燃料電池能源 (FCEL) 2005 Q4 法說會逐字稿

Good morning.

My name is Kelly and I'll be your conference facilitator.

At this time, I would like to welcome everyone to the FuelCell Energy fourth-quarter 2005 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 session. (OPERATOR INSTRUCTIONS).

Mr. Eschbach, you may begin your conference.

Thank you very much and good morning, everyone.

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

On behalf of the executive management team here at FuelCell Energy, I'm delighted to have you join us on our fourth-quarter and fiscal year 2005 conference call.

Delivering formal remarks today are Jerry Leitman, CEO and Joe Mahler, Chief Financial Officer and Dan Brdar, President and Chief Operating Officer, will be available during the question-and-answer session.

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.

Thanks, Steve and I would like to welcome everyone to our fourth-quarter and fiscal 2005 year-end conference call.

Before I talk about our accomplishments for the quarter and the year, let me hand the call over to Joe for more detail on the financial results.

Thanks, Jerry and good morning, everyone.

FuelCell Energy reported a net loss to common shareholders fourth quarter of 2005 of 19.5 million or $0.40 per basic and diluted share compared to a net loss to common shareholders of 21 million or $0.44 for basic and diluted share in the same period of the previous year.

For the fiscal year ended October 31, 2005, FuelCell Energy reported a net loss to common shareholders of 74.3 million or $1.54 for basic and diluted share compared to a net loss to common shareholders of 87.4 million or $1.83 per basic and diluted share for the prior year.

Revenues for fiscal 2005 were 30.4 million compared to 31.4 million in the same period a year ago with product sales increasing and R&D contracts declining from the prior year.

Net cash investments used during the quarter was 11.5 million compared to 17 million in the same period in the prior year on collections of incentive funds for power plants that met customer acceptance.

This is the typical pattern on the receipt of state and federal buydown program incentive funds for our fuel cell power purchasing agreement projects.

The funds are reserved on order acceptance and disbursed upon satisfying on-site customer requirements, a period taking approximately 12 months.

Capital spending in the quarter totaled 3.6 million, which included approximately 3.1 million for equipment billed for power purchase agreement.

Depreciation and amortization expense for the quarter, ended October 31, was approximately 2.2 million.

Cash, cash equivalents and investments on hand as of October 31, 2005 totaled 180 million, an increase of 27.6 million from October 31, 2004.

Components of revenue and costs for fiscal 2005 were as follows.

Product sales and revenues increased 38% for the year and were 17.4 million for the fiscal year ended October 31, 2005 compared to 12.26 million for the prior year.

During the year, we saw our customer move to larger installations with the increase in sales attributable to megawatt power plants.

Margins related to product sales are improving as the ratio of cost to product sales and revenue decreased to 2.99 for fiscal 2005 from 3.16 in fiscal 2004.

We are achieving our cost reduction objectives and clearly see the path to bring costs to market clearing levels.

Product sales margin in the fourth quarter was impacted by power plants for power purchase agreements and cost to upgrade power plants to current product specifications.

During the quarter and year, we fixed an earlier design issue related to ceramic seals.

This increased the ratio of cost to product sales and revenues to 3.36 for the fourth quarter of fiscal 2005 from 2.59 to 1 of the same period a year ago.

The Company's product backlog, including long-term service agreements as of October 31, 2005, totaled 26.4 million equal to the prior year.

Research and development contract revenue for the fiscal year ended October 31 2005 was 13 million compared to 18.8 million for the fiscal year ended October 31, 2004.

The completion of the Product Design Improvement and Bath Iron Works contracts and lower revenues on the Clean Coal and U.S.

Navy contracts reduced both revenue and cost.

The margin for R&D contracts improved as the ratio of cost decreased to 1.02 for fiscal 2005 from 1.45 in 2004.

This improvement is due to the substantial completion of contracts, which had significant cost share commitment.

As of October 31, 2005, the Company's research and development sales backlog totaled approximately 15.8 million of which Congress has authorized funding of 11.7 million compared to 16.5 million, 12.9 million funded as of October 31, 2004.

The decrease in administrative and selling expenses was due primarily to the transfer of the Company's Canadian solid oxide research and development program to Versa Power Systems partially offset by higher bid proposal costs from multimegawatt projects and higher costs related to Sarbanes-Oxley Act compliance.

The decrease in research and development expenses relates to the transfer of the Company's SOFC research development activities to Versa.

Loss from equity investments is attributable to the Company's ownership interest in Versa.

The increases in interest and other income are due to higher yields on cash and investment balances and state research and development tax credits.

We will be shipping our first DFC300MA in 2006.

Consequently, the lower cost for these units will be reflected in our financial statements in '06.

This will be impacted by small PPA activity that carries over from 2005.

Note that in 2006, stock option expense will be included in our P&L and thus reflected in our reporting of EPS to common shareholders.

We head into 2006 with a strong cash position that will enable us to continue to execute our strategy.

Thanks and I will now turn this call back to Jerry.

Thank you, Joe.

I would like to touch on some of the year's accomplishments and elaborate on some of the trends in the marketplace that speak to our outlook going forward into the current fiscal year and beyond.

Overall during the year, we successfully executed our strategy of improving product performance and availability, reducing costs and expanding repeatable business for both our megawatt and sub-megawatt products in our key global markets.

At the same time, with the enactment of the federal energy bill, the growth of Renewable Portfolio Standards, or RPS markets, and other macro factors, we witnessed significant changes in the environment in which we are operating.

The market is increasingly recognizing our DFC products as a reliable source of ultra-clean, very efficient and firm 24/7 power for distributed generation.

This combination of execution, acceptance and market need sets the stage for the growth of our DFC product lines and the emergence of multimegawatt opportunities.

Since 2003, we have generated more than 80 million kilowatt hours at customer sites around the world.

It will come as no surprise to anyone on the call today that rapidly rising energy prices have created an atypical market situation.

The precipitous rise in natural gas prices has had a dampening affect in some markets where it made grid electricity cheaper than operating a DFC power plant.

But we also know that this disparity will go away.

In our key market areas, all utilities have double-digit increases proposed to their PUC.

For example here in Connecticut, CL&P has a 21% increase in front of the state as we speak.

Our high efficiency and ultra-clean operation improves our economic profile against other on-site power generation options like engines and turbines and will against the grid as electricity prices continue to rise.

We improved our fleet of availability to 93% during the fiscal year as compared to 85% a year earlier and the power industry standard target of 95%.

The progress we achieved here stems from a number of factors.

Our rigorous product testing program, resolution of earlier design issues with ceramic seals, a 24/7 call center and regional service teams in the U.S. and Japan and Korea to provide rapid response for products in the field and a robust data gathering infrastructure to capture lessons learned, identify problems and drive root cause corrective actions.

One of our key product development areas has been to concentrate on extending stack life from the current three years to five years and longer.

In addition to having a positive impact on the cost of ownership, an increased stack life also results in improved product availability.

We have developed a rotable (ph) pool system to swap out fuel cell stack modules and minimize the customers' downtime while an enhanced module can be installed at the customer's site.

We met or exceeded our cost reduction milestones in 2005.

We introduced the DFC1500MA power plant, the four module version of the DFC1500, a direct application of cost reductions we achieved earlier in our DFC300MA.

We have reduced the cost of the new power plant by over 30% to approximately $4300 per kilowatt and it will be entering production in the second half of 2006.

We also achieved similar manufacturing cost reductions in the sub-megawatt DFC300MA where we lowered that cost to $4600 a kilowatt by eliminating a blower system, reducing piping costs and by simplifying enclosures of the structural base.

As a result, through our megawatt class products, we are rapidly approaching market clearing prices of 2 to $3000 per kilowatt in key regions of the world.

The market clearing prices are being pressured by the continuing high price of natural gas versus grid delivered power in the short term mitigated somewhat by the investment tax credit and the energy bill and will mitigate further as utility rate increases are approved by the PUCs.

We believe that initiatives already underway establishes a strong platform for new orders heading into fiscal 2006.

Beyond the spiking energy costs I mentioned earlier, other changes in the marketplace, such as the need for CO2 or greenhouse gas reductions, are driving the recognition of FuelCell's benefits.

The high efficiency of our power plants reduces the fuel needed per kilowatt hour and lowers operating costs along with lowering carbon dioxide emissions.

DFC power plants firm, 24/7 baseload power complement intermittent energy sources such as wind and solar.

For example, our one megawatt plant going into Santa Rita prison in Oakland will be for baseload and be complemented by several hundred kilowatts of solar cells on the roof for peakload.

Related to this, government initiatives are improving market opportunities.

In Japan for example, successful performance of our power plant at the city of Fukuoka wastewater treatment plant obtained Japanese government endorsement.

This market is estimated at over 35 megawatts currently for municipal wastewater and the industrial wastewater treatment, which is primarily food and beverage processing, is estimated at three times the municipal market.

In Korea, the government is developing an incentive program to obtain its stated goals for fuel cells, which is expected to result in over $100 million per year in fuel cell power plant installations beginning in 2007.

Our focus with our distribution partners on further developing repeatable markets worldwide has resulted in current installations of 12.25 megawatts and a backlog of 10.75 megawatts for a total of 23 megawatts that extend across key industry sectors and important geographical regions.

As we begin fiscal year 2006, we have installed or in backlog in Japan and Korea 8.25 megawatts, California 7 megawatts, Europe 4.25 megawatts, other U.S. installations 3.5 megawatts.

Slicing this across our repeatable market segments, we have installed or in backlog in wastewater 4.25 megawatts, in hotels and the hospitality industry 2.75 megawatts, manufacturing 2.25, institutional and government 2.25, grid support 1.75, hospitals 1.25, universities 1.25 and other and uncited, that is we have orders in backlog but our distribution partners have not announced who the customers are, of 7.25 megawatts.

Finally, changes in the marketplace, including higher energy costs and in the need for CO2 reduction, are driving the greater recognition of FuelCell's benefits.

The high efficiency of our DFC power plants reduce the amount of fuel needed per kilowatt hour and lowers operating costs while also reducing carbon dioxide and greenhouse gas emissions.

The firm 24/7 baseload from DFC units complements intermittent energy sources such as wind and solar.

The Energy Policy Act of 2005 improves the economics of fuel cells and underscores their efficiency and ultra-clean operation.

The Act provides a 30% investment tax credit up to $1000 per kilowatt of total project cost as well as accelerated depreciation.

As a result of these benefits, Renewable Portfolio Standards are opening up other multimegawatt opportunities.

The (indiscernible) we are pursuing include Long Island Power Authority's 10 megawatt fuel cell proposal, which is an initial response to New York State's plan to get 3700 megawatts from renewable technologies by 2013, which includes fuel cell power plants running on natural gas.

Connecticut Project 100 calls for 100 megawatts of renewable power generation by 2008, also including fuel cells on natural gas.

We are currently working with developers for multimegawatt proposals in the state and have submitted proposals totaling four megawatts to date.

This summer, we announced the Direct FuelCell-Energy Recovery Generation or DFC-ERG system.

This multimegawatt product was developed with our partner Enbridge for a natural gas pipeline market and is targeted for locations in Renewable Portfolio Standards states.

It has a near-term market potential of estimated 250 megawatts in Ontario Canada, California and the northeast U.S.

In response to the increasing market opportunities we're seeing around the world, we're taking two key proactive steps.

First, we're increasing this quarter our production rate and our Torrington cell manufacturing facility with an initial step up of nine megawatts a year from the current six megawatts a year.

Secondly, our primary focus on cost reduction has shifted to the DFC3000, our two megawatt product and this is in direct response to the multimegawatt opportunities we see in 2006.

In summary, FuelCell Energy is improving product reliability and performance.

Our record of meeting customer expectations, our expansion of repeatable business, our continued cost reductions and our strong financial condition position us to increase sales to these growing markets.

And with that, Kelly, we can open the conference up to any questions the audience may have.

(OPERATOR INSTRUCTIONS).

Jarett Carson, RBC.

Jerry or Dan, can you talk a little bit about, from a customer perspective, how just trying to get ahead -- I would say get ahead of the curve, the fact that they kind of see price increases potentially coming down the pipe on the electric side and the tax credit.

Are those things that are being taken seriously in the count (ph) and trying to accelerate some order flow today or are they going to wait until they kind of see all those things that kind of roll out over the next three to six months?

I think there is a direct impact today.

The grid prices are starting to rise.

I saw a report that said every PUC in the lower 48 had electric price increases on their desk and they are all double-digit.

So we see that as a reaction and it is all a reaction to the natural gas pricing, which is reactive to oil price.

So we see that coming pretty much across the board and this whole inverted spark spread should adjust itself.

I don't see us getting back to 4 or $5 gas but 7, 8, $9 gas would be enough at the time.

The IPC is directly being recognized by the various potential customers that we're looking at.

They're all trying to take advantage of it.

This is a -- an IPC different (indiscernible) than a production tax credit is immediate upfront.

You don't have to produce all that time.

Dan, anything to add?

Yes, just two comments.

One is the passing of the ITC and customers being aware that that is now fold into their project economics has done two things.

It has really taken a lot of the uncertainty out of the customers' decision process because what we were seeing is customers were a little reluctant to go forward with any kind of distributed generation because of their uncertainty on where gas prices are going to go.

If all of a sudden you've got $1000 a kilowatt flowing on your project economics, customers aren't as worried about what is going to happen to the gas pricing itself.

The other thing we have seen is just overall it stimulated the level of activity.

People who were a little bit reluctant on whether they want to do a project or not regardless of the economics, all of a sudden the investment tax credit now has stimulated what we're seeing forbidding activity both here in the Northeast and in California.

Next question, Joe.

Maybe if you could give us a little bit of a contextual update on the discussions with project finance-oriented players and where that stands, especially in consideration that it sounds like there may be some big decisions in the first half of '06.

We are getting very favorable response at least on the larger scale contracts.

So I think the larger contracts have been attracting a lot of attention both from our distributors.

In a sense, our distributors can step in and provide that.

They can buy the units from us and work the transactions and then also some financial players have become very interested.

So we are optimistic that on the large projects that we can get some effective project financing to support these projects.

Then I think if you start there then the discussions we start to have with these players is -- distributors will -- what they are both doing -- what has really created the opportunity is the investment tax credit, which Jerry and Dan talked about, plus also fuel cells attract or can capture five-year accelerated depreciation, which is a benefit for fuel cells.

It is in the energy bill.

So when you look at these projects, the cash flow, breakevens on these projects are very accelerated.

The project financing guys are really licking their chops.

So that really brings another stimulant both from a distributor standpoint and then the financial players in the marketplace.

There aren't that many projects being done and this is a terrific opportunity.

There's a path.

You have got potentially LIPA projects followed by significant multimegawatt Connecticut projects.

So they see a path of repeatable business at that level and then once you get beyond those what you have is what we call global programs that are global vendor financing where you can start to pool your funds similar to what gas engines and recip engines, gas turbines and recip engines might do in a sense that you might get yourself a line of credit in effect and you can push through projects that have good credit.

For example, perhaps Starwood projects or that flavor of project.

So the opportunity looks -- from right now, we're thinking positively about it.

Final question, Dan, can you, as the chief cost out guru, give us a little I think insight into the dynamic --?

On this side, clearly I'd like to see cost out either going quicker and/or showing up in the income statement sooner.

But maybe from your standpoint, you have to balance the dynamic of declining cost environment sometimes to either put customers off (ph) or you can't get your service organization.

Can you just talk around that for a minute and how you feel on trying to drive out or step-change down where the costs are today?

Sure.

Part of what you see right now is we're fortunate that we've got a pretty healthy backlog.

So those are units that we have already committed and we have got in the production cycle.

So as we fulfill those orders, what we're doing is we're flowing cost reduced products behind them in the queue.

So it takes time for the realization of the costs when we release a design to actually start flowing through the production.

So we have got a natural lag that happens there.

Another thing we are trying to balance also is since we work through distribution partners, we need to keep the level of change manageable for them.

If we are changing the product dramatically on short cycles, we're going to frustrate them because they are the ones that need to install it.

They are the ones that are providing service for some of the customers.

The other thing that we want to be conscious of is we're fortunate that we have got some great early adopter customers and we don't want them to feel that the fuel cell that they bought a year ago is now obsolete.

So it is really balancing those three things as we start to flow the cost reductions through our P&L statement.

To give you an example, Sheraton San Diego bought a megawatt of DFC300As.

Now they add another half megawatt for the west wing.

Well the 300MA looks different from a 300A so we have to ship them the power cost model just to keep the continuity of all six units that will be a megawatt and a half looking the same.

I would much rather ship them MAs but those are the kind of customer reactions that you have to be responsive to.

John Quealy, Adams Harkness.

Looking on the new opportunities and you highlighted five or six here in the press release.

Jerry, can you talk about, in terms of the timeline, what one of these or several of these opportunities look to be more '06 type events?

Clearly a lot of folks are looking for Long Island but can you rank order priority for us, especially with the focus on some of the nat gas stepdown stuff that could be an attractive market for you folks?

Let me give that to you.

I'm glad you're not asking for an answer on LIPA because I don't have one.

It hasn't been awarded.

They have said year end.

We're getting close to year end so we will just have to see how that plays out.

We have, as I mentioned, we did four megawatts into Connecticut on the round one proposals.

We have been told that PP&L, our partner, will be selected probably this afternoon for that four megawatt project at Wallingford.

And that will be the first award selection under Project 100.

What that does is drives us to the next where PP&L has to negotiate with Connecticut Light and Power.

Connecticut Clean Energy Fund tells the PUC and CL&P that they have selected this project.

Then that drives PP&L to go negotiate with Connecticut Light and Power and then that project is presented to the PUC for final approval.

But the legislation is such that the utility gets its cost back plus a margin.

So we don't expect the utility to stand in the way of these projects as other utilities have against other projects.

So we're quite excited about having at least the first selection, not contract award, probably a couple of months off for contract award.

And then the Project 100 round two bids, which start January 1st and are submitted by February 28th with a selection sometime in late March or April, we see anywhere from 20 to almost 40 megawatts of proposals through developers that we will be putting in for those opportunities.

With the action they're taking on the first four megawatt, I guess all of our confidence levels have increased dramatically that we will something out of Connecticut.

And that is why, as I said, we have switched our cost focus on the two megawatt plant.

The reason we hadn't done much on the two megawatt plant is California has a limit on their incentive plans of up to one megawatt.

That is something, by the way, we want to get changed as these RPSs start to happen.

So we feel -- that's why we stepped up the initial stepup in production.

It is only three megawatts but that's a 50% increase in the production rate of the cells.

So that is kind of how we see it going forward on these multimegawatt opportunities.

Japan, that certification by the Japanese government on the Fukuoka unit was a huge step because we are a foreign supplier and (indiscernible) to have Japanese government approval of a "foreign product" is a big step in the Japanese markets.

And the Koreans passed all these goals last year and now it looks like they are seriously looking at how to put fairly big bucks into it to make it happen.

So we are moving pretty good around the world.

The Enbridge units, the DFC-ERG, Enbridge is both the pipeline supplier and the local distribution company in Toronto, so a big part of their operations.

They have gone to the Canadian government to get incentives from Canada to put pressure letdown stations in and around Ontario, particularly since Ontario is closing their coal-fired plants, as we estimated, 40 megawatts of potential just in the Toronto area.

They have had good meetings with the Canadian government.

As you do know, the Canadian government fell.

It will be new votes in January.

So that has probably put a 30 or 60 day hold on reaction from Ottawa towards Enbridge's request.

I see no reason why they won't be successful.

In addition, one of the bids, like I said, 20 to 40 megawatts we would be bidding into Connecticut starting in January, one of those bids we expect to be a six megawatt DFC-ERG pressure letdown station in western Connecticut, Southwestern Connecticut.

Does that answer your question?

It does.

Let me bring you back to round one of Project 100 with what appears to be PPL getting the four megawatt order --

Being selected.

-- selected for the four megawatt order.

We have got to be a little -- not skeptical -- but we have to negotiate with the utilities.

And that has been difficulties in the past.

So a selection is a huge first step but until they actually do one -- and I think what is important here -- now there is a four megawatt, which is really relatively small, that will be the first one going through the system.

So we get that through the system, I think we can look at the other 40 or 50 megawatts going through pretty good.

Just in terms of your visibility for raising throughput capacity, that is the main driver behind that?

The Project 100, LIPA, the Japanese and Korean activity and a lot of the things we have got going on on the West Coast, it all is and we don't want to jump from 6 megawatts to 20 megawatts.

That's crazy.

But we want to stepwise take it up to see what we need to ship this year and start those initial steps of cranking up.

So from 6 to 20 is tough in a short period of time.

From 6 to 9, 9 to 15, that is kind of the stepwise approach we want to take.

Just finally some housekeeping pieces.

On the cost reduction plan, you took optimized costs this year.

What can we expect for the coming year in terms of cost reductions and I know it is -- in the July time frame this year, we got the new products out with a lower cost and I imagine it is probably a similar timing next year but what are the percentages we're looking again for this year for cost reductions?

Me and the Board have chartered Dan and his team.

We want to see 20 to 25% a year at least three years out in the future.

Dan, I'll let you respond.

No pressure.

Since we're going to shift our focus here to the 3000 because of the megawatt activity, the good thing is we're going to be able to bring forward all the cost reductions that we have already done on the 250 kilowatt products and the one megawatt products.

You saw the impact of that with the one megawatt product this year where we were able to do more cost reduction on a percentage basis than we had the sub-megawatt the previous year.

So you'll see those same kind of things happen on the 2 megawatt product where we will be able to do as much if not more than we did on the one megawatt unit.

The advantage that also is going to happen as a result of this is any cost reductions that we make on the core cell packages themselves are going to flow to all the products.

As we start to see some of this multimegawatt activity happening, the volume impact of that will benefit all the products as well.

Dan, let me try to pin you down if I could.

Of let's say the 20, 25% range that we're looking for in calendar '06, how much have you designed in, how much have you put your finger on in terms of that 25?

Well for what we're going to do in '06 we know what all of it is.

We know what most of it is going to be for next year.

So we have got a pretty robust plan.

So we don't feel there's a lot of risk in missing that target.

Let me put it another way.

For this level of a product, do you see any reason why on a rolling three year we can't do 20% a year?

No.

Last one.

Cash usage next year, Joe, any thoughts what you are ballparking next year?

What we're looking at is we have some trailing PPA activity.

So this year we ran about 71 million cash.

We would expect that to be down.

We would expect that we would run -- we have been talking about base business operating in a 13 to 15 million range.

So that is what we're targeting cash.

Without new PPAs in the system, PPAs are not the business model.

We have now seeded the market for PPAs and we're working very hard get project financing.

So without PPAs, we're expecting 15 million a quarter, so around 60 is our target for the year.

Brian Gamble, Simmons & Company.

Just a couple of quick questions.

Jerry, I was wondering in regards to the U.S. moving to any type of Kyoto type treaty and with carbon issues being a go-forward problem, is there any type of quantification you can put on the carbon savings that your DFC products would have versus other types of BGs such as microturbines or diesel gen sets?

Two points.

I am not sure the U.S. is going to move after reading about that meeting up in Montreal.

That looks like that didn't happen although I saw somebody putting a good spin on it.

We don't really have a U.S. carbon greenhouse gas strategy in our plans because there's enough drivers with the energy tax credit and we are really getting our recognition and it is hard to understate that wind and solar, which are booming now as you know, aren't necessarily the answer.

Neither one is intermittent and wind is also simple station power.

So a fuel cell on natural gas, while not technically renewable, is so darn clean, quiet and efficient that we are seeing this all over as a recognition.

Japan, absolutely the megawatt plant we said we shipped that hasn't been announced won't be until January for one of the Japanese leading industrial giants.

Japanese industrial company is committed to the government for Kyoto and they are looking at how to get every percentage of efficiency.

That's the main driver because of their Kyoto commitment.

I will say what we look coming down the road, we are just testing initial testing of the Direct FuelCell/Turbine hybrid on a 250 kilowatt with a 60 kilowatt microturbine.

And there, we're looking at, even in that small beta unit, electrical efficiency in the 55 to 56% range.

That is a huge jump and that would make a huge difference in Japan or Europe where they have already got greenhouse gas credits and greenhouse gas pressure.

So we are not focusing as much on the U.S. but believe me Japan and Europe is where the focus is.

Has there been any secret participation progress or are there any updates on the solid oxide fuel cell side?

The guys are making good progress.

We're in Phase I, as you know.

We were a second round of contract awards.

I think GE has already gone to Phase II and Siemens Westinghouse may be close to going to Phase II.

We have been through all of our peer reviews.

We have a unit now going through tests starting up next month through March that, if not the final test, it will be near the final test for completion of Phase I for us.

We would hope to get onto Phase II with DOE.

There's been no promises but they seem pleased with what Versa Power is doing and what they're doing up in Calgary and making the stacks.

So very positive so far but until you get selected for Phase II, it is not a done deal.

That decision will be some time the latter half of '06.

Rob Stone, SG Cowen.

I know that you gave the breakdown by geography and markets of the combination of installation and backlog.

Do you have those figures handy in terms of just the backlog to give us a sense of in which of the market segments you're targeting you have the greatest backlog at the moment?

I can tell you off the top of my head while Joe tries to look at it specifically.

Japan, because Japan buys multimegawatt orders to get into production queue and then goes through their customer progress.

So I think that is a probably the bulk of it.

MTU, our partners in Europe, we have just shipped them or just committed to -- we shipped them two stacks late last year and got an order for six more.

See, they buy the cell stacks from us and then put it into their production queue to build the actual products and then announce the customers when they ship.

So I think those are the two biggest, Joe.

Is that --?

No.

I think Jerry's hit it right on the head.

Marubeni has about 5, MTU has about 1.5 and then the remainder is just spread among U.S. customers.

With respect to the end market or the application, is the fact that the biggest chunk is with partners where you don't necessarily know the end customers or are you not able to tell and in the ones where you know which of the application segments they are in what seems to be the leading area there?

Well I think it's -- we talked about Japanese wastewater and the government is making a big push and got very attractive incentive, both industrial and municipal.

So that is one part of Japan.

The other part, and I can't understress it, the big Japanese Fortune 50 companies have made commitments to Kyoto and they are trying to fulfill those.

And a fuel cell operating 48 to 50% efficiency and plus the Cogen is a big win for them.

So you have that driver also for industries I would say industry and wastewater in Japan and Europe is pretty much all over the map.

If you look at our ten key segments they are participating in virtually all of them.

They just started doing wastewater in '05 -- think for us we'll see another, I'm sure a few wastewater plants and then it will run the gamut of across the line I think for the six or eight units that'll be coming out of MTU in '06.

Another question if I may on the cost reduction.

Given the fact that you had some extraordinary costs,retrofitting and PPAs and so forth that impacted the cost to revenue ratio in the fourth quarter can you comment and I know there is a lag for the new designs to get into production, but can you comment on based on the current backlog what you think the Q1 ratios might look like?

This is Joe Mahler.

I will give you a broader take on that.

We will still have PPA activity in the first quarter so you will get some comparable there.

But if you look at the year 2.99 cost ratio, we expect that for next year to significantly drop.

We expect that that will somewhat trail through the year, as Dan described before, as we push the DFC300MA into the marketplace and we start to capture some of the megawatt cost reduction.

That should decline all during the year.

The first quarter will be impacted by some trailing PPA activity that we agreed to last year but then cost generally speaking should be coming down.

So given the likely shape of the year with some of these bigger projects and the benefit of the newer designs and so forth, am I understanding you correctly that it is not necessarily going to be a linear thing through the year but more likely to accelerate toward the back half as you get the benefits of volume and new designs and all the rest?

I think that's a pretty good characterization.

A lot of the multimegawatt will start very late in the year, really go into '07.

So what you are capturing really would be the DFC300 power plants that are moving into the market, the MA design that is in production right now in the second half of '06.

Those should be starting to come in.

That is probably the biggest driver for '06 and then in '07 you will be able to capture really larger dollars related to the megawatt and as these orders come in, the multimegawatt.

That would be the path.

A last question please on the capacity expansion.

Can you comment on what the most significant leadtime items are.

Say for example that things go well in Connecticut with the first four megawatt project and some of these things you talked about and you find yourself wanting to put another chunk behind the three megawatt increase this year.

How long does it take to step up in terms of leadtimes for equipment and things like that?

We've got machinery and equipment in place to do approximately 50 megawatts depending on how smooth it comes in and that.

In Torrington, it is a people issue.

We have to step up to more people and multiple shifts.

That is the pacing item is how quickly do you bring on new people and do it in an orderly fashion.

We are not constrained by any of our suppliers at that level.

We've done I think a pretty good job of getting ready for this ramp by making sure that we're working with a lot of world-class suppliers.

So it is really how do you find and transition new people in the manufacturing facility in an orderly way.

And then depending on the load, we have some constraints in assembly conditioning and testing the equipment, particularly on megawatt class machines.

So we may have to expand that but that is when you get 15 or 20 or 25 megawatts run rate.

That would be a high-class problem to have I guess.

We are looking forward to it with gleeful abandon.

So on the people issue, assuming that you have found somebody who has got the basic skills set, how long does it take to train someone, bring them up to speed for the manufacturing operation?

Well all the process operators we have now go through a multiple phase training so they can do everything on every machine and then swap around the machines.

That is our core (indiscernible) rate.

As we bring new people in, we sponsor a FuelCell course at Naugatuck Valley Community College for process operators.

So as we bring them in, it is a function of the core guys who are trained in everything, bringing the new people up to speed.

It is not -- we have done it before.

We have gone up in volume before and then had to shrink down.

That's why we do want to do it again.

So we don't see it is a terrible constraint.

Connecticut is not a bad job market.

There is not big expansions going on that would suck up a lot of people.

So we don't think it is a problem.

We just want to do it on a deliberate basis so we don't throw too many people at the situation.

Gary Schwab (ph), Janney Montgomery.

Another question about cost out.

You said earlier that your current cost was 4300 kilowatt for the one megawatt.

That is what it will be in the second half of 2006?

That's correct.

And 46 for the 250?

Right.

If you knock off 20 to 25%, that should bring you down to about $1000 to 3300 and then how does the tax credit work?

Can you still expect -- do you get a full 30% tax credit off of that?

Well the tax credit applies.

It is $1000 a kilowatt up to 30% of the project cost.

But it also depends on whether the individual customer can take full advantage of it or not.

We have seen some where customers have other tax credits where they haven't been able to take full advantage and some that have.

So it becomes really much a customer specific issue at that time because the customer is the one that actually qualifies for the tax credit.

And Gary, keep in mind if you go out to California where a natural gas unit gets $2500 a kilowatt incentive plan, that comes off the project cost.

So the project cost has to be $3300 a kilowatt before he can get the full $1000 credit.

So it's 30%.

So it has got to be above the $3300?

Right.

Installed cost.

And Gary, I guess where you would probably see it reflected is you probably see it in potentially our ability in holding sale price.

So you will see the state subsidy really affects cost but the ITC is something that, from a FuelCell standpoint, we're going to be selling that to a customer who can recognize on the credits.

So we will probably -- it will help us hold our selling price.

Okay.

If you're selling it to a customer that can use the credit, I guess where I am coming from is you said the market clearing price right now is 2 to 3000.

You could be -- within a year, if you can knock your 43 down to 33 and you can still get --

Gary, it's Jerry.

Let me say how it works.

We are competing against the grid price of electricity, which is a commodity.

Once we get a customer off the grid we win.

I don't think of a job we lost.

But we are competing against that commodity retail price of electricity to our customer.

If the price of fuel goes up to us the price of capital we get -- capital cost for our equipment goes down.

The two big lumps are capital cost of the hardware installed and fuel costs.

So if the fuel cost equation goes up dramatically, like natural gas has, then the capital cost has to go down dramatically if you still want to pull this guy off the grid.

As the electric prices go up, that pressure goes down as you get an ITC that gives us another advantage.

But it's the combination of fuel price and capital cost is what turns the trick on when you are competing against a commodity price on the grid.

David Smith, Citigroup Investment Research.

You talked about a lot of contracts that seem to be out there today.

I'm just wondering -- I'm caught in this light.

I'm just wondering can you talk about how many of those you have actually won and where the backlog is today?

I'm sorry if you've talked about this but I just missed that.

The backlog today, Joe, is --?

The backlog today is 10.5 megawatts.

And then how many of these large contracts you guys have one won, actually how many you have actually converted.

Let's go back.

There has been no large contracts awarded yet.

We haven't won, haven't lost any.

We have been selected.

Our partner PP&L has been selected, as I think they will announce tonight, for four megawatts -- to negotiate four megawatts from their Wellington facility into the Connecticut Clean Energy Fund.

So that is the first selection in Connecticut.

LIPA hasn't made a decision yet.

Connecticut has said they want 50 megawatts of fuel cells with preference to those manufactured inside the state of Connecticut and that is where we are.

We have said that we will be bidding anywhere from 20 to 40 megawatts in the round that is coming out January 1 of '06 that will -- proposals are due end of February '06.

How many of those will get or be selected for?

Your guess is as good as mine.

I think based on the initial selection of four megawatts, we have some degree of confidence but this hasn't been done yet.

I think the fact that the four megawatt selection will go through the whole process hopefully to contract before the others are a bid then gives us some degree of confidence that Connecticut -- this Project 100 is a workable state system to bring fuel cells into fruition.

So on that contract -- the one that PP&L is bidding on, the other major competitor I'm assuming would be UTX.

Would that be right?

I don't know whether UTC bid in that round one at all.

I don't think they did but I --.

The answer to that question is no.

We have been selected.

There is no further competition.

It's just a negotiation.

The next step is to go to the DPUC and then utility just to negotiate the interconnect --.

The power purchase agreement.

The power purchase agreement.

Right.

When you mentioned Connecticut wanting 50 megawatts built in states, that would pretty much narrow it down to you guys and UTX right?

Well there's --.

Probably.

The other thing, can you just talk on the material side where you're seeing the biggest cost savings?

We're seeing it in all parts of the product.

We're seeing it in the balance of plant as we make some changes to the design from an engineering basis.

We're seeing it in our cell component materials.

We're seeing some significant reductions in what we go through in terms of our service and commissioning when we install and start up a unit.

So we're really taking those savings from all parts of the product.

The other piece of that is, as we improve the technology itself, what you're going to see is, as part of our cost reduction, is an uprate (ph).

So we're basically going to be taking more power from the same size stack because of some technology improvements.

So it comes from all areas.

The last thing, I'm just kind of --.

David, let me just stop you for a second.

It comes from all areas other than volume because all the costs we're talking about that we have published in the press release and we're talking about on this call is cost at a six megawatt a year run rate.

So if I look at that -- I think a previous caller mentioned 4300 and 4600 for the one megawatt and the 250.

Now that is the selling price today right?

No, that is our cost to actually produce the unit.

And the selling price, the list sticker price on those units would be --?

Well market clearing prices are 2 to $3000 a kilowatt depending on where you are in the U.S. now.

In Asia they are higher and in Europe I am not sure because we just sell fuel cell stacks to Europe.

The market clearing prices, as I mentioned earlier, is a function of competition with the grid.

So if the grid price goes up, you have got more room for higher market clearing prices, you get an investment tax credit and you can use that.

You have room for higher market clearing prices because you get the ITC.

So it is somewhat of a moving target, David.

So just to clarify then.

The 43 and the 4600, I am just not quite understanding, is that the price then today or the cost to you today with overhead and everything else?

That is the cost of the next round of the products that we're going to be making that include our manufacturing and engineering overhead, our cost to make the product, our cost to get it started up and commissioned at the customer site.

So basically that is why I am not seeing the gross margin improve today is because it is on a prior product?

What you're seeing come through the P&L now are the previous orders.

We have a lag.

When we release a design, it takes about a year for that to actually start to flow through because after we release the design, we build a first unit, we test it to make sure that there aren't any performance issues with it.

We make sure that we validate it.

We also have to make sure that we take that first unit through all the product certifications to make sure it will meet all the interconnect standards, to make sure it will meet the California 2007 emission standards and then we begin flipping our production.

So you see a lag of when those production basis start to flow out and that takes about a year for that cycle.

Just last thing on cost savings, not product-related but the G&A costs in the quarter looked a little lower than what I was expecting and they are down definitely year over year compared to last quarter.

Should we assume this 3 million run rate?

That run rate is pretty good but we're probably going to add to that run rate.

We are going to increase our sales and marketing expense.

We probably will have more multimegawatt megawatt proposal activities.

So it probably stays at the slightly higher run rate.

David Snow, Energy Equities.

The 2 to $3000 market clearing, seems to me that's a little up.

I think I recall back in the past you had said 1500 or something.

Is this reflecting current electrical grid prices or projected or once you have run through these existing high fossil fuel costs to the grid with the typical lag?

Where are we relative to that?

David, keep in mind what I said.

We are competing by taking customers off the grid.

If we get them off the grid we beat them.

At Sierra Nevada, we were competing with GE Jenbacher engines and we won hands down.

The grid prices are going up but there is a lag cycle.

So if you took it -- so we are competing against an X cents per kilowatt hour on the grid.

That is what the customer's paying.

That is higher in New York than it is in New Jersey.

It varies around the country.

That price, from our standpoint, consists of three components, capital cost of the hardware, cost of the fuel, and the operating and maintenance cost.

So if the fuel cost part of the equation goes up, then capital operating and maintenance doesn't change.

Capital cost has to go down if you want to compete against the grid.

So when the dynamics that are moving as gas price is going up, all the prices are going up and electricity prices are going up.

But because of that lag, it hurts us so we are probably now down in California.

We're probably looking at a market clearing of, with today's cost of gas, about 1500.

We're actually starting to see that come up now with the investment tax credit.

It's an advantage to take the investment tax credit.

You get a $12,000 credit.

That says you can pay 2500 instead of 1500 even with high natural gas prices.

So there are three conflicting things that are moving.

The ITC gives you some credit, electricity prices going up helps you, gas prices going up don't help you.

We believe they have peaked.

We think they're going to somewhere set it down in the 7 to $8 range and yet electricity prices will go up.

There is a lag when you reduce electricity prices.

In fact, I can't remember seeing it on my bill ever where they reduce electricity prices.

So there is a lag raising them but there is a sure big lag lowering them.

Those are the dynamics that put such a broad range on market clearing.

The 2 to 3000 is today cents per kilowatt hour price tag.

It's not a projected one, is it?

Right.

I'll give you another example.

We're doing a project at Camp Pendleton at Twentynine Palms.

Because of the government requirements, their market clearing prices are 3 to $4000 instead of 2 to 3 if you can do government institutions.

Could you just tell us a little bit about the ceramic issue that you alluded to?

What we have seen is in our older design, we use a ceramic that is part of the seal for gas sealing.

It is not related to the stack itself.

It's part of how we seal gases flowing to and from the fuel cell stack.

What we were seeing is a lot of the units as they saw a lot of upset conditions from grid disturbances and so forth, that ceramic seal would lose its integrity.

So what we did was we put a program in place where we would basically swap out the stack in that unit, bring it back, repair the seals and then put that stack back in service.

We think we've got a good handle on it.

We have now had about two dozen units that have come through our testing and conditioning process and are in the process of going out to customers.

We have seen no further evidence of it so we think we've got that problem well under control.

It is now just a matter of taking care of the last couple of units that are out in the field that still have the old seal and design in it.

Operator, one or two more please and then we'll have to ring off.

Bill Mascovitz (ph), Field Sales (ph) Energy.

As a long-term holder, it has been a little bit frustrating thinking back to 2002.

If I would have believed that energy costs, oil would be at $60 and terrorism and this dependency on foreign energy and FuelCell was in single digits.

It is still in single digits.

Sales were down for the quarter.

It is tough to rationalize.

I know you gave a number of factors here today but can we just talk about the sales effort here at FuelCell?

On a scale of one to ten, I would like you to comment where do you think the sales effort -- the system, the people, the processes, ten being the best.

Then secondly, the other thing that I think is -- there are a lot of factors here -- but the other thing I would like you to comment on that has dogged this company is a continual need for capital that we keep getting diluted.

So could you comment on both of those things please?

On the sales aspect, Bill, it is tough.

It is more visionary type selling.

The sales cycle itself is extremely long because you have got to line up with your distribution partners.

We don't go direct.

We are through distribution partners.

I understand.

But where do you think that effort is?

Just rate it one to ten.

Where do you think you are and where do you want to be?

I don't know.

I don't know how to rate that.

You don't rate your sales effort?

Yes, we rate our sales efforts.

But we have got a good team.

We have got some good distribution partners.

So is it a 10 or is it a 1.

I mean where are you?

I am not going to give you a 1 or a 10, Bill.

Okay?

We think it is a very strong distribution organization in a very difficult market because you have got to arrange financing.

You've got to go through government agencies to do that.

You have got to get a customer to do a totally different paradigm shift, which is instead of buying my electricity from the grid, I'm going to generate it myself.

That is a selling process and you end with early adopters.

We've got 40 installations around the world with some absolute class, class customers.

We've got guys like Caterpillar as a partner.

We have got Kawasaki with Marubeni in Japan.

We've got Enbridge in Canada.

So we have got PP&L here in the East and we think the market is absolutely primed.

It is not going to be a 30 degree upcurve.

There is going to be an inflection point, a tipping point and you are going to see sales go through the roof.

We're trying to prepare for that because we think that is going to happen in the near term.

That's good to hear.

What about the dilution that has been dogging us?

If we need to raise capital to dramatically expand the production capacity of this company then we will go to the marketplace to raise that capital because what we are looking to do is grow this company, not incrementally, but to be a huge success.

We have got a proprietary technology.

We have got big, big companies that are three years plus behind us in the marketplace.

We have got the good opportunity to be in the monopoly position in a dynamic booming marketplace and we think that is quite exciting.

Who is in charge of sales?

We are out recruiting a new VP of marketing and sales.

Dan right now is running the seven or eight people we have directly spread around the world as we are recruiting for a new executive in that position.

Well, it has been a long wait.

I hope we're at the breakthrough stage.

One final thing.

When do you think you'll hit profitability assuming that these orders you're talking about come through and you're going to be booming here?

We have said pretty consistently -- Joe, jump in if I am wrong -- somewhere in the 35 to 50 megawatts is gross margin breakeven.

Somewhere in the 75 to 100 megawatts a year is cash flow breakeven.

Now you have got to put into context, as costs keep coming down, those numbers keep coming down.

Is that still a fairly fair statement?

I think the congruence of -- Bill, one thing that helps us in terms of the sales effort is that we had high cost.

We have high cost sub-megawatt unit but the cost is coming down rapidly.

You certainly don't want to make a business in volume on those units so we've seeded the market, setting this opportunity up now.

That is exactly where we are.

Okay, operator, I think we have gone over a little bit.

We will end the call now.

Want to thank everybody for participating and we will be talking to you again after the first-quarter conference call for '06.

Thank you very much.

Thank you for participating in today's conference.

You may now disconnect.