燃料電池能源 (FCEL) 2005 Q1 法說會逐字稿

Good morning.

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

At this time I would like to welcome everyone to the first-quarter 2005 earnings results & Company update conference call.

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

After the speakers' remarks there will be a question-and-answer period. (OPERATOR INSTRUCTIONS) Mr. Eschbach, you may begin your conference.

Thank you very much and good morning.

My name is Steve Eschbach.

I'm the Director of Investor Relations at FuelCell Energy.

On behalf of my fellow executive management team here at FuelCell, we are delighted to have you join us on our first-quarter 2005 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 FuelCell technology.

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

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

Thanks, Steve.

I'd like to also welcome everyone to the call.

Before I get into my comments on our accomplishments and outlook going forward, I'd like to turn the call over to Joe Mahler for more details on our first-quarter 2005 financial results.

Thanks, Jerry and good morning, everyone.

FuelCell Energy reported a net loss to common shareholders for the first quarter of fiscal 2005 of 19.4 million or $0.40 per basic and diluted share.

Net loss to common shareholders include accrued preferred dividends of 1.342 million or $0.03 per basic and diluted share for dividends payable to the preferred holders.

Net loss of 18,024,000 includes a charge for discontinued ops totaling 1.3 million or $0.03 per basic and diluted share related to existing Canadian facilities and 900,000 charge, $0.02 per basic and diluted share as an impairment charge to continuing ops for a planned manufacturing process change expected to result in future upgraded product performance and cost reduction.

For comparison purposes we reported a net loss of 28.1 million or $0.59 per basic and diluted share during the first quarter '04.

First-quarter '04 adjusted net loss which excluded a one-time charge for purchased in process R&D was 15.9 million or $0.34 per basic and diluted share.

November 2004 we completed the combination of our former Canadian solid oxide fuel cell operations with Versa Power Systems and essentially all of the employees and assets have been transferred to Versa at this time.

This transaction increased our ownership interest from 16% to 42%.

We now account for our investment under the equity method.

In the first quarter we recorded a loss of $340,000.

Also in the first quarter, we completed the sale of our Series B convertible preferred stock netting proceeds of 99 million.

Dividends accrue on the convertible stock at a rate of 5% annually and are paid on a quarterly basis.

Cash, cash equivalents and investments in U.S. treasuries on hand as of January 31, 2005 were $231 million which increased 79 million over the 152 million reported at 10/31/'04.

Including the proceeds from the preferred stock offering, cash used in the quarter was 20 million.

Cash used included capital expenditures of approximately 3.3 million, of which 2.8 million was for equipment being built for power purchase agreement.

In addition we spent approximately 1 million on severance and other consolidation activities related to our former Canadian solid oxide operations.

Current with the startup of our two DFC300A power plants for the Santa Barbara power purchase agreement, we applied for approximately 2.7 million in incentive funding from the California Self Generation Incentive Program and the Department of Defense Climate Change Fuel Cell program.

We also expect to apply for money on the Sierra Nevada MW and the San Diego MW plants.

Consolidated revenues for the first quarter of fiscal 2005 was 7.6 million compared to 7.4 million in the prior year.

Components of revenues in cost were as follows.

Product sales were 5 million first quarter '05 compared to 2 million in first quarter '04.

The increase Q-over-Q is due to the manufactured DFC Power Plants from Marubeni and Chevron Energy solutions customers as well as DFC component shipments to MTU.

Cost of product sales were 13.7 million and 7.6 million in the quarters ended 1/31/'05 and '04 respectively.

The ratio of product cost of sales improved from 3.8 to 1 in Q1 2004 to 2.72 to 1 in Q1 2005 and adjusted to the one-time asset impairment charge of 900,000 would be 2.5 to 1.

This ratio includes costs related to PPAs that have no corresponding revenue.

Our product backlog at 1/31 totaled approximately 23 million, up from 16.3 million on the same date a year ago.

This includes 1.4 million and 700,000 respectively related to service agreements.

This financial backlog does not include recurring annual revenue stream from PPA.

For example each 250 kW should generate between 175 and 200,000 of annual revenue to FuelCell Energy.

R&D contract revenue for first quarter '05 was 2.5 million compared to 5.4 million in the same period a year ago.

R&D contract revenues declined due to the completion of the Product Design Improvement contract with DOE, completion of our Bath Iron Works contract, and lower revenues on the Clean Coal and U.S.

Navy contracts.

Cost of R&D contract revenue were approximately 2.5 million and 7.5 million in the first quarter '05 and '04 respectively.

R&D contract revenues and costs were primarily related to solid oxide development under SECA, Direct FuelCell/Turbine development under the Vision 21 program and the Ship Service FuelCell contract with the U.S. Navy.

The ratio of R&D costs to revenue improved to 1.12 to 1 versus 1.39 to 1 same quarter last year due to less 50% cost shared contracts.

Government R&D backlog at 1/31 totaled approximately 24.7 million, of which Congress has authorized funding for 14.4 million.

This compares to 25.7 million, of which 14.8 million was funded at 1/31/'04.

Both SG&A expenses and R&D expenses for first quarter '05 were 5 to 600,000 less than the corresponding period first quarter '04, due primarily to the transfer of our Canadian SOFC operations to Versa Power Systems.

In summary we are managing cash consistently with our strategy.

As we said in the last call, quarterly cash consumption included approximately 3 million for PPA activity and 1 million for severance costs related to our discontinued Canadian op.

Our 230 million plus cash remains targeted to accelerate the market penetration for our DFC products and may be used to aggregate additional equipment purchase contracts with key customers to stimulate key markets that use PPAs or close large MW projects.

We are now at the bid preparation phase for project 100 in Connecticut and the Long Island Power Authority in New York and our strong financial position gives us the flexibility to move forward with both.

I will now turn this call back to Jerry.

Thanks, Joe.

We are very pleased with the progress we are making on our cost ops programs and it's good to see that these impacts are beginning to be reflected in our financial results.

We expect to continue this trend going forward.

The two most important accomplishments since our last earnings conference call are the strengthening of our balance sheet as Joe mentioned by almost $100 million and positioning ourselves for the development of repeatable business for our DFC products.

Starwood with about 750 properties worldwide is clearly an early adopter customer for our products that provides them with a value proposition of ultra clean power at reduced rates versus the grid.

Our partner PPL Energy Plus has a Master Energy Services Agreement, a MESA, with Starwood for the Northeast and has delivered units for three hotels so far with others in the development pipeline.

The Master Energy Service Agreement we have with Starwood resorts for California is an important next step in our relationship because it will streamline the process for fuel cell powerplant projects with them in California where Starwood by the way has over 50 properties.

We believe California provides a near-term opportunity because of local power prices, reliability issues, and especially the well funded self generation incentive funding programs that enables a value proposition to work.

Our first project under this MESA is 1MW of power plants for the Sheraton San Diego Hotel and Marina that will provide base level electricity for this 1000 room hotel and heat for its lagoon pool.

Also in California we have received a second order from Chevron Energy Solutions for a DFC300A powerplant for the U.S.

Postal Service San Francisco Processing and Distribution Center which extends our vertical market segments to include postal facilities.

This project is the epitome of clean, efficient power generation by combining our ultra-clean DFC powerplant for baseload power with solar powered (indiscernible) for peaking power.

This project announcement came about a month after we announced our first project with Chevron and our first 1MW in California for Alameda County's Santa Rita correctional facility in Dublin.

Likewise this is our first prison which we believe is also a repeatable market segment.

Marubeni continued to demonstrate aggressive pursuit of the markets in Asia.

In developing the three-way alliance with POSCO, one of the largest steel producers in the world, we opened the Korea market with POSCO as both a sub distributor and packager of our products in Korea.

Initially POSCO purchased three DFC300A power plants with the first sighting for Pohang University of Science and Technology.

In 2004 the Korean Government selected fuel cell to be one of the 10 growth engines for its economy going forward and POSCO was selected to lead the development of large stationery fuel cell powerplants.

The Korean government has set a goal to install 300 units between 250 kW at 1MW by 2012.

Marubeni also announced that the DFC300A for Tokyo's Super Eco Town in Japan, the wastewater treatment application that extends our wastewater vertical market segment to food processing.

We now have eight wastewater treatment applications led by the 1MW DFC1500 at King County, near Seattle.

Related to developing sustainable markets for our DFC products is the ongoing growth of renewable portfolio standards, which are now in place in 18 states plus the District of Columbia.

In our home state of Connecticut, the Connecticut Clean Energy Fund has a long state legislated approved program called Project 100 requiring the state's utilities to have 100MW of power contracted from renewable generation by mid 2007.

Our fuel cell products on natural gas qualify as a renewable due to their ultra-clean profile.

Next door in New York has also adopted a renewable energy program that would require 3700 MW of new power generation from renewable sources and again our fuel cells on natural gas qualifies renewables in New York.

As Joe mentioned just last month, the Long Island Power Authority issued a request for proposal for 10 MW of fuel cell power for installation in mid 2006.

While these government subsidies are facilitating sales of our products in global regions with high electricity costs and other drivers that require clean, efficient and reliable generation, cost is still a primary focus for us to be able to compete effectively in the broader markets where energy is a commodity mostly dominated by price considerations.

Cost includes product performance through customer satisfaction as well as capital cost of the equipment.

Thus we focus on what he learned from operating hours in the field to enhance product performance and reduce operating and maintenance costs and equipment costs further.

We operate with a rolling three-year value engineering cost up program with targets of reducing product costs by 20 to 25% each year.

During the first quarter of '05 our shipments totaled 1.5 MW; two plants for two 250 kW plants were shipped to Korea; one was shipped to Japan and one to the Salt River Project in Arizona.

In February we shipped the first two DFC300A power plants for the 1 MW Sierra Nevada Brewing Company in California.

Units 3 and 4 will ship later in the second quarter and we expect it will start up in early third quarter of '05.

Through the end of February 2005, electricity from our products at customer sites now exceed 62 million kilowatt-hours, more than double the 27 million kilowatt-hours achieved through the same time last year.

Notably about 5% of this total is from our first MW plant in Seattle that began operating in June and through December 31 had an availability of over 90% operating on both natural gas and digester gas, which is above our current fleet average of 87%.

We have developed a new design for our 250 kW DFC product which incorporates the value engineering cost reductions from last year, approximately 25% lower cost.

We are now building our first unit for initial operation at Danbury, which will be the full system test of the design changes that have previously been verified in the lab and on our engineering test units.

We are targeting to incorporate these changes into production in late summer of this year.

Other value engineering initiatives not related to this new package design we're working on include alternate materials for our cell components that will improve performance, that is operating our technology so that we get more kW from the same stack and at reduced cost.

In addition, process changes are being reviewed that have the potential to combine functionality of balance of plant components that will eliminate other equipment.

As an example of this the recycle heat blower can also be used for fresh air blower that would eliminate a second air blower.

The similarity of our core DFC product enables value engineering initiatives on or 250 kW powerplants to be applicable to our MW class products.

For example we're working on a redesign of the heat recovery system with a smaller, more compact heat recovery unit and integrating nano gas oxidizer into the fuel cell module.

Both were successful in our sub MW product and we look forward to similar success for our MW class products.

We believe our DFC products can provide customers with more reliability at less cost when in volume production and with virtually zero emissions, evidence of the success of our costs op program is now materializing in financial results and we expect the trend to continue.

In the meantime we will continue to secure orders where government incentives enable us to competitively price our products with grid delivered and other distributed generation technologies.

We're confident we can achieve annual cost reductions of 20 to 25% annually without volume advantage and could increase cost reduction further with volume.

Finally as I mentioned, we strengthened the balance sheet during the quarter.

We believe we are well funded for what we see as increasing market opportunities globally for our DFC products.

Our focus is to reduce cost and increase orders to reach profitability as quickly as we can.

With that, operator, Barbara, we are now prepared to open this conference to participants' questions.

(OPERATOR INSTRUCTIONS) Sanjay Shrestha.

Actually this is Steve calling in for Sanjay.

How is everybody doing?

We have seen some nice RFPs out of the state of Connecticut and the Long Island Power Authority.

I was wondering if maybe you could give us a frame of reference for the competition that you would expect from these, and I know it's difficult to talk about, but just trying to get a little more color on that.

It's hard to say.

The only other company that has put 200 kW units or larger multiples of those in the field is United Technology.

What direction they are going to take I just don't know.

Siemens Westinghouse we believe they have announced that they are 2007 to 2009 time period before they are coming out with a 250 kilowatt unit or larger.

So, and the 3 to5 kW small chem systems, I don't see how that can be applicable for large units.

So when it comes to fuel cells, probably us and UTC as far as we can see, but renewables include wind and solar.

So obviously in talking to the Connecticut folks and it's purely anecdotal, they are hoping to get about a third each, a third fuel cell, a third solar, and a third wind.

Obviously our choice is to get 100% fuel cell, but we will see how that plays out.

Great and I just have two quick follow-up questions and I'll hop back into the queue.

Maybe just get an update on opportunities you are seeing in the wastewater market and also an update on your DFC T (ph) project?

Wastewater market, we see that worldwide.

Keep in mind that one is one where we clearly are renewable.

Fuel cell on wastewater is as renewable as solar or wind.

I mentioned in the call about the ones in Japan on food process and there was municipal wastewater.

I expect to see one in Korea, maybe one of the first three units maybe after that.

I know they're looking at a MW plant in one of the cities in Korea and our German colleagues are looking at two units.

I believe one was in an Austrian wastewater treatment plant.

I forget where the other one is.

So it is not just in the U.S.

I will tell you the King County plant in Washington, in Seattle, I was out there last week with some institutional investors who were touring it and it is quite worthwhile if anyone wants to visit it.

It is a very nice looking wastewater plant and our unit is really setting performance records there.

So we think that clearly is an important market segment for us.

What was the second part of your question?

The DFC turbine project?

We're looking at shipping the alpha unit late this calendar year, sometime during the fourth quarter to Montana.

I think it's going into the Deaconess Clinic in Billings, at least that is the last word we had.

So it is being built now.

The balance of the plant has been contracted out.

The cell stacks are later in the early summer and then we'll put it together here with a turbine and operate here and then ship it to Montana and then in '05 -- I mean in '06, we're be building the second alpha unit.

Great.

Okay, thanks.

Jarett Carson.

Good morning.

Could you talk about, Joe, a little bit about project financing and what you are seeing with regard to the PDAs and how you're trying to develop that opportunity relative to the fuel cell products?

Absolutely.

On the PPA contracts, what we're trying to do is follow the normal business model for distributed generation so for example if you're buying a turbine or a natural gas recip (ph) engine, what you typically would do and if the customer was in a position where they just wanted to buy kilowatt hours then you would -- there's a tremendous amount of capital available to fund these small projects.

So our business model is to show the marketplace that the product is absolutely viable in a PPA, in a power purchase agreement scenario and that we fully expect that over time we will be moving these into private financing.

Now the LIPA project actually is a 10 MW project.

One of the obstacles with project financing is that you've got to get enough capital on the table to reduce the transaction costs so that project is a good-sized, meaty project so we're having quite a few discussions.

We've gotten much more interest on that one as a big project than on the individual ones.

The normal path on an individual one is you attach yourself to a pool of distributed generation funding and that is how you do smaller projects.

So we're somewhat encouraged.

We still have working through -- it's an early stage new product.

So we're still working through some of that with the equity guys but we're certainly encouraged by the activity we've had on the LIPA project.

I'm quite encouraged that we're finally starting to see some of the real fruits of the product cost reduction efforts on the income statement and I think to that end, can you just remind us -- it seems to me that it is kind of lumpy, that how you are going about your -- I know cost reductions are going on daily or the work -- but how they actually transition into the income statement and do you -- when do you anticipate doing some of your block changes and how that affects it?

We're seeing on some purchase items -- we're seeing continuous reduction.

You still have a lag with your inventory balances that you've built to support order flow and shipment flow, so we are seeing a good amount occurring now.

We should continue to see some reduction.

And then what happens is that the way it works is that it will go to block two change, which is a little bit more of a redesign in the summer time and that should capture in our finances this 25% reduction that we have been describing and that we have achieved in the design.

So we are designing that product now.

We're running through it.

We're building the first one and that should start to come sometime after.

You have to build some inventory; you've got to go back through a cycle.

There's a little bit of lag but we should start to see the block twos come in post summertime.

So if that starts shipping if you will in the summertime, that's probably clear into fourth quarter before we start to see some of the impact?

Its late summer, Jarett.

Keep in mind what you're doing is everything we have changed in this block two change is to get that 25% out.

We've tested in the lab in our energy (ph) test unit, but this is putting the whole system together and running it and assuming there’s no major surprises, we will roll that into production 30 days later after we operate it.

So as Joe said, we've got to work off some inventory and there is always that trade-off when you're bringing a materially design change to a product in the field of how do you do that the smart way so you don't build up too much inventory but you don't take a lot of risk with the customers.

We don't want to roll out a design that adds some of the same birthing pains that we had on the DFC300A.

We want to reduce that dramatically.

So sometime, we're looking at sometime in the August period is when we'd start shipping orders for the new production.

Can you just comment, there was a press release out by another company a day or so ago talking about incorporating some offtake of your hydrogen and the R&D kind of project there.

Could you just make a comment on that?

Yes.

It is something that we have been trying to push forward.

We generate hydrogen with this internal reforming process and we take -- we use about 70% of the hydrogen.

About 30% we use to preheat the incoming air because that hydrogen had no value in the early days of design.

Now it turns out hydrogen in relatively small quantities has some value in refueling the early automobile fleet.

So working with Quest Air and other big hydrogen equipment makers too besides Quest Air, we are looking at taking than 30% hydrogen off and using -- purifying it through their products and its systems and then having it available as a fuel.

So at one of the California refueling stations you could have the unit generating heat, generating electricity, generating hydrogen and generating heat also in the same location.

So it would compete with just a hydrogen generator because you would have as we call it tri generations of all three value streams.

It turns out that hydrogen does have a value that is better, a better value profit appears than what we get by the heat that we are using, so we trade off.

You get, say, 45 or 50% electricity, 20 to 25% hydrogen, and the balance would be thermal and that looks like it to be promising not as a major supplier of hydrogen for the hydrogen economy but what we look at as a facilitator.

You could have these products all around and I think our 250 kilowatt unit generates enough hydrogen to refuel one hydrogen car -- hydrogen fuel cell car per hour.

So it's not for mass markets but it certainly is a good enabler or facilitator.

Thanks.

John Quealy.

Good morning.

Joe, maybe a couple of questions for you.

With regard to cash used this year, can you give us a ballpark range if the LIPA contract comes to fruition and some things in Connecticut, what is your budget for PPA related cash used this year?

What we did is we raised this capital in November in anticipation of Starwood, master services agreements with Starwood, with -- we had some clarity that project 100 was going to come through it and that LIPA potentially would come through and what we are trying to do is really show the market.

Now the answer to that question is that the base business at our current run rate we expect to be approximately 15 million of PPA plus -- if we put a PPA through that -- but roughly in that 15 to 20 which is what we've been saying, potentially lower.

And then your add on what happens with the LIPA contract if we were to win the LIPA contract -- it's a 10 MW contract -- if you just calculated a 3 to 4000 sale price on that we haven't got all the information on installation, you're talking a 30, $40 million commitment.

What we would love to do is have one of these project finance guys who were expressing a lot of interest step up and take a piece of that off the table.

We are prepared at least on the first one whether its project 100 or LIPA to step up and to make that go forward and show the marketplace that good constraint on a large size is an absolutely viable, more cost-effective, better solution than perhaps alternative solutions like building out transmission and distribution.

So we are looking -- so a long-winded answer to your question is that we are prepared to LIPA and throw some money, $40 million on the table to make that happen.

Great and then lastly for you on the gross margin side we did see some improvement on the cost of product sales quarter on quarter.

Looking through the balance of fiscal '05, would you expect that ratio to stay consistent just based on the comments to the previous question of when the next block of cost reductions come?

Yes, I would say I'm hoping to get the more continuing a little bit more cost reductions but block two as we answered that question will capture most of that.

And then on a cost ratio analysis don't forget if you put another PPA we have the PPA now -- the megawatt PPA for San Diego will come through and that will adjust it because you will have no revenue and you will have cost coming through on the cost of goods sold line.

Great, my final two questions.

It sounds like the new megawatt class units are operating very well at 90% efficiency.

Would we expect that for all new units coming in in the megawatt class to be 90% or better?

And can you just remind us where we were as a group efficiency or a run time a couple years ago?

It is not efficiency, John.

It is availability.

That's right, sorry for that.

It's a reliability metric.

I don't recall off the head.

We went from the fleet from the low to middle '80s to close the year out at 87.

That is cumulative from '03.

The megawatt plant in King County and it's a fleet of one has been better consistently and in spite of the fact that they divert from digester gas to natural gas and we've developed a logic to allow that to happen seamlessly.

So keep in mind we did make a lot of changes to that megawatt plant based on our field experience with the sub-megawatt plants so there is a lot of applicability.

The megawatt has got four stacks and a can instead of one stack and one can.

The balance plant and functionality and serviceability, all of that is very similar.

So as we learn software and hardware changes on the sub-megawatts, we immediately went upstream and did that on the megawatt plant.

So I think what it shows is that the later units in the fleet that had the advantage of a learning curve we keep driving availability higher and higher.

Of course our goal is to get it up equal to the most mature products out there and we are on trend to do that.

Great and the last question, Jerry, we saw some change in the operational management or at least in addition up there.

Can you give us a little bit more detail on the operational side of things in your management team?

Yes, I wanted to get all of the operating functions under common leadership which we did with Dan Devar (ph), and then those functions that reported to Chris asked Chris to work on both managing the government operations of business as well as the available for strategic manufacturing expansion.

If you start talking about 10 megawatt projects, you pretty soon run up against a volume curve.

It is a great problem to have but you've got to be looking ahead at how we're going to handle increased volumes and on a global basis also.

I've asked Chris to do that.

Dan was running our whole product development team which went across functional boundaries in any event but by putting all the manufacturing and non-manufacturing operations together we have under common leadership then all of the functional responsibilities that are both developing the product as well as driving cost out of the product.

Dan has done as he was Product Manager for Gas Turbines for GE, so he has rolled out products in the field before.

So that was the purpose of the change.

Great, thanks.

Pearce Hammond.

Yes, this is a question I think probably for Jerry but any news on the energy bill in Washington and how that might maybe an investment tax credit for fuel cells or anything that you're hearing right now?

I've got a standing requirement with our Washington guy, Dave Fedor, who updates me weekly on the energy bill and I don't have anything new.

I'm not going to handicap whether it's going to make it or not.

We're hearing good things but this Congress is all tied up with Social Security and war and everything else.

It is a huge positive if we can get an energy bill that includes some kind of credit for fuel cells.

We have never had it before.

What they're talking it is 1.8 cents to 2.5 cents depending on the situation per kilowatt-hour.

So that would be very big.

We think the impact to us would be the same as what happened to the wind industry when they had it, it was going great.

When it was cut off for 12 months the business went to zero and when it was turned back on again the business picked up again.

In our case we have never had a federal tax credit or production tax credit or investment tax credit.

So it would be very positive, Pearce, but to handicap that -- if it happens wonderful.

If it doesn't happen we continue doing our business as usual.

Okay, great.

Joe, this question is for you.

You provided guidance on the last call about R&D revenues between 15 and 20 million for '05.

Do you still stand by that?

I'm probably at the lower end of that at this point, Pearce.

We've got a couple of things we're still working on.

They haven't quite come yet so I think I'd say on the lower end of that.

Okay and just one final question, Joe.

Are we done with the discontinued ops, the Canadian solid oxide business as far as showing up on the income statement?

Are we going to continue to see that for the next few quarters?

Mostly it's done, Pearce.

What we did is we moved all of the equipment assets and a lot of the furniture and fixtures over to Versa.

We had three buildings up there.

One of the buildings Versa took.

One of the buildings is empty.

We just cut ourselves a pretty good deal to get out of the leases, so under discontinued accounting we accounted for just about everything.

The only thing you'll see is some real -- maybe some small adjustments to estimates in future periods, but we're basically done up there.

Okay, great.

Thank you, guys.

Adam Krob (ph).

I was hoping you could provide a little bit more information on the California Starwood agreement, as far as what you have going on in the pipeline and what you expect for repurchase going forward.

Could you provide a little information on that?

Repurchase?

Just follow-on orders.

Well, as it says, it is a Master Energy Service Agreement.

It is patterned after the one that PPL developed here in the Northeast with Starwood.

And what it does is layers all the terms and conditions, so we don't have to go through a long legal debate each time, just like any master agreement would.

We then fill in the blanks for San Diego, for the Sheraton San Diego, for example.

We've got quite a few properties we're looking at.

They've got more than 50 in California.

We've got to look at ones where first -- one of the complications of the hotel business and why Starwood is so good is you've got the real estate owner, you've got the landlord, and you've got the hotel operating company.

If those are three separate entities, it becomes very complicated.

When it is all one entity like Starwood, it becomes very simple to do.

So we are selecting properties based on being in the higher electrical price areas in California, based in being in the lower reliability areas of California, and based in being the size area where like megawatt plants where transaction costs don't kill us, and then we're looking at obviously market prestige, too; all of this in conjunction with the Starwood guys in White Plains, as well as the local managers.

So I'm not going to predict other than to say we're working the pipeline, and we expect additional orders from Starwood in California.

Likewise, I would not be surprised -- I know PPL and a little bit less aggressive is working some Starwood properties in the Northeast, which we may be able to turn into orders this year.

And just one other quick question about the backlog.

Can you just remind me, what do you usually expect to record the backlog?

Is that within one year?

I'm not sure I understand the question.

Currently, we have right now through today, we have 10 megawatts backlog.

The financial backlog is about 23 million.

That would be everything except PPA, the financial backlog.

I don't know if I'm confusing it or --.

No, I was just wondering when it's basically going to hit the income statement.

We put an order in the backlog when we have a signed contract both ways.

Until we have a signed contract with payment provisions and all that, it does not go into the backlog.

Does that clarify that that all?

Yes, thanks.

I think that's about it for me.

Thanks.

David Smith.

Good morning.

I think what we're looking for is the timing of when that backlog gets delivered.

Is it through '05 or is it into '06?

I kind of came to the same conclusion after Adam went off.

I would say it is a backlog that is probably in 18 months -- will be realized over 18 months.

What is the current status with Caterpillar?

Is there continued training going on at the dealer level right now?

At certain dealers, yes, and there's certain dealers that are active, California and Northeast primarily.

We have -- there has been some management changes in the organization we deal with in Cat and we've spent a little time in the last 45 days to be followed up in the next 45 days with visits back and forth between Dan Devar in Peoria to get the new team introduced to each other and up the learning curve.

What is the timing then of seeing a Cat branded fuel cell come out?

Their target is late '05.

I will have to check on that, David, to see exactly where they stand but the target has been consistently late '05 and the engineering review sessions are continuing to go back and forth.

In terms of the backlog then of 10 MW, is there any that is Cat or is some of that Caterpillar?

No actually.

The backlog is Marubeni is about 6.25.

California units with Alliance is about 1.5.

Sharebrond (ph) is about 1.25 and we've got the DFC T in the Navy unit which is another MW at this point.

That is our backlog.

Cat bid the unit at Palmdale, which is a big wastewater treatment, LA County Sanitation is a big wastewater treatment group obviously and one of their thrusts is on California wastewater treatment plants, so we know that is their focus.

But Caterpillar has rained enthusiastic even though they haven't got anything in (inaudible)?

There is a thing we all call Cat speed.

I think Cat, their business is booming as you know and the time it takes for them to roll out of product is probably a little different than our timing because they go through the Cat system on how to do that but particularly on a Cat branded product.

What we're seeing, David, is what their excitement is really on the ultra-clean aspect of fuel cells and they see that as an enabler with their existing product lines.

They see which they have announced in the past where if you had a 5 MW operation you could put 2 MW fuel cells, 3 MW of gas recips or something and come out with a pretty good environmental equation that is below any restrictions or standards settings.

So what we're seeing especially in California and that is why there seems to be focus in California that -- California, I just did a trip out there.

I went to King County.

I went to Sierra Nevada and what I saw out there is that the customers are very, very concerned about reliability of the utility grids.

They are worried about the cost of the utility grid because in California they got burned a couple years ago and they want control.

And then the emissions while a part of it is a soft cost, part of it is they are worried about people like California and which may be rightly so coming in.

You have Carbo 7 (ph) for example, so if you put recips or engines in, that's clearly the example at Sierra Nevada that he was looking at engines and looking at fuel cells and he just sees that the ultra-cleans avoids him a problem in the future.

That's where we see Cat is they really coined that term for us several years ago with ultra-clean and that is where they remain very excited.

Last question on LIPA side, it sounds like you are actively going after that.

Is $48 million a rough estimate of what you think the deal -- what costs 10 MW?

Well, that's $4000 a kW, David, which has kind of been an industry norm.

I'm not obviously on an open conference call going to talk about our strategy of LIPA and the like because we don't know who else is going to be bidding it.

And I must qualify also LIPA doesn't have to buy anything as they clearly state in their RFP.

So certainly if you use $4000 a kW, that's a ballpark number of whether it's our fuel cells or United Technologies or others, that's certainly a ballpark cost of the project.

The one thing -- they are not going to be paying anything like you just said for the contract and your cost per kW is much higher than 4000 a kW, so I would think that your cost would be little higher than that, wouldn't it?

Possibly.

But when you start talking about 10 MW, it changes the cost curve too.

And coming back to your comment it sounded like their idea of the contract is that whoever was to put it in from what I read, is going to exactly incur a lot of the cost around the product -- project as well.

Is that right?

Cost around -- you've got to install it and you've got to hook up.

They have gas, potable water and waste drains at the site and electrical hookup at the 13A KV (ph), so all of that is at the site.

So we have to then install at the site and then hook up to their boundary points, so --.

In terms of an upper end cost, what would be looking at here?

Would it be like 80 or $100 million?

Nowhere near and again I'm not going to going into our cost, but I will tell you we have talked about what costs we've driven out of the sub-megawatt product.

The MW product itself is a lot less cost than the sub-megawatt product because of the scale up of the balance of plant particularly.

And all of the value engineering we've done on the sub-megawatt, we have also incorporated into the MW.

So your number is much closer to 40 to 45 million installed than it is to anything else.

One remaining to look at would be your cost of goods sold -- (multiple speakers).

Let me just add one more thing David, to be sure you're aware.

What LIPA is buying is LIPA is providing the fuel.

The variability of natural gas cost is not in the equation.

So it is the capital cost of the hardware and the operating and maintenance cost of the system versus what you'll sell in kilowatt-hours at.

So the fuel cost and the very important point of LIPA is not a variable cost and the cost of natural gas today -- you'd have to really hedge that strong.

When looking at the contract, how do you get paid for the contract?

You get paid for every kilowatt hour we produce.

But if they are providing the gas that goes into the contract, do you provide a markup on top of that?

On the gas, no.

The gas doesn't fit in our equation.

We sell them kW hours for X cents per kW hour, excluding fuel.

They pay the fuel cost whatever it is.

So they pay the fuel cost and they pay the price we charge for the kilowatt hours.

So basically you're making a spread above whatever the cost of the fuel is?

No.

No.

I'm just really trying to clarify how you get paid for this.

There are three key parts of your electricity bill you get.

One is the fuel cost.

One is the capital cost of the hardware, amortizing that over the life of the plant.

And the third is the operating and maintenance cost.

So of those three costs, add up to the $0.11 per kW hour I'm paying in this facility to Connecticut Life and Power.

In the case of LIPA, the fuel cost is for their account, so you only charge them for the capital cost of the hardware and the operating and maintenance cost of the system plus whatever margin you want to put on that.

That's what I'm getting at.

That's how you make your -- okay.

So whatever the spread is above that is how you cover your (multiple speakers).

Thanks

David Snow.

This is David Snow.

I'm just wondering first of all you mentioned $0.10 in your printed material along with a bunch of additional caveats to make that a competitive market and you just mentioned $0.11 in Connecticut that you're paying.

What price could you at these fuel prices going into the market and compete without any additional caveats like reliability constraints and so forth?

I think you have got to take them all together, David, because --.

I was just wondering where you are in the breakeven versus regular grid power?

What the Connecticut is doing in their renewable portfolio standards is they are allowing 5.5 cents per kilowatt-hour on top of the standard wholesale rate of around $0.05 or $0.06 per kilowatt hour for their renewable portfolio standard.

So it varies.

The point is somewhere in the $0.10 range is where we can usually be competitive with what the customer is facing on the grade.

If you get to a Sierra Nevada that was saying I got a lousy grid, I want reliability, I want to either buy gas engines or fuel cells and then of course the emissions will win him over towards fuel cells.

So it varies but if you look at power in the Southeast of $0.05 or $0.06 per kilowatt hour, that is not our target to be ever competitive against that.

So it will be somewhere in the $0.10 range is where we see broad market competitiveness.

Are you going to come down -- are you at that level now?

No.

We are above that level and that's why I'm saying if we got $0.10 power plus we got subsidies or incentive funding from the state of California Self Generation Fund or the Connecticut Clean Energy Fund or things like that, then that brings us down to where the customer is looking at a breakeven with his energy cost today versus his energy cost tomorrow with a fuel cell, then he has reliability and emissions advantage and all the fuel cell that he wouldn't with other DG equipment nor with a grid.

On a subsidized basis, you are around what -- $0.15?

It depends.

What's the fuel cost?

Probably $0.15 to $0.17 with $7.00 gas. $4.00 gas, we're back in the $0.12 to $0.13 range.

That's why fuel cost in today's market is a big variability and that's why see again wastewater treatment plants where the fuel is "free" or you get a case like LIPA where they do the fuel cost or in some cases will hedge the fuel cost or buy forward on it to hedge the price of natural gas.

And just on a financial end I'm wondering is the accrued preferred dividend that is shown as a nonrecurring item, isn't that a recurring item now that you have the preferred?

That is the way you report -- preferred dividends get reported below the net loss line.

So we will show that every quarter.

So that will show up quarterly, David.

All right.

I don't have them broken out separately I don't think but what about the discontinued, the reengineering?

Is that a major change that you only go through every several years and therefore would it not have some contribution beyond the expected annual cost reduction 20 or 25%?

I think that is exactly why we're doing it.

So I think we're taking -- we see -- we are learning a tremendous amount.

Our manufacturing process is in our field operations and we're finding from operations that we can improve that we will not only in this case, not only upgrade the performance of the systems, but we get higher output from the systems but also reduce cost.

So this is exactly why we go down that path.

Okay, just to say that again you have an ongoing goal of reducing your product cost by 25% annually and will this accelerate or add on top of that?

We have a three-year rolling plan and its 20 to 25% depending on the product line per year.

But the realization of that, David, takes longer.

So while we're rolling out our first major change at 25% lower cost than last year in late this summer at the same time the cost out guys are working on a 20 to 25% target for this year.

But you know as your cost goes down at the same percentage you get less cost savings each year, you understand?

We went last year from 8000 to $6000 a kilowatt on the sub-megawatt product, that's 25%.

But 25% on 6000 gives you $1500 savings.

Do you understand?

So this will take you down to 4500 or so?

Yes.

That's our target for the end of '05'.

Great, thank you very much.

With that, Barbara, I think we will have to call an end to the conference call.

I would like to thank everyone for being on the call and we'll talk to you next quarter.

This concludes today's first-quarter 2005 earnings result and Company update conference call.

You may now disconnect.