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FuelCell Energy Inc. (NASDAQ:FCEL)

F3Q2010 Earnings Call

September 2, 2010 10:00 AM ET

Executives

Kurt Goddard – Vice President, Investor Relations

R. Daniel Brdar – Chairman and CEO

Joseph G. Mahler – Senior Vice President and CFO

Analysts

Sarah Martin – Lazard Capital

Mark Seagull – Canaccord Genuity

Walter Nasdeo – Ardour Capital

Pavel Molchanov – Raymond James

Amit Dayal – Rodman & Renshaw

Scott Reynolds – Stifel Nicolaus

Operator

Good day, ladies and gentlemen. And welcome to the FuelCell Energy Reports Third Quarter 2010 results conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions)

I would now like to introduce your host for today's conference, Kurt Goddard, Vice President of Investor Relations.

Kurt Goddard

Good morning and welcome to the third quarter earning call for FuelCell Energy. Delivering remarks today will be R. Daniel Brdar, Chairman and Chief Executive Officer; and Joseph G. Mahler, Senior Vice President and Chief Financial Officer.

The earnings release is posted on our website at www.fuelcellenergy.com and a replay of this call will be posted two hours after its conclusion. The telephone numbers for the 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 the discussion today will contain forward-looking statements including the company's plans and expectations for the continuing development and commercialization of our FuelCell technology.

I would like to direct listeners to read the company's cautionary statement on forward-looking information and other risk factors in our filings with the U.S. Securities and Exchange Commission.

Now, I would like to call -- turn the call over to Dan Brdar. Dan?

R. Daniel Brdar

Thank you, Kurt and thank you for joining us this morning. Policy makers, power producers and energy consumers worldwide are turning to FuelCell because their unique attributes allow them to solve acute energy, environmental and business problems that other technologies cannot.

Our FuelCell technology helps South Korea achieve their low carbon green energy goals, allows agriculture and municipal customers to transform waste problems into renewable energy solutions and generates reliable secure power for commercial and government facilities.

We are the world's only manufacturer of commercial megawatt-class fuel cells for base load power generation. Our products provide energy solution because they use a variety of fuels like renewable biogas or plentiful natural gas to generate ultra clean base load electric power where it is needed. They do this more cleanly, quietly and efficiently than combustion-based technologies and they produce power continuously unlike wind and solar.

Beginning in 2012, South Korea's renewable portfolio standard mandates close to 6,000 megawatts of additional renewable energy over the next decade. POSCO Power, our partner in South Korea, is expanding their facilities and we expect to capture a large share of this market. In the U.S., the problem solving abilities of fuel cells, Government incentives and loosening credit markets contribute to expansion in key vertical markets and multiple orders.

We received three orders totaling 3.4 megawatts in the third quarter followed by three more orders in August totaling 2.6 megawatts for a total of 6 megawatts of products for commercial, government and utility projects.

These actions point to increase in order volume in the near term as projects in our growing sales pipeline move to closure and we are taking steps now to preserve for producing higher volumes of our products.

I’ll get into more detail about our results after, Joe Mahler, our Chief Financial Officer reviews the financials for the quarter. Joe?

Joseph G. Mahler

Thank you, Dan, and good morning, everyone. FuelCell Energy reported total revenues for the third quarter of 2010 of $18.9 million compared to $23 million in the same period last year. Product sales and revenue in the third quarter were $16.2 million compared to $18.7 million in the prior year quarter and $13 million for the second quarter of 2010.

Revenues increased over the second quarter on U.S. order flow. The company's product sales backlog including long-term service agreements totaled $79.8 million as of July 31, 2010 compared to $104.8 million as of July 31, 2009 and $75.5 million as of April 30, 2010. Orders received to date in the fourth quarter of 2010 will add $13.1 million to product revenue backlog.

Product margins measured on a dollar basis improved over the prior year quarter by $3.7 million driven by sales of higher margin megawatt-class modules. The product cost-to-revenue ratio of 1.24 to 1 in the third quarter compared to 1.4 in the third quarter of 2009 and 1.47 in the second quarter of 2010. This improvement in the cost profile reflects continuing success in reducing product and manufacturing costs while enhancing the technology.

Research and Development contract revenue was $2.7 million for the third quarter of 2010 compared to $4.3 million for the third quarter of 2009. The company's research and development backlog totaled $7.4 million as of July 31, 2010 compared to $15.3 million as of July 31, 2009 and $9.9 million as of April 30, 2010.

The company has a number of DOE research and development awards worth about $5 million in contract negotiations and is currently proposing Phase III of the solid oxide contract to DOE with an estimated total value of approximately $30 million.

Total cash and investments in U.S. treasuries were $67.8 million as of July 31, 2010. Net cash used for the third quarter was $8 million excluding net proceeds of $32.1 million from the public offering of common stock. Net cash used for the second quarter of 2010 for comparison purposes was $13.8 million, cash used benefited from lower expenditures and higher receipts from new orders received in the quarter.

Capital spending for the third quarter was $300,000 and depreciation expense was $1.8 million. For the nine months ended July 31, 2010, FuelCell Energy reported revenue of $50.1 million compared to $67.6 million for the comparable prior year period. The product sales and revenues were $42 million compared to $57.1 million for the comparable prior year period as the sales mix shifted to FuelCell components from complete power plants.

Net loss to common shareholders for the nine months improved by $10.4 million. The primary driver with that margin for product sales and revenue improved by $11.6 million over the prior year period due to sales of higher margin megawatt-class products.

On the order and financing front, customers are telling us that their access to capital is improving and recent orders, contracts and negotiations in our pipeline indicate this. We are in active discussions with several parties on the Connecticut projects and also with the department of energy on our Phase II loan application.

We see creative financial solutions employing tax free bonding in California as well as customers deploying their own capital to solve business problems with our fuel cells. Our products help to solve business, economic and environmental issues and we see effort in the marketplace to get FuelCell projects done. We are working these to closure.

Before I close, I would like to re-enforce our message that we are at the inflection point where volume alone will enable company profitability. Our costs are on target and we are focused on closing the orders in our pipeline. Dan?

R. Daniel Brdar

Thank you, Joe. As we prepare for higher production rates on our path to profitability, FuelCell Energy’s business strategy is focused on driving product costs down while growing our key geographic and vertical markets. Our cost reduction program has successfully reduced the unit cost of our megawatt-class products by more than 60% and this is reflected in the improving margins in our financials.

The confluence of both policy initiatives like the South Korean RPS and active and growing order pipeline in the U.S. and expansion in key vertical markets will drive orders and higher manufacturing volumes.

In South Korea, our largest market, the RPS passed in March by the national assembly has created a strong market for fuel cells. Due to the high cost of imported fuel and the poor wind and solar profiles of the Korean peninsula, fuel cell has an excellent green energy solution for South Korea and the Government has designated fuel cells as a key economic driver.

To accelerate the adoption of renewable energy alternatives, the South Korean legislature adopted a far sided and aggressive renewable portfolio standard. The RPS requires 350 megawatts of additional renewable energy per year for 2016 and 700 megawatts per year for 2022, accumulative target of nearly 6000 megawatts.

Fuel cells fully qualify under the Korean RPS because they're extremely clean, highly efficient and can operate on natural gas or renewable bio gas. Our product transforms these fuels into electricity with up to twice the efficiency of conventional technologies resulting in significantly lower green house gas submissions because they do not combus fuel, our fuel cells emit virtually no harmful pollutions unlike combustion-based distributed generation.

An ideal form of distributed generation, our products are easily sited due to the small footprint quiet operation and competitive costs compared with large conventional power plants and their associated transmission lines. Our byproduct heat can be used for commercial or industrial purposes and combined heat and power applications where system efficiencies can reach 90% depending on the application.

FuelCell Energy has a major presence in this market already. POSCO has purchased approximately 59 megawatts of our power plants and fuel cell components today. Our South Korean strategy is based on a long-term licensing agreement with POSCO under which they assemble power plants using fuel cell components supplied by FuelCell Energy.

This strategy allows us to leverage our manufacturing capacity and capture overseas market opportunities. POSCO build a balance-of-plant facility in Pohang. It is now constructing an adjacent fuel cell module facility that is on schedule to be completed by year end. These facilities will have an annual capacity of 100 megawatts.

In support of this project, we are procuring fuel cell stack module assembly and conditioning equipment for POSCO, demonstrating its confidence in the market for FuelCell Power in South Korea and a solid commitment to our long-term partnership. POSCO has invested more than $100 million in their FuelCell facilities and business.

The South Korean RPS will drive orders as POSCO seeks to fully utilize its expanding capacity. We are currently in discussions with POSCO on their order for 2011 deliveries and expect a detail of the Korean RPS pricing mechanism to be finalized by the Korean Government in the very near term.

In the U.S., we received two orders totaling 3.1 megawatts during the third quarter and subsequently received another three orders totaling 2.6 megawatts. These orders demonstrate our customer satisfaction with our products and the growing understanding that fuel cells can solve problems for utilities, agricultural operations, municipalities, food and beverage processors, military installations and other customers needing ultra clean distributed power.

California is setting the pace for clean energy policy in the U.S. In April, the California public utility commission authorized 5.6 megawatts of FuelCell projects to be sited at four state universities. These projects will be the first megawatt-class utility owned fuel cells in the U.S.

In May, following the commission's decision, Pacific Gas and Electric ordered two 1.4 megawatt DFC1500 power plants for Cal State University East Bay and San Francisco State University.

These units will be operational early next year and both power plant also be configured to use the byproduct heat from the fuel cells for facility and swimming pool heating. These units will provide a first-hand opportunity for U.S. utility to become knowledgeable about large scale stationary fuel cells and the problems they can solve for utilities.

These power plants will operate on clean natural gas which is plentiful here in North America. Because of their low emissions, high efficiency and quite operation, these units are an excellent example of how utilities in California and other states can use clean distributed generation to meet their clean air and green house gas emission targets, enhance the reliability of the transmission and distribution systems and relieve grid congestion.

Additionally, we are discussing -- discussions regarding the installation of 2.8 megawatts of FuelCell Power plants at the other two university campuses approved by the California public utility commission. In August, we announced two orders for Fuel Cell Power plants in California.

G3 Power Systems ordered a 1.4 megawatt DFC1500 to be installed at Olivera Egg Ranch located in California. The power plant will run on renewable biogas obtained from ranch operations that will convert a significant agricultural waste problem into clean energy solutions.

The waste from the agricultural operations emit ammonia, methane and other gases creating acute environmental and disposable challenges. All of their egg ranch will install an anaerobic digester in which heat and micro-organism will reduce the volume of waste and create a methane-rich biogas as a byproduct. The power plant will utilize 100% of the methane-rich biogas and fill nearly all of the ranches power needs.

The by-product heat of the fuel cells will used by the anaerobic digester eliminating the need for a combustion boiler. Our fuel cells are well suited for agriculture and food and beverage processing as proven by other installations in California such as the Sierra Nevada Brewerie and Gill's Onions, a food processor.

Olivera is our first animal waste agricultural project and chose how fuel cells can be applied to cell multiple business, energy and environmental problems. They lower the owners’ power costs and insure reliable supply of renewable power while reducing green house gas emissions and virtually eliminating the emission of pollutants.

At the same time, they solve a significant waste disposal problem for the agricultural operation. The problems associated with agricultural waste are significant challenge in many parts of the country.

In California, dairy production alone is estimated to generate several hundred megawatts of waste each year that can be converted to ultra clean renewable energy employing the same approach being used at Oliver Egg Ranch. We now have multiple projects in our sales pipeline based on the same concept.

In August, Eastern Municipal Water District in southern California ordered two 300-kilowatt DFC300 FuelCell power plants for the Perris Valley Regional Water Reclamation Facility in Riverside County.

Following Eastern Municipal’s prior purchase of three DFC300 power plants in 2007 for its Moreno Valley facility, this order demonstrates the customer satisfaction with our products.

These power plants will operate on renewable biogas obtained from the waste water treatment plant in a highly efficient combined heat and power configuration, typical of wastewater treatment facilities.

Our fuel cells are helping Eastern Municipal meet the stringent emission standards of the South Coast Air Quality Management District, the agency responsible for a region that they consider to be the smoggiest in the country.

The use of anaerobic digesters combined with our ultra-clean fuel cells allowed Eastern Municipal and other wastewater treatment facilities to dramatically reduce the volume of waste from their facilities and generate renewable base load power at the same time.

As a result, we have a growing number of wastewater treatment projects in our sales pipeline, moving through the closure process. We expect wastewater in particular and biogas applications in general to be one of our fastest growing market segments, as we become the preferred solution to help these facilities solve their waste problems and power generation needs.

In Connecticut, we received two orders from customers demanding reliable and secure distributed energy. In July, we announced the sale of a 300-kilowatt DFC300 fuel cell power plant to LOGANEnergy, a dedicated fuel cell energy services company that will install the power plant at Carla’s Pasta, a frozen food processing facility in South Windsor.

The plant will provide 60% of the customers power requirements with the byproduct heat used for space heating and production processes. The high efficiency of the fuel cell power plant lowers fuel and electric cost for Carla’s Pasta, while reducing the company's carbon footprint.

Food processing operations like Carla’s Pasta needs reliable power to keep their food processing and cold storage equipment operating around the clock. In August, we also announced the sale of two 300-kilowatt DFC300 fuel cell power plants also the LOGANEnergy to be installed at the U.S. Naval Submarine Base New London in Groton.

The primary home of the U.S. submarine fleet, the base must have secure highly reliable sources of energy. The power plants will be installed near the existing energy plant and will provide base load electricity with the by-product heat being dedicated to the MG plant boiler, reducing fuel costs and carbon emissions.

In addition to the U.S. Navy, we’ve supplied fuel cell power plants to other branches of the U.S. military including the Air Force and Marine Corp helping our arm forces become more energy independent, efficient and secure.

As Joe mentioned earlier, we are in active discussions on multiple financing paths, where the 43.5 megawatts fuel cell projects approved by the Connecticut of Public Utility Control, including commercial financing sources and with the U.S. Department of Energy for a loan guarantee for 27 megawatts of these projects. While both the commercial financing and the loan guarantee process have been slow, our recent discussions on both approaches leave us optimistic about a successful outcome.

In Europe, discussions with perspective customers are progressing well. Europe has always been a leader in green energy and is an untapped market for fuel cells. The European continent is very diverse marketplace geographically and politically. And we anticipate partnering with multiple entities. We are in active negotiations with what we believe will be our, the first of several partnerships for the European market.

And our research and development work, we are demonstrating enormous potential of fuel cells. Our hydrogen co-production concept, the DFC-H2, has been installed as part of a state-of-the art hydrogen vehicle fueling station at the Orange County stations, wastewater facility in California.

It will start up on natural gas and then switch to biogas generated by the wastewater treatment plant and begin co-producing Hydrogen for vehicles early next year. A truly cutting edge technology, the DFC-H2 produces not one but three integrated value streams for customers, electric power, hydrogen for vehicles and heat.

With our partner, Versa Power Systems, we have been meeting the cost and performance objectives of Phase II of a 30.2 million department of energy contract to develop large scale coal-based solid oxide fuel cells.

The ultimate objective of the program is to develop megawatt class solid oxide fuel cell power plants that run on coal-derived syngas thereby reducing greenhouse emissions from coal by 90%. The company is currently in discussions with the DOE for the third phase of the program. And expect a decision from DOE by the end of this year.

With growing momentum in our sales pipeline and order flow in our key markets, we created a Chief Operating Officer position in July. This roll will help position the company for growth as we ramp up production and will insure close integration between manufacturing operations, product development, our quality initiatives and our supply chain.

Tony Rauseo, formerly Vice President of Engineering and Chief Engineer was appointed to fill the position. His strong operational, manufacturing and engineering background will allow us to insure a smooth production ramp.

Fuel cells are an ideal solution for today's energy challenges. In many cases they're the only solution. Fuel cells stationary -- FuelCell Energy stationary fuel cells are helping customers meet clean energy standards, transform waste into renewable energy and generate power, cleanly, quietly, reliablely and securely wherever it is needed around the world.

Fuel cells can solve future energy problem too, co-producing hydrogen for vehicles and extracting clean energy from coal. As a result of the ability of fuel cells to solve a diverse array of problems, we see several significant near-term catalysts for our business.

We anticipate receiving our next order from POSCO Power to support their 2011 needs, now that the South Korean RPS is being finalized. We anticipate a successful conclusion of the next phase of the DOE loan guarantee process or third party financing for some, or all of the projects approved in Connecticut.

And we expect continued order flow from California similar to our recent announcements, as the remaining approved utility projects and the numerous wastewater food and beverage processing and agriculture waste projects in our pipeline are closed.

Increasing order flow from our target markets and a growing recognition of the ability of stationary fuel cells to solve energy and environmental problems, for our customers positions us well to ramp production and move to profitability.

Operator, at this time, we are pleased to take questions from our listening audience.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And our first question comes from Sanjay Shrestha from Lazard Capital.

Sarah Martin – Lazard Capital

Hi. This is Sarah in for Sanjay. Can you discuss timing on the European partnership at this point and comment on the natural gas pipeline opportunity and some of the relationship you have with Enbridge there?

R. Daniel Brdar

Yeah. On the European partnership, those discussions have been moving along. I would hope that we are going to have something done and announced by the end of the year. We are pretty well engaged with what we believe will be our first partner. And we’ve got some key meetings coming up with them that we are hoping to be able drive some agreements to closure. So I would expect that to be an event for this year.

As it relates to the gas pipeline activity, the first significant opportunities for us here domestically are four projects that are part of the Connecticut portfolio, that are based on the FuelCell coupled with a turbo expander for the pressure letdown station.

What's happening is the same time though is, Enbridge is working with the Government in Ontario to get the approvals that they need to get a satisfactory nighttime rate to begin installing the concept at their own facilities, because they have estimated there's about 47 megawatts, those megawatt class within their own facilities where they would like to deploy the concept.

So, I think as they get through the last approvals with the Ontario Government on the rate structure, they will be ready to move forward with their own projects as well.

Sarah Martin – Lazard Capital

Okay. And would you expect the timing on the POSCO order later this year, or do you think that could be in '011 event?

R. Daniel Brdar

No. I think it will be this year.

Sarah Martin – Lazard Capital

Okay. Thank you.

R. Daniel Brdar

We are already in those discussions as we speak.

Sarah Martin – Lazard Capital

Great.

Operator

Our next question comes from the line of John Quealy with Canaccord Genuity.

Mark Seagull – Canaccord Genuity

Hi guys, Mark Seagull for John. Just wondering, with an increased volume of units out in the field and shortly to be out in the field, can you talk about any needs you might have for ramping up staffing, maintenance and support operations or are things good there?

R. Daniel Brdar

The service infrastructure we built is pretty robust. We made sure that we had the regional part storage that we had really good capable service people involved and we had the systems and tools in place to be able to monitor the units remotely.

As the market grows, we will certainly add people to those functions but near-term we are really ready to respond to that. As we ramp up the business here respond to the order flow, the immediate demand for us in terms of people is really going to be in a production facility itself, just to enable us to flush out the rest of the second and third shifts at our facility in Groton.

Mark Seagull – Canaccord Genuity

Okay. And then there’s been a lot of resurgent talk recently within the industry, particularly given competitive dynamics. Has this chatter changed any of the conversation you are having either with potential strategic partners or perhaps even key suppliers?

R. Daniel Brdar

I think there's certainly, there's an increasing awareness. If you think about sort of how industries have evolved there in terms of energy space, wind was certainly the industry that penetrated the market and matured first.

Solar came right behind them and FuelCell now seem to be the next wave, particularly as we are seeing the policy makers and a lot of the key markets openly talking about the challenges that are created by these intermittent solutions and the need to have something as clean and base load.

A lot of people that we are talking to as potential project partners are involved in doing projects that are wind and solar base, so they understand that there's a real need for some kind of a clean base load.

So I think it is really just raising the awareness of where fuel cells fit in to that portfolio, because there's clearly sort of a third leg of the store that's needed and there’s not any other technology that can really fill that ultra-clean continuous duty high efficiency gap.

So I think it’s a good thing that we are seeing some more activity in the marketplace and we are seeing sort of some new players emerging, because it is helping to raise the awareness level where FuelCell as a whole fit into the energy mix.

Mark Seagull – Canaccord Genuity

Okay. And just lastly, can you talk a bit about utility appetite for fuel cells? Are utility -- are your discussions with utilities increasing in volume or are they sort of hanging back to see how things go with PG&E?

R. Daniel Brdar

If you think about the utility side, Korea really is a utility play. The projects that are being put in are all megawatt and multi-megawatt class. They are all being put on to the actual transmission system, where all of the power is being exported to the system. And that's being done through the generation companies.

So the Korean utilities, the first one that have embraced the concept, here in the U.S. we are actually behind the curve because from a demonstration concept, you look at Korea it’s got what is going to be the largest fuel cell power plant in the world is going to be operational here in a few months.

I think and if you look at the domestic marketplace, it’s a little bit different picture whether you are on the east coast or the west coast. California, because it tends to lead in terms of energy policy, we are seeing the utilities there start to embrace the concept first , as they work closely with the utility commissions, I think the PG&E inflations will be important ones.

We need to demonstrate for the utilities in this country that fuel cells really are viable at the multi-megawatt level that they perform like a true commercial product. But we are already seeing more activity that’s coming, as a result of those projects being announced.

As other utilities sort of see the trend that's coming and we will be also finding some of the non-regulated arms are some of those utilities are some of the players that were in discussions with about, things like the Connecticut projects.

Mark Seagull – Canaccord Genuity

Great. Thanks a lot.

Operator

Our next question comes from Walter Nasdeo from Ardour Capital.

Walter Nasdeo – Ardour Capital

Thank you. Good morning.

R. Daniel Brdar

Good morning, Walter.

Walter Nasdeo – Ardour Capital

[How you guys are doing]. I had just a couple of quick questions here. Can you let me know what the time to fulfill these orders is at right now and what your internal capacity is?

R. Daniel Brdar

Our capacity is 70 megawatts of production. Depending on the, the customer or the lead times are anywhere from nine to 12 months depending on what customers needs are. Our approach has been with POSCO for example, they buy basically a year's worth of deliveries from us and then we spread U.S. orders in and among the units that they have ordered, specifically in places like California there's a time window when projects have to be in and operational under the rules of the incentive programs out there. So a typical lead time today is probably 10 months I would say.

Walter Nasdeo – Ardour Capital

Great. And you probably mentioned but I think I missed. When is POSCO’s plant going to be up and running?

R. Daniel Brdar

They're on schedule to actually complete the facility by end of this year. Since, we are providing a lot of equipment for them, to some degree we are pretty close on that schedule in terms of standing what they want. When they're going to actually set the dedication facility, I suspect it will be after the holiday sometime.

Walter Nasdeo – Ardour Capital

Okay. And jump over to the DOE loan application, where are you in that process? I mean obviously it is a multi-tiered process with numerous approvals that need to be met. Where are you at in that process?

R. Daniel Brdar

The way the program is set up, there's really two phases. You submit a Phase I application that has project information. You go through a review and to see if you are accepted or rejected. We have completed that phase successfully. Then we go into Phase II, we have to provide some additional information, typically have to spend little bit of money to get credit ratings for the projects themselves, those sort of things.

We had submitted our Phase II application. We’ve got some questions back from them just looking for some additional information that they need to make their decision. We are expecting that Phase II decision basically at anytime now, because the discussions we have had with DOE have been very productive.

They really – they were looking for information like, what are the performance guarantees under our contract, those sort of things that weren't requested as part of that initial phase II application. And assuming that we get the phase II approval, at that point you begin negotiating your term sheet and move to closure.

Walter Nasdeo – Ardour Capital

Okay. And then, is most of the Connecticut stuff continued upon this then, is that?

R. Daniel Brdar

No. Actually, we have multiple paths here. We have -- there's 27 megawatts that are in the loan guarantee program. But we have multiple players that actually very deep in the due diligence process that would not be relying on the loan guarantee.

So we’re really sort of working these paths in parallel. We’ll see which one of them happen first. Some of the players that we’re working with are actually interested in loan guarantee program and if they came through they would sort of pull that into how they’re structuring the projects, but they’re looking at them first on the standalone basis without a loan guarantee.

Walter Nasdeo – Ardour Capital

Got you. Thank you very much.

R. Daniel Brdar

You're welcome.

Operator

Our next question comes from Pavel Molchanov from Raymond James.

Pavel Molchanov – Raymond James

Thanks for taking my question. Just kind of thinking conceptually about the market opportunity in the U.S., we’re at a point where the natural gas futures curve is around 5 bucks in Mcf. Given that and the potentially very appealing economics of your product that you’re -- what's the push back you're getting that’s preventing the kinds of adoption rates that you guys are hoping for?

R. Daniel Brdar

The only thing that we’re really seeing in terms of push back is just customer’s willingness to spend the capital and in just such an uncertain economic environment. If you look at the things that are in pipeline, there are projects don’t disappear, they just -- some of them have just been delayed.

And the message that we’ve been getting is, customers are feeling increasingly comfortable about two things. One is, that the volatility around gas pricing which can impact, distribute generations seems to be an issue that people aren't too concerned about.

And people are getting the feeling that the access to financing for capital projects is significantly improving, which is why, if you look at the half dozen orders that we’ve announced here since the last call, we’re seeing that pipeline move more quickly to closure. Joe, anything you want to add to that?

Joseph G. Mahler

No. I think generally, probably, on the credit side it’s just more optimism in the marketplace. We obviously got a couple of deals done this month where the customers were able to find credit. We’re seeing interest from more parties. And even most importantly is we’re seeing people coming at us looking to solve these business environmental problems, like the ag waste farm is solving a business problem and they see -- they're really beginning to understand FuelCell and that should drive it.

Pavel Molchanov – Raymond James

And I have a follow-up to that. Can you give an update on the kind of quarterly sales run rate in meg’s that you need to get to positive for, let's say, breakeven cash flow?

R. Daniel Brdar

Yeah. It’s about -- on a quarterly basis it’s about 25 megawatts, so it is a 100 in total. So the assumption would be you’d have 100 megawatts on an annual basis, you’d have about, lets say, you can get 20% gross margin, we think we can get higher but be conservative for a minute.

So you get, 20% gross margin on that 100 megawatts, it provides enough operating cash to support our below the line requirement, our below the line requirement is about $40 million right now. So that’s, it’s pretty simple math. We’re really right at the inflection point and volume will drive it that.

Pavel Molchanov – Raymond James

Okay. That's helpful. Thanks.

R. Daniel Brdar

Yeah.

Operator

Our next question comes from the line of Amit Dayal with Rodman & Renshaw.

Amit Dayal – Rodman & Renshaw

Thank you. Good morning, gentlemen.

R. Daniel Brdar

Good morning.

Joseph G. Mahler

Good morning.

Amit Dayal – Rodman & Renshaw

Some clarification on this sales mix, we’re seeing more component sales happen over the last two quarters. Can you give us color on what's driving this and do we expect to come back to more power plant sales going forward?

R. Daniel Brdar

If you look at the components, the component sales really is our activity with POSCO as they have or localizing the balance of plant equipment. The focus for us going forward with them will be to provide the components they need to make the FuelCell modules themselves.

If you look at what's actually in our production mix, it is actually starting to come back to be more balanced as we shift things like the DFC1500 power plant, the Sonoma, this past quarter and the other things that we’ve got in the U.S. orders pipeline really help balance out the power plant for domestic applications versus components to POSCO to support their needs.

Amit Dayal – Rodman & Renshaw

And in the backlog, we roughly have $92 million, I guess, how much of that is components?

Joseph G. Mahler

Yeah. In the backlog, there is probably, I would say roughly half of that would be, well, I’m sorry, probably a third of that would be components.

Amit Dayal – Rodman & Renshaw

And longer term assuming we get through 100 megawatt level, so that on the later like, what are the margins on the components side that you expect and margins on the power plant side if components and kind of that aspect?

Joseph G. Mahler

Yeah. What we expect, we have proprietary technology here and we’re commercializing the business for entering the market. And where these margins are going to go is, you have a full power plant which consists of balance plant and this proprietary cell technology.

So what you’d expect is that the cell technology will have high margins and that the balance of plant is much more mature, balance of plant is used on typical power plants, engines and turbine, it’s very similar type technology. So we would expect that component margins will be higher and overall power plants will be a little bit lower, I mean, that's what we’re looking for. We’re looking for an opportunity.

A lot of things depend that the future turns out, as the future develops, what kind of competition will come in, what will the market pressures be, but for a company that's leading the pack and we’ll certainly have, what we believe is capacity constraints even as we ramp the business will have capacity expense, we have the ability to manage that margins, we’re thinking technology margins in a $35 to $40 even plus range for the components.

Amit Dayal – Rodman & Renshaw

Okay. Thank you.

Operator

Our next question comes from the line of Scott Reynolds with Stifel Nicolaus.

Scott Reynolds – Stifel Nicolaus

Thank you. Just a couple of quick ones for me. I don’t know if you gave it or not, but what were the megawatt shipped in the quarter?

Joseph G. Mahler

Megawatts shipped in the quarter were 8.4.

Scott Reynolds – Stifel Nicolaus

8.4. And now that's not too much volume but you had a nice step down in your product cost ratio. Now, is that some -- is that mostly from a technology improvement or is there a mix shift in there?

Joseph G. Mahler

In this quarter, in the cost ratio we are reaping the benefits of the technology shift that we put into production in the summer of '09, so those numbers are clearly coming through the financials and we are on track now. I mean this is where we should be in terms of cost ratio and cost ratio should just continue to get better from this point. Volume, the more volume we put in on selling product will actually drive this to that one-to-one and then below one-to-one cost ratio.

Scott Reynolds – Stifel Nicolaus

Okay. And on the OpEx side there was a step down on $1 million, well, $0.8 million quarter-over-quarter, what was driving that?

Joseph G. Mahler

Well, I mean, a couple of things are driving. We had admin and selling. So we have some incremental selling costs coming through. We have a little more focus in R&D dollars. We’re focused on R&D projects in this quarter. They see to go back and forth.

We’re in a little bit of quarterly range between admin and selling and R&D. I would look at like $4.5 million on an average basis for admin and selling and about $5 million for R&D is about the right number. So, that's how I would look at it.

Scott Reynolds – Stifel Nicolaus

All right. Thank you very much.

Joseph G. Mahler

Yeah.

Operator

(Operator Instructions) And we have a follow-up question from Sanjay Shrestha.

Sarah Martin – Lazard Capital

Hi. Just a follow-up on cash burn. Noticeable improvement in the quarter, looking forward, are we still looking at a 10 to 12 range or maybe better than that?

Joseph G. Mahler

Yeah. I think we can start to look at the dynamic of this order flow coming in as we can close the pipeline and the cash flow will get better. The, in fact, you know as you bring, our working capital on the orders is pretty good as we get a nice down payment on the order flow and you can actually, in a quarter actually have a pretty substantial impact on reducing cash flow.

But if you can get your run rate up, if you can get your run rate up to 50 megawatts and then to 70 megawatts, you’re in effect driving cash flow down. So if you’re operating at a 70 megawatt run rate you’re probably driving your cash flow in a range of 6 per quarter and that's what we’re looking for.

I mean all the other factors are. All the cost reduction is played out. I mean, our ability to manufacture has played out and really, if you just drive volume the model works, I mean, the model absolutely works. We’ll reduce cash burn and then we just need to get to that in the K, we say 75 to 125 megawatts of throughput and at that point, we can go operating cash positive. So it’s really, at this point, we’re at the inflection point and lets drive some volume and lets move this business to profitability.

Sarah Martin – Lazard Capital

Thanks, Joe.

Operator

(Operator Instructions)

R. Daniel Brdar

Okay. We’d like to thank everybody for joining us at this point and we look forward to updating you in next quarter because we think we’ve got some pretty exciting things coming we’d be talking about. Thank you everybody.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may all disconnect. Everyone have a great day.

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