燃料電池能源 (FCEL) 2008 Q2 法說會逐字稿

Good day and welcome to the FuelCell second quarter 2008 earning results conference call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Ms. Lisa Lettieri. Please go ahead.

Thank you operator. Good morning everyone and welcome to FuelCell Energy second quarter results conference call. Delivering remarks today will be R. Daniel Brdar, Chairman and CEO and Joseph Molnar, Senior Vice President, and CFO.

Before proceeding with the call, I would like to remind everyone that this call is being recorded and that this presentation contains forward-looking statements including the company's plans and expectations for continuing development and commercialization of its FuelCell technology.

Listeners are directed to read the company's cautionary statement on forward-looking information and other risk factors in its filings with the U.S. Securities and Exchange Commission. I will now turn the call over to Dan Brdar. Dan?

Thank you, Lisa. Good morning, everyone, and thank you for joining us on today's conference call. The second quarter was an important one for the company in terms of our improved revenues, product cost ratio, and product backlog. Our revenues tripled.

Product cost ratio improved 19%, and product backlog was 266 better, percent better than last year's second quarter. During the quarter, we closed the largest order in our history, another important milestone. The large revenue growth is due to the strong demand for our products, especially our megawatt class line.

The increase in manufacturing volume, increasingly favorable product mix, and the continuing impact of our cost out, has combined to bring our cost ratio down to 1.5. Due to the growing demand for high efficiency, ultra clean energy and declining product costs, we're well positioned to provide solutions to the global market. In just a few more minutes, I'll elaborate, but first, let me turn the call over to our Chief Financial Officer, Joe Molnar, for a review of our financial performance for the quarter.

Joe?

Thank you, Dan, and good morning, everyone. We had an exciting second quarter with significant improvements in both revenues and the company's cost ratio. Total revenues for the second quarter were 31.6 million, almost three times the 11.4 million reported in the second quarter of 2007.

Product sales and revenues increased to 26.4 million from 8.9 million, driven by increased orders for megawatt class power plants. Research and development contract revenue was 5.2 million, compared to 2.5 million in the second quarter of 2007.

Our product cost to revenue ratio improved 19% on a year-over-year basis and 25% on a quarter over quarter basis, coming in at 1.5 for the 2008 second quarter compared to 1.85 last year and 1.99 in the prior quarter. This resulted from our cost out efforts and increased demand for lower cost megawatt class power plants.

We continue to see lower product costs and improving product mix. With orders received in the second quarter, approximately 60% of the product backlog now consists of multimegawatt power plants and modules for multimegawatt power plants. As these units are produced beginning in late 2008, the overall product cost ratio is expected to improve.

Volume increases and design changes incorporated into production in the latter half of 2009, are expected to drive the multimegawatt power plants and modules to gross margin profitability. Strong order volume for the quarter contributed to a record product backlog of 134.7 million, more than 3.5 times the previous year's second quarter and up 60% sequentially.

Our relationship with POSCO Power kicked into full gear with an order of 26.5-megawatts, representing nearly 70 million in sales in the second quarter. POSCO has now ordered a total of 38.2-megawatts of FuelCell Energy products and signing our 10-year agreement in February 2007. As South Korea adopts a Clean Energy Distributive Generation program, it favors the installation of FuelCell's multimegawatt power plants and grid support applications.

Research and development backlog was eight million compared to 26.4 million. Our largest contract, the Phase I of the Secret Coal Base program is coming to a close in September. We will submit a proposal for Phase II.

That contract is estimated to be approximately 20 to 30 million and would extend over two to three years. Second quarter net loss to common shareholders was 25.8 million, or $0.38 per basic and diluted share compared to 18.8 million, or $0.32 basic and diluted share in the same period last year.

The sales increase resulted in a higher loss of 5.8 million. Administrative and selling expenses increased approximately a million and were offset by lower research and development expense of 700,000. Interest and other income was lowered by approximately 500,000.

At April 30, 2008, total cash and investments were 121.7 million. Use of cash and investments was 16.8 million for the second quarter, which included approximately 1.6 million in capital spending. Depreciation expense for the quarter was 2.2 million.

In summary, the second quarter of 2008 reflects the increased demand for our products and the results of a focused cost-out program by the company. Now, I'll turn the call back to Dan.

Thanks, Joe. Increased recognition that greenhouse gases are a serious problem in the global warming must be addressed combined with rising energy costs throughout the world is stimulating demand for our direct FuelCell products.

One of the most practical and cost effective ways to reduce greenhouse gases is through increased energy efficiency. Our DFC FuelCells, due to their high electrical efficiency, allow customers to reduce the greenhouse gas emissions from their facilities and generate cost effective ultra clean power at the same time.

Our high electrical efficiency means we use less fuel to make a kilowatt hour of electricity, resulting in lower carbon dioxide emissions and greater fuel cost savings compared to conventional combustion based power generation equipment. For customers operating our products on biogas or using the available waste heat for combined heat and power, the energy savings and greenhouse gas reductions are even greater.

These attributes are particularly important in an area of record high costs for fuel and electricity. According to an article in last Sunday's "New York Times," the U.S. wastes 66% of its energy. A third of all CO2 emission comes from electricity generation.

The Lawrence Berkeley National Laboratory reported that if U.S. industry recycled its waste heat and put waste gases to work instead of flaring them, it could reduce greenhouse gases by 19%.

Statistics like this show that we can significantly increase the useful life of our available resources and reduce the amount of greenhouse gases emitted to the atmosphere, simply by changing the way we use energy. No technology break throughs are required.

With high efficiency distributed generation, more useful energy is used to create delivered kilowatt hours of electricity and much less energy is wasted. Using our DFC products and combined heat and power applications, our customers can generate virtually pollution-free electricity and achieve efficiencies of up to 80%.

In South Korea, California, and Connecticut, customers are taking advantage of these benefits and all signs point to continued growth in these and other markets. Last quarter in South Korea, POSCO Power ordered 25.6-megawatts of megawatt class power plants. At nearly $70 million in sales, this order is the largest we've ever received.

This means that in just 18 months, POSCO Power has ordered a total of 38.2-megawatts of power plants and all but 600-kilowatts were megawatt class. What's driving interest in our FuelCells is the fact that South Korea has some of the highest energy prices in the world. The country is growing rapidly, but relies heavily on imported fuels.

The Korean government is also strongly committed to reducing greenhouse gases. Satisfying these challenges drives the need for high efficiency solutions, like our DFC products. Under Korea's Clean Energy program, alternative sources of energy must be -- must send the electricity they generate to the grid, not to individual business or organizations.

Utilities and independent power producers find our megawatt class power plants, are a more cost effective way to meet this mandate, since they put more power where it's needed, run reliably 24/7 with an efficient use of fuel. The facility POSCO Power is opening in Pohang City, remains on schedule to open this fall. At this facility, POSCO will build the electrical and mechanical subsystems, the balance of plant that, are part of our finished power plants.

This will allow POSCO Power to provide a locally built balance of plant for their market incorporating a FuelCell module supplied by FuelCell Energy. In the near term, we will ship complete power plants to POSCO. In 2009, we will begin to ship modules, together with a complete set of balance of plant components.

POSCON, a POSCO affiliate company, will do the balance of plant assembly with our technical support as a fabricator. Starting in September 2009, we will begin to ship modules only and POSCO will be responsible for procurement of all balance of plants. Initially we'll be responsible for servicing the power plants, until POSCO Power personnel are sufficiently trained.

Once POSCO personnel complete our certification program, they will take responsibility for the balance of plant maintenance and FuelCell Energy will be responsible for all stack-related maintenance and provide technical consultation. Turning to California, given the high cost of energy in the state and the active statewide effort to reduce greenhouse gas emissions and other pollutants, our Direct FuelCell products, bring added value, 24/7 reliability and ultra clean profile to the California market.

To expand the use of clean distributed generated power, the California Public Utilities Commission increased the size of projects eligible for participation in the state's self generation incentive program to 3-megawatts from 1-megawatt and increased the total available funds to $179 million. Today, we have 19-megawatts of direct FuelCells operating or on order for California, for a wide range of applications that include waste water treatment facilities, food and beverage companies, universities, and hotels.

In the case of waste water treatment and food and beverage processors, which is historically about 30% of our business, these customers use anaerobic digesters to produce biogas from their operations. Our direct FuelCell units can use this renewable biofuel and our waste heat can be used in the digesters, creating very high efficiencies for the facilities.

According to a 2007 EPA report, the waste water treatment market potential is 1300-megawatts for just the U.S., including 350-megawatts for California and New York, the two markets with the best RPS mandates. With the successful expansion of the self generation incentive program now complete, our California sales team is focusing on closing the megawatt class waste water treatment projects in the current sales pipeline.

In Connecticut, the state's department of public utility control approved financial commitment letters for the 16.2-megawatts of projects, using six of our DFC3000 power plants. Subsequently, energy purchase agreements, between the project developers and the utilities, were also completed for the projects. The first project is a 9-megawatt DFC-ERG installation at a natural gas letdown station in Milford, Connecticut.

This will be the largest of it's kind anywhere in the world. The system will generate electricity and use its by-product heat, in the station's management of the natural gas pipeline, resulting in electrical efficiency of 57% and significantly reducing greenhouse gas emissions. Some 350-megawatts of similar opportunities have been identified in the northeastern U.S., California, and Toronto.

The other two Connecticut projects are both hospitals, a 4.8-megawatt power plant for a Stamford hospital and a 2.4-megawatt power plant at Waterbury hospital. Healthcare facilities in these large amounts of highly reliable, clean, quiet energy. Additionally, they can make ready use of the by-product heat generated by our power plants for space heating, air conditioning, laundry's and sterilization.

This combined heat and power application will result in system efficiencies of up to 60% at these locations. That reduces both energy costs and CO2 emissions. With the energy purchase agreements now approved by the DPUC, our project partners can finalize their project financing arrangements and enter equipment purchase orders. These projects will then be added to our backlog.

While we're growing our orders backlog, the other key element for us to achieve profitability is to continue reducing the cost of our products. Our product cost reductions come from several areas, engineering improvements, technology advancements, supply chain management, production volume, and manufacturing process improvements.

In the last couple years, the two biggest contributors to our cost reductions have come from value engineering activities to reduce the design cost of the products and improvements in our core technology. Currently we are producing products largely designed in 2007 and 2006. The second half of 2008 will bring more lower cost megawatt class units through the P&L. We've already seen some of the benefits of the cost reduced products running throughout P&L, and that will continue.

By the fourth quarter, we'll see the multimegawatt projects starting to become a larger percentage of our production and we expect our cost ratios to improve as a result. Technology advances also reduce product costs, through the ability to generate more power from the FuelCells. We've already successfully demonstrated the capability to operate our products, with our uprate of the 250-kilowatt stack to 300-kilowatts.

We're pleased with the validation testing of our next uprate that will increase the power output by approximately 15%. As a result of a favorable result that we've achieved, we expect to begin producing these new configurations in mid 2009 and incorporating these improvements first into the DFC3000, which will be operated from 2.4-megawatts to 2.8-megawatts.

The successful validation testing of the technology improvements combined with our other cost out initiatives give us a high degree of confidence that we'll achieve our cost out targets for 2008 for our megawatt class products and allow these products to achieve positive gross margins on a unit basis once they are in production next year.

As our costs are coming down, the cost to build centralized power plants is going up, as described in a "Wall Street Journal" story last week entitled "Cost to Build power Plants Pressure Rates". According to the article, the cost of building coal, gas, wind and nuclear power plants is sky rocketing in North America.

In the last year alone, the costs went up 19% and over the last three years, the increase was 69%. As a result of our high efficiency, low emissions, decreasing DFC product costs and the increasing costs for conventional generation, we're an attractive option compared to conventional power generation equipment.

Regarding our government R&D programs, division 21 program will be completed later this fiscal year. Under it, we completed significant development work, including a submegawatt demonstration of our Direct FuelCell turbine, a product we think has a great future. With its high electrical efficiency of around 60%, the Direct FuelCell turbine is a power plant that meets customer needs to clean, economical power in this era of increasingly expensive fuel.

We'll keep you apprised of our steps to commercialize the products in future calls. Now let's turn to the investment tax credit. The House and Senate are actively discussing a conformed version of the respective bills. The House recently passed a six-year extension for a 30%, or $3000-kilowatt credit that also for the first time allows utilities to take the investment tax credit. The Senate passed its own very similar version a couple of months ago, but is a tax stimulus package.

From our discussions with legislators, we're optimistic. They know the investment tax credit is both an effective business stimulus for alternative energy companies, as well as a tool that will enable positive, tangible improvements to our environment. Another bill is gaining in prominence lately also.

It's the Lieberman Warner cap and trade bill, otherwise known as America's climate security act. This bill seeks to cut greenhouse gas emissions in the U.S. by 66% by 2050, while maintaining America's economic growth. The passage of this bill, or any other bill that would modify its carbon dioxide emissions will be beneficial to the economics of our products, due to the high efficiency and correspondingly low carbon dioxide emissions.

Our record backlog of nearly 44-megawatts and the likelihood of another 16-megawatts from Connecticut near term, is an excellent indicator that the marketplace is adopting our megawatt class products. Customers are realizing that our FuelCells represent an important part of the solution to reducing your energy costs and carbon foot prints.

All signs point to a growing call for an environmentally responsible power generation. With over 300 bills pending before congress and renewable portfolio standard programs beginning to take hold.

Operator, at this point, I would like to open up the call for questions from our participants. Operator?

Thank you. (OPERATOR INSTRUCTIONS) We will take our first question from John Quealy with Canaccord Adams. Please go ahead.

Hi. Good morning, folks. Joe, I don't know if you did this or not? Could you break out Q2 revenues for us and give us the moving pieces? Clearly that number was well above a lot of expectations, if you just give us a little bit more detail there?

Sure, John. If you go back to the first quarter, first quarter revenue now, especially in hindsight looked pretty low. If you look at what happened with inventory first quarter, we had built some inventory.

So we, in anticipation of the order flow that was coming had prebuilt some inventory that we were able to push through here in the second quarter. I mean especially the order flow out of Korea helped to drive that. So that's really, really what happened, is it's really a catch up in effect for inventory that was built in the first -- really in the last two quarters.

And I mean your inventory, I think, if I look at it, five million net-net, quarter to quarter. So I imagine there was more than ten let out of the finished goods to hit and then, obviously you built a backup of working capital. Is that a way to think about it?

Yes, that's the way to think about it. Plus in the dynamic of, in certain cases when we are finishing delivery of a product, our balance of plant sometimes goes straight to cost of goods sold.

That's actually a pretty good model because we buy it late in the process. Cash flow is late in the process, and we sometimes it kind of runs right through inventory and out the other side. So that's why you won't get a direct relationship with the inventory.

Okay. And then digging into the backlog a little bit, how many megs is it right now, Joe?

43.5 megawatts.

Okay and POSCO's how much out of that?

POSCO's about 33 of that number.

Okay, and Connecticut has not hit the backlog yet, or walk us through the time line there?

Connecticut is not in the backlog at this point.

Okay. When does it hit?

It will hit when we have completed the terms and conditions contractually with each of the developers.

Okay, and time lines around there?

Those are reasonably short-term, I would say in the next 30 days, 60 days or so.

Okay, and then maybe a broader market question. In terms of California, looks like the numbers you've done there have been very impressive and pretty quiet actually.

Dan, perhaps you can give us a little bit more context around future opportunities there and I know you did briefly in the remarks, but what sort of entities do you see ordering FuelCells and getting some interest? Is it a new cast of folks that are looking for this?

We are certainly seeing new customers, but what we're also seeing is because of the success that we've had getting some waste water treatment facilities under contract, we're seeing some word of mouth now among the waste water treatment facilities themselves.

So a lot of what is in our backlog are megawatt class waste water treatment municipalities and so forth, that are looking to close orders with us.

We're seeing new customers entering the fray also, that are natural gas base units. The recent rise in natural gas price has slowed those activities a little bit, while people wait to see it normalize. But if I look at the overall pipeline in California, it's a larger percentage of it is waste water treatment than natural gas base.

Great. Thanks a lot, guys.

And our next question comes from Michael Lew with ThinkPanmure, please go ahead.

Hi, good morning. Thank you for taking my questions here. Also, could you also comment on California a little bit more given the recent increase in the cap incentive for 3-megawatts. Have you seen a significant pickup in RFP activity?

Yes, what we're actually seeing are projects we have known about previously, where the size cap was a little bit of a constraint in terms of being able to pursue them.

Now with that constraint off, with both of our megawatt class products at 1.2-megawatts and 2.4-megawatts, it enables us to re-engage with those customers and put projects together that work for them.

So that cap is consistent with what we have been seeing for the last year and a half or so of the transition away from smaller 300 and 600-kilowatt units and more and more towards megawatt and multimegawatt opportunities.

Okay, and you've highlighted California, Connecticut and Korea. But are you seeing any increased activity out of Germany, given the government incentive to drive market adoption?

We are certainly having a lot of discussions with our partner over there, CFC solutions. They are seeing increased activity, but it is a little bit of a long cycle in terms of closing orders. The activity that's going on in terms of driving some more creative programs over there, it takes a while for it to actually flow into the market and generate order flow.

And also, what is the -- can you also provide the current product cost running ratios for the, each of the product lines as it stands today?

The -- as it--

Submegawatt, megawatt and multimegawatt?

Yes, as we communicated those in the past, the megawatts are probably in the mid ones.

Okay.

The submegawatts are in the high ones, low twos, depending on the age of that inventory and the multimegawatts, as we're starting to ramp production, are driving themselves down, down the curve, and so they will be in the low ones at this point in time.

Okay. Thank you very much.

And our next question comes from Sanjay Shrestha with Lazard Capital Markets. Please go ahead.

Great. Thank you. Good morning guys and congratulations on good progress here across all fronts. Couple questions.

First up, can you guys talk about POSCO here? Obviously it's been a fantastic bookings during the quarter, but how should we think about that, with their plan of 50 and 100-megawatt type of capacity expansion, sort of the lead time surrounding that? And is it a big order that we've got and we sort of have to wait? How should we think about incremental order coming from that partner/customers?

What you'll see, as POSCO is bringing that facility online they understand that in order to have FuelCell modules available in time, we have a lead time to produce. So the order that we got this last quarter really allows them to transition into that facility, becoming operational, where they are buying basically balance of plant parts from us that they will assemble as part of training their team to put the product together and then transitioning to just module only from us.

Now, it takes obviously a little time to get staff on, get them trained, get them -- understand how to build the product, so what you're seeing now is the first of the orders that are needed to get that facility operational. What they also understand is for us to expand capacity, there is a lead time associated with that. For us to go from the installed capacity of 60-megawatts that we're going to end up with later this year to some higher level, takes 15 months or so.

And so for them, they are really doing their planning in terms of how do we have capacity and the order signals soon enough so that that capacity will be available for them as they ramp their business. So we're actually spending a lot of time with them on dialogues on what our multiyear look at the business is so that we're actually very much in sync.

Because they want to continue to grow this business, but they want to make sure that we have the order signals to have the capacity available in time, to match their growth.

That's kind of what I was trying to get at, great. Another quick question, so backlog numbers not just growing, but growing with the product mix that's got better margin profile, right? So when is that cross-over point here for us as it starts to hit the P&L? Is it second half of next year? We start to get to break even to positive gross margin? How does this backlog flow through the P&L? Can you guys talk about that a little bit?

Sure, Sanjay. What you have is about 60% of the backlog is multimegawatt and megawatt. The remainder is submegawatt and megawatt. So the submegawatt and the megawatt are, that currently is in backlog, is backlog that we've had and that we're clearing is going to drive the earlier production of that. So you're going to start to swing heavier production to that later this year into '09.

What you'll see, is you'll see, what we hope and what we expect, is to see some improvement in, as you move to that mix you'll see improvement in the cost ratio. In the second half '09, which we talked about in the press release, is you in effect, the design work that's being done on several aspects of our power plants, but one of the bigger ones is the uprate that's coming, is scheduled for completion. The design aspect of that is scheduled for completion at the end of this year. And then that will take a little bit of time to get incorporated into production.

But we are expecting that in production second half of '09. And that's where you see the multimegawatt plants start to go profitable at that point. And that, combined with incremental volume, that, as Dan just said, we would expect, the Koreans to be looking at their future requirements. That incremental volume, the product design, and pushing that in production really drives that event.

Exactly, so you sort of get the double benefit in the second half '09 that backlog that's already sort of positive gross margin and also the scale benefit and operating benefit and that's sort of the logic here, right?

That is the logic.

Got it, got it. That's great. Congratulations on a good outlook here, guys.

Thank you.

Our next question comes from Burt Choa with Simmons Company. Please go ahead.

Good morning, guys. Thanks for taking the questions. Just two quick ones.

With, with the large ramp in revenues and what looks like a successful progress along the cost reduction curve for you all. Is there any chance you could become gross margin positive, or is there a likelihood it could come in the front half of? I know you detailed in the call that there are some things that have to happen, but is there a likelihood that has a possibility of being pushed up at all?

Well as we explained in the -- to Sanjay in the last question, it looks to us like with the backlog, it takes some time to get costs out. You've got to work through your inventories. We are delivering commercial products here and it takes a little bit of time.

We're not really looking at the first half of '09 as that period. We think that you will see margin improvement. I think you will see the product mix improve and I think in the second half of '09 is where we see the multimegawatt products making the turn.

Okay, great. And then finally, just a quick one on the cash level. Joe, how comfortable with you are about the 135 million in cash right now, given your current burn rate? Do you think you'll need that to raise more capital, or is that something that's really not on the radar right now?

Well, we're pretty comfortable. Historically we look at cash raising periodically, as we look at our business. We see that we have -- we see that we have backlog improving. We have good events coming. We have good news coming.

We seem to be getting, from a market standpoint, recognized for our, our true attributes of being green and efficient. So we're not really -- we're comfortable at that level and we'll look at it, we'll look at it periodically.

Great, thanks. And congrats on a great quarter.

Thank you.

Thank you.

Our next question comes from Michael Molnar with Goldman Sachs. Please go ahead.

Hi, good morning, everyone. Good morning. The -- my question is this. In the U.S., when you look at reserve margins, they are strained, forecast to become very constrained over the next couple of years. Base load options, really limited. You can't get coal cited very much. Nuclear is eight to ten years away at best. Hydro, there's no options. Renewables, like wind and solar are growing, but are not base load power.

So when you look at all of that and you did detail some others in the call, it looks like the tail wind for something that's clean and base load would be extraordinary. And my question would be, why hasn't the U.S. utility market become an absolutely huge market? Is it because costs, the tax credits? Is it mainly seen as a distributed source or just a lack of familiarity with the technology? Would love to hear your thoughts on that.

Yes, that's a great question. It really involves a variety of issues. One, is, utilities by their nature are conservative. So they want to see a lot of units out there operating. I think that's a big part of why we're now starting to see a lot of interest from them.

We are pretty routinely meeting now with some of the industries' utilities that are in the markets, like California and here in the northeast that are really going to drive that adoption. Because we're at the point now that we have enough units out there that are operating, a good operating history, and the product and projects are now big enough that they make sense to the utilities.

Historically, utilities that have tried to do smaller distributor generation projects, those have not been a good experience for them. They really need to have products that are truly multimegawatt class, because that's what their business structure is really centered around. We're there, so we're really starting to see the utilities now looking at how does this fit into their solutions.

I think you're going to see the utilities playing an increasingly bigger role in this, and if we see the investment tax credit get passed that will include the utilities' ability to capture it, that will just accelerate that process.

But in terms of them spending time understanding the product, wanting to know what our capabilities are to produce, wanting to understand where they fit in the portfolio of options they have, we're seeing a dramatic improvement just in the last six months to a year of their interest and wanting to spend time just getting up to speed with us.

So I think you're going to see them increasingly playing a role.

And what would be the largest size that you think you could do for a utility? I know it would be a little bit of conjecture, but if a large utility came to you and said, okay, I would love to do this size, what would bet largest amount be that you would be comfortable with, if had you to take a guess?

I think when you look at the kind of projects that we could do, I think anything in the range of ten to 50-megawatts makes sense. Utilities need to be at least ten megawatts typically because that's a level that can start to be dispatched by the ISO.

When you get up to 50-megawatts, you start to have some other, more mature lower cost technologies that you're going to be competing against pretty heavily. So there's a big sweet spot in that ten to 50-megawatt range that I think really fit the utility model.

Okay, thank you.

You're welcome.

And our next question comes from Rob Stone with Cowen and Company. Please go ahead.

Hi guys. Great progress.

Thank you, Rob.

I have several questions, if I may. One, with respect to your outlook for getting to positive gross margins in the second half of 2009, what kind of run rate megawatt volume are you assuming?

Well, the megawatt class products go, as a product, go positive gross margin at the current run rate, because we're driving those costs down, that really is going to be the first beneficiary of our next up rate. So on a product basis, even if we were to stay at the current 25 rate, those megawatt class products would still be gross margin position. As we ramp up beyond that, that cost ratio will just continue to improve.

So -- but let's be clear. What I was talking about is gross margin positive on a blended basis, I think is what you're talking about. And you talked about higher volume, also helping your costs.

So is it, is it really just a function of working through the existing backlog of smaller and prior generation product? In other words, if you were shipping at today's volume all of the newest designs, would you already be at gross margin positive?

The units -- you're talking about what's in backlog today or just the newest design?

Yes, in other words, I'm trying to, I'm trying to separate out the --

If you took today and you took--

Volume and mix.

Yes.

Getting to gross margin positive.

Yes, if you took, if you took the design today, you would need higher volumes to get there. If you take the design that is the result of the work we're doing that will be completed at the end of '08, in effect that captures this uprate, so the uprate goes from -- stack will go from 300-kilowatts to 350-kilowatt, then you'll need less volume.

Some of what we are trying to capture here is to not overly ramp volume at this point in order to capture that uprate so that it requires less volume in going to '10 to get the blended, to get the ability to get to that point. So that's the strategy that we are employing. So we want to build volume off of that uprate really in the second half of '09 and future.

So it's clear that it doesn't make sense for you to make a lot of product that's not gross margin positive, as you get finished with the designs that will be positive. Can you comment on the size of the Korean market and as you think about 2009 full year revenues, how much you think POSCO would account for as a percent of total?

If you look at the Korean marketplace, what they are trying to achieve there is, there's an overall objective to get 5% of the install base to come from clean and renewable sources. The install base is about 70 gigawatts, so they are looking for about 3500-megawatts. Now there will be some wind that's in that mix.

There will be some solar that's in that mix, but they don't have great wind and solar profiles. When we talk to our partner, POSCO Power, they think FuelCells are going play a pretty important role in providing that level of renewable and clean power, because they don't have a lot of good options over there.

So the potential there is literally in the thousands of megawatts and it's really a matter of how quickly we collectively drive costs down, how quickly we ramp up the facility that POSCO's building and continue to capture orders. But it looks like it's an enormous market for us. We just have to execute well.

So the orders you've received to date would represent slightly over 1% of what you estimated is the total target? Did I get that right?

That's correct.

Fantastic. Finally just a housekeeping question for Joe, can you comment on what your CapEx expectations are for the second half of this year and for fiscal '09?

Yes, I'll comment on fiscal '08 and we're still driving our fiscal '09. In effect, we have previously committed to increasing our capacity to 60-megawatts in '08. That will drive at this point somewhere between, probably incremental -- I think the original total we put out was about 14 million. There's probably ten or 11 million of that.

We will be driving that this quarter, next quarter, and probably a little bit into the first quarter of next year. The -- so that will close out the 60-megawatt and then for next year, it's really a function of our -- when we pull triggers for potential expansion beyond that would be the, would be the drivers.

Our maintenance capital, if you want to go to that level for '09, would be somewhere in the three, four, $3, $4 million range. But the real question will be what we do in terms of expansion in '09.

Let me see if I can summarize that and tell me if I got it right. If you don't pull the trigger on stepping up to the next level of annual volume next year, your CapEx would be lower if you did, then it depends on the size of the next increment?

Correct.

Great, thank you.

And our next question comes from Walter Nasdeo with Ardour Capital please go ahead.

Thank you, good morning.

Good morning, Walter.

I would like to jump back to the revenue side for just a second, if I could. Obviously this quarter's revenue was, was a little bit aggressive for what we were looking for, which obviously we like to see.

But going forward, are we now establishing new levels as far as quarter over quarter growth, as far as the orders starting to hit the income statement and then flowing through, or is this just an inventory clearing quarter?

I think you have a little bit of all of the above, Walter. I think you have probably a little bit more inventory capability coming through in the next quarters, but as you get a standard run rate through this business, there were pluses or minus to this number. But at a 25-megawatt run rate, in estimating an average cell price, you're probably talking a standard in the quarter somewhere between 15 and $18 million of revenue.

So that, I think -- if you look at first quarter, that's clearly a jump up. Compared to the second quarter, it's a little bit, it's a little bit lower, but you still have some of that phenomenon in our inventory of units that will clear and create revenue outside of that.

That's how we look at the business, which is really what's the run rate, what's the potential revenue that can come off the run rate and that's how we guide -- not really guide, but how we look at how revenue will flow.

And that's product revenue, right, that's discounting any contract revenue you made?

That is absolutely product revenue and it does not talk to R&D contract revenue.

Got you. Okay. So we can always wiggle a little bit of that in there. Currently where are you at as far as production costs per megawatt?

Production costs per megawatt is roughly -- if you take -- what we've said and what's happening is that our production costs are pretty much coming in where we have said they would and where we expect it, okay? So we've reported, for example, submegawatt power plants are somewhere between 4000 and 4500.

Megawatt power plants are probably in the high mid threes at this point. Clearly couple more design changes coming through there, and the megawatt plants are in the low threes at this time. Some costs that come through, just to add to that in the financial statements, for example, in this quarter, would contain first time costs as we reflect, so you might see a little higher cost coming in in this quarter.

But that's really where they are. They are pretty much, as we've reported it in the past, and as it's coming in, it's really coming in right on target.

Okay, good. So and as I list kind of like quickly bounce around some of those numbers I saw this morning, you're selling these at about 2800, is that right? Is that what the POSCO numbers were, about?

No, if you look at the DFC3000, which really is what's making up most of these sales, billing at about $3000 per kilowatt. In the POSCO numbers, remember, you've got a mix there of full power plants and modules, which tends to look like they are bringing that overall number down, but it's not. We typically sell regardless of the market, around $3000 a kilowatt.

Got you, got you, okay. Good, good. And then I know we bounced this around a number of times on previous questions. I'm just not sure I grasped it properly. What is the target -- and again, this is smoothed over across the whole product line. What is your target cost to revenue ratio for the rest of the year? Have we discussed that? Because I know--

We haven't discussed it, but what we did say on the call is that this quarter is somewhat indicative that the changing mix, so we had talked about 40% of the mix is submegawatt and megawatt power plants that are carrying some of these cost ratios in a we have described on the call, that we will carry the day until the multimegawatts come through.

They will start to come through late in '08 and then clearly start in '09, so you should see some improvement, but the main improvement will come when the design change gets incorporated in manufacturing.

Okay, so we can still basically come in around a 1.5 to one range?

It's your forecast, but--

All right, thanks, guys. I appreciate it.

Sure thing.

Our next question comes from Sam Dubinsky with Oppenheimer. Please go ahead.

Hi, guys. Couple quick follow-up questions. Based on service you gave, in terms of your production targets, what are they for the year and can you ship above them? Because of some products in inventory, and then I have a couple follow-ups.

We're running at about a 25-megawatt run rate. For us to go above that, it's really just -- it's variable cost, so we can actually ramp up pretty quickly to go to a higher level if we need to.

What we've tried to do is balance being able to continue to ramp up the business without producing a lot higher level of higher cost units until they work their way through the P&L. So obviously you know, with 44-megawatts in backlog, running at a 25-megawatt rate, we're staring at when is the right time to take that next response to more fully utilize the capacity.

Okay, and then as a follow-up this quarter, what percent of your shipments were below 1-megawatt?

During this quarter?

During this quarter.

Sure. Just a minute. Let's take a look.

Also, just as a caveat, how much production for the year, in the first half or I'm sorry, as of April, how much have you guys produced so far?

Yes, looks like in the quarter we shipped around, we shipped around 1-megawatt.

Of submegawatt units?

Of submegawatt units.

What I'm trying to figure out here it, seems like something caused a decent upside in the, on the revenue side and doesn't seem like it's pricing getting better, doesn't seem that way because the cogs are still pretty high.

So what's the total megawatts you guys shipped? Seems like revenue upside's coming from somewhere. I just can't--

It's about 5-megawatts shipped in the quarter. What you're seeing is you're seeing the swing from megawatt and multimegawatt units. Multimegwatts had some impact on the quarter, megawatt units come in the quarter and that just drives the ratio right down.

Okay. That's exactly--

That's really the phenomenon that's occurring in the quarter, is you see the swing to the multimegawatts. Once you get away from the submegawatts and then the dollars just overwhelm the sub megawatts, so it just drives the number down, so that's the real positive.

You produced 1-megawatt of submegawatt units and the rest of the 5-megawatts is roughly 1-megawatt and above?

That is correct.

That is a good analysis. Yes.

Okay, and then in terms of your backlog, anything 60% was above 1-megawatt or above. Can you break down how many of those systems you have, so what the backlog is for below one megawatt, what is for one megawatt systems and what is for 2-megawatts?

Yes, yes. I would tell you it's, it's probably somewhere in the range of, say, 20 to 25% megawatt and the difference would be submegawatts at this point.

Okay. And then in terms of your R&D contract revenue, it seems like the backlog is falling, so at some point should we be flat lying this to zero?

Wait a minute, wait a minute. I said something wrong there. I'm reading the numbers here wrong. Sorry. Let me just back up. I have 60% -- starting with the total, 60% of multimegawatt. There's about 25 to 30% of the total is megawatt. And then there's about 10%, 8% to 10% would be submegawatt.

Okay. Okay, great. Thank you. Then on the R&D backlog, it seems like that's falling. So at some point should we no longer see revenue from the R&D contracts?

No. What you're going through is kind of a normal end to a certain number of the projects. The largest of the projects would be this coal-based seeker program contract where we are ending Phase I. Phase I actually ends around October.

So we will work down the backlog of that contract and then we go into a proposal process on Phase II, of which that we feel we're doing very well actually in that contract with the government and that we are in a good position to win the next contract. The next contract actually has a contract value over two to three years. I don't think the government's determined yet of somewhere between 20 and $30 million.

When you give backlog numbers, are they yearly backlogs or are they the backlogs for the life of the contract?

It would be the backlog that is actually funded.

Funded, yes.

For the life of the contract.

Okay. Funded backlog for the life the contract?

Correct.

Okay, thanks, guys. Appreciate it.

Our next question comes from John Roy with Global Crown Capital. Please go ahead.

Thanks. I know you talked about Germany as a possible future and the long lead time there. In terms of other regions that you're getting interest from, is it mostly the U.S. guys? Are they getting more interested? Is the EU just kind of quiet at this point? Just kind of get a little feel for possibly what might be the next reason after the three main focus today.

Well, if you look at the key markets, in the U.S. what we're seeing is California has certainly established a leadership position in terms of driving some of the energy and environmental policy.

We're seeing their activities now come east. We're seeing New York looking at their programs, Connecticut also has their program under way, so we're seeing the northeastern states start to get engaged in how FuelCells fit with the investment tax credit being potentially available now to utilities.

We're actually starting to see some of the southeastern utilities come through, start to understand the product, where it fits in them satisfying their renewable portfolio standard mandates. In Asia, it's all about efficiency.

Asian countries, whether it's Japan, Korea, other locations, with having to import so much fuel and being very committed to the Kyoto protocol, they are looking for high efficiency solutions, so we're seeing increase just in general in terms of the Asian marketplace.

And in Europe, Europe in general is a market that is really well suited to this product. The issue really is we have a partner that has an exclusive territory that has been coming through a lot of turmoil for their parent company, which is now over.

So the discussions that we're having with our partner for Europe are now that those organizational issues are behind them, how do we accelerate the growth of that market to match what we're seeing here in the U.S. and what we're seeing in Asia.

I think we're going to have a pretty good outcome to that because they recognize the potential as well.

Thank you.

Our next question comes from Gary Schwab with Valley Forge Capital Management. Please go ahead.

Yes, Joe, I'm just a little bit confuse order one thing that was mentioned. Earlier on, somebody was asking about the cost ratios on the different product lines and you said that the multimegawatt was in the low ones. But then later on, either you or Dan said that the multimegawatt projects are currently gross margin positive. Were you talking about two different things there?

No, I'm not sure where the -- the multimegawatt products go gross margin profitable when the design change comes through into manufacturing in the second half of '09. To that--

Somebody was asking about currently.

Well, then the answer -- well, the answer may have been wrong, but I'll be very clear right now, and very clearly, it is not gross margin profitable today.

Okay. Now, what about just your multimegawatt modules alone? When you start shipping those to POSCO, I know that's not till next September, but if you were just looking at those today?

We would expect the multi-- when we get the design uprate through and to manufacturing, we would expect multimegawatt power plants and the multimegawatt modules to get the same basic reaction so that they would both be profitable.

They would both be profitable, right. But today are the modules alone --

Well, it's moot because we're not -- they are not scheduled to ship until we first ship into the power plants. As Dan described on the call, we have a transition process to ship the, to ship the -- so incorporating -- and then the other discussion we had is that we are trying to ship volume with the uprate, okay?

Right.

So we are going to -- through the backlog with the existing designs. We're going to create the design change and then ship volume with the uprate, which moves the multimegawatts at that point to profitability.

Okay. I guess what I was trying to get at was right now you're buying a lot of components on your balance of plan from the outside, your modules are -- you're building them in-house. Are your modules just building your modules right now, is that a profitable product for you before you start adding the balance of plant to it?

The answer is no. The answer is the--

Okay.

-- the strategy is we're going to stay -- we currently have a 25-megawatt run rate. We clearly could drive volume earlier here, but we have an obvious point to drive volume off of, which would drive the product line profitable and that's what the plan is.

We could do more buying today and try to get lower costs and potentially get -- but it looks very clear to us that incorporating that design, which is a significant cost reduction by itself enables us, gives us the ability to get to profitability and that's really the plan -- that's the plan, that's the plan that we have. So--

Okay.

And our final question will come from Stuart Bush with RBC Capital Markets. Please go ahead.

Hi. This is Anthony Riley for Stuart. Congratulations on a great quarter, guys.

Thank you.

Most of my questions have been answered, but if I could kind of swing back to revenues again just real quick, the press release states that the $70 million POSCO order should start shipping late '08 into '09. So when you say late '08, are we talking September, are we talking December? If you could bracket that.

The first of those are some 1.2-megawatt units that will ship in the September-October timeframe.

Okay. And then Connecticut, if you could remind us when, assuming everything goes forward as planned, when you would physically be shipping product for those 16-megawatts?

Well, it's really a function of when they get under contract. What we have tried to do is to arrange our production schedule so we have some ability to get some of the hardware from Connecticut on the ground and operational this year before the current investment tax credit expires.

But if for some reason it takes longer than everybody is expecting to actually get to a contract order, that may push out. The majority of it is probably going to get installed in the second half of 2009, just because we have been taking additional orders, large orders like POSCO and some other things that we have taken from California are now ahead of it in the production queue.

Okay, so the majority back half of '09. Okay, that's great. Thanks a lot, and congratulations again.

Thank you.

And ladies and gentlemen, that does conclude today's question and answer session. I would like to turn the conference back over to Mr. Brdar for any closing or additional remarks.

I would just like to thank everybody for joining us and hearing what's been going on in the quarter and we look forward to keeping you updated on future calls, as we continue to execute against our plan. Thank you, everybody.

Ladies and gentlemen, that does conclude today's conference. Thank you for your participation. You may now disconnect.