Shareholder update

Thursday 12 July 2012

Shareholder Update

Ceramic Fuel Cells Limited (AIM / ASX: CFU) a leading developer of small generators that use fuel cell technology to convert natural gas into electricity and heat for homes and other buildings, is providing this update to inform shareholders about our many recent activities and achievements and the near term outlook.

As usual, we will release our June quarter cashflow report before the end of July and our Preliminary Final Accounts for FY12 before the end of August. Shareholders are also encouraged to view a presentation accompanying this update, available at www.cfcl.com.au.

Key Points

·; CFCL has commercialised its technology into products and is selling these products to commercial customers and via distribution partners to retail customers.

·; Strong revenue growth: revenue for FY12 is expected to be approximately AUD 6.5m (GBP 4.3m). This is an increase of around 75 percent on FY11 revenue.

·; Order book doubled over FY11: In total CFCL has received orders for 639 products (375 BlueGens plus 264 integrated mCHP units). This is a 108 percent increase from the order book as at 30 June 2011.

·; Our focus over the last quarter has been to deliver products, to convert these orders into revenue and cashflow. During the June quarter we booked to revenue sales of 76 units, bringing the total sales for FY12 to 169 units. In total, 213 products are installed at customer sites, across nine countries.

·; We believe the sales outlook for the coming financial year is strong, particularly in Germany. Revenue has grown strongly but needs to increase faster to fund operating costs. We are taking several measures to address this, including more aggressive sales pricing, reducing operating costs and pursuing several options to raise additional working capital. This will allow the Company to continue to drive sales growth towards a cashflow positive position. We will keep shareholders informed about capital raising activities.

·; CFCL has the world's most efficient technology for small scale power generation. We believe we have a strong technical advantage over all other mCHP products (micro combined heating and power).

·; As announced in May, the Company's products have been proven in real world operation, with its products having achieved a combined one million hours of operation. Independent studies by customers have confirmed the products operate reliably with very high electrical efficiency and can be modulated up and down, making them ideal for use in the home as well as integration into Virtual Power Plants.

·; During the June quarter the Company and its furnace supplier continued work to bring a large furnace into production at its volume manufacturing plant in Germany. This work is now expected to be finished in August and once this large furnace is operational, capacity will increase to approximately 1,500 BlueGen units per year, based on current operating procedures.

·; There is a very large global market for the Company's products. Policy settings in our launch markets continue to be supportive. Germany and the United Kingdom have recently announced increased feed in tariffs for mCHP products. Germany's CHP law will stimulate large scale deployment of mCHP by 2020. Several State Governments in Germany have created market introduction programs for mCHP products and more programs are expected. North American product approval, due later this year, opens up another large market.

Introduction

CFCL makes small scale generators that use proprietary fuel cell technology to convert natural gas into electricity and heat for homes and small commercial buildings. Our BlueGen product provides electricity and heat for hot water, with our core technology Gennex also being integrated into mCHP products which include a boiler for additional space heating.

The Company's products have many advantages over other forms of electricity generation. These include very high electrical efficiency and the ability to control the power output of the products. Recent studies with customers and third parties have validated both of these important product features. (Please refer to the separate presentation for additional details and data available at www.cfcl.com.au.)

Commercialised - the Company is making and selling products to customers

We believe our products are suited to many global markets. Our approach is to initially focus our efforts on 'deep' markets in Western Europe that have supportive regulatory settings, large volume potential, established infrastructure and a willingness to invest in home energy solutions to avoid the increasing cost of electricity -particularly Germany, the United Kingdom and Benelux. At the same time we are devoting limited resources to develop other markets that in time can grow into 'deep' markets - such as Japan, Australia and North America. Then, once unit costs have come down we can target other large markets such as Asia, Brazil and Russia.

In our launch markets we have made direct sales to early customers as well as appointing local distributors. As at 6 July the Company has received orders for a total of 639 products (375 BlueGens plus 264 integrated mCHP units). 213 products are installed at customer sites, across nine countries. (This number is updated on www.bluegen.net when a unit is installed and connected via the internet.) This is a 108 percent increase from the order book as at 30 June 2011.

Our focus over the last quarter has been to deliver products from our order book, converting these orders into revenue and cashflow. During the June quarter the Company booked to revenue sales of 76 units, bringing the total sales for the financial year to 169 units.

Revenue for the year to 30 June will be finalised as part of the full year accounts to be released in August, and is currently expected to be approximately AUD 6.5m. This is 75 percent higher than revenue for the 2011 financial year. Since our first sales in 2010, the number of units sold, and revenue received, has roughly doubled every six months.

Management and the Board believe this sales growth is extremely encouraging, particularly in the current economic climate in Europe, however sales revenue needs to increase more quickly. Sales have been slower than expected in part due to the delay in anticipated State Government incentive schemes in Germany. The Company also adopted a conservative pricing strategy for market entry. This mitigates the risk of making losses on early sales, but makes it harder to increase sales volume. Management and the Board are revising this pricing strategy and adopting lower margin expectations in order to drive more sales growth. This requires a balance of risks and Management and the Board will monitor this position on an ongoing basis and adjust our pricing to meet the market requirements and opportunities.

Activities in Key Markets

Germany

In Australia and the United Kingdom, the large generators of electricity are also large retailers of energy to end customers: so called 'gentailers'. The structure of the energy market in Germany is quite different.

In Germany the large generating companies (E.ON, RWE, EnbW, Vattenfall) only have a small share of retail customers. About 85 percent of retail customers buy their energy (usually gas as well as power, and often other services like heating and water) from their local Stadtwerke, or 'city works'. There are more than 800 Stadtwerke in Germany. They are usually based in one town or region and often owned by the local municipalities. Typically Stadtwerke do not have large electricity generating assets, so they have to buy electricity from the large generators to on-sell to their customers (at a low margin). Stadtwerke also typically own the local gas network. Electricity demand is increasing by about 2-3 percent per year, while residential demand for gas is falling by about 5-6 percent per year.

Our products provide numerous benefits for Stadtwerke - allowing them to sell more baseload gas (their higher margin product), increasing the utilisation of the gas network, whilst reducing their reliance on the large generators. Many Stadtwerke are recognising these and are offering their customers a capital subsidy or other incentive to purchase a mCHP product. One example is the utility Gasversorgung Main Kinzig, which offers their customers a subsidy of EUR 4,760 per unit (including tax) (http://www.mainkinziggas.de/). This is in addition to subsidies from the Federal or State governments.

CFCL and our sales partner sanevo have started selling BlueGen units to Stadtwerke. Some Stadtwerke, like SW Aalen, are now offering BlueGen units to their customers with a subsidy (refer to http://www.ostalbpower.de/). Rather than approaching 800 Stadtwerke directly, sanevo can sell to co-operatives who provide commercial services to groups of Stadtwerke, such as Trianel and Thūga. In June sanevo sold 23 BlueGen units to Trianel, to be deployed with 17 local Stadtwerke throughout Germany.

Sanevo's commercial model is based on their four years of experience with Stirling engine based mCHP products. Sanevo makes sales directly to end customers and via sub-channels (selected installers from the home heating segment or other partners like solar PV distributors). In addition to being a sales partner sanevo provides two other important skills required for successful commercialisation:

·; Product development partner

o sanevo is using their technical "downstream" knowledge in heating and mCHP products to standardize BlueGen installation and thereby reduce the total cost for the end customer;

o sanevo is experienced with accreditations required for integration in German houses (e.g. flue solutions). Having local experience in these specific regulations can create a competitive advantage against other mCHP manufacturers wanting to introduce their products to the German market;

o sanevo can help to combine BlueGen with other appliances to create additional customer value (e.g. integration with heating systems, solar, batteries, heat pumps).

·; Installation and Service Partner, for the units sanevo sells and also for direct sales by CFCL to utilities and other larger customers.

During this financial year sanevo has made significant investments to introduce BlueGen as a new product to the German market. Sanevo has built up a sales force comprising its own staff and sales representatives in five regions in Germany. Sanevo has approximately 130 accredited sub-channels selling Stirling engine mCHP products. A growing number of these sales agents are now also being accredited to sell BlueGen, for example Volthaus PV (http://www.volthaus.de/brennstoffzelle.html). During 2012 sanevo will publicise BlueGen at more than 40 regional trade fairs in the cleantech/home energy space.

As at 6 July the Company has delivered 30 units to sanevo from their first order for 100 units. We are continuing to work with sanevo to accelerate sales, including through more aggressive pricing. This will include a reference customer program for three market segments (residential, commercial and public buildings) with 100 units to be offered to customers in each segment. The customer offer includes a full service contract for three or 10 years (where the customer pays a monthly fee in return for all service, maintenance and repairs). Based on the positive feedback sanevo has received from the market, we expect to deliver the balance of the 100 unit order over the next four months and for sanevo to place the next order for 500 units shortly after that has been achieved.

During the June quarter we also continued our project with leading energy utility EWE, to deploy up to 200 integrated mCHP units. We have now delivered 48 products, which EWE is installing in homes in the Oldenburg region in Northern Germany. EWE is offering these units to its customers with a 10 year contract for heating. In May EWE reported its progress to the Board of NOW (the German Federal Government body that is funding the project). Among the other positive results EWE reported a fleet availability of 99 percent from the start of operation in customer homes - a very high measure among all mCHP products and the highest for fuel cell mCHP products in this program. In June EWE also ordered 17 BlueGen units. Seven of these were delivered in June. We have started discussions with EWE concerning the next stage of commercial orders.

In early 2012 the Company began a media campaign to position itself and BlueGen to relevant stakeholders in Germany, in particular customer groups and decision makers regarding market introduction schemes. This has resulted in more than 50 articles in energy trade media and the first article in one of the top three mainstream media "FAZ", with a daily circulation of 900,000 readers.

The market settings in Germany continue to provide strong support for our products. Through active lobbying efforts the Company is increasing its profile with policy makers to ensure continued support.

In 2011 Germany embarked on its Energiewende, or energy transition. The scale of this change is immense. Germany, with the 5th largest economy in the world, is revolutionizing its energy supply, moving away from nuclear power (which provides 25 percent of its electricity) towards renewable and low emission power, including CHP (combined heat and power). Market participants and decision makers are in agreement that distributed generation in general (and virtual power plant applications in particular) are set to play a prominent role in the Energiewende.

Germany has enacted a range of policies which provide support for low emission electricity generation, and combined heat and power in particular.

The Federal CHP Law sets a target of 25 percent of Germany's electricity to come from CHP (large and small scale) by 2020. Importantly, this CHP target is supported by all German political parties. In 2010 the 'shortfall' in CHP power was estimated at approximately 56 TWh. With the large commercial and industrial CHP market segments already well serviced, we believe this target can only be achieved with a significant increase in small scale CHP. For example, combining a 1.5 kW mCHP product with the existing 6 million installed small gas heaters (under 25 kW thermal) would result in 9 GW installed capacity, or 72 TWh per year. Looked at another way, if 1.5 kW mCHP units provided only half the 'gap' of 56 TWh, this would equal 2.3 million units.

Other small scale CHP products will have a role in meeting this target, but the high heat output of these units compromises another German policy objective, of reducing heating demand in more efficient buildings. BlueGen's low heat output is ideally suited even for "passive" houses designed for low heat demand.

This general support for high efficiency energy products has led to the following specific policies which will support the Company's products:

·; In December 2011 the Federal Government announced its Impulsprogramm, a capital subsidy for mCHP products. The program was opened in April 2012. BlueGen is eligible for a subsidy of EUR 1,650 per unit. BlueGen is the first and currently the only fuel cell system eligible.

·; The Federal Government's CHP bonus provides a feed in tariff for electricity generated by small scale CHP and exported to the grid. The tariff is equal to the wholesale energy price plus avoided grid fees and a bonus of 5.41 Euro cents - a total of about 11.5 Euro cents per kilowatt hour. The CHP bonus increases from 5.11 cents to 5.41 cents from 1 August 2012.

·; The EEG, or Renewable Energy Act, provides a feed in tariff for power generated from biomass. Several utilities and energy service companies are considering operating BlueGen on bio-methane in order to receive this feed in tariff.

·; Several State Governments including Saxony, Saarland and Hessen have created market introduction programs for mCHP products while other States are considering similar programs. In late 2011 the State of North Rhine Westphalia - the largest State in Germany and the location of the Company's manufacturing plant - announced that it would provide funding of up to EUR 250 million to support CHP deployment. The Company has been involved in consultations on the nature of the program and is confident that the final program will provide strong support for sales growth. Unfortunately the delay in implementing the program has to some degree hurt sales this year however the Company is hopeful that details of this program will be announced within the next few months.

CFCL is now a member of the German Fuel Cell Initiative (Initiative Brennstoffzelle, or IBZ, www.ibz-info.de). IBZ is lobbying the Federal Government for a substantial market introduction program for fuel cell mCHP products. The many benefits of fuel cell products for the German economy are being recognised by policy makers. On 15 June the Bundesrat (the state chamber of the German parliament) asked the Government to consider such a program[1].

United Kingdom

In the United Kingdom we are working with E.ON, one of Europe's largest energy retailers, as well as pursuing direct sales to specific market segments.

In November 2011 E.ON placed an order for 105 units. Of these, 40 BlueGen units are being deployed under the European Union Fuel Cell and Hydrogen Joint Undertaking's Joint Technology Initiative ("JTI") fuel cell demonstration program in homes in UK, Germany, Benelux. A further five BlueGen units are being deployed by E.ON in demonstration and commercial customer sites outside of this programme. CFCL and the UK heating company Ideal Boilers will also develop up to 60 integrated mCHP under the JTI program from early 2013.

As scheduled, all 45 BlueGen units were delivered to E.ON before 30 June. Five units are currently installed, with the remainder to be installed by E.ON once they have selected sites. Under the JTI program some of these units will be installed in Germany.

One part of the JTI program is a pathfinder trial, for 15 BlueGen units to be installed with a separate boiler as a "Beta 1" mCHP installation. This is the next milestone in the original product development agreement signed with E.ON in 2009. Installations are expected to be finalised by the end of September 2012, before the start of the UK heating season. The Beta 1 units have been developed by Ideal in collaboration with CFCL and have been CE accredited for field trials in occupied family homes. They have been denominated as the "E.ON Storage 160". The second part of the JTI program is a full mCHP trial, under which up to 60 Beta 2 mCHP units will be built and installed, based on the results of the E.ON Storage 160 trial.

We are continuing discussions with E.ON about transitioning from a product development agreement to firm orders under a product supply agreement. The E.ON Group is headquartered in Germany and its operations have been impacted by the earlier closure of the German nuclear plants, therefore part of the context for these discussions is a broader strategic review which the E.ON Group is undertaking in response to the German Energiewende process. On 2 July 2012 E.ON Germany announced that it would be expanding its distributed generation business, with particular focus on cogeneration and biomass-fired units, as it believes the investment to be crucial to Germany's energy transformation.

CFCL achieved MCS (Microgeneration Certification Scheme) accreditation for BlueGen in August 2011. MCS accreditation is essential for access to the UK Government's feed in tariff and applies not just to the product but also to the installer. There are currently two UK installers accredited under the MCS scheme for BlueGen: E.ON for the installation of the BlueGen units under the JTI pathfinder trial and Be Green Systems for the commercial installation of units with early UK customers. Be Green Systems is a small but highly skilled and flexible installer based in West London that is working closely with CFCL and its early UK customers.

In April we finalised the installation of the first BlueGen unit in a low energy new build home in the UK. The BlueGen installation, in a home built by Crest Nicholson to very high efficiency standards, provides the power, hot water and heating requirements for the property and was specifically designed for low energy homes. This installation represents a significant step towards the achievement of the UK Zero Carbon Homes standards. Crest Nicholson builds approximately 1,500 new homes each year. Over the last 10 years UK developers have typically built between 100,000 and 200,000 new dwellings each year. During June 2012 a delegation of seven civil servants from DECC attended a site visit to view the BlueGen installation in the Crest Nicholson home in Epsom. A video showing the BlueGen inside the Crest Nicholson home is available at http://www.cfcl.com.au/webcasts/.

CFCL has recently sold two BlueGen units to its first RSL (Registered Social Landlord) customer, Housing Solutions based in Maidenhead. The RSL market in the UK represents more than 2 million dwellings owned by more than 400 RSLs. RSLs are tasked by government with reducing carbon emissions and addressing fuel poverty. The BlueGen units will be installed into care homes belonging to Housing Solutions to demonstrate the product's capabilities to address these two key targets.

The UK Government has also introduced several measures to support mCHP products, notably a feed in tariff and a discounted sales tax (5 percent VAT instead of 20 percent). CFCL has collaborated with a group of other companies also involved in mCHP including all the major mCHP manufacturers and developers, to lobby the UK Government for an increase in the feed in tariff. The group released a vision report explaining the benefits of mCHP in the UK and included an aspiration to see 1 million mCHP units installed in the UK by 2020.

In February 2012 the UK Government proposed an increase in the feed in tariff for mCHP products, including BlueGen. From October 2012 the tariffs would increase from a maximum of 14.2 pence to 15.7 pence, comprising a generation tariff, increased from 11 pence to 12.5 pence, plus an export tariff of 3.2 pence. BlueGen is currently the only fuel cell mCHP product to be eligible for the UK feed in tariff.

The Netherlands and Belgium

The concept of combined heat and power is well known in The Netherlands, with larger scale CHP plants already providing about 20 percent of the market's electricity. For smaller scale CHP, there is a feed in tariff (equal to the retail price for electricity, about 23 Euro cents) for the first 5,000 kilowatt hours of electricity exported per year. There are also some tax benefits for investing in small energy equipment. In Belgium there is also a net feed in tariff, of about 21 Euro cents, for up to 10,000 kilowatt hours exported. Belgium is also considering an incentive program for mCHP products. In these market settings, customers can generate most value from BlueGen and mCHP products if they can use all the power on-site, therefore the initial target customers are local councils, Government buildings and small commercial customers.

The Netherlands is an ideal market for new gas appliances, with a very high penetration of natural gas connections. The Netherlands' Government has an interest in deploying new gas products, through its 50 percent ownership of the gas trading company Gasterra (25 percent is owned by Exxon and the other 25 percent is owned by Shell, which is also testing a BlueGen unit in Germany). Gasterra, Shell and others have created a model for energy transition in The Netherlands (http://www.energietransitiemodel.nl/?locale=en) which shows that using BlueGen alone can achieve The Netherlands' 2020 targets for carbon reductions.

Gasterra began testing a BlueGen unit in October 2010 and has recently ordered nine more units.

Our sales partner in The Netherlands, Zestiq, has changed its name to BlueGeneration to reflect its strategic commitment to the BlueGen product. BlueGeneration brings together sales and marketing staff with experience in sustainability consulting to large Dutch companies as well as introducing new environmental technologies to the mass market.

BlueGeneration is building a sales pipeline using its own sales resources and a sales channel, 'The energy company', focussing on small commercial customers and public buildings. BlueGeneration intends to implement a 'bulk purchasing' model in order to achieve higher volumes. After initially looking at Dutch farmers as a target market (due to specific tax incentives) BlueGeneration is now targeting a wider market segment with a 'community energy' model, together with the Virtual Power Plant project with Liander and IBM (discussed above).

BlueGeneration has contracted with Eneco Installatiebedrijven (EIB) to provide installation and services. EIB is one of the top three utilities in the Dutch market, with more than 800 installers.

As at 6 July, three BlueGen units have been delivered to BlueGeneration. We expect to deliver nine units for Gasterra in August. We continue to work with BlueGeneration to accelerate sales, to fulfil their first order of 100 BlueGen units.

During the June quarter the Company hired a Benelux sales manager to pursue direct sales to support our partners in this region and build up a key account management function as already established in Germany and the UK. Our sales manager is in discussions with potential sales partners in Belgium.

Australia

Market settings in Australia show some signs of improving but are still challenging. Most importantly, there is no feed in tariff for fuel cell products. In May 2012 the Victorian Competition and Efficiency Commission (VCEC) released a draft report recommending that Victoria's feed in tariff be extended to include low emission products like fuel cells[2]. A final report from the VCEC review is due by 27 July 2012. CFCL was involved in the consultation by VCEC and we look forward to the Victorian Government implementing the VCEC recommendation.

At the Federal Government level, the new Clean Energy Finance Corporation (CEFC) is expected to be operating by mid 2013. The CEFC has a mandate to invest AUD 10 billion over five years into the commercial deployment of proven renewable and low emissions technologies. The Company believes the CEFC would be an ideal way to deploy its products into the mass market using debt finance rather than equity. Once the CEFC is established the Company will pursue these opportunities; however we do note there is uncertainty about the CEFC's long term future given that the current Opposition parties have said they will abolish the CEFC should they win the next Federal election in 2013.

Despite the challenging market settings, the Company has sold 70 BlueGen units in Australia into a range of projects, including:

·; 30 units installed in social housing homes in Melbourne and Shepparton with the Victorian Government Office of Housing;

·; 25 units installed in Newcastle with Ausgrid as part of the Smart Grid project;

·; 5 units installed in a commercial building redevelopment in Port Adelaide;

·; Units installed in Government buildings and other showcase sites in Melbourne, Sydney, Canberra, Adelaide, Brisbane and Gosford.

Our sales partners Harvey Norman Commercial and Hills Industries continue to focus on commercial and Government customers, including local Councils.

For the residential market in Australia, Management is assessing a potential market introduction offer for local shareholders. An initial survey was conducted in June to test shareholder interest. Management will continue to work on this potential offer, including the need for a feed in tariff, and will provide further updates in the coming months.

Other markets

North America

Southern California Gas Company (SoCalGas) is testing a BlueGen unit at their Engineering Analysis Center in Los Angeles, California. The BlueGen unit was installed in November 2010 and is a modified European product allowing operation with the local grid. The objectives for the installation include validating the electrical and thermal performance as well as confirming the low-emission characteristics of BlueGen, as California has some of the world's most stringent regulations around airborne emissions. After a successful first 12 months, Southern California Gas extended the field test by another 12 months to continue their evaluation of the technology. Also involved in the BlueGen testing is the US based Electric Power Research Institute (EPRI) and a consortium of energy utilities. EPRI's members represent more than 90 percent of the electricity generated and delivered in the United States. The SoCalGas and EPRI consortium aim to validate the performance of BlueGen before commencing additional field trials.

Over the last six months, we have undertaken extensive evaluation of the US market. The US is a significant, yet fragmented, market for BlueGen. With over 144 million electricity customers serviced by 3,200 electricity utilities and 65 to 70 million natural gas customers serviced by 1,200 gas utilities, the US market presents a sizeable but challenging opportunity. The energy market within the US varies from state to state and we have identified a number of regions which we believe would be receptive to a BlueGen product offering. California and the North-East States are attractive due to high electricity prices and penetration of natural gas, along with other selected states facing rising electricity demand such as Texas.

An essential part of BlueGen sales into the USA and Canada is having the necessary product approvals and certifications. Whilst most of our efforts have been directed to the European markets, we have continued to work towards North American approvals and recently conducted a factory inspection for the certifying body. We are aiming to complete North American product certification by the end of September 2012.

With BlueGen product certification pending for North America, we are taking a practical and cost-effective approach to market development. We continue to stimulate early customer interest in selected key states and qualify opportunities through customer visits. At a later point in time and commensurate with market demand, we will need to assess the market opportunities and invest in resources to effectively manage US customers.

Japan

CFCL retains an active interest in the Japanese market. Key customers such as Tokyo Gas and Paloma continue to test and evaluate BlueGen after extending their test programs. Japan is one of the most developed markets for fuel cell mCHP products in the world. As such, Japan also has some of the most comprehensive and prescriptive fuel cell standards in the world. These standards and product requirements are very different to European, Australian and even North American requirements. In addition, Japan has a regulated energy market meaning installation and connection of fuel cell devices is a tightly managed process via the natural gas utilities.

For CFCL to progress in the Japanese market, demonstrated long-term performance, reliability and durability is a key entry criteria. In addition, accreditation to Japanese product approvals is necessary. Our investment in the Japanese market is modest and appropriate to the nature of long-term testing and evaluation.

Manufacturing and Supply Chain

German Manufacturing

We are currently making an average of six fuel cell stacks per week in small furnaces and five BlueGen units per week at our manufacturing plant in Heinsberg, Germany. During the June quarter we continued to work with our furnace supplier to bring a large furnace into production. Progress has been made but the expected completion date has slipped from June to August. The supplier is providing resources to help rectify the delay at its own cost and we do not expect to incur any more significant capital costs to have this furnace operational.

Once this large furnace is operational, capacity will increase to approximately 1,500 BlueGen units per year, based on current operating procedures. The plant's production throughput can be increased above 1,500 units per year without additional capital spending, by operational efficiencies (such as improving processes and production flow, reducing furnace cycle times, loading and unloading times, robot optimisation), more flexible work practices (the plant is currently operating on a single shift); and by continuing to outsource the manufacturing and assembly of components and sub-assemblies. Modest investments in multiple tooling will also increase production levels.

Apart from operational efficiencies, the next capital investment to increase production would be to upgrade the existing second large furnace. This would add another 30-40 stacks per week or 1,500-2,000 per year, for a total capacity of 3,000-3,500 stacks per year. The capital investment required for this step is approximately EUR 1.2 million.

Supply Chain

The Company plans to outsource the supply of many components of its products, whilst continuing to make the core components such as the fuel cell stack.

One of the critical components is the fuel cell itself - the individual 'chip' of ceramic material which forms the building block of the fuel cell stack. In early 2011 we signed an agreement with HC Starck for them to supply our fuel cells in large volume. As previously reported, we had been working with HC Starck for some time to ensure they could scale up production volumes whilst maintaining product quality, however HC Starck have been unable to supply cells which meet our requirements. This has forced us to incur additional costs continuing to make cells in-house at our pilot plant in Melbourne.

The Company recently terminated the contract with HC Starck and signed a new supply agreement with a different supplier, to manufacture cells to our design. We also terminated a reciprocal agreement under which CFCL's UK powder plant was to supply ceramic powder to HC Starck for them to make into cells. There are no minimum orders required under the new contract and the pricing is significantly lower than the HC Starck contract. Based on the new supplier's strong commitment, investment and performance to date, we are confident they will be able to supply large volumes of quality cells, and potentially assist in supplying other components.

As a result of this change in cell supplier, we have now significantly scaled back production of cells in Melbourne and reduced staffing levels accordingly. Cell production in Melbourne will only continue as part of ongoing research and development and product improvements. We have also redirected activity at the UK powder plant away from fuel cells towards other markets. As a result, the Company has decided to fully write down the value of the plant, which will result in an impairment charge in the FY12 accounts of AUD 2.6m (GBP 1.7m). This is an adjustment to the balance sheet and has no cash impact. We are currently working with a ceramics company to test ceramic powder products for the dental market. The ceramics company is paying CFCL a fee to cover the operating costs of the UK plant whilst we work with them on technical due diligence.

In late 2011 CFCL entered into a memorandum of understanding with Jabil Circuit Inc (Jabil) to assist in moving into higher volume production and to further reduce unit costs. Jabil is a global electronic manufacturing service provider with 55 factories in 22 countries and annual turnover of USD 16 billion. Jabil has begun to supply component samples for testing and quality assurance and we are in discussions with Jabil towards signing a supply agreement for these components.

These measures are all designed to reduce the cost of our products. Placing higher volume orders and engineering changes have already delivered large cost savings in several components. Moving from ordering components in lots of 100 to lots of 1,000 has reduced costs by an average of 25 percent from 2011 to 2012/13. We are targeting a further cost reduction of 25 percent in 2013/14.

We are continuing to reduce unit costs by increasing volumes and by redesigning some high value components. We are confident that costs will come down relatively quickly based on well documented learning curves from other industries (for example solar PV, which has shown a consistent cost reduction of 15-20 percent for every doubling in volume) as well as continued investment in tooling, product value engineering activities and ongoing outsourcing to much larger scale component manufacturers. Given the very large size of the market for the Company's products - even in Germany alone - modest volumes are required to bring costs down significantly.

Highest Efficiency Electricity Generators

The high electrical efficiency of BlueGen has been confirmed by in-house testing and by our customers. For example the German Gas Association (DBI) has published data confirming BlueGen's peak electrical efficiency of 60 percent, far higher than any other small scale power generator.

High electrical efficiency delivers more value for customers, by reducing the cost of generating electricity. The marginal cost of generating electricity is simply the cost of gas (in kWh) divided by electrical efficiency, as shown in the examples below:

Table 1 Marginal Cost of Generation

Products with a lower electrical efficiency have a higher marginal cost of generation. This means that almost all other mCHP products must be designed to run as heating devices with electricity as a by-product. In Europe, mCHP products are required to match the heating demands of the site; that is, if all of the heat cannot be used the product must be turned off. mCHP products with a low electrical efficiency will produce more heat than the average home needs, and will not be able to operate for many months during the year.

For example, PB Power's modelling for the UK Government Department of Energy and Climate Change (DECC) forecasts that a Stirling engine mCHP will run for between 1,500 and 4,300 hours per year depending on the heat demand of the property.[6] The Ofgem average UK heat demand is 16,500kWh per year which would typically translate into 2,000-2,500 hours run time for a Stirling engine mCHP.

On the other hand, BlueGen, with a low heat output, can operate all year round - typically for 8,700 hours per year. By delivering electricity all year round with a low marginal cost- and providing heat as an added benefit - the Company's products maximise value for customers, as shown in the examples below:

Table 2 Simplified Value Model

(For simplicity these examples do not include capital costs or tax and assume the BlueGen operates at 1.5 kW constantly at maximum efficiency. The actual savings will be lower if replacing gas hot water and will vary based on how the unit is operated.)

Apart from delivering lower energy costs, high electrical efficiency also cuts carbon emissions. A report from Ausgrid shows the following environmental benefits from a BlueGen unit installed in a home in Sydney:[8]

Table 3 Environmental Benefits at Ausgrid

Controllable Distributed Generation

'Distributed generation' simply means generating electricity close to the point where it is used, in small generators, rather than in large centralised generators like coal, nuclear or large gas plants. Distributed generation can be a mix of renewable generators (small scale solar PV and wind) and low emission (gas powered co-generation). Distributed generation can provide many advantages over large centralised generation, including savings on power grid costs.

Apart from high electrical efficiency, another feature of CFCL's products is that they are controllable - the power output can be turned up and down remotely (typically over the internet). This 'modulation' feature was recently validated by a report from KIWA Gastec in the Netherlands (see below) and has also been demonstrated as part of the RegModHarz project in Germany.

This rapid modulation feature means BlueGen can respond to pricing or demand signals. 'Time of use' or peak pricing already affects some commercial customers (and residential customers in some markets, e.g. New South Wales in Australia) and is likely to affect domestic customers in more markets as smart meters are rolled out, so increasing the value of BlueGen's power output at peak pricing times and other times of high demand.

Virtual Power Plants (VPP)

Being able to control the output of our products allows them to be operated as part of a Virtual Power Plant (VPP). A VPP is a cluster of distributed electricity generation units, controlled and operated by a central entity using integrated software systems. A VPP allows power generation to be modulated up or down to meet peak loads and balance intermittent power from wind or solar, with higher efficiency and more flexibility than large centralised power stations.

CFCL and its sales partner in The Netherlands, BlueGeneration, have begun a VPP project with Liander and IBM. BlueGen units are planned to be installed with customers across the Netherlands to create a new community of distributed energy producers, connected through the internet and operated as a Virtual Power Plant. Liander is a Dutch regional network operator, distributing electricity to 3 million customers and gas to 2.3 million customers in a large part of the Netherlands. IBM will provide the necessary system integration to control the BlueGen units remotely.

The first phase of the project began in April, with three BlueGen units installed with energy consultants' KIWA Gastec at their testing facilities in Apeldoorn. KIWA is testing the BlueGen units for modulation. Each of the units is being modulated every 30 minutes; one unit from 500W to 1500W, another from 500W to 1750W and a third unit from 500W to 2000W. The test results have been very positive, with KIWA confirming that:

·; Each unit can modulate every 30 minutes;

·; The modulation is rapid: from 500W to 1500W in 7.5 minutes; 500W to 1750W in 9.4 minutes; and 500W to 2000W in 11 minutes;

·; Even with this constant modulation, the units maintained high electrical efficiencies (~57 percent for the high power level, ~44 percent for the low power level);

·; During the first two months of testing, with constant modulation the units showed no significant signs of stack degradation.

The partners are currently developing the VPP design, and intend to scale up the project in the second half of 2012 and into 2013. Once the VPP is established, all the BlueGen units BlueGeneration sells to customers in The Netherlands are intended to be integrated into the VPP.

VPPs are also being developed in Germany. The Company is part of the RegModHarz project, one of eight VPP projects funded by the Federal Government (http://www.e-energy.de/en/). Since early April a BlueGen unit has been connected and modulated as part of this project via a Siemens power control solution. In Germany major industrial companies such as Volkswagen, Deutsche Telekom and Vodafone have entered the VPP market or have announced plans to do so.

Building Regulations and Efficiency Standards

Another important early market segment is the 'compliance' market - where building owners and developers are facing increasing requirements for energy efficiency and sustainability. These regulations can help drive investment in more efficient home energy products. Some examples from our key markets are noted below:

Germany: All new homes must comply with the EnEV standard. Currently a condensing boiler plus solar thermal or heat pump is the most preferred option to comply. A leading EneV research institute in Dresden has calculated that BlueGen delivers a better primary energy factor than these solutions. We are now working to receive official accreditation and have BlueGen included in software tools for specifiers, planners and architects. Separately, the Federal EEWG regulation requires that new homes must source part of their heating from renewable sources or mCHP. We are also lobbying to have BlueGen accredited for this regulation.

United Kingdom: From January 2013 new homes must meet the energy efficiency levels of the Code for Sustainable Homes Level 4, cutting carbon emissions by 44 percent from 2006 Part L Building Regulations levels. In 2016 this requirement for all homes sent to planning increases to "zero carbon", meaning the building fabric of the home and onsite power and heat generation must cut emissions by at least 70 percent from 2006 levels, equivalent to zero net carbon emissions from regulated energy, which is that used for heating, hot water, lighting and building (services) consumption, over the course of a year.

Also, all new homes in the UK must be assessed under SAP (Standard Assessment Procedure). Assessment under SAP requires all technologies affected by regulated energy usage to be registered in SAP, including BlueGen. We are seeking full recognition of BlueGen within SAP from the UK Government to allow full access to the UK's new build housing market. In April we finalised the installation of the first BlueGen unit in a low energy new build home in the UK (discussed above).

The Netherlands: In the Netherlands the energy efficiency of a new building is calculated with software, resulting in a factor called the EPC value (Energy Performance Coefficient). The lower the EPC value, the more efficient is the building. A study by Ecofys on behalf of Gasterra, a major Dutch energy company, concludes that a building with a BlueGen unit installed is not only energy neutral, but actually has an EPC value of less than one. This already meets the EPC rating target for 2020. BlueGen delivers a significantly better rating than a standard boiler plus insulation or a heat pump and insulation. EPC ratings apply to new buildings; for existing buildings an energy assessment leads to an energy label, from "A" to "F". The same Ecofys study concluded that a household with a BlueGen unit gets a "A++" rating because of the large carbon savings.

Real World Operation

Since 2006 CFCL's products have achieved an aggregate of more than one million hours of operation at our facilities in Melbourne and Germany as well as at customer sites. Our products can tolerate a range of operating conditions and inputs, such as variations in natural gas composition and water quality.

Our products can also be installed in many sites, broadening our accessible market. BlueGen units can be installed:

·; Indoors (Europe) or Outdoors (Australia, Japan);

·; In residential or commercial buildings;

·; In new buildings or retrofitted into existing buildings;

·; As a modular system or as part of a co-generation system; BlueGen can be installed with no heat recovery (for example, units in Brisbane and Adelaide), or with a tank for a simple hot water integration (for example, homes in Melbourne), or integrated with multiple hot water inputs like solar thermal or heat pumps (for example, the unit at Alliander in Heinsberg), or integrated with a thermal store as a full mCHP solution for low energy homes (for example, the Crest Nicholson home in the UK where no boiler is required);

·; As a single units or in a series (for example, five units in a commercial building in Adelaide).

CFCL continues to invest in technical improvements, particularly to extend the lifetime of its fuel cell stacks whilst maintaining high electrical efficiency. A number of case studies have also verified the product's modulation ability. (Please refer to the separate presentation for performance graphs and case studies.)

BlueGen-net

Each BlueGen and integrated mCHP unit is monitored and controlled remotely over the internet, through our BlueGen-net system (www.bluegen.net). BlueGen-net is a sophisticated online product maintenance system which has all been developed in-house. We believe that BlueGen-net is unique amongst our peers in its scope and capabilities.

Being able to monitor, manage, maintain and control products on-line is important because it:

·; Reduces our marginal support cost: it is far cheaper to support products on-line than paying for site visits;

·; Creates customer value, for example through deployment as part of a VPP, or being able to modulate power remotely or pre-program modes of operation;

·; Creates positive customer engagement, by providing on-line performance data and historical reports.

Developing such a sophisticated system from scratch requires a significant up-front investment however it delivers significant benefits by reducing the marginal costs of support, particularly as volumes increase.

Products Performing in the Field

One of the important benefits of BlueGen-net is that it allows us to record and analyse product performance, including any product failures. This data is valuable because it demonstrates that: we can measure faults in the products; we have a baseline; we know the causes of faults (which, following an 80/20 rule, allows us eliminate many errors by focusing on a few components); the failure rate is reducing; and we can measure improvements. BlueGen products in the field are performing better than expected and performance continues to improve.

Large global markets for future products

We are currently adopting a focused strategy to get to a cashflow positive position as soon as possible, whilst managing the many risks of commercialising breakthrough technology. This strategy focuses the Company's resources on a single technology (solid oxide fuel cells), for a single product (mCHP), for a small number of geographic markets. At the moment we do not have the resources to pursue many of the development opportunities which we are presented with.

This focus is necessary and appropriate given the Company's resources. However in the longer term there are many other opportunities to generate value from the Company's technology, either with the appropriate resources ourselves, or with new development partners. The most near-term opportunities are:

·; Expanding more quickly in existing markets, particularly the USA;

·; Developing products for new geographic markets, such as China, India or Brazil;

·; Developing products for new fuels such as LPG and biogas;

·; Developing new applications, such as off-grid power, electric vehicle charging stations, on-site generation plus battery storage, and units with a larger power output.

These opportunities, and the strong interest received from many markets, indicate that there is a very large global market for the Company's world leading clean energy technology.

About Ceramic Fuel Cells Limited:

Ceramic Fuel Cells is a world leader in developing fuel cell technology to generate highly efficient and low-emission electricity from widely available natural gas. Ceramic Fuel Cells has sold its BlueGen gas-to-electricity generator to major utilities and other foundation customers in Germany, the United Kingdom, Switzerland, The Netherlands, Italy, Japan, Australia, and the USA. Ceramic Fuel Cells is also developing fully integrated power and heating products with leading energy companies E.ON UK in the United Kingdom, GdF Suez in France and EWE in Germany.

The company is listed on the London Stock Exchange AIM market and the Australian Securities Exchange (code CFU).

www.cfcl.com.au