燃料電池能源 (FCEL) 2009 Q3 法說會逐字稿

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

At this time for opening remarks and introductions, I would like to turn the call over to Lisa Lettieri, Vice President of Investor Relations. Please go ahead, ma'am.

Thank you, Matt. Good morning, and welcome to FuelCell Energy's third quarter results conference call. Delivering remarks today will be R. Daniel Brdar, Chairman and CEO, and Joseph G. Mahler, Senior Vice President and CFO. Our earnings press release is posted on our website at FuelCell Energy.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 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 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. As the economy recovers, the demand for clean, efficient energy will grow, as policy makers look for new ways to create the energy and jobs that drive the global economy. As the world's leading producer of ultra clean highly efficient fuel cells for base load power generation, FuelCell Energy is in the right places with the right products at the right time to capitalize on this growing demand. During the third quarter, our latest cost reduced megawatt class products went into production as planned, an important milestone for the company.

Early in the third quarter, we announced our second large sale to POSCO Power in South Korea for 30.8 MW of modules and components. The order is valued at $58 million and was the largest megawatt order in our history. This order, the licensing agreement we are negotiating to enable POSCO to assemble FuelCell modules and South Korea's pending RPS legislation are significant developments that bode well for our growth in that marketplace. In the US, Sonoma County in California ordered a 1.4-megawatt DFC1500 power plant. The adoption of our products is growing in California among waste water treatment facilities, utilities and food and beverage processors. While the economic downturn has affected every industry, including ours, we see signs of recovery. The availability of the federal loan guarantee program and the investment tax credit grants will help projects in our pipeline move forward in California and Connecticut.

Public policy and environmental legislation in all our key markets strongly favors our products. Our products meet the need for green energy and green jobs. Like solar and wind power, they are environmentally friendly, but unlike solar and wind, they are not intermittent. Fuel cells provide ultra clean power around the clock and do so in a way that's economical, reliable and with reduced greenhouse gas emissions, a unique value proposition that makes fuel cells an excellent solution for customers throughout our growing global marketplace. I'll discuss the markets in more detail in a moment. But first, let me turn the call over to Joe Mahler, our Chief Financial Officer, to review financials for the quarter. Joe?

Thank you, Dan. And good morning, everyone. FuelCell Energy reported revenues for the third quarter of $23 million compared to $27.9 million in the same period a year ago. Product sales and revenue were $18.7 million compared to $23.2 million in the third quarter of 2008. Lower product revenues reflect delayed activity in the US due to difficult credit markets and delays in capital spending. Research and development contract revenue was $4.3 million compared to $4.7 million in 2008. The company's product backlog, including long-term service agreements as of July 31st was $104.8 million compared to the $100.7 million reported as of July 31, 2008.

Research and development contract backlog totaled $15.3 million compared to $5.5 million. For the third quarter of fiscal 2009, net loss to common shareholders was $15.7 million, or $0.21 per basic and diluted loss per share, compared to a net loss of $26.8 million, or $0.39 per basic and diluted share in the same period of the previous year. The product cost to revenue ratio was 1.4 in the third quarter which compares favorably with 1.68 in the same period a year ago and 1.48 in the second quarter. The contribution from the cost reduced modules resulted in higher product margins compared to last year, and mitigating this benefit in the quarter were higher costs related to commissioning multimegawatt power plants in Korea.

Total cash and investments totaled $53 million as of July 31st. During the third quarter, FuelCell Energy sold $6.7 million shares at $3.59 per share in the registered direct offering, raising approximately $22.5 million of cash. We are targeting closing the POSCO transaction in this quarter, which would add $25 million to cash. Excluding the equity offering, net cash use in the third quarter was $11.9 million, which included capital spending of approximately $200,000. Depreciation expense for the third quarter was approximately $2.2 million. For the nine months ended July 31, 2009, FuelCell Energy reported sales and revenue of $67.6 million compared with $74.6 million in the same period a year ago. Product sales and revenues were $57.1 million compared to $59.4 million in 2008. The product cost of revenue ratio was 1.47, which compares favorably with 1.65 for the nine-month period a year ago, reflecting lower per unit production costs and a transition in product mix to primarily megawatt class power plants.

Research and development contract revenue was $10.5 million compared to $15.1 million in the comparable 2008 period. For the nine months ended July 31, 2009, FuelCell Energy reported a net loss to common shareholders of $56.3 million, or $0.80 per basic and diluted share compared to a net loss of $72.3 million or $1.06 per basic and diluted share in the same period a year ago. With this quarter's order momentum and our megawatt products going profitable, we are well positioned. Dan will talk more about the opportunities for FuelCell Energy. Dan?

Thank you, Joe. As I mentioned, during the quarter, we succeeded in putting our newest cost reduced megawatt class products into production. These redesigned products used 350-kilowatt FuelCell stacks that deliver 17% more power than the previous stack design. Our DFC1500 units now generate 1.4-megawatts of power and our DFC3000 units now generate 2.8-megawatts. This latest technology upgrade, coupled with additional design, manufacturing and supply chain improvements have enabled us to once again lower the production costs of our products by another 20%, the fifth year in a row we've met this objective. These products represent an important milestone for the company, as these will be our first gross margin positive products, a key contributor to our becoming profitable. The other key contributor to profitability is to capture increased order flow from the markets. In many regions of the world today, we see an increased focus on green energy. There are two primary reasons for this.

First, there is a growing global recognition that we they'd to do something about the environment and global warming in particular. Second, many countries are looking at the growth that is going to come from green technologies as a way to create jobs and improve their economies. This focus on green energy has been driving policy in places like South Korea for some time, and now we see this here in the US, with discussion about cap and trade, federal renewable energy credits, and smart grids. First, let's look at the South Korean market. Early in the quarter, we received our second large order from POSCO Power, totaling 30.8-megawatts of modules and components for grid support, an order valued at $58 million. Under the terms of the memorandum of agreement executed in conjunction with this order, FuelCell Energy and POSCO are negotiating a new technology transfer agreement. When concluded, POSCO will assemble and condition stack modules in-country using components we manufacture in Torrington.

In conjunction with signing the agreement, POSCO Power will purchase $25 million in FuelCell Energy common stock. This will represent a significant further investment by POSCO in its domestic market and an expansion of the relationship between our two companies. Currently, we have about 22.5-megawatts installed at customer sites in Korea. During the quarter, we had numerous customer DFC3000 units undergoing installation and commissioning at the same time. While this level of activity is exciting, it created some challenges for the POSCO Power FuelCell energy team. While POSCO Power continues to learn quickly, the DFC3000 is a new product for them, and installing and commissioning so many units at once required we temporarily shift our focus away from the stack module license and instead work to ensure the early customer start-ups are a success. Several of the units experienced installation issues that needed to be corrected by the installer before commissioning was completed.

Also, we experience quality issues with some of the purchased electrical components in the balance of plan equipment that needed to be replaced. While these are typical power plant installation and commissioning issues, we felt they needed to be addressed quickly and professionally to ensure customer satisfaction with the new product. Now that most of the units are in operation, we've turned our collective efforts back to completing the license agreement, which we expect to conclude and submit for US government approval before the end of the current fiscal year. The success of the early customer installations is key for POSCO Power and FuelCell Energy, since Korea is very focused on what they call low carbon green tack. The government has committed 2.4% of its gross national product to Clean Energy projects, more than any other developed country.

South Korea has to import much of its fuel and the Korean peninsula has limited solar and wind profiles, so they are looking for a green technology that will help them satisfy their national clean energy and economic growth objectives. The South Korean government is pursuing a national renewable portfolio standard to meet their need for Clean Energy and grow green jobs. The stated objective of the program is to get 4.1% of its power from renewable sources by 2015 and 11% by 2030, so the potential market is anticipated to be over 7000-megawatts of renewable energy. Based on a recent visit to Korea, both POSCO Power and several power generation companies we met with indicated that a strong RPS program is expected to pass later this year and include fuel cells operating on natural gas. Due to the limited wind and solar resources available in-country, fuel cells are expected to play a significant role in meeting the national RPS objectives. In response to this, several of the companies we visited have already installed the infrastructure for additional DFC3000 units.

The national push for green energy is also being mirrored at a local level. For example, the city of Seoul plans to invest the equivalent of $35 billion by 2030 to become one of the world's greenest cities. This initiative is expected to open a large market for fuel cells for commercial buildings. Other cities are pursuing similar programs for green energy deployment. Because of the high efficiency of our products translates directly into much lower CO2 emissions, these policies will directly enhance the sale of our products in this lean and green marketplace. In the US, California is a trend-setting proponent of clean energy and an important market for us.

In June, we announced the sale of a 1.4-megawatt DFC1500 power plant to Aircon Energy for Sonoma County. Operating in a highly efficient combined heat and power configuration, it will supply 100% of the base load power requirements for a county jail and county office buildings in Santa Rosa and will be capable of achieving over 80% efficiency. In the waste water treatment market, municipalities are sharing their fuel cell experiences with each other and our visibility continues to grow. We are currently negotiating with several waste water facilities to install our megawatt power plants. As we continue to deploy units, we are becoming the preferred solution for municipalities waste water facilities.

In addition to the waste water treatment market, we're seeing our first direct utility purchases go to the state public utility commission for review and approval. Utilities in California in particular have the ability to drive the installation of a large amount of ultra clean generation because they serve a large population. In July, several of the projects in the California sales pipeline applied for grants under the Department of Energy's combined heat and power grant program. This program is part of the American Recovery and Reinvestment Act, which was enacted into law earlier this year. The act provides additional commercial and RD funds for fuel cells and technology development and it provides for the deployment of commercial products. The act facilitates job creation and the deployment of green energy through investment tax credit grants, government funding, renewable energy bonds and demonstration projects. In all, the act provides about $9.5 billion that benefits FuelCell technology.

DOE indicated they will be announcing project approvals under the combined heat and power grant program in October. Additionally, there are two new feed-in tariffs being pursued by the California legislature. The first feed-in tariff is for combined heat and power and the other is for renewable energy. The feed-in tariff typically requires utilities to purchase electricity from power generators. Both tariffs are expected to be in place by the end of the year and present an opportunity to grow our presence in combined heat and power applications and the waste water and food and beverage processing markets more quickly and both will help drive sales in California. As intermittent energy sources like solar and wind become more prevalent, utilities and energy policy makers like those in California are beginning to recognize that these technologies can actually play a role in destabilizing the transmission system. As hundreds of megawatts of intermittent sources like wind and solar come on and off stream, they create large fluctuations in power quality, available megawatts of generation and overall stability of the grid. Our ultra clean highly efficient 24/7 fuel cells can alleviate this problem with clean base load distributed generation.

In Connecticut, the 43.5-megawatts of projects approved by the Department of Public Utility Control are pursuing a parallel path for financial closure. With the credit markets finally showing signs of loosening, project sponsors are engaged in discussions with both corporate partners and energy project financiers for traditional power project financing. The projects offer attractive returns under long-term energy purchase contracts. As a parallel activity, the Department of Energy issued a solicitation for the next round of their $6 billion loan guarantee program. This program provides an alternative mechanism for green energy products to move forward in light of the challenging credit environment that has impacted wind, solar and fuel cell projects. Under this program, the DOE provides loan guarantees for projects that encourage the commercial use of new or significantly improved energy technologies and achieve certain environmental benefits.

The current administration wants to significantly increase clean Power Generation over the next several years and also create jobs and ensure a strong, safe and reliable grid infrastructure. Of course our fuel cells do all of these, add power to the grid where the grid is weakest, provide jobs in our plant and installations and produce efficient, clean energy. As a result, all of our Connecticut projects are applying for the loan guarantee program. In Canada and the US, we're working with our partner Enbridge to expand the natural gas distribution market. Natural gas is transported long distances in high pressure pipelines and the pressure must be reduced at let-down stations before distribution to local customers. This means that every natural gas let-down station is a potential candidate for our direct FuelCell Energy Recovery Generation, or DFC-ERG product, which couples our FuelCell with a turbo expander. In this application, the net electrical efficiency is typically around 60%, nearly twice that of the US grid. Our first DFC-ERG power plant went into operation last year at Enbridge's facility in Toronto.

Four additional systems were approved for construction in Connecticut by the states Department of Public Utility Control. The market for gas pipeline applications is estimated to be 250 to 350-megawatts, just in California, the northeastern US, and Toronto. Enbridge is currently working with the Canadian government to find ways to deploy fuel cells on their gas distribution system under the government's $46.6 billion economic stimulus package. FuelCell Energy has always benefited from its highly productive partnership with the US Department of Energy and other US government entities, both in product sales and in research and development contracts. The US government R&D marketplace will continue to be an integral part of what we do and how we develop products. We're submitting several applications under the American Recovery and Reinvestment Act for projects using our DFC technology to produce clean, efficient power, coproduce hydrogen for industrial and vehicle applications, and other technologically advanced uses.

FuelCell Energy just received its first R&D award under the act with a three-year, $1.9 million program for the development of a microchannel high temperature recuperator. The developments under this program are expected to directly benefit the economics and performance of our DFC turbine system. We hope this is the first of several new R&D programs we'll be able to capture under the stimulus program. The American Clean Energy and Security Act passed the House of Representatives earlier this year and companion legislation is being considered by the Senate. When enacted into law, we expect it will contain cap and trade provisions, a federal renewable electricity standard and smart grid positions. Because our products are a low carbon, near zero emissions solution, they will play a key role in meeting the clean energy needs delivered by these sweeping policies.

In spite of the challenging economic climate, we've achieved many important milestones during the year and will continue to execute on our most critical objectives. We have all the pieces in place that drive volume, large installations and profitable operations. FuelCell Energy is the only company in the world with multi-megawatt fuel cell products for utility, commercial, industrial and government use, and we're capturing utility scale opportunities and our cost reduced megawatt class units are now in production. In short, FuelCell Energy is well positioned to achieve profitability and play an essential role in providing practical, timely solutions for the world's critical energy challenges. Operator, we'll now take questions from the audience.

Thank you. (Operator instructions) We will go first to Julie Cudjoe with Simmons & Company.

Hi, guys. Good morning.

Good morning.

Just a couple of quick questions. With the new cost reduced product that you began producing this quarter, do you have a target or expectation on the magnitude that that will impact your overall product margins and when you would expect to see the full impact of those?

Yes, Julie, I think it's been as we've reported reported. We've reported that volume somewhere above 35-megawatts of throughput, 35 to 50-megawatts, we go gross margin positive. And at somewhere between 75 and 125, depending on product mix, the company goes profitable. So the key is really increasing the volume of orders into the business to capture this profitability.

Okay. And looking at the Connecticut orders, I know you've discussed already and a lot in the past that you're in discussions with getting this project financed. Can you give some color on how those are going and timing, if you can, but also on the [dealy] loan guarantees and the crash grants, is your thinking there as it relates to the Connecticut orders that qualifying for those awards would be a bonus, or are you really counting on those to get the project financed and booked?

Yes, the answer is probably yes to everything. The project finance is a tricky animal right now. We have -- our projects in Connecticut are very good projects. They are showing better than 10%, really on 10% to 15% unlevered return. If you lever those, they can get above 20% returns. But the financing market is pretty fickle. To give you an example, we're perfect for tax equity and the tax equity markets are just in flux right now. They are actually moving to things like affordable housing. They perhaps can get corporate bonds at a 7% or 8% rate and they are somewhat risk averse this year, so that's put some pressure on us in that flux. You mentioned the grant. And the grant should slip right in and be very helpful, and it will actually . Everybody's applying for the grant who can't use tax credits and that should be a big positive for us.

So our belief is that we're really working parallel tasks right now. Our belief is that the projects are financable on their own. You are up against early fuel cell as opposed to, you'll remember early wind or early solar, but it does have the project returns that early brings to the table, so they are financable, so we are working with multiple financiers to do this without loan guarantees and in some of the area DOE programs. They will use the ITC grants or the tax credit when that is appropriate. On the DOE loan guarantee program, we fit into that. We think we're the perfect technology for that category. We fit innovative energy efficiency. We're clean. We can use the existing infrastructure. I can go on and on on how we fit into those programs. Everything we've looked at to date says that those programs can potentially lower the cost of capital. So everybody is looking at those programs. So we have a little bit of good news/bad news there.

We certainly expect to get approval for the -- we're submitting the Connecticut projects, and in California there are multiple projects being submitted in California for both loan guarantee and there's also a CHP grant that DOE has put forth. But the good news/bad news is that everybody wants to get lower cost of capital. Perception is there is a lower cost of capital, so we have to wait for everybody to get these applications in, and we have to wait for the government, we're thanking them for putting the program together, but we have to wait for them to finish the rules and to get the process moving, and then to handle the number of submissions. So our conclusion is we're racing forward without loan guarantee. We are going into the loan guarantee, and we expect to get all of these projects closed. If we end up in loan guarantee, it will just take a little bit longer.

Okay, thank you. Appreciate the color.

We go next to Sanjay Shrestha, Lazard Capital Markets.

Great, good morning, guys. Couple of quick questions. First one on the California, I think there is now once again the self-generation incentive program is going to get reinstituted sometime beginning of next year. Wondering if you guys could talk about that a bit and what are you seeing sort of as a -- the project pipeline in that part of your key market?

The self-generation incentive program was already extended a couple of years ago. Looks like it's going to be extended again. There is actually plenty of funds that are in that program that are available for the projects that we're working with to pursue. Fortunately it has not been impacted by the budget problems going on out there because that money's already been appropriated. What we really see as upside are these two feed-in tariffs that are going to legislature right now because they really will take the opportunity to take some of these, for example, waste water treatment facilities who necessarily can't use all the power they would generate by consuming their own (inaudible) per gas and now go ahead with the project and instead sell that excess power out to the utility. So the SGIP program looks like it's healthy and is going to be around for several years, but looks like we'll have two new mechanisms with feed-in tariffs to actually be able to capture some additional projects.

And in terms of the feed-in tariff, do we know what's going to be the expected sale of electricity rates back to the grid?

It is going to be set by technology. So what they have done at least in this early version of this is they have set rates for a variety of different technologies, and the rate that we're seeing on the fuel cell side looks like it's going to be around $0.16 a kilowatt hour.

That's terrific. And in terms of the timing on when do you guys think this might end up becoming more of something that moves forward versus the early stage discussion? What sort of timing are we talking about here?

Well, we're hearing directly from our representatives in California is they expect it to pass by the end of this calendar year.

Okay. Terrific. Few more sort of I guess policy support-related questions here, guys. So you talked a lot about South Korea and pretty big opportunity in that part of the world, obviously already a key important market for you guys. So as they look to really increase their RPS standards and fuel cells will be part of it, do know we how much that have 11% by 2030 could be met by fuel cell technologies?

I will tell you what I heard directly from POSCO Power and I actually heard this from some of the power generation companies I met with. The assessment there is for wind, the places they have to put it that have wind profiles are typically in mountainous areas, which make the projects expensive and create a lot of environmental issues. There are other choices to do it offshore, and unfortunately, if you do it offshore, they are in deep water, they don't have the narrow shelf that we do here in the US. So wind becomes expensive because of locations they have. Solar is the same issue. Solar in South Korea is much like in the northeaster US, where they don't have great solar profiles. So the conclusion that I was hearing echoed back from POSCO Power management and from the power generation companies is they think fuel cells are going to capture half of this RPS opportunity. So it's potentially a very large opportunity for us long term, which is why we've been so focused on making sure that these early customers are happy, the units go well, and that we collectively are really responsive in the marketplace, working very closely with POSCO. Because we think this is the biggest opportunity we've seen in a long, long time.

Got it. One last question, I want to make sure I'm putting this in right context. So as it relates to our pending, if you would, 40, almost 44-megawatt of projects in Connecticut, so if through the treasury's grant program, sounded like it will move sooner versus if we had to wait for the DOE loan guarantee program. So can you put those -- I know you guys, Joe, you responded to that a little bit, but can you put that in context, as are we talking about that not being able to put in the background until next year, given what's going on over with the DOE loan guarantee stuff right now?

Yes, the timing of the DOE loan program looks to us somewhere between December and March and we are pushing on the non-DOE guarantee side and we might be able to accelerate that. So that might be more in a November-January timeframe, but we have to see how that plays out. On the non-DOE guarantee we still need the credit markets and confidence to build and some risk taking to take place. There still isn't a lot of lending going on, we're seeing some movement in the wind side. We're behind wind in terms of getting projects done. So we just have to see how that confidence level builds. The DOE loan guarantee is doing exactly what it's supposed to be doing. It's a back stop and it will provide the necessary support we need to get these projects finished. So it's really just a matter of timing here.

Okay, great. Thanks a lot, guys.

We go next to John Roy with Janney.

Thanks, guys. I had one other question. I know you talked obviously a lot about the CO2 reductions. Do you guys have a number that you put out or that you like to use when you are talking to investors about how much CO2 is reduced relative to say a nat gas power plant?

Actually we do have information. I don't think we've got it right here off the top of my head, but I can tell you from a relative standpoint, we compare ourselves typically to the US grid, which is a mix of gas and -- we're about half of the US grid, we're not doing combined heat and power. We're about 25% of the US grid when we are doing combined heat and power. If you look at on the pounds per MW basis, on simple cycle I think we're around 960 pounds of megawatt hour, to give you a frame of reference.

Right.

Then if we go to the more fuel efficient products, like the fuel cell turbine, or the DFC-ERG, it scales directly with our efficiency.

Great, and one other question. On the work you're doing with POSCO, I know you've actually put this in your press release as well, as you might have some licensing going on as well. Do you expect to see that as an upfront and ongoing or one of the other or what kind of form, not value, but what kind of form do you think it will take?

We expect there to be an upfront payment and a running royalty as well.

Both, okay. Great. Thanks, guys.

We go next to John Quealy, Canaccord Adams.

Hi, good morning, folks. Just coming back to POSCO, if we could just go through the math and recap. 68-megawatts awarded to date, 12 in the ground, how many in work in process, and can we go through visibility, is it the next year and a half or two years? If you could give us some visibility on how that comes through the P&L.

The number on the ground is 22.5.

Okay.

Okay. So do you want to go through --

Yes, the P&L, John, is really based on the production we have and we have regular production. We're running at a 30-megawatt run rate, so it should really come in pretty consistently from quarter to quarter to quarter at this point in time. The one change that will occur is that we have been shipping them power plants and we're converting over, we shipped some modules in the quarter, and then we'll be shipping components. So the sales value actually will come down, but the megawatt totals will -- the production level will remain the same at this point.

Okay. And then in terms of specific opportunities, I know Dan you talked a little bit about Enbridge, but can you quantify for us whether it's on a geographic basis or number of projects basis? What do you think is the addressable market for where you're actually talking to these geographies and these stepdown stations? What's the number right now, do you think, for the addressable market there?

The addressable market is literally hundreds and hundreds of megawatts. If you look at Toronto alone, just Enbridge sites is in excess of 40-megawatts, just the city of Toronto, Enbridge owned and controlled sites. We looked at Toronto, California, in the northeast and we come up with numbers that are around 300 megawatts. With the amount of gas that has been discovered here in the US and the additional pipelines that are being built, it looks like there's going to be a lot of opportunity to start pursuing this pretty aggressively as a marketplace.

Enbridge wants to start really in their own backyard in terms of things they are doing with the Canadian government, which I think makes sense, because they really see an opportunity to improve the operability of their own infrastructure. But they are also working with us and with some other partners to look at, how do we now deploy this more broadly, because gas clearly is going to be an increasingly big part of what we see in our energy mix going forward, just because it's turning out to be a lot more abundant resource than I think what everybody thought and because of its low price point right now, it's going to be a lot of fuel switching that goes on.

And then lastly, with regards to competition, sounds like UTC is, again, rededicating itself to certain parts of larger scale fuel cells, there's obviously a lot of M&A chatter. Can you talk about if it affects the competitive dynamic or not? You guys are only molten carbonate right now, with the big piece of the business, but you've seen a lot of the technologies. Can you comment on how you think the competitive markets shapes up in the next six months or so, next 12 months?

Sure. The competitive marketplace is really one that we would really like to see more players involved here. There are a lot of people, lot of companies that are out there spending an enormous amount of money developing fuel cell technologies, but the challenge that we run into a lot of times is there's really nobody else out there with megawatt class products. So on the policy side, it's always a bit of a struggle. If you look at solar, for example, solar was very effective with a lot of companies speaking collectively to drive broad policy adoption. In the fuel cell industry, you've got a lot of very successful companies that aren't really ready with the commercial product yet, which makes it more challenging from the policy standpoint.

So I think as we see more competition, that will be a good thing for the marketplace in terms of stimulating adoption. In the next six months or so, I really don't see much of that. In fact, what I understand from what's going on in Korea is the relationship between UTC and Samsung really hasn't put any hardware on the ground yet. So, it's going to be important to see how does that unfold going forward, because having another player in that marketplace I think will help everybody feel more comfortable that there really is a competitive environment for all of this activity.

Great. Thanks, guys.

We go next to Stuart Bush at RBC Capital Markets.

Yes, good morning, guys.

Good morning, Stuart.

Hi, Stuart.

I was hoping you could talk a little bit more, if you could expand on your commentary there about natural gas pricing and where we are today. Obviously, the price is down. We have a lot more supply, the forward curve is down. Given that your utility scale units are more expensive up front and there's a -- can you just talk about how that environment going forward, either improves or hurts the competitiveness of fuel cells versus traditional natural gas plants.

If you look at our economics, one of the biggest components in the cost of electricity for a fuel cell or anything else that consumes natural gas is the fuel cost. We aren't typically competing against large combined cycles. We're really typically competing for onsite power or in places where there are RPS type programs to deploy these new technologies. So lower natural gas pricing near-term actually just makes the economics more favorable. Eventually you see it reflected in the grid prices, so it's really always a function of what is the customer paying their local utility. So I think what's really more important is the fact that because there is an abundance of supply that's been discovered, it's going to drive more adoption of natural gas use, and I think it's going to start to change what we see on the policy side in terms of making sure that natural gas is reflected in a broader energy policy since it's the cleanest domestic resource that we have.

So in general, price volatility on fuel is a negative, but the fact that at least for now it's gone the right direction I think should actually stimulate some of the projects that we've been talking about. In fact, the unit that we sold in California to Aircon for Sonoma County was a natural gas fueled unit and we see several more that are in the pipeline that are going forward, the DOE combined heat and power grants.

Okay, great. And then I know that you qualify as a renewable product in Connecticut. Can you just walk us through what some of the other state RPS programs the fuel cells qualify in general, or when you look at the pending climate change legislation in the congress, how fuel cells might fit into any sort of national RPS or federal mandates.

Okay. When you look across the state, there are six states that include fuel cells on natural gas as being defined as renewable, and then all the states that are RPS programs, when we're running on a biofuel, like a waste water treatment facility we qualify as renewable. What I think really matters on the federal policy is the -- it looks as though under whatever scheme comes forward, whether it's cap and trade or something else, carbon is going to be monetized. And as carbon gets monetized, it's going to favor low carbon technologies. And if you're going to run on any kind of fuel, to have the lowest carbon emissions, it's all a function of your efficiency. And if you look at products in our size range, we are the most efficient generator in our size for any fuels that we're going to be using. So the important fact really isn't so much the definition of renewable. It's the fact that carbon is going to be monetized and that's going to drive a lot of focus on energy efficiency, which I think is really a more practical way to deal with the problem in the long run.

So I agree with you that carbon looks to be monetized over the longer term. Can you make some -- any analysis or projections on what you think the cap and trade bill will look like? And I guess specifically if you were to sell your latest unit today into the market, at what price per emissions of carbon would you need to have placed and be monetized to basically offset your higher costs to make it comparable?

Well, we're not going to be competing against the large scale source of generation. So the comparison really is going to be what can the customer spend for our unit versus other choices they have to reduce carbon, because remember, a lot of this is going to get borne by the industrial community that have to deal with their carbon emissions. Depending on the value of a ton of carbon and the range has been pretty significant, when it gets monetized and flows back into our economics, it will be worth typically somewhere between $0.01 and $0.04 a kilowatt hour, depending on that final pricing of a ton of carbon.

Okay. I was hoping for if there's a threshold on the price a ton that would essentially make your economics equivalent. Do you have that number?

Equivalent to what, though?

Equivalent to a normal natural gas plant of that, of a similar size.

But that's typically not the choice the customer makes.

Okay.

I mean a customer that's going to put our unit in, is their alternative isn't a 250-megawatt combined cycle. It's what is the mix of power at the utility that they are buying their power from?

Great, thanks.

Okay.

We go next to Meghan Moreland with Ardour Capital.

Good morning. Just to touch on backlog quickly, any idea of how much of the $104.8 million in product backlog will go to the top line over the next four quarters? I know that some of that is long-term service agreements, but just to base -- just general figure?

I would say 70% to 80% of it.

Okay. And back to POSCO, you say that the reason the licensing agreement has been delayed has been due to a longer than expected commissioning cycle. I'm not exactly sure what that means, does that more have to do with what POSCO is doing, or are they waiting for other projects to finish installation before they sign on for the other ones? I'm not clear on that. And is there any reason to believe that it wouldn't close?

I don't have any reason to believe it wouldn't close. What happened was, we had about five units that were all stacked on top of one another for commissioning. If you think about this from POSCO and the customer's perspective, they are putting in what is to them a new product that they are not familiar with, and what we discovered was on many of those installation, some of our instruction manuals hadn't been followed. There were problems with the way they were installed, and things needed to be corrected to make sure that the units -- that we as the OEM could stand behind the warranty. So what it's really first of a kind of issues that we saw with customers seeing a new product, and some of the things we saw about some of the things we didn't like in terms of the buyout quality so it's really just sort of a unique, perfect storm of many units happening at the same time that we're just new to that marketplace. And they are all just typical installation kind of issues that we just collectively work through and we're now back working on the licensing agreement.

Okay, but you expect everything to be signed by the end of October?

Yes, we do.

Okay. And just lastly, gross margin, I know the target was always gross margin break-even positive by 4Q, 3Q of this year, and I know that reaching break-even or even profitability depends on the level of output. But assuming that you have those critical levels, those 35 to 50-megawatts next quarter, are you at the point where the multi-megawatt systems are profitable on a gross margin basis?

The products will be gross margin and right now the backlog is mostly for the POSCO orders and is mostly modules and components. So they will contribute margin to our financial statements. Also in cost of goods sold, as we've talked about before, we support the systems, we support commissioning. We have long-term service costs, and those add somewhere between 20 and 30 basis points. And in order to get fully gross margin profitable, that's how you have to get enough volume through to cover those costs, and that will happen somewhere when your volume is, depending on the product mix, between 35 and 50-megawatts.

We won't be there in the fourth quarter, but the products, we will be delivering gross margin profitable products in that quarter. So you're seeing the swing. You're seeing the change. And at this point, it's pretty straightforward and we just need to keep driving order flow, and as this economy improves and as capital spending starts up again, we have a lot of prospects that are out there that are looking to buy fuel cells and that should be very, very -- that should help increase that volume quickly.

Thank you.

We go next to Jeff Osborne, Thomas Weisel Partners.

Yes, good morning. On the POSCO front, I was wondering if you could talk about what the delta is on a revenue per megawatt basis for these modules and components how do we think about that?

The delta from --

On a pricing perspective, versus buying the complete system.

Yes, pricing is pretty similar to a full power plant. What you have with a module, for example, the module is about 65% to 66%, 67% of that total, so you're getting about a third less of the revenue coming through.

Okay.

And the components probably changes -- it's probably in the 55% to 60% range. It's not, it's not a significant difference from the module to be honest. So that's kind of the range of revenue that you'll see.

Okay. And the bulk of the backlog today is on the module front for POSCO.

The bulk of the backlog is actually about half and half actually.

Okay, and I may have missed it, but could you just disclose what megawatts shipped in the quarter was and actually how much megawatts are currently residing in the backlog?

Yes. Right now we shipped 4.8-megawatts this quarter and our total at the end of the quarter is 44.

44, okay. And then on the DOE applications, I know you mentioned how many applications, but could you just disclose how many megawatts, so we can get a sense of perspective on how big that would be if they were to come through?

The Connecticut projects are 43-megawatts and in California, it's probably somewhere in excess of 15-megawatts being submitted.

Okay. And then the last question I had is just can you update us on your European partnership strategy for 2010 and beyond?

Love to, Jeff, but I think as most people know, our agreement with MTU is still in place until the end of this year, and to talk about who we're talking to for that marketplace would just be a little bit premature. So I would ask everybody to be patient, we'll get there.

Great. Thanks much.

We go next to Bill Nasgovitz, Heartland Advisors.

Hi, this is Mike [Joel] in for Bill. We're wondering what the burn rate is going forward, if you burned $11.9 million during the quarter and $53 million in cash. Wondering what the burn rate is going forward.

Yes, Mike, at this run rate, to burn cash would be pretty similar at a 30-megawatt run rate, so we would average about, somewhere in that $10 million to $14 million range, the plus or minus would be working capital. What we're looking for is we're looking for the order flow to increase, and then the order flow would have profitable cash coming through and that will help to reduce -- that will actually drive cash flow lower very quickly.

Okay, and we're wondering why there hasn't been any insider buying this year.

A lot of this is really just a function of a lot of what the management team takes in terms of their bonus and everything else is already in stock. So what we've really done is make sure that the management team has significant exposure in terms of the share price itself, and what you don't see is the management selling, because in my own case I can tell you, in the time I've been here, never exercised a single option or sold a single share. I think it's important that management keep itself aligned with what the shareholders are seeing in the marketplace.

Okay, thanks.

We'll take our last question from Sam Dubinsky, Oppenheimer.

Just last minute housekeeping questions. You experienced some product pushouts this quarter. Do you expect shipments to be up next quarter or revenue to be up next quarter?

I would say at this run rate, it should be about the same.

Okay.

We're on a pretty even keel. The good news for the green orders is that, they give us a big order, you can plan it out well and it really allows us to consistently produce. So we're seeing some consistency in these numbers, or consistency in production flowing through the numbers.

Revenue should be flattish until either the DOE loans or financing of these projects come through, is that a way to look at it?

That would be a good way to look at it. Yes.

Okay, and then you did a good job keeping OpEx low this quarter, how should we think about OpEx going forward?

It really should be similar. I mean what we're really trying to do is to manage in the current environment to make sure that we're only spending money where it's absolutely essential to support the markets, and then we'll take a look at that as we start to see order flow come in to decide what do we need to do in terms of just support for the key markets that we're going after?

Okay, and what is your capacity? I think you said 30-megawatts. And when should we expect the next expansion, and how much will that cost to expand?

We're actually running at 30-megawatts per year, but our actual capacity in Torrington is 70-megawatts. So to ramp from 30 to 70 for us is largely variable cost. It's not -- we don't have to spend a lot of capital on expansion. It's just maintenance capital. And then expanding from 70 to the 150 to -- between 150 and 200, we've got to settle on what that will finally look like once the POSCO deal is done as they'll have some conditioning and assembly capacity of their own. It's about $35 million to $40 million of capital to go from 70 to that 150 -- or 150 to 180 range.

And then you mentioned that your sales pipeline is about 44-megawatt in Connecticut and about 15-megawatt in California that could be closed at some point this year, at least put into product backlog. Do you have any other large projects that you consider sort of six-to-12 month oriented in the pipeline and how big are they?

Well, we have what average with -- the Canadian government, we're not sure of the timing of when that starts to come into play. And then if you look at Korea in general, what Korea has done is -- our partner there has ordered sort of a level loading for their business, but individual projects that they're pursuing that are in some cases tens of megawatts would be incremental, so as they see those opportunities move further along, we could see those come in as well. And then there's just the surprise projects that come up every once in a while, as I think some people know, Sharp had announced a few months ago they were looking at doing at 10-megawatt fuel cell project. We see some other things in the pipeline, it's just a questions of what's the timing for them and when do they actually turn into orders for backlog?

Okay, and then my last question is just a clarification. In prior comments today, you said 35, 50-megawatts run rate to get gross margin positive. In the past, I think you mentioned 35 to 70-megawatts. Which one's the correct figure? Is it -- I know it's dependent on mix of modules versus complete systems, but what's the correct number to think about in terms of gross margin positive?

You hit the nail on the head. It's really a product mix scenario. 50 can get you there. If you did nothing but Korean components, it might have to be a higher number, because you have a little less revenue coming through, but somewhere in that range, it's right there.

Okay. Great, thank you.

With no time for additional questions, I would like to turn the call back to Dan Brdar for any additional or closing comments.

I just want to thank everybody for joining us today, so we could bring you up to date on what we've been doing in the past quarter, and we look forward to you joining us again in December, as we update you on all the things we've been talking about in the marketplace. Thank you, everyone.

And that does conclude today's call. Again, thank you for your participation.