be in the range of $140 million to $170 million. We also continue to expect full utilization of the tax equity facility for projects that we currently have under construction.

Previously, we have shared targeted production ranges that are expected to lead to EBITDA and net income breakeven with the lower end of the range reflecting a sales mix oriented towards complete power plants and the upper end of the range oriented towards a mix that includes Asian sales of fuel cell kits.

With 120 megawatt POSCO kit order nearing conclusion at the end of the fiscal year, we are sharing updated targets which do not include Asian sales. Our breakeven points in terms of production volume are now lower, given the mix of complete power plants that are installed by FuelCell Energy, driving engineering, procurement and construction or EPC revenue and margins, lower product and service costs, and also margin from our growing Advanced Technology business.

The upper end of the range is also the sale of complete power plants, but without the same degree of EPC revenue and margin as some projects may not involve FuelCell Energy providing EPC services.

In closing, we have been optimizing our business and adding capital availability, while actively developing projects and further enhancing our product offerings. I like how the company is positioned today as we work hard to close new projects and drive revenue growth.

I will now turn the call back to Chip. Chip?

Chip Bottone

Thank you, Mike. Please turn to slide seven, project development update. Our business is supply and recovery of energy for an increasing number of applications globally. We create strong stakeholder value propositions with attractive financial returns for investors using a proven common technology platform.

I’ll provide updates on progress on our three primary markets, which are preferred resources for ultraclean distributor power generation, emissions reductions with carbon capture and distributed hydrogen for transportation.

Our team has been focused on developing projects for bidding into high-quality clean energy RFPs. A number of RFPs have been issued in 2016, in which we were activity participating. I’ll go through some of these key RFPs to give you an indication of what we're offering and the potential for awards as these projects represent significant future growth opportunities for us.

As announced previously, the 63 MW Beacon Falls Energy Park was bidded for the tri-state RFP in January of 2016. We feel this clean energy project is very competitively priced and brings benefits to the tri-state region as competing bids do not.

It provides ratepayers with affordable and ultraclean power generation in the region, enhancing the resiliency of supply. This project also drives and pays for desirable natural gas, electrical and water infrastructure for the state and region that will help with adjacent economic development and directly benefits ratepayers.

In comparison, many competing bids will require the construction of transmission lines, to connect the region to distant power generation sources. Beacon Falls is the only fuel cell project bid into this RFP, illustrating our focus on utility scale applications.

The Beacon Falls Energy Park also presents a superior economic development profile versus competing submissions. Because of the unique operating characteristics, fuel cell projects like these can be installed in densely populated environments where they provide significant benefits for regional economics.

This project will generate property and sales tax. And because it is located in a region and utilizes locally manufactured equipment, it provides income and payroll tax benefits as well. Competing technologies manufactured overseas and installed outside the region cannot begin to provide this level of regional economic impact.

If awarded, the Beacon Falls Energy Park will generate an estimated $90 million in tax revenue at local and state level for the life of the project, about three times the tax revenues that will be generated by competing solar projects of similar size. It will also generate approximately five times the amount of renewable energy credits or RECs as a similar sized solar array due to low availability for solar in the region. RECs assists states in reaching its renewable energy portfolio standards and represents significant monetary value for a project.

The potential revenue value of the Beacon Falls project to FuelCell Energy is more than $500 million, including both equipment and services revenue. According to the wording of the tri-state RFP, the valuation phase of the process will be complete by the end of July, bidder notification and contract awards are scheduled to occur subsequent to the evaluation phase, likely in late summer or the fall of 2016. If awarded, we expect the project will be executed multiple phases, beginning in 2016. Project financing discussions are in progress.

Our project development, government relations and sales teams have been actively engaged in developing a variety of other projects while also working hard to ensure the fuel cell attributes are understood by utilities and regulators and appropriately valued in RFPs.

We’re witnessing and better structured RFPs compared to just a few years ago. Regulating bodies and an increasing number of utilities are seeing the competitiveness of our fuel cell parks and now see these as an asset group which is increased interest and activity. We are pleased to see the Connecticut Department of Energy and Environmental Protection issued another RFP for clean energy projects in the range of 2 to 20 MWs as it seeks to procure clean and affordable distributed power to enhance grid resiliency. FuelCell Energy submitted multiple bids, total in excess of 50 MW in potential value to us of more than $500 million in this RFP. These are projects that we’ve been developing for a period of time and which we feel are well suited to meet the needs of the ratepayers and the state. We anticipate that decisions will be announced during the fall of 2016.

Recently, public enterprise services group, PSE&G, issued an RFP that seeks up to 40 MW of fuel cell projects in the range of 1 to 20 MW for multiple specific locations within its service area of Long Island and New York.

Like Connecticut’s DEEP, Long Island’s PSE&G wants to enhance grid resiliency with clean and affordable distributive power generation. By identifying specific regions on Long Island that need additional power generation, PSE&G is seeking to defer investment in new transmission infrastructure. In July, PSE&G will be publishing additional information to identify the specific locations for which they’re seeking fuel cell power plants and will state the amount of power needed for each location. Respondents can begin submitting proposals on August 1.

FuelCell Energy has been developing projects on Long Island in anticipation of this opportunity and will submit several projects into this RFP. PSE&G solicitation is a good example of the improvement we're seeing in the quality of RFP being issued. In this case, we are pleased to see the fuel cell-only RFP, one that values the unique attributes of clean fuel cell power generation as part of LIPA’s portfolio.

With their compact footprint and quiet operation, fuel cell power plants are easy to site in high population density areas like Long Island because it does not require large amounts of land and can be sited where power is needed. Long Island power generation with fuel cells will help PSE&G to generate environmentally responsible distributive power, while avoiding the high cost permitting challenges and inefficiency of power transmission and avoiding the peaking power needed to support intermittent power generation. Land-scarce regions like Long Island drive up the cost of intermittent generation as so much land is needed to generate the annual megawatt hours of power needed at the utility scale.

We also have bids into other RFPs beyond those just mentioned.

I would also like to briefly comment on the expected extension of the investment tax credit for fuel cells and other so-called Section 48 technologies. The senior leadership of both parties, of both the US House and Senate, publicly committed to correct what they described as an oversight error within the ITC regulation, promising to address this year, and we are confident this will occur.

Our recently announced partnership on deploying affordable carbon capture system further strengthens the attractiveness of this extension based on our ability to affordably reduce emissions from power generation plants and the opportunity to scale for export.

Our current business is global, so activities in Europe and Asia are not impacted by the ITC. Additionally, all of the projects in our backlog will be completed in 2016 within the window of existing legislation. We continue to focus on operational cost reductions in different configurations of our power plants, such as the 3.7 MW configuration that increases electrical efficiency, which allows us to retain our competitiveness.

Under our agreement E.ON, we’re installing a 1.4 MW power plant at FRIATEC AG's German headquarters and production facility in Mannheim. This customer side of the meter project is on schedule for a September ceremony that will be attended by several E.ON executives, dignitaries and potential customers. We're working with E.ON on a number of additional prospective projects both in Germany as well as other European countries where E.ON operates.

We recently announced that our South Korean partner, POSCO, has started construction on a new 20 MW fuel cell park in Seoul, South Korea for a repeat utility customer. POSCO’s customer, the largest utility in South Korea, will buy the power, the largest district heating system in South Korea will buy the heat. With their continuous power output and strong credit profiles of their power and heat offtakers, fuel cell parks attract private capital.

POSCO’s project pipeline is now in excess of 400 MW. This figure includes a number of multi-megawatt fuel cell parks as well as some large on-site applications that POSCO is pursuing.

Please turn to slide 8, ExxonMobil CCS. In response to the growing global demand for technologies to reduce carbon dioxide emissions, we have been developing innovative carbon capture solutions for coal and gas-fired power plants. These are large global markets with significant potential.

The power sector alone represents the greatest global greenhouse gas reduction opportunity. The challenge has been the lack of carbon capture technologies that are both efficient and affordable. Our carbon capture solution involves – solves this problem in a novel way. Because carbon capture is a side reaction of a normal electrochemical power generation process occurring within our carbon in fuel cells, our carbon capture system efficiently concentrates the carbon dioxide to generate power at the same time.

Because these systems generate a revenue stream of electricity, they provide power plant operators a way to meet their compliance obligations, while receiving a return on their investments as compared to simply an increase in operating expenses.

As our company continues to develop our innovative carbon capture solution, we could not have found a stronger partner than ExxonMobil. The company's extensive research capabilities and vast mobile resources will accelerate deployment and are expected to lead to faster adoption and help to grow the market with our systems.

Recognized as the global leader in sequestration, ExxonMobil has been seeking a capture technology that is both affordable and efficient. As we indicated in our joint announcement, ExxonMobil’s top leadership believes that utilizing carbon fuel cells for carbon capture has the potential to substantially reduce the cost that could lead to a more economic pathway towards large-scale applications globally.

Another important attribute of carbon capture using fuel cells is that they eliminate about 70% of the smog-producing nitrogen oxide in the flue gas of a coal or gas-fired power plant. Conventional carbon capture methods cannot do this.

With approximately $260 billion in annual revenues and 75,000 employees, ExxonMobil is the largest public producer of natural gas and possesses world-class industry-leading research facilities that are backed by an extensive global resource. ExxonMobil is measuring the size of this global market in gigawatts, bearing in mind that a single gigawatt is equal to 1000 MW. 1000 MW of projects will translate into multibillion dollars of revenue for FuelCell Energy.

ExxonMobil is deeply committed to achieving measurable reductions in carbon emissions globally and has been working in this field for some time. With this agreement in place, activities have begun that will have meaningful favorable financial impact on us short-term and much larger and sustainable impact longer-term.

Our next step is to announce the location of our megawatt-scale pilot plant project. We are in discussions with several potentially site hosts and expect to make our selection and announcement within the third quarter.

Our joint announcement with ExxonMobil immediately generated considerable interest around the world. Each party has different drivers for use for the carbon capture solution. For example, beyond the emissions reductions needed for power generation, the European Union is searching for ways to reduce carbon dioxide emissions without inhibiting economic growth, particularly for industries such as steel and cement production.

This situation underscores the flexibility, ease of deployment, and our value proposition. Because we reduce carbon dioxide emissions while simultaneously generating revenue streams of ultra-clean power, our carbon capture solution can help European cement and steel producers reduce their carbon emissions economically, without sacrificing competitiveness or jobs.

Lastly, let me touch on an activity for on-site production of clean, affordable, high-purity hydrogen. Interest continues to gain traction, including interest from ExxonMobil as well as a variety of parties that are involved in fuel-cell electric vehicles and the needed hydrogen fueling infrastructure.

We continue to advance our strategy of siting fuel cell power plants using renewable biogas that generate power, heat and affordable carbon-negative hydrogen for fuel cell electric vehicles. We expect to have project announcements near-term this year.

Please turn to slide nine, summary. More than 125 MW of projects utilizing our ultraclean and efficient fuel cell solutions have been bidded to RFPs in 2016. We expect additional submittals will be made this summer. Decisions on most awards are expected over the next several months. We continue to advance multiple project installations expanding our customers and service base globally. We have begun the first of a two-phase expansion of our North American manufacturing facility, providing near-term operating efficiencies, decreasing our breakeven and additional capacity needed to meet future forecast of demand.

We strive to partner with the world’s leading companies. Our recent affiliation with ExxonMobil, one of the world’s largest and most prestigious energy companies has the potential to dramatically accelerate the development and deployment of our carbon capture systems, a global opportunity measured in gigawatts or thousands of megawatts. Because they economically capture CO2 and generate ultraclean power simultaneously, these solutions are a potential game-changer. ExxonMobil is bringing its world-class R&D, global reach and vast resources to the table, helping to generate enthusiasm and interest for our technology in global markets.

Finally, we expanded access to financing through Hercules Capital, giving our company additional financial strength for growth. This is an exciting time for our company, partners, customers, and shareholders. We appreciate your support and look forward to updating you as events unfold. Operator, we’ll be happy to take questions at this time.

Question-and-Answer Session


Certainly. [Operator Instructions] And our first question comes from the line of Eric Stine of Craig-Hallum. Your line is now open.

Eric Stine

Good morning, guys. My first question, just is related to the guidance. Maybe you can just provide a little more color there. So is this a case of, those RFPs are out there and the timing of awards is slower than you anticipated and will have less of an impact on 2016. And then also, as part of that, you mentioned that you think Pfizer, that that project is up and running in fourth quarter. Is the guidance – the new guidance, does that have to do with the timing of monetizing that and selling that project or how should we think about that?

Michael Bishop

Sure. Eric, good morning. This is Mike. I think you characterized that correctly, Eric. As we put out this guidance at the end of last year and as we were thinking about the timing of the bids that we knew we were participating in in 2016, thought those would come along a little bit sooner than they have. Our bid activity, as Chip mentioned, has been very strong. We do expect awards to come out of multiple RFPs and certainly that will begin to impact the fourth quarter and then going in 2017. So that’s the change in the guidance.

As you mentioned, Pfizer, we are completing commercial operations in the fourth quarter, construction of that site is going very well, and we would expect that to come through revenue recognition in the fourth quarter as that project is completed.

Eric Stine

Okay, got it. That’s helpful. Just wanted to turn to E.ON, you gave an update on that first project. Just curious what you think it means to have a reference site there and maybe just talk about how you see E.ON’s pipeline once that first project is up and running?

Chip Bottone

Eric, good morning. This is Chip. Thanks for joining. Look, we have other activity, megawatt-scale things going on with them. But, certainly, having the first megawatt installation of a fuel cell in Europe is a pretty big deal, particularly where it is. Mannheim is an industrial type area and we see other opportunities for these and larger projects in Germany. So I think – I would say also they have a pretty broad reach across Europe and they’re helping us with both sides of E.ON, I should say. There’s the E.ON side, which is the commercial business, and then there’s the Uniper side as well, which is the ones that retain the assets.

So I’m pleased with what we’re doing there and the recognition of how we fit into the future of the business.

Eric Stine

Okay, got it. Maybe last one for me, I know you put out the Asia update, I believe it was last week. One thing that caught my eye there, just talking about distributed hydrogen and carbon capture, so maybe you can talk about what the pipeline looks like for those two applications in Asia. And just to clarify, that is outside the POSCO license agreement, is that right?

Chip Bottone

Eric, this is Chip. Yes, you're correct on that. Relative to the activity, there’s activity in Europe as well. You asked about Asia, but this carbon capture subject is a global one, particularly if you think about China and India. And I mentioned in my remarks, one of the great things about working with Exxon is they’re a global company, but this represents a huge opportunity for export for us, and we’re uniquely positioned to get that.

But on the hydrogen side, similar story, little more targeted. In Europe, there's a lot of interest for work in specific projects. More to follow on that, and then the biggest driver on hydrogen would be Japan and Korea at the moment in Asia. So we have discussions going on on those topics as well.

Eric Stine

Okay. Thanks a lot.


Thank you. Our next question comes from Sven Eenmaa of Stifel. Your line is now open.

Sven Eenmaa

Yes. Thanks for taking my question. I first wanted to ask about your – actually your energy generation costs to see whether there are any updates in terms of where you currently stand in terms of cents per kilowatt hour cost to generate from your fuel-cell plants and what is the roadmap here?

Chip Bottone

Sven, good morning. This is Chip. Let me take that. Obviously, the way we bid these projects is on a turnkey basis and what really matters is the cents per kilowatt hour. So I'm not really at liberty to divulge those things from a pure public perspective. But I would say this that when I said in my comments here that we’ve competitively bid these projects, we obviously know what the market bears. We know what other technologies can deliver power for, and we’re right there with everybody else if not better. And when you throw in the attributes as I tried to explain a little bit about how these people are evaluating the other things that we provide, we have very attractive offerings, and I would say that, in a nutshell, over the last several years, that attractiveness has probably improved by about a third. And then there’s still more to go, Sven, so we’re on a good track to make sure that we can be competitive with anything else that’s out there.

Sven Eenmaa

Got it. That’s very helpful. Second, wanted to ask about the POSCO relationship, and you mentioned also the pipeline of projects in Korea. What is your expectation of that conversion of that pipeline? And what are the expectations in terms of fuel cell kit sales into Asian markets beyond 2016?

Chip Bottone

Let me start. Maybe Mike has something to add to that. Let me just explain a little about the market. So the market – and what drives the market in Korea is quite different than here and other places in the world. What they have done is they have a policy in place that says they want so much new and renewable energy, fuel cells are the major driver of that over a period of time. The power companies, which are primarily government owned there, then go out and submit license request to the government, Sven, to say, can you build these plants; and long story short is, there’s hundreds of megawatts of licenses out there and basically now it's up to POSCO primarily to go out and find those sites or execute contracts with those utility companies. There’s a handful of them.

You might also know that POSCO Energy itself is the largest independent power producer in the country. So between POSCO themselves and the other power companies, those are our customers, an example is again we don’t announce these things until they’re finalized agreements as Mike made reference to. But the project that they announced that we knew a lot about, we’re involved in some of the contract details was a 20 MW project for the largest utility company there, so things again aren’t just linear there. But what is nice about there is the potential, and frankly, the roadmap there is a lot more visible than it is in some of the other markets that we have, so we’re bullish on that particular market and our position.

Sven Eenmaa

Got it.

Michael Bishop

Sven, this is Mike. Just to be complete on the question, I’ll take the question about the Asia sales beyond 2016. As we’ve talked about in the past, POSCO has been building their manufacturing facility. That is complete and on line now and producing cells. We had been planning with POSCO for this time. Our current order of kits ends at the end of 2016. As you know, that’s pretty low margin business for us, so we will be replacing our manufacturing capacity in the US with higher-margin EPC orders from the US and Europe. And that led to the reduced breakeven targets that we share today. We now expect EBITDA breakeven in the range of 50 to 60 MW with that kit volume coming out.

So POSCO is certainly capable of producing the equipment they need to satisfy their market in Asia. As they produce and deliver equipment, we get a royalty on what comes out of their manufacturing facility at 3% of their sales pricing.

Sven Eenmaa

Very helpful. And the last question, I wanted to just clarify the $2 million of non-recurring charges you refer to, was that all in cost of goods sold? And finally, what are the expectations in terms of OpEx spending in the coming quarters?

Michael Bishop

Yeah, sure. So, yeah, that was included in service cost of goods sold, as I mentioned in my remarks. As far as operating expenses, we did say in my remarks that we did increase OpEx a little bit in the second quarter as we had all of this bid and proposal activity as well as some product enhancements that we are working on on the R&D line, notably the high-efficiency fuel-cell which will go into production next year. So I’d say from just a quarterly basis, this is kind of the high point. We would expect this year and OpEx will be either at this level or slightly below as we continue through the fiscal year.

Sven Eenmaa

Got it. Thank you.


Thank you. Our next question comes from Carter Driscoll of FBR Bank.

Carter Driscoll

Good morning, guys.

Chip Bottone

Morning, Carter.

Carter Driscoll

First question is, just going back to the guidance and the award timing, I think previously you have talked about expectations, at least in fiscal 2016, that you would get some revenue from Beacon Falls. It sounds like the timing of that is towards the latter part of your initial expectations. Do you still expect some revenue contribution from Beacon Falls in this fiscal year?

And then maybe just any color or nuance you could give as to why you think some of these awards have been pushed out? Is the normal bureaucracy? Because a lot of these are from state and municipal level. Any color you can provide? And I have a couple of follow-ups. Thank you.

Michael Bishop

Sure, Carter. I’ll start and I’ll let Chip jump in towards the end. So as you mentioned, we did update guidance and it is taking into account the expected timing from bid awards. We would expect revenue recognition later in fiscal 2016 from new awards, whether it be Beacon Falls or other projects. We do have inventory on hand that can be rapidly deployed late in the third quarter and the fourth quarter as we begin to get project awards. As we take contracts, our contracts are always shovel-ready, so we’re able to execute pretty quickly after contract signing.

As far as timing, the awards that we were bidding into had public notification date that had a range anywhere from April to July. That range, certainly for the bigger projects, is trailing towards the later part of it. So that’s really the answer to that part of question, Carter.

Carter Driscoll

Can you talk about your quoting activity outside of state/municipal RFPs? Obviously, you’ve addressed Pfizer, but maybe more on the commercial side. Can you talk about what you’re bidding into or maybe how that pipeline is comprised for what you just updated today?

Chip Bottone

Yeah, Carter. This is Chip. Let me take that one here. I highlighted primarily the utility side. Remember, there’s two sides of our business. There’s utility scale, which are generally RFPs generated, and then there’s the, what we call, on-site opportunities. There’s a whole laundry list of projects there that we’re working on as well that don't have those same timetables. They could – in fact, they’re shorter than that.

So we have two different teams of people focusing on different opportunities. That process on the on-site power thing has a more diversified portfolio of customers, both geographically and across markets. But, yeah, there’ll be some of those that come in as well.

Carter Driscoll

You talked recently about the average project size increasing, in particular for on-site. Has there been any noticeable uptick and/or flattening in the average size for what you’re currently addressing?

Michael Bishop

It’s a different scale, right? The smallest project we’ll do on the on-site is 1.4 MW, but those are ticking up to be 2.8s or more. And on the utility side, yeah, they’re definitely going higher. We don’t anything below about 4 MW or 5 MW now and then they go up to 20 MWs. And we have projects, as you know in Beacon Falls, that are in 60 MWs. So the idea of a 100 MW project is not out of the question for us today with the economics that we can deliver.

Carter Driscoll

Maybe next question, just talking about – you, obviously, give a lot of detail about the recent announcement with ExxonMobil. You updated us on site selection for the DoE project timing there. Have you narrowed it down to any particular sites? Is there a final sight selection, maybe timing? And whether you expect potentially any revenue from that first phase this year?

And then I think there was, obviously, noticeable wildfires in the Alberta region. Does that have any effect on potential opportunity with some of those that you talked about earlier?

Chip Bottone

So that’s a great question. Thank you for bringing that up. Here are the facts. So we, obviously, have been doing work with Exxon before this recent announcement, but we weren’t at liberty to talk about it. And we actually – this project that we have, to build this pilot plant, we actually had in hand before the Exxon announcement. And what's really happened is we waited on that because we knew we were going to get this agreement with Exxon. And not have Exxon, they are actually going to be involved in that particular project, Carter, as a partner with us and the site host. We kind of put that on hold until we got them in the fold here and now we’re fully engaged with multiple site hosts. In fact, we got people on the road with the Exxon folks meeting those subject things. So more to follow on that. That's going to pick up pace and that will happen quickly.

Relative to the revenue recognition in this year, yes, there will be a significant revenue recognition from not just that project, but from Advanced Technologies business in general. As you saw, the backlog went up pretty sizably. It’s over $60 million now. But as we’re going through that route, as I mentioned in my note, in my comments, all of a sudden, people started calling us about, what about doing carbon capture, oil sands, steel industry or whatever. And we can pursue those opportunities as well in parallel. So I would say, more to follow on that. But that's a good thing that we have a broader base of interest than we had before.

Carter Driscoll

It sounds as though, in general, it was mostly an RFP award pushout, timing in general, that caused the guidance to be lowered at least for fiscal 2016. Does that have any effect on phase two of expansion in Torrington or how do you think about executing on that next leg?

Chip Bottone

All these things come in – the things got pushed out – as Mike talked about earlier, we had to get project financing in line. We did some more of that. As far as the expansion, that’s moving ahead because the first phase of that is as much a cost reduction exercise for us to lower our run rate, as we talked about, or a breakeven rate, as well as making the facility bigger where we consolidate things and not plan for future growth. Now, that’s moving ahead just as previously planned. Some of that is funded by the State of Connecticut which we have received those funds. So that’s moving forward, Carter.

Carter Driscoll

Appreciate your time. I’ll get back in queue.

Chip Bottone



Thank you. Our next question comes from Jeff Osborne of Cowen and Company. Your line is now open.

Jeff Osborne

Good morning and thanks for all the details so far. I was just hoping, Chip, that you could address – I think it was the Korea Herald that had a report about POSCO and some job cuts and delays in some of their projects. It doesn't seem to reconcile well with your analysis of the Asian backlog that you reported a few weeks ago. A, did you see the report? And, B, I guess, what were your thoughts?

Chip Bottone

Well, first of all, Jeff, thank you for asking the question. And, yes, I’ve seen the report. Obviously, we know what’s going on around the world.

But, to your point, let me just be clear on the record on that. There are some comments made that I think from an industry source or I forget how they characterize themselves – that POSCO Energy is the largest independent power producer in Korea. A small portion of their business is from the fuel-cell business. They’re a multibillion-dollar total business. But I think the article was trying to focus in on some of the challenges they were having, which was primarily a result of overbuilding in some of these different core baseload power plants. Remember, the fuel-cell business is focusing on this new and renewable energy piece of that, which is going forward anyway, Jeff.

So somehow it got – some of the comments about retirement got mixed up with all that. But, in fact, POSCO just received this 20 MW order. We’re working on that for a while and there’s more to come in the pipeline. So this idea that they’re not accepting orders, I don’t know where that came from.

But let me address the retirement issue. Look, we know what they do. We’re talking to these guys every day. In fact, we have people over there or whatever. And their relationship with us is actually closer than ever by their own desire and frankly ours as well.

And what we were working with them on is a way to optimize their business from multiple ways, but one of them was, obviously, people – operating expenses. So, yes, there is an effort to reduce some of the people, the headcount, in the fuel cell business, specifically. There are broader things that they’re doing in the business relative to fuel-cell. But that’s a coordinated effort with us because, frankly, they’re going through a different place. They had a lot of built up as they brought manufacturing in there fairly quickly that we now can optimize with us doing some things, equally in engineering. They had some things they were doing because they're trying to localize so many things. So, Jeff, I’d say this is more of a natural business-related activity than anything other than it would be portrayed.

Jeff Osborne

Got it. No, that’s great to hear. A couple other just random questions here on – Mike, on the OpEx trajectory, I think your response to Sven’s question or somebody else you asked, you have consistent OpEx over the remainder of this fiscal year. But given you’ve kind of got this super-cycle of bids that you’re participating in, do you anticipate next year that OpEx would stay at this level or potentially be lower? I’m just trying to look at the puts and takes of the timing of all of these awards that you're participating in.

Michael Bishop

Yeah. Hi, Jeff. Good morning and thank you for the questions. As I said, we see this quarter OpEx kind of at the high point. We would expect this fiscal year, and certainly going into next year, we want to get leverage out of this business. We’re staffed up well right now. We’re executing well on our product enhancements. Those will come into production into next year, so don't expect any major changes in OpEx going forward.

Jeff Osborne

Good to hear. Just a couple other quick ones here. On the optimization of the two plants that you mentioned, are there any other facilities from five, seven years ago that this type of issue might pop up over the coming quarters or do you feel like you’ve scrubbed the issue with other plants?

Chip Bottone

Yeah. Jeff, I think I’ll take that. I’ll let Mike add to it. But I said in my comments that we’re done with that. We had some of that in the first quarter as well. And I would say that all these things were done in a very amicable way. These contracts go back five to ten years ago and, at the time, it was a good idea, but circumstances change. So that's taken care of and we’re moving forward with happy customers.

Jeff Osborne

Good to hear. And then, Mike, what was the interest rate? It might be in the 10-Q when that comes out. But on the Hercules facility, what’s the rate on that and is there any notable covenants that we need to be aware of, either in terms of working capital or minimum cash balances, that type of thing?

Michael Bishop

Sure. Jeff, the cash interest rate on the Hercules note is 19.5%. The note is interest-only for at least the first 12 months and we have the opportunity, if we hit certain milestones, for that interest-only period to expand up to two years, which is really helpful from a working capital financing perspective, which was the goal of the note.

And what was the second part of your question? I’m sorry, Jeff.

Jeff Osborne

Is there any minimum working capital or cash balances that we just need to monitor…?

Michael Bishop

Yes. The only financial covenant is maintaining an unrestricted cash balance of 75% of whatever we have outstanding on that note.

Jeff Osborne

Okay, got it. And the last question, I guess, strategically, how do you think about not looking for the price on the PPAs, but as you bid in these auctions and RFPs, as it relates to the tax credit, for example, doesn't get on the July 15 FAA extension bill. You’re then moving into the timing of the primaries and you’ve got the election in November. So you’re probably looking, at least in my view, more of a retroactive extension some point early next year. But looking at the timing of the PSE&G bid, in particular, you need to put in your price somewhere before that period in the fall. So, I guess, just strategically, how do you go about approaching these RFPs? I assume, is the game plan, if we move beyond July 15 and you don't have an extension that you just make the assumption that it is; and perhaps, if you're awarded it, you can drag your feet and move slowly and wait for it. I guess I just don’t know how logistically that would work.

Chip Bottone

Jeff, I’m in this pretty deeply with some of the highest levels of the government. So I'm very confident it will get done. And like I said, it doesn’t have any impact on our business this year. And when you look at shipments and revenue next year, if we get that even at the end of the year or beginning of next year, we’ll still be fine. And if all else fails, we’re in a position now which is kind of a nice thing given the nature of the products and cost and things like that that if we had to we could absorb it. It's not ideal. But the primary thing is it’s going to happen. It’s going to happen.

Jeff Osborne

Got it.

Chip Bottone

Washington works in strange ways.

Jeff Osborne

Isn’t that the truth? Definitely. All right. Good stuff. Thanks, guys.

Chip Bottone

Thanks, Jeff.


Thank you. Our next question comes from Craig Irwin of ROTH Capital Partners. Your line is now open.

Craig Irwin

Hi. Good morning and thank you for taking my questions. So first thing I wanted to ask for a little bit more color on is the changes that you made to get to the lower megawatt production targets for EBITDA, net income breakeven. If you could share any detail there, that would be helpful.

Michael Bishop

Good morning, Craig. This is Mike. Sure. As we are modeling the business now, it's really – the biggest driver is removing the POSCO kit sales as we talked about multiple times. The sales of those kits are very low margin. So pulling those out of the model and then bringing in much higher margin EPC turnkey projects that we’re doing in the US and Europe and we target margins on those projects in low to mid-teens. And then, of course, service is additive to that, which we target in the low to mid-20s. So those are the major changes. Some kind of additional changes that we also think about as we’re thinking about breakeven is contributions from other parts of the business. So as Chip mentioned, Advanced Technology backlog, that is increasing. We expect that to run at a higher rate, at a more profitable rate than it has run in the past, which also contribute to the lower breakeven level.

Chip Bottone

I would just add, Craig, and we’re always looking for operating expense reduction, product cost reduction, et cetera, et cetera, and we’ve been working really, really hard on that and have good results. Even though we don't make money per se with the kit sales, what that does do is that allows us volume through the supply chain, which does help with the overall product cost. So as POSCO comes online with their own production, the supply chain will continue to deliver, and yet we don't have the burden of the no margin on the volume going through our plant. So it kind of unwinds itself in a very positive way.

Craig Irwin

Okay. So then, if we look at this, if I'm going to sort of step back a little bit, we all knew that POSCO was going to roll off at the end of the year. We've all known that it's very low margin. So it sounds like we can simplify and say the EPC stuff is possibly higher profitability and the technology contracts that you booked were not in original guidance. So how long do you expect the technology contracts to remain a key part of the uplift for profitability for the company? And on the EPC side, are the margins that you expect to book for this year similar to what's in your pipeline?

Chip Bottone

That was about three questions there. So I forget the first one, Craig, but the second one was Advanced Technologies, I think. That business – this company started as an R&D business. That was kind of what we did. And then few years ago, we were doing a lot of work there on new applications, which ultimately turned into commercial products. It was a cost center, not a profit center. The big changes, that's becoming a profit center for us. And I can tell you that while the backlog has increased, the pipeline of activity is advance. So that model will – as Mike said, part of that is transformation of the business. That’s another one that sometimes is overlooked that will generate some very positive margins for us for a sustainable period of time.

I can’t remember the other question.

Michael Bishop

I’ll take it. So, Craig, as far as profitability of the pipeline, as I mentioned, we see EPC – we target EPC profitability in the low to mid-teens and then service about that. Certainly, over time, we’re going to push those numbers up. As I mentioned, we do have new products that will be coming into production in late 2017. The biggest example of that is the high-efficiency fuel cell. That can deliver 60% electrical efficiencies, so that reduces the overall fuel cost of a project over a long period of time, pushing down the LCOE. So value should accrue back to fuel cell energy for that product being out in the marketplace. And then, of course, we’re also working hard to extend the life and the power output of the core technology. So it’s all of those rollout. We do expect margins to grow to the business over time.

Craig Irwin

Great. And then last subject I wanted to hit on was the investment tax credit. So can you maybe give us color on how much of the updated guidance for 2016 you would associate with delays in fixing the investment tax credit? I know there has been public discussion about ITC creating complications, a little for LIPA. I would assume it is elsewhere. And, Chip, we'd heard that you were in DC last week with Exxon, walking around, visiting our good legislators. What we're hearing is, this gets attached to the Puerto Rico debt relief bill. If you have any color there or if you would maybe point us in another direction, that would be helpful. Thank you.

Chip Bottone

I guess you’re tracking my every move here, Craig, but anyway no problem. So, first of all, the ITC question has zero impact on our 2016 numbers because everything I said we’re going to get done. The current tax credit is that everything has to be operational by the end of 2016, which is December when our year ends in 2016 or end of October and everything we can get done by that period of time.

Relative to what’s happening, just maybe to educate the audience here, so this is a tax bill. Therefore, it has to be on a major bill that has tax implications and there are several of those potential tax bills that the Congress is working on. One is the FAA bill. One is, as you said, is the Puerto Rico bill. There’s some others, Craig. So, yeah, we’re working to get that amendment, as we call it, put on any number of those tax kind of bills. I don’t know if it will be specifically Puerto Rico. There’s a number of them. But at the end of the year, there’s a wrap-up kind of omnibus that happens every year to do these things if it doesn’t get done, which is why, as I said to Jeff, I’m very confident that it will get done because nobody is against it. All the leaders, House and Senate, are in favor of it. And it’s just a question of finding the right bill, frankly, to put it on that gets done because it’s not about our amendment, it’s about the other bills that might have some things in there that people might be debating like Puerto Rico and some other things.

Craig Irwin

Yeah. And just if I could share from our DC contacts we hear, you message of, hey, we compete against solar, this isn’t exactly fair, and these are US jobs, don’t make them go away. Those two messages are really resonating. So we look forward to the positive outcome there.

Chip Bottone

You mentioned Exxon, just to be clear, the new news there, the reason for the tax credit was right, fairness and all of the things you said. The mistake that was made by Congress was an omission and it need to be fixed. But the new news, when you show up with Exxon, you realize that this carbon capture thing does a lot for coal, does a lot for clean energy, does a lot for gas. But all of a sudden, you have an opportunity not just to solve some of the domestic problems in an affordable way, but all of a sudden, this thing is a tremendous tool to solve some of the bigger challenges of the two biggest polluting nations in the world right now which is China and India. So that’s exports. So this is all jobs. It’s kind of the reverse of the solar panels where somebody else is shipping it in. We want to be the ones shipping it out. So there’s bipartisan support when you start to throw that in there as well, so it just kind of strengthens our story.

Craig Irwin

Thanks again for taking my questions.

Chip Bottone

Great question. Thank you.


Thank you. Our next question comes Anne Crow of Edison. Your line is now open.

Anne Crow

Good morning. Thank you for taking my question. I had originally wanted to ask about expansion in Europe, but that's been very thoroughly covered in other responses. But I'd like to take the opportunity to ask about the technology. Clearly, you're no longer an early-stage company where technology is all you have to talk about. But I was wondering, are you doing any improvements on the carbonate technology at the moment? And if so, in what areas? And secondly, when do you think you're going to have the solid oxide fuel cell technology commercially available?

Chip Bottone

Good afternoon, Anne. This is Chip. Let me take that. And if I miss anything, Mike could fill in. But your first question was, what are improvements or things to the current carbonate fuel cell. And the answer to that, there’s many. We’ve made public discussions. Obviously, we’re looking to extend the life of the cells, which we’re actively pursuing and that's going fine. We put together some new versions that now have the electrical efficiency growing from 47% to 60%. I can go on and on. But, basically, we continue to make that apply to more applications in a more affordable way around the world. Many of those things that we’re looking to improve would apply to Europe as well.

Relative to solid oxide, we do have a set solid oxide technology, a company that we acquired several years ago, called Versa Power. And there’s really two parts to that business, Anne. One is small-scale products for distributive generation and the technology is different than carbonate. It does lend itself to scaling down and it has some higher – it has about 60% electrical efficiency, et cetera, et cetera. But really the other piece of that is that that product lends itself to a storage application. By way of the fact that you can run that to produce either hydrogen or use the hydrogen and produce electricity. So there's more to follow on that topic. That's an exciting market today. Probably on one of the future analyst calls or earnings calls, we’ll bring that up. But we are pursuing, primarily at this point, early commercial R&D projects with the solid oxide technology that will eventually be a global offering for us.

Anne Crow

Thank you. I look forward to the analyst call where you're talking about that in more depth.

Chip Bottone

Thank you.


Thank you. And at this time, I would like to turn the call over to Mr. Chip Bottone, Chief Executive Officer, for any closing remarks.

Chip Bottone

Thank you very much, everybody, for joining today. Hopefully, what you took away from the call is that we’ve got a lot of activities that will both happen in the near term as well as have a tremendous impact on the company. Our strategy, as I mentioned in my comments, was to work with the biggest companies in the world, not just Exxon, but if you think about E.ON and the others, that’s what we’ve done. We can’t always control time, but we only have one way to do things and that's the right way. The fundamentals of this company have never been stronger. We’ve got great people doing great things. We get compliments every day from some of these biggest companies or governments in the world. So I think, as Mike said, we’re well positioned for the future here. So we thank you for your good comments. And we look forward to talking to you here on the next earnings call. Have a great day, everybody.


Ladies and gentlemen, thank you for your participation on today’s conference. This concludes your program. You may now disconnect. Everyone, have a great day.

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