燃料電池能源 (FCEL) 2006 Q2 法說會逐字稿

Welcome to today's teleconference. [OPERATOR INSTRUCTIONS]

I will now turn the program over to Mr. Steve Eschbach.

Go ahead, sir.

Thank you, 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 I am delighted to have you join us on our second quarter 2006 conference call.

Delivering formal remarks today are Dan Brdar, President and CEO; and Joe Mahler, Chief Financial Officer.

Before proceeding I will read the following Safe Harbor disclosure statement.

This presentation contains forward-looking statements including statements regarding the Company's plans and expectations 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 U.S.

Securities & Exchange Commission.

I would now like to turn this call over to Mr. Dan Brdar.

Thanks, Steve.

Good morning.

I am pleased to have everyone on today's quarterly conference call.

To set the stage for our discussion of FuelCell Energy's accomplishments and outlook going forward I would like Joe Mahler to provide you with detailed information on our second quarter results.

Thanks, Dan, and good morning, everyone.

FuelCell Energy reported revenues for the second quarter of fiscal 2006 of 9.5 million compared to 6.1 million a year ago.

Net loss for the second quarter of fiscal 2006 was 23.5 million or $0.48 per basic and diluted share compared to a net loss of 16.8 or $0.35 the previous year.

The current period includes two items that are not reflected in the prior year.

During the quarter we converted 39.755 million shares [sic -- see Press Release] of our Series B Preferred Stock to common and paid a conversion premium of 4.3 million or $0.09 per basic and diluted share to effect this transaction and also incurred 1 million of stock compensation expense now reported in our income statement or $0.02 per basic and diluted share.

Looking at the quarter, our net loss after effecting these items was higher than prior year as commercial product sales and revenue were higher.

At the same time the cost of sales ratio for commercial product sales improved in the quarter to 2.43 from 3.17 as the Company continues to bring reduced cost DFC power plants into production.

Net cash and investments used during the quarter was 12.2 million compared to 19.5 million in the same period last year, and is in line with our expectations.

Total cash and investments at April 30, 2006, was 150.6 million.

During the quarter the Company received 2.5 million of California Self-Generation Incentive Program receipts which offset power purchase agreement capital costs to 2.1 million and also received 2.2 million of net proceeds from common stock sales that support quarterly dividend payments.

Capital spending other than equipment built for power purchase agreements in the quarter totaled approximately 900,000.

For the six months ended April 30, FuelCell Energy reported revenue of 15.5 million, a 13% increase compared with 13.7 million a year ago.

Product sales and revenues were 9.5 million compared to 8.4 million.

Research and development contract revenue was 6 million compared to 5.3 million.

For the six months FuelCell Energy reported a net loss to common shareholders of 40.2 million or $0.82 inclusive of the one-time conversion premium of 4.3 million or $0.09 for the Series B and 2.1 million which is two quarter's worth of stock compensation which was not reported in the prior year.

Adjusting for these items and counter to the result in the quarter net loss for the six months was improved compared to the net loss to common shareholders of 36.2 million or $0.75 per basic and diluted share in the same period a year ago.

Returning to the quarterly analysis, product sales and revenue increased 3.1 million to 6.5 million or 94% and a quarterly record for the Company for the three months ended April 30, compared to 3.3 million for the same period in '05.

The increase in product sales and revenue recovers from a low first quarter and is primarily due to the timing of customer delivery requirements on existing backlog and the receipt of a new order.

Cost of product sales and revenues increased to 15.7 million compared to 10.6 during the same period prior year.

The ratio of cost of product sales was improved compared to the same period due to reduced cost DFC power plants entering into production.

Research and development revenue was 3 million for the period compared to 2.8 in the prior year.

The ratio of R&D costs to revenue was 0.89 compared to 0.95, pretty much a mix -- a result of the current mix of cost share contracts.

Administrative and selling expenses increased 1.1 million to 4.7 compared to 3.6 million in the prior year primarily due to the stock based compensation of 700,000 and higher marketing and professional costs of approximately 300,000.

The Company's product backlog including long-term service agreements as of April 30, totaled 23.9 million.

It was 20.4 million at April 30, 2005, and research and development sales backlog totaled 9.9 million.

That was 22.3 million in the prior year.

The Company was selected by the Department of Energy for additional awards to develop a high temperature membrane for Polymer Electrolyte Membrane fuel cells and to develop a coal-based multi-megawatt Solid Oxide Fuel Cell system.

These awards will be added to backlog of approximately $20 million once we finalize those contracts.

During the quarter FuelCell Energy entered into transaction of certain holders of the Series B Convertible Preferred Stock to convert an aggregate of 41 million 755 shares [sic -- see Press Release] into approximately 3.6 million shares of common stock. 39,755 were converted during the quarter. 2,000 came in after the quarter.

As a result of this conversion our quarterly dividend obligations have been reduced by approximately 500,000 a quarter.

This was a solid quarter for us with revenue up, cash in line, and cost ratios moving in the right direction.

We have a strong balance sheet with over 150 million to continue to execute our business strategy.

I will now pass the call back to Dan.

Thanks, Joe.

Now let me turn to our quarterly highlights and our progress on accelerating the Company's drive to profitability.

We are pursuing this goal by capitalizing on fundamental changes in the marketplace that favor our ultra clean power plants, by continuing to engineer costs out of our products, and by meeting customer expectations for product performance and reliability.

On these fronts I am pleased with the quarter's results.

We continue to make good progress in product cost reduction, continued strong product performance, and visibility to potential order activity for the remainder of this year continues to look good.

In our markets gas prices continue to retreat from their previous highs, and the price charged by utilities for grid delivered power is going up.

In addition, the federal investment tax credit contained in the 2005 energy bill is also stimulating sales activity in the U.S.

The consequence of these market conditions has been to improve distributed generation and our power plant economics and increase sales activity for the Company and our distribution partners.

Importantly, as we continue to penetrate our key market segments in California, the Northeast, and Asia, our order activity is trending towards larger sized units and multi-megawatt opportunities.

In California during the second quarter Cal-State Northridge purchased a 1 megawatt DFC power plant for combined heat and power applications.

We also negotiated an expansion to 750 kilowatts of the base load power plant at Camp Pendleton.

The closing of this deal was just announced yesterday.

In Asia our Japanese partner, Marubeni, extended its distribution agreement with us committing to 6 megawatts of power plants for expansion in the Asian market.

In the Northeast, Connecticut Light and Power and PP Energy Plus submitted a 4-megawatt long-term project to state regulators for approval.

As I mentioned last quarter, our focus for product cost reduction in 2006 is centered on our 2-megawatt DFC3000 product.

We're on track to achieve our cost reduction target of 3,200 to 3,500 per kilowatt for the DFC3000 power plant.

This is important because it should be our first product to show positive margins and allow us to capitalize on multi-megawatt opportunities developing in the market.

Our design work is confirming our cost out calculations.

Combined with our focus on megawatt class sales we're online with our strategy to build volume and megawatt product sales as a shorter path to profitability.

I am also pleased to report that we continued to meet customer expectations.

Lead availability continues to surpass 90%.

Four of our stacks operating at customer sites have reached or exceeded three years of operation.

The fleet has generated more than 108 million kilowatt hours of electricity representing ultra clean power our customers did not purchase off the grid.

Taken together, these statistics translate into customers' confidence with our products.

During the second quarter we continued to shape the business to ensure we're in a position to capitalize on the emerging markets.

We hired Bruce Ludemann, as Senior Vice President of Sales and Marketing for the Company.

I am excited to have Bruce on board as he is a power industry veteran with a strong track record of success.

He will lead our charge on multi-megawatt scale opportunities and repeatable business.

As Joe Mahler detailed in his financial discussion we continued to manage our cash which was in line for this quarter.

Our previously announced scale-up of manufacturing to 9 megawatts is also on target as we anticipate increasing order flow.

Hiring of additional staff in our production facility is nearly complete, and training of new personnel is in progress.

Let me add two notable results for the Company's R&D program during the second quarter.

FuelCell Energy was selected by the Department of Energy for an $85 million contract to build a multi-megawatt Solid Oxide Fuel Cell Turbine system.

This coal-based technology links to our existing experience with a variety of fuels including clean coal and could be an important factor in giving the nation more control over its energy future.

While commercialization of this technology is a few years down the line, the award speaks to the confidence DOE has in our engineering and design skills and is a strong endorsement of our expertise in megawatt class fuel cell technology overall.

Elsewhere, we inaugurated operation of our combined cycle power plant, the Direct FuelCell/Turbine at Billings Clinic in Montana.

It established a best in class record of 56% electrical efficiency over 800 continuous hours of initial testing.

The system lays the groundwork for the larger systems that should achieve electrical efficiencies in the 65 to 70% range.

Let me wind down my formal remarks this morning by giving you a sense of activity in our target markets and our visibility to orders.

In the Northeast initiatives for clean technologies through renewable portfolio standards and similar state level legislation are continuing to evolve with generally positive momentum.

This is being driven by high energy costs, increasing concern over the environment and our reliance on imported fossil fuels and the need for increasing energy efficiency.

In Connecticut new programs to stimulate distributed generation were approved in April including rebates, the elimination of standby charges, and reduction in natural gas transportation charges.

In addition, a second round of Connecticut's Project 100 was released targeting 85 megawatts of renewable energy.

In cooperation with our distribution partners, we anticipate submitting proposals totaling 30 to 40 megawatts.

One of our projects, the Bridgeport Fuel Cell Park, received a predevelopment loan of $500,000 for a 10-megawatt fuel cell project based on our DFC power plants, funding which will support interconnection analysis, facility design, permitting, and other activities.

California is one of our strongest markets with 8.25 megawatts delivered or on backlog equal to Asia.

A key driver in this market is the California Self-Generation Incentive Program which supports ultra clean power generation.

SGIP support for fuel cells is at its highest level ever.

Through May 2006 we and our partners have submitted 5.25 megawatts of new projects for SGIP funding approval.

We also expect to submit a similar amount of new projects in the remainder of 2006.

In the Asian market our partner Marubeni's recent commitment to order an additional 6 megawatts which supports our longstanding strategy for addressing the growing market conditions in Japan.

Initially we will add local personnel for sales and servicing to support Marubeni's recently increased sales staff.

In addition, we will continue our efforts with Marubeni to form a joint venture for packaging DFC power plants in Japan.

Moving more of the assembly of DFC power plants to Japan and incorporating balance of plan components from local vendors is expected to reduce costs to be more competitive.

Japanese government agencies continue to make subsidies available for introducing new energy.

While high energy costs remain a challenge in this market, the situation is predicted to improve over the next year.

Yet Kyoto protocols continue to be an important factor in Japan.

Our most recent customers in Japan and several now in the queue selected our DFC products specifically because of our high electrical efficiency and the role our products can play in helping Japanese industrial customers meet their specific commitments for carbon dioxide reduction.

We also can report that the Japanese Institute of Wastewater Engineering Technology certified that our DFC products meet or exceed their strict standards for electrical efficiency, heat recovery efficiency, and air emissions.

This serves as a sales endorsement of sorts for DFC units in Anaerobic Digester applications such as wastewater treatment facilities.

Tokyo Gas is currently evaluating a DFC power plant for introducing these units to customers of its energy and industrial gas divisions.

Both of these events are expected to broaden our opportunities for increased sales.

In Korea funding for development and deployment of alternative energy sources including fuel cells is increasing this year.

Our Korean distribution partner, posco, is working with the government to establish a fixed price purchasing program for power generated by carbonate fuel cells such as ours.

We're confident that steps being taken by our partner including partnering with utilities such as the Korea Southeast Power Company, working with Korean government for subsidies tied specifically to fuel cells and the development of a renewable portfolio agreement are providing us prime access to market opportunities.

Canada has ratified the Kyoto protocol and is also focused on reducing emissions in selected regions.

Our distribution partner, Enbridge, is currently seeking to have our core DFC products included in a portfolio to replace 500 megawatts of coal power to meet its carbon dioxide reduction requirements through Canada's C$250 million Sustained Development Technology Corporation program and other government programs.

In addition, we're developing with Enbridge the direct fuel cell energy recovery generation product specifically designed for the natural gas pipeline market with near term opportunities of over 250 megawatts in greater Toronto, the Northeast U.S., and California.

Going forward we're actively bidding at the states with renewable portfolio standard programs.

We have SGIP applications working in California, and we're working closely with partners to secure government subsidies in Asia.

We remain on target for reducing the cost of our 2-megawatt product.

Sales during the quarter grew, and markets are clearly moving to megawatt and multi-megawatt scale projects.

We continue to meet customer expectations.

Now I would be pleased to take your questions.

[OPERATOR INSTRUCTIONS] We'll take our first question from Walter Nasdeo with Ardour Capital.

I have -- basically I have a question and I was hoping that you could discuss what's going on around this PEM development program and when you guys say high temperature, what exactly are you referring to?

High temperature for us is not high temperature in the context of, like with carbon or solid oxide, all it is is elevated temperatures that relate to PEM 200 degrees or so.

For us it has been a good fit where we can keep our involvement in a variety of technologies, and it also helps us with some of the things that we're doing in the marketplace looking at ways to co-produce hydrogen from fuel cell technologies.

There is a variety of initiatives that are looking at how are we going to economically produce hydrogen in the event that a hydrogen economy develops and also to support industrial applications, and we've come up with a unique approach using the PEM technology that allows us to secure DOE funding in areas outside of our traditional core carbonate and solid oxide activities.

But you don't anticipate going into the PEM business any time in the near future?

No, it is not part of our strategy at this point.

Just if I could briefly touch on with the product revenue growth that we saw basically year-over-year and then quarter-over-quarter, is this something that we can start anticipating seeing in this bulk range going forward for awhile now?

Walter, it is Joe Mahler.

If you look at our backlog, it is about 24 million.

I am anticipating that that will get delivered over 12, 15 months, 5 quarters, so you should be at a 4.5 to 6 range arguably on a quarterly basis.

We had a low first quarter.

I think the second quarter pretty much evened that out.

If you look at our year-to-date we're running about 9.5 to 10.

That's probably the right range.

Are you still looking at about 50 megawatts as break even?

Break even is -- gross margin break even?

Yes.

Yes.

I think -- the range we have out there is 35 to 50.

I think that we're pretty excited about if we can bust open the multi-megawatt market with these big projects in Connecticut, I think we could potentially lower that.

But that's the same we've been communicating.

And as far as the multi-megawatt thing goes, this 3500 per kilowatt level that you're getting down to, I am assuming that the bulk of that is coming out of the larger units?

When we talk about the 32 to 3500, that is for specifically for our 2-megawatt product which is what we would use to bid these multi-megawatt opportunities.

Are you there now or is that -- are you working to that?

We're working to that.

That's the focus of what our engineering team is working on for this year.

We'll release that cost reduced design in the fourth quarter of this year.

We'll be in a position to respond to the opportunities that we'll be bidding later.

Okay.

Thanks a lot.

Sure.

Thank you.

We will take our next question from Stuart Bush with RBC Capital Markets.

Please go ahead.

Good morning, guys.

Great work on the cost reduction front.

Thank you.

What I am trying to get my hands around here is the -- looking out towards some of these multi-megawatt projects, especially in Connecticut, I guess it is my understanding that those would also be power purchase agreements, and from what we've talked with you in the past, the forecast I guess is that -- the hope is that we would be able to bundle those power purchase agreements with some of your existing ones and try and track some third party financing.

So with that in mind I am trying to get my hands around how you guys structure those deals and, for example, the actual cost of the electricity that you're selling, is that based on the wholesale price plus a margin over how long of a period?

A couple questions there, Stuart.

Let me take the project finance.

Our strategy for the large projects is to work with developers and our partners, so we have certain partners who will use their balance sheet so that will basically avoid the project finance question on those projects.

Those projects would have to win their bids.

What the strategy is is to put three or four or five of these projects in front of the Clean Energy Fund, and see what appeals to them, Connecticut projects and southwestern Connecticut might have more weight because they have a grid constraint there.

What we're doing is we have a mix of an approach to proposing these projects.

Some will be distributor financed, and some will be project financed.

On the project financed scenario these projects are large enough to have attracted some serious players that we have spent considerable amounts of time with.

We believe we can get these projects financed because of their size, and because of the investment tax credit opportunity.

We're looking at models that show, tax investors for example could be out of the project in four, five, six years.

It is very, very opportunistic for them, and that just in effect excites all the downwind players, the debt players and any other equity players that would step in, so we're pretty -- I think the key is we got to get some projects.

Once we get the projects, I think we'll have some opportunities to, either through distributors or through project financing to get those into the marketplace.

In terms of the pricing of the Connecticut project, it is basically the standard offer plus a premium.

These are basically grid type projects, so the states understand that they have to support us.

It is not quite wholesale pricing.

It is not retail either.

Somewhere in the middle there they have to support us with pricing.

They're giving us in Connecticut a $0.055 premium plus we get part of any regional emission credits.

In Connecticut we would effectively over the term of that transaction -- the other thing that would come into play is that the state would take any fuel risk in play.

We would effect get somewhere between $0.085 to $0.10 per kilowatt hour over the life of the project which is designed somewhere in excess of 12 to 15 years.

Okay.

That's great.

The assumptions -- just to be clear, the assumptions that you're talking about here are a project of that size at around a 32 to $3500 per kilowatt CapEx cost, and then you layer in all the incentives with the payback period of 4 to 6 years.

Actually, the cost would be less.

Because when we talk about 32 to 3500, that's where the cost for the 2-megawatt product is going to be basically building the next unit.

As we start to bid 10 megawatts we'll see that number get closer to $3000 a kilowatt.

If we're doing multiples of those, we will be below $3000 a kilowatt.

Stuart, the returns on this are -- what I gave you was kind of a segmented review on how a tax investor could get out that makes these projects very appealing to the tax investors.

Overall if you looked at the project all in, the hurdle rates of this are pretty attractive.

You're talking 12, 16, 18% returns on this type of product with this type of a revenue stream.

I mean $0.085 to $0.10 without fuel costs is pretty good economics for us.

It looks attractive for the new projects.

What is your outlook on trying to bundle in some of the existing PPA's you have out there?

Well, I think it is a process.

I think we have gotten serious interest in pooling concepts, especially in states like California where you have -- where the spark spread is in our favor or is coming back in our favor because the fuel prices are coming through the electric rates.

You have a market that is supportive, very, very supportive of clean technologies, ultra clean products, they're very concerned about emissions, and that is fostered through the programs they have.

They've set up the subsidy program, Self Generation Incentive Program in California that creates some stability, real solid stability in that market.

We go to apply for those funds.

It is clockwork.

You apply for them, they accept you.

If they like your project, they accept you.

When you deliver, they pay the money.

That marketplace fosters a pooling concepts and we've been working on that strategy in California.

Which one comes first, I don't know.

If we can get a large project out of Connecticut, we may be able to project those.

Those are certainly attractive because of their size.

The pooling concept also is attractive to certain of these players.

We're moving forward on both fronts, and we're optimistic.

Thanks a lot, guys.

Thank you.

We'll take our next question from Pearce Hammond with Simmons & Company International.

Go ahead, please.

Just a couple of questions here.

On the timing of orders or potential orders both in Connecticut and in California, are you still thinking Connecticut sort of August/September on hearing something and then the same thing in California, any sense of timing?

If you look at Connecticut, Connecticut came out with their solicitation I think May 15.

They're looking for responses to be in July 17.

What they had initially indicated was they were going to make selections September 1, but I think since they were a couple of weeks getting their solicitation out, I would expect them to make their selections in probably mid-October.

We would see these things going to the Public Utility Commissions for approval in the fourth quarter.

If you look at California, in California we expect to see it be more of a flow business.

We already announced Cal-State Northridge with the 5.25 megawatts that we already submitted for funding, the funding authorities don't take a long in time in California.

It is a continuous process.

I would expect that we'll see some of those get announced over the summer, and then we'll have another probably 5 megawatts or so that we'll be submitting during the remainder of the year which they will act on those as they receive them.

As some of these come to fruition, what are your thoughts on expansion of Torrington?

What we've done is get ready for this 9 megawatt ramp with the people that we've brought on board in our training.

As we start to see how successful we're going to be in California and with these solicitations in Connecticut, it gives us time to take the next step if we need to do that.

Since we have got adequate capacity in place with up to 50 megawatts of equipment, for us it is a matter of how quickly do we bring people on in an orderly fashion, and what's the next logical step for us to go from a production rate.

We'll have plenty of time to respond to that if we're in a situation where we have the good fortune of having to deliver a lot of units.

Great.

One last question and Joe had just alluded to this on the spark spread.

As we see gas prices coming off here and potentially coming off here and potentially coming off a little bit more at least in the short-term, are you seeing more customer interest?

Certainly in the past it's kind of hurt FuelCell Energy as prices moved up.

Are you seeing the opposite of that now?

Yes, Pearce, it moves around in the different markets.

It is interesting how the spark spread is different.

It is a little different in the East Coast than the West Coast.

But in California, absolutely the electric rates have gone up.

In January the industrial rate we compete in was probably $0.105 per kilowatt hour and in March it was more like $0.138.

We are up around $0.138 we are absolutely in the game.

We have seen a lot of interest.

The other interest we've seen is not just directly related to the sparks, but is the volatility of natural gas and fuel.

A lot of the customers out there who have gone through somewhat of the utility issues back with the Enronitis problems earlier in this decade are looking to hedge an arbitrage their electric generation, so there is a lot of interest of getting -- base load kind of fits into that model, our 24/7 base load and picking off some of that base load at potentially cheaper rates or the ability to arbitrage that over time.

A lot of these businesses are looking at that as a strategy, so we got a couple things really working for us, and that applies not just to fuel cells, but it also applies to DG.

That's how they're looking at it in the California market right now.

Thanks so much.

Thank you.

We'll take our next question from Sanjay Shrestha with First Albany.

Go ahead, please.

It is actually Brian calling in for Sanjay.

Good morning, guys.

Good morning.

I just want to know if you can give like, kind of an update on the cost out strategy, and are you still comfortable with 20 to 25% reductions in the next upcoming years?

The strategy is really going to be respond to what we see in the market place.

If you look at the 2-megawatt product, for example, what we're going to do this year is actually more than 25%.

SO what we're trying to do is since we're getting some visibility now to orders flow, we are going to respond to that with where we focus our efforts.

Certainly this year we want to drive a lot of cost out of 2-megawatt product so that the multi-megawatt opportunities that we're bidding here we can be positioned very well both from a competitive standpoint, but also in terms of where we are on gross margins.

What we'll do as we look forward later in this year at what we're going to do for '07 we'll have the opportunity to shift gears if we need to.

What we have done is we have put together a pretty comprehensive list of cost reduction opportunities for all the products, and what we've been doing is prioritizing them based on what we see in the marketplace.

Fortunately the products are still very early in the life cycle.

There is still plenty of opportunity for cost reduction in them.

Okay.

And then I guess another thing, I guess with the bidding prospects improving, how do you guys feel about cash burn?

You guys are kind of walking the line now between working capital needed and projects you're taking on, right?

No.

I would view that as a good problem to have.

I think if we can get some of these larger projects in, we will have increased working capital requirements to build inventory and whatnot.

The strategies we're employing are to work with -- we talked about project financing before, but project financing would in a certain sense cover some of that working capital from construction to build, so if you're in project finance world it is construction to build.

If you're in inventory sales mode it is working capital, but it really -- it really is all part of the same equation.

If I am building order flow, and I am showing this path to profitability, then I think that's a pretty good story, and I think the equity markets would also be helpful to us if we wanted to build some cushion there.

Currently we have 150 million in cash.

I am pretty comfortable today.

And then I know we kind of talked about it for awhile, but how would Project 100 really play out for you guys now?

In what sense?

Well, like more where it is going to go from here.

You mean beyond this phase?

Yes, exactly.

Yes.

I think -- what we're doing is we are showing the marketplace that fuel cells are a real player for the renewable portfolio standard markets.

There is 25,000 megawatts slated in 22 states for renewable portfolio, but they're not really funded.

Connecticut is the best funded, best program that we've seen.

They have identified a program.

They've identified the economics.

They've identified how to handle the fuel risk, and they've set it up really well.

What we want to do is if we get some projects, and we expect to, certainly we got -- we've gotten signals.

We have got the 4-megawatt product in Walingford, and we've also go got the $500,000 development -- predevelopment money for Bridgeport.

I think the state of Connecticut is very interested.

I think that we are going to show that fuel cells are absolutely viable.

Their 24/7 aspect is a real plus when you're comparing it to wind and solar, and I think -- in Connecticut my bet is that you get a Phase II that would have additional requirements for fuel cells, and I think you would see kind of a domino effect with these other states stepping on board.

I think it is a really exciting opportunity for us.

Yes.

Even in the state of Connecticut there was recently an attempt in the legislature to actually increase Project 100 to Project 150.

They weren't able to get through all of the bills they had on the docket.

They're already looking at what do they do after this current round.

What the Clean Energy Fund has been encouraged to do is if they have enough viable projects in this next round to take the remaining 85 megawatts that's left in the current plan off the table so that they can get moving on what they're going to do after that.

It looks like there is a lot of support within the state to continue a program like this.

As Joe mentioned, what we're seeing as we start to visit some of these other states is they're really looking at the Connecticut model as one that they may want to adopt.

Because if you're in the state programs there is not a lot of incentive to try to create something new.

So what some of them are doing is they are looking at how the first of these projects get executed.

If it looks to them to be a viable model that they can adopt they're giving it some pretty serious consideration rather than try and create some new mechanism all their own.

One last question if I could, just give us a little bit more -- you spoke briefly about the opportunity in Korea.

What else is going on in Korea?

I know you briefly went through that you're working with the Korean government.

We're not actually working with the Korean government.

Our partner Posco is.

When we began working with Posco, we've placed several units in country already just to start to introduce the product to the marketplace.

But when we work together on our strategy one of the things that we shared with them is there really needs to be a fuel cell incentive program early on to get the economics functioning for the marketplace just like we see in California and Japan and elsewhere.

What Posco has been doing is we have been training them in the product itself, getting them smart about how it operates, how to service it, and maintain it.

They have begun a dialog with the Korean government to create that FuelCell incentive program.

What looks like is going to be put into place is something that looks much like a production tax credit.

What we're hearing from them is it looks like it's going to be somewhere around $0.28 a kilowatt hour.

They expect it to pass sometime later this year.

We're waiting to find out what the total dollars are that are going to be available, but they have been pretty effective at working with the government to create that subsidy program to get the early units adopted from a market acceptance standpoint.

Thanks a lot.

Congratulations on the good quarter.

Thank you.

Thank you.

We'll take our next question from John Quealy with Canaccord Adams.

Go ahead, please.

Good morning.

Can you guys here me.

Yes, we can, John.

A quick question.

On the outlook in terms of potential projects coming into the backlog, can you break it down by size?

For example if you have got a certain amount out there.

I don't know what the addressable opportunity is in the near term, six, twelve months, where you're responding to RFP's but can you break it down by the amount by 2 megawatts plus so we can see a distribution of how that goes?

Yes, let me take it, John.

We're talking in Connecticut 30 to 40 megawatts that we're bidding under the Project 100.

We're looking at 10 megawatt or larger, probably three or four projects, and then probably a 5 megawatt project being bid into that.

Everything there would be large scale.

In California we have visibility into the SGIP so far, and we know how much approximately somewhere between 5 and 6 megawatts I think we're chasing under the incentive funding, and I think all of those are larger than 250.

I think they range anywhere from 500 kilowatts to 1 megawatt.

We're seeing across the board an acceptance of the technology, and a desire to get units that match up their base load, what their real base load applications are.

All of that is favorable for our cost out efforts.

We're also seeing and you look at Japan, now that we have our first megawatt installation that's Sharp we're finding that's stimulating some of the other large industrial customers that would be some pretty high profile names to also look at doing larger kind of projects.

We have got a couple that are in the queue right now.

We're starting to move beyond the 250-kilowatt size range in that market as well.

When you look at feedstock source you have got a good footprint in wastewater digester gas, how do those opportunities look both over in Japan and in the U.S?

And is there more of an emphasis here on that given all the sort of movement on the environmental front here?

What we're seeing in Japan is with the certification we got from the Japanese Institute of Wastewater Engineers, it has basically been sort of an endorsement of the product.

We're starting to see that stimulate the acceptance over there.

We're seeing a lot more coming into the queue there, projects that Marubeni is evaluating that without that certification probably would have been pretty tough to convince a customer to go do it.

If you look at what's going on in California, if you look about six months ago when gas prices really started to peak out there, our sales guys and our distribution partners sort of shift focus a little bit to the wastewater treatment.

Since we've got -- it is a great fuel for us.

What you are going to see over the summer and into the fall is a lot of these early opportunities that are coming through the SGIP program are going to take advantage of wastewater treatment applications for us.

I think you are going to see some nice order flow on the wastewater side.

Any movement here in the states on -- this is a longer term opportunity, but capturing the CO2 credits on the fuel cells, customers that you talk to now, are they getting any more engaged about trying to monetize or capture CO2 credit years down the road when a market place really gets up and running here?

Well, in Japan CO2 is the name of the game.

What we see when we talk to the large industrial customers there is most of them have already taken the low hanging fruit in their facilities for CO2 reduction.

It now becomes an efficiency play for their generation.

Sharp and others that we talked to, clearly our efficiency was part of why they selected our product.

Here in the U.S. without something that looks like a carbon tax or some kind of regulated mandate, the CO2 reduction strategy is less of a role.

It is really efficiency taking the impact in reducing the fuel costs.

If you can generate power with a fuel cell that's 50% efficient that's a better option in a high fuel cost environment than an engine or a low temperature fuel cell that may be 35 or 40%.

My last two questions, can you give us an update on MTU and how things have gone there with the change off in ownership.

It's been quite a while now, wondering if that settles out, and then I just have a last one for Joe.

The purchase of Friedrichshafen by EQT, that deal is now concluded.

The discussions have begun with MTU CFC the FuelCell entity with our new parent group.

Michael Boda, who is the [Dechefsfure] of MTU CFC will be here later this month at which point he will be giving us an update on how his initial discussions have gone.

I would hope later this month we'll have a little better visibility in what he is seeing for the thoughts of the EQT group in terms of where they want to go with the fuel cell business that's part of MTU Friedrichshafen.

Joe, lastly on the cash, what do you think cash used is this year and if you could just segregate the PPA for us and obviously you have got things in Connecticut that is somewhat fluid at this point, but if you could just give us a range?

I am still running at this 13 to 15 a quarter range, John.

I think the next two quarters will probably be in that category.

Our PPA activity on the small units is pretty much wrapping up.

There is probably a couple million dollars left in that category from a cash standpoint.

But it is not that large, plus I still have incentive money that will balance that off to some degree.

I am really looking at that we should be in line in the 13 to 15 range.

Great.

Thanks, guys.

Thank you.

We'll take our next question from Sid Mergandoyle with Cohen and Company.

Go ahead, please.

I was just wondering if you could provide some more details on the combined cycle to Montana and how that's going and what you kind of see the next steps are for further development of that technology?

Yes.

That project has really gone well.

We had the Department of Energy senior management here to witness the testing in our facilities here where we hit 56% on the sub-megawatt configuration of that.

Since then we moved the unit to the Billings clinic, installed and it's been operating for several weeks now.

It has been running very well.

Originally this is supposed to be a demonstration, but we're finding that the customer is making noises about keeping the thing there.

We have got to decide what do we want to do after the demonstration period.

In the meantime what we're doing is talking with our distribution partners because we need to figure out what is the right size product for us to introduce to the marketplace.

That answer may be different for the U.S. versus what we would see in Japan, for example.

We've also have begun some discussions with some of the turbine players that could potentially provide a turbine piece of this cycle to understand what their interest is, so I would expect over the coming quarter we're going to start to get some feedback from our distribution partners where we can collectively figure out where do we want to target taking this product next.

Okay.

And then I know you talked a little bit about other states possibly looking into the Connecticut model, and I guess I was just wondering if you could kind of highlight some maybe specifics in terms of RPS standards in states and maybe integrating fuel cells into those and specific progress there that you might have seen?

If you look at the RPS market themselves, they're very large markets.

There is about 25,000 megawatts of renewable power that the various states are looking to install over the next ten years or so.

Many of those states because of the fact that we're ultra clean consider fuel cells even on natural gas to be renewable, and those include some pretty big states like New York, Pennsylvania, so what we're finding is the market certainly is receptive to it.

We're seeing in states like New York, California, New Jersey, Pennsylvania, but what they're focusing now is what's the mechanism they want to put in place to start implementing the RPS programs, so I think a lot of the ground work has already been done in those areas in terms of the acceptance of the product and our ability to actually actively participate in those programs.

Now it is a matter of the state legislatures going through and structuring their programs and starting the bidding process the way Connecticut has done.

Okay.

Thanks a lot.

Sure thing.

Thank you.

We'll take our next question from David Smith with Citigroup.

Go ahead, please.

Can you just tell me how many megawatts were shift in the quarter and how many megawatts are in the backlog?

Yes.

In the quarter we shift 1.5 which was a combination of some components to MTU and then some shipments to Starwood, the DFC product, and then some Japanese shipments.

And then the product in the backlog is about 7.75 megawatts would be in the backlog as product and the difference then would be government related to additional DFCT activities and our Navy projects.

Okay.

Got you.

One thing on the cost reduction target to 32, $3500 a kilowatt, I am assuming that's your cost, right?

Correct.

What would you sell that unit for, then?

In the marketplace we're seeing that we need to be in around the $3000 a kilowatt price range for these projects to make sense.

Is that with incentives or post incentives?

Well, it is without the incentives because the kind of projects that we're going to be bidding these large units on, the applicability of the incentives is kind of questionable.

Most of the incentive programs are really targeted more towards stimulating some of the small units.

I got you.

Okay.

What was -- this is more of an administrative.

Just looking at the share count with the preferred and the additional monies that were raised to pay for that, what's the share count, actual share count at the end of the quarter?

If you effected--?

The conversion and then the additional equity raise in the quarter?

I think the actual, if you take the weighted average for the quarter was 49 million.

Yes, but it looks like there were about 4 million shares issued during the quarter.

Hang on one second.

It is basically on the balance sheet.

It would be 52.900 million shares effecting the preferred stock conversion.

Got you.

Then looking forward for the rest of the year, how much more conversion should we expect?

That's a good question.

If we're presented with what we think are economically advantageous transactions, then we would effect more conversions, so I really can't tell you.

I really don't know.

Okay.

Looking at the projects you've talked briefly on the California timing and then on the Connecticut timing with Canada, can you talk about when you see that unfolding?

And then on the Asia side, I know Marubeni came up with 6 megawatts.

When do you expect those will be cited?

On Canada, what they're doing is, since they're working with the Canadian government to get those programs in place, it is really a function of how quickly their government moves.

Off the top of my head I really couldn't tell you.

I don't know if it would be a couple of weeks or a couple of months.

But they've certainly been making very good progress with them.

We have to just wait and see how the new government in Canada actually implements some of these activities.

In Japan we're really a function of the incentive programs.

Those things are done twice a year.

There is one that's done in May and there's another one that's done in October.

The projects that are going to be coming in this next round, several of them have been submitted for funding for the May round.

We'll start to hear some of those over the coming weeks and months as they finalize their agreements with their customers, and then there will be sort of another round of those that will come in the fall.

It is really a function of the two waves of incentive funds that happen over there during the year.

Those 6 megawatts then haven't been cited I guess, right?

They haven't announced where the sites for them are yet.

Do they have any time frame as to when they can do that or?

Those are units that need to be delivered in '07.

Any comment, though, one thing in the Canadian press lately has been how the conservative government is backing off the Kyoto targets.

Any impact on the Enbridge offer there?

No, we're not seeing any impact from that at all.

In fact our Enbridge partner seems to increasingly be more active with the government.

They see a lot of opportunity both in this pipeline market and just fuel cells as part of a broader solution for the power generation problems up there.

Okay.

You've talked about too, the 2-megawatt program costing.

How about the submegawatt and the megawatt program, just if you could refresh us where you are on cost there and then what the targets are?

Yes.

We released the cost reduced designs for both of those products at the end of last year.

The 1 megawatt product design released is $4300 a kilowatt.

The first of those cost reduced 1 megawatt units is actually being built right now.

Because we need to build one to take it through certification testing for carb 2007, UL listing for the electrical balance of plant, those sort of product certifications that we need to do.

That's being built at our facility in Torrington as we speak.

On the submegawatt unit, the cost reduced design that we released end of last year is at $4600 a kilowatt, and we're already starting to see some of those reductions associated with that design flow in the current product.

We've pulled a couple of those things forward into the product that we're making now.

You will start to see that the 250-kilowatt product, the 4600 show up towards the end of the year or beginning of next year from a production standpoint.

So if I look at the improvement in gross margin which looked good in the quarter, what's really driving that?

I think just going back it sounded like you shipped some components to MTU Starwood in Japan, but what's driving that better gross margin this quarter?

It is effectively we're bringing through the $6200 cost that was last year's design target is starting to come through the financial statements with a little bit of mix of component sales and Japanese sales which have a little bit higher pricing on them right now.

I guess how much -- if I look then at the sales in the quarter, how much of it was sort of percentage of completion projects that are underway and then how much of it was components?

Is there any way to look at it that way?

I would say that -- hang on a second here.

I will take a look.

I would say that the component sales are in the 15 to 20% range of the total.

Okay.

That's great.

Thanks, guys.

Sure thing.

Thank you. [OPERATOR INSTRUCTIONS] We'll take our next question from David Snow with Energy Equities.

Go ahead, please.

Yes.

Just looking at the numbers, it looks like you have referenced about 11 megawatts coming in in the first quarter, but obviously that's not all going into hard backlog.

Can you kind of walk through what is coming into backlog on the quarter and what is coming into the potential backlog?

I am not sure I totally understand that question, but--.

Well, I see 6 megawatts to Marubeni, Connecticut--?

I'm with you then.

Hard backlog what we added in the quarter was in effect the Cal-State Northridge order and the Camp Pendleton order is coming into backlog.

We have not yet put the Marubeni in the backlog.

We'll do that as they're cited, as they firm up.

We did on that order get the down payment you would get on an order.

We've actually collected cash, and it is a commitment, but we want to time that a little bit more to their subsidy cycle and the citing it.

That's really upside for us.

All the rest is upside also, the Connecticut, all the rest?

Connecticut, we really need to close the orders and then we'll put them into our backlog.

So that is all going through the bid process.

What we have is we have terrific visibility into that cycle.

What about the Connecticut 4 megawatt Walingford that's still pending?

That's actually moving along pretty nicely.

The discussions between our partner PPL and the local utility here at Connecticut Light and Power went very well.

They have forwarded the project to the Public Utility Commission for review and approval, and the first of those discussions actually is this week, so we're glad to see that thing moving along.

I think everybody wants to see the first one of these get through the process, particularly if it can happen before the next round of proposals are due in the round two solicitation.

It is continuing to move along, but--.

So it would be second half or when would that go in the backlog?

It could be as early as third or fourth quarter.

Okay.

So then the Project 100, if you got that, when would it go into backlog?

Probably be--.

30 to 40 megawatts?

Since this next round we would expect to be able to move through the approvals a little quicker since the process will have been exercised.

You'll probably see some of that start to show up either the fourth quarter this year or first quarter of next year.

When you say some of it, does it come in stages, or how does that roll out?

It might.

If they're looking to do 85 megawatts of awards, that's a significant increase over what they did in this first round.

We're not sure how they're going to try and implement that, whether they will announce them and forward them on for PUC approval as they select them or whether they will wait until they have got all the proposals reviewed and just make one announcement that covers all of them.

It sounds like as these roll through by next year you could be almost at your 35 to 50 of border backlog.

Yes.

It is hopefully going to be a good problem to have.

Okay.

Thank you.

Sure.

Thank you.

At this time I will turn the meeting over to your moderator, Mr. Brdar.

Go ahead, sir.

Well, I would like to thank everybody for joining us to hear of our progress during the quarter and we look forward to getting back with you again next quarter and continue to report on our progress.

Thank you.

This concludes today's conference.

You may disconnect at any time.

Thank you.