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FuelCell Energy Inc. (NASDAQ:FCEL)

Q2 2014 Earnings Conference Call

June 4, 2014 10:00 am ET

Executives

Chip Bottone – President, Chief Executive Officer

Michael Bishop – Chief Financial Officer

Kurt Goddard – Vice President, Investor Relations

Analysts

Rob Stone – Cowen & Co.

Les Sulewski – Sidoti & Co.

Aditya Satghare – FBR Capital Markets

Sven Eenmaa – Stifel Nicolaus

John-Marc Bunce – Mirabaud

Operator

Good day ladies and gentlemen and welcome to the FuelCell Energy Second Quarter 2014 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 be given at that time. If anyone should require assistance while the conference is in progress, please press star and then zero on your touchtone telephone to reach an operator. Please note today’s conference is being recorded.

I would now like to hand the conference over to Kurt Goddard, Vice President of Investor Relations. Sir, please go ahead.

Kurt Goddard

Good morning and welcome to the second quarter 2014 earnings call for FuelCell Energy. Yesterday evening, FuelCell Energy released financial results for the second quarter of 2014. The earnings release as well as a presentation that will be referenced during this earnings call is available on the Investor Relations section of the company website at www.fuelcellenergy.com. A replay of this call will be available two hours after its conclusion on the company website.

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

Delivering remarks today will be Chip Bottone, President and Chief Executive Officer, and Mike Bishop, Senior Vice President and Chief Financial Officer.

Now, I’d like to turn the call over to Chip Bottone. Chip?

Chip Bottone

Thank you, Kurt. Good morning everyone and welcome. Please turn to Slide 4, second quarter 2014 highlights. During the second quarter, we continued strengthening the business for long-term profitable operation and gained further recognition for our role in the global energy market transformation. New orders and awards totaled 12.6 megawatts or $80 million, raising our year-to-date new orders to 16.3 megawatts, and there are more to be announced in the coming months. The recent new orders speak to the competitiveness of our solutions which will further enhance our business model, enabling shovel-ready projects for short duration execution.

We deepened our relationship with POSCO Energy, our partner in Asia. New strategic initiatives include collaborating on worldwide customer opportunities and integrating our global supply chain to drive down costs. We are uniquely positioned globally in key areas of customer adoption and product cost reduction.

We continue to work towards attaining EBITDA break-even at the current production run rate. Our second quarter was not as high revenue as we would have liked, but this is not a quarter story. The fact that we delivered revenue of nearly $40 million in the quarter but we are not satisfied reinforces the progress we have made. Year-to-date, we have even greater progress and our sizeable sales pipeline includes multiple projects in advanced stages of closure, which will allow us to deliver a strong second half of the year. I will discuss our results, activities and how we are creating value for our customers as well as outlook after Mike Bishop, our Chief Financial Officer, reviews our financial results for the quarter. Mike?

Michael Bishop

Thank you, Chip. Good morning and thank you for joining our call today. Please turn to Slide 5, titled Quarterly Financial Highlights. FuelCell Energy reported total revenue for the second quarter of 2014 of $38.3 million compared to $42.4 million in the same period last year. Product sales for the second quarter totaled $27.7 million, including an additional 5.6 megawatts of fuel cell modules ordered by POSCO Energy during the second quarter, which followed 3.7 megawatts ordered during the first quarter. Service and license revenues increased to $7.2 million compared to $4.1 million in the prior year period, reflecting service module exchanges in the period. Advanced technology contract revenues totaled $3.4 million for the second quarter of 2014. Gross profit was $1.6 million for the second quarter of 2014 compared to $2.3 million for the second quarter of 2013. The gross margin percentage in the quarter was 4.2% compared to 5.5% in the prior year quarter. The sales mix in the second quarter of 2014 was oriented towards fuel cell kits and modules sold. In the prior year quarter, the sales mix included a portion of revenue from the Bridgeport fuel cell project which contributed to higher gross margin. I will be commenting on the future sales mix and expectations and the positive impact to the business on a subsequent slide.

Total operating expenses were $10.4 million for the second quarter of 2014 compared to $9.5 million in the prior year period. We accelerated some spending and product development initiatives to support new order closure, resulting in the year-over-year increase in operating expenses. Net loss to common shareholders for the second quarter of 2014 was $16.6 million or $0.07 per basic and diluted share. On an adjusted basis, which excludes the net expenses related to the conversion of the 8% convertible notes during the period, the adjusted net loss attributable to common shareholders totaled $10.7 million or $0.04 per basic and diluted share. This compares to $8.2 million or $0.04 per basic and diluted share in the second quarter of 2013. EBITDA, which is a measure of cash flow and is based on earnings before interest, taxes, depreciation and amortization, totaled negative $7.5 million.

Please turn to Slide 6, titled Year-to-Date Financial Highlights. Turning to the year-to-date results, for the six months ended April 30, 2014, the company reported revenue of $82.7 million compared to $78.8 million in the prior year period. Gross profit increased to $3.8 million compared to break-even for the comparable prior year period. Net loss to common shareholders for the six months ended April 30, 2014 was $28 million or $0.13 per basic and diluted share. On an adjusted basis, which excludes the net expenses related to the conversion to the 8% convertible notes during the period, the adjusted net loss attributable to common shareholders totaled $19.7 million or $0.09 per basic and diluted share. Net loss improved compared to $20.6 million or $0.11 per basic and diluted share for the six months ended April 30, 2013.

Now I will transition to Slide 7, titled Financial Metrics. Cash and cash equivalents, including restricted cash, totaled $89.4 million at April 30, 2014. Net cash used by operating activities in the second quarter of 2014 was $10.6 million, which includes a $3.9 million increase in inventory in preparation for turnkey projects in the U.S. This inventory will fulfill recent project announcements and be converted to cash during the second half of the year. Depreciation expense for the quarter was $1.1 million and capital spending during the quarter was also $1.1 million.

The company used cash of $5.6 million in the second quarter to reduce the outstanding balance at the revolving credit facility extended by JP Morgan Bank. Also, $22 million of the 8% convertible notes were converted to equity in the quarter. There is only $1 million of principle remaining on these notes, significantly reducing future interest costs.

During the second quarter, we maintained the annual production level of 70 megawatts and shipped 15.7 megawatts of fuel cell kits and modules. Backlog increased to $343 million at April 30, 2014 compared to $327 million as of January 31, 2014. Backlog includes product sales orders of $147 million or 89 megawatts. Service backlog increased to $182 million at the end of the second quarter compared to $158 million at this time last year and $165 million sequentially. Advanced technology contract backlog was $14 million at the end of the second quarter. While the total backlog as measured in megawatts is down as we deliver kits to POSCO on our multi-year order, the total dollar value is up as we transition to a more diverse, higher revenue and margin business by adding turnkey projects in the U.S. and service agreements with recurring, long-term revenue streams of up to 20 years.

Now please turn to Slide 8, titled Financial Model Guidance. Transitioning from the prior slide, I mentioned that total backlog increased sequentially by over $16 million as we are adding complete turnkey installation and long-term service agreements to backlog. The average sales price and margin opportunity per megawatt for projects that we are adding to backlog today are more than double that of our historic fuel cell kit backlog. As we book additional business similar to the recently announced utility award and university project, the sales mix becomes more favorable, leading to expanding revenues and gross margin. As a result, we are forecasting average quarterly revenues in the second half of fiscal 2014 in the range of $50 million to $60 million. At these levels, we expect double-digit margin percentages and expect to reach EBITDA break-even at our current annual run rate of 70 megawatts.

To further drive EBITDA improvement in addition to the sales mix, we see opportunity to further reduce cost through value purchasing in our supply chain agreements with POSCO, and by implementing manufacturing efficiency improvements. We will also increase production levels as backlog supports. The annual production capacity for our North American facility is 100 megawatts, which the company will leverage as prudent to drive additional growth. We expect net income profitability to be achieved in the range of 80 to 90 megawatts of annual production volume.

Let me reiterate that the management team is intently focused on driving sales of complete power plant and service agreements to expand future revenues and margins and to achieve EBITDA-positive results. The company is well positioned to execute on near-term market opportunities.

I will now turn the call back to Chip for further discussion of our operations and markets. Chip?

Chip Bottone

Thank you, Mike. Please turn to Slide 9, Strengthening the Business. As Mike discussed, we have a strong fundamental business model that can deliver growth and profitable results. We are executing on critical initiatives that will allow us to further penetrate what we estimate is currently a $12 billion market opportunity, which is a very tiny portion of the multi-trillion dollar energy market globally.

At this stage, our key initiatives are primarily commercial and operational in nature. I would like to focus on the things we’ve accomplished this quarter that demonstrate the strength of the business and our focus on execution. We currently serve two primary markets with ultra-clean stationary base load distributed generation power plants, utility grid support and on-site combined heat and power, or CHP generation. Recent orders – one to a utility company and the other to a university – typify each of these markets in project repeatability.

We recent announced a 5.6 megawatt award from United Illuminating, one of Connecticut’s two electric utilities for two 2.8 megawatt DFC 3000 power plants. This represents the second-largest fuel cell power plant award we have ever received in North America. Both plants will provide clean and continuous power to the electric grid, enhancing the resiliency of the grid in a manner that supports environmental policies. We will operate these plants for UI under 20-year service agreements.

The United Illuminating installation in Bridgeport is also an example of urban renewal as a capped landfill is converted into a source for tax revenue for the city and showcases the power density attribute of our power generation solutions by providing 2.8 megawatts of continuous base load power on approximately a quarter of an acre, complementing 5 megawatts of intermittent solar generation that is using 8.5 acres. In this instance, the city has the land available for the solar, but in many urban environments the space needed for intermittent solar is not available for utilities via power generation.

Illustrating clean on-site combined heat and power, we recently announced a 1.4 megawatt fuel cell power plant project for a university, the University of Bridgeport. The CHP configuration increases the overall project efficiency by generating two value streams, electricity and heat, from the same unit of fuel. The unique attributes of the ultra clean power plants make them especially well suited for universities. Generating environmentally responsible distributed electricity on site enables universities to attain their sustainability objectives while enhancing their energy independence and security. The project also includes benefits to the university and local utility by avoiding investment in infrastructure to improve reliability and site security.

Our company is undertaking this university installation is in discussions with multiple project investors regarding the sale of the power plant and retention of the associated multi-year operation and service agreement. Minimizing the use of construction-related financing reduces the overall costs of capital and provides better margins to the company. Our ability to develop and finance the construction phase of the project mitigates risk and enhances the value of the project for both the university and the private investor owner.

We announced initiatives to strengthen our strategic relationship with POSCO that will enhance global market development and contribute to further reducing product costs. First, we are collaborating with POSCO to support multinational customers expressing interest in fuel cell projects in the other partners’ geographic territory. Together, we can now support global customers in each other’s local market to ensure consistency of communication, quality and execution. We are already working several projects in this way.

Second, we are synchronizing our integrated global supply chain, which is key to achieving the overall material cost reductions we are planning. The combined purchasing volume of FuelCell Energy and POSCO results in lower product costs for both organizations and supports greater market adoption with increased margins. By consolidating purchase with the same supply chain, we reach volume targets that lead to lower pricing; or put more simply, the more we buy together, the lower the pricing for both of us.

Leveraging the existing supply advantages at both companies, including POSCO’s steel manufacturing capabilities and mining operation, provides enhanced security of supply for risk mitigation for our customers and investors. Construction of POSCO’s manufacturing facility in South Korea is about 60% complete and on schedule. When it becomes operational in mid-2015, it will double global production capacity of our products, providing us cost advantages. The strength of our business model is that POSCO is committing the capital for the facility while we benefit from the further validation of our project solution by the continuing investment in capacity and market development by POSCO, as well as a second source of supply.

Our strategic alliance with POSCO is a powerful differentiator in the industry. This strong partnership leverages our organizations’ respective strengths as we work together to grow our markets while driving down costs and improving financial returns. Our team in Europe continues to make progress on several fronts. Our high-profile (indiscernible) sites are both operating and available for visitors or in the final stages of commissioning. Our organizational capabilities and business model aligns with what we have in North America and with POSCO in Asia.

We continue to maintain 70 megawatt annual production rate at our Torrington, Connecticut manufacturing facility. Based on our continued high confidence level and near-term order projections, we plan to maintain this rate and will increase it as demand dictates. As Mike mentioned earlier, we did accelerate spending in the quarter to support the contract development of projects, which is expected to enhance the probability and speed up the timing of closure while aligning with our ability to immediately start construction and to recognize revenue.

Recent orders for complete power plant installations for United Illuminating and the University of Bridgeport are contributing to a more favorable sales mix and will support our target of attaining EBITDA break-even. Other factors will contribute to improving margins, including the enhancement of our manufacturing processes and lower cost materials for higher volume purchases. Some time is required to realize the full value of these measures as they flow through the business. Similarly, leverage from our existing service infrastructure will be realized over time as new multi-year service agreements are secured with new orders.

Please turn to Slide 10, Reducing LCOE – Levelized Cost of Energy. Our competitiveness increases as our levelized cost of energy reduces. As we participate in the transformation of the energy sector, what is important is that we provide affordable, clean and secure power and thermal solutions to our customers. Part of building a great company and business is understanding what is important and then executing on it. Our customer value proposition is providing megawatt-scale ultra clean, efficient and reliable distributed power generation. Given the size of our projects we built for our customers from 1 to 60 megawatts, financing of some form is required. Today, we speak in terms of cents per kilowatt of power that our plants can deliver. When you look at the overall make-up of pricing, you can see that we have four different elements of cost: capital, operating, fuel, and cost of capital.

While we have increasingly competitive offerings today, reducing our price per kilowatt further will accelerate demand and expand the size of the market opportunity. We have efforts in place to reduce costs in all four areas to enhance our competitiveness. Several examples of focus are listed. We have always focused on capital costs, but nearly equally is important is the cost of capital. As an example, rapid execution of installation enhances value for utility customers seeking to add clean distributed generation to their portfolios as large scale fuel cell parks for grid support require much less time to design, approve and build to conventional generation.

We broke ground the day after signing the contract for the 15 megawatt Bridgeport fuel cell park and completed it in a short 12 months. The 59 megawatt fuel cell park in South Korea, the world’s largest, was completed in only 14 months. Short construction periods lessen risk and minimize the term of construction-related financing. Construction finance is typically the most expensive piece of financing, so faster execution minimizes the term needed for construction-related capital.

Please turn to Slide 11, Business Development Overview. We talked about our continuous focus and improvement of our business model and competitive position. I would like to share with you what we’re working on to drive our new order flow and our confidence level of getting this done. Our activity levels are the highest we’ve ever seen. Our expanding install base and our reputation for delivering successful projects is driving inquiries and supporting progress towards closing orders in our on-site CHP and utility grid support markets. We are actively bidding on multi-site megawatt utility projects that we were not in a position to pursue in the past. Marquee customers like Dominion validate our solutions and lead to inquiries and closing projects with new customers, such as United Illuminating. Delivering the Bridgeport fuel cell park on schedule demonstrates our ability to execute. The financial strength at POSCO Energy, their investment in capacity and market development, and the on-time construction and delivery of the 59 megawatt South Korean fuel cell park adds further validation.

We are actively developing projects similar to what we are doing with the University of Bridgeport. These include single-plant combined heat and power applications as well as multi-megawatt fuel cell parks. Customer financing options and deployment via our relationship with NRG Energy is appreciated by prospective North American customers that we are engaged with for potential projects. Our relationship with Fraunhofer IKTS helps open doors in Europe leading to further validity, plus the potential for product enhancements through leveraging their research and development capabilities. We are in advanced stages of discussion with utility and end users in Europe for near-term projects. We are in active discussions in areas of countries that we have no current install base. We are doing our due diligence to ensure that we can deliver a compelling value proposition and that the markets will support significant business volumes.

Legislative and regulatory policy can and do support the adoption of clean distributed generation without financial incentives. In the U.S., the Connecticut legislature enabled utilities to own renewable power generation, an exception to deregulation that previously prohibited them from directly owning power generation assets. Utilities in other states are seeking tariff approval to rate base on-site generation. This week’s new EPA regulation announcement will create demand for cleaner and more distributed solutions that fit us well. Last month, the Fuel Cell and Hydrogen Infrastructure Act for America was introduced to the U.S. House of Representatives. Similar discussions are taking place in countries in Europe and at the European Parliament.

Please turn to Slide 12, Summary. We are strengthening our business for the long term, enhancing our competitiveness and value proposition through strategic initiatives that are mitigating risk and lowering costs. We have generated 16 megawatts of orders in the first half of 2014 with additional order flow expected near term. I am confident of this based on the ongoing contract negotiations for letters of intent we have with a variety of customers worldwide. The power generation needs of the global market continue to move in our direction. Our stationary base load distributed generation solutions and diverse services are being validated by our growing customer base, including utilities.

The team and I remain very enthusiastic about the future of our business and we thank you for your continued support. Operator, we’d be happy to take questions at this time.

Question and Answer Session

Operator

[Operator instructions]

Our first question comes from the line of Rob Stone from Cowen & Company.

Rob Stone – Cowen & Co.

Hi guys. Chip, I wanted to focus on the increased operating expenses for a minute. You mentioned that you’re working to accelerate pulling in orders and being ready to start quickly when they come in. Does that mean that you essentially pulled in some expenses from future periods, or should we be expecting this elevated run rate to continue?

Chip Bottone

Hey Rob, hello. Long time no hear from you. Yes, so we had these added expenses in the quarter, and the way these projects work, there’s obviously work to do when we do bid and proposal things, and some of these projects that we had, we tried to provide – some of the projects that are complete – micro grids, so we have to integrate things in the factory. So some of that is material, some of that is people cost, some of that is testing; but yes, those are some expenses that we thought we would do later on in the year that we pulled forward into the year to basically accelerate closure of those projects.

Rob Stone – Cowen & Co.

So should we expect then that some of this is being pulled forward, that your expenses in dollars may go down sequentially?

Michael Bishop

Hi Rob, it’s Mike Bishop – good morning. Yes, so the way we’re thinking about it is operating expenses will be flat to down from here for the remainder of the fiscal year.

Rob Stone – Cowen & Co.

Okay. My follow-up question is more of a mix-related one, Mike. So service margin was significantly lower sequentially, and I guess you mentioned there were some replacement stacks in there. Could you just give us a little more color on the mix in there, how much was license and royalty and what are the drivers for service margins in the second half?

Michael Bishop

Sure. Yes, as you mentioned, there was module replacements coming through in the period that drove the increased revenue in the period. These are some older units, so it also impacted margin in the period. Service revenue is lumpy by nature in that we do defer revenue recognition until we do module replacements at their scheduled time – that’s after five years. You also asked about royalty and licensing – that was about $900,000 in the quarter that came through.

Rob Stone – Cowen & Co.

Great. I’ll jump back in the queue. Thanks.

Operator

Thank you. Our next question comes from the line of Les Sulewski from Sidoti & Company.

Les Sulewski – Sidoti & Co.

Good morning. Thank you for taking my questions, guys. First, just to clarify it for the second half of the year, you plan to book or recognize the revenue from one of the 5.6 megawatt plants, correct?

Michael Bishop

Good morning, Les, it’s Mike. So we have one of those plants in backlog at the end of the second quarter. We expect the second one to come into backlog in our third quarter, and we would see revenue recognition on both of them during the second half of the fiscal year.

Les Sulewski – Sidoti & Co.

Okay, and then the 1.4 megawatt plant at the university, is that going to reflect in the third or fourth quarter?

Michael Bishop

So the one—let me give a little bit of background on the 1.4 megawatt order with the university. That’s a project that FuelCell Energy fully developed. It’s a power purchase agreement signed by the university. We are under construction on that project right now, and it actually has micro grid capabilities. It has a ticket price in the range of $7 million to $8 million. What the company expects to do with that project is to close on permanent financing with a long-term owner of the project at commercial operation. That commercial operation is expected in the fall, so that could happen in either our fourth fiscal quarter or our first quarter.

Les Sulewski – Sidoti & Co.

Okay, that’s helpful. And then, do you see a higher gross margin on the larger plants, on the medium size? What’s kind of the lay out there, if you could provide some thought on that?

Michael Bishop

Sure, Les. Our product scales very well, so we see our lowest cost products when you get up to the higher megawatt sizes. So the larger the project, the bigger the margin opportunity there, and we would expect a mix going forward. As we announced this quarter, we had two 2.8 megawatt power plants and a 1.4 megawatt. We’re certainly targeting power plants in that size range and above here over the next several quarters.

Les Sulewski – Sidoti & Co.

All right, and just to kind of follow up with that, looking out on your bidding pipeline in terms of megawatts, what’s your visibility in terms of what’s out there available to bid on? What are you bidding on? Just kind of a layout of what can we expect to happen in, say, 2015, 2016?

Chip Bottone

Les, this is Chip. Let me kind of start with the near term. We do have visibility – I mean, obviously we’ve got approximately 300 megawatts, if you will, split between Europe and the U.S. in total. If that number goes up, it changes, but we move things through a funnel; so yes, we have an idea of the value, the type of project, as well as the approximate timing, which is subject to change here a month or two either way.

So our immediate focus is on what we call the most qualified ones, and those are typically ones that we either are in contract negotiations with customers who have all the contracts and have access to capital, either on their own or us enabling it, so we’ve got a substantial number of those projects right now that would be near-term things. Then you can think about as part of that 300 megawatts of total pipeline out there, obviously some of that stuff, you might get contracts in certain years but then there is a delivery component as well. So we do track that, we do know exactly what we’re trying to book in for 2015 and ’16 at this point, and we’re focused on closing the projects to basically fill those because with those commitments, we have to commit to deliver those plants. So I wouldn’t say that we’re picking and choosing orders, but we do have a very good handle on what we can produce in those years and how that matches up to revenue.

Les Sulewski – Sidoti & Co.

Great, thank you. That was very helpful. I’ll jump back in the queue. Thanks guys.

Operator

Thank you. Our next question comes from the line of Aditya Satghare from FBR Capital Markets.

Aditya Satghare – FBR Capital Markets

Good morning, guys. Two questions here from my side. So first on the backlog, how should we think about the duration of the 90 megawatts of backlog, and as we look at that $50 million to $60 million of revenue in the second half, what part of that revenue is covered from existing backlog and what is the potential for new bookings?

Michael Bishop

Hi, good morning. This is Mike. So as far as the backlog that we have today, 89 megawatts, there is two components of that. There is the POSCO kits which we are manufacturing over the next several years – that was a five-year order and it stretches to the end of our fiscal 2016, so the total kits in backlog are 84 megawatts. Then on top of that, we have these U.S. orders that we announced and then we’d also be bringing in this United Illuminating order here in the near term.

As we think about what is booked in backlog and what’s still to come here, the $50 million to $60 million forecast is based on what we currently have in backlog plus expectations of what we will close here over the next several quarters, as Chip mentioned, and we mentioned in the release that we expect to close above our 30 megawatt target here in the near term. So there is some of that in our second half forecast, but we’re confident that that will close and we’ll achieve those targets.

Aditya Satghare – FBR Capital Markets

Got it. That’s helpful. Then my second question was on POSCO. When we think about the expanded agreement with POSCO, does it sort of drive down your overall cost of projects? I mean, should that sort of lead to an update in terms of your overall cost structure? And then maybe, Chip, if you could sort of elaborate on how we should think about the opportunities for multi-national customers, especially going both into Asia as well as in the U.S.

Chip Bottone

So let me first answer the cost one here. I mean, there is the material cost, right? You think about that, the more we buy, the better the pricing; but I would put the asterisk on that as well, saying that POSCO, the biggest things that we have, the biggest component we have in our product is stainless steel. POSCO is one of the largest stainless steel suppliers in the world, and they are currently not the supplier of the stainless steel, so I’ll let you connect the dots on that.

But basically, we’ve kicked off the teams on the supply chain and we want to actively and as quickly as possible maximize the benefit of that. As they are going to be starting their plant in July of next year or mid next year, they are obviously right now in that procurement—beginning that procurement cycle for those materials to support both our production and theirs. So we’re very optimistic about that piece.

From a project perspective, that just flows down, the cost of materials flows down. We do see benefits on a project level – for example, the University of Bridgeport project, we consolidated some of the balance of plant stuff that led to a lower balance of plant cost of that project, and by working together with them, we see other opportunities like that. So there is a material cost piece and there is a project piece that has been helpful.

Relative to this collaboration on an international basis, I would say this. It’s interesting – we’re the only person really that can operate in the world like we’re talking about, and we build great relationships on different parts of the globe, them and some of the customers they have in utility, and some of the customers we have. And now, what’s happening is those people are saying, hey, I’m going to try to build the plant over here or somewhere like that, so the fact that we can coordinate things with them, have a common technology platform so all that gets off the table, and then have common design criteria is really important to these global customers.

So I can just tell you that we have a handful of customers without trying to actively pursue this, that find this exciting, and when we actually proactively promote this, we’re going to see a significant increase in activity. And as we’ve kind of noted already, we’re in a great position to execute that since we really, as far as teams working together and transparency, we do that very, very well as two companies acting as one real effort here.

Aditya Satghare – FBR Capital Markets

All right, thank you. That’s all I had.

Operator

Thank you. Our next question comes from the line of Sven Eenmaa from Stifel.

Sven Eenmaa – Stifel Nicolaus

Yes, hi. Thanks for taking my questions. The first question I had was just looking at the $50 million to $60 million quarter run rate revenue (indiscernible) over the second half and double-digit cost margins on that, based on what you have commented on United Illuminating contracts of $28 million for one plant plus the POSCO backlog you have, and then quarterly shipments plus the University of Bridgeport, it sounds to me that you guys need only at most one to two additional 2.8 Dfc plants to meet your full-year guidance. Is that the right way to think about it?

Chip Bottone

I’ll let Mike answer that one. Go ahead; I’ll probably add something.

Michael Bishop

Hi Sven. Yes, so that’s the way to think about it. There is a couple more plants that we need to close to bring through the revenue, but a large percentage of it is already in backlog, as we mentioned, that United Illuminating order. So yes, it’s in the range that you mentioned in your comments there.

Chip Bottone

Just to add to what Mike said, we spent a fair bit of time this earnings call kind of going through our business model, and really to your point, the fact that we can get contracts that really are ready to execute as compared to a bunch of engineering needs to be done and delays to start, because that’s what we do – we try to get all the work done and then sign the contracts and then get to it. Then when you combine that with the fact that we have some of these materials and we do percentage of completion invoicing, you can kind of see how you can catch up with the revenue, just to add to what Mike says.

Sven Eenmaa – Stifel Nicolaus

Got it, that’s very helpful. The second question I had – I know you had historically some of the kind of lower profitability service contracts. What is the kind of overall margin in your service backlog currently?

Michael Bishop

So Sven, when we’re quoting service agreements today, we’re targeting margins in the mid-20% range. That can vary depending on the life of the service agreement and other considerations, but that’s what we’re currently targeting today. There is some legacy service agreements that we have out in the fleet that have margins south of that, but we’d certainly see margins in the service business trending up here both in the near and long term.

Chip Bottone

I would just add to what Mike said – you know, what really led to that was years ago when we put out some of these less profitable or unprofitable contracts, we’d been working very, very hard at either finishing those projects off because it’s been approaching about five years since they started, but more importantly what we’re finding success with is converting customers to larger plants once those particular contracts end. So to Mike’s point, basically we’ve got two things going on here: one, you’re getting rid of some unprofitable or less profitable revenue and replacing it in the future with higher margin, higher value service contracts as well.

Sven Eenmaa – Stifel Nicolaus

Got it. That’s all I had. Thanks so much.

Operator

Thank you. Our next question comes from the line of John-Marc Bunce from Mirabaud.

John-Marc Bunce – Mirabaud

Hi Chip, Mike. Thanks for taking my call. My main question sort of regards the business model, and you mentioned this transition to turnkey, and I presume some of that is seen by the (indiscernible) increase in the backlog. Just wondering if you’d sort of give us some detail on what proportion of your backlog currently relates to the turnkey projects and how you see that going forward. And then also, how do you see the infrastructure needed to support that developing? You know, are you going to need more working capital, more people, those kind of things?

Michael Bishop

Sure, let me take that, John-Marc – this is Mike Bishop. So when you look at our backlog today, in terms of megawatts, a very large percentage is kits to POSCO, so of the 89 megawatts, there is 84 megawatts that’s kits to POSCO. So as you mentioned, as we bring in turnkey projects, the backlog will go up as a result of that in terms of megawatts; but more importantly in terms of average sale price, the average sale price for our turnkey projects is at least double the price for kits because you also include the balance of plant, ancillary equipment, any value-added services such as micro grid capabilities, that type of thing, and of course that brings with it higher margins. So we certainly see the dollar value of the backlog increasing at a rate much higher than the megawatt value, and the other point I would make there is, as Chip mentioned, we complete these projects pretty rapidly. So while this kit order that we have in backlog was stretched over five years, as we bring in utility-scale projects in the U.S. and Europe, those will be executed quickly and in the course of 12 months, so that’s the other dynamic that’s going on in the backlog.

It results, to follow on to your question related to infrastructure and any changes there, we have the infrastructure in place today to execute on these projects. We have a strong development team, we have the capacity, so no real changes in the business to execute on these projects.

John-Marc Bunce – Mirabaud

Okay, well thanks for already answering my follow-on on the margins. Maybe you could also answer what markets would be most relevant for the turnkey offering – is it primarily the U.S. or are you looking to expand that into Europe?

Chip Bottone

John-Marc, this is Chip. I’ll answer that one. Interestingly enough, in the projects in Asia, they always started out as turnkey projects. In the U.S. in the earlier years, they were not turnkey projects, but as I’ve talked about before publicly, probably the smallest project we do today is about U.S. $5 million or $6 million, and what we’re finding is all these projects are financed. When you start looking at it that way, it really becomes more advantageous to whoever the investor is or the owner, for us to do these on a turnkey basis. So that’s actually what’s happening in the U.S. The last projects, that’s all that we do. The Bridgeport project was the biggest one – 15 megawatts. POSCO did the 59 megawatt one as well.

And we’ve brought that business model to Europe, and the discussions we’re having right now with our customers are to actually deploy that same exact business model where we develop the project, we are doing the engineering of the project, we’ll build the project, we’ll turn it over to whoever the investor might be or owner, and then we’ll operate that plant for multiple years. That is a business model particularly relative to fuel cells that Europe has never seen before until we showed up, but I will tell you the response to that is very, very welcome because it deals with a lot of different things that in the past were obstacles, such as timing of things and who is responsible for what, and such as that. So we’ve taken a lot off the table and really added confidence to people wanting to deploy these plants that we now have.

John-Marc Bunce – Mirabaud

Excellent, okay. Thank you.

Operator

Thank you. Our next question comes from the line of Rob Stone from Cowen & Company.

Rob Stone – Cowen & Co.

Hi guys. A couple of follow-ups, if I may. The first one for Mike is on interest expense, which declined sequentially. You had converts that were redeemed and so forth. How should we think about your run rate of interest expense just in general going forward? In particular, are you going to have to take on some more short-term debt related to some of these projects?

Michael Bishop

Sure, Rob. As far as short-term related to these projects, we don’t really anticipate the need for that. As I mentioned in my remarks, we have built some inventory for this, so that’s kind of how we’re thinking about financing these projects in the short term. We have the liquidity, we’ve built a little bit of inventory, and we expect to turn that. As far as interest expense on the financial statements, yes, as a result of all of the conversions, that will come down significantly here over the next several quarters. I think we’re modeling in the range of $700,000 a quarter.

Rob Stone – Cowen & Co.

Okay. My follow-up question is related to the micro grids that you mentioned. So how much does that add to an average project value, let’s say a 2.8 megawatt project for example, and how prevalent is that in the pipeline that you’re working on?

Chip Bottone

Rob, this is Chip. So from a price perspective, it doesn’t add a great deal to the project. I mean, it depends on how you define micro grid, but generally what people like to see is the function that we’re basically, Rob, on some of these sites, if it’s a university or something, our fuel cells might produce 60%, 70% of their base load power, and what they want to make sure is if they do have a utility trip or something like that, that the fuel cell continues to run and support all the different critical buses and things for security and other reasons, which we are able to do. So a great majority of it is really engineering, just making sure you’ve got the right software or the right programming of other things.

There is some hardware – sometimes we put in some other ancillary equipment, but they see a lot of value in it, frankly, for the incremental cost of a project. So in general when we do micro grids, it enhances the value proposition, and of course in many cases they finance this, or if it’s financed by somebody else, the infrastructure, they don’t put any capital in so they get something basically—they avoid a capital expenditure anyway. So it’s got high value in the base case where you pay for it, and it’s got really high value when you finance the whole thing as a power purchase agreement.

Rob Stone – Cowen & Co.

Great. My final follow-up is you’ve been working on this sort of 300 megawatt-type pipeline for a while, and it sounds like you’ve got a lot of stuff going on with building inventory and accelerating some of the expenses. In general, is the timeline towards closing the near-term portion of this stuff taking longer than you expected, coming in about the same? If it’s changed, what’s behind that change?

Chip Bottone

First of all, we obviously—you know, things come on, things come off of the project, I mean, when you get orders and the pipeline goes down, and new proposals and some things maybe don’t make it all the way through the funnel. But I would say in general, this is a long cycle selling process, right, and sometimes we have situations where, for example, a real life one is this project for United Illuminating. There were people out in the public domain talking about it months before we disclosed it, and the reason for that is we wanted to make sure that all the contracts were signed and all the site work was done, so we were ready to go. So that’s a case of people talking about it before we announced it, but I would say by and large, what we try to do is invest the time up front in the proposal and development process so that the execution period can be done in the shortest possible way. Frankly, the bigger bang for the buck or the higher margin opportunity is after you get the contract and start to execute it, and you don’t want to have surprises, you don’t want to have delays and things like that.

So we are seeing shorter development times, but I would tell you that we’re spending more time and in some cases more money upfront when we know there’s a high probability to close, so that we can avoid things on the back end.

Rob Stone – Cowen & Co.

Is that something where you see another area for improvement? You talked about how shortening the build cycle reduces the cost of construction financing as an example. As you get more project examples that are proved and built, would you expect to be able to kind of smart copy some of these things going forward and have the sales cycle get shorter, and how many flagship examples do you need before that starts to happen?

Chip Bottone

Rob, you’re exactly right. I mean, if you take the Bridgeport project for example, there was a lot of stuff it took to develop that project. We did everything we said, so obviously there’s a bunch of due diligence that went on and things like that in that, and I can tell you that Dominion and others that are now looking at more projects, we avoid a lot of that stuff that we had to do up front. So there’s no question – I think as we do bigger and bigger projects and more and more with repeat customers or repeat financers, that whole front end of due diligence or whatever gets drastically reduced, and that’s our goal. That’s exactly our goal.

Rob Stone – Cowen & Co.

Great. Thanks for taking my questions.

Chip Bottone

Thank you.

Operator

Thank you. That concludes our question and answer session for today. I would like to turn the conference back for any concluding comments.

Chip Bottone

Okay, just a few comments everybody – this is Chip. First of all, thanks for joining the call. We tried to go into a little more detail on the business model and be very transparent on this call today because we do feel very good about the business model that we have developed, and it is in transition, as Mike talked about, where we’re going to have per-megawatt revenues and margins doubling as compared to what we had in the past. So I think it was important that we made sure everybody is aware of the business model we’ve produced and what in fact that business model can deliver.

I would also tell you, just from a pure—it’s nice to be involved with some of the biggest companies in the world talking about projects and how you can solve problems, and that’s what we’re doing. I’m highly confident and our team is highly confident that we’ll be able to continue and in fact accelerate some of these order closures that we have with big name, marquee customers on a global basis. Sometimes these things take a little while to start and get some significant flow, but I want to tell you that I monitor things very carefully. We have great people working with customers. I get the feedback that our people show up, they’re prepared, they know what they’re doing. It certainly makes my life and Mike’s life a lot easier.

But we’re making real progress and we’re going to turn it into real money here in the near term, so thank you very much again for being on the call and we look forward to talking to you next quarter. Have a great day.

Operator

Thank you. Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program, and you may now disconnect. Everyone have a good day.

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