燃料電池能源 (FCEL) 2002 Q3 法說會逐字稿

Good morning.

My name is Amy, and I will be your conference facilitator.

At this time, I would like to welcome everyone to the FuelCell Energy third quarter earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speaker's remarks, there will be a question-and-answer period.

If you would like to ask a question during this time, simply press star then the number 1 on your telephone keypad.

If you would like to withdraw your question, press star and then the number 2 on your telephone keypad.

Thank you.

I will now turn the call over to Stuart Eschbach, Director of Investor Relations.

You may go ahead sir.

Good morning.

On behalf of my fellow executive management team here at FuelCell Energy I'm delighted to have you join us on our third quarter 2002 conference call.

Delivering formal remarks today are Jerry Leitman, Chairman, President and CEO, and Joe Mahler, Chief Financial Officer.

Before proceeding, I will read the following Safe Harbor disclosure statement.

This presentation contains forward-looking statements including statements regarding the company's plan and expectations of the development of the fuel cell technology.

Listeners are directed to read the company's cautionary statements on forward-looking information and other risk factors in its filings with the Securities and Exchange Commission.

I would now like to turn this call over to Mr. Jerry Leitman.

Thanks, Steve.

Before I proceed with my formal remarks I'd like to turn the call over to Joe Mahler, who our CFO, who will review the third quarter financials.

Thank you.

FuelCell Energy reported a revenue increase of 57 percent in the third quarter of 2002 to 12 million compared to 7.6 million in the same quarter of the previous year.

Net loss for the third quarter of 2002 was 13.2 million or 34 cents for basic and diluted share compared with the net loss of 2.8 million or 8 cents per basic and diluted share during the same quarter of the previous year.

Revenues increased 42 percent to 27.5 million for the nine months ended July 31, 2002, from 19.4 million for the same period of 2001.

Net loss for the 9 months ended July 31, 2002, was 28.1 million, or 72 cents per basic and diluted share compared with a net loss of 10.6 million, or 32 cents per basic and diluted share in the previous year.

Revenue increases in both the current quarter and the year to date periods were due to the acceleration of our 2-megawatt clean coal project, continuing activities on contracts involving the 1-megawatt King County Wastewater treatment facility, the 500 kilowatt U.S.

Navy Marine diesel program and the Department of Energy's 250 coal mine methane project as well as fuel cell components that we shipped to our European partner MTU.

Sequentially total revenues increased 40 percent over second quarter '02 while most of that revenue is recognized on the government contract line, it's important to note in the aggregate this activity reflects work towards the delivery of a variety of DFC power plants utilizing multiple fuels.

The net loss for both the current quarter and the year date periods reflect the company's focus on developing standard DFC power plant products increasing production volume and developing our distribution network.

Activities including first article design and testing of sub-megawatt and-megawatt products, sales force and field service development and training, increased staffing and for cost shared research and development contracts.

Cash used in the third quarter was 17.8 million, including 4.5 million for capital expenditures.

Inventory during the quarter was approximately the same as the prior quarter.

We start the fiscal fourth quarter with 240 million in cash and investments.

Essentially, the net amount of our follow on offering in June of last year leaving us in a strong financial position with the flexibility to maintain, reduce or accelerate our business activities consistent with market demand.

We are on course with our previously stated estimate for cash burn for this year in the range of 50 to 80 million.

We are seeing capital expenditures running below and bottom line losses running above our previous anticipated levels and we see that trend continuing for the next three to six months.

Consequently, fiscal year end results will likely approach the mid- to upper end of that cash estimate.

I will now turn this call back to Jerry.

Thanks, Joe.

Our product strategy is to have the best performing, most reliable and lowest cost Direct FuelCell power plants in various sizes and utilizing multiple fuels for base load power generation.

In order to achieve our product strategy, our efforts remain focused on developing our DFC power plants at standard products, increasing production volume, and developing our distributor network.

Before I get into the detail behind these efforts, let me briefly address our view of the market.

In spite of the turmoil in the power industry, the key drivers for distributed electric power generation have still in place.

The existing transmission and distribution infrastructure in many areas is aging and constrained and investment in new transmission and distribution lines has not kept pace with either demand or the increased generation infrastructure.

Global political tensions and terrorism are placing greater emphasis on energy independence and security, environmental concerns are limiting traditional electric generation installation, and finally the digital requirements for higher quality and more reliable power continue.

Our DFC power plants are designed to accommodate all of these drivers.

During the past year, a weak economy, lower industrial power demand and a sharp decline in commodity prices made financing generation plants difficult.

On top of this many financial problems of energy companies created a credit crunch in the power industry.

Today, we continue to see the slowdown and cancellation of new power plant construction by the likes of Duke, NRG among others.

The sluggish economy not withstanding however, power use records are being set.

ConEd, LiPa and ISO New England reported peak demand in power and usage this summer.

The New York ISO reported that despise the recession the risk of an energy crisis is high if there isn't significant power generation online by 2005.

Incentive programs for fuel cell technology are available in our North American, Asian and European target markets.

We are seeing success already with one of our more established North American distributed parents, PP&L securing subsidies for its projects in Massachusetts and New Jersey.

They are gaining ground with power plant sitings in Germany and Japan, as well.

We're positioning ourselves to take advantage of these market opportunities by developing the best performing most reliable and lowest cost DFC power plants.

In various sizes and utilizing multiple fuels for base load power generation.

To implement this product strategy across all three products, the DFC 300a, 1500 and 3000, we're focusing our efforts on developing our DFC power plants as standard products.

We're focusing on increasing production volume and on developing our distributor network.

Let me highlight some specific activities.

We're qualifying multiple suppliers for critical balance of plant systems, equipment and components through extensive in-house test program and multiple purchases.

We're working with four vendors for the fuel humidifier heat recovery system, two vendors for water treatment system, three vendors for electrical balance of plant, and four vendors for module fabrication and packaging.

We have conducted factory acceptance testing for such mission critical systems as the heat recovery system, the anode gas oxidizer and the electrical balance of plant with emphasis on the inverter and the DCS control systems among others.

Similar efforts are continuing for critical materials to support cell component production this includes worldwide vendor surveillance for corrugated stainless steel, nickel wire mesh, clad steel catalyst and others.

With units scheduled to operate on wastewater treatment gas, coal-derived syn gas, coal mined methane, natural gas, peak shaped gas and in both 50 and 60 hertz configuration, emphasis is being placed on the necessary applications engineering work.

We also conducted our DFC turbine proof of concept testing with a Capstone 30 kilowatt turbine with successful results.

Our continuing the efforts or system integration for 40-megawatt DFC turbine power plant and are preparing for additional testing for a larger 60 kilowatt turbine this fall.

As we prepare for the delivery of sub-megawatt and-megawatt DFC power plant to customer sites we have made modification to both our Torrington and Danbury facilities.

Our manufacturing processes are advancing toward our goal of 20 to 25 megawatts of annualized production by October 31.

A second casting line is on schedule for delivery in October of this year and is expected to be fully operational by December 31.

We expanded our Danbury testing and conditioning facility by 25 percent for sub-megawatt units and added equipment for balance of plant integration.

We also built a megawatt facility at our Torrington location where we'll operate our first 1 and 2-megawat power plants of natural gas connected before delivering to customer sites.

Regarding manufacturing expansion during the summer, we have taken the necessary preparations steps for expansion of our Torrington facility to 150 megawatts.

We have reviewed vendors for key equipment such as continuing centering furnace, additional weld cells and materials handling and have developed specifications to meet our specific needs.

The results of these preparatory steps is that the longest lead time for major equipment purchase is now 6 to 9 months.

We will continue to review the expansion decision so that we are prepared for timely expansion as market conditions warrant.

Our distributor network is developing.

We conducted training classes in June bringing in sales teams from our distribution partners and in total more than 35 representatives of our distribution partners participated.

Additional sales and service training, applications engineering development, marketing activities, and product design work with our OEM partners will continue.

We have added 94 employees during this past quarter bringing our head count to over 400.

We conducted fuel cell training sessions to develop both our field service technicians and our applications engineers.

To accommodate our growing organization and business needs, our information systems are being enhanced.

Regarding our shipping schedule, we are about 2 to 3 months delayed in shipping completed units from what we expected in the last conference call in May.

Although we have continued on schedule in shipping fuel cell components to MTU in Germany.

Some of the delays caused by engineering issues that we did not expect, for example, solving the flow distribution in thermal management issues on the DFC 300A design were more complex than we expected.

Some of the changes were made to ensure that these next units have incorporated our latest improvements.

As one example, we're retrofitting all our sub-megawatt balance of plant systems with a new fuel humidifier heat exchanger that is more efficient and yet about 1/2 the price and 1/10 the weight of our previous design.

We expect to start shipping units in October and by calendar year end we expect to deliver 8 to 12 of the sub-megawatt units and components to our partners in the US and Japan and in Germany as well as a 1-megawatt plant to King County.

In summary, these efforts to implement our product strategy, developing our DFC power plants as standard products, increasing production volume, and developing our distributor network will continue for another 3 to 6 months.

At that time, we will assess market conditions with our distribution partners to determine the appropriate level to advance our business.

We are in a strong financial position to accelerate if the market opportunities are present or to slow down and preserve our cash until market conditions warrant.

While there is short-term market uncertainty, we believe that our DFC power plants are the technology advancement needed for today's evolving energy markets.

With that, Amy, we're now prepared to open this conference call to the participants' questions.

Thank you, sir.

If you would like to ask a question, please press star then the number 1 on your telephone keypad at this time.

We'll pause for just a moment to compile the Q & A roster.

Your first question comes from David Cursman with HC Wainright.

Good morning, gentlemen.

A question regarding plant capacity.

What kind of visibility do you have at this point that gives you the confidence to make the move 150 kilowatts?

And as a follow-up to that, are we still on track for 400 megawatts by '04?

Did you get my question?

Yes.

Sorry.

I did.

Let's take the first part of it expansion of 150 megawatts.

We have sort of through what we need do.

We have talked to vendors, we're comfortable we can do that expansion in six to nine months.

That has two pieces to it.

One is Torrington, where we make the automated cell production.

The other is the assembly and test facilities that we have here in Danbury.

As we expand, we want to put those assembly and test facilities out near where the markets r today we have two, one in Danbury and one in Munich with MTU.

We want to locate those in North America nearer where the markets are and we've offered tests and assembly facilities to various states where we're trying to penetrate the markets.

And it becomes a very attractive market incentive for states for us to locate -- for us to locate facilities there.

So those are the two pieces of that decision.

We haven't made that decision yet.

We'll continue to monitor the market.

We're prepared to make the decision.

As I've said I think in the previous call, if we make the decision too early, we have tied up the time value money of that capital.

If we make it too late, we lose a big market opportunity.

And that's what we continue to evaluate.

So we're prepared for the decision, but we haven't made it yet.

Now, assuming we make that decision by calendar year end 2001, implement it -- I mean 2002, implement in 2003, then we can -- have to follow that decision in mid '03 with the decision to expand to 400 megawatts in order to achieve that capacity during '04.

Okay?

So the -- the -- the timing is you have to take the first step and if we do that by the year end '02, then we could be on track to achieve 400-megawatt run rate during calendar '04.

Did that answer your question?

Basically, yes.

Then also, let me follow up if I can ask about the backlog.

It sounds like, if I'm doing my mental math right, you have about 12 to 13 megawatts in backlog as of quarter end, is that about right?

Joe, I think that's about right, isn't it?

Yeah, Jerry.

David, yeah, I think that the backlog is, I think, exactly 12 megawatts at this point.

Okay.

Great.

Thanks.

Your next question comes from David Snow with Energy Equities.

I'm wondering if you can give us a little more color on when you think from your compatriot at the equipment companies and the utilities, when the surplus will be off enough for the capital cycle within the utility industry to begin turning around?

Say that again, David?

When will the capital cycle in the utility industry start to turn up on a macro basis from what you can tell talking to GE or ABB or your customers?

Well, we don't to GE or ABB a lot but we do pay a lot of attention to the power industry.

Kind of a macro view as we see it and a think it's been confirmed with some of the comments late this summer on power usage is that, you know, with the very great slowdown in new plant construction, if there was a glut, there is not going to be one now.

Most of the new plant that we see that it if -- if it doesn't come on line by '03, it's probably not going to happen, which says that in '04 and later, you know, there is a lag to build a new power plants particularly central station combined cycle plants.

So there could well be a very shortage, if you will, of generation capacity in the '04 and later time range.

That's kind of how we see it.

Unless things turn around quickly, and I don't see that happening, because the financial structure in the power industry is not real good right now.

There is a credit crunch.

What did you mean when you said if it's not online by '03 it won't happen?

They will cancel the orders or what did you mean by that?

They have cancelled -- the IPPs have cancelled a lot of orders, and from what we have heard is that even if the plant is under construction, if it's not going to come on line by end of '03, it will probably get cancelled itself.

And I think there's some anecdotal evidence of that in the last few weeks with some of the companies.

Wouldn't those be partly completed to be revived for '04 if they were cancelled midstream?

It depends, David.

Obviously, that -- that could happen.

But, you know, when you're gearing up for turbine manufacturer, there is a lag cycle there.

I think there have been some layoffs at GE, and I'm not that privileged to GE, I can just give you the macro picture.

I think the other thing that has to be kept in mind is the T&D system.

We're having a lot of excitement in southwestern Connecticut right now with trying to run 750 killavolt lines down through the state to go under order to feed Long Island.

These kind of issues, you can have a lot of power but you can't get it to where the users are, is very much a stimulus we think for our business.

That was the other question I was wanting to ask about.

The FERC was going to try to put an adequate rate of return and send it in for T&D investments to take place.

Has that happened or is it in progress or what is your take?

I don't think so.

But I'm not he totally up to speed on it.

I think, you know, it's not just the rules, okay?

You got to get society to accept high voltage transmission lines in their backyard and that's darn near as tough as putting power plants in their backyard.

I think if we get the knowledge out in the marketplace to the ISOs, to the government and so forth that there are other options than stringing wires which is to put clean power plants on site where the need is.

And then the cost of urban distribution is prohibitive.

Even if you get the high voltage line into Connecticut, you got to get in our case from Norwalk terminal on the coast down to Greenwich or Stamford where it's needed which means you have to string more wires and that gets very problematic.

So there are two pieces of the puzzle.

One is do you have enough generation capacity?

Two is are you going to have the power where it's needed versus where it's generated and both of those, I think, work in our favor.

Is there any need for to you demonstrate to the world the reliability of your system before there will be mass acceptance of it?

I don't -- uhm... uhm... those are all subjective terms.

Yes, okay, in general.

But most of the early adopters we have talked to now where they haven't even seen it or anyone running for an extended period of time understand the basic technology that when there are no moving parts within the fuel cell, that it's a gradual decay rate versus a -- with no moving parts, versus the friction occurrences you have in rotating machinery, they understand the reliability factors and the inherent reliability of that kind of device.

Okay.

Thank you very much.

You're welcome.

Our next question comes from Christine Falkiss with Merrill Lynch.

Thank you very much.

Jerry, I just wanted to confirm firstly your indication of shipping 8 to 12 sub-megawatt and components as well as the 1-megawatt King County by the end of calendar '02, is that correct?

Calendar '02, Christine, yes.

Okay.

Great.

And I'm wondering, Jerry, if you can comment on how the backlog growth is looking including the $5 billion new clean coal initiative just announced by the DOE, and Joe, if you could give us what the working capital number was in Q3 and if R&D will stay at similar levels going forward.

Thank you.

Okay.

Let me address what our partners are up tomorrow.

The actual backlog is 12 megawatts.

As you know, some of those -- most of those are sited.

Some of those sitings haven't been announced.

There are some that have been made public that haven't closed yet.

Pepperidge Farms for two units here in Connecticut.

Sheraton Towers in Manhattan.

The SUNY up in Syracuse installation.

All of these are in process.

And it's interesting because the two in New York we're running against [INAUDIBLE] and ConEd and we're going through our partner P&L and Cat are going through discussions on the utilities with interconnect standards and stand by charges and so forth and that's been going on for a couple of months.

Those are the kind of issues one runs into with distributed generation and it takes time to close them.

And that's where we see as well as other people in the DG business, the biggest opportunity for governmental involvement is to settle the interconnect issues, settle the stand by charges issues and really jump-start a DG market.

Would those Manhattan projects be included in the backlog or these new --

If you notice the way we've done our backlog, Christine, our distribution partners have committed to buy so many units.

They've given us down payments and we have started building the units.

Then they have to go out and locate customers for those power plants.

When they do, they announce them as sites.

PP&L has officially announced four sites.

The Coast guard, two Starwood hotels in New Jersey and Ocean County just announced last month -- or this month.

They have three more that they will announce as soon as they close the contracts on but they have bought them regardless.

Okay?

Same way with Marubeni.

So our financial backlog is what's been bought.

Our shipment backlog is based on these siting announcements because we didn't want the units sitting in inventory at our partners' facilities.

We want them out at customer sites.

Then the others, Chevron, Viron, MWH, they are working multiple projects on the West Coast and Northeast.

They are working 250 kilowatt units, they are working quite a few megawatt projects and as those close we will add those to our financial backlog.

Joe, you want to pick up the R&D?

In terms of working capital, let me just talk to the components of what happened in the quarter, Christine.

In the two accounts that are really the primary drivers in terms of cash activity would be inventory and other current assets.

That inventory balance compared to the prior quarter has actually declined, but let me before I talk about that let me just talk about what's in other current assets.

Other current assets include deposits on our balance of plant.

Just prior to moving it into inventory and just prior to moving it to projects.

So in effect, if you look at the two accounts, you have 16 million in inventory, 7.3 in the deposit account, versus 18, 2.

So we have a little bit of a mixed shift.

But we have inventory related items is approximately the same in the quarter.

And we would expect over the next quarter or so in a that level is probably a good -- that's probably a good level.

In terms of the IR&D account, that number is clearly higher.

I think in Jerry's comments, I think we talked to some of the work that we have been doing in the quarter and again, for the next, you know, quarter and somewhat into the fourth quarter, that level will probably remain the same then we'll -- and then those related items will decline.

The items we're working on obviously are the A300 and the A300 engineering issues, the prime drivers in the IR&D account.

Christine, I didn't get the other part of your question, which was the coal or the clean coal initiative.

Yes.

That's an exciting program.

I think just read this morning that there's like 36 proposals into DOE for $5 billion.

We have a proposal in to them, also.

And you know, whether it will be this round or the next round award, we feel pretty good about it.

We are -- there is a lot of excitement in DOE and they were very -- working very well with us in Global Energy to get this -- the two-megawatt plant shifted from Kentucky to Indiana so we could put it out right away.

And the fact that 2-megawatt will follow the 1-megawatt plant in Torrington, grid-connected, and we ought to ship it next year rather than two or three years from now.

So and that got as you saw from the announcement, got all the way up to Spencer Abraham's attention.

I think clean and coal will see a lot of support from this administration.

Great.

If I could have one more follow-up with Joe.

On your cost of product sales and revenue line that number there, can you discuss, is there anything in there that's more of a one-time related item, such as retrofitting the units for heat exchangers or is this really on going development that we could look for the next couple of quarters?

No. -- that's a good question, Christine.

No, I think it has a lot of first-time costs.

And it, uhm, it's the cost of retrofitting like you just said.

I think you hit the nail right on the head.

It's the cost of retrofitting these units because we think we're very close to putting good, reliable commercial units out and we want to make sure that that gets reflected throughout the product line.

So I would expect that that relationship should decline very quickly.

Can you quantify how much of that would be considered retrofitting and more one time versus on going costs?

I think if you go back over the -- historically, we were running I think last year about 1 to 3 relationship between the revenue and the cost.

We're expecting that that as we increase volume -- the goal is to get the 50 megawatts volume at 50 megawatts, you know, we expect to be margin equal or in that range plus or minus.

You know, we expect volume will get us there.

And, you know, as we get down that path, we expect that the 1-3 ratio should be driving down to 1-1.

And we would expect that once we get on the cost curve, we're not there quite yet.

We're still doing the one off units.

But as we get orders and get production through-put, that we will drive, you know, we'll drive that number from 1-2, down to the 1-1.

Great.

Thanks a lot.

Your next question comes from Jarrett Carson with RBS Capital Markets.

Good morning.

On the -- Joe, on the operating revenue product sales revenue line, obviously, it didn't really come in where I was expecting.

I think and we've talked about that.

Is that simply a result of obviously we're making some changes there that slowed the shipments down and because I know, you know, obviously 3 to 6 months ago we were talking about third quarter showing an uptick and then fourth quarter showing a even bigger uptick.

So is that -- a lot of that simply slid to the fourth quarter, is that a fair statement?

Yeah.

I mean, I think actually we've talked about, you know, same philosophy in prior quarters is it that -- is that it has shifted out to the next quarter.

So I think, you know, in the fourth quarter of this year, I would expect that revenues will start to increase and then in the first quarter of next year, you'll get the completion, you know, most of the completion, I believe, of the back -- you know, what's in the backlog delivery cycle.

Obviously, there will be continuing deliveries in '03 but you'll see, you know, activity starting in Q3 and then more heavy in Q4.

I do want to say, however, that in the research and development contract line, you know, the primary driver of the increase in that revenue is really product -- it would be the same type of transaction.

It's really the King County getting the King County units ready and it's clean coal, and those -- and coal mine methane and those are all product delivery type activities.

So you really -- in a certain sense, have to look at the two lines together.

Okay, yes.

That's fair.

Second, Jerry, can you talk a little bit about maybe a nearer term opportunity kind of a T&D congestion opportunity, particularly obviously we're seeing some issues in the Northeast.

How are you approaching those?

And then some of your, you know, what do you think the prospects are near term for some order flow in that -- in those areas?

Well, we're obviously jumping on anywhere there is grid congestion because we have the solution -- and the only potential solution in the megawatt class and what we're looking at is anywhere from 5- to 20 watt installation that would be substation oriented if not into commercial/industrial customer plants where we can offset this demand with a phased investment.

When you put in -- when you go from a 375 kilovolt line, you put in much more excess capacity than you need, that you probably won't need for ten years.

Better that to put in the megawatts you need year by year is the approach that we are taking and making the ISO's FERCs and all those guys that there is another choice.

You don't have to put in double capacity transmission lines.

You can do these in incremental or phase type investment.

And whether that will get traction to turn into orders or not remains to be seen, Jarrett, but there is a significant interest as you would expect in multiple places in the Northeast and in California and even in selected place in the big area in between the two coasts.

We're seeing some strong interest level.

There are a lot of issues that have to be ironed out more and beyond just the price of the units and the value that they bring.

Because you have utilities who aren't allowed to generate putting in Tand D lines so they have a different interest level than the local PUC and the consumer demand.

So there are a lot of factions involved in this because it hasn't really been done before.

You really didn't typically have a solution that said we can put something in clean and yet so highly efficient that it becomes competitive.

That hasn't existed before.

And we think -- we think it will.

When it will close, I think remains to be seen.

Okay.

How do you see the following -- your big sales meeting with all your distributors to get them up to speed any mean, what do you see as kind of the next six to 12 months, the charge, I guess, that you gave these guys as they left those meetings?

And what are kind of your expectations for those guys over the next six to 12 months I guess in particular Catapillar?

We have very high expectations but we know it takes some period of time to get traction I don't mean weeks, I mean months.

It is new.

It's different.

It hasn't been done before.

You are going against -- the product that you can put in base load that you can site anywhere and yet a high enough efficiency to be competitive with grid power hasn't existed.

Engines and it your bins won't do that in these small-megawatt sizes.

So we got to get them up the learning curve, we have to do a lot of hand holding, we got to go on a lot of customer qualification visits, okay?

We get them all the time.

They get them all the time.

Boy, I'd love to -- I want to see that -- I want to see that FuelCell.

You are qualifying who are the right customers, who are the wrong customers and that takes time to do.

It takes time for traction.

Our measurement points are Marubeni in Japan and P&L in the US and those are the two newest.

MPU has been a partner for ten years or better but the two newer ones and how long it takes them to penetrate the market and it's taken about a year, you know, we're hopeful that Cat and Chevron and the others will get traction in six months.

But we're expecting six months to a year.

Just to guide of go through a couple of key distributors here, make sure I'm on track, pretty much now units announced or ordered by MTU are accretive.

Maybe I'll use that word, too.

To backlog, a, there is no slack, my expectation is PP&L is probably close or any announcements to them would be accretive to backlog and Marubeni has probably one to 1 1/2 megawatts or so of slack still left in kind of what they have committed to?

What's been actually cited?

I think that's pretty close here.

Okay.

All right.

Thank you.

Your next question is from Lisa Callahan with Bank Equity.

Hi, guys.

Just a question on the current German legislation.

Is MTU still using the older program?

And when they start implementing the .05 kilo watt subsidies hours?

That's a better question for MTU than me.

I can give my top of the head.

The earlier program has more net present value than the 5 cents.

The 5 cents is equivalent to almost $3,000 capital costs.

But it's paid over 10 years.

So depending on what discount factor you put in there, it changes that $3,000 a kilowatt to something different the earlier program and I don't know how long it lasts or I thought it was -- I thought it only lasted through this year end, the earlier program was a fixed capital subsidy if I remember.

And if you look at a lot of the installations, the RWE and all, most of the MTU's customers are puting in really showcase what I call showcase installations.

They're in, you know, glass museum-looking things.

I've seen the one that's going into Deutsch Telekom in Munich and it's going to be in a glass-enclosed structure outside, you know, this main building.

So, you know, a lot of their costs goes into building those structures.

Which is fine.

And I know MTU is focusing on the five Euro cents but they have done real good on the current program and they want to tap those funds as far as they can.

Could we expect follow on orders from the original site that is were announced last September with the current orders that were just recently announced?

Yeah, what -- what they have done during the quarter is ordered six more stacks, six more 250 kilowatt stacks for as yet to be named sites.

We know who they're talking to.

But if obviously they're our partner.

It's up to them to make announcements as they see fit and as they close their situation with their partners.

Obviously, if they -- for them to give us a purchase order, you know, and be subject to invoicing, uhm, they feel pretty confident about it.

But again, it's up to them to make announcements with customers, not us.

Thanks, Jerry.

Joe, could you just in the inventories that came down, but could you just break that out between raw material.

Actually, the primary driver of the inventory line coming down was the removed -- we removed some costs related to clean coal. -- into cost of sales, as a result of recognizing the revenue on that.

So the significant reduction in the account was really that.

And then we did ship some units to MTU and then we increased actual -- actually increased some cell -- net cell production in the quarter.

And then the other piece is that the balance of plant for the moment is showing up in this quarter is showing up in other assets as they represent deposits on balance of plant.

All right.

Thanks, guys.

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

Good morning, guys.

Good morning, David.

Coming back to the backlog for a sec, can you give us a sense of what the amount over 12 megawatts has been sited and then a figure for your financial backlog?

The -- Joe -- I know, all of these units, these committed units are in the 4,000 to $5,000 a a kilowatt price range, David, so I think you can probably use that number, Joe, with that -- is that correct?

Yeah.

I mean, I think that that's, uhm, we consider this the 12 megawatts.

While there are still some unsited units within the backlog, for example, the new order from MTU is up sited, but it is an order and it goes into our financial backlog.

That we would consider this you know, commitments for the 12 megawatts that we have here.

So it includes the combination of both sited and unsited units.

Is roughly 75 percent sited or --

Yeah, I would say that, uhm, 75 percent is probably a pretty good number.

Okay.

And you've mention several times about some fairly interesting cost reductions that seemed to have delayed the commercial product coming out.

Does that impact anything towards getting to your cost close?

It sounds to me like some of them are pretty significant.

Well, as I was trying to say in my formal remarks, David, there's three main things going on right now.

One is standardizing these products with the right suppliers, with the right components, with the right equipment.

Second is getting volume production up.

And yields at the same time.

It doesn't do any good to brute force production and not get the yields.

And third is getting our distributor networks up to speed, trained and developed.

Those are the three primary components of our cash burn right now.

We see another 3 to 6 months before we'll be basically complete.

Now, you are never finished with, you know, we're doing the 300A now, there will be a 300 b, c and d.

But the bulk of it will be completed in three to six months and at that point in -- the bulk of it will be completed in three to six months and at that point in time we won't be smending major funds on those areas before.

We'll be using our funds for market penetration, okay, or we'll -- if the market doesn't give us that option or depending on the degree of it we'll preserve our funds for market penetration.

The big thing we want to do is launch 50 megawatts and then beyond that, 150 and 400, of production.

That's what we're trying to do but we got to be positioned to do that.

And then in terms of the cost of the actual units, though, like, you know, you have talked in the past, say, about 2500 or below.

Is that sort of the target on these commercial systems?

From what our partners feed back to us and it's a direct parallel to the incentives and all from the states, in that $2500 to $3,000 range, you start becoming -- the numbers pencil pretty good in a lot of the -- you know, Northeast, West Coast, Japan, Europe.

You get below those numbers and it becomes even more attractive.

Okay?

So -- and somewhere at 50 megawatts of production, we still believe we're in the 2800 to 3200 depending on the product, the 350, or 3,000.

So if you know our 400-megawatt goal is 1500, then we know that the economics are really attractive then.

And we know that because we know what we're selling to our partners for.

We know what they're putting in from cogent and all and we know the incentives they are getting in New Jersey, Massachusetts or what they're proposing in California, and it makes the numbers pencil.

Okay.

Last thing.

On California power authority, we haven't heard a lot on that lately.

I'm not sure if you guys have heard anything else, as well.

But similarly, there is a Texas program that seems to be under way.

And my understanding it was to be announced kind of in the fourth calendar quarter.

Are you guys -- have you guys heard anything on that or do you --

Yeah we have the head of marketing and sales out in California this week.

But David Freeman head of California Power Authority does confirmed.

It looks like they are trying to become more instead of the buyer aggregate, they are trying to be if they can raise the bond, the financial backer of putting in fuel cells so they provide very attractive and low-cost financing to the various state facilities to get these fuel cells in.

I would mention there is other monies in California than just what California Power Authority is trying to do.

The CPUC self-generation initiative I think has $40 million funding now.

And we're qualified -- qualifying for that money.

You have the south coast air quality district.

You have California Energy Commission money.

You have the California fuel cell initiative being formed.

So there are multiple other things going on in California.

In Texas, as I understand it, the legislation will be debated in January.

I think it will be -- it's submitted now.

And it's an interesting program because they are talking about a thousand megawatts of fuel cells but the uniqueness is that they want to tax the dirty power plants to pay for the new clean fuel cell power plants.

That is -- probably doesn't make the utilities too happy, but it sure is politically I think pretty good.

It's hard to be against taxing the dirty ones to pay for the clean ones.

But we'll have to see.

That legislation has not passed in Texas.

We'll have to see if it eventuates.

How about in California, Department of General services, anything there?

There is -- I think they are looking at some aggregation but I'm not that familiar on it Dave, to comment further.

Okay.

Great.

Thanks, guys.

All right.

You're welcome.

Your next question comes from Kelly Nash with McDonald Investment.

Hi, guys.

I just had two questions.

Can you provide any kind of operating data as far as how the units currently in the field are running?

And then secondly, can you give us an idea of what we might see as far as employee count over the next year or so?

And what functions are you increasing, if any, over that time period?

Okay.

As far as operating data, Kelly, we are consistent I think consistent with most equipment manufacturers that we don't publicize field trial operating data at conclusion of programs, we'll do typically do a report.

But not on an interim basis.

Obviously, they're doing what we expect them to do.

We are running them, putting them through the paces.

We're learning a lot.

We have had some issues that surprised us and some issues that pleased us.

But it's very typical of a new product introduction program.

So that's on the operating data.

And your second question was?

Employees.

Employee count.

We're probably around 440 today, Joe, somewhere in that neighborhood?

And we're pretty much rounded out.

We'll slow down now for the next three to six months and see what the market looks like.

But let me give you some of the examples.

Now, we hired, I don't know, three or four months ago a fellow to run our spare parts business.

Okay?

Obviously, if you are an R&D company, you don't need a parts company.

But you sure do if you put parts in the field and hired a lot of field service engineers to work with our distribution partners in installing, starting up, operating and troubleshooting these units.

We have hired increased our information systems support because we're putting in enterprise resource planning and communications tools.

So it's all the kind of things, functions you would expect that you -- either we need more people because of volume or there are functions that we didn't traditionally have as a company moving from development stage to commercial.

Okay.

But over next year or so you don't anticipate --

I'm going to say three to six months because if we -- as depending on what level we launch for market penetration, whether it's, you know, 10 or 50 megawatts that could change our head count pretty dramatically.

But it will be filling in for volume, not for key skills.

Okay?

Got it.

Thank you very much.

Your next question comes from Chris Kwan with TD Securities.

Hi.

It's Chris Kwan.

One question that was answered by the last person, I'm just wondering on the additional employees -- you added I think, 90 -- I think in the quarter?

I'm just wondering what are some of those people added, what functions are they doing?

As I said, a lot of field service.

Production workers in Torrington, those are the bulk of them both assembly and production in Torrington.

Beyond that, it's, you know, one off engineers here, special skill there.

I'd say probably design engineering, production, field service, and design engineering are the three main categories.

Okay.

And of the -- you said 440 today, is that all salaried?

Any hourly?

That's a mix of salaried and hourly.

But I can't tell you off the top of my head.

I mean, I would look at it, Chris, in terms of what do you have in Danbury, uhm, you know, Danbury's got, you know, R&D, has field service support, application design engineering, functions, uhm, I would say the headcounts are probably 50/50, you know, 200-plus in Torrington and 200-plus in Danbury.

Okay.

The second question, of the -- those new orders -- the additional orders to MTU, are these different than the ones that you guys have already talked about as to, uhm, orders that MTU was -- that new your current backlog?

I'm just curious as to what --

The answer is yes.

The ones that are -- that have been identified in our backlog are Deutsch Telekom, IPF, BSE, off the top of my head.

Those were announced plants from MTU about a year ago, Joe?

September.

The growth numbers.

And this is six additional units or stacks for six additional units that they ordered during the summer that will be delivered for next year.

So these are six in addition to the ones --

In addition to the 7 or so I have named, six additional ones.

But they have not announced where they are going to be going or who the customers are.

But you don't include this in your backlog?

We do include this in our backlog.

This is an order -- this is an order that we had to deliver on to MTU.

We may actually deliver before they site them.

But these are shipments that are planned from Fuel Cell to MTU.

Okay.

Just one last question on your costs.

You alluded to that there are some one-time costs.

I'm just wondering, uhm, in terms of your R&D, -- initiatives, are you -- to bring these costs down, like, you have been at this -- the costs into the -- into the field is around 4- to 5,000 for some time.

Are you just waiting for volumes, or are you experiencing some cost reductions somewhere else that you are doing in your labs that is different?

I just haven't seen that cost number come down much.

The -- the -- the R&D focus is on improving the performance of the technology as well as cost reduction of the fuel cell components themselves.

Different materials, lower cost of tears, et cetera. -- materials, et cetera.

The other big area of the cost is not in our R&D -- of the cost reduction, but is in engineering.

Which is engineering, the balance of plant and everything outside the individual fuel cells to reduce cost.

And you get that by -- I gave the example of this Sumitomo heat exchanger that's, you know, one half the price and one tenth the weight of what we were using and we're retrofitting all our plants with that.

You know, there are other examples that we're looking at.

I have electrical balance of plant for 300 kilowatt, 1 1/2-megawatt and 3-megawatt from three different suppliers.

Okay?

So it's not only you got to get the supplier for the 300 kilowatt but it's even necessarily the right supplier for the other.

He might not be.

You not only buy them, I try all three of them.

Now I have 3 qualified vendors for all three electrical balance of plants and then it puts me in a good position to reduce costs through either value engineering or volume or competitive pressures.

Of that I'm just wondering how much when you talk about the first part, improving the fuel cell components, how much of that are you experiencing in terms of your costs?

If you were to split the two of your focus, is it like 50/50 between the two or....

Let me answer it a little different way.

If you look at the fuel cell components themselves, we have a much steeper cost curve -- steeper learning curve or cost reduction curve than with the balance of plant because the balance of plant is pretty mature equipment although it's custom-engineered for us, you know, it's heat exchangers, blowers, water treatment systems, electrical controls, switch, gear and burners.

So it has a much less steep cost curve or learning curve than the fuel cells.

So we'll get more percent cost reduction out of the fuel cells than we will out of the balance of plant.

But we got to work on both of them and the third area to work on is when you are trying to reduce dollars per kilowatt, you you want to reduce dollars but you want to increase the denominate earthquake the kilowatts.

And that's the main thrust of R&D is to take these plants that we are initially putting in the market at 250 kilowatts, one and two megawatts, and mature them to 300 kilowatts, 1 1/2 and three megawatts.

It may not be clear to you, but the balance of plant that we're shipping with these units is sized for the larger size, the nominal rating.

The actual fuel cell stacks, the initial fuel cell stacks, will operate at the lower ratings.

So part of the cost that we're incurring even in the early units is so that the customer over the 20-year plant life doesn't have to replace his balance of plant as our technology guys increase the kilowatt performance output.

Great.

Thanks.

Your next question comes from Mike Harris with Robert Baird.

Can you give us some idea of which units, if any, will likely become operational in the next quarter or two?

For example it sounds like the MTU unit for the telecom application will likely come on line here in the near future.

Just looking for a little detail there.

Thanks.

I don't -- again, I don't want to speak for MTU.

But the MTU -- the RWE unit in the RWE energy pavilion is in operation.

The one for Spain for the ship builder has been delivered, although not started up yet.

The next one to be delivered is Deutsch Telekom.

All of those, I, you know -- we're talking a few months, not a long time before they're up and rolling.

And then there's others following those.

From our shipment standpoints, we want to focus on some early units for PP&L, the early units for Marubeni and LA.

Those are three kind of highest priorities that we want to get out the door first.

Which one will actually ship first, you know, I wouldn't want to say right now.

But it will be focused on the early PP&Ls, the krks the New Jersey hotels, it will be focused on Kirin brewery and and the next units for LA

Great.

Thank you.

Your next question comes from Ali Aga of Bank American Securities.

Thank you.

Couple of quick questions.

Joe, could you give us a sense of what we should expect from a percentage completion basis in the full fiscal fourth quarter?

How much would you be booking versus just some sense of on a percentage completion basis, how Q3 came out, whether it's in megawatts or some other measure that you track?

Yeah.

My expectation, Ali, for the fourth quarter is that the research and development contract, that will be relatively the same range as it was in the third quarter.

We got revenue of 10.3 and, you know, give me a little bit of range on that but it should be generally in the same area, the same contract pattern is in effect, Clean Coal, King County, coal mine methane, and the DOE large DOE project.

I would also expect that, you know, as Jerry just described, you know, the first three units we are focused on getting those out.

As we get closer to that, then we expect to increase the product sales and revenue.

So in effect what we see is we think that the third quarter is somewhat indicative of both the fourth quarter and probably the first quarter.

It will have a somewhat of a change in the components.

I mean, third quarter, we were developing standing products or increasing production volume, costs related to the developing and distributor network.

In addition to those, we will also be delivering these units which will carry probably a little bit more cost into the those -- into those quarters.

So we would expect the same pattern for the next two quarters come out of those quarters, we would expect, you know, a lot of these one-time expenses to decline at that point.

And we're looking at, you know, based on how the market develops, we're looking at the penetration strategy at that point and, you know, we fully expect that we'll be moving into that strategy where we have volume production that we are getting orders and that we will be delivering, you know, volume at that point.

We also will be at a point, however, that, you know, we can look at -- we'll have a pretty good view of the market at that point.

We can look at our cash run rates and how -- and what it looks like, and in effect, Ali, we would expect we'll have in excess of 200 million in cash at that decision point.

So we'll have $200 million looking at what the market is bringing to us, and then we have you know, flexibility.

I think we have the financial flexibility to move forward and hopefully the market develops as we're seeing it.

Or we could also manage our situation.

We could actually reduce cash burn and then preserve our cash.

So that's really what we're working for.

We're working for, you know, the two-quarter period where we are going to finish off the engineering work, get these units delivered in the field, you know, start running up the kilo watt hours and then be able to react -- you know, our manufacturing plant will have 50 megawatts of capacity at that point in time.

We can react to the marketplace.

And given those different scenarios that you are looking at, Joe, could you give us a sense of what from budgeting purposes the cash burn could look like in fiscal '03, what kind of range you're talking about?

I'm not really -- what I would like to do and what we have tried to do on these conference calls is to give, you know, give you the visibility that we have.

And the visibility I have is really out the next two quarters.

So what I'd like to do is really kind of reserve that, you know, reserve that for potential next conference call, Ali.

Okay.

Jerry, coming to you, in terms of the discussions that you're seeing out in the market, all the initiatives through you and your distributors, what's the biggest challenge that you are heading back from potential customers, is it budget constraints, is it the reliability of the units?

What is the biggest challenge that you think you need to overcome before some of this volume actually goes out the door?

I think it's more market education, both of our partners as well as of the marketplace.

I mean, you know, I mean, ISO New England never thought that they could solve their problems with distributed generation plants that are clean enough and highly efficient enough to be an economic proposition.

And you got to explain that to them, okay?

And obviously, they're fairly knowledgeable people.

So, one, I think is just market education.

This is a new product that does exist.

Okay?

Prior to this.

The second area is I alluded to earlier, this whole area of interconnects, stand by charges and so forth.

You know, our partners are doing this on two projects for which we -- they will receive a million dollars each in funding.

Approximately a million.

For 250 kilowatt unit.

If it takes three months of negotiation of interconnect and standby charges for a little 250 kilowatt unit, you know, that's not helpful to the market.

If you are talking 2 or 3 megawatts, you can take 90 days to do it.

So that's probably as big a stumbling block as the market education.

And, you know, there's a lot of companies both competitors of ours and in distributed generation business whether engines, it your turbins, fuel cells, photovoltaic or solar or wind that are finding the same kind of issues.

And that's probably the biggest stumbling block to DJ, which of course impacts us.

And final question.

Along those lines, Jerry, as you guys are out there marketing your product and looking at these various initiatives, generally, who have you found to be your biggest competition, whether it's other fuel cells manufacturers or other products within this new technology sort of framework, who have you found to be your biggest competition out there?

The only fuel cell competition that we look over our shoulder at is Seimens Westinghouse because they have the potential to reach the same performance levels as our fuel cells and then it becomes who has the best capital cost.

Other fuel cells, the low temperature fuel cells they're 15 to 18 percentage points lower in efficiency and they don't have a waste heat product.

So we don't really look at that.

It's really overcoming the inertia of engines and turbines.

For base load generation, even if you can site an engine and a it your birngs you put on enough environmental controls to site it, at the end of the day it's a 30 to 35 percent efficient machine so you can't get the economics to compete against base load.

So this is, now to get one that is high enough efficiency and siteable that you can compete against the grid hasn't happened before and that's an education process we have go through.

Even though, you know, as we even as we have incurred some dlaid delays in our redesigns and all this stuff, we don't see that we have lost any ground in the marketplace.

We think we still have a couple of year advantage over anybody else coming out with a fuel cell that can do anything close to what ours does.

So we feel pretty confident.

It's just an education and overcoming the distributed generation barriers that are our main focus.

Thank you.

You're welcome.

Amy, we have time for maybe one more?

Okay.

Your next question comes from Bill with Wachovia Securities.

Good morning, guys.

Good morning, Bill.

Just wondering if you could give us any additional details on the potential for, additional distribution partners.

Do you have essentially other partners that you need at this point, or could we expect some more to be announced going into the future?

I think the right way to say it is that we have rounded out pretty good.

Obviously, if additional ones surface, we'll sure take a look at them but we're not actively pursuing directly.

We have had and will continue to have some discussions.

It's not a highest priority for us right now, Bill.

I don't want to say no because, you know, part of what we're doing also is monitoring our partners' progress.

And, you know, as -- that's why we wanted 8, 10, 12, worldwide is that we are going to have some doing better than we expected, some not as good as we expected and that list will kind of evolve itself over time.

Thank you, Jerry.

My other questions have been asked already.

Very good.

Well, thank you for this conference call.

And with that, we'll conclude and talk to you again in a few months.

Thank you very much.

This concludes today's FuelCell Energy conference call.

You may now disconnect.