燃料電池能源 (FCEL) 2008 Q4 法說會逐字稿

Good day, everyone and welcome to the FuelCell fourth quarter 2008 earnings results conference call. Today's conference is being recorded.

At this time, I'd like to turn the conference over to Ms.Lisa Lettieri. Please go ahead, ma'am.

Thank you, operator. Good morning everyone and welcome to FuelCell Energy's fourth quarter results conference call. Delivering remarks today will be R. Daniel Brdar, Chairman and CEO and Joseph Mahler, Senior Vice President and CFO. Our earnings press release is posted on our website at www.fuelcellenergy.com, and the replay of this call will be posted two hours after its conclusion. 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 the continued development and commercialization of our 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 Securities and Exchange Commission. I will now turn the call over to Dan Brdar. Dan?

Thank you, Lisa, and welcome everyone. I'm glad you could join us this morning. This was a breakthrough year for FuelCell Energy in a number of ways. We doubled revenues, tripled production and for the fifth consecutive year, we achieved our cost reduction goals, putting us firmly on the path to profitability. Our success this past year has been due largely to customers demanding low carbon, green technology solutions to generate clean, economical electric power. All indications are this trend is only going to grow with the new clean energy initiatives in South Korea and the US, and we're well positioned to capture the opportunity. I'll go into more specifics in a moment. But first, let's turn the call over to Joe Mahler so he can review the financials. Joe?

Thanks, Dan and good morning, everyone. We are pleased to report revenues in excess of $100 million, improved margins, record orders and product and service backlog up over 50% for the fiscal year ended October 31, 2008. During fiscal 2008, revenues doubled to $100.7 million from the $48.2 million reported in 2007. Product sales and revenues were up 154% to $82.7 million from the prior year's $32.5 million. Research and development contract revenue was $18 million, compared to $15.7 million in 2007. For the year, the product cost to revenue ratio improved to 1.62 to 1, compared to the 1.90 in fiscal 2007 due to cost reductions across all product lines and a megawatt product mix compared to the prior year. Net loss to common shareholders was $96.6 million or $1.41 per basic and diluted share compared to a net loss of $71.9 million or $1.16 per basic and diluted share. Losses expanded as higher volumes of product sales and revenues resulted in increasing operating losses although at a lower rate than in the prior year as margins improved. We booked record orders in fiscal '08 closing 32.3 megawatts of new product orders, more than double the prior year order quantity of 14.8. Product backlog as of October 31, including long-term service agreements was up 52% to $87.6 million, compared to last year's $57.8 million. Research and development contract backlog was $4.8 million, compared to $18.5 million on October 31, 2007. We expect a decision on our approximate $21 million phase two proposal that was recently submitted for the seeker program to be in January. Fourth quarter net cash used was $17.5 million and total cash and investments in US treasuries were $86.9 as of October 31, 2008. The product cost of revenue ratio was 154 to 1 in the fourth quarter, an improvement over the third quarter and in line with the Company's objectives. Capital spending for the fourth quarter was approximately $1.7 million and depreciation expense for the period was $2.2 million. All in all, a very good year with some exciting momentum. Dan?

Thanks, Joe. We're launching into 2009 in excellent shape. Our investment in technology and product development continues to pay off. Not only is our backlog strong, but it's also clear that public policy will be supportive of continued growth in alternative energy going forward. In 2008, we completed the design of our newest megawatt class products. We met our 20% cost reduction goal through a combination of product design enhancements, specifically, increasing the power output from 300 to 350-kilowatt per FuelCell stack, along with better component and raw materials pricing from volume manufacturing and global sourcing. Full scale stack testing to validate our up rate and the new cost reduced designs are ready to move into manufacturing. As part of this process, we're getting our suppliers up to speed to produce the new components in volume while we consume inventories of old components and complete production of our previous design for our existing orders. We're on track to have the new cost reduced megawatt class products in production in the July time frame. We increased our manufacturing rate to 30 megawatts in 2008, up from 11 megawatts in 2007. Right now, 94% of our backlog consists of megawatt class products. As our production shifts to our newest cost reduced megawatt class fuel cells, we expect to yield positive gross margins on our megawatt class products in the fourth fiscal quarter of 2009. In order to satisfy the growing demand for our megawatt class products, we spent roughly $3.5 million to double our megawatt class conditioning capacity to 50 megawatts. The additional conditioning equipment is now installed in our facilities and ready for production. This was part of our planned expenditure of $14 million to $15 million to bring our total production capacity up to 60 megawatts per year. Through continued process improvements in our manufacturing, we're also able to reduce the total capital needed for our first capacity expansion by several million dollars. This increase in production rate and product profitability is made possible by demand in our target markets.

In South Korea, our partner POSCO Power ordered 25.6 megawatts of DFC power plants and modules this calendar year, representing approximately $70 million in sales. POSCO Power opened its balance of plant manufacturing facility in September and is planning to manufacture BOP equipment by the end of fiscal 2009 as it fills demand in South Korea. The investment by POSCO Power puts to continued and growth order flow. Recently, South Korea's President Lee announced his green growth plan. South Korea included FuelCells as one of the country's top green technology economic drivers. This incentive drives technology, job creation and economic growth and creates an excellent market for our products. In the US, we're seeing the development of broad public policy that will drive faster growth in our domestic market. This type of support drove rapid growth and adoption of other clean technologies like wind and solar. In October, the federal investment tax credit for fuel cells was increased to $3,000 per kilowatt or 30%, whichever is less and extended for eight years to 2016. In addition, utilities can now take the credit for the first time. This extension happened late in the year, and we're now seeing orders delayed by the ITC moving the closure. We are also seeing very strong interest from developers and companies who want to take advantage of the investment tax credit.

In the Northeastern US, we're finalizing negotiations for 16.2 megawatts of projects and round two of Connecticut's renewable energy mandate. These projects include the largest FuelCell installation in the world, our 9-megawatt DFC-ERG gas letdown station and two DFC-3000 based projects at hospitals that we use the by product heat for sterilization, space and water heating. In the fourth quarter, our first DFC-ERG was installed in Toronto at a natural gas letdown station owned by our distribution partner, Enbridge. This system has two roles. It replaces pollution emitting equipment used to manage the pressure of gas that's being delivered to local distribution lines at city gates and it captures energy that is normally lost in the process and sends it to the grid as ultra-clean electricity. While reducing pollution, the DFC-ERG turns a gas utility operating cost into a revenue stream. Gas pressure letdown stations worldwide are the target market for this product. In just Toronto, California and the Northeastern US, the initial opportunity is estimated at 250 to 350 megawatts of DFC-ERG systems. Round three of Connecticut's Project 150 identified an additional 27 megawatts of projects using our DFC fuel cells. These projects were forwarded to the Department of Public Utility Control and final decision is scheduled for next month. Of the five projects under consideration, three use our DFC-ERG and another uses our first multi megawatt DFC/turbine. With approximately 60% electrical efficiency, these are our highest efficiency power plants, unmatched by any other distributed energy solutions. The fifth project is a 15-megawatt power plant for the Bridgeport FuelCell park. Our fuel cells are the only projects under evaluation for this round of the Connecticut RPS.

California continues to be one of our strongest markets with 30% of our installations in backlog. Of these, about 40% are waste water treatment or food and beverage applications. These are good customers for our power plants because these facilities generate biogas as a part of their process that can be used as a fuel for the FuelCell power plant. In addition, the byproduct heat is used to accelerate waste treatment. Customers can achieve up to 80% efficiency with these combined heat and power systems and drastically reduce the emissions currently produced by the use of reciprocating engines or from flaring. California has also been aggressive implementing green technologies including wind and solar. With 55% of its electricity coming from natural gas and the impact of intermittent technologies on the transmission system becoming better understood, the state is now focusing on how to increase efficiency, lower greenhouse gas emissions and move to a more distributed generation model. 24/7 fuel cells are a good answer because of their high efficiency, scalability and low carbon, green attributes. Earlier this year, funding for California's self generation incentive program was increased and expanded to include our megawatt class power plants. The increase adding $96 million to the self generation incentive program brings the total available funds for FullCell projects to approximately $176 million.

When we look at 2008, we're also proud of our contract R&D accomplishments. We successfully completed phase one of a 10 year Department of Energy program to develop megawatt class, coal based solid oxide FuelCell power plants. We recently submitted a $21 million proposal for the next phase for the continued development and scale-up of solid oxide FuelCell technology and we expect a decision in January of 2009. We also began building a DFC hydrogen co-production demonstration unit that will produce electricity and heat while generating hydrogen for transportation. While early from a market perspective, this is a critical technology development program that is focused on producing low cost, on site hydrogen. We also met the objectives of DOE's Vision 21 program with the operation of a submegawatt DFC/turbine system that demonstrated 56% electrical efficiency. A megawatt class DFC/turbine system with projected electrical efficiency of close to 60% was proposed and selected in round three of Connecticut's Project 150. The DFC/turbine is a great example of our ability to leverage government development dollars to meet our product development objectives. These accomplishments create a solid foundation for 2009. For fiscal 2009, we're focused on producing our multi-megawatt DFC-ERG fuel cell and completing the design of our new multi megawatt DFC/turbine. These products are ideal for utilities because of their baseload 60% efficiency that helps utilities meet their clean energy, carbon reduction and reliability goals and for the first time, utilities can take advantage of the federal investment tax credit.

While our prospects for 2009 look very bright, we recognize the macroeconomic picture does present some challenges. The credit squeeze is obviously impacting many companies. How will this impact FuelCell Energy? When we look at our near term order opportunities, we have Connecticut round two projects of 16 megawatts, the Connecticut round three projects of 27 megawatts, California waste water treatment facilities and POSCO Power planning its 2010 requirements for its 50-megawatt balance of plant facility. The developers and customers for many of the US based projects have strong balance sheets and continue to have a US tax equity appetite. POSCO Power also has a strong balance sheet and is incentiveized by the green growth initiative put forth recently by the Korean government. Because of the strength of customers like POSCO Power and our US project developers, we're optimistic that we can close a good portion of this business, all of which is expected to be gross margin profitable over the next three to four months. This may allow us in the short-term to avoid the current credit crunch issues while building up our backlog and giving the overall market time to stabilize. We continue to have discussions with third party project finance tax equity investors. While we have seen a broader slowdown in these markets, there's been strong activity in the background to prepare to take advantage of the opportunity to put projects on the ground with excellent financial returns. From a Company standpoint, closing these orders and growing the backlog will show a Company on a continued growth track which should be positive for investors. We believe that the combination of gross margin positive orders, the optimism surrounding alternative energy around the world, including the new administration in the US and our ability to generate growth and jobs put us in a good position.

Regarding Company financing, we believe we have options. We're comfortable with our current cash balance of $87 million, and our need for capital will be driven by orders and backlog driving expansion. To increase our flexibility in 2009, we'll balance our spending to match orders and backlog. We've spent considerable time over the last three months communicating with investors. Companies who demonstrated growth with profitability will be well positioned to lead as the market recovers. In addition, our strategic partners are investing significant capital to deploy fuel cells and are strong supporters of fuel cell energy. This combination puts us in good position. While I'm on the subject of the global credit crunch and its potential impact on FCE, I should mention that lower material and fuel costs reduce the lifecycle cost of our products. For example, natural gas cost going from $11 to $6 a million BTU in California reduces the cost of electricity by almost $0.03 a kilowatt hour, making fuel cells more economical than the grid. I've also gotten questions on the effect of the South Korean won on our business. While the won has gotten weaker, the price of natural gas has come down significantly, more than offsetting the weakness of the won and improving the positioning of our products.

Despite this financial market uncertainty, it appears the new administration is going to be much more aggressive on alternative energy. The President-Elect and congressional leaders are pushing for a cap and trade program, a federal RPS and significantly increasing funding for low carbon initiatives to create jobs, all of which would support our FuelCell power plant sales growth. In South Korea, the green power plan specifically names fuel cells as an important economic driver and working with our partner there, we expect to continue that to be a major market for our Company. In closing, we're excited about what we accomplished this year in executing our strategy. We're entering the new fiscal year well positioned to achieve our 2009 objectives which are close pending orders in Connecticut and California, expand the South Korea, California and Northeastern markets to maximize order flow, deploy the multi megawatt DFC-ERG to natural gas utilities, complete the design and capture our first order for our multi-megawatt DFC/turbine and produce gross margin profitable megawatt class products by the fourth fiscal quarter of 2009. Operator, at this point, I would like to open up the call to any questions from our listeners.

Thank you, sir. Today's question-and-answer session will be conducted electronically. (OPERATOR INSTRUCTIONS). We'll take our first question from Michael Lew with ThinkEquity.

Thank you. Good morning, Dan, good morning, Joe.

Good morning.

The question I had is that while FuelCell should benefit from increased market adoption based on public policy incentives, and you've talked about the current potential backlog of customers being well funded, are you seeing more deferrals or cancellations today in this environment where the central customers have just decided to put off potential purchases in light of the economy?

We haven't seen any customers cancel their projects. We haven't seen anybody back away from doing a project. The only thing that we saw here in the US was just delay, because it became pretty clear with all the people we were working with, things like the projects in Connecticut, everybody's confidence level that an ITC extension was going to happen was very high, so people basically were of the -- we have to wait until this ITC passes before we can spend more time and effort to close these projects. But all the things that we had in the works six months ago that were delayed by the ITC, they're all still there, and they're all now back moving towards closure.

Okay, good. And also, on the topic of ITC, when can we expect the Linde Group order to be added back into backlog? Are there any unforeseen holdups right now?

Right now, they have to go back through their approval process. What they had to do was -- because we had to delay this with the ITC, they actually had to go back out for new construction bids because it had been long enough, their management wanted to see updated installation bids. That process is complete. It's now back to their board for approval. So we would expect to see that get finalized here short term.

Okay, and also, one last question with regards to the technology upgrades, are the customer inquiries RFPs noticeably now shifted. Obviously, with the benefits of the public policy incentives, are the RFPs now noticeably shifted towards the multi-megawatt products from the submegawatt? Are you seeing that?

We're seeing in basically all the markets, our whole business looks like it's going towards megawatt and multi-megawatt. Especially now that we have megawatt class units out there operating, they have a good operating history, and this expansion here in the US, the investment tax credit, everybody's increasingly moving towards doing larger and larger installations.

Thank you very much.

You're welcome.

Next question comes from Stuart Bush with RBC Capital Markets.

Yes, good morning, guys.

Good morning, Stuart.

I was hoping you could give us some more color on the economic landscape in Korea. I understand that POSCO is a big driver for you guys, and it's dependent on the feed-in tariff set up there, which does necessitate some payments out of the Korean government. So if you could give us some color on any risks that you think are surrounding that green power plan there, I know you said it was a specific economic driver, but just wanted to know if there's any economic risks to them scaling back that program in the future?

To predict political risk is anybody's guess, but what we have seen is when President Lee came out with his announcement, this was really only less than two months ago. So the global economic situation was already sort of well unfolding. The sense that we get is President Lee's approach and the Korean government's approach sounds similar in many ways to what we're hearing from the Obama administration, and that is we have a global market slowdown, we have a need to do something about global warming and green energy and the obvious solution is to put those two things together. To grow our way out of this recession, to create jobs. To grow markets by spending money to solve our global warming issues. So there seems to be a lot of commonality in that theme. What we hear from POSCO Power when we talk to them is because this is has got such a broad level of support and involves so many companies over there, Samsung, POSCO, Hyundai and being designated as a driver for the economy as part of their long term planning, it seems like it has pretty high probability of being successful.

Okay. Great. And then switching to your target of gross margin profitability on the megawatt scale, you mentioned that 94% of your backlog is megawatt size products and bigger. Is there -- how can we think about why in Q4 '09 we shouldn't expect a companywide gross margin profitability if you're planning on shipping such a large proportion of a product that is gross margin positive?

Good morning, Stuart. It's Joe Mahler. In our cost of goods sold, we have multiple elements in the cost of goods sold. So what we're showing is that gross margin profitability occurs for the megawatt, multi-megawatt products including megawatt modules, so they will go gross margin positive and then in our numbers, is we have service requirements under our long term service agreements that carry, or in the process of changing out all those three-year stacks and we now have put in five-year stacks, and that model doesn't achieve profitability with three year stacks. As we change that out, that has a drain on our cost of goods sold. So while our products go profitable, we will still carry some lag on that. As we move to longer stack life, that -- and you increase volume of manufacturing, because it's a very capital intensive, the stack replacement is capital intensive, that model goes profitable and is actually a very good model. Our future forecast for the service model are actually excellent. It's very similar to the service models you see for turbine manufacturers and engine manufacturers. That's the dynamic that's happening that will happen in the fourth quarter, but that transition is fabulous, because as you put more volume through the business, that will drive us to gross margin profitability and then Company profitability.

Okay. So you're entering into this fiscal year with 50 megawatts of capacity. Can you just give us an update on what you see as the shipment run rate that would get you to that gross margin profitability and eventually to cash flow positive?

It's very similar to what we've talked about in the past, Stuart, with -- I think in our 10-K last year, we talked about 35 to 50 megawatts get you the gross margin profitability and 75 to 100 megawatts get you to Company profitability. I think those numbers stand. There's probably a little adjustment. Some adjustment you'd have to make is if our mix went to all modules, we think we get about two-thirds of the profitability to the module. The module is about two-thirds of the entire power plant, so if you went to all modules, you might have to increase those numbers somewhat. But that plan is basically intact. That's about the range we see, and that's what we're currently targeting. We are seeing some benefit from the investment tax credit in our ability to maintain and actually increase sale price, so that's another driver when you start circling around those numbers, that's another driver, and that's a good driver. So for the moment, let's say that's the current range, it's been consistent with our past reporting and we're still targeting in those ranges.

Okay. And then lastly, you did mention that you had some process improvements that should bring down your CapEx requirements from what you originally expected. What is your target for CapEx spending in the coming year?

It's really going to be a function of what we see on the order side. Right now, we have adequate capacity for everything we've got in backlog, and in the decisions about what we do to ramp that capacity are going to get driven by these large near term opportunities that we're seeing, like the next order from Korea, the magnitude of that order will certainly have a factor, the projects in Connecticut. So until we have better visibility of what exactly's going to close and when, we can't make that call yet. Our capital in the current plan really is what we would spend for our maintenance capital, but the next ramp up will be driven by our orders flow.

Can you give us a low and a high end on possible.

Our next logical step for increment would be about an additional $8 million, would take us up to almost 70 megawatts of capacity. And then to go beyond that, we would be in the range, including that $8 million of 35 to 45, if we wanted to go all the way up to 150 megawatts of capacity.

Thanks a lot, guys.

Sure.

Our next question comes from John Quealy with Canaccord Adams.

Good morning, folks. Joe, could you just talk a little bit about fiscal '09, if you would, in terms of expectations or guidance? Clearly, it looks like you're going to go through maybe $27 million, $28 million of backlog, but can you just give us a little more clarity on what you're thinking about the top line?

Right now, John, we have about 30 megawatts in backlog. We look at what the market is doing and we also look at our potential order flow. So in order to be -- stay more on the market conditions, we're looking at a conservative approach right now and so right now, we're going to start with 30 megawatts. We have opportunities to go and plans to go to 36 and beyond in the year. But we're going to start the year at 30, and we're going to watch the order flow. And then depending on the order flow, that will dictate what '09 will look like. I mean, we are -- there's multiple scenarios that are coming at us here, and we have some very exciting scenarios with significant expansion. But it seems like the best strategy for us at this moment is that -- let's be conservative and let's buy a little time and let's let those scenarios clarify, and they will absolutely clarify based on order flow.

And back to that order flow, with South Korea and Connecticut, could you go back and refresh us, where do the weeks and the months in the quarters we should be watching to get clarity on that order flow for those two geographies?

If you look at round two of Connecticut, those projects are very active negotiation right now. So we would expect to see the projects from round two closing sometime over the next month or two. Assuming that there aren't anything unusual that happens in terms of delays of getting approvals, I would expect to see our friends from Korea back over after the holidays to start finalizing what their plans look like for their 2010 needs. They understand that with the backlog that we have and with things from the first -- the second round of Connecticut about to go into backlog, that in order to make sure they've got adequate modules for their plans for 2010, they're going to have to place an order before too long, and then we expect to see just continuing smaller order flow out of California. We've got several waste water treatment projects that are teed up, going for approvals at the various city councils. So we look at just over the next two to three months, we see a pretty significant potential for order flow activity.

Great, thanks very much.

You're welcome.

Our next question comes from Brian Gamble with Simmons & Company.

Good morning, guys.

Hi, Brian.

Joe, I was hoping to touch on the cash balance for a second, if I may. I know you guys have the shelf in place and have availability there. I know Dan, you mentioned obviously, controlled spending, trying to stay within the order and backlog flow as the year progresses, but what is your comfort level? What are you thinking there in light of your previous comments about being patient on the orders as we go into '09, how does that start to juxtapose itself with the cash on hand, I guess?

We -- at the end the year, Brian, pretty comfortable. We have about $87 million. That's an adequate cash balance for us, makes us pretty comfortable. Certainly, it's enough cash to get away from the current environment and hopefully, it doesn't take too long for that environment to stabilize. We have really multiple scenarios, but the two we're most focused on is a very excited growth scenario driven by the order flow that Dan just articulated. We think that that will close. Those are pretty much big balance sheets that appear to be moving forward, appear to be tax -- have a pretty good tax appetite. and the second scenario is really, a delay of that scenario. We don't really see a downside play here. We see just potential, Because of economic conditions, everybody goes a little bit slower. And in that scenario, as Dan said, we have taken some steps. We have reduced spending. We look -- makes us even more comfortable with the current cash balance. In that scenario, we can have discussions with our strategic partners. Our strategic partners have been very supportive. They are spending capital, they continue to spend capital, actually, certainly in Korea, on building out their balance of plant manufacturing. So our objective -- if it is scenario one, take advantage of that, go to the markets. We have visited, in the last three months, a tremendous number of investors worldwide. We've been to Europe, California, we've been to Canada. We've had multiple discussions, we have compared scenarios. To be honest, the feedback we're getting is that there's a lot of optimism about alternative energy. A lot of people believe that even with market conditions that -- some of the rhetoric coming out of Washington and these green initiatives in Korea are actually going to be -- could be a leading path for us and for alternative energies. So we have exciting scenario, number one, we have a delay scenario, number two. And our strategy right now is reduce cash use on that, improve our flexibility with that cash balance, work with our strategic partners, and buy some time, move it out and just not be forced into any tight positions or anything like that. I mean, overall, very optimistic outlook.

Okay. Let me get you straight. Under both of those scenarios that you both outlined, neither one of those requires the short term need for more cash on the balance sheet?

Not quite. The strategy is that if you want to expand capacity, so if we get hit with quite a few orders and we get real indications that that order flow is sustainable, then you're going to want to ramp the business, and then the ramping the business will be dictated by the appetite of equity capital in the market, how much debt. That will push you more into a question of, can you raise debt to fund this. I think Dan articulated, $35 million, $45 million of capital spending, which really isn't that much given the amounts of sales revenue you can generate off of that. I think that scenario we would look to do an expansion. I think in scenario two, I think we would try to manage the business waiting for those indicators to happen. So I think those are the two scenarios we're focused on.

Okay. Thanks, Joe. And then when you mentioned earlier products being shipped out in the fourth quarter, break-even to positive on the gross margin side for the product, but then you mentioned having to go back and spend some money on replacing the old stacks, if you just called the new products a one to one on the cost ratio, what would the extra spending have to be on the cost side, given what the old stack replacement is going to look like? Is it 1.2? Is it 1.4? What does that move it to?

It's pretty close. We looked at how many basis points, if we stay on the cost ratio analysis, we expect that the new products will be better than one to one. And then you'll see somewhere a 20 to 30 -- probably a 20 to 30 basis point effect of these service costs that come through our financial statements. We've gone back over multiple years and quarters and that's been reasonably consistent, but that's the impact of service cost at this point.

And then finally, just on POSCO's plans, they have given no indication that they're changing their plan to ramp up the 50 megawatts to 100 megawatts in 2010. Is that still the plan?

That is still the plan. I have to tell you, going over to the dedication for their facility, it was very impressive. Not just the facility itself and what they have spent to make this facility a reality, but the level of government support they had at the ceremony included cabinet ministers, members of Parliament. So this is something that has extremely high visibility for them in country as a corporate initiative, and it's allowed them to really align a significant part of their business with what the government's long term objectives are for the economy. So, the support there continues to look to be very strong.

Sound good, guys. Thanks.

You're welcome.

Our next question comes from Rob Stone with Cowen & Co.

Good morning, guys. I have a few questions. Following up on your comments on POSCO, I know it's too early to say exactly what, but it sounds like from what you just said, whatever their level of orders is for their F10, it's going to be up versus this year?

I'm sorry, Rob, I didn't catch the end of that.

The question is, I know you can't put a number on it at this point, but is it reasonable to expect that POSCO orders would be up year-on-year versus flat?

Reasonable expectation. Their original stated plan was the facility would have a capacity of 50 megawatts per year when it opened. And granted, they're not going to run that at 100% of capacity all the time, but it was supposed to go to 100 megawatts a year in 2010 and based on the success they've had capturing orders, you would expect it to be something that would be a growing trend in terms of the orders that they place.

Okay. Another question, with respect to the new DFC-ERG for the letdown stations, what do you think might be the take rate for that technology? Can you describe it, for instance, in terms of time to pay back for a natural gas operator? And do you see the uptake more dependent on new pipeline construction or upgrades? How should we think about the uptake in that very large potential market?

I'll let Joe address the payback situation. In terms of an uptake, any existing gas letdown station can use this. In fact, where the first one was installed in Toronto was at a gas letdown station that had been there for many years. The 9-megawatt project we're doing in Milford is an existing gas letdown station. So, it really is something that can be deployed both at new facilities when they're built or at existing ones. And what it allows the gas utility to do is really to just change their mode of operation, get out of having to burn gas to heat the gas expansion equipment in the pipelines and get away from burning gas in a boiler and turn it into a way to take that operations expense and turn it into revenue stream so they can basically sell electricity back to the utility. So they actually get the opportunity to take an operating expense and turn it into high volume revenue stream. So it's something that applies to just about every gas distribution facility that you can think of. And really, it's a question of getting those first units in and operational and have utilities have the opportunity opportunity to talk to others in their same space about how their experience was with the product.

Given how effective that concept is, turning an expense into revenue, at some point, isn't it reasonable to expect that all new letdown stations would get constructed this way?

I can't think of a reason why they wouldn't.

Okay. So, Joe, can you address the payback question?

Yes, and I think what -- as Dan said, the analysis that the gas utilities do is that changing it from an operating cost to a revenue generator actually creates a return on investment scenario. So, you really look at is what's the IRR? As the utilities are making their decision, presenting this for approval, it's really what's the IRR on these projects, and the IRRs are looking very favorable. If you look at the impact of the investment tax credit on these projects, it's actually very substantial. On a $35 million DFC-ERG project, the tax credit is $10.5 million, and you get that credit pretty much in the first year. Adding to that the makers accelerated tax depreciation, it really accelerates the return of equity on these projects very early in the project. So what we're looking at is IRRs right now, unlevered IRRs in a range in double digits, above 10% to 15% at this point. And you can think about leveraging those, these are pretty exciting financial models. That's certainly the reaction that we have been getting on the projects. So these are getting a lot of interest. Our developers, I mean, as -- in round one, we picked up the 9-megawatt Milford project. In round three, we have Energy East bid three more of these because of that dynamic. So we see it as a very exciting market.

Since the ICC extension was passed, have you seen a significant uptick in your discussions with utilities directly?

Yes. Both gas and electric utilities have both increased their discussion as a result of now being able to take the investment tax credit.

Turning back to the -- to R&D revenue, looks like you're going to be going into a little bit of a soft patch as you complete existing contracts and wait for new ones to be approved. If you get that next phase in January, what's the outlook for getting back to some run rate of R&D revenues?

Yes, Rob, I think that -- we completed phase one in very, very good shape, very successful. The Department of Energy has been working closely with us on phase two. It's a $20 million, two year contract. Getting that revenue puts us right back where we were. We get right back to the levels we were at in previous years. May not quite hit this year at $17 million, but we're certainly in that $12 million to $15 million range for R&D revenue.

Final question, if I may. You got the target for megawatt class breakeven by Q4 on new orders. What should we think about in terms of progress on the cost of revenue ratio between now and then?

If you look at having a pretty substantial backlog that's already set, cost of revenue ratio is likely going to be pretty flat here the next couple of quarters until that next round of projects go into production with the new cost reduced designs. Because that --

There's not that much more that's going to happen other than possibly a volume effect until you cut over to the new design?

Correct.

Okay. Thanks very much.

You're welcome.

Our next question comes from Sarah Martin with Lazard Capital Markets.

Hi, this is Sarah in for Sanjay. You had commented that orders delayed by the ITC are now moving to closure. Can you say anything more specific about that, either about the specific projects or at least the types of projects those are?

Well, if you look at the projects that we've been talking about, the round two projects from Connecticut, the 16-megawatts there, the BOC Linde project that was actually taken out of backlog because it couldn't be delivered before the end of this calendar year, those projects specifically are back now, re-engaged, looking to get closed now that the ITC has passed. There are several other projects also that were in development at a couple of locations in California that were in the same boat. So a lot of some of the projects that we have been talking about, particularly the larger ones like the BOC Linde and the Connecticut round two.

And then other than Korea are you seeing any other international opportunities at this point?

Yes, we think Europe is a market that really should be delivering relatively significant order flow for us. We've had a long term relationship there with our partner, MTU. And we've been in discussions here for a while with our partner to figure out how do we accelerate the deployment of FuelCell products in the European market, because it's been so supportive of other green technologies like wind and solar. So I would expect to see Europe being one of the next markets that starts to open up for us in a significant way.

Thank you.

You're welcome.

Next question comes from John Roy with J&A.

Hey guys. You were talking about obviously Korea, and everybody is focused on POSCO. One of the questions was, I know the won, obviously, has changed a lot, and you said that natural gas has helped with that. Is there any pushback on pricing at all based on where they're at? Do you feel like pricing is not an issue for those guys? I shouldn't say not an issue, but not a major issue?

I never met a customer where pricing isn't an issue.

Right, of course.

(laughter) We haven't seen any extraordinary pushback versus the same challenging negotiations we went through last round. I would expect it to be pretty similar. It hasn't raised any particular concerns or any change in strategy or tactics on their part. So I think it's just really business as usual. Everybody tries to negotiate the best deal that they can under whatever the current conditions are.

One other quick question. I know you're moving to a five year stack from three. Any glimmer in your eye for a seven year stack at some point?

Actually, we have what we hope is a seven year design on test right now.

Okay. Great.

Our next question comes from Walter Nasdeo with Ardour Capital.

Thank you. Good morning.

Good morning, Walter.

Gosh, most of my questions have already been addressed. But I would like to touch over, Joe, if you could just real quickly break out for me on the deferred revenue and customer deposits line, how much is deferred revenue and how much of that are deposits?

It's about $2 million of deposits, Walter.

Okay. And what do you have to do to get that deferred revenue over to the income statement?

All we have to do is produce, continue to produce the products and ship them. As you would suspect, most of it is with Korea, and we are operating at a 30-megawatt run rate, so that actually should come -- that should come through pretty consistently over the year.

Very good. So if I can just touch on -- my favorite topic every quarter is on the FuelCell turbine hybrid and the development, not just on the product side, but what do you see as far as markets for that going forward? Are they starting to crystallize at all now that you're getting a little further down the development line?

Yes, , we did the original development under the DOE program on a submegawatt unit because we looked at, how do we do this in a way that's cost effective without trying to bite off too big of a design challenge? As we have operated a unit and as we start to see how these RPF programs are unfolding and how the utilities are viewing the product, it's really looking to be increasingly a multi-megawatt product like the DFC-ERG that will be targeted at utilities and large industrials who can't use all the waste heat from a multi-megawatt installation, whether it's a fuel cell or an engine or any other generating technology. So it's going to be large scale industrial and utility as the targeted customers.

What turbines are you using with that right now?

I don't want to identify that yet, because we're still in negotiations with couple of the players, and we haven't concluded our agreements with them. As that wraps up, we'll be more public about it.

Got you. Over on the SOFC side, how is that developing, and what is your expectation for after the next round of development, to start actually producing, and what markets are you identifying, and how are you figuring on maybe slotting those in around the molten carbonates to go in? As I understand, it's a little bit smaller capacity that you're looking at there?

Yes, I think that that is absolutely correct. How we view the solid oxide development is that solid oxide has opportunities between 3-kilowatts and up to hundreds of kilowatts and at some point in the future, can probably get megawatt scale. But that will take some time to develop. So right now what you have is -- the objective of the program is to develop stacks that you can scale and then you can get bigger sizes of solid oxide fuel cells. Our guys have done very well, our solid oxide technology has done very well. The DOE considers us to be one of the best under that contract, and you know there's some pretty big names under the SECA contract and with that strategy, we see the next development is to start to scale it up, and we'll be in a range of somewhere -- we're currently doing work on a 10-kilowatt stack and then we're working on scaling that up somewhere in a range between 50 and 100 kilowatts. So there's a lot of markets between 50 and 100 kilowatts. There's auxiliary power units, there's small stationary installations that could use that size range. And so what the strategy is is to continue to work with strategic partners to develop those markets. We're working on a specific application. We have contracts with other manufacturers that are working on different applications. We have some very exciting applications that in effect, take solar, create hydrogen, hydrogen runs fuel cell, fuel cell turns that back around. So the commercialization strategy is to clearly demonstrate the core stack technology, demonstrate our leadership with that technology and then attract partners.

Very good. And then just if I can touch on this real briefly, Dan, you mentioned Europe and MTU. Are you guys looking to work with anybody else over there? Because I know MTU had some problems or some issues of their own over the last couple of years, and there really wasn't a whole lot of development going on over there. Are you looking to work with anybody else, or do you see this aggressively ramping up? I do agree with you, I think there's a lot of opportunity over there that doesn't seem to be developing very quickly.

We've actually been approached by several large European based companies that see the opportunity. I think part of what we've seen there, when somebody has a captive market, it doesn't simulate a lot of competition. So I think we're going to be more likely to be looking for, how do we partner with some of the other companies that are over there that see the opportunity and do it in a way that will hopefully stimulate MTU to do more as well.

Great. Okay. Thank you very much.

You're welcome.

That is all the time we have for questions. I'd now like to turn it back over for additional comments and closing remarks.

Well, thank you everybody for joining us on today's call. On behalf of the management team, we look forward to speaking with you again the next quarter. Thank you.

This concludes today's conference. Thank you for joining us, and have a wonderful day.