Bloom Energy Corp (BE) 2018 Q3 法說會逐字稿

Good afternoon, and welcome to the Bloom Energy Third Quarter 2018 Earnings Call.

(Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to turn the conference over to Mark Mesler, Vice President of Finance and Investor Relations at Bloom Energy.

Please go ahead.

Thank you very much.

Good morning all, and thank you for joining us on Bloom Energy's third quarter 2018 earnings conference call, our first as a publicly traded company.

To supplement this conference call, we have posted to our Investor Relations website our Q3 2018 shareholder letter as well as some supplemental financial information that we will periodically reference throughout this call.

Please note that this call contains forward-looking information regarding future events and the future financial performance of the company.

We caution you that such statements are predictions based on management's current expectations and beliefs.

Actual results may differ materially as a result of risks and uncertainties that pertain to our business.

We refer you to the company's SEC filings, including the company's quarterly report on Form 10-Q for the fiscal quarter ended June 30, 2018.

These documents discuss important factors that could cause actual results to materially differ from those contained in the company's projections for forward-looking statements.

We assume no obligation to revise any forward-looking statements made on today's call.

During this call and in our Q3 2018 shareholder letter, we refer to GAAP and non-GAAP financial measures.

These non-GAAP financial measures are not prepared in accordance with generally accepted accounting principles.

A reconciliation between GAAP and non-GAAP is included as part of our Q3 2018 shareholder letter.

Joining me on the call today are K.R. Sridhar, Principal Cofounder and Chief Executive Officer; and Randy Furr, Chief Financial Officer.

K.R. and Randy will review the operating and financial highlights for the quarter, and then we will take questions.

I will now turn the call over to K.R.

Hello.

This is K.R., and good afternoon to all of you.

Welcome to our Q3 earnings call, our first as a public company.

In fact, it was during Q3 July 25 that we completed our successful initial public offering on the New York Stock Exchange.

I'm gratified by the response we have seen from the investment community because it tells me there is clear understanding for the need for always-on, clean power in our digital world and how Bloom Energy plays a unique role in providing a viable solution.

So how does this energy landscape look like?

We live in a digital economy, and electricity is the lifeblood.

We see that the centralized electric power grid that we have relied upon for over 100 years is not keeping up with the new demands and we see disruptive threats mounting.

Power service outages pose significant risk to the global economy and to our society.

Simply put, we need reliable and resilient always-on electricity.

This need is driving the transformation of the $2.4 trillion global market for electricity, and we at Bloom Energy offer a capability no other company or technology can provide.

Today, we live in a post-climate change world.

While it remains imperative to combat the causes of climate change, we also have to be become resilient enough to address the disruptive impacts that are already occurring.

We're all too familiar with the tragedies of major hurricanes that are occurring more frequently and with greater severity than ever before.

Hundred-year weather events seem to occur annually these days.

Such events expose the vulnerability of the centralized grid as power lines come down and major power outages compound misery, threaten health, disrupt society and impact our economy.

We are also gaining an understanding of the risks of cyber-attack on our critical infrastructure.

Our national intelligence community is fully united in calling attention to the vulnerability of our electric power grid as one of the most important security challenges.

The consensus is not if but when an attack occurs.

We do see positive signs that government and private sector are beginning to take this risk seriously and are working to secure the grid to the extent possible as well as seek microgrid solutions for certain applications.

We have the challenge of emissions, not only reducing CO2, the need for which is well documented, but also the need to reduce criteria pollutants that threaten the health of local populations.

Finally, we have the global challenge of expanding access to the billion people who are not reached by the central grid model today and another billion plus that are underserved by the legacy model.

A new solution is required to meet these challenges, and this is why the Bloom platform of distributed baseload electricity generation is so important.

Our mission is to make clean, reliable energy affordable for everyone in the world.

To enable this mission, we have developed a unique advanced technology platform that delivers secure, reliable and resilient always-on power with very low emissions on site.

Our solution is behind the customer meter.

We generate power on site where the power is consumed.

This avoids the inherent risks of the exposed transmission and distribution network of the centralized grid.

We deliver a complete solution to the customer with a total delivered cost of electricity that is less expensive than the grid where we deploy today.

We address the biggest challenges of our era: the need for power that won't be interrupted by disruptive events.

The 1.25-megawatt microgrid solution supporting a 3.5 million square feet Osaka Fish Market in Japan exemplifies the resiliency of our solution.

The market's microgrid, deployed in 2015, not only rode unscathed through Typhoon Jebi, the worst in 25 years, but also protected the market from Super Typhoon Lan in 2017 and in June 2018, Osaka earthquake, which was greater than a 6.0 and had its epicenter just 1 kilometer away.

In North Carolina, a Bloom Energy power data center also continued normal operations through both Hurricanes Florence and Michael.

Power that has a very low to 0 net impact on CO2 emissions, the U.S. has reduced energy-related carbon emissions by 14% since 2005.

According to the Energy Information Administration, 61% of this decline can be attributed to the shift from fossil fuels to natural gas.

Bloom Energy Servers convert natural gas to electricity with the highest electrical efficiency of any commercial device, further reducing CO2 emissions.

Today, our platform produces 60% less CO2 emissions than the average of the U.S. grid.

At the same time, we are simultaneously pursuing multiple paths to 0 carbon solutions.

One such path lies in using biogas as a fuel for our Energy Servers.

Today, just under 10% of our deployed fleet of Energy Servers by megawatts deployed utilize directed biogas.

We see a very significant opportunity to directly use biogas from landfills, wastewater treatment plants and agriculture to power our systems.

For example, California generates 80 million MMBtu of economically viable biogas from human activity per year.

This amount of biogas would generate approximately 1.26 gigawatts of electricity using our Bloom Servers, sufficient to power about 1 million American homes.

We previewed a highly efficient solution for generating clean electricity from biogas at the Global Climate Action Summit in San Francisco last September.

The elimination of criteria pollutants is another important factor.

Because we don't burn fuel to generate electricity, we do not produce criteria pollutants.

The reason you can't breathe in cities like Beijing and Delhi is not because of CO2 but because of smog emissions, and we do not produce those emissions, improving respiratory health.

In addition, our systems consume no water during normal operation.

Another criteria is expanding access to unserved populations.

We are already working on solutions that will enable us to address rural populations without access to the grid.

We can solve 2 problems at once by using bio waste as fuel.

This is feasible in part by the on-site nature of our solution.

There is no complicated or expensive process required to aggregate waste and transport it over long distances.

Instead, bio waste can be turned into biogas and used locally to produce 24/7 electricity that is clean with Bloom Energy Servers.

We are piloting solutions today in India and are very excited by the potential of this approach for the future.

You can see from these examples why our solution is so relevant.

We continue to innovate at a rapid pace, but also equally importantly, we are relentlessly bringing down the cost of our solution.

For example, each of the last 3 years, we averaged a greater than 25% reduction in our product cost alone.

Our strategic program to reduce cost has many drivers, including innovation and design and process improvements that are independent of volume.

At the same time, we also have tremendous leverage within our supply base and our own manufacturing operations as our volume increases.

We are optimistic about continuing the strategic programs to bring down cost, harnessing all of the drivers.

Because our solutions address these critical issues and our solutions are increasingly cost effective, we have seen rapid adoption by customers that represent a broad and diverse range of industry leading companies, including 25 of the Fortune 100 companies.

We have seen particular strength in foundational areas of our modern economy that rely on clean, highly reliable power: health care and data centers.

Our solution is unique.

There is no other platform that combines always-on resiliency, clean emissions profile with energy density and cost effectiveness to make a solution practical for customers.

Our exciting business opportunities in South Korea illustrate these points.

We are in the final stages of commissioning a 8.35-megawatt utility-scale solution near Seoul, South Korea.

Land in this area comes at a great premium, and so we developed a solution that we call the Bloom Power Tower that enables us to increase the amount of power that we can pack into the same ground-level space by over threefold, resulting in dramatically improved financial results for the project where land is expensive or constrained.

We see the Bloom Power Tower as a key tool in meeting market requirements around the world for significant power capacity in a very small footprint, for example, dense urban locations in large cities such as Tokyo or New York.

There is one more important aspect that I would like to call attention to.

Unlike other new or emerging energy technologies, this is one in which America has a big lead on the rest of the world.

Bloom represents the best of American innovation and our ability to make things right here in the United States.

We are particularly proud that our solution is adopted by the market.

We are driving high-quality American jobs, including traditional manufacturing jobs.

Our extremely talented employees are our most precious assets.

They are a significant competitive advantage for us in the market, which we want to preserve and protect.

For investors, they are one of the key drivers that will continue to increase the value of the company and one of the key ingredients along with our intellectual property that form a formidable moat around our technical and market leadership.

With that, I would like to give you a high-level summary of why you will see a near-term spike in our stock-based compensation.

Our IPO listing price was well below the option strike price for employees that joined Bloom within the 7 years prior to our IPO.

As a consequence, we made a strategic decision to treat them fairly and bring them to market, and this resulted in a short-term spike in stock-based compensation that Randy will discuss later.

This adjustment is to preserve and protect our most precious asset, our employee base.

After this market adjustment, you will see our stock-based compensation return to normal benchmarks.

Randy will describe this further.

Finally, I would like to discuss the deployment of our backlog, including installations and commissioning of new customer sites that are the key to revenue recognition for the company.

However, on installation, we still have challenges, and we cannot always deploy our systems to customers' sites on our preferred timelines.

The installation process can be unpredictable from a timeline perspective.

Construction and tie in to the utility is required.

And for example, a hospital may only have certain timeframes where they can accommodate this or a retailer may not want to have this work go on during a critical consumer retail season.

Weather events can also impact timing as well as issues such as labor strikes at utility companies that must support the final tie-in to the electrical or gas grid.

These conditions can create a problem for us on timing, and we still have timing predictability issues with our installations.

It is important to recognize that should a planned installation be moved out of a quarter because of such factors, they are not lost revenue.

We have many strategies that we are deploying today, which we believe will eventually reduce the impact of timing risk on our quarterly results.

With that perspective, I would like to invite our CFO, Randy, for -- to further comment on the business performance in Q3.

Randy?

Thanks, K.R. Throughout my prepared remarks, I'll be referring to the slides in the earnings call presentation that Mark referred to earlier.

First, some highlights.

Note that all profit numbers that I reference will exclude stock-based compensation.

So on to Slide 3.

In summary, a very respectable quarter.

Acceptances were 206 systems, a record.

Revenue was $190.2 million, up sequentially from 12.6%.

Gross margin came in at 20.8%.

Our operating income was $5.6 million with adjusted EBITDA coming in at $15.1 million.

EPS was a loss of $0.13; and we ended the quarter with $412 million in cash and short-term investments, and this excludes $36.7 million of PPA cash.

Before I dive into the numbers, I'd like to spend a few minutes at a high level on an overview of Bloom Energy's business model and some of the accounting.

We view ourselves as a technology company that provides a solution, and that solution is providing clean, reliable, resilient and affordable power to our customers.

We provide a prospective customer with a competitive proposal that provides an energy solution that is cleaner, more reliable and generally less expensive than the grid.

For sites where we can provide this value proposition, we execute a contract with the customer.

The execution of the contract results in an order, and that order is entered into backlog.

We generally book orders from our customers for multiple sites at one time, and these sites are most often deployed over multiple quarters.

As such, orders in any 1 quarter tend to be lumpy, so keep in mind that orders tend to be large and lumpy, whereas system deployments or acceptances, as we refer to them, tend to be more linear, as we deploy the systems out of our backlog.

In addition, historically, we've experienced a bit of seasonality to our incoming orders based on customers' budgeting cycles and timing.

Given the lumpiness and this seasonality, we will not be disclosing quarterly orders or backlog information as it may not reflect the true health of our business.

We recognize revenue at the time of system commissioning, so it is at that point that the system moves out of our backlog and onto the P&L.

We refer to this as system acceptance.

Thus, one of our key metrics is period system acceptances as this correlates closely to revenue and is one measure to gauge the overall trajectory of the business.

One other key term we use is system.

System acceptances are in 100-kilowatt equivalents.

We use 100 kilowatt as a base because the very first systems deployed by Bloom Energy, approximately 8 years ago, were 100-kilowatt systems.

Today, about the smallest size of deployment at any one site would be 250 kilowatts.

So a 250-kilowatt site deployment would translate to 2.5 systems in Bloom Energy speak, and 10 systems would translate to 1 megawatt, or if we said total acceptances in the period were 200 systems, that would equate to 20 megawatts of power.

As I previously mentioned in the highlights, we achieved 206 acceptances for Q3 or 20.6 megawatts of power capacity.

This was below the bottom end of our estimates, which was 215 systems and come as a result of construction delays.

However, it was up almost 14% from Q2 '18's 181 acceptances number and 46% increase from Q3 '17's 141 system acceptances.

Let me make a few comments on what drives an order to be an acceptance.

During the time the order is in backlog, we conduct due diligence of the site, perform the site design work, obtain all necessary permits and approvals, construct the systems, start and finish site construction and finally, install and commission the Bloom Energy Servers at the customer's site.

This whole process can take as little as 5 months, but on average, it is more in the 10 months' timeframe to accomplish.

When you review all the steps we go through to get the site commissioned, much of it is outside the control of Bloom.

The process almost always includes approvals from customer, landlord, local city government, the building permits and the gas and electrical utilities and the construction phase includes multiple periodic progressive inspection approvals as well, all outside the control of Bloom.

Bottom line is predicting the timing of acceptances accurately can be difficult and exact on-time acceptance for all of our projects, a real challenge.

So how do we deal with this?

We go into the quarter with a pool of potential sites that could yield and be accepted within the quarter by realizing that some sites will likely not accept in the current quarter and be delayed to the following quarter due to circumstances that are not known at the beginning of the quarter.

Example of unforeseen circumstances are construction delays due to soil issues such as hitting bones from an historic burial site during excavation or utility interconnection crews being unavailable for electrical or gas tie-in due to crews being sent to natural disaster areas such as the massive fires in California, hurricanes in the Southeast or actually even being on a strike.

Generally, we target to yield anywhere from 60% to 75% of the potential pool in any 1 quarter.

This will vary from quarter-to-quarter depending upon the size mix of the sites and the overall stage of completion each site is in at the beginning of the quarter.

Also, before I turn to financial details, I'd like to spend a couple of minutes on GAAP versus operating metrics and the federal investment tax credit.

Beginning in 2018, for external reporting purposes, we simply use GAAP financials adjusted for stock-based comp.

However, I should point out that, historically, prior to 2018, a significant portion of our revenue was treated as ratable, meaning that despite receiving the cash upfront, the revenue for the equipment and installation was recognized over the term of the contract, typically 15 years.

As you might recall and as outlined in our prospectus, we sell under a variety of financing models to our customers, and depending upon which customer financing model is used, the timing of the revenue recognition for the equipment and installation is either all upfront or all over the contract period.

If the revenue was spread over the contract period, again, typically in 15 years, we refer to this as ratable.

Again, to simplify our financials, today, revenue for our product and installation is recognized at the time of commissioning, in other words, upfront and generally in line with when the cash is received.

And the revenue for the service portion of the contract is recognized over the life of the contract as the service is performed.

So in 2018, practically all of our revenue is recognized upfront for equipment and installation.

And because, historically, a portion of our revenue was recognized as ratable, we have provided you with supplemental information in the form of key operating metrics for the prior periods to help you understand the impact of the mix change and help you understand the true trajectory of the business.

Now with this behind us, let's move to some color on the quarter.

I'm going to be referring to Slide 4. The 206 acceptances translates to $190.2 million in revenue, up 12.6% from Q2's $168.9 million and up significantly from last year's GAAP revenue of $93.8 million.

The quarter-over-quarter increase in revenue is attributable to the growth in acceptances.

On a year-over-year basis, from a GAAP perspective, the majority of the increase was attributable to the realization of the federal investment tax credit, which was not available in 2017.

Note, from an operating metrics perspective, year-over-year revenue was up by 89% with some of the increase due to the increase in acceptances but the vast majority due to the reinstatement of ITC in 2018.

Onto Slide 5. As many of you know, cost, and more specifically product cost, is of high importance here at Bloom.

Historically, we have seen an average of annual cost reduction of our product cost of 27% per annum over the last 3 years.

The reduction in product cost comes from a combination of increased system output, cost reductions from component and system modifications, yield improvements, system reliability and from simply volume as we leverage and more fully utilize our investment in our manufacturing assets.

These continuous cost reduction activities have consistently driven improvement in our gross profit and gross margin.

Gross profit, excluding stock-based compensation, improved from $34.7 million in Q2 '18 to $39.5 million in Q3, a 13.8% sequential increase.

Year-over-year comparisons are not particularly meaningful given the absence of ITC in 2017.

As many of you know, we do provide some quarterly estimates, and in our Q2 shareholder letter, we provided you with Q3 average sales price estimates as well as total installed system cost estimates.

Our actual ASPs and TISC exceeded both the top end up of these estimates.

However, as I have previously emphasized, the real key metric is the delta between the 2, which represent our margin on the equipment and installation of the acceptance during the quarter.

The midpoint of the estimated ASP and TISC yielded a delta or margin estimate of [15 50] or $1,550 per kilowatt.

As you can see on Slide 5, our actual margin delta was $1,583, a number above the midpoint of our estimate.

As you can see on Slide 6, operating income in Q3 was $5.6 million, excluding stock-based compensation.

This is up from Q2's $2.6 million and up considerably from Q3 '17's operating income loss realized both from a GAAP and operating metrics standpoint.

Our adjusted EBITDA was up from $12.5 million realized in Q2 of this year to $15.1 million in Q3.

Once again, given the absence of the federal ITC in 2017, year-over-year comparisons are not particularly meaningful.

Nonoperating expenses were per plan and adjusted EPS come in at a loss of $0.13.

Turning to the balance sheet on Slide 7. We ended the quarter with $448.7 million of cash and short-term investments.

This includes $36.7 million of PPA cash.

So excluding PPA cash, we ended with $412 million of cash and short-term investments.

Free cash flow was approximately a negative $0.6 million.

This clearly contrasts with our non-GAAP operating income of $5.6 million.

The difference between the 2 numbers is our investment in working capital to support our substantial increase in installations in Q4.

In general, working capital metrics came in, in line with our expectations.

Referencing Slide 8, days of sales was down 7 days from Q2 to 19 days as we collected cash for a number of our PPA deals within days of their commissioning.

Our days of inventory outstanding was up by 2 days from Q2 to 87 days.

As I just mentioned, our average inventory increased for the quarter to support our Q4 installation schedule.

Our payable days was down from Q2 by 1 day to 34, basically, normal business cycle variations.

At this time, I'd like to clarify what I think might be a couple of misconceptions relative to Bloom.

Some of this confusion might have come from the prospectus, and one of that is customer concentration.

The prospectus uses our financial partners as customers, and given 50% plus of our sales last quarter was under a third-party PPA, for which our financing partner for our current PPA is the Southern Company, so it appears that the Southern Company is a large customer.

In reality, we have multiple customers using this particular PPA for financing, and in Q3, the highest customer concentration we had from any 1 customer was 25%.

To drive home this customer concentration point, if we look at our backlog at the end of Q3, the customer making up the largest portion in terms of systems represents only 21% of our backlog.

The other clarifying point I'd like to make is on our debt.

Of the total $741 million in debt on our balance sheet, $349 million is nonrecourse to Bloom and related to our PPAs.

[While] despite only having a minority ownership interest, we are required to consolidate onto our financials.

Again, I want to stress, this debt is nonrecourse to Bloom.

Of the $392 million remaining, $293 million relates to convertible debt that is well into the money and which we fully expect to eventually be converted into equity.

That leaves $99.1 million for which $95.5 million is our securitized debt instrument and $3.6 million represents a small term loan.

So by backing out the nonrecourse debt as well as the "well into the money" convertible debt, you can see our balance sheet is not highly leveraged.

I also think it appropriate to make a comment about the increase in Bloom's stock-based compensation charges.

Leading up to the time we went public, we knew a very large population of our employees were underwater with respect to their equity and we needed to address the situation.

A significant number of our employees held stock options where the strike price of those options were well above the eventual IPO price.

In fact, the average strike price of those options issued since 2011 was $29.71, and the IPO price is $15.

The result was a large percentage of our employees were underwater with respect to their equity in Bloom, and that gave us obvious concern given the demand for our talent by other companies and the fact that employee equity is common here in the Silicon Valley.

As a result, leading up to the time of the IPO, we issued some RSUs with up to 2-year vesting that was, for all practical purposes, a true-up accounting for the difference in the strike price and the IPO price.

This provided Bloom with market equity and a retention vehicle for our people talent.

The net of this is that we will incur a disproportionately larger stock-based compensation expense for an 8-quarter period starting with Q3 of this year.

And because some of these shares will vest every 6 months, that expense will be higher in earlier quarters.

Of the $71.6 million stock-based compensation charge realized in Q3, approximately $40 million was related to these true-up grants.

That number will be approximately $55 million in Q4 and then will gradually decrease to 0 by Q4 of 2020.

And to illustrate, the true-up portion of the total stock-based compensation charge for Q4 of next year, 2019, will be approximately $15 million, so again, a decline to 0 over the next 2 years.

And once this true-up grant expense rolls off, our stock-based compensation charge, whether you measure it in terms of burn rate or as a percentage of revenue, will be in line with our peer companies.

Changing the conversation to our outlook.

In Q4, we expect acceptances to be between 225 and 275, ASPs to be between $6,495 and $6,845, and our total installed system cost to be between $5,040 and $5,390.

The midpoint of acceptances for Q4 is lower than what we were planning primarily due to one specific anticipated Q4 order and acceptance being pushed to Q1.

Otherwise, the midpoint of our outlook would have been closer to a 300-system acceptance number.

Also, what you will see is a substantial difference in both ASPs and TISC from Q3.

The reason for this is in Q3 we did not have any international acceptances.

However, in Q4, we expect approximately 60% of our total acceptances to be international in Korea.

In Korea, we work with our infantry partner, SK, who performs the installation.

Thus, no installation revenues or costs are included in either the ASP or the TISC for the Korea orders.

And you will also notice that the midpoint delta between the ASP and the TISC is lower than the $1,583 posted in Q3.

This is due to a substantial portion of Q4 acceptances, again, being international, where, today, our margins are lower than in the U.S.

You might ask then why do international at this time.

Reason is the long term.

After ITC sunsets, the international will likely represent some of the highest margin opportunities for Bloom, and we need to cultivate those markets today.

Korea is a great example of a large market Bloom can grow and expand within.

And with further cost reductions, we believe we can achieve our targeted margins in Korea within the next 12 to 18 months.

As we've discussed earlier, we have to continue to balance market growth and margin improvement.

Once again, thank you for your time, and I'd now like to turn it back to the operator for Q&A.

(Operator Instructions) Your first question comes from Michael Weinstein from Crédit Suisse.

So could you, first off, just discuss a little bit more about the acceptances and where they're -- the levels that are coming up in the fourth quarter guidance and I guess, for overall 2018 more like an 800 range versus -- it was probably a little below expectations at this point.

I'm just wondering, you mentioned delays, project delays, and things would have been different without those delays.

What can you say about how this will affect acceptances in 2019?

Is some of this just being pushed to 2019 so that 2019 acceptance rates will be higher than expectations?

Yes.

Great question.

So look, I think when it comes -- we were a bit light in Q3, which we talked about here.

And then when it comes to Q4, some of those acceptances in Q3 got pushed to Q4.

I think, normally, under normal circumstances here, we'd probably be looking at a bit higher in Q4.

But bear in mind, Q4 for us, we have a lot of customers that are, say, in the data center business or in the retail business, and there's a fair amount of blackouts in Q4.

Plus, we're often challenged with the weather certainly on the East Coast.

And from the estimates that we put out there, the outlook of going forward, we just didn't feel comfortable with just taking all that and increasing the amounts in Q4.

On top of that, there was one acceptance that was in the neighborhood of about 50 systems that could make the quarter and could not.

And we just felt like it was a little bit too risky to put into the outlook, and we took it out.

So the combination of not being able to kind of take some of the ones that pushed from Q3 into Q4, not feeling comfortable to increase Q4 and that one order out there provided that the outlook that we have for Q4 is to be a number that would be sub-900 for the year.

With respect to how does that impact the outlook for 2019, look, the fact that some of these orders are pushed into 2019 is certainly going to help from a backlog point of view.

We're not anticipating -- at this point, we don't guide or outlook more than 1 quarter at a time.

But we're not anticipating that's going to increase that overall number for 2019 nor are we necessarily saying that it's going to decrease any numbers that are out there for 2019.

So we think it's just going to help with further backlog for 2019, but we're not increasing or decreasing our expectations right now for 2019.

Yes.

Related to the same thing, if -- you explained that a lot of the permitting issues and thing -- and construction delays are somewhat unpredictable.

And I'm just wondering, would it make sense to maybe acquire a construction company or somebody -- another company that has more expertise in this area?

And then the second question I have and I'll just ask you now and then I'll get off, is can you talk a little bit about the gross margins?

Because the number for the third quarter is about 21%.

Fourth quarter prediction is -- looks about -- also about 21%.

At what point do you think you'll be getting up to that 30% level that you've talked about over the long term?

Yes.

So look, on the first part, look, we're continuing to tweak and tune the recipe there for acceptances.

We are definitely improving.

I know it might not totally appear that we're perfect and we're not, and we're continuing to improve.

We do look at different options when it comes to contractors.

But bear in mind, we operate in 10 or 11 different states, including international markets, and finding one construction firm is going to be a little -- do an acquisition and -- to solve all those problems is not necessarily going to solve everything.

On top of that, we are kind of creating an industry here.

Each time we go into one of these jurisdictions or territories, we have to educate the local authority who's -- the gas company, electric company and the people who have given you the permits so -- which is part of the cycle.

But clearly, the message is received.

We need to get better at that.

This is K.R. Let me add one more thing.

When we go to Korea, we do have a construction partner, and they do all the construction.

It is SK, our partner in Korea, that does all the construction.

That'll be our model internationally.

Domestically, we do use construction firms as we have, but a lot of these projects in its early days as we are continuously innovating, us being [the locals is] extremely important.

And it is not just construction delays.

It is sometimes joined by customer mandates like what Randy alluded to.

A hospital does not want you to do it at the timeframe that you can but at the timeframe that they want to shut down, or a -- or, like Randy mentioned, 2 of our large sectors, retail as well as data centers, during the holiday periods all the way from Thanksgiving through New Year's, they would not like to see any construction happen on their sites.

And these are irrespective of whether it is a construction firm doing it or us doing it.

So that's an added color here.

With respect to gross margin, that's a good question as well.

And look, we are continuing to improve there.

And again, we had the mix issue for Q4 here.

But even if you take a little bit margin hit on the Korean part, you still increase the margins domestically.

You're kind of getting to that kind of midpoint of the guidance that we had.

But I think, look, if we were running at full capacity utilization today, we'd be very, very close to our targeted margins.

We're just not there.

We're continuing to increase that.

That number's more in the 500 kind of acceptance a quarter kind of build rate.

But given what our outlook that we have here in the future, we think, by this time the next year, we'll be somewhere north of 25%, maybe closer to 30% but probably not to 30%.

Certainly by 2020, we'll achieve that targeted margin.

Your next question comes from Stephen Byrd from Morgan Stanley.

I wanted to just talk about your raw materials cost, and occasionally, we'll get questions about whether or not any kind of international trade issues may cause other issues either with cost or availability on then any of your raw materials.

I know this has come up in the past, I just wanted to get your latest thinking as to whether you've seen any impacts, if you have, how you've addressed them.

Just love to catch up on this.

Yes.

Stephen, I hate to dominate the conversation here, but I'll go ahead and take that because I've done a fair amount of work on this.

But certainly, K.R. can add here a little bit as well.

Look, I don't think there's any secret on a world basis that commodity prices have increased.

But nevertheless, we've done a good job at continuing through the things I mentioned in my script to drive our overall cost and certainly our product cost down.

And the thing that's clearly all over the press these days are the tariffs and how is that impacting.

The thing -- before I specifically answer the question, what I will say is that at Bloom we employ a supply chain strategy that employs multiple suppliers for the various components that we buy outside.

And generally, we try to put those suppliers in different locations in the world.

Often, one could be, say, in China for low cost.

Another one might be in Taiwan and another one here in the U.S. or Japan or some friendly place.

Obviously, from time -- if you employ that strategy, there might be a cost differential, but you do have options.

And that option is just to move from one region to another if there's a reason to do that.

Clearly, the tariffs here in China has caused us to really fine tune and focus on our supply chain strategy.

We have less or about 20% -- slightly less than 20% of our total bill of material today is sourced in China and could be subject to the tariffs.

So if you were to say kind of if they were 10% and you still bought 20% there, you can see that's in the neighborhood of 2%.

With that and talking to our supply chain folks, they can clearly mitigate that, and the way they mitigate that is that even though there might be a small price difference between, say, a China and a Taiwan, it isn't that much of a price difference and they can just increase the allocations from one region to another to mitigate that.

So we've kind of analyzed the impact to Bloom on a cost of goods sold basis, and we said, look, it's probably about 1%.

But if we wanted to be conservative and say it's somewhere between 1% and 1.5%., that's what the tariffs, we think, could ultimately impact us, and we put it in that category.

And that's, again, a percentage of our cost of goods sold there.

That's super helpful.

And then just as we think about potential uses of capital, you're obviously underutilized at this point.

You have a lot of excess capacity in terms of manufacturing, but you've also had some really good success in Asia.

And I'm just curious if that causes you to think about deploying capital in some way, shape or form in Asia or elsewhere.

But broadly, obviously, you're in a good position.

You have a lot of excess capacity.

Curious though if you -- if there's been any change in terms of your thinking on uses of your excess capital and your cash.

No.

Look, our #1 priority is to fill the sites we have.

We still have tremendous opportunities to grow in Delaware, and that's an important site for us.

And we plan on growing in Delaware.

And -- so we've got a tremendous investment in our facilities and equipment today, and our #1 goal is to utilize that, leverage that and further cost down.

And the marginal cost associated to get that leverage once we start shipping those many units and the absorption benefits we get is pretty phenomenal.

So to Randy's point that's our #1 goal, and we are very focused on that.

Your next question comes from Paul Coster from JPMorgan.

So acceptances is slipping relative to our expectations, and I'm just wondering if this is having any impact on customer satisfaction, on order intake.

Are your larger customers cutting back on their deployment expectations knowing that the lead time is stretching out and the complexity of these deployments is escalating?

And then the related question to that is what can you do about it outside of recruiting more people because you can tend to scale dramatically.

Is there anything you can do to systemically bring down the lead time on the installation?

Paul, this is Matt Ross.

I'll start off by addressing your question.

Is there a link between the rate of acceptances and customer satisfaction?

And we really don't see any connection between those.

To some degree, some of those delays are related to customer preference as Randy had already identified their blackout periods, their preferred dates for tying in systems, particularly in the health care and data center sectors.

So I wouldn't draw any link between the rate of acceptances and customer satisfaction, nor does it have any impact that we can see on the pace for new POs.

I don't see a link there.

And in terms of the cycle time for -- from the time we have a firm order to actually turning the system on and converting that to an acceptance, Paul, we have a multipronged strategy that we have taken.

This is clearly an area we as a company want to both become predictable and improved.

Given that these are construction projects, and multiple of construction projects, there'll be certain level of uncertainty.

But reducing that uncertainty as we march forward is very important to us, and we're doing everything we need to, and we have a multipronged strategy, including acquisition of skill set that you talked about, are all key parts of that strategy.

So your question is right on, and we are doing everything we can in this area right now.

It's a big area of focus for us.

Yes.

So just one other question then.

So you've got obviously strong demand.

You're unable to meet it as timely as you'd wish.

In view of that, I mean, have you got an opportunity to start picking off market segments that are easier to address?

Market segments for which the deployment complexity is a lot less?

And is that part of your focus it seems now on going after, for instance, the biogas market or some of the underserved markets elsewhere?

Are they just easier to not just sell into but also deploy into?

Look, I -- the answer, Paul, in my opinion, no, that -- we're pursuing the other markets because you look at -- K.R. is better to talk about this, but you look at 10 years down the road, the importance of the number of things that we're doing today is just extremely important, and that's why we're going down the road.

In terms of the acceptances, look, I want to stress, we have to get better at hitting any outlook that we have out there.

But there is just a lot of this that is just without our control and we don't know it going into a quarter.

But there's -- if there's a massive fire and they send all the crews that are going to do the tie-ins or do the inspections, up to deal with that and there's nobody here to do that, there's not anything we can do about that other than say we're just going to have to anticipate there's going to be more fires or more hurricanes or more strikes at utility companies or these things that happen.

And maybe that's just what we need to do is just ultimately be more conservative.

But that's really the issue.

It's not like our customers are upset.

It's not like we're losing business.

It's not like there's an easier path to go down here.

Can we get better at our processes, people, equipment, tools?

Absolutely and we're going to do that.

And we have gotten better.

I will tell you, our -- I mean, despite being a little light in Q3 in terms of this number, we still pretty much come pretty close to the midpoint of our guidance in terms of revenue here.

So we've gotten better, but we still need to get better.

And I think it's going to just boil down to just being even more conservative in entering a quarter, and that's a lot of what you saw reflected in what we're telling you for Q4.

On your question on market segments [to gain], understand the following.

The biogas is an ag and not an [R].

We are not defocusing some area to do biogas, either demand strategy.

And the important thing is biogas, really, if you think of a 0 carbon baseload and if you think of the emerging load and think of taking what would otherwise be a liability is a fuels problem, and big petro fuels convert that to fuel and provide clean electricity in places that otherwise will not get served and the size of that market is enormous, but it's a longer term future.

And we are doing the right things today, so a few years from now we can play a very important role in that market.

However, we are not doing that at the expense of our C&I market.

And within the C&I market, these delays are location specific.

They are, depending on the circumstances, and I'm going to walk through that, specific and not really customer specific.

So it's not like we can pick one particular segment and make it better.

To explain that further, we were hit with a perfect storm in Q3, and that perfect storm was multiple hurricanes, forest fire out here.

Those 2 distracted our utility partners that had to do tie-in enormously.

On top of that -- and then that gets pushed out.

Unfortunately, it happened in Q3, and you come into Q4.

Q4, for all practical purposes, is a short quarter for us because of the blackout periods in -- with like most of our customers.

There's not enough make-up time to be able to catch up to that.

So one thing we are doing and you will see us already acting, Randy mentioned that with respect to our international markets and other things, we are creating diversification in our portfolio as quickly as we can so the profiles look very, very different for each of these segments we address.

That diversification and reducing the percentage that we have to convert by having a larger pool are the 2 things that'll get us there.

We are committed to doing that.

We will get there.

Your next question comes from Colin Rusch from Oppenheimer.

With the management changes at the PowerSecure division within the Southern Companies, given that they've been an informed partner for you, can you talk about what your expectation is for how the relationship moves forward?

And any changes you've seen already?

Sure.

I'm more than happy to discuss that.

Our first point of contact at the senior level, and it is with that gentleman I first shook hands to say are we serious, are we going to grow, are we going to be there for long term was Mark Lantrip, and he now has taken over as the CEO of PowerSecure.

So I would say, if anything, these changes have further strengthened our relationship, and we look forward to a great relationship.

Okay, great.

And then can you give us the assumption on stack life for the warranty approval and pricing and service for the installs during the quarter for both third quarter and then what you're expecting for the fourth quarter?

So we don't discuss stack life by the quarter because what we deploy today has an expected life for it and that life keeps going up every quarter.

But remember, our service is for all the systems out there that have different legacies depending on when they were shipped with very different lifetimes.

So if you look at a metric to look at how our system's performing in the field, a proxy to that will be our service cost and what you're looking at.

And I think Randy can add more color, if you want, to that particular area.

Just tell us what you're looking for.

Okay.

I'll take it offline, guys.

Your next question is from Tahira Afzal from KeyBanc.

I guess, first question is on the construction side.

From all my companies that have reported today and the one I met today, it seems like construction labor, even electricians is going to be tight from several years to come.

So given that potential risk, I know you guys are looking at mitigating elements and strategies.

But should we be using sort of the acceptance rate year-on-year trend you're sort of indicating in fourth quarter really as a good benchmark, which is more like 25% year-on-year growth versus maybe the 40% that myself and consensus might be building?

Yes.

Look, again, it makes it a little bit -- great question, great question.

I love the question.

The problem is we don't really provide an outlook more than 1 quarter at a time.

But I think I said earlier, look, I wouldn't necessarily change any of the expectations you have for Bloom in the future.

Yes, we certainly have our challenges.

Look, if you think about it, Bloom has a great product.

It's in demand.

We provide a very compelling value proposition.

It's very, very simple.

We're going to provide you clean, reliable, resilient power, and we're going to save you money.

So what's the challenges?

The great thing is we have a great set of operations folks that do a terrific job.

In fact, my 3.5-plus years here, we haven't been late on one delivery that I can think of and the quality has just been phenomenal.

So just a great hats off to the whole ops team for that.

The challenges obviously come down to once we get these systems shipped from our site, once they arrive in the field, it's just getting them commissioned.

And it's really not that last part that I mentioned.

Although sometimes, there is an inspection or something that comes due that the inspector is late or has to do something else.

But generally, it's just getting to that point.

So look, we've -- we're a small player in a very large industry of the construction industry.

We should be able to get the resources we need to get this done in a timely manner.

We do have the demand.

So again, I wouldn't go off and significantly change your expectations for Bloom in terms of growth.

But clearly, the limiting factor will be the construction and getting these sites installed into the field, and that's the bottleneck in the company today.

And Randy, to add to what you said, and that's a great question, we should all be thankful that we have a construction boom, but we should also acknowledge that we have a construction boom and that means finding that kind of talent that you're talking about.

Plumbers, electricians, contractors, they're all busy, right?

So one of the things that we are consistently doing is reducing the amount of fieldwork and increasing the amount of things that we can do at Bloom, including facilitating a -- as much a pre-assembled installation kit and stuff like that.

So the actual amount of time an electrician or a plumber has to be in the field to connect all our systems is as low as we can.

So while we can't change the macroeconomics, we can, by engineering and technology, reduce the amount of tack time, the touch time that is needed for somebody to do this in the field.

So that's how we're trying to address it.

We are problem solvers.

We're trying to figure out creative ways to solve these problems.

I guess, as a follow-up, obviously, free cash flow in the quarter was slightly disappointing.

Randy, it seems, by your comments, this might be a 1-quarter blip perhaps.

Or should we be resetting our free cash flow trajectories?

No.

Look, it wasn't materially off from -- I mean, it was down a little bit.

I mean, it was less than $1 million negative of free cash flow.

And as we pointed out, we're going to go from a little over 200 acceptances to midpoint's 250 acceptances.

That's going to take a little bit more working capital to get that done.

So I -- my view, honestly, is that there's nothing unusual there.

It's really just kind of timing here.

We don't -- it's not a number that we provide an outlook to.

But it shouldn't be anything, in my opinion, that should give you concern.

With that said, we do sell under a variety of models.

From time to time, if we have a customer that's buying directly, as we call it, a CapEx customer, the vast majority of that money comes in on a net 30 basis.

That's different than a PPA or a lease deal that comes in very, very quickly right after the sites are commissioned.

So cash flow from quarter-to-quarter could vary but on a long-term trend, no our -- we should be generating enough cash in this business to fund our working capital growth.

So you shouldn't see us be a big user of cash.

And I think last quarter's a pretty good example of that.

Thank you.

Your next question comes from the line of Julien Dumoulin-Smith of Bank of America.

This is actually [Eric] on for Julien.

We just wanted to touch upon primarily the growth rate and how you think about that beyond 2019, both for deployments as well as revenue given the previous cadence expressed of about 30% revenue growth longer term, as particularly beyond 2019 and what level do you assume comes from -- in terms of how you think about the cost reductions versus the ITC through 2023 if you guys have a safe harboring plan and how you view it beyond that.

[Eric], look, I'm going to do the best job I can answering that without breaking my rule of giving more than 1 quarter of outlook at a time.

So look, cost down, I can't emphasize that enough.

I can't emphasize how it's a way of life here at Bloom.

And if you look at -- I think I mentioned it in my script, the 3 prior years, it's been 27% per annum in terms of our product cost down.

And our goal is to continue to drive cost down in the future.

There is -- there are the normal things that I mentioned a lot of those in my script.

But there's a big step function there, and that's each time a new generation of product comes out of Bloom.

And the next generation of product that we have, which is, honestly, it's not going to be out there, it's north of 18 months, somewhere between, say, 18 months and 24 months that you'll see this next product, is a big step function.

It's -- if you just -- if you look at the footprint, we're going to produce a minimum of 50% more power in that same footprint, which is essentially the same price to build.

In fact, we think it'll be less because there's fewer moving parts -- or no, there's no moving parts, sorry, or very few.

There's fewer parts in the newer system than there will be in the current generation.

So given that and given that it's 50% more power, a huge step function, so we continue to see our ability on a long term to innovate and drive cost down very consistent with what we've been able to do in the past.

And as I mentioned earlier, as our capacity utilization moves up, that's further going to help be a tailwind for that cost down.

As our cost down -- come down, that will enable us to enter additional markets and make our targeted margins.

In addition to that, it will let us make higher margins in the markets we serve today.

So we think the long term is still pretty positive.

We've said we've set targets of long-term targets of 30% revenue growth and 30% margin.

We think both of those are achievable.

It will vary from time to time and quarter-to-quarter.

For example, growing revenue 30%, if you're increasing the percentage on a year-over-year of the business that we do in Korea, might make that revenue growth a little bit challenging because there's no install in Korea and there's no cost of install either.

So -- but the margin, it won't impact.

In fact, it might be a slight tailwind to improve the margin, the gross profit would be the same.

But we're still optimistic that long term there's going to be opportunities for us to achieve our long-term goals here.

And then in addition to everything Randy said, also remember that we are improving the capability of our systems.

So for example, it was less than 3 years ago that we started the microgrid solution, which is for resiliency.

Today, over 10% of our deployed fleet is microgrid solutions.

As we move more and more farther into a post-climate change world where resiliency becomes important, it's a brand-new market.

Electrification of automotion -- sorry, electrification of transportation is going to create a huge demand in inner cities.

That's going to be a new market.

So there are -- even within our existing market segments -- sorry, existing market geographies, there are going to be new segments that we are going to break into as our capabilities go and increase, as our costs come down and as the grid becomes less resilient and more expensive.

Great.

But could you also discuss the implications on growth as the ITC steps down?

Are you just expecting to shift more towards international if I'm understanding correctly?

Yes, absolutely.

Look, our cost down is on a faster curve.

You just do the math here.

And we continue -- even if you were to take it to only 20% cost down, significantly reduce what we've been able to do in the past, you'll certainly see that we're going to be able to reduce our cost at a faster rate that we'll be able to mitigate the impact.

Bear in mind, the ITC rolls off to not all at once.

It has a step function there.

And we think that given our trends on cost down -- I mean, the fact that we have a new generation of product coming out before that ITC rolls off.

We're confident that, that's not going to impact our overall growth rate or ability to achieve our targeted margins.

Right.

I'm thinking more so rather than offset the incremental opportunity granted by the ITC to improve economics kind of that being down but okay.

There are no further questions at this time.

I'll turn the call back over to the presenters.

Thank you so much.

We really appreciate you all participating in our very first call, and we appreciate you taking the time.

And look, at the end of the day, our mission of clean, reliable, always-on electricity in a digital world, that always-on resilient electricity being provided at a cost that's affordable is what separates us from any other distributor energy platform.

And we are excited about this opportunity and thank you for taking the time.

And I'm sure with many of you, we will be in touch with you before the next call.

Hope to see you here at Bloom or see you in one of the meetings.

Thank you all.

Thanks, everyone.

Thank you.

This concludes today's conference call.

You may now disconnect.