Good afternoon, and welcome to the Bloom Energy Third Quarter 2018 Earnings 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. As a reminder, this conference call is being recorded. I would now like to turn the conference over to Mark Messler, Vice President of Finance and Investor Relations at Bloom Energy.
Please go ahead.
Thank you very much. Good morning all and thank you for joining us on Bloom Energy's Q3 2018 earnings conference call, our first as a publicly traded company.
To supplement this conference call,
we have posted to our Investor Relations website our Q3 2018 shareholder letter as well as some supplemental financial information that we will periodically reference throughout this call. Please note that this call contains forward looking information regarding future events and the future financial performance of the company. We caution you that such statements are predictions based on management's current expectations or beliefs. Actual results may differ materially as a result of risks and uncertainties that pertain to our business. We refer you to the company's SEC filings, including the company's quarterly report on Form 10 Q for the fiscal quarter ended June 30, 2018.
These documents discuss important factors that could cause actual results to materially differ from those contained in the company's projections or forward looking statements. We assume no obligation to revise any forward looking statements made on today's call. During this call and in our Q3 2018 shareholder letter, we refer to GAAP and non GAAP financial measures. These non GAAP financial measures are not prepared in accordance with generally accepted accounting principles. A reconciliation between GAAP and non GAAP is included as part of our Q3 2018 Shareholder Letter.
Joining me on the call today are KR Sridhar, Principal Co Founder and Chief Executive Officer and Randy Ferg, Chief Financial Officer. KR and Randy will review the operating and financial highlights of the quarter, And then we will take questions. I will now turn the call over to KR.
Hello. This is KR, and good afternoon to all of you. Welcome to our Q3 earnings call, our first as a public company. In fact, it was during Q3, July 25, that we completed our successful initial public offering of the New York Stock Exchange. I'm gratified by the response we have seen from the investment community because it tells me there is clear understanding for the need for Always on clean power in our digital world and how Bloom Energy plays a unique role in providing a viable solution.
So how does this energy landscape look like? We live in a digital economy and electricity is the lifeblood. We see that the centralized electric power grid that we have relied upon for over 100 years is not keeping up with the new demands And we see disruptive threats mounting. Power service outages pose significant risk to the global economy and to our society. Simply put, we need reliable and resilient always on electricity.
This need is driving the transformation of the $2,400,000,000,000 global market for electricity. And we at Bloom Energy offer a capability no other company or technology can provide. Today, we live in a post climate change world. While it remains imperative to combat the causes of climate change, We also have to become resilient enough to address the disruptive impacts that are already occurring. We are all too familiar With the tragedies of major hurricanes that are occurring more frequently and with Greater severity than ever before.
100 year weather events seem to occur annually these days. Such events Expose the vulnerability of the centralized grid as power lines come down and major power outages compound misery, Certain health, disrupt society and impact our economy. We are also gaining an understanding of the risks of cyber attack on our critical infrastructure. Our national intelligence community is fully united in calling attention To the vulnerability of our electric power grid as one of the most important security challenges, The consensus is not if, but when an attack occurs. We do see positive signs that government And private sector are beginning to take this risk seriously and are working to secure the grid to the extent possible as well as SEEK microgrid solutions for certain applications.
We have the challenge of emissions, Not only reducing CO2, the need for which is well documented, but also the need to reduce criteria pollutants that threaten the health of local population. Finally, we have the global challenge of expanding access To the 1,000,000,000 people who are not reached by the central grid model today and another 1,000,000,000 plus that are underserved by the legacy model. A new solution is required to meet these challenges And this is why the Bloom platform of distributed baseload electricity generation is so important. Our mission is to make clean, reliable energy affordable for everyone in the world. To enable this mission, we have developed a unique advanced technology platform that delivers secure, reliable and resilient Always on power with very low emissions on-site.
Our solution is Behind the customer meter, we generate power on-site where the power is consumed. This avoids the inherent risks of the exposed transmission and distribution network of the centralized grid. We deliver a complete solution to the customer with a total delivered cost of electricity that is less expensive And the grid where we deploy today. We address the biggest challenges of our era, The need for power that won't be interrupted by disruptive events. The 1.25 Megawatt Microgrid solution supporting a 3,500,000 Square Feet Osaka Fish Market In Japan, it simplifies the resiliency of our solution.
The market's microgrid Deployed in 2015, not only rode unscathed through Typhoon Jebi, the worst in 25 years, But also protected the market from super typhoon land in 2017. And in June 2018, Wasaka earthquake, which was greater than a 6.0 and had its epicenter just 1 kilometer away. In North Carolina, a Bloom Energy Power Data Center also continued normal operations Through both hurricanes Florence and Michael, power that has a very low to 0 net impact on CO2 emissions. The U. S.
Has reduced energy related carbon emissions by 14% since 2005. According to the Energy Information Administration, 61% of this decline can be attributed to the shift from fossil fuels to natural gas. Bloom Energy servers convert natural gas to electricity With the highest electrical efficiency of any commercial device, further reducing CO2 emissions. Today, our platform produces 60% less CO2 emissions than the average of the U. S.
Grid. At the same time, we are simultaneously pursuing multiple paths To 0 carbon solutions, one such path lies in using biogas as a fuel for our energy servers. Today, just under 10% of our deployed fleet of energy servers by megawatts deployed utilize directed biogas. We see a very significant opportunity to directly use biogas from landfills, wastewater treatment plants and Agriculture to Power Our Systems. For example, California generates 80,000,000 MMBtu of economically viable biogas from human activity per year.
This amount of biogas We generated approximately 1.26 gigawatts of electricity using our Bloom servers, Sufficient to power about 1,000,000 American Homes, we previewed a highly efficient solution for generating clean electricity from Biogas at the Global Climate Action Summit in San Francisco last September. The elimination of criteria pollutants is another important factor. Because we don't burn fuel to generate electricity, we do not produce criteria pollutants. The reason you can't breathe in cities like Beijing and Delhi is not because of CO2, But because of smog emissions and we do not produce those emissions, improving respiratory health. In addition, Our systems consume no water during normal operation.
Another criteria is expanding access to unserved populations. We are already working on solutions that will enable us to address rural populations without access to the grid. We can solve 2 problems at once by using bio waste as fuel. This is feasible in part by the on-site nature of our solution. There is no complicated or expensive process required to aggregate waste and transport it over long distances.
Instead, Biowaste can be turned into biogas and used locally to produce 20 fourseven electricity that is clean with Bloom Energy Servers. We are piloting solutions today in India and are very excited by the potential of this approach for the future. You can see from these examples Why our solution is so relevant? We continue to innovate At a rapid pace, but also equally importantly, we are relentlessly bringing down the cost of our solution. For example, each of the last three years, we averaged a greater than 25% reduction in our product cost alone.
Our strategic program to reduce costs has many drivers, including innovation in design and process improvements that are independent of volume. At the same time, we also have tremendous leverage within our supply base on our own manufacturing operations as our volume increases. We are optimistic about continuing the strategic programs to bring down cost, harnessing all of the drivers. Because our solutions address these critical issues and our solutions are increasingly cost effective, We have seen rapid adoption by customers that represent a broad and diverse range of industry leading companies, including 25 of the Fortune 100 Companies. We have seen particular strength in foundational areas of our modern economy that rely on clean, highly reliable power, health care and data centers.
Our solution is unique. There is no other platform that combines always on resiliency, Clean emissions profile with energy density and cost effectiveness to make a solution practical for customers. Our exciting business opportunities in South Korea illustrate these points. We are in the final stages of commissioning 8.35 Megawatts Utility Scale Solution Near Seoul, South Korea. Land in this area comes at a great premium.
And so we developed a solution that we call the Bloom Power Tower that enables us to increase the amount of power that we can pack for the project where land is expensive or constrained. We see the Bloom power tower As a key tool in meeting market requirements around the world for significant power capacity In a very small footprint, for example, dense urban locations in large cities such as Tokyo or New York. There is one more important aspect that I would like to call attention to. Unlike other new or emerging energy technologies, this is one in which America As a big lead on the rest of the world, Bloom represents the best of American innovation and our ability to make things right here in the United States. We are particularly proud that our solution is adopted by the market.
We are driving high quality American jobs, including traditional manufacturing jobs. Our extremely talented employees are our most precious asset. They are a significant competitive advantage For us in the market, which we want to preserve and protect for investors, They are one of the key drivers that will continue to increase the value of the company and one of the key ingredients along with our intellectual property that form a formidable moat around our technical and market leadership. With that, I would like to give you a high level summary of why you will see a near term spike in our stock based compensation. Our IPO listing price was well below the auction strike price for employees that joined Bloom within the 7 years prior to our IPO.
As a consequence, we made a strategic decision We treat them fairly and bring them to market and this resulted in a short term spike in stock based compensation that Randy will discuss later. This adjustment is to preserve and protect our most precious asset, our employee base. After this market adjustment, You will see our stock based compensation return to normal benchmarks. Randy will describe this further. Finally, I would like to discuss the deployment of our backlog, including installations and commissioning of new customer sites that are the key to revenue recognition for the company.
However, on installation, We still have challenges and we cannot always deploy our systems to customers' sites on our preferred timelines. The installation process can be unpredictable from a time line perspective. Construction and tie in to the utility is required. And for example, a hospital may only have certain timeframes where they can accommodate this While a retailer may not want to have this work go on during a critical consumer retail season, Weather events can also impact timing as well as issues such as labor strikes at utility companies that must support the final tie in to the electrical or gas grid. These conditions Can create a problem for us on timing and we still have timing predictability issues with our installations.
It is important to recognize that should a planned installation be moved out of a quarter because of such factors, They have not lost revenue. We have many strategies that we are deploying today, which we believe will eventually reduce the impact of timing risk on our quarterly results. With that perspective, I would like to invite our CFO, Randy, to further comment on the business performance in Q3. Randy? Thanks, KR.
Throughout my prepared remarks, I'll be referring to the slides in the earnings call presentation that Mark referred to earlier. First, some highlights. Note that all profit numbers that I reference will exclude stock based compensation. So on to Slide 3. In summary, a very respectable quarter.
Acceptances were 206 systems, a record. Revenue was $190,200,000 up sequentially from 12.6%. Gross margin came in at 20.8%. Our operating income was $5,600,000 with adjusted EBITDA coming in at $15,100,000 EPS was a loss of $0.13 And we ended the quarter with $412,000,000 in cash and short term investments, and this excludes $36,700,000 of PPA cash. Before I dive into the numbers, I'd like to spend a few minutes at a high level on an overview of Bloom Energy's business model and some of the accounting.
We view ourselves as a technology company that provides a solution, and that solution is providing clean, Reliable, resilient and affordable power to our customers. We provide a prospective customer with a competitive proposal that provides an energy solution that is cleaner, more reliable and generally less expensive than the grid. For sites where we can provide this value proposition, we execute a contract with the customer, the execution of the contract results in an order, And that order is entered into backlog. We generally book orders from our customers for multiple sites at one time, And these sites are most often deployed over multiple quarters. As such, orders in any one quarter tend to be lumpy.
So keep in mind that orders tend to be large and lumpy whereas system deployments or acceptances as we refer to them tend to be more linear as we deploy the systems out of our backlog. In addition, historically, we've experienced a bit of seasonality To our incoming orders based on customers' budgeting cycles and timing. Given the lumpiness In this seasonality, we will not be disclosing quarterly orders or backlog information as it may not reflect the true health of our business. We recognized revenue at the time of system commissioning. So it is at that point that the system moves out of our backlog and on to The P and L, we refer to this as system acceptance.
Thus one of our key metrics is period system acceptances As this correlates closely to revenue and is one measure to gauge the overall trajectory of the business. One other key term we use is system. System acceptances are in 100 kilowatt equivalents. We use 100 kilowatt as a base because the very first systems deployed by Bloom Energy approximately 8 years ago were 100 kilowatt systems. Today, about the smallest size of deployment at any one site would be 250 kilowatt.
So a 250 kilowatt Site deployment would translate to 2.5 systems in Bloom Energy speak and 10 systems would translate to 1 megawatt. Or if we said total acceptances in the period were 200 systems, that would equate to 20 megawatts of power. As I previously mentioned in the highlights, we achieved 2 0 6 acceptances for Q3 or 20.6 megawatts of power capacity. This was below the bottom end of our estimates, which was 215 systems and come as a result of construction delays. However, it was up almost 14% from Q2 'eighteen's 181 acceptances number and 46% increase from Q3 'seventeen's 141 system acceptances.
Let me make a few comments On what drives an order to be an acceptance. During the time the order is in backlog, We conduct due diligence of the site, perform the site design work, obtain all necessary permits and approvals, Construct the systems, start and finish site construction and finally install and commission the Bloom Energy servers at the customer This whole process can take as little as 5 months, but on average, it is more than the 10 months time frame to accomplish. When you review all the steps we go through to get the site commissioned, much of it is outside the control of Bloom. The process almost always includes approvals from customer, landlord, Local city government, the building permits and the gas and electrical utilities and the construction phase Includes multiple periodic progressive inspection approvals as well, all outside the control of Bloom. Bottom line is predicting the timing of acceptances accurately can be difficult and exact on time acceptance So how do we deal with this?
We go into the quarter with a pool of potential sites that could yield and be accepted within the quarter. While realizing that some sites will likely not accept in the current quarter and be delayed to the following quarter due to circumstances that are not known at the beginning of the quarter. Example of unforeseen circumstances are construction delays Due to soil issues such as hitting bones from an historic burial site during an excavation or utility interconnection crews being unavailable For electrical or gas tie in due to crews being sent to natural disaster areas such as the massive fires in California, Hurricanes in the Southeast are actually even being on a strike. Generally, we target to yield anywhere from 60% to 75% of the potential pool in any one quarter. This will vary from quarter to quarter depending upon the Size mix of the sites and the overall stage of completion each site is in at the beginning of the quarter.
Also, before I turn to financial details, I'd like to spend a couple of minutes on GAAP versus operating metrics and the Federal Investment Tax Credit. Beginning in 2018, for external reporting purposes, We simply use GAAP Financials adjusted for stock based comp. However, I should point out that historically prior to 2018, a Significant portion of our revenue was treated as ratable, meaning that despite receiving the cash upfront, the revenue for the Equipment and installation was recognized over the term of the contract, typically 15 years. As you might recall and as outlined in our prospectus, we sell under variety of financing models to our customers. And depending upon which customer financing model is used, the timing of the revenue recognition for the equipment and installation is either all upfront We're all over the contract period.
If the revenue was spread over the contract period, again, typically in 15 years, We refer to this as ratable. Again, to simplify our financials, today revenue for our product and installation is recognized And the revenue for the service portion of the contract is recognized over the life of the contract as the service is performed. So in 2018, practically all of our revenue is recognized upfront for equipment and installation. And because historically a portion of our revenue was recognized as ratable, we have provided you with supplemental information in the form of key operating metrics for the prior periods to help you understand the impact of the mix change and help you understand the true trajectory of the business. Now with this behind us, let's move to some color on the quarter.
I'm going to be referring to Slide 4. The 206 acceptances Translates to $190,200,000 in revenue, up 12.6 percent from Q2's $168,900,000 and up significantly from last year's GAAP revenue of $93,800,000 The quarter over quarter increase in revenue This is attributable to the growth and acceptances. On a year over year basis from a GAAP perspective, the majority of the increase was attributable to the realization of the federal investment tax credit, which was not available in 2017. Note, from an operating metrics perspective, year over year revenue was up by 89% With some of the increase due to the increase in acceptances, but the vast majority due to the reinstatement of ITC in 2018. On to Slide 5.
As many of you know, cost and more specifically product cost is of high importance here at Bloom. Historically, we have seen an average of annual cost reduction of our product cost of 27% per annum over the last 3 years. The reduction in product costs comes from a combination of increased system output, Cost reductions from component and system modifications, yield improvements, system reliability and from simply volume as we leverage and more fully utilize our investment in our manufacturing assets. These continuous cost reduction activities have consistently driven improvements in our gross profit and gross margin. Gross profit, excluding stock based compensation, improved from $34,700,000 in Q2 'eighteen to $39,500,000 in Q3, A 13.8 percent sequential increase.
Year over year comparisons are not particularly meaningful given the absence of ITC in 2017. As many of you know, we do provide some quarterly estimates. And in our Q2 shareholder letter, we provided you with Q3 average sales price estimates as well as total installed system cost estimates. Our actual ASPs and TISC exceeded both the top end of these estimates. However, as I have previously emphasized, the real key metric is the delta between the 2, which represent our margin on the equipment and installation of the acceptance during the quarter.
The midpoint of the estimated ASP and TISC Yielded a delta or margin estimate of $15.50 or $15.50 Per kilowatt, as you can see on Slide 5, our actual margin delta was $15.83 a number above the midpoint of our estimate. As you can see on Slide 6, operating income in Q3 was 5,600,000 Operating income loss realized both from a GAAP and operating metrics standpoint. Our adjusted EBITDA was up From $12,500,000 realized in Q2 of this year to $15,100,000 in Q3, once again, Given the absence of the federal ITC in 2017, year over year comparisons are not particularly meaningful. Non operating expenses were per plan and adjusted EPS come in at a loss of $0.13 Turning to the balance sheet on Slide 7. We ended the quarter with $448,700,000 of cash and short term investments.
This includes $36,700,000 of PPA cash. So excluding PPA cash, we ended with $412,000,000 of cash in short term investments. Free cash flow was approximately a negative $600,000 This clearly contrasts With our non GAAP operating income of $5,600,000 the difference between the two numbers is our investment in working capital to Came in line with our expectations. Referencing Slide 8, days of sales was down 7 days from Q2 to 19 days As we collected cash for a number of our PPA deals within days of their commissioning, Our days of inventory outstanding was up by 2 days from Q2 to 87 days. As I just mentioned, our average inventory increased for the quarter to support our Q4 installation schedule.
Our payable days was down from Q2 by 1 day to 34, Basically normal business cycle variations. At this time, I'd like to clarify what I think might be a couple of misconceptions relative to Bloom. Some of this confusion might have come from the prospectus, and one of that is customer concentration. The prospectus uses our financial partners as customers and given 50% plus of our sales last quarter was under a third party PPA, for which our financing partner for our current PPA is the Southern Company. So it appears that the Southern Company is a large customer.
In reality, we had multiple customers using this particular PPA for financing. And in Q3, the highest customer concentration we had from any one Was 25%. To drive home this customer concentration point, if we look at our backlog at the end of Q3, The customer making up the largest portion in terms of systems represents only 21% of our backlog. The other clarifying point I'd like to make is on our debt. Of the total $741,000,000 in debt on our balance sheet, $349,000,000 is non recourse to Bloom and related to our PPAs, where despite only having a minority ownership interest, We are required to consolidate onto our financials.
Again, I want to stress the status non recourse to Bloom. Of the $392,000,000 remaining, dollars 293,000,000 relates to convertible debt that is well into the money in which we fully expect to eventually be converted into equity. That leaves $99,100,000 for which $95,500,000 is our securitized debt instrument and $3,600,000 represents a small term loan. So by backing out the nonrecourse debt as well as the well into money convertible debt, you can see our balance sheet is not highly leveraged. I also think it appropriate to make a comment about the increase in Bloom stock based compensation charges.
Leading up to the time we went public, we knew a very large population of our employees were underwater with respect to their equity And we needed to address the situation. A significant number of our employees held stock options where the strike price of those options We're well above the eventual IPO price. In fact, the average strike price of those options issued Since 2011 was $29.71 and the IPO price was $15 The result was a large percentage of our employees were underwater with respect to their equity in Bloom, and that gave us obvious concern Given the demand for our talent by other companies and the fact that employee equity is common here in the Silicon Valley. As a result, leading up to the time of the IPO, we issued some ISUs with up to 2 year vesting That was for all practical purposes a true up accounting for the difference in the strike price and the IPO price. This provided Bloom with market equity and a retention vehicle for our people talent.
The net of this is that we will incur a disproportionately larger stock based compensation expense for an 8 quarter period Starting with Q3 of this year. And because some of these shares will vest every 6 months, That expense will be higher in earlier quarters. Of the $71,600,000 stock based compensation charge realized in Q3, Approximately $40,000,000 was related to these true up grants. That number will be approximately $55,000,000 in Q4 And then we'll gradually decrease to 0 by Q4 of 2020. And to illustrate, The true up portion of the total stock based compensation charge for Q4 of next year 2019 will be approximately $15,000,000 So again, a decline to 0 over the next 2 years.
And once this true up grant expense rolls off, our stock based compensation charge, whether you measure it in terms of burn rate In Q4, we expect acceptances to be between $225,275, ASPs to be between
$6,495 $6,845
and our total installed System costs to be between $5,040 $5,390 The midpoint of acceptances for Q4 is lower than what we were planning primarily due to one specific anticipated Q4 order and acceptance being pushed to Q1. Otherwise, the midpoint of our outlook would have been closer to a 300 system acceptance number. Also, what you will see is a substantial difference in both ASPs and TISC from Q3. The reason for this is in Q3, we did not have any international acceptances. However, in Q4, we expect approximately 60% of our total acceptances to be international in Korea.
In Korea, we work with our in country partner SK who performs the installation. Thus no installation revenues or costs are included in either the ASP or the TISC for the Korea orders. And you will also notice that the midpoint delta between the ASP and the TISC This is lower than the 1583 posted in Q3. This is due to a substantial Portion of Q4 acceptances, again being international, where today our margins are lower than in the U. S.
You might ask then why do international at this time? Reason is the long term. After ITC sunsets, The international will likely represent some of the highest margin opportunities for Bloom, and we need to cultivate those markets today. Korea is a great example of a large market Bloom can grow and expand within. And with further cost reductions, We believe we can achieve our targeted margins in Korea within the next 12 to 18 months.
As we've discussed earlier, we have to continue to balance market growth and margin improvement. Once again, thank you for your time. And I'd now like to turn it back to the operator for Q and A.
Your first question comes from Michael Weinstein from Credit Suisse. Your line is open.
Hi, guys. Hello, Michael. Hey. So could you first off just discuss
a little bit
more about the acceptances and where The levels are coming up in the 4th quarter guidance and I guess for overall 2018 more like in the 800 range versus It was just probably a little below expectations at this point. I'm just wondering, you mentioned delays, project delays and Things would have been different without those delays. What can you say about how this will affect acceptances in 2019? Some of this just being pushed into 2019 so that 2019 acceptance rates will be higher than expectations?
Yes, great question. So look, I think when it comes we were a bit light in Q3, which we talked And then when it comes to Q4, some of those acceptances in Q3 got pushed to Q4. I think normally under normal circumstances here, we'd probably be looking at a bit higher in Q4. But bear in mind, Q4 for us, we have a lot of customers that are, say, in the data center business or in the retail business, and there's a fair amount of blackouts Plus we're often challenged with the weather certainly on the East Coast. And From the estimates that we put out there, the outlook of going forward, we just didn't feel comfortable with just taking all that and increasing the amounts in Q4.
On top of that, there was one acceptance that was in the neighborhood of about 50 systems Yes. Could make the quarter and could not. And we just felt like it was a little bit too risky To put into the outlook and we took it out. So the combination of not being able to kind of take some of the ones that Pushed from Q3 into Q4, not feeling comfortable to increase Q4 and that one order out there provided that the outlook that we have for Q4 It's to be a number that would be sub-nine hundred for the year. With respect to how does that impact The outlook for 2019, look, the fact that Some of these orders are pushed into 2019.
It's certainly going to help from a backlog point of view. We're not At this point, although we don't guide or outlook more than 1 quarter at a time, We're not anticipating that's going to increase that overall number for 2019, nor are we necessarily saying that it's going So we think it's just going to help with further backlog for 2019, but we're not Increasing or decreasing our expectations right now for 2019.
Related to the same thing, You explained that a lot of the permitting issues and construction delays are Somewhat unpredictable, and I'm just wondering, would it make sense to maybe acquire a construction company or somebody that some another company that has And then the second question I have and I'll just ask you now and then I'll get off is can you talk a little bit about the gross margins The number for 3rd quarter is about 21%, 4th quarter prediction is also about 21%. At what point do you think you'll be getting up to that 30% level that you've talked about over the long term?
So look on the first part, look, we're continuing to tweak and tune the recipe there for We are definitely improving. I know it might not totally appear that we're perfect and we're not and we're continuing to improve. We do look at different options when it comes to contractors. But bear in mind, we operate in 10 or 11 different states, Including international markets and finding one construction firm is going to be able to do an acquisition and to solve all those problems is Not necessarily going to solve everything. On top of that, we are kind of creating an industry here.
Each time we go into one of These jurisdictions or territories, we have to educate the local authority who's the gas company, electric company and The people who are building in the permits, so it's just part of a cycle. But clearly, the message is received. We need to get better at that. This is KR.
Let me add one more thing. When we go to Korea, we do have a construction partner and they do all the construction. It is SK, our partner in Korea, That is all the construction. That will be our model internationally. Domestically, We do use construction firms as we have, but a lot of these projects in its early days as we are continuously innovating, Us being in the loop is extremely important.
And it is not just construction delays, it is sometimes driven by customer mandates like What Randy alluded to, a hospital does not want you to do it at the time frame that you can, but at the time frame that they want to shut down Or like Randy mentioned, 2 of our large sectors, Retail as well as data centers during the holiday periods all the way from Thanksgiving through New Year's, They would not like to see any construction happen in their sites. And these are irrespective of Whether it is a construction firm doing it or us doing it, so let's add a color.
With respect to gross margin, that's a good question And look, we are continuing to improve there. And again, we had the mix issue for Q4 here. But even if you take a little bit margin hit on the Korean part, You still increased the margins domestically. You're kind of getting to that kind of midpoint of the guidance that we had. I think, look, if we were running at full capacity utilization today, we'd be very, very close to our targeted margins.
We're continuing to increase that. That number is more in the 500 kind of acceptance a quarter kind of build rate. But given what our outlook that we have here in the future, we think by this time next year, we'll be Somewhere north of 25%, maybe closer to 30%, but probably not to 30%, certainly by 2020, we'll achieve that targeted margin.
Thank you, Eric. Thank you, Eric. Thank you.
Our next question
comes from Stephen Byrd from Morgan Stanley.
Hi, good afternoon. Good afternoon.
I wanted to just talk about your raw materials Costs and occasionally we'll get questions about whether or not any kind of international trade issues It may cause either issues either with cost or availability,
than any
of your raw materials. I know this has come up in the past. So just wanted to get your latest thinking as to whether you've seen any impacts, if you have, how you've addressed them? Just love to get a heads up on this.
Thanks, Tim.
Yes. Stephen, I hate to dominate the conversation here, but I'll go ahead and take that because I've done a fair amount of work on this, but certainly they are Matt here is aware of it as well. Look, I don't think there's any secret on a world basis that commodity prices have increased. But nevertheless, we've done a good job of continuing through the things I mentioned in my script to drive Our overall cost and certainly our product cost down. And the thing that's Clearly all over the press these days are the tariffs and how is that impacting.
The thing before I Specifically to answer the question, what I will say is that at Bloom, we employ a supply chain strategy that employs multiple suppliers for the various components that we buy outside. And generally, we try To put those suppliers in different locations of the world, often one It could be, say, in China for low cost, another one might be in Taiwan and another one here in the U. S. Or Japan or some friendly place. Obviously, from time that if you report that strategy, there might be a cost differential, but you do have options.
And that option is to move from one region to another if there's a reason to do that. Clearly, the tariffs here in China has to really fine tune and focus on our supply chain strategy. We have less or about 20%, slightly less than 20% Our total bill of material today is sourced in China and could be subject to the tariffs. So If you were to say kind of if they were 10% and you still bought 20% there, you can see that's in the neighborhood of 2%. With that and talking to our supply chain folks, they can clearly mitigate that.
And the way they mitigate that is that Even though there might be a small price difference between say a China and a Taiwan, it isn't that much of a price difference and they can just Increase the allocations from one region to another to mitigate that. So we've kind of analyzed the impact to Bloom On a cost of goods sold basis, and we said, look, it's probably about 1%, but if we want to be conservative and It's somewhere between 1% and 1.5%. That's what the tariffs we think could ultimately impact us And we put it in that category. And that's again a percentage of our cost of goods sold there.
That's super helpful. And then just as we think about potential use of capital, you're obviously underutilized at this point. You have a lot of excess capacity in terms of manufacturing, but you've also had some really good success in Asia. I'm just curious if that Causes you to think about deploying capital in some way, shape or form in Asia or elsewhere. But broadly, obviously, you're in a good position.
You have a lot of excess capacity. Curious though if there's been any change in terms of your thinking on uses of your
No. Look, our number one priority is to fill the sites we have. We still have tremendous opportunity to grow in Delaware and that's an important site for us And we plan on growing in Delaware. And so now we've got a tremendous investment in our facilities And equipment today, our number one goal is to utilize that and leverage that and further cost down.
And the marginal cost associated to get that Leverage, once we start shipping those many units and the absorption benefits we get It's pretty phenomenal. So to Randy's point, that's our number one goal and we are very focused on that.
That's very helpful, Randy. Thank you.
Thank you.
Your next question comes from Paul Coster from JPMorgan.
Yes. Thanks for taking my question. So acceptances are slipping relative to our expectations. And I'm just wondering if this is having any impact on customer satisfaction, on order intake, Your larger customers cutting back on their deployment expectations knowing that the lead time is stretching out and the complexity of these deployments It's escalating. And then the related question to that is, what can you do about it outside of Recruiting more people because you can tend to scale dramatically.
Is there anything that you can do to systemically bring down The lead time on the installation.
Yes. Paul, this is Matt
Ross. Good afternoon. I'll start off by addressing your question. Is there a link between the rate of acceptances and Customer satisfaction, we really don't see any connection between those. To some degree, some of those delays are related customer preference as Randy has already identified their blackout periods, their preferred dates for tying in systems, particularly in the healthcare and data center sectors.
So I wouldn't draw any link between the rate of acceptances and customer satisfaction, Nor does it have any impact that we can see on the pace for new POs. I don't see a link there.
And in terms of the cycle time for from the time we have a firm order to Actually turning the system on and converting that to an acceptance call. We have a multi pronged Strategy that we have taken, this is clearly an area we as a company want to both become predictable and improve. Given that these are construction projects and multiple of construction projects, there will be certain level of uncertainty. But reducing that uncertainty as we march forward It is very important to us and we're doing everything we need to and we have a multi pronged strategy, including acquisition of skill set That you talked about are all key parts of that strategy. So your question is right on and we're doing everything we can
So just one other question. So you've got Obviously, strong demand. You're unable to meet it as timely as you'd wish. In view of that, I mean, have you got an opportunity to start picking off Market segments that are easier to address, market segments for which the Deployment complexity is a lot less. And is that part of your focus, it seems now on going after, for Since the biogas market or some of the underserved markets elsewhere, are they just easier to not just sell into but also deploy into?
Look, the answer, Paul, in my opinion, no. We're pursuing the other markets because You look at it's always better to talk about this, but you look at 10 years down the road, the importance of The number of things that we're doing today is just extremely important and that's why we're going down the road. In terms of the acceptances, look, I want to stress, we have to get better at hitting any outlook that we have out there. But there is just a lot of this that is just without our control and we don't know it going into the quarter. If there is Massive fire and they sent all the crews that are going to do the tie ins or do the inspections up to deal with that And there's nobody here to do that.
There's not anything we can do about that other than say we're just going to have to Anticipate there's going to be more fires or more hurricanes or more strikes with utility companies or these things that happen. And maybe that's just what we need to do is just ultimately be more conservative. But that's really the issue. It's not like our customers are upset. It's not like we're losing business.
It's not like there's an easier path to go down here. Can we get better at our processes, people, equipment, tools? Absolutely, and we're going to do that. And we have gotten better. I will tell you, Art.
I mean, despite being a little light in Q3 in terms of this number, we still pretty much come pretty close to Just boil down to just being even more conservative in entering the quarter, and that's a lot of what you saw reflected in what we're telling you for Q4.
Mark, your question on market segments again, understand the following. The biogas is an and and not an or. We are not defocusing some area to do biogas. It is a NAND strategy. And the important thing is Biogas really, if you think of a 0 carbon base load And if you think of the emerging world and think of taking what would otherwise be a liability, It's a fuse problem and take that refuse convert that to fuel and provide clean electricity in places that otherwise will not get served And the size of that market, it's enormous, but it's a longer term future.
And we are We are doing the right things today. So a few years from now, we can play a very important role in that market. However, We are not doing that at the expense of our C and I market. And within the C and I market, These delays are location specific.
They are
Depending on the circumstances, and I'm going to walk through that specific and not really customer So it's not like you can pick one particular segment and make it better to explain that further. We were hit with a perfect storm in Q3 And that perfect storm was multiple hurricanes, Forest fired out here. Those 2 distracted our utility partners that had to do dine in enormously. On top of that and then that gets pushed out. Unfortunately, it happened in Q3 And you come into Q4, Q4 for all practical purposes is a short quarter for us because of the blackout periods and with like most of our customers, There's not enough makeup time to be able to catch up to that.
So one thing they're doing and You will see us already acting. Randy mentioned that with respect to our international markets and other things. We are creating diversification in our portfolio as quickly as we can, so the profiles look Very, very different for each of these segments we address. That diversification And reducing the percentage that we have to convert by having a larger pool are the 2 things That will get us there. We are committed to doing that.
We will get there.
Excellent. Thank you very much.
Your next question comes from Colin Rusch from Oppenheimer.
Thanks so much guys. With the management changes at PowerSecure division within the Southern Companies, given that they've been an important partner for you, can you talk about what your expectation is for how the relationship
Sure. I'm more than happy to
discuss that. Our first point of contact At the senior level, and it is a jet that gentleman I first took hands to say, are we serious? Are we going to grow? Are we going to be there for Long term was Mark Landrum and he now has taken over as the CEO of BarSecure. So I would say, if anything, these changes have further strengthened our relationship, and we look forward to a great relationship.
Okay, great. And then can you give us the assumption on Stack Life for the warranty approval and pricing and service for the installs during the quarter for both third
So we don't discuss Stack Life And by the quarter, because what we deploy today, there is an expected life for it and that life keeps going up every quarter. But remember, our service is for all the systems out there that have different legacies depending on when they were shipped with very different lifetimes. So if you look at a metric to look at how our systems performing in the field, a proxy to that will be our service cost and what you're looking at. And I think Randy can add more color if you want to that particular area. Just tell us what you're looking for.
Okay. I'll take it offline, guys. Thanks so much. Okay. Thank you, Kona.
Your next question is from Tahira Afza from KeyBanc.
I guess first question is on the construction side. From all my companies that have reported today and the one I met today, It seems like construction labor, even electricians, is going to be tight from several years to come. So given that Potential risk, I know you guys are looking at mitigating elements and strategies, but should we be using Sort of the acceptance rate year on year trends you're sort of indicating in 4th quarter really has a good benchmark, It is more like 25% year on year growth versus maybe the 40% that myself and consensus might be building.
Yes. Look, again, it makes it a little bit great question. I love the question. The problem is we don't really provide an outlook more than 1 quarter at a time. But I think I said earlier, look, I wouldn't necessarily change any of the expectations you have for Bloom in the future.
Yes, we certainly have our challenges. Look, if you think about it, Bloom has a great product. It's In demand, we provide a very compelling value proposition. It's very, very simple. We're going to provide you clean, reliable, resilient power and we're going to save you money.
So what's the challenges? Well, the great thing is we have a great set of operations folks that do a terrific job. In fact, my 3.5 plus years here, we haven't been late on one delivery that I can think of and the quality has just been phenomenal. So just a great hats off to The challenges obviously come down to once we get these systems shipped from our side, Once they arrive in the field, they're just getting them commissioned. And it's really not that last part that I mentioned, although sometimes there is an inspection or something that comes due The inspector is right or has to do something else, but generally it's just getting to that point.
So look, We're a small player in a very large industry of the construction industry. We should be able to get the resources we need To get this done in a timely manner, we do have the demand. So again, I wouldn't go off and significantly change your expectations for Bloom in terms of growth. But clearly, the limiting factor will be the construction and getting these sites installed into the field, That's the bottleneck in the company today.
And Randy, to add to what you said, Sadira, that's a great question. We should all be thankful that we have a construction boom, but we should also acknowledge that we have a construction boom and that means Finding that kind of talent that you're talking about, plumbers, electricians, contractors, they're all busy, right? So one of the things that we are consistently doing is reducing the amount of field work I'm increasing the amount of things that we can do at Bloom, including facilitating as much a preassembled Installation kit and stuff like that. So the actual amount of time an electrician or a plumber has to be in the field To connect all our systems is as low as we can. So while we can't change the macroeconomics, we can buy engineering and technology We reduced the amount of stack time, the touch time that is needed for somebody to do this in the field.
So that's how we're trying to address it. We are problem solvers. We are trying to figure out creative ways to solve these problems.
That's actually pretty helpful. Thank you. I guess as a follow-up, obviously, free cash flow in the quarter was slightly disappointing. Randy, it Seems by your comments this might be a 1 quarter blip perhaps or should we be resetting our free cash flow trajectory?
Look, it wasn't materially off from I mean, it was down a little bit. I mean, it was less than $1,000,000 Negative but free cash flow. And as we pointed out, we're going to go from a little over 200 acceptances to midpoint 250 That's going to take a little bit more working capital to get that done. So my view honestly is that there's nothing unusual there. It's really just kind of timing here.
We don't it's Not a number that we provide an outlook to, but it shouldn't be anything, in my opinion, should give you concern. With that said, We do sell under a variety of models from time to time. If we have a customer that's buying Directly, as we call it, a CapEx customer, the vast majority of that money comes in on a net 30 basis. That's different than a PPA or a lease deal that comes in very quickly right after the sites are commissioned. So cash flow from quarter to quarter Could vary.
But on a long term trend, no, no. Our we should be generating enough cash in this business to fund Under working capital growth, so you shouldn't see us be a big user of cash. And I think last quarter is a pretty good example of that. Thank you.
Got it. Thank you very much, Sandy.
Thank you.
Your next question comes from the line of Julien Dumoulin Smith of Bank of America. Your line is open.
Hi. This is actually Eric. Hi. This is actually Ivan for Julien. We just wanted to touch upon primarily the Growth rate and how you think about that beyond 2019, both for deployments as well as revenue given the previous Cadence expressed as about 30% revenue growth longer term as particularly beyond 2019 And what level do you assume comes from in terms of how you think about it cost reductions versus the IPC through 2023 if you guys have a safe harboring plan and how you view it beyond that?
Thanks.
Eric, look, I'm going to do the best job I can at answering that without breaking my rule of giving more than 1 quarter kind of outlook at a time. So look, Cross down, I can't emphasize that enough. I can't emphasize how it's a way of life here at Bloom. And if you look at I think I mentioned it in my script, the 3 prior years, it's been 27% per annum in terms of our product cost down. And our goal is to continue To drive cost down in the future, there is there are the normal things that I mentioned, a lot of those in my script.
But there's a big step function there and that's each time a new generation of product comes out of Bloom. And The next generation of product that we have, which is honestly, it's not going to be out there. It's north of 18 months, Somewhere between, say, 18 months 24 months that you'll see this next product is a big step function. It's If you just if you look at the footprint, we're going to produce a minimum of 50% more power in that same footprint, which is essentially the same price to build. In fact, we think it will be less because there's fewer moving parts or there's no moving parts, Sorry, very few.
There's fewer parts in the door system than there will be in the current generation. So given that and given that it's 50% more power, a huge step function. So we continue to see our ability on a long term To innovate and drive costs down very consistent with what we've been able to do in the past. And as I mentioned earlier, as our capacity utilization That's further going to help be a tailwind for that cost down. As our cost down come down, That will enable us to enter additional markets and make our targeted margins.
In addition to that, It will let us make higher margins in the markets that we serve today. So we think the long term It's still pretty positive. We've said we've set targets of long term targets of 30% revenue growth and 30% margin. We think both of those are achievable. It will vary from time to time and quarter to quarter.
For example, growing revenue 30%. If you're increasing the percentage on a year over year of the business that we do in Korea, Might make that revenue growth a little bit challenging because there's no install in Korea And there's no cost of install either. So but the margin, it won't impact. In fact, it might be a slight tailwind to improve The margin, the gross profit would be the same. But we're still optimistic that long term there's going to be opportunities for us To achieve our long term goals here.
And then in addition to everything Randy said, also remember that we are improving the capability of our systems. So for example, it was less than 3 years ago that we started the microgrid solution, which is for resiliency. Today, over 10% of our deployed fleet is microgrid solutions. As we move more and more farther into a Most climate change world where resiliency becomes important, it's a brand new market. Electrification of our Sorry, electrification of transportation is going to create a huge demand in inner cities.
That's going to be a new market. So There are even within our existing market segments sorry, existing market geographies, There are going to be new segments that we are going to break into as our capabilities go and increase,
Great. But could you also discuss the implications on Growth as the ITC steps down, are you just expecting to shift more towards international, if I'm understanding correctly?
Yes, absolutely. Look, our cost down It's on a faster curve. You just do the math here and we continue even if you were to Take it to only 20% cost down, significantly reduce what we've been able to do in the past. You'll certainly see that we're going to be able to Reduce our costs at a faster rate that we'll be able to mitigate the impact. Bear in mind, the ITC rolls off to not all at once.
It It has a step function there. And we think that given our trends on cost down and the fact that we have a new generation of product coming out Before that ITC rolls off, we're confident that that's not going to impact our overall growth rate or ability to achieve our targeted margins.
Right. I'm thinking more so rather than offset the incremental opportunity granted by the ITC to
There are no further questions at this time.
I'll turn the call back over to the presenters.
Thank you so much. We really appreciate you all participating in our very first call and we appreciate you taking the time. And look, at the end of the day, our mission of clean, reliable, always on electricity In a digital world that always on resilient electricity being provided at a cost that's affordable is What separates us from any other distributed energy platform? And we are excited about this opportunity and thank you for taking the time. And I'm sure with many of you, we will be in touch with Before the next call, hope to see you here at Bloom or in one of the meetings.
Thank you all. Thanks, everyone. Thank you.