燃料電池能源 (FCEL) 2003 Q3 法說會逐字稿

Good morning.

My name is Jeanette (ph) and I with your conference facilitator.

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

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

After the speakers' remarks, there will be a question-and-answer period. (OPERATOR INSTRUCTIONS).

Thank you.

Mr. Steve Eschbach, you may begin your conference.

Good morning, everyone.

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

I'm delighted to have you join us for our third-quarter 2003 conference call.

Delivering formal remarks today are Jerry Leitman, 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 of the development and commercialization of its 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.

Before I provide my opening comments, I'd like to turn the call over to Joe Mahler, our CFO, who will review our third-quarter and year-to-date financials.

Good morning, everyone.

FuelCell Energy reported revenues of 7.3 million in the third quarter of 2003, compared to 12 million in the same quarter of 2002.

Net loss for the third quarter was 15 million, or 38 cents per basic and diluted share, which compares to a net loss of 13 million, or 34 cents per basic and diluted share, during the same quarter of the previous year.

The increased year-over-year quarterly loss reflects decreased revenues and increased costs associated with certain government research and development contracts, increased administrative and selling expenses and increased internal research and development -- (technical difficulty).

Cash, cash equivalents and investments, U.S.

Treasuries on hand as of July 31, 2003 totaled $168.6 million.

In the third quarter, we reduced our total cash use to 11.9 million for the quarter, compared to the 20 million used last quarter.

We achieved this 8.1 million improvement in cash use due to a lower net loss of $6 million and an improvement in working capital of approximately 2 million over the prior quarter.

Capital expenditures were 1.8 million and depreciation expense was 1.5 million during the quarter ended July 31.

Revenue for the nine months was 26.5 million, compared to 27.5 million for the same period in 2002.

Net loss for the nine months was 52 million, or $1.32 per basic and diluted share, compared with a net loss of 28.1 million, or 72 cents per basic and diluted share.

Year-to-date losses reflect the Company's investment standardization DFC power plants, continued investment in the demonstration of DFC power plants, reduced funding on certain government contracts, increases in operating costs and increased costs for the manufacture and delivery of our products as we bring these products to market.

These costs include employee expenses.

Operating costs include employee expenses, sales and marketing costs and other cost related to plant expansion, information systems and infrastructure.

Our results to date have been consistent with our financial projections.

The trend in cash flow moves us towards our targeted quarterly cash use of between seven and ten million in 2004.

This goal is based on a near-term order flow of five to six megawatts of orders, production (inaudible) delivered annually.

Our cash use strategy is to effectively manage our balance sheet and operating costs while continuing to invest in the future growth of the business.

Nearly 170 million in cash -- we had the financial strength to be flexible for market conditions.

I will now turn this call back to Jerry.

I might add that our cost reduction efforts are focused not only on our DFC products but also on our organizational effectiveness.

These efforts, which we call cost out and workout programs, are already beginning to have a favorable impact, and we believe continued emphasis on these programs will result in further cost savings.

The end result is twofold; it will enable us to deserve our cash in advance of increasing order flow and allow us to reduce the price points of our DFC products that will broaden our market opportunities.

Now, I want to focus on our key accomplishments this quarter -- first, on developing sustainable markets for our DFC products through our key partners.

Our Asia-Pacific strategic partner, the Marubeni Corporation, released for production three megawatts of DFC power plants to meet new customer commitments.

This adds to their initial 1.25 megawatt order and demonstrates acceptance of our technology by customers in Japan and Asia.

The DFC300A -- (technical difficulty) -- Kirin Brewery, our first installation in Japan, has received more than 500 visitors, both interested customers and Japanese government officials.

As I'm sure you know, penetrating Japanese markets can be difficult.

Marubeni is doing a great job and has made significant progress in obtaining Japanese government acceptance.

First, our DFC products have been accepted under the Electric Reliability laws, allowing them to be cited anywhere in Japan.

Further, they've been approved by the Ministry of Environmental Protection as meeting or exceeding all environmental laws.

Finally, our products have been approved for unmanned operations by METI, the Ministry of Economy Trade and Industry.

Previously, high-temperature fuel cells in Japan required a full-time operator.

Three drivers are supporting the increased interest (indiscernible) products in Japan.

First, emissions reductions from the power generation sector -- Ministry officials are motivated to live up to their Kyoto protocol goals and combined heat and power technologies are a preferred method to reduce CO2 emissions because of efficiencies exceeding 80 percent versus central generation efficiencies in the low 30s.

Our ultra-clean DFC power plants meet or exceed all standards and have a significant advantage over conventional generation technologies, especially in urban areas.

Next, regulations requiring increased use of wastewater treatment facilities, particularly in the agriculture and farming sectors -- these new facilities are being heavily subsidized by the government, including any power generation equipment, to make efficient use of the byproduct gases, such as methane.

Marubeni expects our DFC power plants represent the most sufficient use of these "opportunity fuels".

Finally, renewable portfolio standards -- Japan adopted a national renewable portfolio standard for power generation.

Although the targets are modest at this point -- about 1.5 percent or a little over 3000 megawatts by 2010 -- and the focus is on solar, wind, geothermal, small Hydro and biomass.

But that includes gas location and anaerobic digestion, whose gas by-products can be used as a fuel for our DFC power plants.

To facilitate the implementation of clean (indiscernible) generation technologies like our DFC power plants, foreign government agencies have incentive programs with incentives ranging from 33 to 55 percent of the project costs, and our technology is eligible for support under these initiatives.

The market for small, on-site power generation continues to grow in Japan.

Distributed generation and installations increased by over 25 percent, both in numbers of units and installed megawatts in fiscal year 2002 in such facilities as supermarkets, hotels, hospitals, office buildings and factories.

As each additional unit is cited, Marubeni is seeing increased interest in DFC power plants for DG (ph) applications such as these.

Marubeni intends to vigorously pursue those market segments that afford government grants (indiscernible) subsidies while we are increasing unit volume to bring DFC product costs down to meet broader market opportunities.

The competitive situation is also changing.

While there were several large Japanese companies developing carbonate fuel cells, all of those efforts have been consolidated by the government into one company called IHI who is significantly behind us in the development of commercial products.

Marubeni and FuelCell Energy remain on track to further develop their relationship as order volume increases.

I would expect, in the next one to two quarters, for Marubeni to start initial sourcing of (indiscernible) plant equipment from Asian suppliers or partners.

Over time, we expect that Marubeni will produce its own DFC power plants in Asia using our fuel cell components made here in Connecticut, just as our European partner, MTU, does now.

As you may recall, in early 2003, our European technology and distribution partner, MTU, which is a subsidiary of DaimlerChrysler, formed a separate subsidiary to focus on commercialization of our DFC power plants.

It's called MTU CFC Solutions GmbH, CFC being carbonate fuel cells, which is our core technology.

In July, MTU CFC Solutions announced a strategic venture with RWE Fuel Cells GmbH, a subsidiary of Germany's largest utility, RWE.

The two companies are combining their respective strength of technology and distribution to establish a leading market position for carbonate fuel cell power plants.

To get a better sense of the market potential that RWE brings, let me mention to you that they're number one in Germany in electricity and number two in Germany and number five in Europe in natural gas, and they're number one in Germany and number three in the world in water and wastewater.

We view this as a significant development for our DFC products, as carbonate fuel cell technology developments we have experienced with MTU over the years can now be leveraged to broader markets with RWE's established leadership position in Europe.

According to RWE, Germany is already viewed as an early adopter market with a share of DG (ph) higher than the European average, and they expect distributor generation to grow significantly in Europe over the next to to 15 years.

Both RWE and MTU expect fuel cells to play an increasing role in this growth, given their environmental friendly and resource-conserving method of generating power.

We also see continued progress with key U.S. partners.

PP&L is delivering units to its customers and dedication events at the Coast Guard, Sheraton Addison and Zoot Enterprises have been very well received.

Our two units at Zoot are being configured around fully grid-independent as is PPL unit in the Coast Guard (sic), which already operates grid-independent.

Official dedications are planned for PPL units the been delivered to Sheraton in Parsippany, New Jersey and Ocean County College later this fall.

Caterpillar continues developing its own CAT-branded products, focusing initially on megawatt class products.

As an important next step in this effort to develop CAT-branded products, we will also install a DFC300A power plant at Caterpillar's technology center near its corporate headquarters in Peoria, Illinois.

This unit will be grid-connected and be used to demonstrate installation, operation and serviceability to its dealer representatives, to its engineering staff and most importantly, prospective customers.

This will be our second unit in the Midwest, our first being Grand Valley State in Michigan, which was delivered to Michigan last week.

We believe it will generate a lot of interest, even beyond Caterpillar.

It will be followed by in AMP (ph) in Ohio, which opens up the Midwest in addition to our current focus on the Northeast and West Coast.

Last month, the blackout in the northeastern U.S. and Canada clearly demonstrated the vulnerability of the existing transmission and distribution grid.

Many industry analysts have recognized this for years, as transmission and distribution investment have not kept pace with investment in simple-station generated capacity and the siting of these central station merchant plants have been focused on the intersection of a gas pipeline and a transmission system, not on supporting the grid.

Even if the TMB (ph) infrastructure were adequate, centralized power will still be subject to vulnerabilities such as weather, accidents and in some cases, even squirrels.

According to EEI, 94 percent of power outages are caused by events other than loss of generators with weather at 65 percent being the largest contributor.

The need for reliable power and critical applications also came into focus as airports, government buildings, hotels, hospitals, data centers faced unplanned disruptions.

We believe, as do many others, that distributed generation is part of the solution.

Smaller on-site power plants remove load from the grid, which is equivalent of adding grid, and will not only ease the existing load but accelerate recovery, should large-scale outages repeat.

Distributed generation increases electrical reliability of customer locations and bypassing or supplementing the grid when outages arise provides critical applications with needed power at all times.

We believe our DFC power plants are a clean and efficient distributed generation solution, and the blackout has increased focus on our solution. (inaudible) propose programs to accelerate the deployment of stationary fuel cell power plants, including investment and production tax credits as well as incentives, are expected to be part of a comprehensive solution to the electrical infrastructure problem.

FuelCell Energy is well positioned to capitalize on these proposals and to power critical applications at government buildings, military bases, airport control facilities, wastewater facilities, hotels, hospitals, data centers and universities.

To summarize where we are, our cost-reduction measures are beginning to show favorable results and we have been able to reduce our quarterly cash consumption.

Our global distribution partners are all strengthening their positions in the markets as we continue to cede units around the world in key market segments and applications.

Wastewater treatment facilities are emerging as one sustainable market for our DFC products, and we continue to work on identifying additional applications in market segments with similar order potential.

We continue to have the capabilities and recognition to receive additional financial support for developing technologies, including hybrid fuel cell turbines, diesel fuel sell power plants and most recently, solid oxide fuel cell technologies.

With nearly 170 million in cash, we're in a strong financial position to execute on our core business strategy.

Finally, we have the financial strength and capabilities to be flexible under all market conditions and continue our leadership role in high-temperature fuel cell systems.

With that, operator, we can open the call to any questions they may have.

Operator?

(OPERATOR INSTRUCTIONS).

Your first question comes from Jarett Carson, RBC Capital Markets.

Good morning.

Joe, could you remind us a little bit -- should we start to see a little improvement in -- (technical difficulty) -- cost of goods sold with regard to the cost reduction and headcount reduction programs, which you guys started instituting earlier this year?

Should we start to see that in the fourth quarter?

I think you start to see the beginnings of that, but that really will start to come through more in '04.

I think we still have units that we are delivering that are the one-off units that are still carrying some high cost.

I think that on the product sales side, the ratio -- you know, one to three -- about the ratio we had last time -- probably comes through in the fourth quarter and should get better in '04.

But you will see, Jarett, that the cost reductions -- I think what you see in this quarter, if you look at the government side, the R&D side, you see an improvement in that ratio, and I think you see it more clearly there what some other reductions have done to that, because we have been able to bring that ratio down as we manage better the costs related to those contracts.

Fair enough.

Could you detail maybe two or three things or one or two things that -- I know it's still early days (indiscernible) post-blackout -- but things that -- steps that you guys are taking, perhaps either by yourselves or with some of your distributors here in the States, or conversations (indiscernible) picked up with regard to either new sightings or steps that you're taking to capitalize or take advantage of the situation?

Yes, I think, Jarett -- we're taking individuals steps, and we are also aligning ourselves in various groups with other distributor/generation suppliers.

You know, we're the only guys that can put in megawatt fuel cell power plants today.

There's nothing else that, from a fuel cell standpoint, that can really provide significant quantities of electricity from the fuel cell power plant.

But we are teaming up with other distributor/generation makers of engines and turbines and all, because if you read some of the articles, there is a big momentum for just throw a lot of money at the grid, at stringing new wires.

While some of that has to be done, we want to get the recognition that there is another alternative, that distributed generation can be a solution that while not totally replacing the grid for sure, it's the same as relieving the grid.

For every megawatt we put in, that's a megawatt less wire you have to string through the grid; it's like stringing another megawatt.

So, while it's hot in everybody's mind and debating the Energy Bill and all that, we're trying to put a lot of focus on taking people's eyes off just fixing the transmission grid, but look at other alternatives.

We're doing it in all areas.

Obviously, on the Energy Bill we're looking at -- on some defense installations; we're looking at it with Homeland Security and the like, okay?

The Coast Guard unit, which is a small unit -- 250 kilowatt unit -- had that happen up in Cape Cod -- the Coast Guard unit would have diverted to its critical (indiscernible), which is the barracks.

So, the barracks would have light and heating and air-conditioning and the like.

That started to get some recognition.

Military bases went down too.

I can tell you, it's from approaching individual senators and congressmen to putting on presentations as a group on various trade associations we belong to, to going after very specific projects where we know there is a critical need -- all of that is being done.

Herb Nock, who runs Marketing and Sales, is up at the New England Governors Conference this morning making a presentation.

Yesterday, they totally re-changed the agenda of the Governor's Conference from what it was to half a day focusing on the blackout and what to do and how to do it.

So again, he's giving a talk on the same approach -- that fuel cells are another answer; you don't have to just keep stringing wires.

That's quite interesting.

One final question -- an update on the acquisition of Global Thermo-- how's that tracking?

It's tracking well.

Obviously, it's under SEC review, and then you have the Canadian courts, so it's a little more complicated than a U.S.-to-U.S. transaction because the Canadian courts get involved in Alberta.

But it's tracking on schedule.

We've had additional meetings; we've met a lot of people; we had a whole technical review last week, and we're more pleased that we were the day before we made the offer.

We like what we see and we think it will be a big support on the solid oxide program (indiscernible) program.

Thank you.

Your next question comes from Chris Kwan, TD Securities.

Hi, gentlemen.

A couple of questions -- first, do you have a revised backlog figure?

Yes, Chris.

The current backlog, as of today, would be eight megawatts, which includes the two megawatt Clean Coal project, the one megawatt King County project, half a megawatt for Vision 21, which is the two units that will go to Montana and the Navy units.

Those are the R&D side.

Then, on the commercial side, there's also four megawatts in backlog, which includes the production of the Marubeni orders.

Okay.

You have an improvement in the cost profile in the quarter relative to last quarter.

I was just wondering, where are you seeing the bulk of those cost enhancements -- the improvements coming from?

Well, one, we had the reduction in fourth, which is starting to come through now.

We've paid out any severance payments related to that.

Those cost are coming through.

I think that we're managing the R&D projects.

As you know from the last quarter, we had a little bit of a surprise with some of the R&D funding.

That's all settled in now.

We're doing better in managing those projects.

In terms of the products, we are doing better now with (indiscernible) some of our "cost-out" processes are kicking in.

We're getting some improvements in productivity in the organization in addition to reduced cost.

Our BOP costs continue to come down, so really across the board, Chris, we are getting better results.

If I could add, too, remember, we spent a lot of money in the last 12 to 18 months developing and then qualifying and then buying products from multiple vendors.

If you recall, the first dozen or so units came from GE.

We've now qualified, I think, three or four other vendors.

The qualification also means buying first article from them and testing first article.

So, once you get that very expensive work behind you, then you start selecting specific suppliers; you have multiple ones to choose from and your prices start getting very competitive.

Most of the cost reduction so far has come from that.

The product "cost-out" program that we are in is where you start value engineering and technology upgrades, along with volume procurement.

But we're in a position to do that, particularly on future business.

Okay.

Joe, you mentioned the run-rate on the cash burn -- maybe seven to ten million a quarter in '04; that's based on five to six megawatts of production annually.

Is that what I hear (inaudible)?

Yes.

Annually.

That's both R&D and product?

That would be seven to ten in total.

Seven to ten (indiscernible).

Our cash consumption in the quarter for the business.

Okay.

The last question -- maybe you can shed some light on -- you talked about the Energy legislation.

What are your sources saying as to any changes that might arise as a result of the blackout or that you guys are hearing about, or where or what the timing --?

Chris, I wouldn't begin to predict.

I can tell you what we and certainty the fuel cell industry as well as the distributed generation industry are pushing for, besides the generic comments earlier; we're looking at investment tax credits and production tax credits, which wind and solar have had for years.

We're looking at -- and I forgot the name of it -- advanced system-type approach, where you would get 1.8 cents per kilowatt-hour, ten-year rebate if you will or subsidy, if you put in clean distributed generation technology and another .8 cents, which would make 2.5 cents total if it's in a mission-critical facility like a hospital or university military base.

We're also looking at renewable energy and renewable portfolio standards, which is something Connecticut triggered -- has just triggered in here, where fuel cells count and there's a mandatory requirement in Connecticut that was just -- in New England, there was a first trade on these renewable portfolio standards; it was 3.5 cents per kilowatt-hour.

So, that is a plan in Connecticut and other states will adopt it, but it will also push the federal government to look at renewable portfolio standards, which would trigger a lot of impact on our business. when you throw in things like the $87 billion request for Iraq yesterday and Afghanistan, I don't think anybody can really predict what's going to come out of Congress.

Then the last quarter, just getting on this backlog point -- what's the big staller as to why that keeps declining?

I know you're still trying to solicit new orders, but it's just been consistently declining the last three quarters.

Chris, let me take you back a second, okay?

When we brought these partners in, we said "We don't want partners who are going to sit on their thumbs and wait for somebody else to do the heavy lifting."

We want you guys to bid it.

As you know, most are either put in equity or committed to sweat (ph) equity.

Then they had to actually buy units, okay?

Take Marubeni, for example; they had to buy one in five units, one in a quarter megawatts without the first customer, alright?

And they had to pay us ten percent down and take delivery on those units, which puts pressure on them to go out and get customers, alright?

At the same time, they just, this summer, re-upped for another three megawatts, okay?

They are paying us ten percent down; that's another -- it's either eight 250s and one one megawatt, or four 250s and one two-megawatt; that's still being debated, but we can start making the stats.

Again -- so we locked in a financial backlog a years ago.

At the same time, the real market penetration is as you see our partners start identifying customers and getting shipments and deliveries -- that's why the financial backlog hasn't changed but the customers have.

So, we could have said, okay, don't give us any backlog.

What you would see would be these new orders coming in as additions to backlog.

I think we did a pretty smart thing in locking these guys up at the same time so they had pressure to go sell orders.

At the same time, it doesn't change the financial backlog until we ship them.

Do you understand what I'm talking about, Chris?

I got you.

So any new customer announcements in citing is the equivalent of a new order, even though it doesn't change the financial backlog.

Okay, great.

Thanks.

You next question comes from Sanjay Shrestha, First Albany.

Good morning, guys.

A couple of quick questions here -- first one, Jerry, can you give us an update on your Vision 21 program -- if there's anything new there?

No, we're working away.

I think the -- you know, it was originally to develop this 250 kilowatt proof-of-concept.

We had a 60 kilowatt turbine (indiscernible) 30 kilowatt turbines and (indiscernible) (indiscernible).

This summer, we had some problems with the 60, shipped it back to CapStone (ph) and they fixed it and they shipped it back.

It should be installed and operating again this fall.

Then the program was extended to build two Alpha units -- not proof of concept but two Alpha units, one here and one for Montana state University up in Bozeman, Montana.

Those programs are on schedule.

The funding has stayed consistent;

I think it's $26 million or something in total -- sixteen million and total.

The continued development of that concept, of using fuel cells with (indiscernible) gas turbine, continues to look very favorable, Sanjay.

We haven't seen any new holes to shoot in it yet.

There's one that little wrinkle that may change it.

You know, what we do is we take the heat energy coming off the fuel cell and put it into where the recuperator would be, or the burner would be, in the turbine.

That heat energy is primarily from hydrogen, but we don't use all the hydrogen; we use about 70 percent of it.

There's another use for that hydrogen, which is to use as part of the hydrogen infrastructure or to refuel hydrogen automobiles, so we do have some kind of side work going that -- (indiscernible due to multiple speakers) -- fuel cell turbine.

That hydrogen maybe as valuable as the extra kilowatts would be from a fuel cell turbine.

So, that's kind of a new wrinkle.

We have been saying ever since Bush said hydrogen fuel cells that we don't need hydrogen; we generate it internally from multiple fuels and generate more than we need.

So, that could be a wrinkle that could get very interesting, depending on how the hydrogen automobile business --.

(indiscernible) kind of unfolds.

I are really appreciate that.

Another question -- if you could once again remind us remind us, Jerry, about -- number one point, where exactly is your product cost right now?

Number two, if you could also remind us how do you sort of see the market evolving at the various price points for your product at a particular (indiscernible) cost per kilowatt range, and how do you sort of see that playing out here, especially with your efforts to kind of bring the cost down from the value engineering and design engineering before you really get into the mass manufacturing?

First, we know what the market clearing prices are because we know what our products sell to to our partners; we know what subsidies and so forth they get.

Several of these are generating energy and selling energy, so they are not selling the product.

We've got a pretty good handle, certainly in the Northeast and West Coast of what is the marking and clearing prices in cents per kilowatt-hour plus (indiscernible) and we convert that back into capital.

So, we know what our targets are.

Then the question is, how much value engineering and technology upgrades the "cost-out" program will bring you and at what volume level will you be with that?

That's what we're doing; we're driving the cost down.

At the same time, we are looking for the markets.

At some point, those two curves will cross.

To give you some example, the first dozen sub-megawatt BOPs we bought -- the second dozen were 35 percent cheaper than the first dozen.

We're not up to a third dozen yet, but we have quotes on delivering one BOP a month for a year.

That's from 30 to 50 percent less than the first 24 would have been.

So, we know -- and that's without value-engineering plugged into it; that's purely volume.

So the two of them cross.

I'll stand back and give you another one; a couple of -- three years ago, we looked at somewhere in the 100 to 150 megawatts a year range being our cash flow breakeven number.

We think that's too much volume.

We think we can do it at a lot lower volume rate, and that's what we are focusing on.

That would be extremely positive to us, but we have to see the results of the program.

As I've told a lot of people, including by board, that you've got to have a unit that meets customer acceptance and operating in the field as your base before you can start taking cost out of it, okay?

The performance has to be there, the operability and serviceability and it has to satisfy at least early adopter customers' expectations.

Once you do that, then you can focus all of your efforts on cost.

That's right, but just kind of taking it a step back in terms of where exactly is it on a per kilowatt basis and maybe given the price of the -- (indiscernible due to multiple speakers)?

(indiscernible due to multiple speakers) -- you exactly where it is, but I will tell you that it appears that with the current price of gas that we are from two to four cents per kilowatt-hour, on a lifetime basis, above where we need to be.

We've been bridging that two to four cents with these various incentives and subsidies and so forth.

That's actually not too faraway here.

I'll tell you, at $6 gas, that's 12 to 14 cents.

We really need to be at nine to ten cents.

Of course, in Japan, with a higher power prices and all, we fit better.

Jerry, this is one of the things that -- I guess one sort of struggle, right?

Given that you guys are already here at 12 to 14 cents per kilowatt-hour and considering that the price of electricity is pretty high in Japan, I mean, why haven't you really received a meaningful order right now?

It's not like you're too far away here.

I mean, we've heard a lot about the grid is sick; we've got to do something about it.

Has anything really changed here from your perspective,especially post-August, you know, the blackout --?

Are you talking about Japan, or are you talking about the blackout here?

One from Japan; that's the first point.

The second point is we've heard so much about the DG (ph) and stuff like that.

Obviously, it's intuitive; we need to do something about it.

There's no question about that.

Have you really seen anything change here from a tangible standpoint?

What's your expectation out of this whole thing?

First, in Japan -- I guess you don't know much about that market.

It's extremely difficult for foreign companies to penetrate the Japanese market.

That's well-known I think.

Agreed.

When you have existing -- HI (ph), Mitsubishi and Hitachi were the three big carbonate developers in Japan.

We told our friends from Marubeni, "Watch out because if we are successful and you penetrate, somebody loses some serious space.

The government has down selected the other two, put all their eggs in the HI's (ph) basket;

HI has come and tried to cooperate with us and we said, "No, we've got a partner in Japan."

So penetrating that market -- the first unit went in and started up in January; it was delivered in late October.

Without one unit on the ground, okay, they got the first five orders.

Now, with Kirin on the ground, that's why they've ordered three more megawatts, okay?

So I see it's proceeding absolutely great.

I wish I could've gotten Kirin a year earlier and we'd be smoking now.

So Japan -- they've done a magnificent job.

They had to fight the government agencies and a strong, big company competition to penetrate that market.

Now, they've got big companies coming to them wanting to cooperate, okay?

That's what I feel very strong about.

The U.S. -- it's fighting the established wires companies, the utilities.

DG (ph) has been doing it for 20 years -- (indiscernible due to multiple speakers) -- distributed generation components, and it is a battle because for every unit we put in, that's one kilowatt that that local utility -- we're taking his revenues.

And that's a battle.

Companies fight like hell with that.

I'm telling you, as long as the United Technology 200 kilowatt units and I think some of our 250 kilowatt units -- well, that's okay; that's not a big threat.

The megawatt units that we're putting in and the megawatt proposals we're putting in around the country -- we are getting serious feedback from the established utility in that area that he will fight it like crazy.

Because when you start talking about megawatts, you're talking about serious revenues taken from the local utility.

That's what we've got to fight.

What the blackout helps, okay, is to focus Congress' attention on that, and they are talking about it.

Some of this Advanced Technology Proposal -- you're talking about 2.5 cents per kilowatt-hour.

In many places, that is going to bridge the gap for us, and that's for places where we go.

For example, we've got a 250 unit at the Coast Guard.

Let's retrofit all the Coast Guard with grid-independent systems around the country; that's Homeland Security and all.

Then you're talking about multi megawatts.

Two and a half cents per kilowatt subsidy for ten years would absolutely blow the socks off this market, no question about it.

That's good.

Again, we do believe that you guys do hold a lot of potential here from both the near term and long-term standpoint, but you know, just waiting for the market to kind of set that whole thing, right?

It's kind of hard for a small company sometimes to move totally all viewpoints in Washington, but we're doing our best.

I completely agree with that.

Thanks a lot, Jerry.

I really appreciate it.

You next question comes from Mike Harris, Robert W. Baird.

Good morning, gentlemen.

I just wanted to -- first off, your shares had advanced pretty significantly since the proposed Global Thermoelectric transaction was announced.

I just wanted to discuss -- will that transaction in terms of ratios of the transaction change (sic), or will they remain the same regarding the ratio of shares?

There's a collar on the transaction, Mike, which fixes the number of shares at a high collar of 974.

Obviously, we're trading around that range.

It will fix the shares at that level.

That share number -- I think the range is eight to ten million shares, and I believe at that end of the collar, it's about eight million shares.

Okay, that's helpful.

Then, regarding the Marubeni and the three megawatts that was released for production, can you give us any detail on the specific end applications for some of that -- (indiscernible due to multiple speakers)?

No, I can't.

In fact, of the first five units they bought, or six, there's still three that have not been officially announced.

The problem you have is that they are getting some government financing too and until that actually -- ink is on the paper and cash in the bank, they don't want to announce it because then you are presupposing the government and the bureaucrats get all uptight about it.

So you'll see, with Marubeni, announcements closer to actual unit delivery in most cases.

But it's for that reason because it's -- you don't want to announce something and then assume the government will do it, so until all the "i"s are dotted and "t" crossed -- this is not unusual in Japan.

That's reasonable.

So, that three megawatts that was released for production, that was already included in the previous backlog, correct?

It was included in the financial backlog, meaning Marubeni was committed; they had not released it for production.

They've now released it for production, paid ten percent down, going to be progress payments as we manufacture.

So while it was a contractual backlog commitment, the timing on it was open.

By them releasing it, that means they've already got customers lined up for each of those.

That's reasonable.

Regarding the current backlog estimated at eight megawatts, I'm assuming that both the two megawatt and the one megawatt plants will come off in near term?

That's absolutely correct.

So you're really going to be at about five megawatt to maybe even a little bit lower than that probably when we talk at this time next quarter?

Why?

You're saying we are not going to get any orders between now?

Excluding the impact of any future orders.

Okay, that's fair enough.

I just want to confirm there were no new orders received during this quarter.

Only the Cat Tech Center -- (indiscernible due to multiple speakers).

Pardon?

That is considered an additional order?

They're paying us for it, so I would hope so.

Fair enough, Jerry.

That's all I had.

Thanks.

Eric Prouty, Adams, Harkness.

Joe, just a quick clarification on your cash flow projection for next year -- you said it was (indiscernible) based upon five to six megawatts.

That was an annual number to get to that cash burn?

Yes.

I mean, is that your expectation for 2004 megawatts would be five to six?

No.

My expectation is that we should be able to get more orders through the pipeline.

But we have been talking about how do you get your cash flow to seven to ten megawatts and how do you drive it to that?

Our backlog right now -- we probably have -- you know, for six megawatts of production and sales in '04, we probably have three to four of that already existing, so we would only need to get two megawatts and the types of activities we're working on should really exceed, should exceed that number.

But as a guide as to how the business works and if you were to run a production of five to six megawatts -- which gives our plants operating; it keeps us in position to launch the business.

We're running all processes; we are running the plant completely at that point -- it puts us in a good position to be able to take orders, take additional orders and move those out in '04 and then going into '05.

That's what our intent is.

Eric, what we did, we went back and looked at calendar '02 and calendar '01.

Obviously, the markets were a lot earlier.

We looked at what our partners had been able to commit as far as cited orders.

We already had their financial commitment.

If you look at all those numbers, they were doing about six megawatts in new orders a year, identifying customers and developing customers and so forth.

So, we don't think it's a big stretch to run six megawatts for the next year.

That's about the run-rate we're at, plus the R&D work and the additional megawatts there.

So, I'm expecting and hoping with all the efforts we're putting in, it will be a lot more than that.

But anything less than about six megawatts, we can't run smooth production; we would have to do some batch process and start and stop.

So at six megawatts, we can keep Torrington running smoothly and then still be ready to expand production volume four, five, tenfold at real quick.

Joe, I guess just to put that into context, what's the anticipated megawatt shipment for this year?

The megawatts shipments for this year, including the three megawatts, is going to be around -- three megawatts plants -- it's going to be close to six megawatts.

So, I guess --.

Actually higher (inaudible).

No, I think it's more like eight.

It's closer to eight megawatts.

So it sounds like barring new orders -- I mean, you guys are looking for a not insignificant decrease for fiscal '04 potentially?

No.

We have reduced our production in July to a run-rate of six megawatts a year.

There's no shelf life issues or anything.

Sure.

We're only talking about the fuel cells themselves; we're not talking about the (inaudible).

We would buy that with new orders.

We will keep a consistent run-rate of in it -- in the inventory -- until we see how the order level develops. (indiscernible due to multiple speakers).

Keep in mind, we're shipping fuel cells to Germany for MTU to make into power plants.

When I look at Germany, Japan and the U.S. and say, hey, if we can take the new orders sightings for the last two years, we ought to be able to treat that at our minimum level for '04, and that's kind of what we are doing.

Okay, great.

Then, Joe, on Marubeni, it sounds like they're going the route of MTU of producing their own balance of plan.

I mean, will that significantly impair the revenue per megawatt you're going to be receiving for those plants since you're shipping the stack out to them?

Let me answer that.

I hope it does.

Keep in mind, we are buying two things; one, we're buying (indiscernible) plant from suppliers.

We can't get near the margin on that that we could if we make it ourselves. (indiscernible due to multiple speakers) fuel cells.

The other is, shipping fans, switchgear, steel to Japan is just totally uncost competitive compared to buying it from Japanese or Asian supplier sources.

That's why we want to push Marubeni to do this, because it makes a power plant that much cost-effective.

Keep in mind, balance of plant is at least half of the cost of the total unit.

So, if we can work on that reduction in Japan at the same time we focus on the fuel cell, it's much better off for us.

Okay, great.

I mean, the stack alone is of higher gross margin, since you probably just more passing through the balance (sic) of (indiscernible) costs?

Even if we are selling -- if our sale price is above our cost, we would still put a much lower margin on the pass-through item than on proprietary technology.

The future, Eric, is -- I think you are right on, is that over time, the proprietary technology will carry the margins.

So, the faster we can move the Japanese to their own balance of plant, they get more cost-effectiveness; they lower their balance of plant costs, and we can make a better margin on the stacks.

Then just one final question --.

The other thing that does is that increases volume in our U.S. manufacturing and helps drive down the costs in the U.S. (inaudible).

Keep in mind, these people like Caterpillar -- Caterpillar sells more than 20,000 packaged power plants a year.

Now, they are diesel engine with gas engines and gas turbines.

They know a lot more about packaging balance of plants than we do.

We had to do be the first to build the first product but we're looking at them; we are looking at Mitsubishi -- Marubeni -- and we're looking at MTU to come up with much -- in fact, MTU is here this week and we are comparing balance of plant costs, their design versus ours, who they buy it from, who we it buy from as part of the cost-reduction strategies.

So, having one more leg on that shoe -- two more with Caterpillar and Marubeni.

This helps, certainly, any global sourcing and ideas on bringing cost (inaudible).

Great.

Then just a final question, a tough one but I think one that's probably worth discussing -- you know, we talked a bit about the Coast Guard stack. (indiscernible) their kind of monthly upbeat, and their last one, at least, stated that you guys have given them maintenance and restacking costs, I guess what they term significantly larger than originally expected.

You know, putting I guess into jeopardy the cost/benefit of the project.

This is just because that's an older technology, or what's driving that?

It seems like these guys got caught a little bit by surprise with these high ongoing O&M costs.

I don't know about the O&M costs;

I know about the -- I'll look that up, Jarett (sic), because that's the PPL's -- I'm sorry, Eric -- that's (inaudible) customer.

But let me just put it is way, if you're looking out three to five years for stacking costs, you make a certain assumption of volume going to our Torrington facility.

That assumption drives what that stack cost.

Our volume assumptions are lower now than they were a couple of years ago, so that's part of the issue.

I will look up the Coast Guard.

I'll have to talk to the project manager on that and see where we are (inaudible).

But that's the underlying problem; it's just what volume assumption do you make when the stack needs replacing.

Thank you very much.

(OPERATOR INSTRUCTIONS).

Are there other questions, operator?

Your next question comes from Gary Suave (ph), Janney Montgomery Scott.

Go ahead with your question, sir.

Your next question comes from Jeff Feinaman (ph).

Hello, Jerry.

How are you today?

Have you made any progress with the use of diesel fuel as opposed to natural gas?

Yes, we have a 26, $28 million program with the Navy to develop a diesel-fueled ship service fuel cell.

We were supposed to start building it during the fiscal year.

It looks like it's going to be more towards year-end because the Navy pulled some funds out of this year and rolled them into next year so that they could -- I guess they needed to buy some more tomahawks or something for some ships.

But it's progressing fine.

The important thing is is the natural gas fuel cell power plant with the diesel fuel processing upstream of that.

The plant is to test it here then take it to the Philadelphia Navy yard for land-based trials, and if that works good, put it on a ship for a see-based trial.

So it's a multi-year program.

Diesel is very difficult to get clean enough in a small-scale program to put into fuel cells, but we can do it.

Will this reduce -- will that be less expensive than just using natural gas?

It will be more expensive because of the cleanup of the diesel fuel.

It's primarily getting sulfur out.

Diesel is -- if you have low sulfur, virtually a zero sulfur diesel, it's pretty easy to use diesel in our fuel cell power plant.

It's when it's high-sulfur diesel -- and of course, the Navy wants to use NATO F76 (ph) fuel.

Okay, thank you.

Very good.

It's been -- one more question, operator?

It's been almost an hour.

Yes, sir.

At this time, I show that there are no further questions, sir.

Very good.

I'd like to thank all of you and we will see you next quarter.

Thank you very much.

This concludes today's FuelCell Energy third-quarter conference call.

You may now disconnect.