燃料電池能源 (FCEL) 2006 Q3 法說會逐字稿

Welcome to today's teleconference.

At this time all participants are in a listen-only mode.

Later there will be an opportunity to ask questions during our Q&A session.

Please note this call may be recorded.

I now turn the program over to Mr. Eschbach.

You may begin.

Thank you and good morning, everyone.

On behalf of the executive management team of FuelCell Energy, I'm delighted to have you join us for the Company's third-quarter 2006 conference call.

Delivering formal remarks today are Dan Brdar, the Company's President and CEO, and Joe Mailer, the Company's 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 and Exchange Commission.

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

Thanks, Steve.

Good morning, everyone, and thank you for joining us for a discussion of our third-quarter results and accomplishments.

We've made solid progress in the last several months -- executing effectively on our mission to drive down product costs; gained market share in target applications and geographies; and put the Company in a position to capture large multi-megawatt opportunities developing in the market.

Our third-quarter financial results were in line with our expectations.

Product revenue growth and order flow reflected our increasing footprint in California.

Cost reduction efforts on our multi-megawatt DFC3000 are on target.

And net cash used in the quarter was within our target range.

At this point I'd like to turn the call over to Joe Mahler who will discuss the Company's fiscal third-quarter financial performance and then I'll update you with details on our operational program, market conditions and our business opportunities.

Joe?

Thanks, Dan, and good morning, everyone.

FuelCell Energy reported revenues for the third quarter of fiscal 2006 of $8.7 million, similar to last year.

Product sales and revenues increased to $5.4 million compared to $4.9 million last year; research and development contract revenue was $3.3 million compared to $3.9 million in 2005.

Net loss to common shareholders for the third quarter of fiscal 2006 was $19.8 million or $0.37 per basic and diluted share compared to a net loss to common shareholders of $18.6 million or $0.38 per share last year.

Third-quarter 2006 results included $1.1 million or $0.02 per basic and diluted share of stock compensation expense as well as $700,000 of additional research and development spending attributable to megawatt class cost reduction efforts.

The ratio of cost to product sales and revenue of 2.83 to 1 was comparable to the year ago period.

Our manufactured product cost ratios improved over the prior year and are in line with our expectations.

The quarter cost ratio was primarily impacted by changes in inventory mix resulting in higher lower-cost to market charges on our inventory and additional costs for megawatt first article development.

We see no trending from this that would change our cost out targets as presented.

Administrative and selling expenses were $4.3 million during the three months ended July 31, 2006 compared to $4 million for the same period a year ago.

Excluding stock-based compensation of approximately $700,000 in 2006 SG&A spending was down $400,000 year-over-year.

Internal research and development expenses increased by approximately $900,000 which reflects the increase in our engineering, material and labor focused on cost reductions for the megawatt plants.

Total cash and investments at July 31 was $133.6 million; net cash and investments used during the quarter were $17 million compared to $20.5 million in the same period of 2005.

Power purchase agreement capital costs totaled $1.7 million during the quarter bringing cash close to our target.

For the nine months ended July 31, 2006 product sales and revenue were $14.9 million, a 12% increase above the $13.3 million in 2005.

Research and development contract revenue was $9.3 million compared to $9.2 million in '05.

For the nine months ended July 31, 2006 FuelCell Energy reported a net loss to common shareholders of $60 million or $1.19 per basic and diluted share compared to $54.7 million or $1.14 in 2005.

Adjusted for the onetime conversion premium of $4.3 million for the Series B convertible preferred stock and stock compensation expense of $3.2 million, the 2006 year-to-date net loss is lower than 2005.

This was a transitional quarter for us as the organization moves to capture our multi-megawatt opportunities.

We are in a strong position with over $133 million to continue to execute on this strategy.

Dan?

Thank you, Joe.

In the third quarter we continued to capture tangible results from our comprehensive cost reduction efforts.

A key accomplishment was our recent announcement of an advanced cell stack design to boost the output of our power plants by 20%.

This [uprate] is applicable to our full productline and the improvements have been implemented in our production facility.

Building on the technology and engineering enhancements that led to this 20% uprate we're now testing improvements that we expect to allow us to increase the power output of our plants to 3 MW for the DFC3000, 1.5 MW for the DFC1500 and 375 kW for the DFC300 -- in the end a 50% increase in power.

The implementation of the 20% uprate is an especially important milestone in confirming the cost of our multi-megawatt DFC3000.

With most of our component sourcing for the DFC3000 completed we can reaffirm hitting our target cost of 3200 to 3500 per kW by years end and further planned cost reductions.

Our DFC3000 product is an ideal match to the multi-megawatt requirements of states with renewable portfolio standards.

Our products provide ultra clean, efficient baseload power around the clock and serve as a perfect complement to intermittent power generation by other ultra clean alternatives like wind and solar.

We have significant multi-megawatt bidding activity underway in the Northeast to secure orders from renewable portfolio standards initiatives requiring clean power.

We expect these large scale projects will allow us to capitalize on economies of scale and with that volume further lower the cost of all our products.

We've been selected by the Connecticut Clean Energy Fund in the first round of submissions for a 4 MW project that incorporates our multi-megawatt power plants.

This has received preliminary approval by the Connecticut Department of Public Utility Control and our expectation is to receive final approval shortly.

As of yesterday the DPUC has placed this case on its docket for September 13th.

Successful conclusion of round one awards is also expected to clear any remaining delays for submitting proposals under round two of Connecticut's Project 100.

We're partnering with multiple developers to submit projects for rounded two, an effort that we expect to result in more than 40 MW of the proposals featuring FuelCell Energy products.

In preparation for round two bidding, our Bridgeport FuelCell Park proposal was awarded initial financing from the Connecticut Clean Energy Fund for project predevelopment work.

While our primary focus for the year is cost reduction on our DFC3000 and positioning ourselves to capture multi-megawatt opportunities, the delays associated with Project 100 allowed us to pursue some additional activities during the quarter that strengthened our ability to respond to market opportunities and requirements.

We completed building the balance of the plant for the first cost reduced DFC1500.

The 1500 balance of plant was delivered to our facility in Torrington and is about to undergo product certification and emissions testing, essential for markets such as California.

Also to support our growing fleet of sub MW units we built several FuelCell modules to be used as spares for stacks that will reach the end of their life during the coming quarters.

Having these spare modules available enables us to quickly return a customer's unit to service, maximizing the amount of ultra clean power a customer can generate during the year.

In addition to the multi-megawatt opportunities in the Northeast, we expect demand for larger scale projects to increase in both California and in Asia to geographies where FuelCell energy has market leadership.

This is another point I'd like to call to your attention, how we're increasing our presence in the markets we've targeted.

Reported revenues and recent orders reflect our strong market position in California, a state that is at the forefront of adopting ultra clean distributed generation.

Last week California announced the country's most sweeping regulation to limit carbon dioxide emissions, calling for a 25% reduction in greenhouse gases from electric power plants and other sources by the year 2020.

Carbon dioxide emissions are directly proportional to efficiency.

Since our products are one of the most efficient ways to produce electricity, measures like this heighten the value of our ultra clean DFC power plants in the California market where we currently have over 30% of our worldwide installed capacity.

In addition, California expects to serve as a model for other states adopting similar emissions caps, suggesting potential future possibilities.

Some of our recent successes in California include expansion of Camp Pendleton's existing DFC power plant installation to 750 kW.

We also announced the purchase of a power plant by Gills Onions', one of the largest fresh produce producers.

Gills will use renewable biogas created from onion peel waste products to generate electricity.

The significance here is it's a triple win in the marketplace -- first, it demonstrates the flexibility of fuels customers can use to operate our DFC units.

Second, Gills obtains an ultra clean, reliable and economic source of electric power.

And third, they lower their operating cost by using a waste product they would otherwise have to pay to dispose of.

Also in August we joined our partner, Chevron Energy Solutions, to dedicate a 1 MW power plant at the Santa Rita Jail in Alameda County.

This is our third site in California to generate a megawatt or more of power.

It combines electricity produced around the clock by our fuel cells with the jail's daytime solar panels, so the facility is attracting a great deal of interest as a model for how to use alternative energy sources in complementary ways.

Finally, as an indicator of future demand, California-based customers have obtained funding approval from the state's Self Generation Incentive Program to purchase an additional 8 MW of our products.

We will continue to grow our presence in this important market, looking to build our business in a range of industrial, university and mission critical settings.

Turning to Asia, Japan's telecommunications giant, NTT, has incorporated a DFC power plant into an electric supply system that provides reliable baseload power to a number of institutions in Sendai City in Northeastern Japan.

Our DFC products address two significant energy issues in Japan -- first, demanding high efficiency solutions to cope with high-energy costs; and second, meeting commitments to reduce carbon dioxide emissions.

Japan's central government of course is a signer and chief proponent of Kyoto protocols.

But what often gets overlooked is that individual businesses and entire industries in Japan have also made commitments to reduce greenhouse gases.

Although market fluctuations in energy costs made our sales efforts in Japan more challenging in the third quarter, we believe the stage is set for improved conditions that will accelerate our marketing efforts there.

As one indicator of this, during the third quarter our distribution partner in Japan, Marubeni, renewed its marketing agreement with us and committed to ordering an additional 6 MW of our fuel cells.

As part of our market leadership in Asia we've also entered into discussions with companies in both Korea and Japan that can manufacture and our balance of plant using local components.

These packages provide us with the opportunity to localize our products for the market and we would expect these relationships to also produce significant cost reductions as well.

Both of these will help increase our market penetration in Asia.

I want to underscore that while this market development work is underway we've closely monitored our installed base.

In the third quarter we reached a milestone of having generated over 120 million kilowatt hours of clean electricity, almost a 60% increase from last year, by our more than 50 sites around the globe.

Fleet availability continues to meet customer expectations and exceed 90%.

Let me close my formal remarks with a few words about our progress in R&D.

During the quarter we won a Defense Department research contract to continue developing a process for generating pure hydrogen that is based on our carbonate fuel cell technology.

This has important implications as a cost-effective way to separate hydrogen from a gas mixture.

Purified hydrogen has commercial value today and industrial applications and people are excited by the prospect of using our technology to support market demand for hydrogen that relates to upcoming fuel cell automobiles and other transportation applications.

Separately, we've demonstrated the ability of our DFC plants to rapidly switch between different types of fuels.

This capacity validates their reliability and potential use in a wide range of circumstances as a hedge against interruptions with fuel supplies either from natural disasters or market fluctuations and security-related issues and mission critical facilities.

Finally, we received new funding from the Office of Naval Research to advance our development of a high-efficiency fuel cell aimed for use onboard ships.

In this application it's the quiet profile of our DFC power plants that makes them particularly interesting to naval planners.

With no moving parts the fuel cell becomes one more means of reducing the noise associated with vessels and adds to their stealth capabilities.

With all these advancement and flexibility of the use of our technology we continue to execute on our parallel strategies of reducing the cost of our power plants by reinforcing our leadership position in targeted geographies and applications.

Thanks for your attention; now let me open the line for your questions.

(OPERATOR INSTRUCTIONS).

Stuart Bush, RBC Capital Markets.

I was hoping you could expand on the technical progress you guys have made with the increased power output of the stack.

You mentioned it was an improvement with thermal management, so what level of efficiency are these new stacks operating at?

And what are the next technical challenges you need to solve to get to your next target of improving the output by an additional 25% from where we are now?

The thermal management was one piece of it.

We've also done some changes to the cell design itself to improve the electro chemical activity that goes on.

The challenge in any kind of a high temperature fuel cell is you want to increase the amount of current you can get from a stack and when you increase the current you generate more heat.

So that's why heat management becomes important.

So what we've done is we've made some changes in terms of how we cool the stack and some of the things that promote increased electrochemical activity to get the current up right.

The things that we're doing going forward are on a similar line, but they're really going to be focused a little bit more on improving the electrochemistry that's in the stack itself.

We're pretty excited about what we've got going on because we have things on test now that look like we've got a very clear path to get to the mature ratings that we've always based our business plan on.

Okay, great.

Secondly, can you clarify what changes were made recently to the way the electricity base rate is calculated in the Project 100 and how you might think that would impact the attractiveness of signing a power purchase agreement from a utility's point of view?

What happened in the first round was they had come up with a couple of pricing mechanisms that really didn't reflect the ability to pass through fuel cost because people always have a difficult time predicting what fuel price is going to be in the future.

So for the second round they revised it to allow the fuel cost to basically flow and get passed through to the ratepayers.

So what it did was it made the projects much more attractive economically because you weren't asking developers to make predictions on what the fuel price is going to be ten years from now.

What it's also done is with the advent of the investment tax credit it's really created some very nice returns for people who are developing these projects because they can get the tax credit upfront coupled with the premium that exists for the renewable power, end up with attractive margins in the 10, 12, 14% range for their projects.

Joe, do you want to add to that?

No, I think that's right on.

So the conclusion is that for round two bidding the rate of return is more predictable than they were for the round one bidding, is that right?

Very much so.

What we found is when most people looked at round one they thought it was an attractive option, but they really wanted to have more flexibility.

Since we've seen so much volatility in fuel pricing they really wanted to have a mechanism to insulate themselves a little bit from that since it's a long-term commitment you're making for power supply.

Okay, great.

And do you think it's likely that all of the remaining megawatts of bids will pass-through completely in phase two of Project 100 to meet their target of 100 MW?

Well, we know that the Clean Energy Fund has certainly been encouraged by the state and the DPUC to actually take the remaining 85 MW or so off the table in the next round if they have enough qualified bids.

Ultimately that will depend on how many proposals get submitted and are they considered really strong proposals.

If the Clean Energy Fund doesn't get a lot of proposals I would suspect they'll go ahead and have the third round as planned.

But I know based on what we're planning on bidding ourselves, they certainly have the capability to wrap it all up in round two if they choose to.

Okay, thanks a lot, guys.

Pearce Hammond, Simmons & Co.

Going back to Connecticut, what sort of timing do you expect to hear back on some of these round two as far as having success with any of these bids?

The way it's unfolding right now is they wanted to delay submissions of the round two proposals until they had completed the review of the process the Clean Energy Fund was using and they made final awards on round one to make sure there was nothing else that needed to flow back into the request for proposals for round two.

It looks like the DPUC is going to make a ruling next Wednesday for the round one projects.

At that point we'll know whether there's any reason to change any of the requirements in the RFP for round two.

Based on what we know so far we don't think there will be.

So I would expect that the Clean Energy Fund will probably give two to four weeks for submission of proposals.

Some people already submitted for round two based on the past deadline.

And then I suspect they're going to take probably about three months or so to evaluate those proposals.

So we'll hear first selections I would think the end of the year or in January.

Okay, great.

And Dan, do you still see threshold prices that you need to get to, say between 2000 and $2500 a kW?

And then can we expect these 20% cost declines moving forward out through '07?

Yes, as we look at the marketplace that 2000 to $3000 kW still looks to be the right range where we need to be competitive.

We saw a little bit of pressure on that when the spark spreads inverted for awhile but that's corrected itself.

So we're pretty focused on getting well into that range.

But as far as our own cost reduction efforts, Pearce, what I would just advise you is think about where our product is and its lifecycle compared to gas engines or gas turbines -- it's still a very young product, there's still plenty of cost reduction.

And as we start to get volume it enables us to do other cost reductions that maybe wouldn't make sense at low-volume.

So I think we've got plenty of opportunity yet to keep driving the cost of our products down to get well within the competitive range.

Okay, great.

And so you do think the threshold is still at about that 2500 in California?

Yes, based on what we're seeing and the jobs that we're closing out there, the economics right now are in the 2500 to $3000 a kW for jobs we're closing.

As we get to these bigger projects we might see little better opportunity there, but it seems to be pretty consistent with most of the markets we look at.

Okay, and then one last question.

The ratio of cost to product sales and revenue is 2.8 to 1 and in Q2 it was like 2.4 to 1.

So why the backup?

This is Joe Mahler.

Let me take that.

Affectively in the quarter what you have -- and you know how we tend to have some up-and-down quarters.

We have low-volume coming through the quarter, so you can get impacted by certain items coming through.

What we're seeing is we're seeing delays.

We're in kind of a transitional phase here, we're seeing delays in the multi-megawatt strategy.

I think we were first selected for the 4 MW project in May I think.

That hasn't gone through yet so we've been doing some shifting of production.

We've built some additional stacks to anticipate what we believe is a very strong California pipeline and also to build instrumental stacks to prepare for stack replacement for stacks that are past or are going to go past their three-year stack life.

So we incurred some costs there.

As you know, we have to take -- based on current market pricing you would take a lower cost to market adjustment on something like that.

So that has an impact on us.

I look at the same question, Pearce, and I look if there's a trending, any issue here.

In this quarter what we're seeing is that product costs are coming in between -- and the cost ratio 225 and 245 which is we're still clearing out the $6200 a kW sub MW product and then you have these other incremental charges in the quarter.

There's nothing that I see that is trending me away from saying that the cost targets are what we're anticipating and what we're stating.

If you look at the year-to-date trend, because we also looked at that, is the year-to-date trend is last year at nine months the cost ratio was 287 and year-to-date this year it's about 271.

So that all looks pretty positive.

We're moving to the megawatt strategy.

As the megawatts -- which is a good half year, nine months away perhaps depending on when the orders come -- you're looking for dramatically lower cost ratios there and that's really what we're gearing to.

Okay, great.

Thanks, Joe.

Thanks, Dan.

Rob Stone, Cowen & Co.

Two questions if I may, the first one on me biogas generation opportunity.

Can you comment a little bit more on how that site is set up with respect to who else is providing I assume it's an anaerobic digester for the sorters?

And given, as you said, that that's a double win turning a cost into a fuel supply, if you can elaborate on perhaps the size of market potential you see for biogas fueled sites?

Sure.

You are correct, it is a digester.

What Gills Onions' had been doing was disposing of their waste.

But as their business has grown they've gotten to be very successful.

And because they are a very environmentally conscious business they've tried to look for some other ways to deal with their waste issue.

So they're putting in an anaerobic digester where they're going to take the waste product that they used to dispose of, decompose it and basically produce a waste gas that will be used as fuel for our fuel cell.

What we're finding in discussions with them and other customers like Sierra Nevada Brewery and others, it turns out that in the beverage and food processing industry this is becoming increasingly the practice.

Because at the markets get more competitive they want to get away from the costs and the challenges of disposing of their waste.

So they want to find some way to recycle it.

What we typically see when we do the first of these is it starts to pull in others in that segment.

Sierra Nevada is a good example where as a result of doing that product we've now been introduced to others in the brewery market, others that work with Sierra Nevada like the company that does their packaging.

We expect to see the same thing here with Gills onions' since they're such a leader in the California marketplace.

Food and beverage as a whole is a very large market, so that's why it's important for us to get these marquee sites in, have them run really well so we can get that positive reference from the early adopter customer.

What company is the first of the digester technology if you can comment?

Off the top of my hand I don't know, but we could certainly find out for you.

Okay.

On a separate topic, can you put some more color on the timeline for having potential volume production for these ship based fuel cells?

And is that going to require developing a very different type of product or would you see this as a variance of your same stack technology that you're developing for everything else?

What we've done with the navy, while the balance of plant system is a little bit different -- which we tend to have others make for us to our design -- actual cell packages that he uses are identical to every other product that we use.

So we're not going to have to really change anything about the product that we make in our factory in Torrington.

But what it does do is it starts to open up other markets outside of just what the Navy is doing.

Doing things for the Navy would certainly be an interesting market for us, but it really also opens up all the other markets that rely on any kind of a diesel fuel like the islands, cruise ship lines which are big users of power when they come into ports.

So it really gives us the opportunity to really leverage our core technology to a whole new market segment.

So in terms of timing to get to more than the R&D stage and the fuel source is what if the ship is away from port?

For the work we're doing with the Navy it's a high sulfur diesel that we're using.

Because the Navy isn't interested in changing their logistics for their fuel supply.

But what we've developed there we could apply to most any type of a diesel fuel.

What we've done now is we've built the first of those units that's operating at our facilities.

After we do some test work here we're going to move to a land-based trial for the Navy at which point we'll evaluate if we do shipboard or not.

So that's going to be something that we're looking to be looking to do here in the coming months.

And depending on how the land-based trial goes will determine if we try and roll this out as a product sometime next year or not.

We really want to make an assessment of how competitive we think it's going to be for some of these markets.

And for the island markets, the real breakout is the refineries producing lower sulfur diesel just enables that market.

They're producing it now, they're using it to dilute trucking diesel in the U.S., but there are mandates to get lower sulfur diesel.

It would be easier to clean that diesel at the island level and then once they do that it really enables that island market.

And it's hard to put timing around that, but that's the sequence of events that will open up that market for us.

So is the decision for you really whether this becomes a commercial product with those other applications or -- you mentioned, for instance, that part of the attractiveness to the Navy is that it's stealthy and for that capability they might be willing to pay.

The military has a different sensitivity to cost.

So do you see two paths here, possibly a military only or would you only proceed if it also can get to costs that will be commercial?

I think we're going to look at both of those.

I think in either case they're not a big market compared to the other markets that we're looking at.

And if you look at the RPS markets for example, those are tens of thousands of megawatts of markets.

The Navy, while they sort of can pay a higher premium that some of the more commercial markets, they tend to be a lot smaller than that size range.

So we're going to evaluate it based on how well the unit performs; what we think we can do with it from a cost standpoint; and we'll do an assessment of how big we think both the island and military markets could potentially be for us.

But right now with what we've got in front of us for near-term multi-megawatt opportunity, that's really going to be where our focus is.

And fortunately, all the things that we're going to do on megawatt class products and our core cell cost reduction activities will benefit what ultimately comes with the Navy program.

Great, thanks very much.

Mark [Siegel], Canaccord Adams.

I was wondering if you could provide any color moving forward on cash burn.

Cash burn -- it looks to be about the same level right now.

We're running about 15 million a quarter.

I think we're going 46 for the year;

I think first quarter was 17; second quarter was 12; third quarter was 17; it's averaging a little bit around the $15 million level.

I would say we're looking at the same level of activity going forward right now.

Okay, great.

And also if you could provide any color or updates on the Enbridge partnership?

Enbridge has been very actively engaged with the new government in Canada.

The Canadian government actually has got a very large program, about $1 billion they're going to invest in fuel cell technologies.

So what Enbridge has been doing is working with the Canadian government to carve out a piece of that that would be specifically applicable to stationary power.

They've had a lot of good progress in the discussions with them.

I think you're going to be successful getting a program created.

But in the interim, what Enbridge has done is they've looked at the markets that exist here in the U.S. and they've been working with us to develop projects here where we take the product we developed together for the pipeline market and start to bid it into some of these RPS programs.

For example, in this next round in Connecticut we expect to see them bid a project that's gong to be several megawatts that's really building on that pipeline application that we've jointly developed.

Okay, great.

Thanks a lot.

Sanjay Shrestha, First Albany.

Actually it's [Graham Madison].

I was wondering if you could give a little bit more color on your outlook for Asia in terms of potential projects or orders coming from that region.

Asia is going through the same scenario we had in California six months to a year ago where the spark spread has gotten inverted there.

Fuel pricing has basically gotten flipped with electricity pricing.

We'll see the same thing happen there that we saw in the California market where that will turn itself around where electricity rates will start to rise to reflect the true cost of fuel.

What we've been doing in the interim though is because we want to get to a more domestic looking product for Japan we've begun discussions with a company that will basically do the balance of plant over there.

We think it's key in terms of the acceptance of the product.

We think it's key in terms of being able to bring more government incentives to the marketplace for us.

I think we're also going to see some pretty significant activity developing here in Korea.

We're pretty far along in our discussions with POSCO in terms of expanding our relationship with them.

They've done a lot of work developing an incentive program with the Korean government that looks like it's going to be a $0.28 a kW hour incentive program.

We're expecting that to be announced sometime in the fourth quarter this year.

We continue to get positive feedback from them about the nature of the business they see there in wanting to further their relationship with us.

So I think really in Japan you've got an issue of the inverted spark spread has to sort itself out, that will take a couple of months.

And in Korea we're going to start to see activity pick up here in the near-term.

Okay, great.

Thank you very much.

David Smith, Citigroup.

Actually it's [Samir Assad] calling in for him.

A couple of questions -- a few of my questions have been answered.

First, when are you guys going to start to see a material benefit from your cost-cutting initiatives?

I know your cost to sales ratio has kind of been hovering around 2.8 and you kind of touched upon this earlier.

Let me give you some flavor for how we see the cost ratio moving.

The 2.8 and actually the year number for '06 is about 2.7.

What you're looking at is for the actual product cost you're looking at a factor of say around -- for those units that are coming through right now around 6,200 to $6,500 a kilowatt, if you had a sales price of $2,500 you're looking at a 248 cost ratio.

The actual number is a little higher than that.

It looks like our average selling price is more in the $2,800 our range which gives you about a 226.

If your cost ratio at 6,200 was $3,000 you'd be at 210.

What we're expecting is that in the first half of '07 that on a sub megawatt basis we would see units coming through with a 4,600 to $5,000 cost.

I think we publicly said $4,600.

If you had a $2,500 price on that you're looking at a 184 -- 184 cost ratio to a 2 cost ratio.

That's what we're seeing.

And if you look at our megawatt strategy, for example on the 4 MW product or plant coming through if we get this Wallingford order, you're looking at say a $3,500 cost.

And even if your pricing had to be $2,000 which is actually a little bit higher than that, then your cost ratio is at a 175 range.

If your pricing is $2,500 you're at 140.

We should start to see the impact of that in '07 at this point.

So it's I guess based more on the types of projects you guys win?

Clearly our strategy is shifting.

We are not actively trying to sell 250 kW units at $6,200.

We're trying to get the multi-megawatt strategy engaged.

There are tens of megawatts available.

We're going through a little delay cycle in this part of '06 that's forcing us to do some alternative things with production and things in this period.

But once that kicks in then a cost of 3,200 to 3,500 has a dramatic impact on the cost ratio.

It certainly moves us closer to gross margin profitability and then any of those projects and volume will drive the cost from the 3,200 to 3,500 range, under $3,000 a kW.

So clearly our focus is multi-megawatt.

Thanks.

I'm not sure if you touched upon this before, but the NTU project in Europe, is there any update there?

Yes, MTU -- for those that don't know -- they have an acquisition where EQT basically bought MTU Friedrichshafen which is the off-road engine business at MTU.

That's also where their fuel cell business resides.

They had been going through a review of that business.

We were expecting to have some feedback from them here in the quarter.

Our understanding of the discussions with MTU is their meeting is scheduled for this month and I'll be meeting with MTU's senior management at the end of the month.

We'll hopefully have some feedback and some visibility on where EQT is going to go with the fuel cell business itself.

Okay.

You gave us a dollar amount for the backlog, what's that in terms of megawatts?

Hang on one second, let me just get the list of the backlog. the backlog at this point is 6 -- as of the conference call it's 6 MW, as of July 31st it was actually 6.5 MW.

I'll probably get this question later just to look at the -- in the quarter we had 2.25 MW of shipments in the quarter.

So right now currently today we're at 6 MW in backlog.

Okay.

I know you touched upon the different timelines for the different projects.

I guess what kind of timeline are you seeing for the projects you haven't already talked about in terms of happening next year, is this happening in two years?

I'm reading our press release and guys have a lot of things going on here.

When do you see all of this coming to fruition I guess?

If you look at California for example, we've got 8 MW of projects that have been submitted for cell generation center program funding and approved.

We're going to start to see those -- well, we've already seen the first of those, Gills Onions' -- you're going to start to see those flow out on a pretty routine basis here over the next probably four to six months.

And then beyond that what you'll start to see is in Japan they do their incentives twice a year, May and October.

So October we'll start to see what's the next round of awards from them.

The Wallingford project -- that 4 MW opportunity that we talked about -- we expect to see a decision based on the DPUC's announcement next week at which point we'll be able to wrap that one up.

We've already had the discussions with the utility and with our partner, PP&L.

So it looks like in the coming quarters here we're going to have a significant amount of activity.

Right.

And I guess lastly, any update on LIPA?

I guess you guys had been talking about that before?

LIPA -- it's one of these things where we're just waiting for them to chart their path forward.

Unlike what's going on in Connecticut and some of the other locations there's no mandate for them to do the project.

So they have been sorting through the issues surrounding the KeySpan National Grid merger, which has certainly impacted their business, has delayed a lot of the other things that we're doing.

We are having discussions with what we think are some other good opportunities in New York and we'll see which one of these breaks first.

But LIPA hasn't chartered a clear path in terms of when they're going to make a decision either to move forward or not do the project.

Right.

So you I guess have no timeline on that?

No, they haven't given us one.

That's it.

Thank you.

Mark Manley, Ardour Capital.

Any update on the coal-based SOFC?

Actually -- Versa has actually been demonstrating at DOE headquarters in Morgantown.

So the technology development of the cell [oc] is doing very well.

We believe that in comparison to Delphi and the other players in the SECA contract -- GE, Siemens -- that we are one of the leading stack technologies.

So we're very, very encouraged by that.

The coal-based project is a relatively long-term project.

It matches up nicely with our carbonate program because it brings together the synergies of large-scale integration.

The first phase, which will be completed in '08, is to develop the building block for an 80 kW stack that would be in effect a building block for a much larger megawatt solid oxide.

So from a development standpoint it's going very well.

But again, long-term, a longer-term technology product commercialization route.

Okay, great.

And any update on the Starwood Hotel relationship?

Are they ordering more?

Actually what we've been doing is since we had sited the first several units that we had done either with PPL or in our case some that we did directly as PPAs, Starwood looks like they're pretty happy with our products.

We've had some really good experience with them.

So what we've done now is in order to not keep using our balance sheet to do PPAs and because there's now interest in seeing project financing with the investment tax credit and some other developments in the marketplace, we've actually been working with them on an aggregation scheme where we're looking at putting a whole bunch of sites together and doing this as one common transaction.

Particularly in California, that looks like probably the first place that we'll do that because there's just so much interest in seeing more clean power going out there.

So what we're doing is going through the sites that we've collectively identified that make a lot of sense, we're going to put them together, we'll sit down with the people that we've been talking to for Project Finance and do sort of a pooling concept to do a group of them at one time.

Okay, great.

And just a bit of a follow-up to what Sanjay was asking about -- gross margins.

Is there any indication of when these are going to go to a 1 to 1 ratio?

It's all a function -- it's hard to pick an actual time, but the path that the Company is on is that as we can get multi-megawatt projects it can get there very quickly.

I mean if we can get a 10 MW project -- let's say we got 20 MW of projects and we can put that through our production plants and we can get -- let's say we get with the combination of ITC and other subsidies we end up actually realizing $3,000 a kilowatt then that's a 1 to 1.

So it's really a function of if we can crack through, and our expectation would have been at this point in time that we would have had the 4 MW project in Wallingford and that we would either have heard on round two in Connecticut or we'd be about to head that.

So there's obviously a delay there, but we're very confident that that will move forward and we will get multi-megawatt projects to execute this plan.

I believe earlier you said you bid on about 40 MW for the phase two of Connecticut.

We haven't bid yet since (multiple speakers) the date back.

We're going to be bidding in excess of 40 MW.

When all the bids are finally in we'll get an indication of what we actually submitted.

But we're going to be in excess of 40 for what we're going to bid.

Now how much of that we win will depend a lot on what other proposals go in and how our offerings compare with anybody else's that makes a bid.

I see, right.

When you bid, typically is that on independent projects or are there multiple bids usually on the same project?

What we've done is we've worked with our partners to actually -- they've each crafted a unique project that they're going to be submitting for a bid.

So what the state will actually have are multiple projects that are each unique from a different developer that will be in different locations and have different features and they'll have to use their selection criteria to decide which of those do they want to pick.

Will there be a pretty good chance of a majority of those being improved?

Well, it's tough to say because we expect there are going to be other projects that get bid into this.

There will be probably some kind of a biogas gasification project, there could be wind projects, who knows what else.

So I think until we see what actually gets submitted it will be tough to say how we're going to stack up versus the alternatives.

But our thinking on that is that this is "according to Connecticut, the fuel cell capital" -- you've got UTX, you've got us, you've got other fuel cell developers who are trying to make an industry out of that here.

So we think positively towards the results.

Right.

And you said there was pressure from Hartford to kind of wrap things up in phase two?

Yes, what they would like to do is there seems to be an interest in doing more beyond Project 100, but in order to do that they need to wrap up the program that they currently have.

So what the DPUC had recommended to the Clean Energy Fund was if you get enough adequate proposals in round two go ahead and take all of the remaining 100 MW off the table in round two to collectively move on to working on what comes after Project 100.

Great, that's it.

Thanks a lot.

Gary [Schwab], Ryan Beck.

Yes, just a follow-up on the testing that you're doing to get to a 50% improvement on your [DMC].

Do you expect the next step to be the full 50% improvement and do you have any kind of a timeline on that and what the resulting cost per kilowatt would be?

Well, there are a couple of things that happen.

We're at the point now where we have full area stacks that we're testing that exhibit a pretty significant improvement.

But we need to make sure that we do not produce more power at the expense of stack life.

So we have to do some long-term testing to make sure -- we run them at elevated conditions so don't have to run them for five years, but we do need to run them for several months to make sure that we do not sacrifice stack life to get the increased power output.

We'll have some visibility into that probably first quarter of next year; they will have run long enough, we'll know whether we've got any impact or not.

And at that point we'll decide what level do we want to flow to the product for an update because we want to make sure that we're not pushing these things to the limit because we want to make sure that we maintain the reputation for the product working.

So what we'll do as we go forward here in future quarters, we'll give you some better visibility into how that's progressing and what we think we're going to be doing in terms of its implementation for the product.

And once you reach that level is this improvement in the cell output part of your cost out reduction plan or is this in addition to your cost out reduction plan?

It is part of our plan.

If you look at where our cost reductions are going to come from, they really come from a variety of areas.

One is improvements in the core technology itself.

Others are engineered cost reductions for the system.

Others are things that we're going to do in sourcing.

So it's a combination of things that all come together to make the product more competitive.

Okay, thanks.

David Snow, Energy Equities.

The 40 MW that you and partners are bidding on, how much are you -- what would be your net share if all that got awarded would you guess?

How much are you exposed to in that 40?

Well, the 40 that we're bidding, that would be all bids that would include our equipment.

All right.

So it would really be your fuel cell system but not the balance of plant on the whole 40?

No, no.

We're selling a complete product, so it will be the fuel cell stacks themselves and the balance of plant that would make up that 40 MW of product.

But then you mentioned partners, are they in addition to the 40 or are they part of the 40?

What our partners do is they're the ones that are playing the role of developing the projects.

In many cases they would install the products and operate them.

They would take care of gas supply, interconnections with the utilities.

So basically what we would do is we sell our equipment to our distribution partners, they develop and execute a project using that equipment.

I see, okay.

Terrific.

So your exposure is really a pretty big one there?

Yes it is.

That's why we're excited about it.

Great.

Thank you.

Mark Manley, Ardour Capital.

Sorry, just to follow-up.

I believe last quarter you were guiding about 4.5 to $6 million for revenue per quarter and then would that still apply for the fourth quarter?

Yes, I think that that's -- I think that's a pretty good number.

I think that Wallingford is probably -- could be some upside on that.

But yes, I think that range is pretty good.

Okay, thank you very much.

It appears there are no further questions at this time.

Well, with that I'd like to thank you for your participation today and we look forward to updating you on our progress again next quarter.