燃料電池能源 (FCEL) 2002 Q4 法說會逐字稿

Good afternoon, my name is Dawn.

I will be your conference facilitator.

Welcome, everyone, to the 2002 year-end results conference call.

All lines have been placed 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, then the number 2 on your telephone keypad.

Thank you.

I would now like to turn the call over to Mr. Steve Eschbach, Director of Investor Relations.

Sir, you may begin your call.

Thank you very much.

Good morning, everyone.

This is Steve Eschbach, Director of Investor Relations at FuelCell Energy.

On behalf of my fellow executive management team at FuelCell Energy, thanks for joining us on our year-end and fourth 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 plans and expectations, and the development and commercialization of its FuelCell technology.

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

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

Thank you, Steve.

Before I provide my remarks, I'd like to turn over the call to Joe Mahler, to review the fourth quarter and year-end financials.

Thanks, Jerry and good morning, everyone.

Revenues for the fiscal year increased 57% to $41.2 million from 26.2 million in the previous fiscal year, while revenues in the fourth quarter of 2002 doubled to $13.7 million as compared to $6.7 million from the previous year.

The company ended this year with over $220 million in cash.

For the year, FuelCell Energy increased revenue 45% to $7.7 million on product sales and 61% to $33.5 million on revenues from research and development contracts.

Revenue in both the current quarter and the year to date periods included the Department of Energy's cooperative agreement, the 2 megawatt Clean Coal project and 250 kilowatt Coal Mine Methane project.

In addition, revenue in both periods include the one megawatt King County waste water treatment facility.

The U.S.

Navy Marine diesel program.

FuelCell shipped to our European partner, MTU.

And production of DFC 300 A power plants for PPL, Marubeni and the L.A.

Department of Water and Power.

The company reported a net loss for year end at October 31, 2002 of $48.8 million or $1.25 per basic and diluted share compared with a net loss of $15.4 million or 45 cents per basic and diluted share in the previous fiscal year.

For the fourth quarter ended October 31, FuelCell Energy reported a net loss of $20.7 million or 53 cents per basic and diluted share, compared with a net loss of $4.8 million or 12 cents per basic and diluted share in the same quarter of the prior year.

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

For the fiscal year, full-time staff increased by 161 employees, including 76 in production, to a total of 425 employees at October 31, 2002.

Cash, cash equivalents and investments, which are U.S. treasuries, on hand as of October 31, 2002, totaled $220.6 million.

For the fiscal year, the company used $69.9 million of cash, including $15.4 million in capital expenditures for 2002.

In the fourth quarter, $19.9 million of cash was used, including $5.1 million for capital expenditures.

Depreciation expense for the year was $3.1 million and $1.1 million for the fourth quarter.

The cash use of $69.9 million was in line with our estimates of 50 to $80 million for 2002.

Heading into 2003, we start the year in strong financial position with $220 million of cash.

During the August conference call, we outlined that for the short-term period of three to six months, we would focus on our near-term product strategy of developing standard products, increasing production volume, and developing the distributor network.

At the completion of this effort, we will have flexibility to maintain, reduce, or accelerate our business activities consistent with market demand.

We continue on this course.

We expect the same pattern for the first and probably the second quarter of 2003, at which time we will be in position to execute the next phase of the company's growth strategy.

At that point, our cash position will remain strong and we will have the flexibility to adjust to market conditions.

We will update you on our next conference call.

I will now turn this call back to Jerry.

Thanks, Joe.

I'm pleased to report we've made significant progress during 2002 on our near-term product strategy, which focuses on four areas.

First on standardizing our DFC products, including system and subsystem design, incorporating field trial improvements, qualification amongst our suppliers, factor acceptance testing, emissions critical equipment and components and materials.

The next focus area is to increase production capacity.

We have received our second tape caster, and as a matter of fact, ran our first test cast yesterday.

We have enhanced our process control for quality and productivity in all manufacturing areas.

In Danbury, we've expanded our test and assembly capability and leased additional space across the street for locating our park and service infrastructure.

Our European partner, MTU, expanded its facilities in Munich.

We have formed our belief of expanding distribution alliances and focused on sales, training, as well as market and application development.

Finally, as Joe mentioned, we built the organization to implement our strategy, filling out most of the key spots during 2002.

As we head into 2003 and beyond, we believe we have the right products, strong distribution alliances, and the organizational and financial strength to penetrate markets in Asia, Europe and the U.S. with our Direct FuelCell products.

Let me make a few comments on how we see the markets.

The power industry continues in turmoil with the economy weak, demand for power down, especially in the industry, uncertainty about government actions is also a factor.

Power plant financing is virtually impossible.

And even if things improve, there is always a lag before significant megawatts can be put in place.

However, the key drivers for generation remain in place and may be strengthening.

While the U.S. lags in addressing CO2 emissions and we await a national energy policy, the rest of the world is moving forward, especially in Japan and Europe, enacting substantial incentives for clean and efficient distributor generation, which is synonymous with our GFC products.

Global tensions increase concern about [INAUDIBLE] fuel.

The cost impact of unreliable power supply continues to grow, and the lack of transmission and distribution investment exasperates the issue.

The expectation is a 25% growth in electricity demand over the next ten years, with only corresponding growth in T&D investment of 4%.

It came home to us at FuelCell Energy when our Torrington facility was knocked offline for 36 hours a few weeks ago from an ice storm.

The recent events in the Carolinas is even worse, as are the current snowstorms Northern California.

We also are starting to see real recognition that by adding DS and power plants for grid support, the growth and electricity demand can be satisfied in a phased investment in smaller increments of tens of megawatts, versus hundreds of megawatts, which is necessary when considering new transmission and distribution networks.

In fact, we're actively pursuing several multi-megawatt opportunities to relieve grid congestion at this point if time.

So, we believe the drivers are there and the market is large.

Just in the U.S., a study recently prepared by DOE and EIA in late 2000 identified a combined heat and power installation potential of over 74,000 megawatts, including 6600 megawatts for hotels and motels, 8300 megawatts for hospitals. 17,500 megawatts for schools, colleges and universities.

And over 18,000 megawatts for office buildings.

Based on the accumulated experience with our submegawatt products in both the Alpha units and field trials, we developed the next generational product, the BSE 300 A, which has better performance, lower cost and a smaller footprint than the DSE 300..

We're shipping the units now and implementing a follow-up program to monitor fleet performance, including additional instrumentation, field service, and data gathering.

We successfully completed a joint safety and serviceability of the 300 A units about four months ago.

In the megawatt correspondence, we completed the design, procurement, and factory testing, and installation of the first one megawatt plan in Torrington.

The first portion of that we ship to Danbury in the next two or three weeks for tests and conditioning, then return to Torrington for operational testing of the full DSE 1500 power plant, prior to shipment King County to operate on waste water treatment digester gas.

It will be followed by about three months with our first 2 megawatt plan for DSE 2000.

When design and procurement are complete, factory testing is ongoing, and the first BOP equipment are being delivered; again, following testing on natural gas in Torrington, the unit will be shipped to Indiana to operate on coal steam gas.

During 2002, we started the initial systems integration for 40 megawatt Direct FuelCell combined cycle with a turbine, and completed operation of the proof of concept system that combined a 50 megawatt cell with a 30 kilowatt turbine.

In October, we received a $16 million [INAUDIBLE] modification to the Vision 21 contract to include two packaged submegawatt demonstration units, one in Danbury and one at a customer site in Montana.

In the patented DLC patented turbine system, the FuelCell power is augmented by a [INAUDIBLE] gas turbine, using the [INAUDIBLE] FuelCell.

In the larger 10 to 50 megawatt combined cycle design, it is expected that the DFC turbine will approach the 75% electrical efficiency, as specified by DOE's Vision 21 program and retaining the same ultra-low emission of the plant.

We also made good progress in the last year on the diesel FuelCell for the Navy.

We will build a 500 kilowatt unit and the fuel processing system here, test it and ship it to the Navy site for land-based durations later in the year.

As we've said before, our strategy for commercial distribution is to work with strong alliance partners and electric power equipment sales and service, what we call OEMs, as well as energy services and solution companies.

The Escos [PHONETIC] and specialty application developers.

We conducted a number of training sessions last year for all of our partners that focused on application sales, service and installation.

Based on the experience with MTU, PP&L, and Marubeni, we expect our newer partners to start getting real traction in the marketplace this year.

We and our partners are very excited about the potential before us and are engaged in a number of opportunities.

We're focusing on such states as California, Ohio, Texas, New York, New Jersey, Connecticut and Massachusetts.

And applications, including universities, hospitals, waste water treatment facilities and grid support in T&D constrained areas.

We cannot provide you with any specifics, but we are finding our FuelCell power plants are attracting broad interest, even with 12 to 14 cents per kilowatt hours generation cost at the current gas prices that we have today.

While encouraged about the level of interest, the sales cycle time from initial discussion to contract closing is much longer than traditional or mature equipment.

There are three primary reasons for this.

First, our DCF power plants aren't replacing existing [INAUDIBLE] electrical generating equipment, but creating a new marketplace for clean and efficient baseload power.

So new sales plans have to be developed in personnel training.

The transactions are more complex and time-consuming, with the involvement of government incentives.

Then we must overcome obstacles to distribute a generation that all DG companies face, turbines, engines, whatever, such as stand by charges and exit fees.

Let me give you a few examples that you've probably seen in the media.

Our partner, PP&L, was awarded with the Sheridan New York Power Hotel, a $1 million subsidiary in June and the project is still not yet closed because of inner connect issue.

Another is an award to PP&L for Pepperidge Farms for two units here in Connecticut, that likewise haven't closed.

Another is for Suni in Syracuse with an unidentified partner that we're waiting on closure.

As a matter of fact, the unit that was going to Yukon is now being cited at Yale.

While we expect all of these to close, the order cycle is longer and more complex.

On a final not, our partners added 11 new customers with various applications in our target market segments during 2002.

In 2003, we're focusing on a few key areas.

First, delivery and commission of the DFC 300-A power plants in the backlog.

We started the process, shipping the first unit to [INAUDIBLE] and Tokyo.

It arrived earlier in December.

The second is planned to ship to L.A. before year-end.

Followed by three more in January, four more in February, and with the remainder in the spring.

Next is to generate orders for DFC products through the distribution networks by focusing on targeted commercial and industrial markets, universities, hospitals, hotels, industrial, critical reliability, waste water treatment, grid support.

And by offering competitive terms and conditions.

We will manage cash consistent with market demand, as Joe mentioned, following completion of the near-term product strategy.

Our goal is to preserve and extend our cash to ensure that we have sufficient capital to advance the business as market conditions warrant.

We will implement a field follow-up program for the DFC 300-A, to monitor complete performance, and initiate the field drive program for the megawatt class DFC 1500 and DFC 3000 power plants.

Operating on natural gas, grid connecting here first before delivery to customer sites.

We're excited because these megawatt plants, will be the first megawatt class high temperature fuel cells in the world.

Finally, we will focus longer term strategy which is reduce product plus cost, focusing on [INAUDIBLE].

Additionally, we will focus on the development of the Direct FuelCell turbine combined cycle because of its significant potential for large distributor generation in the 10 to 50 megawatt size range.

We're encouraged by the progress we've made to date and we move into 2003 as the leader in what we believe is the best near-term market for FuelCells, the commercial and industrial stationary power market.

With that, operator, we're now prepared to open the call to any questions the participants may have.

Dawn?

At this time I'd like to remind everyone, if you would like to ask a question, press star, then the number 1 on your telephone keypad.

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

Your first question comes from Garrett Carson with RBC Capital management -- I'm sorry, Market.

Good morning.

Good morning, Garrett.

On a -- a couple of questions on the income statement, Joe.

On -- first on SG&A, looks like it was coming in a little better than previous couple of quarters.

Can you give a little highlight there?

Yes, there are a couple of factors, Garrett, that affect SG&As.

If you look at the year for SG&A for FuelCell, a lot of our costs come in in the earlier quarters, a lot of that related to shareholder relations, our annual meeting, and this year I think related to a lot of our efforts to move this business forward.

In the -- in the fourth quarter, what happened is that we obviously had reduced shareholder investor relations activities in the quarter that we spent money on and we also have reduced some consulting costs in the quarter.

I don't see that as a major trend.

I think that if you took the four quarters, divided by four, I think that's about the range you would get.

With its skews somewhat earlier in the year, based on the activities we have in the year.

Okay.

On -- on gross margins, I'm going to use a -- kind of a multiplier, which may be a different number, I guess this quarter ran about cost of goods versus product sales about 4:1.

Yes.

And we've kind of been in a range of 3 1/2 to 4 1/2 the last couple of quarters.

Is that number -- that trend down or likely to stay the same over the next one or two quarters given let's call it the level of volume or initial one-time -- is there still, you know, a number of initial one-time stuff, probably in my mind, hanging that up a little higher than what it is likely to be on a regular basis?

Yeah, Garrett, I think you've pretty much hit the nail on the top of the head.

I think to the one-time costs should start to reduce, the ratio of 1 to 4, as you know, I mean, our goal is obviously to get to a 1 to 1 ratio at approximately a 50 megawatt run rate.

The 1 to 4 includes one-time costs.

Going into this quarter, which is the January 31 quarter, I think that pattern is pretty similar to the last quarter, and then the following quarter should reduce.

Okay.

And I think that is how it should flow.

Okay.

And -- and then I think we typically ask this Cap Ex question, that's got a pretty broad range for '03, depending on what you see over the next quarter or two, if you could just remind us of where that might fall out?

Yeah, I mean, I think that what we're focused on now is the strategy to complete the standardization of the products, deliver the units out of backlog.

Then, I think, Garrett, it's what the market will -- will bring to us.

You know, our estimates for next year, like you said, have a wide -- wide range, depending on order flow and our ability to -- to launch the business.

So, on the low end, you know, we could have a range as low as say $5 million, and on the higher end, you know, we will cover that in subsequent conference calls.

Okay.

And Jerry, just turning to North America and maybe particular caterpillar PL and caterpillar, can you detail some of the things, I guess they've -- you've been locked up with them or hooked up with them for going on 9 to 12 months now.

And could you kind of detail where we are and what maybe the next six to 12 months will hold relative to them?

Yeah.

Garrett, it is not not 9 to 12 months.

We signed a market development agreement, which was just a one-year sales distribution agreement, which we had to file before the California bid last December.

That was going to be public and we had to -- we had to -- you know, expose that in order -- in essence of fair disclosure.

We then spent the next three or four months, probably no more than one or two key dealers in California, while we were developing the alliance agreement, which I think, Joe, closed in April.

That's correct.

And then in the summer, we brought 60 or so of their people in for training.

We didn't get cranked up until late summer.

They're active, very active part of what I said on this learning to sales cycle.

They have to learn to sell baseloads, power plants that aren't engines, versus diesel or other gas engines.

That's a learning curve you have to go through.

We're working with them very solidly, very strong.

We have quarterly management meetings.

We have -- they're also focusing on the design of the first CAT-branded power plant, which is on schedule, if not ahead.

I think I mentioned in the press release of the conference call, we did a joint serviceability and safety audit, where bringing their people in, very well used to power plants, went through the serviceability, maintainability, and safety of our unit and was very successful.

So, you know, they're coming up to speed.

What we've seen with Marubeni and PP&L, particularly, it takes about a year start getting traction.

Do I wish it were quicker, yes, I sure do.

But look at PP&L in Marubeni.

But by next spring, summer, we ought to be seeing good activity out of caterpillar.

They have lots of projects in various stages of proposal.

So, we feel comfortable with that.

I'm not going to share with you where they are and how much, but we feel good about them, but it takes time get some traction.

Okay, thank you.

Uh-huh.

Your next question comes from Neil McKaty with Morgan Keegan.

Good morning, Jerry and Joe.

Good morning, Neil.

I had a question, maybe I missed it,, and if I just look at some of the fourth quarter it looks sort of like your operating run rate is $15 million a quarter.

So, it sounds like maybe it is a little high in the first part of next year and maybe it declines a little bit as you start dealing with the revenue.

I guess that's the first question.

Is that the right way to look at sort of underlying burn?

And then second is: Could you just go over on top of that, for your Cap Ex, you think you will be spending next year?

Yeah, I -- I think you're looking at it correctly.

We had a cash burn, not counting Cap Ex, in the quarter of about $15 million.

I think the pattern for that is the same in the quarter ended January and I think that it will continue into the second quarter, and I think it should start to decline at that point in time.

So, I think you're right on the way you're looking at that.

At this point in terms of Cap Ex, we have built capacity both in Torrington and Danbury to handle 50 megawatts of throughput.

So, our strategy at this point is, we want to complete the near-term focus, which is the -- continue the development of the standardization of these products, trying to complete that process.

We have, in effect, completed the manufacturing capacity additions at this point.

And we are -- we are in the process of finishing off the development of the distribution network.

So, in effect, at this point, our Cap Ex requirements are very low, given that our order flow is not yet at 50 megawatts capacity.

So, the range on next year is what we're doing from a strategy standpoint, as we come out of January and then come out of the following month is to look at what the market is presenting to us and then adjust -- adjust accordingly.

We think that, you know, to ramp up beyond 50 megawatts would probably take us a year, 18 months, in that time range.

I think we have given visibility, you know, when the visibility appears in the marketplace, we have time to do that.

So, that's really the picture at this point.

And I think that the next conference call we can -- we can -- we can give you an update on the status of that.

Okay.

So, I guess the way to look at it is if you're spending more on the Cap Ex, it's a problem because the flow is pretty good.

That's exactly right.

And then Jerry, can you talk in general, I mean I know you talked a little bit about what's going to drive the demand, but what's sort of the turmoil that continues to surround the power market, I mean are -- are you concerned that maybe companies are still worrying about keeping their credit ratings so they can continue to trade energy, and less worried about maybe moving out into a newer, you know, a new product, or are you finding that there are at least some customers out there that are financially sound enough that they're not worried about those issues.

That they -- they -- they are in a position to maybe branch out and give your product a little bit -- a lit bit more of an opportunity?

I think the -- the -- the turmoil in the industry, having financial difficulties, means nobody is building new power plants.

I can't tell you about how many thousands of megawatts have been cancelled, it's been written up enough.

That is, from our standpoint, if all the plants don't get built, there is a lag cycle.

The ones will be completed through '03 and then no new ones built.

If you drop the energy that much and want to rebuild it with demand, there is a lag to bring it back to demand.

So, that's what we think is a great opportunity for us.

There are areas where there is a perception that power prices are going to be low and, you know, energy cost will be low.

I don't think it's universal through the U.S., in fact to the contrary.

And even beyond that, the distribution issues are impacting businesses, companies, and so forth where they're looking for solutions.

Kind of a new wrinkle we're seeing in the last, oh, 6 to 12 months, is that the distribution transmission issues impact local utilities.

So, we're seeing utilities, not the merchant providers, but the regulated side, looking at how do they solve problems?

It's right here in southwest Connecticut.

It is a huge transmission distribution problem.

And we're seeing interest in putting megawatt-class plants at substations in lieu of bringing more wires, and there is a value proposition there as well as a -- a social one, where people don't want new transmission distribution lines in their backyards.

So, that's the kind of a new wrinkle, but we continue to see the distributor generation wrinkle with hotels and universities and hospitals and the like.

I think if you will look at our backlog list and where we're shipping, because we've done this consciously -- it wasn't accidentally.

We have units going in, I think there were 11 new ones last year, to customers in every one of our target markets and applications, from telecom to waste water to industrial facilities to hotels to hospitals to universities.

Each one of those is a key target market for us and, you know, these units, while they satisfy a customer's energy need to a large extent, they're showcase units.

These are, let's try one, let's kick the tires.

That's why we feel pretty excited about it.

That also will help the distribution organizations.

A lot more if there are 20 units out in the field to take customers to than one or two.

Did it answer your question, Neil?

Yes, that's great.

I think, you know, you got a great opportunity and got the cash to see it through and it's just, you know, we never said it would be overnight, just a patient, patient deal.

But it sounds, you know, sounds like it's still right around the corner.

We think so.

But I hoped for overnight, Neil!

I think that those days are over!

Instant gratification days over.

Right.

Thank you, Jerry.

Thank you.

Your next question comes from Lisa Callahan with Think Equity Partners.

Good morning, gentlemen.

A couple of things.

When will the Kiernan Brewery unit be up and running?

Did you state that, I'm sorry?

I will tell you what the schedule is, Lisa, but it -- it -- end of the day Marubeni sets the schedule, okay?

Okay.

It was delivered, it takes about 45 days on a boat.

It was delivered I think in mid-December.

And they celebrate our holidays over there.

So, they're in the installation process now.

The first -- that should be complete mid to late January.

It doesn't take that long, but there is a lot of holiday periods in between, and then we start the commissioning process, the start-up process.

And that is -- and we have an extended 90-day plan for that, as I said, for the first unit in Japan.

While they've been over here training, part of it will be to have on-site training of both Marubeni people, Kiernan people from our people.

So, we will have a several-man crew over there for the next three or four months.

So, is it safe to say that it would be up and running by March?

Oh, yeah, we're starting up in mid to late January.

That's a two to three week process with the operational, certainly in mid-February, I'd expect.

Okay.

Good.

So, could you provide us with kind of the -- a growth assessment in Japan, as these units are up and running and stalled potential follow-on orders and then quantifying the numbers such as, you know, such as could Kiernan, you know, entertain "X" amount of -- you know, how many breweries they have or give us more clarity on the growth in Japan?

Thanks.

I will give you what I have.

Marubeni is very aggressively involved.

Marubeni is talking to other Japanese partners to broaden their distribution capability.

Kiernan, for example, has 18 breweries in Japan and they also own San Miguel in the Philippines.

They've told our people and you can't book this, obviously, but told our people if we like it, we got a lot more.

The 250 kilowatt is more of a slip stream, anyway.

Most of the breweries are anywhere from 200 kilowatts to a megawatt or two.

Waste water treatment is a key overall market in Japan, pushed by the Japanese government because of all kinds of groundwater issues they have in Japan.

So, likewise, Marubeni is focusing that, their second unit, you know,is [INAUDIBLE], then they announced the metals earlier this week.

So, industry, waste water treatment, are their main focus.

I don't see a lot so far, and, again, this is Marubeni calling their strategy in Japan.

We're satisfied with that.

Don't see a lot so far on the university side.

The hospital side, probably will come earlier.

But, you know, having units on the Japan -- on the ground in Japan from when I had companies in Japan, I will tell you, while they are more important than any other country you can deal in is for them to see local unit with Japanese labels on the gauges and so forth.

Great.

Jerry, switching gears, are there any new state incentives that you can share with us that you're seeing out there?

Government programs?

The -- the newest ones, Ohio, Michigan and -- which is a little surprising with the midwest.

Texas is going in front of the legislature in January with some -- some huge plans, you know, whether they all work or not, we'll see.

California, we see 30 or $40 million, not California Power Authority, not the big 350 Meg Walt program, but in multiple state programs that have been developed over the last six or eight months.

The key focus is that we still have are the northeast, couple of states in the midwest.

We're keeping our eyes on Texas, and then California.

What did you say about the 30 to $40 million?

These are other programs in California, not the 350 megawatt, the big Cal Power program, these are the South Coast Air Quality District, California Air Resources board and a couple of others.

You add them up, it is $40 million.

So those are the ones we're focusing on, because the Cal Power thing is mined and waiting for financing.

Okay.

Great.

And then, Joe, from a guidance standpoint for '03, the R&D under contract, the cost associated with the research and development contract, you know, that continues to be a little higher than I was projecting; is that -- I think you stated that Q1 and Q2, we could see that still trending, you know, at the $16 million range, but then trending down from there?

Is that correct?

Or is that too high?

Yeah, let me reset the research and development contracts, Lisa.

In the prior year, we did about $21 million.

This year we did 30, $34 million.

I think our guidance in the past for both years was in the 20 to 30 range, and I'm going give you the same guidance for '03.

The government -- the research and development contracts -- should be somewhere between 20 and 30.

This year we got a little bit of a boost because we got the acceleration of Clean Coal came into '02, and that was really the reason for the increase in '02.

What happens in '03 is that King County, effectively, we deliver King County, there is not a lot of revenue there, it is replaced by the King Coal and goes back to to the 20 or 30 for government.

And I would say that the trending on the government revenue is probably -- a little bit early, like you said, in the year, but it trends probably flatter during the year.

So, almost divided by four with a little more in the beginning of the year.

That helps.

Thanks.

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

Gentlemen, you just mentioned the government R&D revenue of about 20 or $30 million, can you give us some idea of what you expect product delivery revenues to be?

Yeah, I think in terms of commercial, what we have in the backlog, and all I can really talk to is -- is what's in the backlog at this point, David, there's about 7.5 to 8 megawatts -- probably 7.75 exactly, megawatts worth of product commercial backlogs that remains.

Included in that would be shipments to -- to MTU.

So, the estimate on that backlog is it is probably running, you know, including the MTU units, an average of somewhere around $3,000 a kilowatt I would say.

Okay.

That would be all delivered in 2003?

I would say the majority of that -- there are some units that are not yet cited from Japan that could move into the following year.

Okay.

How about, you know, in terms of order generation, I just thought -- my understanding coming out of the second half of this year is that you had a lot clearer visibility into order generation.

I think part of that sounds like it is due to a delay in the -- the final commercial product.

But, you know, we've seen the backlog now dwindle down to about 7 megawatts.

Should we kind of expect the same sort of level throughout the year?

David, let me -- the backlogs that we have is at today -- is 11.5 megawatts.

At -- at 10-31 it was 12 megawatts.

We've shipped Kiernan subsequent to that, and we shipped another stack to MTU.

The total backlog would be 12.

In the backlog, 7.75 would be the product line backlog, and then 4.25 is the research and development contract backlog, which includes the 2 megawatt Clean Coal, the megawatt King County, the Navy Unit and the Coal Mine Methane unit.

And also, the DFCT unit.

So, that's how the backlog -- that's how the backlog works out.

David, let me clarify, too, you know, when we put our distribution partners on, to the largest extent we required them to commit and pay for multiple units at a fixed price.

That established our backlog and also got them committed and aggressive.

Then they had to go out and find customers for those units.

So, as I mentioned in my comments, we cited 11 new customers this year.

And so that's -- while it's -- while it's new orders from a market standpoint, it's -- it doesn't change the financial backlog, okay?

But it is progress made, okay?

Okay.

The other thing I wanted to drill down a little on is cost to goods sold this quarter.

The number to me just seemed astronomically high.

It's what threw me off in terms of my estimate and I assume the 13 cent miss versus the Street estimate was really driven by the cost of goods sold number.

I think it was a misconception somewhere along the line in here coming from the operating income or operating loss.

Can you just drill down; this the kind of thing we should expect going into next year in terms of, you know, devising our estimates?

No, David, no.

We -- this is the completion of the -- of the process that we've been going through in terms of standardizing the products and delivering the backlog.

Obviously, the backlog deliveries have been delayed.

We have been working these units.

I think there are six or seven units currently on our pad that are operating, and those costs are really attributable directly to that effort.

We see a little bit more of that cost coming through in this quarter, which is,effect, more than half over, the January quarter.

And it should start declining after that, as the -- as the submegawatt product is settling down and maturing and operating well, then the costs will go away.

Then, what we need to do is get a cost curve, on the cost curve, where we can drive the ratio, the 1 to 4 ratio which we hit in this quarter down to the 1 to 1 we're trying to get to at the 50 megawatt level.

And when do you see the 1 to 1?

It is really a volume relationship.

We're not seeing, you know, in fact what we're seeing is opportunity in cost reduction.

We don't see ourselves getting off track, what we need to do is push volume through -- through the facilities to get -- to get the cost covered.

Okay.

And last thing, can you give us some of the operating results you've been getting out of the 300 stack?

Given that it sounds like it's the final version that you're going to go ahead with.

Can you give us reliability, availability type of numbers, so we can get a sense of how it's working?

Let me give you a top of the head type of numbers.

What -- the DFC 300 program, which we're now replacing with the 300-A program, we -- we confirmed the 47% efficiency is the right number and target.

We confirmed the operating life expectations.

We operated at one site 16,000 hours, that's two full years of operation.

We confirmed the 95% availability expectation is, we're comfortable with.

We confirmed the stacked degradation, i.e. stack life.

And we got 250 -- the 250 kilowatt rating, depending on where the 300 was, we had 80 to 90% continuous rating. and as I said, we went over 90% generation in Europe.

So, we feel good about that.

We able to, in the 300-A, take 15% of the footing out.

That relates to a 10% cost reduction. then we had good cost reduction in other areas.

And the big thing and as you talked about with the cost, the big thing is we qualified multiple vendors.

That's pretty key for the future.

It means a lot of run-off costs right now.

But I've got five fully qualified vendors for electrical balance appliance plan.

I've got multiple vendors for exchangers, gas oxidizers and the like.

And having multiple vendors, from those vendors we now have strategic quotes of one unit per month, five units per month, 10 units per month, et cetera.

That puts us in good condition.

We've looking ad our previous cost curve from previous development, compared to the actual cost today and our expected cost from the vendors, as well as our own manufacturing, and we feel pretty confident that we can hit the cost curve, as Joe mentioned.

At 50 megawatts a year run rate, we feel very comfortable with the cost levels we estimated and the cost curve we're on.

So, at 50 megawatts then, what then is the fair cost per kilowatt?

What would be a fair number?

It depends on the size of the unit, but, you know, nominal plus or minus $3,000 a kilowatt.

Okay.

Now, to get -- looking at a year from today; is that where you expect to be if you're still at 50 megawatts?

If -- we have -- right now we have 50 megawatts production equipment capacity.

We're not at a 50 megawatt run rate, because we don't have the backlog to do that.

Right.

Assuming the backlog increases substantially , we will jump to that 50 megawatt run rate.

At that run rate, okay, we're talking about sell prices in the $3,000 a kilowatt.

And that makes us pretty viable.

We know, for example, because, David, the -- our partners have put in these units with state or federal incentives, we know the market clearing price.

We know what the cost per kilowatt has to be to make the units cost effective against the established grid connected power.

So, based on the cost of goods sold ratio today, is it fair then to say your actual cost per kilowatt at today's production level is at between 8 and $12,000 a kilowatt?

I don't think so.

With -- You said three times one.

With some of the one-time -- With the one-time costs in there, it's probably fair.

Okay.

That's what I'm drilling at.

Yes.

Okay.

For example, David, the King County is our first megawatt plant.

Okay?

Let me give you a real simple example, one off cost.

We're building that plant in Torrington and will operate it on natural gas in Torrington, then we'll dismantle it and ship it to Seattle.

We don't have to do that.

We're doing it primarily to get all of the cost of installing a megawatt plant documented, detailed and videotaped and so forth so we can share it with our partners.

Okay, so, by building in Torrington, dismantling and shipping it, we will ship to Seattle four skips and a kit.

And the kit will be all the pipe interconnects, all the wires, everything you need, just like putting together a -- a lawnmower or something.

And we're doing the same with the 2 megawatt plant.

All of those run off costs of double construction, double handling and all is going against that project, okay?

Okay.

Yeah, I see where you're coming with that.

Okay.

Thanks.

Thank you.

Your next question comes from Eric Prady with Adams Harkness.

Hi.

Just to follow up in the previous questions, could you just discuss some of the percent of the components on your systems which are standardized, as compared to customized, for some of your different end markets, like the waste water treatment plants or some of the CHP-type end applications and, you know, which of the end applications wind up being the most profitable for you guys?

Thanks.

Okay.

Eric, all of the units are designed on a natural gas basis.

Because that's the predominant fuel that we see.

All of the units are designed for co-generation, meaning we have an exhaust stack at 700 degrees fahrenheit, all right?

And from there we can go absorption chillers or steam generators or condensing steam turbines, or whatever.

All of our units we transform, we both invert to A.C. and then transform with the new power into 480 volts.

Association the customer hooks into 480, whether he wants 480 or 13.5, or whatever, that depends on the customer after that.

We then, on fuel, add a fuel processing skit to any unit that's going to be different from natural gas, if it's waste water treatment gas, it is an actual skit difference.

If it's peak shaving gas, we have a peak shaving kit that goes inside the unit, on the small units.

If it's any other fuel, it is handled by a separate skit.

So, all of this starts with a natural gassed baseline, if you will, with fuel processing additives to fit a particular application.

Did I answer your question, Eric?

That's great.

And I guess just a follow-up on that.

Is there some -- some of the other companies in the distributed generation market have started to really focus in on one or two particular applications to help, you know, even more standardize their products and drive down costs.

Is that anything you're considering, especially with some of the government programs where you might be working with, you know, the diesel, et cetera, where there might not be a very broad, large markets for that?

Is that something under consideration?

We are focusing on, as I said, natural gas and waste water treatment are the two big market areas for us.

Diesel will be there one day.

It is not ready yet.

And we're obviously putting some resource these if t under the Navy contract, but we are not looking at commercializing that product soon.

The other big potential, and it is a big potential, is coal gas.

If this country ever gets a coordinated energy policy involving coal, we will have the experience on that, okay?

And it becomes a pretty good answer.

Co-generation, we don't do as much so far in the U.S., totally throughout Europe you won't have any without co-generation.

And then the only other wrinkle is, you know, 50 and 60 cycle.

Half of Japan is 50.

Half is 60.

We're 60 cycle here and Europe is 50.

We have to take that into accordance.

But our focus area is natural gas and waste water treatment with a potential of coal gas.

Diesel, if and when the fuel situation gets resolved on diesel, then, you know, we'd look at putting a more commercial focus on that, but not right now.

Thank you.

Your next question comes from Chris Kwan with TD Securities.

Just a couple of follow-ups here.

Joe, did I hear you right?

The backlog is 11 3/4?

Can you go over quickly those numbers again?

As to how you got to there.

The backlog today is -- is 11.5 megawatts.

That includes 4 megawatts for Marubeni, half a megawatt for L.A., 1.75 PPL.

We got the unit going to Yale and there is 1.25 for MTU.

Clean Coal is 2.

King County is 1.

Navy is a half. 500 kilowatts.

Vision 21 is 500 kilowatts.

And Coal Mine Methane is .25.

That would give you the backlog at 10-31.

Subsequent to that we shipped an MTU unit and we shipped the unit to Kiernan.

That's the -- that's what we have.

Okay.

And then the second question, the -- just related to the gross margins on the R&D contract, are the coal project you got and you are getting is a 50% cost recovery.

Is that in general or is that what we're seeing for government contracts for you guys?

They're only going to cover 50% of our costs or...

No, I think we take a very careful look, you know, we're looking at where we're going to invest our capital.

Historically on the DOE, for example, the DOE's 30-3 contract, we actually, that is a cost share that includes covering GNA costs.

That's almost 100% to us in effect.

That's an excellent contract.

We have taken on other contracts, the Navy contract is a 20% cost share.

We have recently taken on some 50% cost share contracts because two of those contracts have helped us develop a megawatt program.

King County and Clean Coal.

So we're not setting any precedent here that the only contracts that we will take are 50%.

We will look at each contract and we will look at the benefit to the company of that contract, and we will make the investment, you know, appropriately.

And if I could add on, Chris, the vision 21 contract originally $3.5 million for the start of the design of the 40 megawatt FuelCell turbine and the 250 megawatt in test phase, that was a 20% cost share.

Then we saw the opportunity to go to the next step, which is actually to build packaged units with -- of that size range and our focus has been large on 40 megawatts, 10 to 50 megawatts.

We see the opportunity to use 50% cost share to see if we can develop a product that could be commercial, even in the small size range.

So, as Joe said it was a conscious decision.

We don't have to take these contracts.

We take them if the long-term commercial direction of where we're trying to go.

We do have a very small amount that our technology guys can do the creative things directly in line with our commercial direction, as you do with any good R&D group.

But 90%-plus of our efforts are focused towards what will be a commercial product down the road.

Great.

Just secondly on guidance, you mentioned Cap Ex, some minimum of you're probably looking around $5 million on the low-end.

You gave us a 50 to 80 million cash usage last year.

What could that range be this year?

Let me go back and reiterate the strategy.

Then I will give you an idea of one scenario where the cash could come back to.

You know, we -- we ran last quarter $15 million operating cash, plus we had $5 million in cap expenditures.

At this point, cap expenditures, the $5 million, is really cost reduction opportunities, process improvement opportunities for the 50 megawatt level.

Some of those will actually increase capacity on an individual basis, plus, we're also building some systems, we're building the system infrastructure, you know, for a much larger company and making that investment.

So, that's where the low end comes from.

We expect that the pattern of that cash will stay similar to the January quarter; it should probably come down in the following quarter.

At that point, we will look at market condition.

Let's take one scenario, if market conditions are not very good, let's say that the order flow isn't good, the energy industry didn't come back, financing is not available, et cetera, I think we can reduce that cash in half -- cash use in half at that point in time.

At the annual run rate, from that point on, I think you're talking, you know, an annualized $30 million to $40 million cash run rate.

That's what I think.

That's what we're planning, for multiple scenarios, and that's one the scenarios that we're looking at.

And on staffing levels; is that the appropriate number right now at 425?

For today? 425 is the appropriate level, and that's a number that we will look at as we come out of the January/February period.

And a question for Joe.

The energy policy, still nothing, when are you guys expecting anything on that?

Or what have you heard?

Well, you know, you hear a lot of things up until the majority leader gets in trouble, also.

So, it was going to be a focus starting in January now, you know, all that depends on what happens in Iraq and I think getting the Senate getting its House back in order.

We do see -- it is -- from talking to the DOE people, particularly in our consultants in Washington, it is a key focus of this -- of this administration, certainly not -- certainly not more key than Iraq and terrorists, but up there near the top.

So, we expect the action on that as soon as they reconvene in January.

Great, thanks a lot.

Your next question comes from Michael Harris with Robert Baird.

Jerry, in your formal commentary you talked about some targeted time frame in the first half of '03 to ship additional units and components.

Is it still safe to assume there is a short lead time from the time when product is shipped to the time when that unit becomes operational?

In general I think the first unit in Japan, as I mentioned earlier, is a little more -- a little different than that, but we can typically -- we expect if a site is ready, you know, assuming there is a pad there and the gas, water and power lines are brought up to the edge of the pad, we typically, you know, can deliver it one day and hook it up the next day and start to heat it up the third day, on the 7 megawatt plants.

The megawatt plants, we're trying to get that down pretty short.

I will be able to say more when we ship the Seattle one.

But on the first installation in Torrington, we documented everything we did to make changes.

We want even the megawatt plants, you get them at a predetermined concrete pad.

We get a fifth box with all the tools and connection parts in there and then put yourself a power plant.

If you have to construct these like traditional power plants, they will never be cost effective.

This is equipment, a product is being delivered versus a construction.

Okay, great, that's helpful.

And just refresh my memory, the 250 KW unit targeted for the U.S.

Coast Guard, what's the targeted timing of delivery for that unit?

I think that's one of the ones in January.

I think we had three in January, four in February, and then the rest of them will all be done, you know, by the spring or during the spring.

Okay, great.

And then the --

I mean, frankly -- one program -- Let me just quantify, we can ship faster than that.

Part of this is, and we jockey things around.

Part of this depends on our customers and our partners dealing with their customers and site conditions and this, that and the other.

So, we try to target that they get the unit exactly when they want the unit, when all the conditions are right.

Sure, that's reasonable.

I understand.

Okay.

Just shifting to the DOE vision 21 program, the division recently announced, there will be two units, one in Danbury, one in Montana.

Can you give us an idea of when you think the units will be operating?

Well, the first one will be done here, so, it drives everything.

And -- and the difference is, you know, we operate at a 30 kilowatt cap stone turbine with a 250 kilowatt stack.

But it was an Alpha unit proven concept.

It wasn't optimized, but it looked pretty good.

The -- the -- this Vision 21 add-on, of course, then on our own we will add a 60 kilowatt because it is a better fit to the 250, we're in the process of doing that right now.

These units will be packaged units, it will look like the DFC 300-A, okay, it will be packaged like that, but with the micro turbine in it.

The first one we do we will do here and then we will replicate that and enhance it and ship it to Montana.

The one here should be done this year, '03, and the one in Montana probably, you know, early '04, first half of '04, we will -- we will do them in parallel, but run the first one before we finalize the second one.

Okay, great.

And just a last question here, I just wanted to confirm the number of field trials that are currently running right now?

I pegged it at about seven field trials; that correct?

I think you're right, five in Europe, two here, the Germans are on the process of starting one up.

We may be one short there.

And then we've got six or seven operating on the pads back here in Danbury, but the customer sites are seven right now and probably another six or seven we've got operating here.

Great, thanks, that's all I had.

Okay.

Your next question comes from Gary Holzworth with Wedbush Morgan Securities.

Okay.

Hi, guys.

Morning, Gary.

A question I have was on -- just, we're trying to go through the backlog to be sure we have the right, giving you guys in check here.

Yukon unit has not shipped yet?

Nope.

And it's not a Yukon unit anymore.

Right.

And -- and that's one of the issues.

I think they're in final -- in fact -- the -- the -- the Yale -- and that's why it's public -- on the Connecticut citing council website, you will see the Yale application through the citing council to permit the unit at Yale.

Okay.

For the MTU units, of the ones you had in the press release, I didn't see the VSE unit or the Degusa unit.

Is Degusa one of those that shipped recently?

No, they are to be shipped.

The ones that are operating, I think we listed them in there, energy by entire power plants it was the Eon, the other big utility in Germany that has the unit going into Degusa.

Right.

Eon is the buyer of it.

Degusa is where it would be located.

That hasn't shipped yet.

And BSE hasn't shipped yet.

Okay.

As I said, they are momentarily.

So...

And, again, Joe's 11.5 backlog does not include Pepperidge Farm, [INAUDIBLE], or the Suni units?

That's correct.

Okay.

That's good for now, thanks.

Operator, Dawn, we can take one more question.

It's been an hour.

Your final question comes from Gary with Janney Montgomery Scott.

Yeah, just a follow-up on CAT.

Of the 60 sales people you have, how many exclusively sell FuelCells?

I don't think any are.

There is a designated and I'm probably at the wrong table, but a designated FuelCell responsible person in Peoria, from corporate.

Uh-huh.

Okay.

But in the -- first, you know, you take the CAT dealers and out of all the CAT dealers, there is only a certain number that are also electric power deals.

Out of the electric power dealers, we're probably dealing with, oh, anywhere from 60 to 80% of them right now today.

And within the dealership is one or two guys, okay?

So --

Of the 60 that went through your training?

Uh-huh.

They are electric, power, CAT sales people, okay?

And they sell everything?

No, only electric power, but everything in electric power.

Right.

So, they sell diesel, gas engines, stand by, et cetera.

And they sell the -- the -- the what do you call it?

The fly wheel unit, the backup power unit they're getting from active power.

Uh-huh.

So -- but they don't sell earth moving and mining equipment and all the other stuff.

I understand.

Okay.

So, what's the difference -- and how about on PP&L, do they have exclusive FuelCell sales?

PP&L Energy Plus, which is the nonregulated, they're selling energy solutions, okay?

PP&L have four or five mechanical contractors that've a-- they've acquired in the northeast.

That's their primary sales channel.

They do have three dedicated people who focus on FuelCells among other distributed generations.

Engines and micro [INAUDIBLE].

It was just my feeling that only salesman who actually focus on FuelCells exclusively could become experts in selling the FuelCells and the CAT people don't have any exclusive sales people there.

No, but they are selling distributed generation power equipment and what we've found because we've hired a lot of service guys, engineers and so forth, from the power industry, from other equipment suppliers supplying traditional equipment to the industry.

If you have a guy used to dealing with power-generated equipment, he can -- he can pick up FuelCells real quick.

Uh-huh.

It's a solution-type scenario.

He doesn't have to be a FuelCell chemist, okay, but he has to understand the differences in operating characteristics of this one.

You know, I'm giving you an example, one of the first things you run into.

We run a halfload and have the same efficiency or better at full load.

You got an engine or turbine running half load, your efficiency goes way the hell down.

So, you know, that's one of the kind of the first thing to hit them in the head, so we have to then say, hey, we have a unit, that front load operation is real efficient.

That opens up a new set of customer demands that he hasn't had to deal with before.

That's kind of the -- the learning curve they have to go through.

Okay.

One other thing, the other day there was an article about a release earlier that some company had sold 1100 kilowatts, an 1100 kilowatt distributor generation plant in New Jersey for a couple of -- it was a commercial building complex.

And I don't know exactly what the power source was, they said it would be a very low pollution output.

But you had mentioned that on last -- the last conference call, that ConEd was working with Niagra most hawk, also trying to sell distributor generation.

Are you basically competing against ConEd?

I don't remember mentioning that, Gary.

I will go back and look at my notes.

Low emissions is relative.

Uh-huh.

Okay?

The best icy engines with everything on them, you're still going to have a couple of hundred or more times more emissions than we do, okay?

Well, I wasn't specifically talking about the emissions, I was talking about are there -- are you competing against the utilities in trying to sell DG?

Yes, all distributor generation guys, to an extent, are competing -- that's part of the obstacle, [INAUDIBLE], turbine engines and everything.

If you put DG, Distributor Generation, into a facility, the local utility, regulated utility, loses kilowatt hours and loses revenues.

Okay?

That's what you need the -- the state and federal guys pushing and -- and because of that, the local utilities slow things down.

Okay?

They don't -- can't stop it because of the state department of public utilities will get on them for that.

They slow it down and talk about inner connect safety issues, exit fees, stand by charges, all of that, and to try to make it go away.

And this is -- it happens to be something where there are -- there are multitudes of equipment suppliers like ourselves going after the industry. [INAUDIBLE].

That's the example I use with the Sheraton Towers and Pepperidge Farm and Suni, and Syracuse.

Will we get them?

Yeah.

Is it getting better, it absolutely is.

But it hasn't gone away.

In Europe, in Germany, they pulled the utilities on the side of DG and said hey, utility, we will give you incentive for distributor generation and you can get the same revenues.

So, you know, we're going to win because of the drivers over the long-term.

Distributor Generation will win, but it's a battle that's been going on and will continue.

Amazingly, when you see what happens, that's why Energy by Burtonburg, the three big ones in Germany, they've jumped on board.

They can use a FuelCell to solve some of their problems rather than fighting it off by saying, you know, if a FuelCell comes in, I lose kilowatts.

Now they put in a FuelCell and don't lose kilowatt hours.

And you have the states putting new regulations, mandating that we must have so many kilowatts --

The states are putting in the metering, putting in demands for distributed generation.

I'm telling you, this is -- I mentioned earlier, you can look in any literature, this is part of the battle going on between Distributor Generation and Central Generation right now today.

But you should win this?

We absolutely will win it.

The drivers are pushing towards that, okay?

Okay.

All right, thanks.

Okay, gentlemen, thank you very much.

We look forward to talking to you in -- in February, Joe?

In February.

Very good.

Have a nice holiday, everybody.

Bye-bye.

Happy holidays.

Thank you for participating in today's conference call.

You may disconnect at this time.