燃料電池能源 (FCEL) 2002 Q2 法說會逐字稿

Welcome to the FuelCell second quarter conference call. Jerry Leitman is your leader today, on May 30, 2002 at 10:00 o'clock a.m. eastern time. This is the on core replay for conference id. number 426-7497.

At this time I would like to welcome everyone to the FuelCell second quarter conference call. All lines have been placed on listen only mode to reduce background noise. After the speakers' remarks there will be a question and answer period.

If you would like to ask a question during this time simply press star and the number one on your telephone keyed pad. If you would like to withdraw your question, press star then the number two on the telephone key pad. Thank you. Mr. Leitman, you may begin your conference, sir.

Actually this is Steve [Destar], director of investor relations at FuelCell Energy. On behalf of the executive management team at FuelCell Energy we are happy to have you join us on our conference call. Delivering formal remarks today are Jerry Leitman, president and CEO, Chris Bentley, COO, and Joe Mahler, CFO. Before proceeding I need to fulfill our legal obligation to read the following safe harbor statement. This presentations forward-looking statements including the company's plans and expectations regarding development and commercialization of the FuelCell technology. Directed to read the caution area statements on forward-looking statement in its filings with the SEC commission. I would like to turn the call over to Jerry Leitman.

Thanks, Steve. I would like Chris Bentley to give you an update on the facility in Torrington.

Thanks, Jerry, the stock assembly area is rapidly building in process inventory of submegawatt stack modules, assembling and increasing rate of production of all components and subassemblies. We are pleased at excellent progress has been made on production recovery in the tape casting area. We are producing electrodes and major [inaudible] on a single tape casting machine with good quality. We have consistently met our planned objectives for both of these components as we continue to increase production rates to an expected annualized level of 20 to 25 megawatts this summer.

The second tape caster has been ordered and it is scheduled for start up in the fourth calendar quarter of this year.

Our procurement team made progress working with engineering for the balance of planned equipment. Either in the first 16 to 20-megawatt plants are delivered we are completing a comprehensive engineering program that we expect to further reduce the cost of follow on product.

Initial deliveries of megawatt class D.O.P. will be arriving in Torrington this summer, in preparation for testing of the 1 megawatt power plant late this summer that will be shipped to King County later this year. Manufacturing continues to ramp up in all production areas, we are preparing for the next level of production capability. All major equipment required to produce 150 megawatts per year has been identified. For instance, continuous cinerator furnace, well as well as, materials handling equipment, et cetera. In order to achieve the volume, additional testing facilities and module testing facilities will be required. We continue to produce a strategy that would place these facilities at regional locations in order to enhance customer service and reduce shipping costs.

I'll turn the call back to Jerry.

Thanks, Chris. I would like Joe Mahler to review the recent financial results.

Good morning, everyone. FuelCell Energy reported a revenue increase of 32 percent in the second quarter of 2002, compared to 8.6 million. In the second quarter of '02, to - I'm sorry.

8.6 million compared to 6.5 million in the same quarter of the previous year. Net loss for the second quarter was 8.9 million or 23 cents per basic and diluted share, compared with net loss of 5.1 million or 16 cents per diluted share during the same quarter of the previous year. Revenues increased 32 percent to 15.6 million for the six month ended April 30, 2002 from 11.8 million for the same period of 2001. Net loss for the six months ended April 30, 2002 was 14.9 million or 38 cents for basic and diluted share, compared with the net loss of 7.9 million or 25 cents for basic and diluted share, cash, cash equivalent and the investments, being primarily U.S. treasury, on hand as of April 30, 238 million.

Cash decreased by 15.5 million in the second quarter and cash decreased 32.3 million in the six month period ended April 30, 2002.

The loss were the primary items behind the cash use of the three and six month period ended April 30, 2002. Revenue increases in both the current quarter and the year to date were due to contracts involving the King County waste water, U.S. Navy marine diesel program and the DOE coal mine methane project, as well as items shipped to MTU, our European partner.

The net loss for both the quarter and year to date reflect the increased head counsel, research and development contract, continuing development of the field trial program, design of the submegawatt and megawatt products and increased selling and general administrative costs, primarily sales and marketing and other sales related to growth of our business. The result of the activity has been to prepare for the commercial loss. We are incurring losses now to position ourselves for the future. We have added over 150 new employees during the past year primarily in field services and manufacturing to bring the total employee count to 320.

The strategy is to have the staff hired and trained to follow the increase of the power plant units and work with the distribution partners and customers as the units are delivered to the field. Another initiative, develop our balance to [balance of plan] and bonus suppliers. This involves a number of first time costs as well as the vendors and their suppliers for non-recurring engineering, first article testing, vendor qualification, and inspections and so forth. These first time costs are part of the early commercial field trial units, leading to cost effectiveness and reduction in the future. I will turn the call back to Jerry.

Thanks, Joe. We are making significant progress to prepare ourselves for the commercial launch. The key near term objectives are getting early units in the field at customer sites, increasing production capacity, qualifying suppliers and subsuppliers, and building the organization to support our distribution partners and the market demand.

Our distribution partner network was enhanced by the alliance agreement with Caterpillar we announced on April 30. The strong commitment we reached with them included incentives for order delivery, expansion of the dealer network, selling the DSC power plants, and product development is further validation of the FuelCell Technology. Our market development agreement with MWH as a partner with Anaerobic Digester Gas Processing expertise for municipal and industrial waste water facilities, enabled us to penetrate this renewable biogas market. The global distribution partner base includes equipment manufacturers as MTU in Europe, [Marabini] in Asia and Caterpillar in North America, as well as energy solutions companies here in the U.S. PP and L EnergyPlus, Chevron Energy Solutions, [CMS By-Ron] Energy Services, and MWH Energy Solutions.

We may choose to add partners in the foreseeable future especially for market secretaries. We are confident we have a comprehensive group of established energy solutions and power generation product companies to compete effectively in the global distributed generation marketplace. Consistent with this we are focusing on day-to-day inter action and training of sales and service staff of all of our distribution partners. During the summer, more than 75 representatives from our distribution partner companies will be visiting us here in Danbury for in depth sales and training on DFC power plants. The partners with us for awhile are demonstrating success with the power plants. PP and L announced the siting of two sub-megawatt units for two different Starwood Hotels in New Jersey, and was named finalist by the Connecticut clean energy funds for two more sub-megawatt units for Pepperidge Farms bakery here in Connecticut.

We continue to see progress by [Marabini] with the Kirin Brewery announcement earlier this year and today with the announcement of the 250 kilowatt unit for the city of [Fukaroka], with one being a municipal wastewater unit and the other being industrial waste water. We continue to establish a strong global position in this important market segment. I might add that King County waste water plant where we are installing a one megawatt power plant processing 115 million gallons a day, generating in total 8 megawatts of gas, while the waste water treatment plants in [Fukaroka] process 119 million gallons a day. We see potential at both sites.

FCE completed the commissioning process and are ramping up a sub megawatt unit for combined heat and power plant at a fuel cell energy park owned by RWE, Germany's largest utility. Another heat and power plant unit is completing testing and conditioning now and will be shipped in mid June to Spain for Europe's largest ship building company. The attractive operating characteristics of distributed fuel cell power plant are gaining wider recognition throughout the U.S. Three additional states, Michigan, Ohio and Texas advanced initiatives to advance the commercialization of fuel cell technology, adding to the list that includes Connecticut, Massachusetts, New York, New Jersey, and California. Partners are being considered for incentives in many of these states already.

Incentive programs are gaining momentum overseas as well. Germany's legislation for 5.11 cent per kilowatt hour credit for grid connected heat and power celled power plants up to 2 megawatts in size was approved and became effective last month. In Japan there's continuing government focus on subsidies, up to 50 percent for projects involving municipal and industrial waste water treatment facilities. As we mentioned before we need to make the decision to Torrington plant by this summer if we are to remain on track for 400-megawatt production goal in 2,004. Recent sitings and placements of the units in the field and a broad as well as the positive developments with global government initiatives are the drivers we are looking at carefully as we assess the decision to expand.

We will continue to work with our partners to Market our power plants before making this decision. Our focus is the strategically position ourselves tore the leader in our markets. We are making good progress towards achieving that objective. We have a world class distribution partners. Production capacity that is established and expandable. We are learning from the current field trial units and expect to accelerate delivery during the next six months. Finally we are building a strong organization and we have a solid financial base.

With that I would like to open the call to any questions you may have. Operator?

At this time I would like to remind everyone if you would like to ask a question, press star. Then the number one on your telephone key pad. We will pause for just a moment to compile this Q and A roster.

Your first question comes from Christine Farkus of Merrill Lynch.

Thank you very much. A question for Joe. Is there a way to quantify the impact of the tape caster accident in the second quarter on a cent per share basis?

Christine, I haven't really done that. There's quite a few factors or several factors that play into what we are working on right now. We are really working to get the units, the new designed units to come into the field. I think those, the combination of the tape caster and the redesign have delayed it. But, you know, those are multiple factors. We are at the development stage company, moving forward. It's really tough to try to pin it on the tape caster by itself.

Just as a follow-up then in terms of inventory, a brief discussion at the beginning about how this is, how you are building inventory, do you expect the inventory to climb in Q3 and Q4 as you accelerate delivery? Can you comment on the expected burn in the first half versus the second half of the year?

In terms of the inventory level, we clearly have built some stacks at this point in time. We expected those stacks will move to product and will be delivered.

At the same time, however, that we expected the business to the company to continue to expand. We have a goal of getting production rate up to 20, 25 megawatts in the summertime. We are preparing for '03. I would not expect to have inventory really decrease. The components of the inventory I think would change perhaps, but we are looking to build for the visibility we have in the marketplace, we are looking to continue to build the business at this point. What was the second question?

Do you have comments on your expected burn in the second half of the year versus the first half of the year?

There's a couple pieces to that question. And the question is, we build inventory, the biggest part, one of the big parts of the burn in of the first half was working capital. We expect to continue to build working capital in the second half. One of the key decisions will be the decision to move to 150 megawatts. And depending on the timing of that, it will have an impact on how much we spend.

I think originally we were talking, I think in the last conference call between ten and $25 million for that expansion. Depending on when you start to do that, that will will impact our cash flow. Assuming we move forward, I expect the burn will be higher in the second half

Thanks a lot.

Your next question comes from Paul Freemont of Jeffries and Company.

Thank you very much. Really a couple of questions. One is can you give us any type of a sense at this point as to what it costs per KW to manufacture a single cycle unit? And to the extent that the subsidy program is currently in place in Germany, why has that not resulted in any material types of orders for your product as part of your partnership with M T U?

Finally, can you give a percent of the track of commercialization of the hybrid product? And how is that unit performing and testing?

Paul, this is Jerry. As far as the dollars per kilowatt, we said that with commercial launch at 50 megawatts a year, the dollars per kilowatt is in the 2500 to $3,000 per KW range. That generates the cost of electricity that we have shown before.

We still see that to be the case. And as Chris and Joe both mentioned, we are doing a lot of one ups with suppliers to to position ourselves to have the right group of suppliers for volume commercial production

We are incurring a lot of those, first article testing and the like today. You can't look at the field trials and say these are the same cost level as commercial launch.

The second question on MTU, I am not sure that your premise is right. MTU has not announced any newed orders. In fact, I am going to see them in a few weeks, but we know they are diligently pursuing. I think if you look at the list of units they have in the backlog now, you've got R W E, you have EI, Energy [Burtberg], the three largest in Germany. There is a reason you have field trials. Deutsch telecom is another one.

I think you'll see some traction from that German legislation. But MTU tends to announce as they did last time bunches of orders at one time rather than one to one. As soon as they announce, we will announce likewise.

As far as the hybrid cycle, it is performing as well as expected if not even better. What we need, and I think we talked about this before, the 30 kilowatts Capstone unit doesn't quite take the heat transfer we need. We still have to bring in fresh air, which hurts the cycle.

Capstone is committed to send us a 60-kilowatt unit. We are buying it. But they are having to specialty engineer it. The delivery is sometime in August. As soon as they do, we will install it on the machine and see even better results.

We are very pleased with where we are to date on that hybrid unit.

Does that answer your question, Paul?

I guess the only thing is, you're currently in partnership with Caterpillar. You guys had originally thought that the best application of a hybrid might be somewhere in the 30-megawatt range. Wouldn't testing with a solar turbine as opposed to a Capstone turbine be required in order to see if that unit had a market?

You are very astute. Solar turbinees, we think is the right turbine partner for our large cycle units. But you don't do pilot testing with 30-megawatt plants, Paul.

We can learn enough from the small scale 250-kilowatt with a 60-kilowatt. With our D.O.E. contract - there's proof of concept so we can approve - the solar turbinees certainly work. The key issue is how do you get the heat to run into the other and back? And so our plan is to finish the proof of concept testing and then look at the systems integration of a 40-megawatt plant. That's under the figures 21 contract. Once we do that we will develop a commercial strategy and launch it as a product line. That's an '03 target as far as developing the strategy and how we will launch.

Thank you.

Your next question comes from Jarrett Carson of RBC Capital Markets.

Good morning, guys. Backlog for a moment. The announcement, I believe, from [Maribani] this morning, is that already kind of built into the previous kind of purchase agreement? And then if you could comment on kind of where backlog is at this moment?

Jarret, the [Maribani] bought nine sub megawatt units. They announced the first, and then this one today from [Fukaroka]. The backlog, Joe, somewhere -

Just under twelve. That would be just under twelve with - it's real in the same position. This is deciding what is in the backlog. The backlog is about twelve.

So delivery, we would still anticipate a bit more of a healthy ramp on product delivery starting this quarter, Q3?

Let me talk calendar quarters. Q3 calendar we'll see some deliveries starting and Q4 calendar we'll see quite a bit of deliveries.

We are, as you can anticipate with the delay we impacted from the tape caster one to two quarters, that allowed us to build up balance of plant inventory and the like.

As we start shipping, we will be shipping pretty often. And then following that into '03 obviously

Back to the California CPA. I believe there was a release that the CPA had chosen its agents for the revenue bonding. What can you give is there in terms of what you are seeing or hearing in terms of moving that forward and getting some monies available, loosened up there?

Cal power wants to do it. They understand that both our technology and other new technologies, their role as an aggregator is the way to make this thing really move forward rapidly. New technologies in the marketplace. From my viewpoint the desire is very strong.

Whether or not they can get the financing, Jarret, there's so many other influences there. It is a political year also. So I just wouldn't be able to comment on whether or not they will make the financing.

Another question here on product commercialization. I know we discussed before and I think your phrase is close to, we are selling commercial units, but we just need to tack on commercial terms and conditions.

What is, what are the steps, the two or three things that we have to get over here to have commercial products with commercial terms and conditions available and maybe some type of time frame around that?

The time frame is, as we start shipping these earlier units, Jarret, what we need to do is get performance read outs in customer sites, as well as testing here first and then customer sites, on the various applications so we know how to put parameters around the commercial terms and conditions.

Whether it's waste water plants or natural gas plants, with co-gen, without co-gen and the like and build up the experience base.

That doesn't stop us from taking commercial orders in '03. We know enough about the products that we know what commercial risks to take and what not to take. This is in concert with our partners.

But as we get more experience with operating units around the world, we can take, we can reduce our risk and take stronger and stronger commercial terms

Thank you. I'll hop back in the queue.

Next question is Eric Prouty from Adams and Harkness.

Thank you. With the additional states joining on promoting FuelCell technology, can you give a little indication of what you feel the aggregate dollar amounts, this would be not including the large amount of money available to the California power authority. Could you give us an idea of how much money is available out there? I guess more specifically, if you have a number of the dollar value of the RFPs that are out there currently for specific FuelCell power plants that your product could address? Thank you.

RFPs we won't talk about. If they are public, they are public. If they are not, we don't talk about our proposal activity. We only talk about awards.

It varies by state. Connecticut I think has about $8 million in the state. They are trying to expand that pot of money bigger. Massachusetts has, last I heard, 40 or 50 million. New Jersey, Joe, do you recall on New Jersey what they had? About 20 million?

I think it was around 20.

New York has a lot of [CERTA] money that they have. Michigan, Ohio and Texas are talking big time. Texas is looking at a California type approach, but for a thousand megawatts of FuelCell power plants. They would pay for them via tax or rate increase on the dirty power plants, quote. The dirty power plants would pay for the FuelCells. That legislation will go also into early next year.

So it is a varied map. And we track it pretty heavy. I don't have the numbers at the tips of my fingers.

Keep in mind our partners, all of them in Europe and Asia and here, they go for the funds, they or their customers. We look at it more from a, we promote it at the state level. It's the partners and the customers that do the applications and go for the funds.

Thank you.

Your next question comes from Lisa Callahan of ThinkEquity Partners.

Yes. Between now and until this summer, what needs to be done to get the old tape caster to full load? And will that be an announcement that will be made in your next earnings call?

I don't know whether we will announce or not, but we will be answer questions. Chris, you wants to address what you are doing now?

Maybe you can go over the question again for me, Lisa, I'm not quite sure I understood.

As I understand it right now, the older tape caster is are you positiving at partial loads, two loads a Kay day, two shifts a day. What needs to be done to get it to full load between now and this summer when you say it will run in the 20-megawatt capacity range?

I understand the question. We are trying to be cautious with the way we ramp the equipment up. We sort of planned and discussed in the last conference call. And the progress we are making is really very good.

It is simply a matter of extending the length of each of the casts that we make on a daily basis. Currently we are making two casts. Those two casts together cover roughly eight or nine hours of the day. As we extend those casts out we will be able to bring it up to 20 megawatts. We don't have to change the processes or add any people. We just need to keep doing what we are doing by adding a bit of length to the cast each day

That takes how long? You said something about hours?

We would expect -

If the question is how many hours does it take to cast 20 megawatts? Is that the question?

Sure.

It is roughly twice what we are doing now. It would be about 16 hours of casting on a daily basis.

Okay. All right. Thanks. One last question. Regards to the competitive environment, in FuelCell how do you think is the most formidable competitor and why, and can you comment on Mitsubishi electric?

The biggest competitors are traditional generation, the turbines. FuelCell competition? The only company that is in our space is see man's Westinghouse. We know them well. Used to be a joint venture with them many years ago.

We think we have a lead of a year or two, based on what they publish and present as far as when they are going to have, what capacity when. So that's, you know, where we see the competitive landscape.

Mitsubishi electric?

Electric. They are doing molten carbon, right?

Mitsubishi electric some years ago was a licensee of ours for motel en carbon and FuelCells. They were what they call down selected from their R and D funds from the government were cut way back and which jumped on to [Maribani] as our partner in Japan as a result of that.

IHI in Japan is the chief one now. We know them well and [Maribani] knows them well. We are more years ahead of them than even [Seamans] Westinghouse, both from cost and performance and reliability standpoint.

Ingersoll Rand and [Stephens] announced recently they are running a FuelCell gas micro turbine, 190 kilowatts. They announced that was the world's first micro, you know, gas turbine FuelCell hybrid

Can you comment on that? And is it safe to say you have done the same thing as a demonstration, if you will.

I am not going to comment on what their claim are. We saw the same claims. Anybody can claim anything.

As far as the difference there, it is a dramatic difference. Our FuelCell and turbine are de coupled. We take the heat energy from the FuelCell and put it into the turbine. The net result of that is the turbine can run at its pressure ratio, whatever it wants to do and the FuelCell can run unpressurized which is what we want to do.

The traditional approach that [Seamsns] Westinghouse has taken is the turbine pressurizes the FuelCell. We believe that approach is more complex and more costly. For the same degree of performance than the approach we're taking.

And that's as much as I can really say about that. We were - other than that, we mentioned in the press release, we gotp got a patent on that. Any high temperature FuelCell set were you present a heat transmitting to a turbine like this. Any high temperature FuelCell. We are quite pleased with that.

Thanks, Jerry.

Your next question comes from David Smith of Salomon Smith Barney.

Good morning. I want to follow on to Christine's question. She talked about the profit impact of the tape caster. You didn't really have a, I guess a definitive answer. Would sales be impacted by the tape caster, impacted in this quarter?

I think absolutely. I did try to say that. That the sales are clearly delayed. I mean the two major things that we have been working on in the first and second quarter are the redesign and getting those units ready to go. And then the tape caster, you know, that incident occurred in January. So it obviously pushed us out, you know, one to two quarters.

So it's really - I guess I'm wondering about your planned deliveries. What has been the impact of the tape caster on this quarter?

I can't talk to the quarter, David, but we said, what, Joe, five to 8 megawatts for the fiscal year? We were talking 15 to 20 megawatts prior to the tape caster incident, if not more. It has been that kind of impact as far as shipments

Okay. So obviously a portion, which is left to be determined, but of that 20 megawatts or 50 megawatts, it would have been in this quarter? And ramping up during the year?

I think the impact was more like two quarters and while we don't like that impact on the financials and the like, the main impact from our standpoint and our partners was getting product out in the field. The more applications, the more diverse units we have in the field, the more the it stimulates market interest. That was more our regret than anything.

Okay. The second thing, can you comment on the availability and reliability of the systems that you put in the field? Leading up to the commercial release of the next generation? Can you comment on what kind of operating results you are getting out of the new product?

We haven't reported on any of our field trials and really don't intend to. The competitive data and confidential data.

Number two, afield trial by its nature, you don't turn it on and see how long it can run on a stable condition. You take it through its trials. You do various testing, test techniques at the customer site and with the customer's blessing. That data, we retain that as internal proprietary data.

From our viewpoint, we are quite pleased. We already mentioned on previous calls, the information we gained from the units in Germany and the units we ran here in the U.S. have led to some significant changes both in primarily in cost but also in opera built of the units. We are pleased with where we are right now.

Is it system cost or reliability? What are the main focuses?

The main focus is work ability right now, and ease of work ability to operators. That is the main focus. That is what the marketplace demands.

The secondary priority is cost. But, you know, that's secondary right now. Pretty soon cost becomes the big driver. Reliability, performance, work ability of the product is the main thrust right now.

All right. Work ability, does that encompass reliability and performance?

It is reliability. It is ease of performance. It is ease of service engineers. When we do have to perform service. It's understanding inter connections to the grid. It is all of that together. It is not just part of seeing how long it runs at a certain point. What is the grid trip? What is the best way to inter connect and change out filters for the water system? What is the best temperature to keep the control cabinets? What is the best control algorithms. All of those you learn with each site and each application

That's what I'm looking for. One thing on capacity. I might have heard it right, but you said maybe in a different location. Did you say that?

Yeah owe mow

The capacity would be at a different location?

Our strategy has been inconsistent about that, David. We expect to continue to expand the production of the basic FuelCell package in Torrington through 400 megawatts. But as we expand our final assembly testing, conditioning, module integration steps and capacity, we would expect to do that at remote sites. Satellite locations which ideally would be close to where the customer's clusters are to improve service and reduce transportation costs.

We don't see much volume leverage associated with the final assembly and testing as we do, on the contrary, see on the production of components. Basically that has been our strategy for quite some time.

Is that with the U.S. you are focused on that?

Right now we have two facilities. One in Danbury for testing and conditioning and one in Munich for final assembly and integration with the balance of the plant. What Chris is saying is, Torrington as far as automated cell production will be the site at least through 400 megawatts.

But the assembly and test conditioning and testing should be done remotely. We are doing in Germany now. Maybe in California and Asia, et cetera. Rather than doing it all here in Connecticut.

Got you.

I might also add it is attractive for some of the state initiatives if you are willing to put a FuelCell plant in their home state. We obviously are using that.

The last thing, quickly. I am not completely clear. I know you are talking about product deliveries by year end. But the amount of inventory that's building up, can you just comment on one last time a little and just clarify for me? I think, we expect all the inventory we see on the books now to be delivered by calendar or fiscal year end? To me it seems like a pretty large jump that we are seeing at this point.

The inventory is moved up to about $18 million. In the inventory we have some cell stacks that are completed. We are building our inventory of cells and then we have also built up quite a bit of raw material.

So about half the inventory, you know, could be considered raw material, which is your basic material, your nick em, stainless steel, those things.

What we are ramping for, we are going to get to 20.5-megawatt run rate. That's the kind of inventory we have to build.

Then we will be adding D.O.P. to the inventory for a shorter amount of time. The theory there is to try to keep it on the balance sheet as short as possible.

Yes, we will be building inventory, but you will see some movement in the inventory. You will see a bunch of units starting to go out of here. You will see the characteristic of the unit playing through. We will get it finished and out the door and start the process all over again.

A lot of this is a backlog thing?

You know, there's no activity in the quarter. We see the business is there and we are continuing to build the business.

You will see that inventory currently on the books decreased, but I hope you see inventory build. That means we are getting orders and increasing the backlog. That's how we want to do it when we launch into '03.

This is targeted at what is in the backlog now. If, your net net would work itself down, but this is for building towards the remainder of the year?

The next question comes from Neil McAtee from Morgan Keegan.

Hello, Jerry. I just was, it looked like you're now moving ahead. The question I had was, and Joe may be the one to answer this. Costs of research and development contracts was up a lot more than the revenue. And also the R and D expenses were up. Is some of the expenses of getting the tape caster back, is that where they would show up, number one? Number two, is the increase in employees from 165 to 320 mainly run through R and D? And - or is there some other reason that maybe the costs of the R and D contracts are up more than say year over year? It looked like you had a positive gross margin last year. Maybe there's something in the April 30, 2001 number. You need to refresh my memory why that was actually positive and the flip flop this year.

Let me walk you through what happens in our financial statements. In the quarter we had a nice increase in the government contracting line item. Let me back off of that for one second and the view of the quarter as I have it, most of the impact is timing. Product mix really drives our financial statements. So as the product mix comes in, this leads to the question, why do you have a positive product margin on government contracting last year and why is the margin showing now a loss?

The difference is we are getting from the government the 50 percent cost share contracts. In those contracts we supply up to 50 percent of the contract. Those are good contracts for us because we are getting terrific R and D. These are, for example, King County, an EPA contract to put the mega watt waste treatment unit in the field. It's R and D, but it's putting a workable unit into the field. We can get 50-cent dollars. If we go back to some prior conference calls, we were estimates this year na part of the government contract base would be the overall deal D.O.E. contract, with clean coal, coal methane and Navy, all have a cost sharing piece to that. The whole year, 20 to 25 of government contract revenue. We would incur a loss of somewhere around, you know, somewhere between three and eight, three to $10 million on contracting because of the cost share contracts.

That's how our financial statements will work. In the quarter it happens that a big part of the quarter was the King County contract at a 50 percent cost share. That is how the financial statements work.

On the R and D contract, the line down below, we are spending R and D money and some value engineering with some value engineering firms to help to engineer the packaging of these units, which is one of our cost reduction goals and the opportunity for us to do that was to do it now. That's why you see that those costs are higher than last year.

So just to summarize, really what you see in the quarter is timing and you see product mix. And then your last point is yes, we are, you know, we really are moving forward. We are building this business. We are adding people. We are over 300 people now. Yes, we need volume out the door to absorb those costs. But you know, we see that volume coming.

Great. This sounds like the third quarter is where some excitement can begin.

We think every quarter is exciting.

Thanks, Joe and Jerry.

Next question comes from Bill Fogel of Wachovia Securities.

Good morning, guys. Could you give us the total kilowatt shipped for the quarter?

What was it, Joe?

I think in the quarter we actually shipped sales to MTU, one plus - one plus.

One to two stacks. I don't know exactly where the quarter went. We shipped to MTU. Those are the units I mentioned. The unit for the RWE energy park and for [EASER] in Spain. We didn't ship any out the door, any units from here, from FuelCell energy.

Okay. Also in terms of potential additional distribution partners, are you where you want to be there? Should we expect some more distribution partners announcements potentially over the next number of quarters?

I wouldn't think so, Bill. We are not aggressively seeking. There are some specialty niches that we may do. When you look at, you know, we have three strong OEMs, MTU in Europe, [Marabini] in Asia and Caterpillar here. We have four good solutions companies. I won't say no, never, but if people knock on the door, if they make sense, if it's a good market segment - frankly, as I mentioned, we will have over 75 people here in our Danbury offices starting in a couple of weeks for sales and service training.

By the wait, that only represents about a fourth of the Caterpillar electric power dealers. Just primarily in the northeast and west coast.

We are going to have plenty to say grace over as far as getting these partners up and trained.

One of the interesting things we have seen, it takes about a year for these guys to get traction in the marketplace. And that's why we want to take our current crop of partners and train them so they can start getting traction. After that, you know, in there is a specific partner that has a specific strong market position, we certainly would look at it. But we are not aggressively seeking anything like that.

Great. One last question. In terms of the power electronics that you are looking to use for the units, have you decided who the vendor is going to be for those? If so, who that is or what stage of the process are you in currently?

No, bill, we haven't. That is where a lot of the first time calls come through. We have operated G.E., we have A.B.Bs coming in, [Sef-con] coming in. These are sub megawatt, 1 megawatt, and 2-megawatt. We have mag na tech we are going one with, going through a test period with them on our unit here in Connecticut. We talked to emmer son.

In the three to five, four to five is where we want to do it. We want to test them and put them in the commercial field trial units and put them out at customer sites to get a handle on who is the one, two, or three best suppliers of that.

All of this takes time and all of which means you incur a lot of first time costs. We would have been better to stay with G.E. But in order to have the best suppliers and the best costs going forward, we have to sort through and see who really the best guys are.

Thanks, Jerry.

Your next question comes from Cyrus Lowe of J.P. Morgan.

Good morning. Most of my questions have already been answered. Can you talk about your intellectual property and what the average remaining life is on the patents?

We said in the press release, it's 39, Cyrus, in the U.S. and 90-something overseas. We have somewhere between eight and nine years left. Some of the much older ones have dropped off in the last year or so. But we've got 39, of which 25 to 30 are really core, no how ones. Then we have some others, as we are learning new things and going forward, we are continuing to add these. I won't say every quarter, but it's a major thrust of us.

As you get operational, you start finding all kinds of creative ideas that may not be core technology, but they are pretty neat. It is a key thrust for us.

We don't believe, we looked at the portfolio in the last three months. We don't believe that we have any real exposure. We think we have the belt and suspenders pretty well around our I P.

Can you tell us about the relationship with MWH and quantify the opportunities you see for this relationship? When do you expect as to see new orders coming through?

They have to get trained. This just happened. We are talking to them. We initially talked to them on the west coast, that's where the relationship started. They have multiple offices.

They are also big in power generation. But the key thrust we are looking at is waste water treatment. I think you will see that starting on the west coast. That's our thrust. I don't want to say concretely.

They are one of the ones we need to get in and trained on sales and service and from them to learn on their knowledge on an aerobic digester gas. They are not directly involved in King County, but when we crank that unit up in late summer that is part of the training process we want to go through with them.

Okay. Great. Thank you.

Your next question comes from Kelly Nash of McDonald Investments.

Hi, guys. Can you go through, other than the King County, which other units are scheduled to be delivered this calendar year?

, I can give you off the top of my head we are looking at the coast guard and one, at least one of the hotel properties for P P and L.

We are looking at Kirin Brewery for [Marabini]. We are looking at three or four more stacks for MTU. - Chris, three to four? Three or four more. One or two more units for L.A.. Help me guys if I'm missing anything.

Probably the University of Connecticut unit will go in, the one that the governor announced.

It is - we are doing some juggling because we have two things. One, we want to satisfy all of the partners' commitments to their customers. Two, we want to get the most interesting, the broadest geographical spread. The ones that give us the best market impact going forward to generate interest are the main thrust.

Can you talk about some of the problems that you are running - can you give us the length of the negotiation process that takes place as you are looking to install or add new units to the backlog?

Part of it is getting these guys trained because they tend to end up. We have a better feel for where some of the market opportunities are than they. So it is getting them trained to where they are.

Obstacles, inter connect standards are always an obstacle. The local power gap doesn't want us around. That's true around the world. Getting the gas company involved, that has been successful in New Jersey, for example. Because the gas company wants to be our partner, wants to sell gas during the summertime.

Getting the multiplicity of co-gen operation options. The FuelCell, particularly on natural gas or waste water gas is standard to us now. But each cogeneration is different whether you are generating esteem or direct firing to an absorption chiller. Each of the co-gens is a different scenario

Besides the inter connects, the local codes and standards. The other issue is that, it's not surprising, I think to anybody who looked at distributed generation. Many of the customers don't want products. They want the energy. The electricity and the heat from the co-gen. Therefore, it is in effect a power sale agreement. Those are more complex to develop than just selling a product across the transom. Those are some of the issues, Kelly. I think they are certainly not impossible. They have been proven so far. From our standpoint we will have an order of magnitude more salesmen, ten times the number of sales membership on the street by the end of this summer than the end of last summer. That will make a big difference as far as impact in the marketplace.

Finally, can you give us an idea of how many employees you are likely to add over the next six months, year or so?

I think the paste,, going towards '03, it will slow down. There are key areas that we are hiring that we will continue to hire. It won't be bulk process operators or a lot of field service or engineers. A month ago we hired a very key guy for our spare parts after market business. Now, you don't need a spare markets spare markets guy until you go into a commercial business. It will be that type of organizational add of key people we need.

We looked at where the organization needs to be 30 years from now as we get to 4 megawatts of capacity. We are looking at the core spots within that and looking at how do we add those. We have the people before we need them instead of after we need them.

So the ramp up of employees -

Will slow down.

Okay, thank you.

Next question comes from Chris Kwan of TD Securities.

Hi, guys. A couple of accounting questions first. You went into a little bit on inventory. Do you have a breakdown of that 1829 between within and finish goods?

I haven't broken that down. In effect, Chris, the - we've gotten stacks that are completed in one context that would be finished goods. It's just work in process to the completion of the total unit.

We don't break it down into that type of detail. I say half the inventory is raw material and half is either finished stacks or finished or cell components or in process cell components. That is where the majority of the inventory would lie.

And you have other current assets that has been rising the last couple of quarters. What is in there?

Let me take a look. Bear with me for a moment.

It's that 5.4 million.

In effect what it is, it's cash that we are controlled substancing to vendors, primarily for balance of plant type items.

Testing?

No, it's Dow payments.

The investments, what is in there?

That's U.S. treasury with alonger term than 90 days. There is really no marketable securities or anything like that. It is longer term U.S. treasuries.

Pretty much we probably average less than a year of maturity on that.

Those investments could be considered cash?

Absolutely. That's how we view it. In the press release we tried to outline that these are treasury. We view them as cash.

A bigger picture. Between the three primary distributors, MTU and Caterpillar, how would you rank those guys, one, two, and three in terms of the near term and longer term prospects for more significant orders?

I don't want to get in trouble with the partners, but let me differentiate it this way. We call these guys OEMs. We will eventually ship them FuelCell or FuelCell modules. They will incorporate it into a [Marabini] or MTU today or Caterpillar power plant, as they develop the product.

So that is why we call them like an OEM. It will be their power plant but with our FuelCell module as a prime mover.

The others, Chevron, MWH, P P and L don't make products. They offer total solutions to customers.

We don't know in the de regulated distributed generation world who will win out. Maybe both will. That's why we want a mix of product type companies and energy solutions type companies. I'm just not willing to bet. Obviously Caterpillar is the largest in the world in distributed generation. MTU is one of their competitors. [Marabini] has a lot of partnership relationships in Japan and has put in 20,000 megawatts of power plants. The energy solutions companies in the U.S. have been all very successful.

That's why I said consistently, we want six, eight, ten of these guys. And then I know we will have some that exceed expectations, some that don't immediate expectations but in the mix we should come out okay.

What I'm trying to get at is, especially between the three of those, you have U.S., Japan and germany. Which market do you see opening up?

Germany, incentive is big. They had good subsidies - you'll see some real traction. It just became law. And there's a big green influence and a big carbon tax issue in Europe.

Japan, big green influence, big carbon tax, Japan is slower to adapt new technologies than North America and Europe. When they adapt, they adapt very strongly.

U.S., much more free market, much more de regulation, less environmental influence. So you know, I don't know which one is going to win. Each has pros and cons. I wouldn't be surprised to see all three major regions track about the same way, but for different reasons.

Okay, great. Thanks a lot.

Your next question comes from Ali Agha of CS.O.

Hi, from Banc of America Securities. Couple of questions. Could you remind us of your larger sized units that are being produced right now, looking at what is the percentage completion so far?

The perjt exrietion completion is - I don't have that in front of me right now, Ali. It's - we had a big boost this quarter. We should have impact next quarter on that. And then a little bit more in the following quarter. I would say it's under 50 at this point.

Is that average for all of them or one particular project?

That's really King County?

What about the Navy and the coal mine methane?

They are in various states of completion at this point.

Okay.

We talked Ali for this year, year to date we have 13, 14 million in - 13.1 in R and D contracts. We are expecting to hit between 15 and 25 for the rest of the year. You'll see activity on King County, coal mine methane, Navy, DOE contract, vision 21 to a smaller degree and perhaps some build up in clean coal for the rest of the year.

Remind me, the total value of those government contracts is what?

Another good question that I don't have. I would say that the total backlog, I would say it's probably in excess of 50 million.

But does that also include the sub kilowatts in there? Is that just for the megawatts and higher?

That includes everybody.

Also for the sub megawatts, are those also right now accounted for on a percentage completion?

Yes, they are.

And with regard to the units that were, that you planned to ship out, in Q3 and Q4, especially the sub megawatt units, are some of those revenues already showing up in the percentage of completion accounting?

Small amount is showing up. There is some that is showing up in inventory, Ali. That inventory will be transferred over to those units over the next several quarters.

Okay. Jerry, as you look at the market environment right now and you talked a fair amount on the three different continents, generally speaking is it fair to say that the near term opportunities are primarily coming from some kind of government supported or sponsor or subsidized programs? Are you seeing any pure private companies without any subsidies right now stepping up to the plate?

In general, no. If the money is there, anybody is going to go for it. If the money wasn't there, with the early adopters still buy? I think they would. You are never going to find anybody not turning down that money and it takes them some time to go through the application process and the like.

The money is where we would focus anyway, northeast, west coast, Germany, Japan. It is there. Therefore, people are going after it.

Okay. Is it fair to say, then, that the conversation that you are having particularly in the U.S. for potential customers, your distributors are having, you find a change in mind set today from twelve months ago when everyone was focused on California and blackouts, et cetera?

You seeing a change in people's thinking as you talk to them today?

The ones that we are focusing on, the ones we are getting proposals to - not talking about an industrial plant or anything, these guys are as a have I. The four star hotel chains, these guys are savvy. Kilowatts are going to be free. There won't be another blackout. The whole power industry was manipulated in Californi. Electricity is cheap. That is kind of a front page of the newspaper assessment. But commercial and industrial customers our partners are talking to don't believe that.

Okay. Final question. Jerry, as you look at the decision to ramp up production and the parameters that are out there, are you expecting or would you look at the orders coming through the door that would, you know, take you over the hump? Would it be more comfort level in activity that is going on? What exactly would be the key criteria for you to decide on capacity expansion?

Comfort level in the commitment and capability of our distribution partners. Comfortable with that right now. I will be more comfortable after we train 75 or 80 of them.

That's more than anything, Ali - we will probably then make that decision to CapEx, to spend the CapEx to go to 150 megawatts. It's 20 to $25 million, of which that also includes some potential regional testing on the assembly facilities which we can keep here in Connecticut. Don't have to make them regional.

I don't want to be behind the production machinery curve. I want the CapEx in there so I have a plant with machinery to do 150 megawatts because I believe it can happen. Then we'll control the cash burn by raw material inventory, how many people we hire, how many workers, and the like. It would be a darn shame to have a huge market demand and be sitting here without the machinery capacity to do it. It takes a year. I mean, the replacement tape caster Chris mentioned earlier, we are getting it in six months. That is where we were saying hey, if you get it to us faster, we'll pay more. Six months is what it takes.

We don't want to be behind the eight ball when it comes to machinery. We would rather control our cash burn to volume based on what we see the market doing.

That would not necessarily mean orders being signed?

Comfortable, as I am now, we have the right distribution partners and coming up on the learning curve and getting feet to the street, we will spend the money. I won't make the decision right now, but during the summer we will make that decision.

Thank you.

Your next question comes from Marco Pencak of Credi Suisse First Boston.

Good morning. You have been talking about inventory an the evaluation. Would you tell us how many megawatts of stacks are actually in inventory today?

No, I don't think I'm going to, I think it's related to the bag log. About half of the inventories is related to cell manufacturing and to stacks and it is being built up. You know, when we start delivering these units, they will come out actually and should be starting to come out one after the other that.'s what we are preparing for.

We won't break out the pricing publicly between cell stacks and balance of the plant, marco.

I'm not trying to do that. Here is the fundamental question. Your backlog has been potentially flat for three or four quarters in a row now. You are talking about expanding your near term, you know, production run rate to 20, 25 megawatts. Looking to make a decision on the 150-megawatt expansion.

Basically your backlog hasn't gone anywhere. You are looking at the market. I know there's a lot of encouraging signs. I'm just trying to get a sense of when that all starts to come to, you know, a decision point.

I guess my question really to you, Jerry, is, you know, the fact that you have not had the order intake to support the kind of growth plan that you are talking about and looking to, I mean, is it really that, you know, number one you haven't yet had, you know, the sales force in the field to be able to support that? And now that you made those distribution agreements you are getting to that stage? Is it that your field trials have not yet proceeded sufficiently far that the end customer, the ultimate customers are not yet prepared to place that?

In fact, are you sharing any of that data with them? I'm trying to put myself into the shoes of a prospective purchaser and saying what is it I need to see to make that commitment to one of your distribution partners and give you the order?

Can you help me put that together?

What you don't see, marko is the proposal activity. That is what drives me. But go back to your basic premise. One is, the more field trials, the more units you put out in the field, the different application and the more you stimulate interest. I can't tell you how many Kirin Brewery plants in the world and San Miguel and what the feeling is towards what they want to could once we show them the unit in Japan. That gives me some comfort level.

The second point is of not having the actual feet on the street, if you will a year ago compared to what we will have this year. I have probably more than 50 just Caterpillar people coming in. Ten, twelve, 14 dealers.

When you start doing that and you look at - these guys will want to quote a certain price, which is okay. But they want to quote a certain delivery. If you say no, delivery is two years, the order is over. Okay?

Sure.

You say I can deliver a sub megawatt plant in six months, you've got them. In nine or twelve months, you've got them. That's a chicken and the egg thing. Once the distribution organization thing gets traction, once we get more units out in the field for show and tell, then I think you will see this thing take off. I don't want to be behind the manufacturing and production line. What I would rather not spend any capital until we get the order backlog? Of course I would. On the other side of the coin, that says to expand from a machinery standpoint it will take twelve months. That will kill me in the marketplace.

Let me ask you, because I can appreciate it was a bigger sales force you are going to, you know, hopefully generate more proposals but you said, you know, what is giving the confidence today, which I obviously don't see. The market doesn't see specifically is what happens from the proposal standpoint. A lot of that proposal activity would have been generated from the, you know, sales force that was in place before you sort of ramped it up or partially from them.

Let me ask you, of the proposals that are out there, you know, what is it that you need to happen for those to get closed? Or what needs to happen for that proposal that is being discussed? What needs to happen for the actual sales cycle to, you know, to shorten on those ones? I'm talking about what additional ones might come. I'm getting a sense, you've seen something, it's given you confidence. What is it you need to see that converts you from the possibility to it's in my hands?

One of two things. One would be and easy one. A big aggregate tore like California power an other states that we are talking about where they are talking about a lot of megawatts at one time. A big aggregate tore would be the easy way.

The other way is an aggregation of multiple orders from our distribution partners. Let me correct you and maybe the audience.

We signed the market development agreement with Chevron, C.M.S. [By-Ron] and right before the power bids. We had to do that. We since signed an alliance agreement with Caterpillar. These guys have been in the marketplace since January. They are not trained well. It's hit and miss. But they haven't not been doing activity. Part of what you do with a new technology like this, there's a lot of qualification process. You have a customer, potential customer, very interested. You have to go through what is he paying for power now? What you can do to lay it out, price it out and price it through them. If you want to do it with a big chain like star wood, you have to negotiate master agreements and the like. All of that takes a certain amount of selling cycle far beyond the traditional cycle. That is what we see behind us. And you know, we could get order tomorrow or they could take 90 days or 120 days. What we are doing is positioning that. And as we see that internally, that is what triggers us to do the expansion.

Okay. A final point is, I appreciate you can't and certainly shouldn't give specifics given the uncertainty, but is there any metric that you can share with us to help frame what you've just described?

I can't, marko. I don't know what metric there is. Just watch for the orders. We'll announce them as they come in. Watch for progress and shipping units. Watch for the decision to expand or not. The manufacturing facility.

Those are the key metrics that we go by externally.

Great. Thanks.

We have been more than appear hour. I will take one more call, operator, please

Final question comes from Gary Holdsworth of Wedbush Morgan.

First for Joe, the second tape caster, how much incremental CapEx would na require? Is that still in your budget or thinking that you shared with us for like calendar 2002?

Yes. I think that the majority of the tape caster will be covered by insurance minus a small deductible. I believe that we have added some additional capital to that, to enhance that operation with some new things that we learned in the review of the tape casting operations. That is probably in the rake of half a million to $750,000 additional. That we think we will not only improve the process but could add yield, et cetera.

Are you comfortable with around 20 million for calendar 2003?

More of a function, Gary, of when we give the facility the go ahead on the 150-megawatt expansion. Most of the capital dollars in the budget are directed to that effort.

A clarification. So we know, on the Pepperidge Farms, two sub megawatt unit. You are, it's not in your backlog yet, right?

PP and L has seven units, sub megawatt units in backlog. They announced coast guard and two units at the Sheraton hotels in New Jersey. So this would be part of the remaining four units that we have in backlog that are orders with them, payments and the like.

Great. Thanks.

Very good. I want to thank everyone. Sorry we ran a little long. Look forward to talking to you again next quarter. Thanks a lot. By by.

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