燃料電池能源 (FCEL) 2004 Q3 法說會逐字稿

Good morning.

My name is Patrice and I will be your conference facilitator.

At this time I would like to welcome everyone to the third quarter earnings results and Company update 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.

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.

Mr. Eschbach, you may begin your conference.

Thank you very much.

Good morning.

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

On behalf of my fellow executive management team here at FuelCell Energy, I am delighted to have you join us on our third quarter 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. Leitman.

Thanks, Steve, and good morning, everyone.

I would like to welcome all of you to the call to review the quarter.

Let me first turn it over to Joe for more detail on our third quarter financial results.

Thanks, Jerry, and good morning, everyone.

FuelCell Energy reported a net loss for the third quarter of fiscal 2004 of 18.9 million, or 39 cents per basic and diluted share, compared to 15 million or 38 cents per basic and diluted share the same period of the previous year.

Revenues for the third quarter of fiscal 2004 were 8.1 million compared to 7.3 million in the same period a year ago.

Cash, cash equivalents and investments, U.S.

Treasury's on-hand as of July 31, 2004, totaled 169.4 million.

Net cash used during the quarter was 1.9 million including the cash proceeds from the sale of Global of $16 million.

On a stand-alone basis, FuelCell operations used 17.9 million including 2 in Canada and 15.9 in the U.S.

Included in the U.S. operations, cash use was 3.4 million for capital expenditures, which captures power purchase agreement costs in the quarter, including 2 million for the 2 DFC power plants for the Santa Barbara PPA and 1 million for the DFC 300A shipped to the Fuel Cell Test and Evaluation Center.

Components of revenue and cost for the third quarter and year-to-date of fiscal 2004 were as follows: Research and development contract revenue for the third quarter of fiscal 2004 was 4.4 million compared to 4.7 million in the same period last year.

During fiscal 2004 the Company's revenues increased on its Product Design Improvement contract, Vision 21 DFCT contract and Solid State Energy Conversion Alliance to seek a contract with the U.S.

Department of Energy.

These were offset by the completion of the Company's first 2-megawatt DFC3000 plan under the Clean Coal contract also with the Department of Energy.

The cost of research and development contract revenue declined by 2.2 million in the third quarter of fiscal 2004 due to the change in cost share mix of those contracts.

Fuel cell product sales were 3.6 million for the third quarter of fiscal 2004, compared to 2.6 million in the same period a year ago.

Revenue during the quarter ended July 31 was higher than the previous year primarily due to progress on power plants from Marubeni and Caterpillar customers.

Product sales backlog at July 31 totaled 25.4 million compared with 17.1 million for the same period a year ago.

This backlog does not include PPA contracts.

The increase of 200,000 for administrative and selling expenses over the prior-year quarter was primarily due to Canadian operations and higher sales and marketing costs.

Research and development expenses for the 3 and 9 months ended July 31 were 6.7 and 19 million compared to 2 million and 6.1 million for the same period of the prior year.

Of these increases, approximately 1.7 million for the 3 months ended July 31, 2004, and 6.8 million 9 months ended were related to solid oxide fuel cell research and development costs in Canada.

The remaining increase is on plan and is our continued focus on product development related to cost reduction.

In closing, our Canadian SOC operations used about 2 million in cash this quarter and we believe that we will be able to drive much of this cost into the SECA program and reduce this cash use.

Regarding quarterly cash use going forward, we expect PPA costs on Santa Barbara and Sierra Nevada to continue to come through in the fourth quarter.

I will now turn this call back to Jerry.

Thanks, Joe.

Our strategic business objective is to develop sustainable market segment for our DFC products, to provide the volume we need to get to cash flow break-even.

Our strategy is to identify and establish positions in key market segments, beat customer expectations of product performance, drive cost out of the product to build repeatable order flow and manage our cash consistent with this strategy.

We've identified and established positions in 7 customer segments globally to date.

They are waste water treatment facilities, hotels, hospitals, universities, manufacturing plants, grid support for utilities, and high reliability applications for telecom, data processing and government, especially the military.

During the quarter we added Logan Energy as a U.S. distribution channel partner with a particular focus on megawatt-class power plants in California.

Logan has an established track record for turn-key fuel cell power systems that dates back to the '90s.

An important milestone during the quarter was the startup of our first megawatt-class power plant, a DFC1500 at King County in Washington on natural gas and completing the testing requirements in some fittings and applications for certification by the California Air Resources Board for their 2007 emission standards.

Following certification of our sub megawatt-class products last year, certification of the megawatt product this year will enable us to broaden our market penetration in California.

California remains a key focus market for us going forward.

Over the past 2 years we've qualified for incentive funding for 40 to 50% of the project cost.

We received an exception from utility exit fees valued at approximately 3 cents per kilowatt hour, and are now placing reference units in commercial and municipal waste water applications in addition to the earlier units placed at Los Angeles Department of Water and Power.

Going into 2005 and assuming CARB '07 certification on our megawatt plant we now have access for our megawatt plant targeting sessions including waste water, hotels, universities, hospitals and prisons.

This morning we announced the finalization of an agreement with Marubeni and Kawasaki Heavy Industries for packaging and distribution of our DFC power plants in Japan.

This is an important strategic development that fits into our strategy in 2 distinct areas.

First of all, it gives us additional expertise in product cost reduction from an established leader in delivering stationery power systems to commercial and industrial customers.

Secondly, it provides an additional distribution channel for developing repeatable markets in Japan for Marubeni, broadening the customer reach of our products.

Kawasaki is a world leader in its field.

It's industrial gas turbine business has the top share of the gas turbine market below 10 megawatts, and has delivered more than 7,000 gas turbines.

This 3-way partnership will give us 2 energy industry leaders in Japan to help us reduce cost and further penetrate the Japanese market.

There are a total of 5 DFC300 units presently installed in Japan, each of them in applications which have the potential for considerable follow-on orders.

The fundamentals, which have driven adoption of fuel cells in Japan have not changed.

Electricity prices are still high.

Japan's leading in companies increasingly strive for CO2 emissions reductions and clean energy incentives are growing.

With Kawasaki now part of our team, we believe local manufactured content and customization to Japanese customer needs and integrating our core technology into a cost-reduced balance of plant will significantly strengthen our position.

Operating our unit at the Democratic National Convention at the Fleet Center in Boston provided us with a number of firsts.

Besides all the others, it also showed the feasibility of shipping a unit to a site, leaving it on the flatbed of the truck, completing all hookups and inspections, and starting operating, shutting down and vacating the site in less than 30 days.

That unit is now in Johnstown, Pennsylvania with the Department of Defense Fuel Cell Test and Evaluation Center for an evaluation in a combined heat and power application.

This distributed generation fuel cell system will supply electricity and the byproduct heat will be coupled with an absorption chiller for air conditioning.

We are pleased to note that the Department of Defense Appropriation Bill for fiscal-year 2005 includes $7 million for carbonate fuel cell projects.

We expect the funding to result in contracts in calendar '05 using our products.

The government, particularly the military, are heavily dependent on a continuous source of reliable power.

As the U.S. responds to Homeland Defense continues to take shape, we are increasingly seeing interest by military bases for having their own power generation resource and a dependable local fuel supply.

While our products have demonstrated capability to run on propane and natural gas at our factory test center here in Danbury, we are now working with the military to demonstrate this capability in a mission-critical environment at the DoD Fuel Cell Test and Evaluation Center in Johnstown.

We anticipate this program extending into the use of military logistics fuels operating in parallel with natural gas over the coming years.

This combination should make fuel cells the technology of choice as the military pursues its critical power needs.

During the quarter we shipped 3 units for waste water treatment applications, 1 to LA County Sanitation District and 2 to the City of Santa Barbara in California. 1 for municipal grid support to American Municipal Power in Ohio, and 1 for the government military to the DoD Fuel Cell Test Center.

Our first DFC300A commercial unit began operating in early 2003 in Kiren Brewery in Japan.

Since then we have operated units at 35 customer locations in Europe, Japan and the U.S. and generated more than 45 million kilowatt hours to date.

The current install fleet can generate more than 60 million kilowatt hours annually, greatly increasing our performance experience.

The fleet's availability has met customer expectations, especially recognizing it is a nonlegacy product, that is it's not a new model of an existing product but the initial product of a new and potentially disruptive technology.

Our overall fleet availability is in the mid-80% range, with the first year of operation of the U.S.

Coast Guard unit at 96% availability -- at 96% availability, and by the way, the Coast Guard report on this first year of operation is linked on our website if you want to read the entire report.

Either the success rate or the fact that this unit is designed to run in an island-in mode, so when grid disturbances occur, it can separate itself from the local utility transmission distribution system and continue to provide power.

Causes of unexpected shutdowns and impact availability include external events, such as grid disturbances and fuel supply interruptions and balance of plant equipment issues, such as water treatment system pump failures, instrumentation failures, fuel and water control valves leaking or sticking, valve actuator failures, and of course, the thermal management issues imposed on the fuel cell module from these external and equipment related disturbances.

Collectively, we and our partners and their ultimate customers understand that we continue to learn as we gain increased operational hours and have a clear path for continual improvement in operational performance.

Increased operational hours not only enhances performance, but also materially drives our cost reduction efforts.

We now have a dedicated team of 20 product engineers who receive cross-functional technical input from another 40 professionals in various departments, as well as input from our distribution partners, our component suppliers and our packagers.

Our product cost reduction targets are 25 to 30% a year from 2003 through 2006.

A unit shipped this quarter is 27% less cost than one shipped a year ago.

It is important to note that we are rolling out design changes in blocks 2 to 3 times a year, which results in a 6 to 9 month lag before the benefits of the cost reduction are captured in our financial results.

During the last quarter, the focus was on using our sub-megawatt experience to drive cost out of the megawatt plant by optimizing the electrical balance of plant design, redesigning and competitive sourcing of the water treatment system, combining functionality of fuel treatment components and substituting materials and piping assembly has allowed us to reduce VOP cost for both the 1-megawatt as well as the 2-megawatt plant by about 10%.

Improvements to the manufacturing process of integrating the sub-megawatt fuel cell module in the balance of the plant reduced the cost of that operation by over 50%.

These include the accuracy of the piping interface, enhanced factory acceptance testing at the BOP packager and various Kaizen [ph] activities.

Improvements of sub-megawatt fuel cell test conditioning process reduced the cost of conditioning our sub-megawatt products by over 40%.

This includes cross training of test personnel for enhanced productivity, simplified the processes in the conditional cycle -- conditioning cycle and other Kaizen activities.

Continued improvements in the cell package manufacturing area reduced labor costs by about 3% this quarter.

This cost savings applies, of course, to all of our DFC products.

Most of these savings are the result of improved tooling and fixturing, as well as standardizing processes for efficient work flow.

In summary, our product cost reduction program is on track, and falls in line with what more mature generation products did early in their product introduction phases.

Our near-term strategy is quite simple.

We will continue to establish positions in key market segments for our DFC power plants.

We will continue do meet customer expectations for performance of our products.

And we will continue to aggressively reduce product cost.

And finally, we are in a strong financial position, as Joe mentioned, with nearly 170 million in cash.

Operator, with that we are now prepared to open this conference call to any questions the participants may have.

At this time, I would 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 Jarett Carson of RBC.

Good morning.

With regard to maybe a little bit on the financial front, Joe, the decline on the R&D contract side, down to around 4.4 for the quarter, is that a more applicable number given that the 2 -- apparently the 2-megawatt unit now has been delivered?

Is that kind of a more applicable run rate?

Yeah, I would say so.

We basically -- completing the 2-megawatt was a large contract.

I think your conclusion is correct.

Okay.

The -- can you talk a little bit about, we got the nice improvement in gross margin that we were expecting and that seems to be a function of starting to see some of the cost benefit, cost-out reduction filtering through.

But can you maybe talk a little bit, I know there are some one-time stuff last quarter related to the PPA contracts relative to this quarter.

I guess the negative 167% gross margin this quarter which looks quite good.

Does that have some one-time positive benefits maybe relative to the stuff shifting 1 quarter or another, can you maybe give little more light on that?

I think you are right on track, Jarett.

I think that there -- last quarter we got penalized a little bit for early recognition of costs in the quarter.

I think a little bit of that turned around in this quarter.

I think if you normalized it you probably would probably end up at a 1- to 3-type of a ratio, up from the 1 to 2.67.

So I think there is a little bit of positive benefit in there.

Okay.

And the announcement out this morning, Jerry, looks very, very interesting with continuing down the pathway of building out the capabilities in Japan.

Your expectation is 2 things.

I mean it says that or in the press release you state that the deal was not closed yet, I mean in terms of finalization.

Number 1, when do you think that would be, roughly?

And then secondarily, the expectations, sometimes these large distributors, the lag time between kind of getting them up and running has been, or the amount of time has kind of lagged relative to expectations, just some color around that.

Okay.

We've been negotiating with ourselves, Marubeni and Kawasaki for probably a year now, at least a year.

And as you know with big Japanese companies things move slowly and trips have to go back and forth.

And we are all 3 have shaken hands.

We have a deal that's taken some final administrative reviews both here and in Japan.

But we wanted to talk about it at the call and agreed that it's in the final stages of agreement and virtually no risk of it failing.

So we wanted to bring this out.

It's important for 2 purposes.

One is, I can't tell you how difficult we make it on ourselves by shipping an American product with English labels to Japan.

They are not used to it no differently than we would be used to working on the Japanese product with Japanese labels here in this country.

So Kawasaki is a major power equipment supplier on a global basis, particularly in small units of 1 to 3 megawatts and less.

They have a lot of packaging expertise and they have particularly packaging expertise that applies to the Japanese market.

So it's important for us to get a Japanese supplier supplying the balance of plant.

Obviously, we lose some revenues, but we greatly expand both the performance and the acceptance of the product by it being a Japanese packaged product.

So that's clearly a major scenario.

And from Marubeni, to be able to capture a heavy weight like Kawasaki versus just some small local packagers is a real coo, I think.

And it took some convincing of the performance of the product and so forth.

But Kawasaki will be accepting delivery of 1 of the Marubeni units to their facility and use that as their test bed, if you will, for developing the Japanese product.

So I think it's a major system forward.

The second part of that equation is for Kawasaki to be a sub-distributor which expands Marubeni's reach into the Japanese market.

As we've talked before Marubeni has, I don't know, 35,000 megawatts or so of power plants around the world, and until they put our fuel cells in, they had no power plants in Japan because they were a trading office and a trading company and the local market was dominated by a handful of major equipment suppliers one of which was Kawasaki.

So to partner up now with a major equipment supplier through the Japanese home market I think has a strengthening to Marubeni's position that we could get in no other way.

As an aside, I think you'll see Marubeni over time continuing to develop additional partners not only in Japan but also in Asia as they go after that market.

So that's kind of the background.

So there's 2 issues, 1 is to have a Japanese packager of power equipment who knows how to do it.

Second is to strengthen the distribution capabilities.

There's probably a third.

As you know we are in development on the fuel cell turbine.

And one of the key turbine potential suppliers is Kawasaki because they have small turbines that fit into the smaller products, not the 10 to 50 megawatts, but if you are looking at a few megawatts, 1, 2, megawatts then Kawasaki has turbines that would fit very well into that envelope.

Thanks.

Final question with regards to Caterpillar, I think movement on that front has kind of trailed expectations.

Where are you right now with CAT?

And maybe are you guys trying to do to kind of jump start -- jump start things on the distribution side with the CAT guys here in North America?

Well, I think 2 things, Jarett.

CAT may move slowly, but they always get there.

And I think what we and Peoria both didn't fully anticipate is the difficulty of the kind of visionary or missionary selling we have to do with fuel cells where you have to not only convince a -- not only find an early adopter but convince them that the fuel cell is the way to go and then somehow make the value proposition work by getting state incentives and other incentives to make it work which can include power purchase agreements.

It's much more difficult than the CAT distribution organization which is 70, 80, 100 dealers, I think about 70 electric power dealers, much more difficult selling than they are used to.

There are the exceptions.

Quinn in Southern California where we're starting up the LA County sand right now, Southward Milton is up here in the Northeast in the Boston area and maybe 1 or 2 more.

So we and Peoria both are focusing all our efforts on the handful of dealers who have both shown the capability and the desire to take on the difficult selling it takes for a new technology product.

That's step 1.

Step 2, in parallel to that, is CAT developing their own CAT-branded product which would also help.

The dealers aren't very used to selling something that's not branded CAT and painted yellow.

It's human nature being as it is.

And we think that which is coming out first quarter of '05 -- calendar '05, we think that will help, too.

But in the meantime, while we wish results were faster, in hindsight we probably couldn't have expected them to be more than that.

CAT continues to be dedicated to the success of the product.

I think it's just going to take a longer period of time than any of us really like.

Including our friends at Caterpillar.

Okay.

Thank you.

You're welcome.

Your next question comes from John Quealy of Adams Harkness & Hill.

Hi.

Good morning, folks.

A quick question on the operating expenses.

With regard to R&D under contract as well as R&D costs ticked up a little bit sequentially from the April quarter.

Can you comment a little bit about what we should be looking for moving into the Q4 period for those particular line items.

Let me just follow your question.

So you're saying that the quarter-over-quarter?

Yeah, that's right, ticked up just a little bit, is that a trend that we should expect to continue or what are your comments there?

That's, you know, John, it depends on the mix of the contracts that we work on in the quarter.

Some contracts are 50/50 VAR share.

Some are less.

This pattern right now, this is probably, you know, it's probably okay.

Okay.

That's fair.

And, Joe, in terms of the backlog of the $25 million, can you couch that in terms of units or kilowatts potential for us, just to give us sort of an operating view of that number?

Yeah, the 25 million relates to about 8.75 megawatts of units.

Okay.

That has nothing in there with the recent Kawasaki news?

Nothing in there for the recent Kawasaki news.

Okay.

My last 2 questions, on the cash usage for Q4, should we be looking at roughly an $18 million type number in the Q4 period similar to what you did without the global swap out in Q3?

I would say that what I'm expected in Q4 is probably a little bit more activity on a Sierra Nevada PPA to come through in that quarter.

Okay.

Great.

And then lastly, can we talk a little bit about the outlook on the Clean Power initiative?

I know FuelCell was one of the few, if only, fuel cell manufacturers to submit a proposal under that Clean Power initiative from the DOE.

Can you just characterize that project a little bit for us?

Sure, John, I will do it, but before I do, let me go back to the backlog number.

Keep in mind quite a bit of that backlog Marubeni business, maybe half of it.

And Marubeni as our partner is obligated to an increasing volume of orders per year to maintain exclusivity in Japan.

And as a result of that, they order in one lump and then go find customers for it.

So it gives us the protection of a financial solid backlog and then as they get, in this case, one of the units that will go to Kawasaki is one of the units out of their backlog stream, so just to clarify that, John.

Okay.

Going back to Clean Coal Power initiative.

This is a 14-megawatt fuel cell turbine.

It's the initial size of this 10 to 50 megawatt Vision 21 fuel cell turbine development.

We bid it.

It has 10 megawatts of fuel cells and 4 megawatts of turbine running on coal gas, following up on the coal gas unit we have in Wabash in Indiana, 2-megawatt plant.

But really we think the 14-megawatt size is the size niche that fits best on a footprint and everything else for the fuel cell turbine.

So 50 megawatts would be 3 of those plants, something like that.

So it's a key linchpin for us if we can get the financing to -- from the government to push this thing forward.

How to bet on that is hard to do.

We had a strategy meeting yesterday with our Washington folks and it's just impossible to read as to whether we will be awarded or not.

The pros are that it's fuel cell turbine, very high efficiency.

It's really at 54 million or so, a fairly small contract compared to how much they are giving out on this Clean Coal Power initiative.

On the other side of the coin, they will already had a fuel cell operating on coal gas, so whether that is something that's 2-me-2 [ph], we just don't know how to read.

Be very excited to have it come in, but on the other side of the coin we are not counting on it.

If it doesn't, we are still looking at building 2 alpha, an alpha and a beta 250-kilowatt with a fuel cell turbine early next year.

So we will continue that program and look for the larger hybrids coming down the road.

Great.

Thanks very much.

You're welcome.

John Adams of Adams Harkness & Hill.

Good morning, Joe and Jerry.

Good morning.

Good morning.

The hours of operation now 45 million kilowatt hours, can you as a matter of perspective give us how many operating hours there were a year ago, and then 2 years ago?

John, I don't have that off the top of my head.

I think it's important if you look at it, we shipped the first unit in January of last year, that's what, 18 months, 20 months.

The fleet is operating, we've only operated 45 million kilowatt hours, but the current 30-something units in the field would generate 65 million annually.

So you can see we have less than a year's worth of annual run in there.

So we are just on, you know, 45 million is a lot, but it's really the curve starts growing assymtidally [ph] I guess or almost vertical now, once we get megawatt plants in operation and running as we do at King County now.

So they go up pretty fast.

Which says that if we didn't ship another unit a year from now, we would have 110 million kilowatt hours, but as we are shipping more units that continues to go.

By the same token --

And let me just qualify, John, the importance is anybody that has rolled out a new product hours are what counts.

Operating hours are what counts in order to fine-tune availability and reliability and nuisance trips and things like that and to fine-tune which vendors are really supplying the right components that last the best and the like.

It's a numbers game.

The more operating hours you have, the more information you learn.

The more you learn, the more you improve the product, as well as reduce cost.

Speaking of which, I'm delighted that you are giving us some insight into your actual availability.

I know you've been reluctant to do up until now because of the thinness of the population and the fact that 1 or 2 units could really sway the data.

Now you have a much thicker population and presumably more representative data.

If you are in the mid-80s, again looking backward, where were you 6 months ago?

Where would you hope to be 6 months from now?

Well, the timing, as far as 6 months from now, that availability is from day 1 of the DFC300A population, which was the first one was secure and it shipped out in January of '03.

If you look month-to-month and slice it different ways, look at only American units, look at only European units, look at only Japanese units, look at only wastewater units, look at only hotel units, you know, you can slice the data and make it go pretty much any way you want.

In our case we said, look let's take the fleet and because that's what we want to measure and what our customers and partners are measuring us by.

We take the fleet -- total fleet data, it's not a question -- you do improve over time, but you also learn new things over time.

So if a valve, it turns out has an 18-month life you don't know that until about 18 months into the mission and then you got to retrofit every unit in the fleet with a new type valve.

So the more you get out, the more issues you have but much more of the learning curve goes your way.

We see no reason why that with a lack of moving parts within the fuel cell module itself and the maturity of balance of plant stuff, there's no reason why you won't be in the high 90s as far as availability as you get to maturity into the product line.

That's what we expect.

Thank you.

You're welcome.

Your next question comes from Craig Urban of First Albany.

Hi, guys.

Hi.

Just a couple questions here.

First of all, King County, wanted to know what sort of lessons you learned up in the -- learned on the start-up in the first megawatt-class unit here?

And potentially what's going to be involved in the certification of this class of product?

Okay.

King County started up on natural gas, I think in early July or we got to full load in early July.

This unit, as you will recall, we actually operated short term a couple weeks in our Torrington facility then we uninstalled it, shipped it to King County and reinstalled it again so that we could do 2 things.

One, we wanted to try it on our own facility, but second, we wanted to fine-tune installation costs so that we can use those costs of what it would take to put one of these together out in the field for our future pricing.

It's been operating virtually 995 to 1,004 kilowatts daily pretty steadily.

We haven't transitioned over to digester gas yet.

I expect that to happen in September.

But there's some things that the plant has to do, that King County has to do to make that transition happen.

We kept it on natural gas at first so that we could complete the emissions testing that's required by the State of California, Air Resources Board to meet 2007 emissions standards.

We have filed an application with our test report that says we met those standards, obviously, it's up to CARB to do their own analysis and we expect that to be within the next few weeks.

Don't anticipate any problems because we know the results and we did it last year with a sub-megawatt -- sub-megawatt plant.

What that does for us, the importance of it is, it in effect certifies that product for the California market.

And if you're certified for CARB '07, it opens up all kind of doors for California Public Utility Commission self-generation incentives for the fact that you're ultra clean which means you will avoid standby charges and exit fees by the investor owned utilities, so it opens a lot of doors for the California market that have not been opened up to us before.

The unit we are putting into Sierra Nevada, for example, our 4250-kilowatt units, not a megawatt, but 4250s just because we didn't have the certification at the time that order was placed.

So it's a pretty important -- it's a pretty important milestone for us and as I said, the next important milestone is to switch over to digester gas and there we have quite a few waste water treatment plant customers waiting to see that -- West Coast customers, waiting to see that, they want to go to Seattle and take a look at the unit and watch it in operation.

And we certainly expect that to be very positive towards the waste water treatment market.

Have you had many customers going to see the unit while it's operating on natural gas?

There's been a couple.

They didn't go through us.

We heard about it from the site people.

But primarily they want to see it on -- most of the people that want to see it want to see it operating on digester gas.

Great.

And that's what I'm saying, we are waiting for that change over now.

And then in the future it will be dual fuel.

It will operate on digester gas, if there's an issue with the digester gas it will flip back to a natural gas operation.

Great.

My next question is really on the DFCT units.

I was wondering if you could give us an update on the alpha units.

You did mention early next year as when we should sort of see those things maybe in the field.

But can you update us on the funding and sort of the visibility that you have for these units?

The funding comes as part of the Vision 21 program and it was, I think it's a total program package now of around $24 or $25 million, about $3 or $4 million per year assuming Congress authorizes it.

I think they've already authorized all the funding that we need through the fiscal-year '05.

We either are just finishing or have finished the design phase.

We are in the procurement phase.

What make it different is not only the addition of turbine and heat exchangers, but the fuel cell module in the sub-megawatt plant is an integrated anogas oxidizer.

We use the heat from the operate -- from the electrochemical reaction to preheat the incoming air and we do that internally in the module.

When you do that with a fuel cell turbine, there's not room in there to do all the piping and heat exchanges we need.

So we've got to redesign that module so that that mixing happens externally to the fuel cell module and that's where we take advantage of the turbine and that's why it's been a design process to go through.

I expect in early calendar '05, some time in first quarter calendar '05, we'll have the first alpha unit built here.

And then we have an obligation to build another one and ship it up to Montana, I think it's going to be at the Billings -- new Billings hospital there, as far as where it will actually be located, but I think that may be still up in the air.

So that's kind of where we are on it.

Great.

So then the unit for Montana is financed, just to be clear?

Yes.

Okay.

Excellent.

And then can you give us an update on --?

Let me make sure, I think that it's 80/20 cost share, so 80% financed by DOE, and 20% cost share by us.

That's pretty favorable.

And then can you update us on potential customers for the 14-megawatt DFCT?

Just, it's difficult to handicap whether or not things are approved when applying for government money, but previously you had mentioned that you were looking to make a commercial sale of the first unit.

Have you had discussions here with potential customers?

And can you sort of update us on this process?

Yeah, I think you have to -- from the testing we've done on the fuel cell turbine, it's an engineering issue, it's not a technology issue, okay?

The fuel cell works.

It has certain heat energy in its flow streams.

You have to get that heat and put it into the combustion -- where the combustion chamber is on a turbine.

We've done that in a -- in our test facility here on a 60-kilowatt, Cap Stone with a 250-kilowatt stack, so we know the engineering issue is involved and how to solve it.

The next step is to go build a 14-megawatt plant.

Well, you don't build a 14-megawatt plant on speculation.

But where that plant would go, it's what we've been doing is looking at partnering with some big utilities and the like because the customers for that are, it's kind of a wholesale generation business, it's grid support where you've got an issue, Southwest Connecticut where you can't string wires, but you could be permitted to put a fuel cell at a substation run it with the turbine and get the kind of electrical efficiencies that would allow you to compete with wholesale generation and transmission.

The Clean Coal Power initiative project, if it goes, would be very nice because there you could do all the engineering, all the development, all the procurement on a 14-megawatt natural gas plant would be done under the Clean Coal plant and then you would run it on coal gas by having an upstream processing skid that we've also learned how to do by doing our Clean Coal project in Wabash.

So what it would do would be to allow you o have a -- not an alpha or beta, but a prototype unit that could be then made commercially available in repeat orders, and they would allow you to go after major power users who could use the grid support requirements of a 14-megawatt or multiple ones that were a megawatt or 2 really doesn't give them what they need as far as real power generation help within the grid.

Great.

Then, Jerry, you mentioned that you are done with the design of the alpha and you are in the procurement stage.

Can you update us potentially on some of the design improvements or lessons learned from the proof of concept that are being incorporated into the alpha and potentially the overall improvements?

It is how do you package it.

I mean, we think we know what the performance will be.

Obviously, you are not going to get the performance you have on a megawatt-class plants because the balance of plant is just such a bigger component in a smaller unit.

I mean, that's true whether a turbine is involved or not.

The issue always comes down to how do we get with the appropriate, with the -- without too much temperature drop or too much pressure drop, heat from the fuel cell over to the turbine and from the turbine exhaust back to the fuel cell and do that in an economical mechanism.

That's what the whole issue is all about.

Then there are operational issues that come about because of, gee, what if the turbine has a malfunction while you are running the heat for the fuel cell?

What if the fuel cell has a malfunction while you are running the turbine?

How do you operate them together or how do you control them?

What's the software and logic you put into the instrumentation.

Those are all things we learned in our test facility here.

Great.

And you mentioned, I guess, you did touch upon the turbine and potential problems there and lessons learned.

Have you found a turbine that might be a better match for the alphas or the alpha, the beta and then the 14-megawatt?

I mean, have you identified these as potentially different units than what was used before?

The Cap Stone is what we've used before.

We will probably continue to use them on these alpha units just because we've got an experience base and a knowledge base.

And there's not too many, if any other suppliers in -- exactly in that size range.

If we're starting to talk a couple of megawatts or so then that opens the door to Kawasaki and maybe 1 or 2 others.

And if we are talking 10-megawatts or 14-megawatts, that opens the door up to Solar which fits very well in that range, which is also a subsidiary of Caterpillar, so part of the group if you will.

So it opens up possibilities depending on what size plant we're looking at.

But we'll probably -- I don't know if it's a definite decision, but I am pretty sure that we will continue to use Cap Stone on these next 2 units.

Great.

Great.

Thanks a lot, guys.

You're welcome.

Your final question comes from Michael Hong of Ardour Capital.

Hi, just a quick question.

Can you give a little guidance on your net income for the year?

We really don't give guidance.

We real don't give guidance.

Okay.

Thank you.

Okay.

Okay, anything else?

Operator, I think that will do it.

I thank everyone and we will be happy to talk to you in about 3e months.

Thank you very much for your time.

Good bye.

This concludes today's conference call.

You may now disconnect.