12.08.04

12.8.2004: Stuart Energy Systems Corp.: Results for First Quarter Ended June 30, 2004

Stuart Energy Announces Results for First Quarter Ended June 30, 2004
Wednesday August 11, 7:00 am ET
Delivers 86% revenue growth, continues margin improvements and revises revenue guidance upward

TORONTO-- Aug. 11, 2004-- Stuart Energy Systems Corporation (TSX: HHO - News), a hydrogen infrastructure company, today announced its consolidated financial results for the first quarter ended June 30, 2004.

"I am pleased to report that our order book is growing and is currently in excess of $22 million, our revenue growth remains strong, and our margins continue to improve," commented Jon Slangerup, President and CEO of Stuart Energy. "During the quarter, we delivered 86% organic revenue growth compared to the same quarter a year ago. As a result of our growing sales order book and pipeline, we are revising our revenue guidance upward to a range of $27 million to $30 million in fiscal 2005, representing an approximate 51% to 68% increase over fiscal 2004 revenue."

Revenue for the quarter ended June 30, 2004 increased to $5.7 million compared to $3.0 million in the quarter ended June 30, 2003. Stuart Energy Station (SES) product sales for the first quarter were $5.3 million for the industrial market, or 93% of sales revenue, and $0.4 million for the transportation and power markets, or 7% of revenue. Gross margin contribution for the quarter was $0.6 million, or 11%, compared to negative $0.2 million, or negative 7%, in the quarter ended June 30, 2003.

"Our work to improve operating performance and reduce product costs continues to yield margin improvements and we remain committed to our corporate milestone of achieving positive gross margins of at least 10% for the year," said Mr. Slangerup.

The net loss for the quarter decreased to $7.3 million compared to $7.4 million in the same quarter of the previous fiscal year. This decrease in net loss is primarily the result of improved operating performance including improvements in our revenue and cost of product and services offset by an 82% decrease in investment and other income. During the quarter, cash, cash equivalents, and short-term investment balances decreased $7.8 million to $51.8 million, a 22% improvement compared to a $10 million decrease during the first quarter a year ago.

"Our cash burn for this quarter is in line with our expectations, and we remain committed to decreasing cash utilization by at least 30% over last year, excluding costs related to any acquisition or investment," said George Kempff, Vice President Finance. "Our cash utilization this year is expected to decrease sharply each quarter on a year-over-year basis, following a similar pattern experienced last year, and moving us closer to our goal of becoming cash flow positive in 2006."

Research and product development costs in the quarter ended June 30, 2004 decreased by $0.1 million or 4% to $2.6 million compared to $2.7 million in the same quarter of the previous fiscal year. While gross research and development expenditures increased $0.1 million, or 6%, to $2.8 million compared to $2.7 million in the same quarter of the previous fiscal year, funding for research and product development was $0.3 million during the quarter compared to none in the same quarter of the previous fiscal year.

Sales and Marketing

"The demand for our products remained strong in the first quarter," commented Robert Campbell, Vice President, Sales and Marketing. "We believe that the pick up in sales and lead activity is due to a number of factors, including increasing demand from the power and metallurgy sectors, the rising price of natural gas as the feedstock for reformed hydrogen, key transportation demonstrations, and our strategic supplier arrangements with industrial gas companies. We are seeing strong organic growth in both the global industrial and energy markets."

Industrial Market

During the quarter, we received orders for industrial systems from customers in Europe and Asia Pacific. Of these, two orders were for metallurgy applications. The increased worldwide demand for steel has contributed to the demand for our products, as hydrogen is used in the manufacture of steel. In addition, we received two orders from the power sector for generator cooling: the first from a customer in Spain, and the second from the Vietnam Machinery Erection Corporation (LILAMA). For the Vietnam project, we will supply an SES to the Uong Bi 300MW Extension Power Plant Project. This important order marks the 15th industrial hydrogen generation plant that we have sold or delivered in the Asia-Pacific region over the past year.

In addition, during the quarter, we shipped products to Korea, China, Germany and Morocco for a variety of industrial applications. We shipped a customized SES hydrogen generation plant to a customer in Korea, which will be used to purify deuterium gas for a nuclear application. We shipped an SES for power plant cooling to a customer in China. We also continued to leverage our preferred supplier agreements with four of the leading industrial gas companies, shipping SES units to Germany and Morocco through our partnerships with Linde Gas and Air Liquide, respectively.

Energy Markets

During the quarter, we received an initial order from ChevronTexaco Technology Ventures to design, build and integrate SES hydrogen fueling station modules that intelligently interface with ChevronTexaco Technology Ventures" proprietary hydrogen reformer technology. This project is part of the United States Department of Energy (DOE) hydrogen fleet and infrastructure program.

"Our order from ChevronTexaco Technology Ventures was an important order for us as it marked our first non-electrolysis based station and provided third party validation of our station integration expertise as a valued product," said Mr. Campbell. "We expect to see continued demand for our SES solutions in other energy applications, particularly as more DOE-funded projects are approved in the U.S."

Also, during the quarter, we shipped one SES product for the transportation market, an SES Hydrogen Generation Module that will be integrated, by our customer, into a fueling station located near a large international airport in California. This unit will produce clean hydrogen fuel for a vehicles located at or near the airport. Finally, our customer, South Coast Air Quality Management District in California, expects to officially open a hydrogen fueling station on August 13, 2004. This station is expected to be designated as Southern California"s first Hydrogen Highway station. The vision of Governor Schwarzenegger"s Hydrogen Highway initiative is to ensure that by the end of the decade every Californian has access to hydrogen fuel along the State"s major highways, with a significant and increasing percentage of that hydrogen produced from clean, renewable sources. Jon Slangerup sits on the Governor"s Implementation Advisory Panel.

"We believe that these hydrogen infrastructure initiatives and demonstrations will pave the way for the early introduction of hydrogen powered vehicles," commented Mr. Slangerup. "While there are several near-term alternative fuel pathways, there is a global consensus that hydrogen is the world"s energy end-game, and we are well positioned to remain a key infrastructure player in this market. To help achieve near-term energy security and environmental benefits, stakeholders are turning to the hydrogen internal combustion engine (H2ICE) as a near-term clean transportation solution and a practical bridge to the future of fuel cell applications. Hydrogen infrastructure being built today could support both H2ICE as well as future fuel cell vehicle and power generation applications."

Operations

During the quarter, we were very active in a number of key operational areas, including supply chain management, implementing manufacturing improvements, codes and standards, and research and development. We continued to work with our supply chain. We have developed important strategic relationships with key suppliers that have enabled us to deliver finished products to customers on time and on budget.

We achieved another important milestone in quarter; we now have both our facilities in Mississauga and Oevel accredited to ISO 9001. Our ISO plan contemplates additional ISO accreditation by mid calendar year 2005.

In addition, we continue to be very active in hydrogen codes and standards development, safety, and international compliance in two main areas: codes and standards development and coordination; and numerical simulations of hydrogen releases and dispersion using Computational Fluid Dynamics (CFD). Our highly specialized expertise in CFD modelling for codes and standards development has been recognized in the industry and has led to commercial contracts for us.

Internationally, we participate in five Working Groups of ISO/TC 197 Hydrogen Technologies. In Canada, we are involved in the development and realization of two important projects: Hydrogen Clearance Distances and Virtual Fueling Station. We are also participating in the development of Canadian Hydrogen Installation Code that is expected for publication in November 2005. In the US, we are working with the DOE on their Hydrogen Codes & Standards Coordinating Committee, National Fire Protection Association (NFPA) and International Code Council (ICC). In addition, we are actively involved in the California Hydrogen Highway Network project.

"Our work in codes and standards is critical to the success of our company," commented Peter Wressell, Chief Operating Officer of Stuart Energy. "Our ability to sell our CFD modelling expertise to other companies who may or may not be purchasing our infrastructure hardware is clear validation of our hydrogen safety expertise. In addition, our CFD expertise has been leveraged across our research and development activities."

Our research and development program remained on track during the quarter with the roll- out of our R&D plan for the year. The plan focuses on improving efficiencies and reducing capital cost for all product platforms, improving our intellectual property protection, expanding product ranges and optimizing our product offering through proprietary modelling design tools. During the quarter, we also received a notice of allowance of a U.S. patent that is directed to hydrogen energy stations, including hydrogen fueling stations, that are networked with primary energy resources and a controller for controlling hydrogen production according to data inputs such as user demand, availability of energy, and hydrogen production status. Stuart Energy has filed for additional patent protection in the U.S. and other key global markets.

"This is a key addition to our patent portfolio as it covers a number of our developments that enable us to effectively manage a network of hydrogen stations, which is important to our customers," commented Mr. Wressell. "We are continually refining our research and development activities to ensure that we address immediate commercial opportunities while keeping future customer needs in mind."

Conference Call

A conference call will be held on Wednesday, August 11, 2004 at 10:00 am (ET) to discuss our consolidated financial results for the first quarter ended June 30, 2004.

To access the conference call, participants may call 1-866-384-0144 five minutes prior to the start time. A simultaneous webcast can be accessed from our website at www.stuartenergy.com which will require that Windows Media Player or Real Player be installed prior to the call.

An archived webcast will be available for approximately three months at our website.

About Stuart Energy

Stuart Energy Systems Corporation (TSX:HHO - News) is the world"s leading developer and supplier of integrated hydrogen infrastructure solutions based on water electrolysis. Stuart Energy integrates its proprietary hydrogen generation technology with products from corporate partners to serve existing and emerging markets for industrial, distributed power generation and transportation applications. The Company"s website address is http://www.stuartenergy.com


MANAGEMENT"S DISCUSSION AND ANALYSIS OF OPERATING RESULTS
First Quarter (April 1, 2004 through June 30, 2004)
Fiscal Year Ending March 31, 2005


This discussion and analysis covers our interim unaudited consolidated financial statements for the three-month period ended June 30, 2004. As well, it provides an update to the discussion and analysis contained in our 2004 Annual Report. This discussion and analysis should be read in conjunction with the "Management"s Discussion and Analysis" and the annual audited consolidated financial statements contained in our 2004 Annual Report.

Overview

We are a leading global provider of integrated solutions for distributed hydrogen infrastructure requirements based on water electrolysis. Our Stuart Energy Station (SES) product line offers integrated, turn-key solutions for onsite hydrogen production, compression, storage, fuel dispensing and distributed power generation. The SES is designed to meet a growing and diverse set of requirements for the industrial, power generation and transportation fueling markets. We integrate our proprietary hydrogen generation systems with other leading hydrogen products from our strategic partners to provide integrated SES products.

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Overall Financial Performance

Three Three Three Three Three
Expressed in months months months months months
thousands of ended ended ended ended ended
dollars, except June March December September June
per share amounts 30, 31, 31, 30, 30,
2004 2004 2003 2003 2003
---------------------------------------------------------------------

Revenue $5,663 $5,790 $5,180 $3,846 $3,048
Gross Margin $ 596 $ 579 $ (334) $(2,085) $ (223)
Net Loss $(7,346) $(7,830) $(14,388) $(7,961) $(7,384)
Basic and Fully
Diluted Net Loss
Per Share $(0.20) $(0.24) $(0.51) $(0.28) $(0.26)
Total Assets $99,968 $110,740 $95,701 $104,305 $112,408
Cash and cash
equivalents and
Short term
investments $51,825 $59,603 $42,308 $48,992 $56,294


Revenue for the quarter ended June 30, 2004 increased to $5.7 million compared to $3.0 million in the quarter ended June 30, 2003. This increase reflects a combination of increased revenue from our preferred supplier agreements with leading global industrial gas companies as well an increase in the average size of the SES systems delivered. Gross margin for the quarter improved to $0.6 million compared to negative $0.2 million in the quarter ended June 30, 2003. This is the result of a combination of revenue growth, product standardization and improvements in manufacturing and delivery execution. Net loss for the quarter was $7.3 million compared to $7.4 million in the quarter ended June 30, 2003. This primarily reflects the improvements in revenue and gross margin offset by a significant decrease in investment income.

During the quarter cash, cash equivalents and short term investment balances decreased $7.8 million to $51.8 million from $59.6 million at March 31, 2004. In the quarter ended June 30, 2003, cash, cash equivalents and short- term investments decreased $10 million.

Outlook

Our order backlog at the end of the first quarter was $15.1 million, an increase of $1.4 million since March 31, 2004 after delivering $5.7 million in orders in the first quarter. Since June 30, 2004, our order backlog has increased to in excess of $22 million. Consequently, we expect that revenue growth in fiscal 2005 will be in excess of 50%. Gross margins in the first quarter were 11% and we continue to expect that average gross margins will be in excess of 10% in fiscal 2005. We also anticipate a reduction in cash utilization of at least 30% in fiscal 2005, excluding the costs of any acquisitions or investments.

Results of Operations

Revenue

Revenue in the quarter ended June 30, 2004 increased by $2.6 million, or 86%, to $5.7 million, compared to $3.0 million in the first quarter of fiscal 2004. Stuart Energy Station (SES) product sales for the first quarter were $5.3 million for the industrial market, or 93% of sales revenue, and $0.4 million for the transportation and power markets, or 7% of revenue. This size and mix of revenue compares with SES product sales for the first quarter of fiscal 2004 of $1.7 million for the industrial market, or 58% of sales revenue, and $1.3 million for the transportation and power markets, or 42% of sales revenue. Our preferred supplier agreements with four of the leading global industrial gas companies (Air Liquide S.A., Air Products and Chemicals Inc., BOC Gases, and Linde A.G.) provided 38% of the revenue in the quarter, compared to 19% of revenue in the same quarter of the previous fiscal year.

The $3.6 million increase in revenue from industrial applications is primarily attributed to the mix of revenue in the quarter compared to the same quarter in the previous year. We delivered two large systems during the quarter to Korea and Germany that delivered revenue in excess of $1.5 million each. In total, we delivered four SES systems to the industrial markets during the quarter. In the same quarter of the previous fiscal year, we delivered four SES systems at average revenue of over $0.4 million each. This mix of revenue is indicative of the scaleable size of our products.

The decrease in revenue from transportation and power applications in the first quarter of fiscal 2005 is primarily attributable to two large orders that were delivered for the CUTE (Clean Urban Transport Europe) project in the same quarter of the previous fiscal year. During the quarter, we delivered one SES system in the transportation market.

Based on our increased backlog we expect that revenue will grow in excess of 50% in fiscal 2005 over fiscal 2004.

Cost of product sales and service

Cost of product sales and service in the quarter ended June 30, 2004 increased $1.8 million or 55% to $5.1 million, compared to $3.3 million in the first quarter of fiscal 2004. This increase is primarily attributable to the 86% increase in revenue in the quarter compared to the same quarter of the previous fiscal year. As a percentage of revenue, cost of product sales and service was 89% of revenue, providing gross margin of 11% during the quarter. In the same quarter of the previous fiscal year, cost of product sales and service was 107% of revenue or a negative gross margin of 7%. This improvement in gross margin is attributable to a number of factors, including our product standardization program, our product cost reduction program, an improved product pricing environment, our enhanced manufacturing and quality processes, our overhead synergies and rationalization program relating to the integration of Vandenborre, increased economies of scale, and our expanding experience base at siting, installing and servicing turn-key, fully-integrated SES stations, including related codes and standards approvals.

We expect to achieve positive gross margins in excess of 10% for fiscal 2005.

Research and product development

Research and product development efforts are directed at technology development, new product development, and product improvement. Net research and product development in the quarter ended June 30, 2004 decreased $0.1 million, or 4%, to $2.6 million compared to $2.7 million in the same quarter of the previous fiscal year. While gross research and development expenditures increased $0.1 million, or 6%, to $2.8 million compared to $2.7 million in the same quarter of the previous fiscal year, funding for research and product development was $0.3 million during the quarter compared to none in the same quarter of the previous fiscal year. The increase in gross research and development expenditures is primarily attributable to new basic research programs that are focused on enhancing the efficiency of the IMET cell stack as well as ongoing work on our small SES prototype.

General and administrative

General and administrative expenditures for the quarter ended June 30, 2004 were $3.9 million, which is unchanged compared to the same quarter of the previous fiscal year. Savings realized in the quarter compared to the same quarter of the previous fiscal year from the integration of Vandenborre were offset by greater expenditures on market development activities related to hydrogen internal combustion engines and our Homefueler®. Effective April 1, 2003, we have adopted the recommendations of the Canadian Institute of Chartered Accountants with respect to recording stock-based compensation. The stock-based compensation expense for the quarter was $75,000 and is included in general and administrative costs. Stock-based compensation expense was $70,000 in the first quarter of the previous fiscal year.

Amortization

Amortization for the quarter ended June 30, 2004 was $1.6 million, unchanged from the same period of the previous fiscal year.

Investment and other income

Investment and other income for the quarter ended June 30, 2004 decreased $0.9 million, or 82%, to $0.2 million compared to $1.1 million during the first quarter of fiscal 2004. This decrease is primarily the result of the increase in interest rates experienced in Canada during the quarter. Our investments are in investment grade corporate securities for capital tax purposes. The market values of these securities fluctuate with the change in the general level of interest rates in the economy. As the general level of interest rates increase the values of the securities that we hold decline offsetting accrued interest that is earned.

Net loss

The net loss for the quarter ended June 30, 2004 was $7.3 million, a decrease of $0.1 million or 1% compared to $7.4 million in the same quarter of the previous fiscal year. This decrease in net loss is primarily the result of improvement in our gross margin as a result of higher revenues and improved cost of product and service, which was offset by lower investment and other income.

The net loss per share for the quarter ended June 30, 2004 decreased to $0.20 from $0.26 primarily as a result of the increase in the weighted average number of commons shares outstanding. This is attributable to the share offering that was completed in the last quarter of the previous fiscal year.

Liquidity and Capital Resources

Cash and cash equivalents and short-term investments

Our total cash, cash equivalents and short-term investments balances at June 30, 2004 were $51.8 million, down from $59.6 million at March 31, 2004. At June 30, 2004, we held cash and cash equivalents of $5.1 million and short- term investments of $46.7 million compared with cash and cash equivalents of $4.5 million and short-term investments of $55.1 million at March 31, 2004.

Total cash, cash equivalents and short-term investments decreased by $7.8 million in the quarter ended June 30, 2004 compared to a decrease of $10 million in the same quarter of the previous fiscal year. The majority of this amount was used to fund operating and investing activities.

During the quarter ended June 30, 2004, net cash outflows from operating activities decreased by $1.4 million to a net outflow of $7.4 million from $8.8 million in the same quarter of the previous fiscal year. This decline is primarily attributable to increased revenue and improved gross margins offset by decreased investment income as a result of increasing interest rates. Also accounts payable declined as many costs associated with projects shipped at the end in the previous quarter and other activities in the previous quarter that were accrued at March 31, 2004 were paid during the quarter. During the quarter, we had a significant reduction in our customer deposits as projects shipped during the quarter were not replaced with down payments and progress payments from new orders received during the quarter. The decline in accounts payable and customer deposits was offset by the collection of accounts receivable that were outstanding at the end of the last fiscal year during the quarter and with reductions in our inventory levels.

During the quarter ended June 30, 2004, there was a decrease in net cash outflows from investing activities, excluding movement in short term investments of $8.4 million, to a net outflow of $0.3 million from $1.2 million in the same period of the previous fiscal year. The decreased cash outflow is primarily attributed to a decrease in the acquisition of capital assets.

We believe that our current cash balance, including the net proceeds from our public offering in fiscal 2004, will be sufficient to meet our anticipated cash needs to fund operations, including working capital and capital expenditures for the next 36 months. At this time, we have no plans for additional financing.

Contractual obligations

There has been no change to our contractual obligations that are outlined in our Management"s Discussion and Analysis in our fiscal 2004 Annual Report.

Credit facilities

We have lines of credit for an aggregate amount of $10.4 million available for operating purposes and for letters of credit. At this time, only letters of credit aggregating $3.4 million are issued against these lines of credit. These letters of credit have various expiry dates extending through to February 2007. We are in full compliance with all of our debt covenants.

Contingent Off-Balance Sheet Arrangements

We have research and product development funding arrangements with various governments, and other agencies that provide funding for our research and product development program. Typically, these funds are repayable if the resulting intellectual property is commercialized and we achieve certain revenue milestones. Since fiscal 2002, we have received funding of $5.7 million towards our research and product development efforts. Under the applicable agreements, the funding parties have a right to receive royalties, ranging from 0.3% to 1.0% of gross revenues attributable to the intellectual property, if it is commercialized. We are obligated to make royalty payments after certain dates and/or revenue levels are achieved from products that contain the funded intellectual property. To date, we have not made any royalty payments and do not expect to make any such payments in fiscal 2005. At this time, it is uncertain whether the threshold revenue levels will be achieved and, accordingly, we have not accrued any liabilities for repayment. These arrangements will expire in stages between 2010 and 2020, or when total amounts repaid reach the amount of the funding specified in the agreements. The amount of funding available to us, from these and similar arrangements, varies from year to year. Although we are confident that these arrangements will continue to partially support our research and product development expenditures for fiscal 2005, there is no guarantee of the amount of future funding.

Accounting Policies and Estimates

Please refer to "Accounting Policies and Estimates" section of the "Management"s Discussion and Analysis" in our Annual report for the year ended March 31, 2004.

Financial Instruments

At June 30, 2004, we had outstanding currency call option contracts, giving us the right, but not the obligation, to purchase Cdn$0.6 million at an average rate to the U.S. dollar of $0.733 until December 2004. The purpose of our hedging activities is to reduce the risk that the eventual U.S dollar cash flows, relating to a portion of our future Canadian dollar, will be adversely affected by an appreciation of the Canadian dollar versus the U.S. dollar. The fair value of these contracts at June 30, 2004 was $18,000.

Recently Issued Accounting Standards

Hedging relationships

In November 2001, the Canadian Institute of Chartered Accountants issued Accounting Guideline 13, "Hedging Relationships" (AcG 13") and in November 2002 the Canadian Institute of Chartered Accountants amended the effective date of the guideline. AcG 13 establishes new criteria for hedge accounting and will apply to all our hedging relationships in effect on, or after, April 1, 2004. We are currently re-assessing all hedging relationships to determine whether the criteria are met or not, and will apply the new guidance on a prospective basis. To qualify for hedge accounting, the hedging relationship must be appropriately documented at the inception of the hedge and there must be reasonable assurance, both at the inception and throughout the term of the hedge, that the hedging relationship will be effective. Effectiveness requires a high correlation of changes in fair values or cash flows between the hedged item and the hedging item.

Consolidation of variable interest entities

In June 2003, the CICA issued Accounting Guideline 15, "Consolidation of Variable Interest Entities" ("AcG-15"). The guideline provides guidance for applying the principles of Section 1590, "Subsidiaries", to those entities defined as "Variable Interest Entities" ("VIEs"), and more commonly referred to as "Special Purpose Entities" ("SPEs"), in which either the equity at risk is not sufficient to permit that entity to finance its activities without additional subordinated financial support from other parties, or equity investors lack either voting control, an obligation to absorb expected losses or the right to receive expected residual returns. AcG-15 requires consolidation of VIEs by the Primary Beneficiary. The Primary Beneficiary is defined as the party which has exposure to the majority of the VIE"s expected losses and/or expected residual returns. AcG-15 will be effective for all annual and interim periods beginning on or after November 30, 2004. The Company is currently assessing the impact of this guideline on the Company"s consolidated financial statements.

Summary Quarterly Financial Data (Unuadited)

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Expressed in 3 months 3 months 3 months 3 months
thousands of ended ended ended ended
dollars, except June March December September
per share amounts 30, 31, 31, 30,
ended 2004 2004 2003 2003
---------------------------------------------------------------------
Revenue $5,663 $5,790 $5,180 $ 3,846
Gross Margin - $ $ 596 $ 579 $ (334) $(2,085)
- % 11% 10% (6%) (54%)
Net Loss $(7,346) $(7,830) $(14,388) $(7,961)
Basic and Fully
Diluted Net Loss
Per Share $(0.20) $(0.24) $(0.51) $(0.28)
Weighted Average
Common Shares
Outstanding ("000s) 36,249 32,834 28,228 28,215
---------------------------------------------------------------------


Expressed in 3 months 3 months 3 months 3 months
thousands of ended ended ended ended
dollars, except June March December September
per share amounts 30, 31, 31, 30,
ended 2003 2003 2002 2002
---------------------------------------------------------------------

Revenue $3,048 $2,892 $2,574 $357
Gross Margin - $ $ (223) $(2,083) $(1,622) $(1,712)
- % (7%) (72%) (63%) (480%)
Net Loss $(7,384) $(11,466) $(7,351) $(8,868)
Basic and Fully
Diluted Net Loss Per
Share $(0.26) $(0.49) $(0.35) $(0.43)
Weighted Average Common
Shares Outstanding
("000s) 28,207 23,452 20,830 20,800
---------------------------------------------------------------------


Results by Quarter

We have experienced strong sales growth over the past seven quarters with a slight decrease in the last quarter, due to a number of factors, including: the acquisition of Vandenborre Technologies on February 28, 2003; the recovery in the industrial markets that we serve; and enhanced sales under our preferred supplier arrangements with four of the leading industrial merchant gas companies, Air Liquide S.A., Air Products and Chemicals Inc., BOC Gases, and Linde A.G. We also had increasing sales of our products into the transportation fueling market as a number of jurisdictions engaged hydrogen infrastructure demonstration projects. Our sales cycle typically ranges between six and 18 months and the size of our projects can range from less than $100,000 to many millions of dollars. Because of the lengthy sales cycle and variance in size of our projects, quarter over quarter revenue can have significant fluctuations.

Gross margins have improved since the second quarter of fiscal 2004. For the first quarter of fiscal 2005, gross margins were positive $0.6 million or 11% of revenue, our second consecutive quarter of positive gross margins. This improvement is a result of a number of factors, including higher general levels of revenue to offset fixed manufacturing costs, our product standardization program, our product cost reduction program, an improved product pricing environment, our enhanced manufacturing and quality processes, our overhead synergies and rationalization program relating to the integration of Vandenborre, and our expanding experience base at siting, installing and servicing turn-key, fully-integrated SES stations, including related codes and standards approvals.

Additional Information

Share Capital

As of June 30, 2004, we had outstanding 36,252,879 common shares and no preference shares.

Public Securities Filings

You may access other information about our company, including annual information form and other disclosure documents, reports, statements, or other information we file with Canadian securities regulatory authorities through SEDAR (System for Electronic Document Analysis and Retrieval) at www.sedar.com.

BUSINESS RISKS

Operating and financial risks and risk management strategies are detailed in the Management"s Discussion and Analysis included in the Company"s 2004 Annual Report.

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STUART ENERGY SYSTEMS CORPORATION
Unaudited Consolidated Balance Sheets

June 30, 2004 and March 31, 2004
(in thousands of dollars)

June 30, March 31,
2004 2004
As restated,
See Note 2(a)
---------------------------------------------------------------------
Assets
Current assets:
Cash and cash equivalents $ 5,112 $ 4,522
Short-term investments 46,713 55,081
Accounts receivable 4,648 6,160
Inventories 4,586 4,889
Prepaid expenses 425 568
------------------------------
61,484 71,220

Capital assets 10,161 11,157
Intangible assets 16,939 17,116
Goodwill 11,305 11,167
Other non-current assets 79 79
------------------------------
$ 99,968 $ 110,739
------------------------------
------------------------------

Liabilities and Shareholders" Equity
Current liabilities:
Accounts payable and accrued liabilities $ 12,859 $ 14,956
Customer deposits 3,273 4,842
------------------------------
16,132 19,798
Shareholders" Equity:
Share capital 217,040 217,057
Cumulative foreign currency
translation adjustment (84) (267)
Contributed surplus 363 288
Deficit (133,483) (126,137)
------------------------------
83,836 90,941

$ 99,968 $ 110,739
------------------------------
------------------------------


(Signed) Jon Slangerup (Signed) Douglas S. Alexander
Director Director



STUART ENERGY SYSTEMS CORPORATION
Unaudited Consolidated Statements of Operations

Three Months ended June 30, 2004 and 2003
(in thousands of dollars except loss per share)

Three Months Ended
June 30
2004 2003
As restated,
See Notes
2(a), 3
---------------------------------------------------------------------

Product sales and service revenue $ 5,662 $ 3,048

Cost of product sales and service 5,067 3,271
------------------------------
596 (223)

Research and product development 2,579 2,688
General and administrative 3,881 3,856
Amortization 1,673 1,669
------------------------------
8,134 8,213

Loss before under noted (7,538) (8,436)

Investment and other income 192 1,055
------------------------------

Loss before income taxes (7,346) (7,381)
------------------------------
------------------------------

Income taxes - 3

Net loss $ (7,346) $ (7,384)
------------------------------
------------------------------

Basic and diluted net loss per share $ (0.20) $ (0.26)
------------------------------
------------------------------

Weighted average number of common
shares outstanding 36,248,857 28,207,083
------------------------------



STUART ENERGY SYSTEMS CORPORATION
Unaudited Consolidated Statements of Deficit

Three Months ended June 30, 2004 and 2003
(in thousands of dollars)

Three Months Ended
June 30
2004 2003
---------------------------------------------------------------------

Deficit, beginning of the period, as
previously stated $ (125,872) $ (88,441)

Re-statement for Asset Retirement
Obligation (Note 2(a)) (265) (132)
------------------------------

Deficit, beginning of the period,
re-stated (126,137) (88,573)

Net loss (7,346) (7,384)

------------------------------

Deficit, end of period $ (133,483) $ (95,957)
------------------------------
------------------------------


STUART ENERGY SYSTEMS CORPORATION
Unaudited Consolidated Statements of Cash Flows

Three Months ended June 30, 2004 and 2003
(in thousands of dollars)

Three Months Ended
June 30
2004 2003
As restated,
See Notes
2(a),3
---------------------------------------------------------------------

Cash provided by (used in):

Operations:
Loss for the period $ (7,346) $ (7,384)
Items not involving cash:
Amortization of capital assets 1,279 1,236
Amortization of intangible assets 394 377
Amortization of deferred charge - 56
Stock based compensation expense 75 70
Change in non-cash operating
working capital (1,840) (3,140)
------------------------------
(7,438) (8,785)

Financing:
Net proceeds from issuance of common shares (17) -


Investments:
Decrease in short term investments 8,369 9,083
Purchase of capital assets (283) (1,197)
Patents (41) (15)
------------------------------
8,045 7,871

------------------------------
Increase (decrease) in cash and
cash equivalents $ 590 $ (914)

Cash and cash equivalents,
beginning of period $ 4,522 $ 2,988
------------------------------

Cash and cash equivalents, end of period $ 5,112 $ 2,074
------------------------------
------------------------------

Supplemental Cash flow Information:

Interest paid $ 28 $ 11
Income taxes paid (recovered), net $ - $ (61)


STUART ENERGY SYSTEMS CORPORATION
Notes to the Unaudited Consolidated Financial Statements

Three months ended June 30, 2004, and 2003
(in thousands of dollars)


1. Significant Accounting Policies

The notes to these interim consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles but do not contain all of the disclosures required by generally accepted accounting principles for annual financial statements. Accordingly, these interim consolidated financial statements should be read in conjunction with the consolidated financial statements for the year ended March 31, 2004 and the notes thereto.

These interim consolidated financial statements follow the same accounting policies and methods of application as the consolidated financial statements for the year ended March 31, 2004 except as described in Note 2.

2. New accounting standards
# (a) Asset retirement obligations

Effective January 1, 2004 the Company adopted the CICA Handbook Section 3110 "Asset Retirement Obligations", which replaced the guidance on future removal and site restoration costs included in the CICA Handbook Section 3061 "Property Plant and Equipment". The standard requires recognition of a liability at its fair value for the obligation associated with the retirement of a tangible long-lived asset. A corresponding asset retirement cost is added to the carrying amount of the related asset and amortized over the useful life of the asset.

The Company has asset retirement obligations to restore leased facilities upon termination of the leases. Management has estimated a discounted liability at April 1, 2002 of $484,000. The total undiscounted amount of estimated cash flows required to settle the obligation at lease end is $531,000. These costs have been discounted and added to the carrying costs of leasehold improvements as at April 1, 2002. These costs are being amortized over the remaining lease term of fifty-two months. For the three months ended June 30, 2004, the Company recorded amortization and liability accretion expense of $28,000 and $5,400 respectively related to these obligations. The amortization related to prior periods has been accounted for retroactively with re-statement of prior period comparative amounts. The amortized balance of Asset Restoration Cost at June 30, 2004 is $232,000 (March 31, 2004 - $261,000). The credit adjusted risk-free discount rate used to calculate these obligations is 4.1%.
# (b) Hedging relationships

In December 2001 the CICA issued guidance on accounting for hedging relationships. These guidelines specify the circumstances in which hedge accounting is appropriate, including the identification, documentation, designation and effectiveness of hedges and also the discontinuances of hedge accounting.. The Company has implemented this accounting guideline on April 1, 2004. The adoption of this new guideline did not have a material impact on either the Company"s financial position, results of operations or cash flows.

3. Share Capital

As of June 30, 2004 there were 36,252,879 (March 31, 2004 - 36,246,879) shares outstanding.

Stock Option Plan: Stock option transactions during the three-month periods ended June 30th are summarized as follows:

-0-

2005 2004
--------------------------------------------
Number Weighted Number Weighted
of Shares Average of Shares Average
Exercise Exercise
Price Price
--------------------------------------------

Outstanding, beginning
of period 2,827,520 $5.41 2,907,150 $5.48

Granted 177,000 2.68 164,500 2.95
Exercised (6,000) 0.01 (37,680) 0.01
Cancelled (20,000) 7.95 (120,660) 6.22
------------ -----------

Outstanding, end of period 2,978,520 $ 5.25 2,913,310 $5.38

------------ -----------
Options exercisable,
end of period 1,760,834 $5.36 1,627,970 $5.07
------------ -----------


The assumed exercise of these options would not have a dilutive effect on loss per share thereby resulting in the same weighted average number of shares outstanding at June 30, 2004 being used for purposes of calculating the basic and diluted earnings per share figures.

The Company uses the Black-Scholes option pricing model to estimate the fair value at the date of grant for options granted subsequent to April 1, 2002. In the first quarter of fiscal 2005, 177,000 (June 30, 2003 -164,500) options with a weighted average fair value of $2.68 (June 30, 2003 - $2.46) were granted and valued using the following weighted average assumptions;

-0-

---------------------------------------------------------------------
June 30, 2004 June 30, 2003
---------------------------------------------------------------------
Risk free interest rate (%) 4.70% 4.50%
Expected volatility (%) 86% 86%
Expected life (in years) 10 5-10
Expected dividends nil nil
---------------------------------------------------------------------


The company adopted fair value accounting for stock based compensation expense at April 1, 2003. For the quarter ended June 30, 2003, stock based compensation expense was previously disclosed on a pro-forma basis. The quarter ended June 30, 2003 has now been restated to reflect the expensing of these costs.

Had the fair value method of accounting for stock options been adopted effective April 1, 2002, the pro forma impact of the compensation would be as follows;

-0-

---------------------------------------------------------------------
(in thousands of dollars except June 30, 2003,
per share amounts) June 30, 2004 As restated
---------------------------------------------------------------------
Loss attributable to common
shareholders -as reported ($7,346) ($7,384)
Stock-based compensation expense,
As restated 68 132
Loss attributable to common
shareholders-pro forma ($7,414) $(7,516)
---------------------------------------------------------------------
Loss per share - as reported ($0.20) ($0.26)
Loss per share - pro forma ($0.20) ($0.27)
---------------------------------------------------------------------
Weighted average number of shares
outstanding 36,248,857 28,207,083
---------------------------------------------------------------------


4. Research and product development

Research and development expenses are recorded net of program funding received or receivable. For the three months ended June 30, 2004 and 2003, the following research and development expenses had been incurred and program funding received or receivable:

-0-

---------------------------------------------------------------------
Three Months Ended
June 30
2004 2003
---------------------------------------------------------------------
Research and product development expenses $ 2,840 $ 2,688
Research and product development funding (261) -
---------------------------------------------------------------------
Total research and product development expense $ 2,579 $ 2,688
---------------------------------------------------------------------
---------------------------------------------------------------------


5. Employee future benefits

During the three month period ended June 30, 2004, an expense of approximately $ 60,000 ($45,000 in the three month period ended June 30, 2003) was charged to income for defined contribution pension costs.

6. Guarantees

Standby Letters of Credit and Letters of Guarantee

As at June 30, 2004, the Company has outstanding standby letters of credit and letters of guarantee issued by several financial institutions of $3,416,000 (March 31, 2004 - $5,822,000) which have various expiry dates extending through to November, 2008. These instruments primarily relate to obligations in connection with the terms and conditions of the Company"s sales contracts. The standby letters of credit and letters of guarantee may be drawn upon by the customer if the Company fails to perform its obligations under the sales contracts and the Company would be liable to the financial institution for the amount of the standby letter of credit or letter of guarantee in the event that the instruments are drawn upon by the customer.

7. Segment Information

Summarized product sales and service revenue by geographic region as determined by location of the customers is as follows:

-0-

---------------------------------------------------------------------
Three Months Ended
June 30
2004 2003
---------------------------------------------------------------------
China $ 363 $ 677
France 429 -
Romania - 490
Spain - 1,199
Korea 2,176 -
Germany 1,758 -
United States 518 121
Other 418 561
---------------------------------------------------------------------
$5,662 $ 3,048
---------------------------------------------------------------------
---------------------------------------------------------------------


Capital assets are located in the following countries:

---------------------------------------------------------------------
June 30, 2004 March 31, 2004
---------------------------------------------------------------------
Canada $8,290 $8,996
Belgium $1,871 2,161
---------------------------------------------------------------------
Total $10,161 $11,157
---------------------------------------------------------------------
---------------------------------------------------------------------



Contact:

Stuart Energy
Wanda Cutler
Communications
(905) 282-7769
OR
Stuart Energy
R. Randall MacEwen
Corporate Development
(905) 282-7773


Source: Stuart Energy Systems Corporation
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