FuelCell Energy, Inc. F2Q09 (Qtr End 04/30/09) Earnings Call Transcript

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 |  About: FuelCell Energy, Inc. (FCEL)
by: SA Transcripts

FuelCell Energy, Inc. (NASDAQ:FCEL)

Q2 2009 Earnings Call

June 9, 2009 10:00 am ET

Executives

Daniel Brdar – CEO

Joseph Mahler – SVP & CFO

Lisa Lettieri – VP IR

Analysts

Michael Lew – Think Equity

[Julie Kuju] - Simmons & Company

John Quealy - Canaccord Adams Limited

Sanjay Shrestha - Lazard Capital Markets

Robert Stone – Cowen and Company

Walter Nasdeo - Ardour Capital Investments

John Roy - Janney Montgomery Scott

Pavel Molchanov - Raymond James & Associates

Samuel Dubinsky - Oppenheimer & Co.

Operator

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 would like to turn the call over to Miss Lisa Lettieri; please go ahead.

Lisa Lettieri

Good morning everyone and welcome to FuelCell Energy's second 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 www.fuelcellenergy.com and a replay of this call will be posted two hours after 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 U.S. Securities and Exchange Commission. Now I'll turn the call over to Daniel Brdar.

Daniel Brdar

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 ultraclean, reliable, baseload 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 MW 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’ll discuss this in more detail later in the call but we are very excited about what this means for the 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 and Congress is focused on a Federal renewable portfolio standard and a [cap in 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’re 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 [inaudible] combusta fuel, there’s near zero knocks and socks 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 and excellent solution for a wide variety of large low users like the grid, manufacturing facilities, and wastewater treatment facilities.

Before we talk about the markets in more detail, let’s turn the call over to Joseph Mahler, our Chief Financial Officer, to review the financials for the quarter.

Joseph Mahler

Thank you Daniel 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 then 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 the 1.50 reported in the prior year quarter and the 1.52 in the first quarter 2009 in line with our expectations.

As we begin to produce gross margin profitable products this quarter we expect the cost to revenue ratio to continue to improve. Cash used 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 fuel cell 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 MW, clearly illustrating the demand for the 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 401K 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 us in 2009 compared to 2008 although cash use for fiscal 2009 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 effecting our ability to finance projects. We see a tight tax equity market but potential openings 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 projects and adds 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 MW, the combined projects totaled over $220 million. This size is clearly getting attention in the marketplace, the project fundamentals are very good with up to 20-year power purchase agreements with investment grade utilities, and the returns are good.

I believe these projects can get done. Let me turn the call back over to Daniel.

Daniel Brdar

Thank you Joseph, 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 am 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 an 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 part of these improvements, our megawatt-class fuel cell module and DFC1500 will be up rated from 1.2 MW to 1.4 MW and our DVC3000 will be up rated from 2.4 MW to 2.8 MW. Currently our production volume is at an annual rate of 30 MW and with this morning’s order announcement, our product sales backlog is approximately 49 MW.

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’re 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 plant. This first Korean built unit will be installed with fuel cell modules from our factory later this year.

To date, POSCO has 18 megawatts in operation or in various stages of installation out of the 68 megawatts they’ve ordered. They are mostly multi megawatt DFC1500 and DFC3000 units. One DFC1500 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 DFC3000 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 MW and impending $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 stationary fuel cells are a key part of their country’s clean energy mandates.

The 30 MW order is for megawatt fuel cell modules and module components. This order provides backlog to take us into early 2011 and provide the 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 us to 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. Its 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 fuel cell 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 MW of projects approved by the Department of Public Utility Control include our newest most efficient products, the DFC-ERG, and the DFC/Turbine. In fact four DFC-ERG plants totaling 18.8 MW were approved. These power plants are approximately 58% to 65% electrically efficient which is important for reducing carbon dioxide emissions, and achieving energy cost savings.

To put it in perspective, the DFC-ERG and DFC/Turbine offer up to twice the electrical efficiency of the average central generation fossil fuel power plant in the US and are more then 33% more efficient then most distributed generation plants their size.

As Joseph described, the credit crisis has slowed our ability to get these projects in 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 financers 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’re 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 up rated 1.4 MW fuel cell operating on natural gas to not only produce electricity but also to provide heat and hot water for a prison and several country office buildings.

Natural gas is a plentiful domestic fuel that powers 55% of California’s customers and a large potential market for our fuel cell power plants. Customers are recognizing that our fuel cell’s operating on natural gas deliver a highly competitive, low carbon and near zero emission solution for baseload power.

As a result we offer a unique value proposition for the California market as they work to find clean baseload 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’re looking forward to more business from natural gas customers.

Wastewater treatment facilities continue to be a target market for us in California. Knowledge of our installations is widespread in the California wastewater treatment industry and its 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 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 Twentynine 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. Its logical they would want to deploy the highest efficiency, lowest carbon baseload generation possible, FuelCell Energy power plants.

Moving to the government initiatives that [inaudible] 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 RPS standard, regulations that will certainly encourage further deployment of our products for a wide array of applications.

A Federal RPS and a cap in 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 in trade system will limit big polluters like the power industry, and steel and cement manufacturers’ 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 MW 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’re excited about 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 these markets are looking for clean, highly efficient energy generation, the kind our products provide.

We will now take questions from our listening audience.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Michael Lew – Think Equity

Michael Lew – Think Equity

First congratulations on the order from POSCO, also I wanted to clarify, is the composition, is it all for megawatt-class or the 2.8 MW modules.

Daniel Brdar

Its all megawatt-class modules and megawatt module components.

Michael Lew – Think Equity

And also you’d mentioned the expanding relationship with POSCO which I expect includes penetration to the Asian markets, while its still a bit early could you characterize that opportunity.

Daniel Brdar

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 marketplace and continue some cost reduction, but really where they want to go more broadly is the entire Asia region, which places like China, many of the 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.

Michael Lew – Think Equity

Do you have like a size on that opportunity, while it is still early.

Daniel Brdar

Its still early. We’re seeing a pretty rapid change in terms of even the adoption within countries like China. If you look back a few years ago, it was just purely coal-fired power plants, now you’re starting to see them move towards adopting some green solutions as well.

So I think as we start to see that take shape and we share our market information between ourselves and POSCO we’ll be able to get a better assessment of where we think the next early opportunities are and how big those opportunities are as well.

Michael Lew – Think Equity

And also could you characterize the size of the current pipeline over the next 12 months, beyond POSCO, is it primarily megawatt demand and also the types of market segment deployments.

Daniel Brdar

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 to 900 kilowatt sized 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.

Michael Lew – Think Equity

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.

Daniel Brdar

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 and untapped opportunity for us. But it’s a little bit premature to talk specifically about that yet.

We’ll be addressing it in some of the coming calls later this year.

Operator

Your next question comes from the line of [Julie Kuju] - Simmons & Company

[Julie Kuju] - Simmons & Company

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.

Daniel Brdar

There’s nothing from Connecticut that’s yet included in the backlog, so those 43 MW are yet to be added, and we’ll do that once we close the contracts and our partners close their project financing. So that’s all upside on the backlog right now.

[Julie Kuju] - Simmons & Company

And the POSCO order, the 30 MW, 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.

Joseph Mahler

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

[Julie Kuju] - Simmons & Company

And just wondering with this POSCO deal you’re getting about and additional $25 million in cash, can you speak a bit 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.

Joseph Mahler

Yes, basically, actually there’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, we’re assuming we’ll get to $25 million in a short time period. That would actually push our cash balance to $67 and at that point we’re pretty comfortable with our cash.

Operator

Your next question comes from the line of John Quealy - Canaccord Adams Limited

John Quealy - Canaccord Adams Limited

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

Daniel Brdar

Its 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.

Its really bringing back customers that at higher gas prices 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 up being one of what we hope is going to be several megawatt-class orders that are going to be natural gas based in markets like California.

John Quealy - Canaccord Adams Limited

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

Daniel Brdar

Sure, the very first unit 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’s ability to speak as a gas distribution company so its been a great location to take potential customers to.

The next project that we’re hoping to do will be the project that came out of round two in Connecticut, the project in Milford, its about nine megawatts, it will be the largest fuel cell power plant in the world when its done. And then we have three more right behind that that are in the 3 to 3.5 MW size range in Connecticut also as part of the round three bidding.

So what we’re finding is getting a unit in and operating and then having a product that competes so readily in the RPS markets 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 ground quickly, I think will really start to drive some of the adoption for the larger installations that we see around the world.

Operator

Your next question comes from the line of Sanjay Shrestha - Lazard Capital Markets

Sanjay Shrestha - Lazard Capital Markets

Congratulations on this POSCO announcement, first question, I just want to get this right, so you have $43 in cash plus $25, you burned $8 and while you don’t want to quite get into the cash burn dynamics given some of the macro uncertainty is it fair to say though the burn shouldn’t go up given that what’s in your backlog has a lower cost profile and you’re 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.

Joseph Mahler

Well, that’s a big bite there but yes, I think that that, I think the only thing I would tick back on is that there’s a couple of buttons to push so right now we’re trying to maintain the 30 MW run rate, the POSCO order allows us to maintain the 30 MW 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 on 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 MW and even give us opportunities to go beyond the 30 MW run rate. So that’s the only thing I would really caveat there.

Sanjay Shrestha - Lazard Capital Markets

Fair enough, that’s what I was trying to get at. 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 projects rather then just the next generation technology related funding, so are you in active dialogue with if you were the prequalified lender and could you see that really bridging the gap here even before the project financing market comes back 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-vie in the form of the government, is that something that you are in discussion with at this point in time.

Joseph Mahler

Yes, there’s some lack to clarity, but we are certainly focused on Washington. We have a lot of the financiers are focused on Washington and we do get some good feedback. There is some lack of definition right now that is stalling that. But in addition to that we have, I’m seeing more creativity right now in the marketplace then I’ve seen in the last three or four years.

I’m seeing people finding capital, for example public financing is playing, we’re 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’re seeing a lot of creativity in the marketplace. Its just a function of, for example, the tax grant, they just need, they’re supposed to define the 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’re now able to put over $200 million of projects in front of 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 this is a lot of projects coming so they’re spending the time, they’re working their due diligence.

I can’t tell you exactly which deal or which structure will actually play out but we’re looking at multiple and a lot of creativity right now.

Sanjay Shrestha - Lazard Capital Markets

And it was good to see you last week, one could question to you I guess on POSCO you mentioned that you’re sort of looking at the licensing relationship and its 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 just going to just provide the license to POSCO even to build the fuel cell stack or is it really more just on the balance of system side and its going to be stack revenue, fuel cell energy, balance the system, incremental licensing revenue, FuelCell Energy and POSCO the distributor in Asia.

Daniel Brdar

We really had never contemplated licensing the core technology through any partners. Its really, its where most of our intellectual property rests. Its something we’ve gone to great lengths to protect, not that there’s anything wrong with our partners, or we’re concerned about them, but I’m just saying 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’re going to do more of these kind of arrangements. 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 will determine whether we do it solely as FuelCell Energy, whether we do it as a license or whether we do it as a joint venture, somewhere in between. Its really what’s 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.

Sanjay Shrestha - Lazard Capital Markets

It certainly seems like we’re probably going to get the Federal renewable electricity standard here as a part of the new energy Bill, and are you 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 given the [inaudible] issue of wind and as wind makes a bigger part of that RES they’re 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 we could even see out of the European utilities.

Daniel Brdar

We’re not seeing it so much as the wind developers yet, the ones that we’re 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 have been coming to us to understand the product, to understand how does it work, where have we deployed it, how big are the units that we’ve done.

We’re also finding that we’re 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 enable the deployment of more of these intermittent technologies.

So we’re really starting to see the utilities look at this from a portfolio approach, recognizing that there’s 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.

Sanjay Shrestha - Lazard Capital Markets

We have to keep some stimulus money northeast as well, right.

Daniel Brdar

Absolutely.

Operator

Your next question comes from the line of Robert Stone – Cowen and Company

Robert Stone – Cowen and Company

To continue on the theme du jour, I have a couple more questions about POSCO, so I know you’re still finalizing the agreement so it would be premature to comment on the details, but is it correct to assume that 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.

Joseph Mahler

You could expect it to be component sale, of running royalty and probably an upfront royalty as well.

Robert Stone – Cowen and Company

So the upfront royalty would be in addition to the equity investment.

Joseph Mahler

Yes.

Robert Stone – Cowen and Company

Great, with respect to operating expenses you mentioned a number of steps you’re taking to get through the tough economy the 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.

Joseph Mahler

Yes, I think what you might want to take a lot 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 our, 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.

Robert Stone – Cowen and Company

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

Joseph Mahler

It would be somewhere in that range, between, you’re not talking, I mean historically our second quarter has always been higher then the previous quarter, the prior quarter, so its in that range. You’re talking like four and a half per quarter, something like that.

Robert Stone – Cowen and Company

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.

Daniel Brdar

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 treatments some of those are going to be sub megawatt units or multiple sub megawatt units. Overall the sub megawatt unit is still going to be a small percentage of our business. Its probably going to be certainly less then 20% of our business mostly because we’ve been using it as sort of a market seeding opportunity.

And as people have gotten comfortable with the product it as the only company offering megawatt-class fuel cells, that’s where the business has moved. And we believe there’s going to be an ongoing marketplace for multiple sub megawatt units, we’ll 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 makes the most sense.

And then Joseph do you want to talk about what the mix is going forward in terms of what’s already in the production.

Joseph Mahler

Yes, the backlog is primarily 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.

Robert Stone – Cowen and Company

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

Joseph Mahler

That’s correct, yes.

Robert Stone – Cowen and Company

So about how long would that take.

Joseph Mahler

I think you start to see a move in the fourth quarter and I think first quarter 2010, I think its all at, those products, it should be all those products at that point in time.

Robert Stone – Cowen and Company

Okay so by Q1 2010 you’ll be on all the newest generation.

Joseph Mahler

The only thing you’ll have is any sub megawatt activity that we, for strategic purposes we want to take a three 300 set a wastewater treatment plant in California, you could have those come in and those will have higher then one cost ratios, but other then that the, most of everything is megawatt based at this point.

Robert Stone – Cowen and Company

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 requirement going to be for the second half of the year.

Joseph Mahler

Its minimal, its really maintenance capital.

Robert Stone – Cowen and Company

So a couple of million or—

Joseph Mahler

Probably, at the most.

Operator

Your next question comes from the line of Walter Nasdeo - Ardour Capital Investments

Walter Nasdeo - Ardour Capital Investments

Good morning guys, how’s everything going.

Daniel Brdar

Actually it’s a pretty good day, moving along nice but a pretty good day.

Walter Nasdeo - Ardour Capital Investments

If I could just briefly touch on what you’re current capacity is and if you have any CapEx 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 conditioning time does each one of the existing systems take before its ready to be completely up and running and is there any change in that in the new higher output systems.

Daniel Brdar

You know us too well, let me start with the conditioning first. The conditioning process has historically taken about eight days. As we go through 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 to eight day conditioning process of the current product.

If you look at our capacity we had previously been talking about 50 MW of capacity at the factory in Torrington, but as we have continued to conduct [lee] operations there and as we’ve continued to improve the core product, we believe that capacity is now closer to 70 MW.

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 wrap the business up particularly with POSCO moving to building their own facility where they’ll do the local conditioning of their megawatt modules.

Walter Nasdeo - Ardour Capital Investments

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.

Daniel Brdar

We’re comfortable with them right now but its been an ongoing process because we have had a concerted effort to 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 its actually something that we are going through about on a monthly process to continually reassess them because we’re finding that we’re, some people’s business environment is improving or deteriorating more rapidly then others.

So its 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.

Operator

Your next question comes from the line of John Roy - Janney Montgomery Scott

John Roy - Janney Montgomery Scott

Real quick question, with your kind of change in your 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 an 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 thought a lot about that obviously.

Daniel Brdar

We have, we haven’t gone back to remodel it so we really need to lay that back out for everybody to understand. We have historically said that when we’re making complete power plants, when we’re producing 35 to 50 MW a year, we the company got gross margin positive and when we produce 75 to 100 MW of complete power plants, we’re 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 MW. But we’re going to do a re-pass through this now to 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.

John Roy - Janney Montgomery Scott

Yes, because also obviously with the royalties, that will also change obviously the corporate situation as well.

Daniel Brdar

Correct.

John Roy - Janney Montgomery Scott

We’ll look forward to that, great job.

Operator

Your next question comes from the line of Pavel Molchanov - Raymond James & Associates

Pavel Molchanov - Raymond James & Associates

I know it’s a small component of revenue but how should we think about R&D contracts, they obviously jump from quarter to quarter, any sense of what the run rate might be for the next couple of quarters.

Joseph Mahler

Yes, we typically look at R&D contracts in a $10 to $15 million annual range, that’s about where we see this year. We think they’ll be similar to the current level, maybe a little bit higher as we increase some intensity on our [inaudible] contract, but yes, in about that range.

Pavel Molchanov - Raymond James & Associates

Understood and a follow-up with 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.

Daniel Brdar

There’s actually several things going on with Enbridge right now, they’re looking at other installations in Canada. They’ve identified their next couple of target units and they’re working with the Canadian government also as part of the province and the country’s overall renewable energy plans. But they’re also involved in taking a look at some of the projects we’re doing in Connecticut.

They are a participant in the Milford project and they’re looking at whether it make sense for them to play a bigger role in that and we’ll hopefully have some feedback from them on that particular issue here in the coming weeks.

Operator

Your final question comes from the line of Samuel Dubinsky - Oppenheimer & Co.

Samuel Dubinsky - Oppenheimer & Co.

Just some clarification, today you’re operating at a 30 MW 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.

Daniel Brdar

No, 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 IRD that we’re funding, we have to ramp that production up into that 35 to 50 MW range but the capacity is already there. Its installed. Its really a matter of just variable costs to bring on some additional people to ramp up the production rate.

Samuel Dubinsky - Oppenheimer & Co.

What does the production rate have to be, is it 35 MW you have to ramp to but you have the capacity in place.

Daniel Brdar

We have about 70 MW of capacity and then the business becomes gross margin positive when we’re producing 35 to 50 MW of complete power plants.

Samuel Dubinsky - Oppenheimer & Co.

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 bidding for today. I know there’s 40 MW in Connecticut, can you just run through potential sizes of other deals.

Daniel Brdar

Sure there’s about, well there’s 43.5 MW 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 MW 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’re looking to partner with some people to do new activities.

Samuel Dubinsky - Oppenheimer & Co.

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

Daniel Brdar

Well it certainly has been able to enhance the situation in terms of what we’re offering to Korea for example. The weak dollar has certainly made our product from an export basis look more attractive but its also why we want to quickly get into doing more in Europe because we think particularly with the dollar not looking like its 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.

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’ve talked about already today, but on some other exciting new things that we’ve got in the pipeline. Thanks everybody for joining us.

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