interview with andrew neilson (LON:CFU) is a leading developer...

interview with andrew neilson
(LON:CFU) is a leading developer of solid oxide fuel cell technologies dual listed on the London AIM Market and Australian ASX Market. The company is developing micro heat and power (mCHP) and distributed generation units to generate clean heat and electricity for homes from natural gas. Yesterday morning the company made two announcements that show how both the business and the climate surrounding the adoption of these technologies is progressing. We spoke to Andrew Neilson (Group General Manager - Commercial), on the phone to Melbourne about these announcements and on the general outlook for Ceramic Fuel Cells.
Over the last six months the company has started taking orders for its BlueGen fuel cell generator recording 17 orders as of the last quarterly cashflow report on April 29th and a further 30 a day later. The first of these BlueGen units was delivered to VicUrban, the Victorian governments residential housing developer. Yesterday the company announced that the unit is performing as expected. Its generating about twice the amount of power used by the average home in Melbourne on an annualised basis.

Q. Before we go onto more general questions, can you comment on todays update about the VicUrban installation? [1]
VicUrban is responsible for managing new residential developments in Victoria and as a government body they also have a mandate to encourage energy efficiency, sustainability and emerging technologies. They are putting three BlueGen units into their sites, the first was commissioned in this housing development at the end of April... and its running and performing well at an electrical efficiency of 58%.
We are starting to deliver and install orders taken over last 6 months, which will continue progressively over next month or two. We have the beginnings of a mini production line out here and are starting to ship some units, some have been installed in Germany. Generally speaking we wont give updates to the market when each unit has been installed, but as this was the first we wanted to give people an update but for future units we will just include an update in our quarterly update.

Q. Can you comment similarly on the second announcement? [2]
Its a bit more general and of more interest to our Australian shareholders. The Federal Government had tried to introduce a carbon trading scheme thats now been put on the back burner, so they are now preferentially making energy efficiency their priority. The Prime Minister has now set up a task force on energy efficiency and quite a few of the submissions to the task force made the point that distributed generation, small scale generation and in particular fuel cells are an important way of reducing emissions and increasing efficiency. This is a chance to reassure our local shareholders that were not the only ones who think this is a good idea!

Q. Can you describe the differences between the BlueGen and the integrated Combined Heat and Power units (mCHP)?
You are right that we are developing integrated products as well, in the UK, France and Germany. The integrated product includes the same core fuel cell module which we call Gennex which runs on natural gas as fuel but the integrated product also has a condensing boiler included. So the integrated product will provide power, hot water as well as additional heat for space heating . It is designed for markets that need a sophisticated heating solution, Western Europe, East Coast of the US, and BlueGen is designed for markets that dont need sophisticated heating - Southern Europe, West Coast of the US. But BlueGen is also perfect for homes within other markets that dont need sophisticated heating.
So just to explain that, if you are living in Germany or the UK and youve got a perfectly good home boiler system, but you are interested in low emission power then BlueGen could be an add on product. Its not a replacement for a complete home heating system, it could be an add on product for homes that have a perfectly good heating system but just want to have access to low emission power.
Typically CHP technologies produce a lot of heat, but a small amount of power - e.g. a internal combustion engine or a Stirling engine. They are primarily heating systems, whereas we are the opposite - power generators with a little bit of heat.

Q. So you can export excess power to the grid?
The average home in Melbourne uses about 6000kWH of electricity per year, in the UK about 4500kWH, so typically in markets where youve got a feed-in-tariff like the UK the ability to generate more power than the home consumes over the course of a year creates a revenue opportunity. You effectively become a mini Power Station. So to put that into context, the range of average annual consumptions varies from Japan which is quite low at 4000kWH up to 12-15,000kWH for the West Coast of the US, primarily because of air conditioning use. When you are looking at CHP technologies its important to understand how much power it will produce over the course of the year, which will give you an idea of whether the product will provide half, all or 200% of the homes requirement.

Q. Could you elaborate on feed-in-tariffs, capital subsidies and your European focus?
The Europeans were ahead of the curve on this. So back in 2004 we listed on ASX and shortly after hired our first UK staff. From 2004 to mid-2009 we were really focused on the Western European market. The reasons for that are the Europeans had the emissions trading scheme. Its not directly relevant to us as we arent really a carbon play, but it has helped create an environment where utilities and others have to think about and put a value on energy efficiency.
And in certain markets there are more specific incentives - in Germany theres the feed-in-tariff - which has now been introduced in the UK. Certainly feed-in-tariffs are important for UK market. It also helps to send a strong signal to many other markets that if they want to reduce emissions, then sure encourage renewables, but recognise that renewables arent the only answer - there are other technologies out there.
Generally speaking what weve found is that most feed-in-tariffs are restricted to renewables typically small scale solar, certainly thats the case here in Australia, but as policy makers start to look further into the opportunities they realise it makes sense to broaden the FITs to other technologies that reduce emissions which is why the UK includes an FIT for small scale combined heat and power units. We think feed-in-tariffs are a sensible policy because they reward the outcome you are looking for which is efficient electricity. Capital subsidies are a reasonably blunt instrument - which tend not to reward the right outcome. In Australia the solar PV capital subsidies have encouraged a race to the bottom - manufacturers tend to source the lowest cost product which typically has lower efficiency and poorer output which doesnt reward the outcome you want.
Editor - For more information on UK Feed in Tariffs - click here

Q. Ceramic Fuel Cells is often compared with Ceres Power Hldgs (LON:CWR) as you are both AIM Listed Solid Oxide fuel cell companies aimed at a similar market space. Who are your other main competitors in Europe?
Other companies targeting the same market space in Europe, include Topsoe in Denmark (a similar fuel cell technology, tending to larger units ), Hexis in Switzerland (a small company developing a similar product ) and Staxera in Germany. Hexis and Topsoe have fully developed systems and Hexis has had early field trials similarly to CFU - but none of them have yet moved into volume manufacturing. We have invested EUR 9.5m into the development of a manufacturing facility in Germany which is designed to produce a capacity of 10,000 fuel cell stacks per year
Another key difference is that none of our competitors have multiple commercial customers or arrangements across multiple markets - [whereas] we think its important to spread our commercial risk and not just rely on one customer or market.

The other main differentiator for us is our very high electrical efficiency. We think to offer value to the end customer the product has to be better than the incumbent technology. The incumbent technology for producing heat in the home is the condensing boiler which is extremely efficient (more than 95%) whereas the incumbent technology for creating power is the [national] grid and when you take out transmission and distribution losses you are looking at about a 35% efficiency. Thats why we have focused on electrical efficiency because we can do it better than the grid and electricity is more valuable than heat. The peak electrical efficiency we have achieved a 60% efficiency [for our Gennex fuel cell stack] which is far ahead of any other technology and any other fuel cell in small scale generation.

Q. Where and where are the biggest market opportunities for Ceramic Fuel Cells?
There is no shortage of interest or demand. If you think simplistically about the market potential, its every house that has a connection to the Natural gas Pipeline. We arent worried about a lack of demand we are more worried about scaling up in a managed or a sensible way creating the best conditions for those early customers to come back for more [larger] orders.
In terms of market take up, we think Germany will be the biggest market [in the short term] and the UK [close behind]. The Netherlands has an extremely high domestic gas penetration. France has a lower emissions profile due to the high nuclear penetration but in spite of this we are working with GDF Suez which has 11 million customers http://www.cfcl.com.au/Partners/. Other good potential markets are in Italy and Spain. Outside Europe, we are selling into Australia. Its quite a small market, but its still important to us we are based here and we have a lot of Australian shareholders. It can take quite some time to penetrate the Japan market, but if youve got patience it can be quite big. Further afield the West Coast of the US. California is introducing large incentives for gas generation.
Medium to Long term, youd have to look at China, India and Brazil - but wed need to get the product quite a bit cheaper for those markets to take it on.

Q. Youve been picking up sales momentum for the BlueGen product. One of our readers has posed the question of when you will generate fully commercial sales. Could you comment on that?Interest is picking up, we are deliberately starting off with non residential consumers, mainly utilities in Germany, Switzerland and the Netherlands and some government organisations particularly in Australia. Typically utilities and governments can afford to pay more than the average home owner. Its important for us to recover the costs of the early units which are reasonably high in low volumes. We are selling to non residential customers first, we get lots of calls and emails asking to buy units.
Regarding residential sales, If we wanted to we could sell thousands in a short space of time, the constraint or the challenge for us is to be able to scale up our manufacturing. To sensibly go from 5 units to a thousand takes time. We also need to make sure we have the installation and support network in place, the plumbers and electricians to install the products and provide the after sale service. Thats not difficult, its just a practical matter of getting the right people trained on the ground.
We need people to have a positive experience from our products. We see the utilities as being the most likely customers for our products in volume. We wont sell directly to homeowners. In the UK we will sell through resellers and distributors, the types of organisations that already sell and install home energy systems, Solar PV, heat pumps etc. In other markets, e.g. Germany, it will more likely be the utilities themselves.
We think the destination is for the utilities to roll these products out in volume, but in the short term well be happy to sell through other distribution channels in order to get the products out there, volumes up, costs down and seed the market. Appliance companies could be another distribution channel - they have the network of skilled tradespeople.

Q. What is the groups current financial situation and when will you reach breakeven?
Cash at the end of the last quarter was 10.1m and the underlying cash outflow was higher than in previous quarters... as we placed large component orders . The quarterly cashflow figures are also a little bit thrown around by foreign exchange movements, so I would encourage you to strip those out when you are looking at the underlying cashflow .... We are comfortable with the cash position , with early sales revenue coming through . We will need to start to investing in working capital, so as we start to build up stock and inventory to supply demand we will obviously need to buy all the components in order to turn them into products and generate the revenue. [3]
The equipment we have in the factory has the capacity to make 10,000 units per year. Weve got plenty of capacity there. We have taken the decision to invest shareholders money in building the plant, investing roundabout EUR 9.5m. On our projections we reach breakeven well below 10,000 units per year. Less than half of that should let us reach cashflow positive.
When we reach that point comes down to the balance between going after volume or maintaining a high average selling price. We get a lot of shareholders coming to us saying why dont you sell 5000 units for 8000. We are confident we could do that, but we dont think its in shareholders best interests to do that when weve got customers willing to pay a lot more than that. It also significiantly increases the risk in deploying the product. If we need to replace a widget on the BlueGen units wed rather replace it on 200 units than 2000. So it is a bit of a balance between going after volume and maintaining high initial prices in order to make sure were not loss leading.

Q. What keeps you up at night?
The biggest challenge over the next 6-12 months will be rolling out product, installing it and providing a good service so that those early customers have a positive experience and ideally place larger follow on orders. But its also managing the challenge of taking the technology from an R&D and development phase, where engineers and scientists can continually tweak and improve the product, to a manufacturing and product sales environment. The product needs to be manufactured for a sensible cost and needs to be reliable. Weve cracked the efficiency, but the main focus is on making it last for a long time. Its the same challenge for all fuel cell companies.

Q. How easy do you find it is to generate press and broker coverage?
It is a bit of a challenge. On the broker side, we typically we have enthusiastic supporters within houses, but [other than our house broker] not formal research coverage Broker houses only write about stocks where they get enough commission on the trades to justify the cost of the analyst. It can be a challenge for Australian company to generate traction in the UK. We are familiar with lots of brokers and come across twice per year and Hogarth PR maintain the momentum.

Thanks to Andrew for providing us with such an in depth update.