燃料電池能源 (FCEL) 2009 Q2 法說會逐字稿

Good day and welcome to the FuelCell second quarter 2009 results conference call. Today's conference is being recorded.

At this time for opening remarks and introductions, I'd like to turn the conference over to Ms. Lisa Lettieri. Please go ahead.

Thank you, operator, good morning everyone and welcome to FuelCell Energy's second quarter results conference call. Delivering remarks today will be our Daniel Brdar, Chairman and CEO, and Joseph G. Mahler, Senior VP and CFO. Our earnings press release is posted on our website at www. fuelCell.com, and a replay of this call will be posted two hours after its conclusion. The telephone numbers for the phone replay are listed in the press release.

Before proceeding with the call, I'd 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 continuing 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 US Securities and Exchange Commission. Now, I'll turn the call over to Dan Brdar. Dan?

Thank you, Lisa and thank you everyone for joining us this morning. Despite a challenging economy, FuelCell Energy continues to execute its strategy to penetrate our target markets, drive down product costs and provide ultra-clean, reliable, base load power solutions to our end user customers. This morning, we announced another significant step in implementing that strategy as we completed another order with POSCO Power for 30.8 megawatts of modules and components. This order, valued at $58 million, is the largest single megawatt order in our history, and is part of an expanding relationship with POSCO Power for the Korean market.

We will discuss this in more detail later in the call, but we are very excited about what this means for continued growth of our business. Additionally, the worldwide initiatives for clean energy generation continue to open markets for our products as policy makers look for solutions to our complex energy and environmental problems. In the US, the American Recovery and Reinvestment Act provides stimulus funds for clean energy.

Energy policy in Congress is focused on a Federal renewable portfolio standard, and a cap and trade program limiting carbon emissions of large polluters. These government initiatives and others like them around the world provide the foundation for continued growth in the use of clean energy. Our products meet this need for a new, greener marketplace. They are highly efficient, and therefore are a low carbon solution, and use less fuel to make a kilowatt hour of electricity compared to conventional generation equipment.

Also, since they do not combust the fuel there is near zero NOx and SOx and particulate matter. Additionally, the fact that our power plants operate 24/7 means they provide a clean energy solution that can't be addressed by intermittent technologies such as solar and wind. This makes our products an excellent solution for a wide variety of large load users like the grid, manufacturing facilities, and waste water treatment facilities. Before we talk about the markets in more detail, let's turn the call over to Joe Mahler, our Chief Financial Officer to review the financials for the quarter. Joe?

Thank you, Dan, and good morning everyone. In the second quarter of 2009 FuelCell Energy reported total revenues of $22.9 million from $31.6 million in the same period last year. Product sales and revenues were $19.3 million from $26.4 million in the 2008 second quarter, and slightly lower than last year's unusually strong second quarter. The Company's product sales backlog as of April 30, 2009, including long-term service agreements was $59.2 million, compared to $70.9 million as of January 31, 2009, and $134.7 million as of April 30, 2008. Orders from POSCO and the County of Sonoma add approximately $64 million to this backlog. Research and Development contract revenue was $3.6 million in the second quarter of 2009, compared to $5.2 million in the second quarter of 2008. Research and Development contract backlog was $19.5 million compared to $8 million at April 30, 2008.

Second quarter net loss to common shareholders was $19.9 million, or $0.29 per basic and diluted share, compared to $25.8 million or $0.38 per basic and diluted share in the same period last year. The product cost to revenue ratio was 1.48 comparable to 1.50 reported in the prior year quarter, and the 1.52 in the first quarter '09, in line with our expectation. As we begin to produce gross margin profitable products this quarter, we expect the cost of revenue ratio to continue to improve.

Cash use in the quarter totaled $8.4 million resulting in a total cash and investment balance of $42.4 million as of April 30. Depreciation was $2.2 million and capital spending in the quarter totaled $800,000. The credit crisis is delaying our order flow. This is affecting our planning growth and cash estimates for the quarter and fiscal year. While the uncertainty around the credit crunch and federal programs is frustrating, we are very optimistic about our strong global pipeline of FuelCell projects.

We believe that the value proposition of these projects is attractive, and meets clean power generation and efficient energy initiatives. We are seeing growing interest in Asia, California and the Connecticut markets. The most recent evidence is the POSCO order for 30.8 megawatts clearly illustrating demand for our products in South Korea.

While we await the economic recovery, we reduced operating costs and cash use in February 2009, including a 6% workforce reduction, suspension of employer contributions to the 401(k) plan, a freeze on the level of salaries for all employees, except for production employees and other expense reductions. As a result of these actions, we expect reduced cash use in 2009 compared to 2008, although cash use for fiscal '09 may not meet our previous expectations due to the delays in US orders. The County of Sonoma order and the POSCO order will certainly help us recover some of this delay factor, especially going into 2010. If the markets remain pressured, we are prepared to make further adjustments to our production rate and spending.

Like others, the credit crisis is affecting our ability to finance projects. We see a tight tax equity market, but potential openings when the tax grant -- when the tax grant rules get defined, and also in a new area for us, public funding. Several of our California projects have used public funds, and several prospects are considering these funds. In a sense, we are finding this to be early stimulus money. If you look at how we have approached product finance to this point it has typically been on a relatively small, individual project basis which is difficult to fund even in good markets.

However, when Connecticut awarded us an incremental 27 megawatts, the combined projects total over $220 million. This size is clearly getting attention in the marketplace. The project fundamentals are very good with up to twenty-year power purchase agreements with investment grade utilities, and the returns are good. I believe these projects can get done. Let me call -- let me turn the call back over to Dan.

Thank you, Joe. A key part of our strategy has been to aggressively drive down our product costs. Due to the continued growth in the demand for our megawatt class products, they have been the focus of our cost reduction efforts for the last couple of years. The most recent cost reduced designs were targeted for production this summer. I'm pleased to report that our new cost reduced megawatt class designs are now in production, and the first units will begin shipping in a few weeks. These products are our first gross margin positive units and their production represents a significant milestone for the Company, and important step on our path to profitability. These new megawatt class products incorporate our latest technology improvements, and the early results from our global sourcing initiatives.

As parted of these improvements our megawatt class fuel cell module and DFC1500 will be upgraded from 1.2 megawatts to 1.4 megawatts, and our DFC3000 will be upgraded from 2.4 megawatts to 2.8 megawatts. Currently our production volume is at an annual rate of 30 megawatts, and with this morning's order announcement our product sales backlog is approximately 49 megawatts. While we do not plan to immediately change our production rate, we will continue to evaluate it as new orders are closed. In recent months, the global credit crisis caused delays in closing new orders for many companies, including FuelCell Energy. Order activity in our US markets has been particularly impacted by the situation. While the global economic situation is troubling, we are seeing signs that the situation is improving. This morning's order announcement is certainly one of those signs.

However, we continue to be cautious in our spending and our production plans, due to the limited visibility that still exists in several of our key markets. Despite the economic environment, the global support for clean energy continues to remain robust. In Korea, the government has announced a green New Deal program to support deployment of more clean energy generation and create more jobs. This $38 billion program is strong support for our partner POSCO, as it works to deploy our products throughout the country. The POSCO balance-of-plant facility in Pohang. is now in full operation, and during the quarter they began building their first megawatt class balance-of-plants. This first Korean-built unit will be installed with FuelCell modules from our factory later this year.

To date, POSCO has 18 megawatts in operation or various stages of installation, out of the 68 megawatts they've ordered. They are mostly multi-megawatt DFC 1500 and DFC 3000 units. One DFC 1500 unit is at POSCO Power's headquarters in Pohang. Another unit is at a paper company called Natura. Two independent power producers called HS Holdings and MPC are producing power for the grid with DFC 3000 units.

The most recent announcement reflects our continued growth with POSCO, as we build on our mutual success and expand our relationship. The announcement includes an order for 30 megawatts, and a pending $25 million investment in FuelCell Energy, and an expansion of our license agreement. These activities attest to POSCO's conviction that clean energy-efficient DFC stationery fuel cells are a key part of their country's clean energy mandates.

The 30 megawatt order is for megawatt fuel cell modules and module components. This order provides backlog to take us into early 2011, and provides a solid foundation to further expand our presence in the Asian market. Our strategy has always been to penetrate key geographic markets, and as order volume warrants build regional assembly and conditioning facilities. These facilities also become a base for deploying service personnel for the regional market.

This approach accomplishes several objectives. It allows to us show local job growth which is key to building government support in our target markets. The employment of local labor is also more cost-effective, resulting in continued product cost reduction. It's also a practical solution. Since our products are large and heavy, shipping finished power plants around the world is a costly approach that factors into customers' economics.

For Korea we are working with POSCO to expand the licensing arrangement already in place, for the balance-of-plant equipment. The intent is to create a regional stacking and testing facility at their new site in Pohang. When completed, the arrangement will allow FuelCell Energy to provide cells and module hardware for the FuelCell modules to POSCO, and will build on our success in the Korean marketplace.

While the licensing agreement must be finalized, both FuelCell Energy and POSCO are confident in our path forward, and as a result approximately half of this morning's order reflects parts intended for the new stacking and conditioning facility. We'll provide more details regarding this exciting new step in our relationship in the coming weeks as the necessary agreements are concluded.

In addition, POSCO has also agreed to provide an additional equity investment in FuelCell Energy. POSCO will invest $25 million in FCE common stock. They obviously want to have a healthy partner for the long-term, and their additional investment is a strong commitment to our strategic relationship.

Turning to Connecticut, the 43.5 megawatts of projects approved by the Department of Public Utility Control include our newest and most efficient products, the DFC ERG. and the DFC turbine. In fact, four DFC ERG plants totaling 18.8 megawatts were approved. These power plants are approximately 58% to 65% electrically efficient, which is important for reduced carbon dioxide emissions and achieving energy cost savings. To put it in perspective the DFC ERG and DFC turbine offer up to twice the efficiency of the average central generation fossil fuel power plants in the US, and are more than 33% more efficient than most distributed generation plants their size.

As Joe described, the credit crisis has slowed our ability to get these projects from Connecticut concluded and into backlog. The Connecticut projects represent in aggregate over $200 million of business with attractive project returns for our project partners and participants. Potential project financiers are cautiously working their way through their assessments and project due diligence. While we can't precisely determine closing dates for the Connecticut projects, we are cautiously optimistic about the discussions that are going on now with the project finance entities.

California continues to be a leading market for us, as you saw from the Sonoma county order. It will use our new operated 1.4 megawatt fuel cell operating on natural gas, to not only produce electricity but also to provide heat and hot water for a prison and several county office buildings. Natural gas is a plentiful domestic fuel that powers 55% of California's customers, and a large potential market for our FuelCell power plants. Customers are recognizing that our fuel cells operating on natural gas deliver a highly competitive, low carbon and near zero emissions solution for base load power.

As a result, we offer a unique value proposition for the California market, as they work to find clean base load solutions to balance their expanding deployment of intermittent wind and solar power. We are already well-established with renewable gas customers in California, and we are looking forward to more business from natural gas customers.

Wastewater treatment facilities continued to be a target market for us in California. Knowledge of our installations is widespread in the California wastewater treatment industry, and has driven a number of referrals and proposal opportunities for us. We have several projects moving through the municipal review and approval process, and look forward to deploying more megawatt class units at wastewater treatment plants in the site -- in the state.

I want to take a moment to discuss the two US government facilities orders we announced during the quarter. One unit will go to Barksdale Air Force base in Louisiana, and the second unit will go to 29 Palms in California, the largest training facility for the US military. We view these two DFC 300 power plants as sowing the seeds for future megawatt class orders, as the government gains experience with our product's reliability, cost savings and low emissions. After all, the federal government is the largest electric consumer in the world, and they have a mandate to deploy low carbon, high efficiency generation wherever possible. It's logical they would want to deploy the highest efficiency, lowest carbon base load generation possible, FuelCell power plants.

Moving to the government initiatives that should benefit our business, as you know, the American Recovery and Reinvestment Act allocates $30 billion for clean energy programs. Of that, nearly $10 billion could include FuelCell projects. As programs are implemented to spend the stimulus funding, we expect to participate in those opportunities both for research and development, and for commercial product sales.

We also see Congress moving forward on greenhouse gas regulation and the Federal RPF standard, regulations that will certainly encourage further deployment for our products for a wide array of applications. A Federal RPS and a cap and trade program are included in the American Climate and Energy Act. The bill aims to cut greenhouse gas production to 17% below 2005 levels by 2020. The proposed RPS is 20% clean energy generation by 2020.

The cap and trade system will limit big polluters like the power industry, and steel and cement manufacturer's CO2 emissions, requiring them to offset their emissions with renewable energy credits purchased from the government or other companies that generate clean energy. This will establish a powerful incentive for companies to reduce emissions by generating their own clean electricity, which they can do with our fuel cells.

Another bill being proposed in Connecticut requires utilities to buy 100 megawatts of clean energy over the next three years. Utilities will likely evaluate several technologies as part of the program. As demonstrated by the Connecticut project 150 bidding process, we expect to be able to provide a competitive offering for the utilities since, like many eastern states, Connecticut has a poor solar profile for economic solutions, and has no meaningful wind resources. Since DFC power plants are the most efficient and cleanest energy generation solution available, we expect fuel cells to do well under this scenario, and we are excited by the opportunity to work directly with utilities to install our units where they'll do the most good.

In summary, we see opportunities in several areas. South Korea, where the country is determined to deploy clean energy solutions and grow green jobs, and POSCO Power is moving quickly ahead to grab market share with our products. Connecticut, as it works to meet its renewable portfolio standard. California, a consistent leader in the deployment of clean energy technologies, and government facilities that support energy efficiency and low carbon technologies, and are beginning to recognize our fuel cells' role in the worldwide clean energy solution. All of these markets are looking for clean, highly efficient energy generation, the kinds our products provide. Operator, we will now take questions from our listening audience.

Thank you.

(Operator Instructions)

We will go first to Michael Lew, Thinkequity.

Thanks, good morning Dan, good morning Joe.

Good morning, Michael.

First, congratulations on the order from POSCO. Also wanted to do clarify, is the composition, is it all from megawatt class or the 2.8 megawatt modules?

It's all megawatt class modules and megawatt module components.

And also, you had mentioned the expanding relationship with POSCO, which I expect includes penetration to the Asian markets. While it's early, still a bit early, could you characterize that opportunity?

Well, when -- we meet with POSCO, sort of understand where they see their business going, the opportunity that they see really is to take the Korean programs ,and use it as a base to deploy units, get people familiar with the product in the Asian market place, and continue some cost reduction. But really, where they want to go more broadly is the entire Asia region, places like China. Many other parts of Asia are untapped markets for us. And we think that POSCO represents a really good partner to go pursue those markets with, in the long-term.

Do you have a size on that opportunity? It's still early.

It's still early. We are seeing a pretty rapid change in terms of even the adoption within countries like China. If you look back a few year ago, it was just purely coal-fired power plants. Now you are starting to see them moving towards adopting some green solutions as well. So I think as we see start to see that take shape, and we share our market information between ourselves and POSCO, we will be able to get a better assessment of where we think the next early opportunities are, and how big those opportunities are as well.

Also could you characterize the size of the current product line over next 12 months beyond POSCO, is it primarily megawatt demand, and also types of market segment deployments?

The, most of what we see in the pipeline is megawatt class. We do have several wastewater treatment facilities, though, that would take multiple sub megawatt units. They tend to be 600 kilowatt to 900 kilowatt size units. I would say the wastewater treatment is probably about a third of what's in the pipeline. And then the rest of it is large scale megawatt class that are largely grid applications like in Connecticut, like in Korea.

Okay. And one last question, can you also, you mentioned -- can you also update us on any progress in Europe, any near term possibilities there, opportunities there?

Well, our current arrangement with our partner there, NTU, expires the end of this year. We have several current partners who would be potential candidates to go into that marketplace with, and we have discussions going on with others, to really assess what do we think is the right way to grow the market, because we view that as largely an untapped opportunity for us. But it's a little bit premature to talk specifically about that yet. We will be addressing it in some of the coming calls later this year.

Thank you.

You're welcome.

We will go next to [Julie Cudjoe], Simmons and Company.

Hi, guys, good morning.

Good morning.

Good morning.

I was just hoping if you could give us an update of the backlog that you had at the end of Q2. Is the round three Connecticut decision is that included in that number?

No, there is nothing from Connecticut that's yet included in the backlog. So those 43 megawatts are yet to be added and we will do that once we close the contracts, and our partners close their project financing. That's all upside on the backlog right now.

Okay, and you may have said this, I may have missed it, the POSCO order, the 30 megawatts, is that included in -- I know your press release outlined about $65 million in backlog that was added since the end of the quarter, is that included in that amount?

Yes, the POSCO order is actually around $58 million. So that, that plus Sonoma, gets you to the $64 million incremental.

Okay. Perfect. And one last question, just wondering, with this POSCO deal you are getting about an additional $25 million in cash. Can you speak of it, to your cash balance? I guess at the end of the quarter you had roughly $17 million. Can you speak just to your comfort level there?

Yeah, basically actually it's a couple of line items that you have to add together. All of our investments are US treasury, so it actually adds up to about $42 million. So the 20 -- we are assuming we will get the $25 million in a short time period. That would actually push our cash balance to 67, and at that point we are pretty comfortable with our cash.

Okay. Thank you very much.

We will go next to John Quealy, Canaccord Adams.

Thanks. This is Jim Moore for John. Good morning.

Good morning.

I wonder if you could talk about any change in the characteristics of the conversations you are having, with natural gas prices quite low, and seemingly expected to stay here for some time.

It's really brought some industrial players back to the market, because what we saw people struggling with is we saw a lot of volatility, and that upside volatility scares people. But for whatever reason in the marketplace when gas pricing goes down people tend to want to jump on it, particularly if they can lock in a source of supply. It's really bringing back customers at higher gas prices who were probably struggling with the economics, and the order we announced with Sonoma is a perfect example of that, where the low gas pricing really enables some pretty attractive returns for their investment in the product, and ends of being one of what we hope is going to be several megawatt class orders that are going to go natural gas-based in markets like California.

Great. And I guess if you look at the natural gas step down station opportunity, if you could just provide a bit of an update there?

Sure, the very first units has actually been installed in Toronto at our partner Enbridge's facility. That unit is, we wanted to get it in in a place, that was at a gas site where we had our partner able to speak as a gas distribution company. So it's been a great location to take potential customers to.

The next project that we are hoping to do will be the project that came out of round two in Connecticut, the project in Milford. It's about 9 megawatts. It will be the largest FuelCell power plant in the world when it's done. And then we have three more right behind that, that are in the 3 megawatt to 3.5 megawatt size range in Connecticut, also as part of the round three bidding.

So what we are finding is, getting a unit and in operating and then having a project or product that competes so readily in the RPS market, because the Milford project was the highest scoring project, says we really have an attractive solution for the gas companies. It solves a problem for them, and it actually allows them to get into the RPS markets, which is something they would clearly like to do. So getting these next couple of projects from Connecticut, and moving forward in terms of getting the financing done, getting them on the grounds quickly, I think will really start to drive some of the adoption for the larger installations that we see around the world.

Sure. Okay. Congratulations. Thanks.

Thank you.

We will go next to Sanjay Shrestha with Lazard Capital Markets.

Good morning, guys, first off, congratulations on this POSCO announcement. First question, maybe this is for Joe, just want to get this right, so you guys have 43 in cash, plus 25. You burned 8. And while you guys don't want to quite get into the cash burn dynamics given some of the macro uncertainty, is it fair to say, though, Joe, the burn shouldn't go up, given that what's in your backlog has a lower cost profile? And you are going to be mindful as to ramping capacity, mindful as to working capital management, things along those lines, so it gives you at least another eight more quarters of cash cushion?

Wow, that's a big bite there, Sanjay; but, yes, I think that that, I think the only thing I would kick back on is that there's a couple of buttons to push. And so right now we are trying to maintain the 30 megawatt run rate, the POSCO order allows us to maintain the 30 megawatt run rate, you want to extend that out. We do want to keep putting order flow through, so the delay could have what I would consider to be kind of a short term issue in the cash flow, not really an eight quarter issue in the cash flow, but probably a little bit of variability in the short term. Certainly closing the Connecticut projects would flow some terrific cash through and would really in effect maintain the 30 megawatt and even give us opportunities to go beyond the 30 megawatt run rate. So that the only thing I would really caveat there, Sanjay.

Okay, fair enough. Fair enough. That's what I was trying to get at. So now at a few more questions, first off Connecticut, then some questions on POSCO and potential new partnership. So for this Connecticut project, now that I guess the DOE loan guarantee allows you also to use that money for the commercial renewable energy project, rather than just the next-generation technology funding. So are you guys in active dialogue with, if you would, the prequalified lender? And could you see that really bridging the gap here even before the project financing market comes back? And sometime over the next quarter or two all that $200 million ends up hitting the backlog, because we found this sort of bridge financing if you would, vis-a-vis in the form of the government? Is that something you guys are in discussion with at this point in time?

Yes, there is some lack of clarity, but we are certainly focused on Washington. We have a lot of the finance ears are focused on Washington and we do get some good feedback. There is some lack of definition right now that -- that is stalling that.

But in addition to that we have, I'm seeing more creativity right now in the marketplace than I've seen in the last three or four years. I'm seeing people finding capital, for example, public financing is playing, we are spending much more time with public financing vehicles right now, looking at how to finance projects. We've actually done a couple of projects in California with public financing. So we are seeing a lot of creativity in the marketplace. It's just a function of, for example, the tax grants, they just need, they are supposed to define rules in a couple of weeks. I think once those rules get defined, that helps the financing players.

But as I said in the comments, the fact that we are now able to put 200, over $200 million of projects in front of the some real players. And these players are coming to the conclusion that fuel cells are going to be a major, major part of renewable portfolio standards so there's a lot of projects coming. So they are spending the time. They are working their due diligence. I can't tell you exactly which deal, or what structure will actually play out ,but we are looking at multiple and a lot of creativity right now.

Got it. A few more if I may, and Dan, it was good to see you last week. One quick question to you, I guess, on POSCO. You mentioned that you guys are sort of looking at the licensing relationship, and it's going to be a modular approach, given the transportation costs and things like that. Can you go into some more detail as to when you said licensing, over time are you going to just provide the license to POSCO, even to build a fuel cell stack? Or is it really more just on the balance of system side, and it's going to be stack revenue, FuelCell Energy balance of system incremental licensing revenue, FuelCell (Energy and POSCO the distributor in Asia?

We really have never contemplated licensing the core technology to any new partners. It's really where most of our intellectual property rests, it's something we've gone to great lengths to protect. Not that there's anything wrong with our partners, and or we are concerned about. I am just saying it's what really differentiates us in the marketplace, so we really want to protect that core.

If you look at our product itself, the whole balance-of-plant was something we didn't make ourselves anyway, we outsourced it. So it's a logical first step in licensing. And this next step really is to take what is basically an assembly operation and a testing and conditioning operation, teaching them how to do that because it really helps to localize the product. And then where we go from there is really going to be a function of how the markets develop. I suspect at some point we are going to do more of these kind of arrangements.

I would expect to see us do one hopefully at some point in California. We may do one at some point in Europe or other parts of the world. And then depending on that market, we will determine whether we would do it solely as fuel cell energy, whether we do it as a license or whether we do it as a joint venture or somewhere in between. It's really what is the best way to reach the market. And the conclusion we reached as a small Company trying to penetrate a market like Korea, the most practical approach to keep growing the market quickly was to go the license approach.

That makes perfect sense. One last question for you guys. It certainly seems like we are probably going to get the federal renewable electricity standard here as a part of the new energy bill, and are you guys starting to see a lot of inbound from the wind developers, or even the utilities that are very heavy in the wind energy side, to sort of partner with you folks given the intermittency issue of wind and as wind makes a bigger part of their RES, they are going to need to sort of rely on something like what you offer, is that type of a dialogue taking place at this point in time domestically? And is that something that could even, that we could even see out of the European utilities?

Well, the, we are not seeing it so much as the wind developers yet. The ones we are seeing first are the utilities, the utilities that are really out ahead of this game. And particularly ones where they don't have a lot of solutions like solar and wind are looking for other resources, and have been coming to us to understand the product, to understand how does it work, where we have deployed it, how big are the units that we have done. And we are also finding that we are seeing some interesting creativity from some of the new utility management.

We had some senior utility planners that came through here a couple of weeks ago and their first comment was, well, you guys are part of the smart grid. You guys actually enabled the deployment of more of these intermittent technologies. So we are really starting to see the utilities look at this from a portfolio approach, recognizing that there is going to be regional differences in the solutions, but that fuel cells are going to play a significant part of it, and maybe a majority part depending on whether you can do some of the other technologies in a given utilities service territory.

Got it. We have to keep some stimulus money in the Northeast as well, right.

Absolutely.

Terrifica. Thanks a lot, guys.

Next, Rob Stone, Cowen and Company.

Hi, guys, busy morning.

Yes, it has.

To continue on the theme de jour, I have a couple more questions about POSCO. So I know you are still finalizing the agreement so it would be premature to comment on the details, but is it correct to assume that, if this is going to be a component sale, plus some element of licensing, that there would be a royalty stream in there, and this would be in general a margin sweetener?

You could expect it to be component sale, a running royalty and probably an up front royalty as well.

Okay. So the up front royalty would be in addition to the equity investment.

Yes.

Great. With respect to operating expenses, you mentioned a number of steps you're taking to get through the tough economy rest of this year. I noticed that R&D was lower, but SG&A was actually up sequentially in the quarter. Can you comment on the expected expense trends in the next couple of quarters at least directionally?

Yes, I think, Rob, what you might want to take a look at is take a look at the year-to-date, and you see that both SG&A and R&D are down substantially. The second quarter is kind of our big shareholder meeting, and it carries a little bit more expense. But I think that between the first and second quarter, if you extrapolated that out, that's probably pretty close to what the year is going to look like.

So because of the one-time items in Q2, would you expect in general a down tick in Q3?

It would be somewhere in that range. Between, you're not talking, I mean historically our second quarter has always been higher than the previous quarter, or the prior quarter. So it's in that range. You are talking like 4.5 per quarter, something like that.

The question on the mix of products, as you start to manufacture the newest gross margin positive products in Q3. I think you said that the wastewater treatment, which were in most cases sub megawatt class, were about a third of the pipeline out there. As you look at what's in backlog, and older versions that are still flowing through production, what should we expect, approximately, the mix to be between the newest components that are going to be gross margin positive, and the legacy or sub megawatt class over the next couple of quarters?

Let me just correct what I said, because it may not have been clear. When we look at the mix, from the market standpoint, about a third we expect to be wastewater treatment based on what's in the pipeline for things like Connecticut, and what's in the pipeline with Korea. Of those wastewater treatment, some are going to be sub megawatt units or multiple sub megawatt units.

Overall, the sub megawatt unit is going to be a small percentage of our business. It's probably going to be certainly less than 20% of our business. Mostly because we've been using it as a sort of a market seeding opportunity. And as people have gotten comfortable with the product, as the only Company offering megawatt fuel cells, that's where the business has moved. And if we believe there is going to be an ongoing marketplace for multiple sub megawatt units, we will probably do another round of cost reduction on that product, maybe tailor something a little bit more specifically for the wastewater treatment market, if we think that's the space that make the most sense. And then, Joe, you want to talk to what the mix is going forward in terms of what's already in the production.

Yes, the backlog is primarily megawatt, megawatt power plants and megawatt modules at this point in time. The POSCO order is all megawatt based, so there's actually very little sub megawatt in the backlog, or in this new backlog.

But you will need a few quarters still to burn off stuff that was in progress of the prior generation? Is that correct.

That's correct, yeah.

So about how long would that take?

I think you start to see a move in the fourth quarter, and I think first quarter '10, I think it should be all those products at that point in time.

So by Q1 '10, you will be on all the newest generation?

The only thing you will have is any sub megawatt activity that we -- for strategic purposes, we want to take a three 300's at a wastewater treatment plant in California, you could have those come in and those will have higher than one cost ratios. But other than that -- most everything is megawatt based at this point.

A final one relating to cash, if I may. If you elect to hold the run rate where you are now, what's your CapEx requirements going to be for the second half of the year?

It's minimal, it's really just the maintenance capital.

Minimal capital.

So a couple million or --

Probably at the most.

Great. Thank you.

You're welcome.

We'll go next to Walter Nasdeo with Ardour Capital.

Morning guys.

Good morning, Walter.

How's everything going?

Actually it's a pretty good day. A long night, but pretty good day.

If I could just briefly touch on what your current capacity is, and if you have any cap expectations here in the relative near term to make sure that you're able to meet these orders and any expected orders that are on the horizon? And then just kind of a quick question on how much time, how much conditioning time does each one of the existing systems take before it's ready to be completely up and running? And is there any change in that in the new, higher output systems?

Walter, you know us too well. Let me start with the conditioning first. The conditioning process has historically taken about eight days. As we go to the new design, that process is going to take a little bit longer, because we want to make sure that we understand the repeatability of the process. We have not fully automated it with the new design yet, so there's going to be some manual operations. That conditioning process is probably going to go to 10, maybe 11 days. As we get more comfortable with it we will shorten it down and we expect it to get back to the same seven, eight-day conditioning process of the current product.

If you look at our capacity, we had previously been taking about 50 megawatts of capacity, at the factory in Torrington. But as we have continued to conduct lean operation there, and as we have continued to improve the core product, we believe that capacity is now closer to 70 megawatts. And with the investment that we've made recently in our testing and conditioning facilities on the megawatt side, we think we've got plenty of capacity available to address continuing to ramp the business up, particularly with POSCO moving to building their own facility where they will do the local conditioning of their megawatt modules.

Great, and just a quick follow up to that, how does your supply chain look? Are all your suppliers in pretty good shape right now? Do you have any concerns? Have you been looking to get a couple of levels of redundancy there, or are you pretty comfortable with where that's at?

We are comfortable with it right now, but it's been an ongoing process because we had a concerted effort to go back through all of them to understand which suppliers, for example, have exposure to the automobile industry, which ones are just in financial trouble generally, because other parts of their business are slowing down. We did identify two that we had some particular concerns about so we have been bringing some other suppliers through that qualification process. But it's actually something that we are going through about on a monthly process to continually reassess them, because we are finding that some people's business environment is improving or deteriorating more rapidly than others. So it's going to be an ongoing process for us certainly through the end of this year, and probably into the beginning of next year as well.

All right. Thank you very much, guys, appreciate it.

We will go next to John Roy, Janney Montgomery Scott.

Hey, Dan. Hey, real quick question, with your kind of change in run rate levels going forward possibly, obviously that's going to change when you might hit profitability, but then again your mix is changing a little bit here, and it looks like you won't need as much capital to hit certain run rates. Can you give us kind of an update on when you might be cash flow positive, and when you think you might hit profitability longer term? Have you guys thought a lot about that, obviously?

We have. We haven't gone back to remodel this, and we really need to lay that back out for everybody to understand. We have historically said that when we are making complete power plants, when we are producing 35 to 50 megawatts a year, we are as a company gross margin positive. And when we produce 75 to 100 megawatts of complete power plants, we are cash flow positive.

As we shift towards modules and components, since they don't carry as much revenue with them, that range could be 75 to 125 megawatts. But we are going to do a repass through this now that we really understand a little bit longer term, what our delivery is going to look like because of the long-term delivery for the POSCO order and then we can recast that for everybody.

Because also obviously with the royalties it will also change, obviously, the corporate situation as well. Cool. Look forward to that. Great job, guys.

Thank you.

We will go next to Pavel Molchanov with Raymond James.

Thanks for taking my question, guys. I know it's a small component of revenue, but how should we think about R&D contracts? They obviously jumped from quarter to quarter. Any sense of what the run rate might be for the next couple of quarters?

Yes, Pavel. We typically look at R&D contracts in a $10 million to $15 million annual range. That's about where we see this year. We think they will be similar to the current level, maybe a little bit higher, as we increase some intensity on our solid oxide contract. But, yes, in about that range.

Understood. A follow up on your discussions with Enbridge, you alluded to that earlier, the installation of the first system. Any sense of when they might make a decision on a larger commitment?

There is actually several things going on with Enbridge right now. They are looking at other installations in Canada. They've identified their next couple of target units, and they are working with the Canadian government also as part of the province, in the country's overall renewable energy plans. But they are also involved in taking a look at some of the projects we are doing in Connecticut. They are a participant in the Milford project, and they are looking at whether it makes sense for them to play a bigger role in that, and we will hopefully have some feedback from them on that particular issue here in the coming weeks.

Understood. Thanks, guys.

You're welcome.

We'll go next to Sam Dubinsky, Oppenheimer.

Hey, guys, just some clarification. Today you are operating at a 30 megawatt run rate. And just to be clear, you can't hit gross margin positive or cash flow positive until you announce a capacity expansion. Is that correct?

The capacity is already there. So while our units are going to go gross margin positive, for the business to go gross margin positive, since we've got SG&A and IR&D that we are funding, we have to ramp that production up into that 35 to 50 megawatt range. But the capacity is already there. It's installed. It's really a matter of just variable cost to bring on some additional people to ramp up the production rate.

I'm sorry, what does the production rate have to be, for 35 megawatt, you have to ramp to be at the capacity in place?

We have about 70 megawatts of capacity, and the difference becomes gross margin positive when we are producing 35 to 50 megawatts of complete power plants.

Okay, great. And then, can you just run through your pipeline again? I know you mentioned that your backlog should be up next quarter, but how many megawatts are you guys bidding for today? I know there's 40 megawatts in Connecticut. Can you just run through potential sizes of other deals?

Sure. There's 43.5 megawatts in Connecticut that's already been approved by the public utility commission. In California, it's a collection of projects that are largely wastewater treatment or industrial sites, there's about 15 megawatts worth of projects there. And then, it's a matter of what other markets do we start to open up because we do see some other markets that are becoming receptive to the product. We've got other states and other locations where we are looking to partner with some people to do new activities.

Okay, and is there also any benefit from a weakened US dollar, since your products may be cost competitive if you were to sell abroad? And have you seen any pick up from foreign customers or foreign activity?

It certainly has been able to enhance the situation in terms what have we are offering for Korea, for example. The weak dollar has certainly make our product from an export basis look more attractive, but it's also why we want to quickly get into doing more in Europe, because we think, particularly with the dollar not looking like it's going to be terribly robust here for the next several quarters, it's a good time to enter another market where the dollar will help us, from an export standpoint.

Okay, great. Thank you.

Your welcome. Operator, I believe that is the last person in the queue. So I want to thank everybody for joining us today on the call. And we look forward to updating you, as we make progress, not only on the things we talked about already today, but on some other exciting, new things we've got in the pipeline. Thanks, everybody, for joining us.

This concludes today's conference. We appreciate your participation.