FuelCell Inc. Q3 2008 Earnings Call Transcript

| About: FuelCell Energy, (FCEL)

FuelCell Inc. (NASDAQ:FCEL)

Q3 2008 Earnings Call

August 28, 2008 10:00 am ET

Executives

R. Daniel Brdar - Chairman and Chief Executive Officer

Joseph Mahler - Senior Vice President and Chief Financial Officer

Lisa Lettieri - Investor Relations

Analysts

Chip Moore - Canaccord Adams

Chris Simmons - Simmons and Company

Sanjay Shrestha - Lazard Capital

David Wilson - Neuberger BermanMarkets

Walter Nasdeo - Ardour Capital

[Lord Tom] - Oppenheimer

Operator

Good day everyone and welcome to the FuelCell Energy Third Quarter 2008 Earnings Results Conference Call. Today’s conference is being recorded. At this time I would like to turn the conference over to Ms. Lisa Lettieri of Investor Relations. Ms. Lettieri, please go ahead now.

Lisa Lettieri - Investor Relations

Thank you, operator. Good morning everyone and welcome to FuelCell Energy’s third quarter results conference call. Delivering remarks today will be R. Daniel Brdar, Chairman and CEO and Joseph 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 the calls conclusion. Before proceeding with the call, I would like to remind everyone that this call is being recorded and that this presentation contains forward-looking statements including the company’s plans and expectations for the continuing development and commercialization of its Fuel Cell Technology. Listeners are directed to read the company’s cautionary statement on forward-looking information and other risk factors in it’s filings with the US Securities and Exchange Commission.

I will now turn the call over to Dan Brdar. Dan?

R. Daniel Brdar - Chairman and Chief Executive Officer

Thank you, Lisa. Good morning everyone and I appreciate you joining us for our third quarter conference call. Today I will begin with the brief overview of the quarter before having our Chief Financial Officer, Joseph Mahler go through our financial performance.

Built on our strong first half of the year our continuing cost reductions, record revenue, backlog and order pipeline and production ramp up were well positioned to close out fiscal 2008 in record fashion. We are on schedule to deliver another 20% cost reduction on megawatt class products to improve production in the second half of next year. With strong traction we achieved over the last year among customers seeking efficient ultra-clean power generation coupled with our investment and ramping up production to fulfill current backlog led to a current run rate of 30 megawatts per year compared to a 11 megawatts last year.

As a result of this year’s cost reduction efforts we expect to see positive gross margins on multi megawatt power plant and fill some modules which would be the majority of our production in the latter half of 2009. The market is definitely moving fuel cell but they all needs clean, efficient and reliable power plant that can offer economical power using the fuels available today like biogas and natural gas. Our fuel cell details that and our target markets are increasingly adopting that products.

However in a few minutes I will turn the call over to Joe Mahler to look at the quarter’s numbers. Joe?

Joseph Mahler - Senior Vice President and Chief Financial Officer

Thank you Dan and good morning. We are reporting strong product sales and revenues as well as backlog while continuing to execute on our cost out program. Total revenue for the third quarter of fiscal 2008 were $27.9 million compared to the $13.5 million reported in the third quarter of 2007. Product sales and revenues tripled to $23.2 million from $7.8 million in the same period a year ago. The certain development contract revenue was $4.7 million compared to $5.7 million. We are now producing product at a 30 megawatt run rate. The net loss to common shareholders for the third quarter was $26.8 million or $0.39 per basic and diluted share compared to a net loss to common shareholders of $16.2 million or 20% per basic and diluted share in the same quarter of last year. Higher cost volumes of product sales and revenues resulted increased operating losses albeit at a lower rate than in the prior year period as margins continued to accrue.

The product cost ratio for the quarter was 1.681 as compared to 1.91 in the year ago period, improved product margins over the prior year can be attributed to result from ongoing cost out program and increased production volumes on megawatt power plants. Product cost reduction is on target with a focus primarily on megawatt and multi megawatt products. The cost to revenue ratio was impacted by manufacturing defect related to a bad part that affected stat production, the impact of this was $2 million charge during the third quarter.

The year-to-date cost ratio is 1.65 compared to 2.07 a year ago demonstrating the results of our continuing cost reduction. We are confident we will continue to hit our product cost targets. Product revenue backlog including long term service agreement was a $100.7 million slightly more than double to prior year third quarter. In terms of megawatt it’s 34.6 megawatts versus 13.4 megawatts in last year’s third quarter, last quarter we’ve reported a megawatt backlog of 43.5. As you know, the passing of the investment tax credit by Congress has been delayed, Dan will discuss the status of this in more detail in his comments. From a number of standpoint delay has impacted our backlog, specifically one of our customers requested a change order that has pushed it’s deliveries beyond 2008, which is the end date of the existing credit.

Accordingly, in our backlog we have reduced it by 3.9 megawatt value at 11.8 million of product sales and 5.3 million of service contracts. Once ITC passes we will return these to the backlog.

Total cash and investments were 104.4 million as of July 31, third quarter net cash is 17.4 million which is inline with our expectations, capital spending totaled approximately 2.6 million and depreciation expense for the quarter ended July 31 was approximately 2.2 million, when you look at the year-over-year comparison we have made significant progress increasing production, reducing product costs and expanding our market. Dan?

R. Daniel Brdar - Chairman and Chief Executive Officer

Thanks Joe. In managing the company, we watch for market trends and customer requirements that have the ability to shape or drive our business some of these can be internal such as the focus we have applied to our cost out program or they can be external factors like the proliferation of renewable portfolio of standards. Increasingly leasing these external drivers fundamentally improved our long term ability to sell in the key markets, these factors include the broad recognition of the need for energy configuration and efficiency due to concerns about carbon emission and the long term high cost of fuel, the widening demand to develop to renewable fuels and the cost to build adoption of renewable alternative energy products to address our current energy problems.

The growing worldwide market demand for high efficiency ultra clean power generation is reflected in our backlog, which doubled to 100.7 million from 49.6 million last year. Importantly, over 90% of that backlog is now megawatt cost power plants and modules. And in response to that demand, we successfully increased production to 30 megawatt annually from just 11 megawatts last year. We’ve also updated our own capacity expansion and alternate plans to be able to respond to the growing orders pipeline. The first major step of our expansion to 60 megawatt of capacity is in progress, later this quarter we take delivery of an additional equipment that doubled our capability to condition megawatt flat fuel module and increases our total conditioning capacity to 60 megawatts.

In terms of internal drivers, our cost out program is on track to deliver another 20% reduction in our megawatt class products from several initiatives. One of the increase in the power output for megawatt power plants, there are improvements to the balance of the plant design to use fewer products and less material and have reduction in cell package material cost and higher labor productivity and yields to more efficient manufacturing and finally, the introduction of the lower cost fuel cell module.

This is our important advances incorporating technology innovations, manufacturing improvements and initial results of our global sourcing program. This progress year after year has been critical to driving down our product costs to the gross margin positive and now it’s within sight. Because now the cost reduced design to be released later this year, beginning the middle of next year to new cost reduced 2.8 megawatt DFC 3000 and updated megawatt price modules will be in production followed shortly that accurate by the new 1.4 megawatt DFC 1500.

The bottom line you could continue to excess in cost reduction combined with increase in backlog of megawatt and multi megawatt power plants and fuel power modules drive us to profitability, with today’s high cost fuels and a need the reduce carbon emissions high electrical efficiency is an increasing and important driver for sales. We have responded to these market conditions with the introduction of our gas pipeline product, the DFC ERG and DFC turbine both of which have system electro efficiencies of approximately 60% the highest efficiency of any product in this size. Our first DFC ERG is installed in Toronto and a natural gas let down station at (inaudible) headquarters. We are excited about the large potential market for high efficiency DFC ERG almost any medium to large natural gas let down station located at city base with a potential installation for the product. A 9 megawatt DFC ERG was approved for the Milford Connecticut natural gas let down station as part of project 150, which will be the largest fuel cell installation anywhere in the world when its completed.

Three additional DFC ERG projects with gas utilities in the third round of Connecticut project 150. Our program with the US Department of Energy to develop our FuelCell turbine system exceeded all of its milestones in a 300 kilowatt configuration and demonstrated electrical efficiency at 58%. As a result of the successful development and demonstration we began marketing of multi megawatt version of the product and proposed a multi megawatt DFC turbine for round three at Connecticut project 150. This system’s electrical efficiency of close to 60% gives it broad applications for large industrial and utility scale customers. Both products have the advantage of being based on our common DFC platform utilizing all the cost reductions and performance enhancements going into our existing products.

Turning to our target market, South Korea is currently our largest market. POSCO Power is awarded over 38 megawatts of FuelCell and modules since we signed our alliance in February 2007. By the way of background in 2006, the Korean government created a renewable energy program that provides the power first be export to be grid favoring the installation of large power generation systems. The intent of the program is to provide clean, reliable and more economical electricity. Just a couple of weeks ago South Korea’s President publicly emphasized his commitment to increase the country’s energy independence by employing more low carbon green technologies like FuelCell. That means they will need much higher power generation efficiency and attribute our FuelCell’s offering. Because of this high efficiency and our product’s ultra low emission our DFC fuel cells put out more power to each unit of fuel with almost no emissions and much lower carbon-dioxide than other base low generation technologies.

In a couple of weeks, PASCO power’s fuel stock balance of plant manufacturing facility and Pohang City is schedule to open with a capacity of 50 megawatts per year growing to 100 megawatts per year by 2010. FuelCell energy will initially deliver complete power plants to PASCO, the main transition fuel supplying fuel for modules in the latter half of 2009. Our relationship with PASCO power is off to a very strong start and the opening of their facility, positions us to continue to grow the market opportunity in Korea and elsewhere in Asia.

In the US market, alternative energy companies are somewhat hampered by the uncertainty surrounding the timing of the extension for the federal investment tax credit. The senate in-house in capacity long versions of the bill which are remarkably similar giving us a 6 to 8 new extension with a 30% or $3,000 per kilowatt credit. Unfortunately the bills have not gotten to the floor provoke despite several attempts. In contempt it seems to be over the past. So, we remain very optimistic.

In the mean time we keep lining up opportunities that we can execute quickly after the ITC extension is complete. In Connecticut as many of you know, 16.2 megawatts of projects that included our multi megawatt fuel cells were awarded by the department of public utility control in round two of project 150. These projects satisfy the need for reliable, ultra clean cover that operates 24/7 and can be easily found in good constraint areas. We are currently negotiating the final contracts with the project developers and expect to be ready to move forward through and after the ITC passes.

The next round in Connecticut project 150 is also underway. Proposals were submitted for next 25 megawatts of clean energy projects for the state and are currently under review by the clean energy front. Several project developers submitted proposals based on our products including our newest highest efficiency multi megawatt products. Three with DFC ERG systems and line it with a DFCT coder. We expect these projects to be very competitive in both the resounding costs of electricity and in green credentials. With electrical efficiencies of approximately 60% and no combustion they provide economic electricity and near zero emissions. The clean energy fund productions and DPUC hearings will be in the fall and we’ll keep you updated on the progress as the process progresses.

In California, commercial industrial customers that would use natural gas were impacted by two recent market conditions. The first is the uncertainty of the timing of the extension with the federal investment tax credit. The second factor, which impacted all gas based distributor generation were short term volatility and natural gas pricing. This California market developed and inverted spark spread when natural gas prices rose and that was not a corresponding increase in the price of the utility supply generation. These market conditions ultimately correct themselves either as a result of the utility rate increases or lower gas prices. Since the third quarter, gas prices would come back down to $8 and change and we are seeing significant re-engagement in the commercial industrial sector.

Waste water treatment facilities continued to be an important vertical market segment for us because they recognize the need to move to low emissions and greater electrical efficiency, the need to use what resource they have for maximum affect. Our fuel cells run all the time providing base low power efficiently and cleanly making the 24/7 waste water treatment facilities a perfect application for us. In addition, these facilities are often owned by municipalities. So, we are not dependant on the investment tax rate. Potential customers now have numerous waste water treatment facilities to visiting California at San Flactulally in Southern California and (inaudible) San Francisco Bay area and at least a half a dozen other sites where they can talk with California customers who are enthusiastic about our ultra clean, quiet, reliable power plants.

Most recently in Riverside California a one megawatt DFC 1,500 power plant just came on mind with the City’s waste water treatment facility. Another 1.2 megawatt FuelCell is in route to the Turlock Irrigation District from California which is expected to reduce the area’s carbon footprint and more than 5,200 tons annually through the use of our fuel cell. About half of our California installations are now running on biogas. And we expect that trend to continue simply because our fuel cells are so efficient and ultra clean solution for waste water treatment facilities.

The other exciting market dynamic is California’s increase in the self generation incentive program last April. The project size limit was increased from 1 megawatt to 3 megawatts and the available incentive farms doubled to 179 million creating a terrific opportunity to provide our multi-megawatt power plants operating on biogas. While this new larger incentive is in place, we expect to see continuing move to larger megawatt and multi-megawatt fuel cell installation.

While decision making in municipalities can at times be painfully slow compared to industrial customers will be coming at preferred solution for waste water treatment facilities in California as a result of our numerous successful installation.

Before I wrap up my prepared comments; let me spend just a few moments updating you on our R&D activities.

During the third quarter, we received a $1.5 million federal award to continue developing in electrochemical hydrogen separation system. When combined with one of our direct FuelCell power plants, this system generates both electricity and through the hydrogen. This solution is ideal for industrial settings that require hydrogen in their operation and may also serve a recurring station for our new generation of trucks and cars that rely on hydrogen for fuel.

As you can see we’re executing on a solid backlog, ramping the business, driving down product cost and introducing even higher efficiency products, while we actively pursue orders from utilities in Connecticut and South Korea, waste water treatment customers in California and commercial and industrial customers in California in the North East in our target markets for our megawatt class products.

Operator, at this point I’d like to open up the call to questions from our participants.

Questions-and-Answers-Session

Operator

Thank you, sir. (Operator Instructions). And for our first question, we go to John Quealy with Canaccord Adams.

Chip Moore

Thanks, sir. This is Chip Moore for John. I’d like to start with the $2 million charge really to the manufacturing defect. Is that all in-house or does that affect any units in the field?

R. Daniel Brdar

No, it’s all in-house, it believes from our long-time supplier where we had a part that sounded flay into production. We actually found the bad parts before units were shipped because we actually take the FuelCell through a testing conditioning process but there were couple of stacks that were impacted as a result but nothing actually found its way outside of the plant. So, our quality control systems actually caught the air of our supplier.

Chip Moore

Okay, good. And looking at Connecticut the 16.2 megawatt just to clarify is that completely dependent on the investment tax credits getting extended this year?

R. Daniel Brdar

The way the projects were proposed they were based on the assumption that the tax credit is there. If for some reason it looks like there’s kind of a protracted delay I suspect that we will get back together with the project participants and see how we want to restructure the projects. But, the feedback that we are getting from both the project here in Connecticut and customers that we are working with in California is everybody is confidence seems to be very high that the investment tax credit will pass which is the question of timing. So, no one (inaudible) and engaging in kind of the restructuring discussion because people are pretty confident that they are going forward as proposed.

Chip Moore

Okay. And I guess last one from me given the news that South Korea is increasing its renewable targets as well as increases in California incentive programs. What if any increase are you seeing in RFP activity?

R. Daniel Brdar

Well actually I have been requested to come over there next week because they’ve got couple of things going on. One is the large dedication ceremony to dedicate the facility where they are going to have a lot of high level executives from the government side and we are going to get our first preview on what we think the expansion with fuel cell program looks like because our partners are pretty excited that they are going to have some success taking the current program and significantly opening up the opportunity for us. So, I expect next week to be pretty exciting in terms of kind of news that we are going to hear based on the feedback we are getting so far from our partner.

Chip Moore

In Korea, and what about California?

R. Daniel Brdar

In California the program has already been expanded there for the self generation incentive program. So, really its just getting the way sort to treatment facilities there municipally owned through their city council processes and start to close some of the orders. We already seen a shift in the kind of projects that we are doing there away from the small 600 kilowatt now onto the megawatt and even some multi-megawatt opportunities. So, they are just keeping moving them along cause they rolled out dependent on the tax credit. The program in California is already there, it’s robust, it’s just working through the municipal approval processes.

Chip Moore

All right, thanks.

R. Daniel Brdar

Welcome.

Operator

For our next question we go to Chris Simmons with Simmons and Company.

Chris Simmons

Good morning.

R. Daniel Brdar

Good morning, Chris.

Chris Simmons

Yeah. Just curious if you can give some guidance for the next quarter on the ratio product cost or revenue, should we see it step down a little bit more?

Joseph Mahler

Yeah Chris, this is Joe Mahler. Yeah, I think we are not expecting to have our manufacturing defect come through again. So, that gets you back closer to the 1.5 level. We think we still have product mix, we still have to some old megawatt units cost coming through. So, we think we are going to be in that -- in about that 1.5 range I think in that -- to the next quarter.

Chris Simmons

And then for next year obviously you stated that in the latter half, calendar year 2009 that gross margin passed it on those multi-megawatt systems. So, when we start thinking quarters for ’09 for the fiscal year for the fuel cell, would we expect it to be a gradual improvement throughout the year or more of a step change towards the end of Q4?

Joseph Mahler

Well, I think where you are going to see is -- having over 30 megawatts in backlog where all the older design its kind of take us to a couple of quarters to produce the rest of that. And then when we actually start putting the units in production that have the next round of cost reduction, you will probably see the quarter where you got a blend and then you will see the next quarter out probably the fourth quarter you start to see significant change in it.

Chris Simmons

And then Joe on capital, looking at the balance sheet right now on the cash and then the cash burn, what are your thoughts on capital is?

Joseph Mahler

Yeah, obviously we keep it right now -- we can’t direct this every quarter. Here’s we look at that number and as we look forward we are -- we want to launch capacity expansion of this business. We expect that the order flow will drive that process and I think that’s when we really look at that issue. We see a lot of good news coming in this business and we see significant opportunity. We think the market is really resonating on efficiency at this point. I think we are getting through first wave of the alternative energy, wind and solar. People are implementing it. They are finding it intermittent and now we are getting a lot of feedback from especially Korea and California about efficiency and we see our product fitting very nicely in that. So, that’s the dynamics we are looking at in terms of capital rate.

Chris Simmons

And then finally, Dan if you could provide an update what’s going on in Europe, is there any new developments where we could see that market turn on?

R. Daniel Brdar

Yeah, it looks these are familiar, we have a licensing arrangement with CFT solutions is used to be part of MTU but a long-term agreement that’s been around for probably 15 years. That license agreement actually ends at the end of next year. So, we are having discussions with CFT solutions in terms of how do we accelerate the progress in that market because Europe is a market that should be producing significantly more orders than it does. But if you are able to find a way to work with them to accelerate that market great, but if not, this would become the non-exclusive market at the end of next year. So, we could also partner with others. And if you look at the companies that we are working with now, folks like (inaudible) industrial gas company in the world, (inaudible) Germany we have several partners than actually have a significant European presence but I think we might have an opportunity to participate in that market. So, we see how our discussions go with our partner but if my view is generally been that if you have competition in the market place you can stimulate the market little faster.

Chris Simmons

All right, thank you.

Operator

We go next with Sanjay Shrestha with Lazard Capital Markets.

Sanjay Shrestha

Hi, guys. It’s actually Gramin for Sanjay. How are you?

R. Daniel Brdar

Good morning.

Sanjay Shrestha

A simple question on SG&A in the quarter, tend to come down pretty significantly in some prior quarters. Is there anything one time in that or is that just slower sales being recognized?

R. Daniel Brdar

No, its really more go back to last quarter was a little higher. In the second quarter you had your -- lot of shareholder costs come through. You got your annual meeting (inaudible) thus we had some incremental sales and marketing activity in that quarter changing some contracts and working on the finishing of the project 150 in Connecticut activity and I think you are back down to a more standard level.

Sanjay Shrestha

All right, it’s a pretty good run rate for the coming quarters.

R. Daniel Brdar

Yeah and its probably I mean the other factor that comes to is stock, even non-cash item comes through stock compensation. It could be slightly higher going out but it’s in the right range now.

Sanjay Shrestha

All right, perfect great. And then also looking at the R&D backlog I know you mentioned in some federal contract. What’s your outlook for potential or there additional larger activity in that R&D market?

R. Daniel Brdar

One of the biggest changes that’s been happening over the last year is the backlog that we’ve been coming down on is the (inaudible) program from US Department of Energy. We are coming to the end of the first phase of that contract. We are in the process of proposing for the next round. So, we expect to be pretty successful, their base number we are hearing on, our performance in round one. So, going in the Phase II will be $20 million to $30 million new award depending on way the contract finally ends up. So, we could have a pretty significant increase here in the coming months in terms of the funded backlog as part of government R&D side. So, with some pretty interesting opportunities out there in front us and two other reflection of some of the current programs to reaching the logical conclusion before the next round starts.

Sanjay Shrestha

Great. So, that would be in the coming next quarter to or just I’m trying to get an idea there, timing when you think it might here something on that?

R. Daniel Brdar

That would be sometime in the next quarter.

Sanjay Shrestha

Got you. And, then one final question I could, just following on Peterson’s question looking beyond, are you seeing any other markets that are good potential for you particularly other Asian market outside of Korea?

R. Daniel Brdar

Well, actually there are couple of things that are going on, we are seeing activity again now in Japan because finally the ability to artificially hold electricity rates its kind of run out in there. So, Japanese partnerships in backlog and that’s a couple of pretty large projects they are doing, we have been approached by people who want to find away to bring our product to other market like, India and Australia. So, when the process is evaluating, which of those make them more centralized where we can be competitor, we’ve already paid actually be able to support them from service standpoint. So, as the result of our cost coming down and just energy prices going up around the world, we started to see other market that’s actually coming to ask, to look at how they can bring the product in country to help adjust some of those issues.

Sanjay Shrestha

Okay, great thanks very much.

R. Daniel Brdar

Welcome.

Operator

(Operator Instructions). We will go next to David Wilson with Neuberger Berman.

David Wilson

Actually my questions has been answered, thank you.

Operator

And with a follow up question, we return to Chris Simmons with Simmons & Company.

Chris Simmons

Yes. The first question, are you seeing any new competitors emerging in the markets that you are targeting?

R. Daniel Brdar

Well, what’s interesting is, we have seen united technology actually reengaged in the market but the success that we have been having capturing orders and we got more in backlog right now, when I think they have produce problem last ten years. So, I think when we come to the real market we are seeing them actually look at how they can take FuelCell technology in trying to position it into the market place. So, actually running into they from time-time-time in the market which is good having other players out there help simulate the market, in many other companies they are spending a lot money I am FuelCell technology like seems and another are still several years away from product, they are still doing with quarter technology issues but its pretty clear that we are going to see a lot of players out there in the coming years when they finish their technology development stage and so long product are.

Chris Simmons

And, then have you had any discussions with any say, solar integrators or companies like that, that are selling solar farms that might be looking space load, clean and noble power generation technology (inaudible) up there?

R. Daniel Brdar

Yeah, we are seeing that specially, now that we have installations like (inaudible) were it’s actually demonstration of. So, (inaudible) fuel cell based load and with only done the short put there new factory, where they could follow on roof and [chuffers] into base load, we having a couple place like that particularly from high profile customers in operational, people really certain understand. So on FuelCell, we working very well together in terms of what the product attributes are and a kind of loan profile that served. So, those who really certain simulate people looking at more comprehensive solutions.

Chris Simmons

Great. And then one final question, they have seen a little after all but we got a number of domestic natural gas companies, that have great deal of success and in shale place and natural gas production is growing quite rapidly in the US, and these companies are now actively seeking ways to utilize natural gas, an obviously the (inaudible) plan we see the as on television about utilizing more natural gas, have you had any discussion or given any thought to try tap under this potential incremental supply on the natural gas side?

R. Daniel Brdar

Absolutely, there is really two place here. First, is to distribute that gas once they produces place right to the direct fuel cell energy recovery generator product that we are now starting to roll out, that we been installed and attract because all those are going be high pressure gas distribution system there ultimately creating an opportunity to put up Fuel Cell in to be with their operating issues to, when they go to the pressure let out station and the other is just, at the gas companies in general are always looking for way they can get into the electricity side of the business because it enables and pick there product and basically generate by -- higher source of revenue by making electricity. So, we are seeing the gas company, the one has actually start to have a bigger role particularly from the independent, one understand more about the product and they are coming to land what we are doing, what are operating experience is there, and look likes products we have offer. So, all this focus on the gas industry is actually really got most people and that’s space looking for some solution that will help address some of the concerns people have about important oil and also the environment. And, our products really fit very nicely into that.

Chris Simmons

Great, thank you very much.

R. Daniel Brdar

Thank you.

Operator

We will go next to Walter Nasdeo with Ardour Capital.

Walter Nasdeo

Thank you, good morning.

R. Daniel Brdar

Good morning, Walter.

Walter Nasdeo

Most of my questions have already been answered, one thing that I was curious about since obviously moving to the megawatt and multi-megawatt, product line. What’s the –do you felt of the sub megawatt unit going forward, I know you clearing some out of the existing, what does is that looking like going forward and how challenging is that if they are significant already in some that area? How challenging is it to get the gross margins, where they need to be from back has you blend them together?

R. Daniel Brdar

No, if we drive volume by doing megawatt or multi-megawatt, that benefits to the cost basis of the sub megawatt unit. The sub megawatt unit really has two challenges with it. One is, this transaction productivity it doesn’t take longer to sell one or two megawatt unit and does a 300 kilowatt unit. So, we really want to look for ways to do aggregation schemes, where you can take one customer discuss multiple sides, where we can provide 300 kilowatt unit and the other is just the unit cost basis but all those things that we are doing on reducing the cost of the core fuel cell stack, which also module and the volume that comes at the multi-megawatt, all that do help that sub megawatt cost structure. From the business standpoint, what we are basically doing as we’re limiting the number of those, that we put in our production plan, just because most of the opportunity that we see coming our way are megawatt based.

Walter Nasdeo

Got you, okay. And, far as capacity goes, you ramped it up to 30 on the run rate of 30, what your expectation on getting at the 50?

R. Daniel Brdar

Its really the function of what we see for order flow here in the near term, if you look at if you took just the BSE project that we actually took out of backlog and the current rounding Connecticut that alone is 20 megawatts, once it passes on the grabbed up those contracts did always suddenly better put in the backlog people don’t want, 18 month till every times. So that forces us to ramp and we are expecting to see our Health Care partner. PASCO power partners coming back for what their needs are for 2010. So, under our current planning we are going to be ramping again when we get into the beginning of 2009 and that order flow will drive how high we ramp.

Walter Nasdeo

Okay and in which (inaudible) PASCO’s assembly facility is online what is that deal for filing up capacity on year end it’s the whole consider into calculation that you got in, you can actually these capacity assemble it up?

R. Daniel Brdar

No, it is actually what (inaudible) which we outsourced now and I think we buy the products and then we have package of assemble for us. So, we wanted to make sure that where business ramps and as they have their own facilities that we will be getting the benefit of that volume. So, when we are buying that completed fuel cell module which is from our factory which is what we always been making and there will be a shift to making the outsource balance of plant design.

Walter Nasdeo

Thank you so much guys.

R. Daniel Brdar

You are welcome.

Operator

And we go next to [Lord Tom] with Oppenheimer.

Lord Tom

Good morning

R. Daniel Brdar

Good morning.

Lord Tom

Two questions, lets think the government (inaudible) you would expect that fuel cells would be bounding over the Pennsylvania, you guys have any sales prospects in Pennsylvania or other states that have renewable energy initiatives?

R. Daniel Brdar

We haven’t focused having it on Pennsylvania yet simple because we see markets where the current pricing provides a little bit better opportunities, prices like New York state, I will state purely in the North East with Pennsylvania because of their proximity to very cheap dirty coal plants in Mid West and that a lot of old coal plants within the state would be overall cost of electricity is still relatively lower compared to the other northeastern markets but in DCU the state developing their own plans on how they are going to facility, they need the portfolio kind of mandates and is starting to see the price increases. So, it’s a market because of its signs and because it’s moving towards solutions but I would expect (inaudible) after as well and probably some time within the coming year.

Lord Tom

Lastly there was article line deteriorating nature of national grid in the times the other day and it would have seem to me unless I have it wrong this was really a add for distributor generation and yet there is no mention of distributor generation in the article. Is there anything am I thinking wrong about this?

R. Daniel Brdar

No, you are right on target in fact, if you really look at who drives the lot of policy, we spend the lot of time talking with the regulators in California and elsewhere. California actually is starting to move towards distributor generating solutions by mandate because they understand the challenges of building new transmission. Now, here at Connecticut we are in the process of having a 20 mile transmission line its costing $1.2 billion and it’s a [nearest] to get it through over the public approval process, you start looking at more urban areas and even if you wanted to closing transmission its such a lengthy and cost prohibitive activity that the regulators were starting to mandate some of these distributed solutions. Let’s start with California and there is actually programs that are already in discussion out there and we will see that trend to come in.

Lord Tom

Thank you

R. Daniel Brdar

You are welcome.

Operator

We will go next to David Wilson with Neuberger Berman.

David Wilson

Hi, could help us understand the effect issue to a greater extent was this an item of manufacturing, or is it component that runs into the fuel cell itself and do you avoid that happening again and is there any potential for recovery either from the supplier that its truly defective component I am not sure I understand it well that’s one of the clarification and/or insurance?

R. Daniel Brdar

The part that we are talking about is from a long time supplier where they basically make a particular component for us so we expect (inaudible) and what they were producing actually got out of spec and since we have pretty tolerance whole lot of components when you get at components that’s not a spec like that if it flips through their testing we don’t expect every part to come down because its not a practical way to be with quality issues. And in two production it actually got into complete stacks. Now fortunately when we go to actually condition the stack and put it on power test we can see that there is actually a problem there so we don’t have actually something that escapes but there are some parts (inaudible) buy pretty much of a finished piece material that we don’t see the impact of them until they are actually into a completed unit. Now we have gone back to the supplier to make sure that we understand why did that happen in both in terms of how their process went out of spec and then how the part actually got outside of dislodged control procedures themselves and we put corrected actions in place both on our end and their end to ensure that doesn’t happen again. But it is one of those things where because we had worked with the supplier for such a long time and had bought so many of these products with them and sell them over the years. One that I think people just got a little bit lazy on the process side and a lot of things to escape. While billing to recovery from insurance standpoint I think its limited because the impact of that its one of the things we wanted to explain and put into production, the value impact is beyond the magnitude of what the supplier did. So, its one of those things we have it view it from a scrap standpoint and hopefully that’s the robust processes where you can limit to a sort of things from happening.

David Wilson

And is the nature of this component is such that you will continue to deal with the supplier, do you have the second source in the supplier?

R. Daniel Brdar

One of things that we are doing is now as volume to getting the second source on the supplier so we actually can make sure that not only getting the parts that we need by changing some of the processes that we use for controlling quality but we are not stuck with somebody that might be on underlying supplier in higher volumes.

David Wilson

Can I ask one more not relating to the defect but to the hydrogen side, this has been talked about in your 10-Qs for a while and you chose to make it part of your release, is there a reason and its coming to the slower ground now?

R. Daniel Brdar

Because we have received it during the contract for further development of that activity so just a factor that’s its – relative significant R&D work on the successful quality and with the reasonable inputs.

David Wilson

Thank you.

R. Daniel Brdar

You are welcome.

Operator

And with that, ladies and gentlemen, we have no further questions on our roster. Therefore, Mr. Brdar I will turn the conference back over to you for any closing remarks.

R. Daniel Brdar

I want to thank everyone for joining us on today’s conference call and we look forward to speaking with you again in our next quarter. Thank you everyone.

Operator

And again, ladies and gentlemen this does conclude the FuelCell Energy third quarter 2008 earnings results conference call. We do appreciate your participation and you may disconnect at this time.

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