燃料電池能源 (FCEL) 0 Q0 法說會逐字稿

Good day and welcome to the FuelCell Energy fourth quarter and year end earnings results and company update conference call.

All lines are in a listen-only mode.

I would now like to turn the call over to Lisa Lettieri.

Please go ahead.

Thank you, operator.

Good morning everyone, and welcome to FuelCell Energy's fourth quarter and year-end results conference call.

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

Before proceeding with the call I would like to remind everyone that this call is being recorded and that this presentation contains forward-looking statements including the Company's plans and expectations for the continuing development and commercialization of our FuelCell technology.

Listeners are directed to read the Company's cautionary statement on forward-looking information and other risk factors in its filings with U.S.

Securities and Exchange Commission.

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

Thanks, Lisa.

I want to wish everyone good morning and thank you for joining us on FuelCell Energy's year-end conference call.

In fiscal 2006 we focused on executing the strategy we've communicated throughout the year to build large-scale repeatable business in key geographies while driving down product costs.

Over the last 12 months we have delivered growth in product and sales revenue, increased our backlog both sequentially and year-over-year and met our 2006 cost-out goals.

Importantly, during the year we worked on successfully laying the groundwork to grow sales in these markets, including establishing distribution relationships, delivering product cost reductions and improvements and ensuring production capacity to meet the needs of the market.

I will share more details on the individual market successes and opportunities and our goals moving forward, but right now let me turn it over to Joe Mahler, our Chief Financial Officer to provide with you the financial results.

Thanks, Dan.

Happy holidays to everyone.

We are pleased with the quarter, with revenue and backlog increasing and cash in line.

The results of our cost out efforts in 2006 moving to 2007 are very promising and we continue to work on product cost reduction as a means to open broader markets.

Total revenues for the fourth quarter of fiscal 2006 were up 15% to 9.1 million from the same period last year.

Product sales and revenues increased 61% to 6.7 million from 4.7 million driven by strong sales in California.

The Company's product backlog, including long-term service agreements saw sequential and year-over-year increases as we continue to penetrate the California market.

Backlog as of October 31, 2006, totaled 27.9 million, an increase of 39% from the 20 million reported as of July and higher than 26.4 million reported as of October 31, 2005.

Research and development contract backlog increased to 30.1 million from 15.8 as of the prior year end, primarily reflecting the contract awards from the Department of Energy for large-scale stationary solid oxide FuelCell development and the U.S.

Navy program for the ship service FuelCell.

The net loss to common shareholders for the fourth quarter was 25.1 million, or $0.47 per basic and diluted share which included stock compensation of 1.2 million, or $0.02 per share, compared to last year's fourth quarter net loss to common shareholders of 19.5 million or $0.40 per share.

The ratio of cost to product sales and revenue improved to 3.19 to 1 from 3.36 to 1 in the year-ago period.

Factors that impacted the cost ratio in the quarter included lower product costs offset by short-term pressure on selling prices in California, delays in Connecticut's RPS program, and higher aftermarket costs on a larger installed fleet.

The higher net loss in dollars in the 2006 quarter primarily resulted from higher product sales mostly submegawatt units, and we incurred incremental costs associated with transitioning to produce larger units.

Moving forward, sales of our latest design sub megawatt and megawatt-class unit are expected to improve the cost ratio and resulting operating margin.

To illustrate the average DFC300 product costs that moved to our plant in the fourth quarter cost $2,000 less than in the fourth quarter of 2005.

In 2007 the next block of cost reduced units are moving through our production facility with 300-kilowatt units costing approximately $4,900 a kilowatt, and 1.2 megawatt units costing approximately $4,300 a kilowatt.

Assuming a selling price of approximately $2,500 a kilowatt, this would move our cost ratios in the 1 to 2 range.

We are also beginning production of our lowest cost per kilowatt product, the cost reduced 2.4 megawatt which has a cost of less than $3,000 per kilowatt with volume.

These multimegawatt products for the RPS market are at market clearing prices and present us with the opportunity for large-scale production which will help cost reduce all of our products.

The cash used for the year was in line with our expectations of 60 million.

Total cash and investments at October 31, 2006, was 120.6 million.

Net cash and investments used during the quarter was 13 million, and depreciation and amortization expense was approximately 2.7 million.

For the year ended October 31, 2006, reported revenues were up 10% to 33.3 million, compared to 30.4 million reported in 2005.

Product sales and revenues were 21.5 million, 24% above the 17.4 million a year ago.

For the year ended October 31, 2006, net loss to common shareholders was 84.2 million, or $1.65 per basic and diluted share as compared to a loss to common shareholders of 74.3 million or $1.54 per basic and diluted share.

Fiscal 2006 results included a one-time charge of 4.3 million, or $0.08 per basic and diluted share for the conversion of a Series B convertible preferred stock, and also stock compensation expense of 4.4 million or $0.09 per basic and diluted share.

The ratio of costs to product sales for the year was 2.86 compared to 2.99, again showing improvement.

As I noted last quarter we are transitioning the Company to capture the RPS and multimegawatt market opportunities.

Our 2.4 megawatt power plants are expected to be gross margin profitable in these RPS programs.

While intermittent solutions like wind and solar have their roles our FuelCells provide ultra-clean, reliable, 24-7 base load power.

We are well positioned to capture these markets.

Dan?

Thanks, Joe.

Now let me address some highlights of our business operations for this quarter and the fiscal year.

I want to touch on two main areas.

Our cost-out program and changes in our key geographic markets that favor our business plan and our position in those markets, then I'll discuss the outlook for 2007 and take your questions.

One of our primary objectives in 2006 was to achieve significant cost reduction goals for our Direct FuelCell power plants.

We specifically focused on driving down the cost per kilowatt of our flagship DFC3000 to position us for the multimegawatt projects we're pursuing in 2007.

We successfully reduced the cost of the DFC3000 by 39% to $3,250 a kilowatt.

A significant force behind the cost reduction came from value engineering, developing lower cost designs for various elements of the power plant.

We also folded in the lessons from our earlier cost-out work and performance improvements from the DFC300 and DFC1500 products and improved the efficiency of our manufacturing, testing, ad commissioning processes.

Our ability to produce more electricity from our FuelCell stacks in the same basic footprint was another major contributor.

This 20% up rate which we announced last summer applies across all our DFC power plants.

These cost reductions at our current production volumes, at higher volumes we can expect to capture additional cost reductions of 20% or more.

By driving down unit costs, we were able to address the needs of states with renewable portfolio standards, or RPS programs, and other locations here and abroad where there are similar initiatives to provide ultra-clean power or solve issues with utility transmission and distribution systems.

In New York alone the state's RPS objectives are 3700 megawatts by 2013.

This brings me to the topic of changes we are seeing in the market.

RPS and other legislative initiatives here in the U.S. represent a growing opportunity that's currently being addressed with intermittent energy solutions like wind and solar, but these initiatives call for major increases in the production of green electricity.

Our DFC products provide 24/7 power output providing an ultra-clean, quiet, cost-effective, and reliable solution that compliment more intermittent solutions like wind and solar.

In fiscal 2006 we have taken a number of steps to ensure that we are prepared to address these RPS market opportunities.

We engineered a lower cost product for multimegawatt configurations.

We also initiated production process improvements to increase the efficiency of our assembly and test operations.

Worldwide we see expanding support for FuelCell products.

In the United States via the federal investment tax credit which we expect to be extended, in California the extension of the Self Generation Incentive program and the Greenhouse Gas Reduction bill with tight controls over other emissions.

In Connecticut, the RPS program.

In Korea, subsidies for FuelCells.

And in Germany a proposal to support volume unit production for manufacturers.

Looking at specific regions, California continues to be our leading market.

Electricity prices have now corrected to incorporate recent high fuel costs.

As you saw from our press releases in the fourth quarter this resulted in strong order flow from California, selling 2.6 megawatts this quarter.

In addition we shipped 1.2 megawatts of products to customers in California during the quarter.

Our West Coast sales team is focused on building a strong orders pipeline evidenced by the large number of projects submitted for incentive funding.

Due to the increased demand for our product the California FuelCell incentive program is oversubscribed for the first time in the Company's history.

The state also extended its self-generation incentive program to 2012 demonstrating a long-term commitment to FuelCells.

California's financial support for solar energy has grown to $3.2 billion and is enabling that industry.

We believe FuelCells are on a similar trajectory.

Many of our orders in the region use anaerobic digester gas, which is a renewable fuel.

Some high-profile examples include the Sierra Nevada brewery which is generating electricity from a waste byproduct, or the fermentation process.

The waste water treatment plant in the city of Tulare, California is gearing up to generate digester gas from a dairy processing waste.

And Gills Onions will turn food processing byproducts into clean energy.

These kinds of customers underscore our fuel flexibility, our ability to plug into the existing power infrastructure and our credentials as green.

In 2006, our DFC power plants continued to excel at meeting customer expectations.

At the end of our fiscal year our fleet had generated over 150 million kilowatt hours of ultra-clean power.

If you think back to this past summer the heat wave that covered a large part of the country was especially severe in California.

They experienced ten straight days of 100-plus-degree temperatures and set three new records for peak electric demand in just over a week.

During this time California's independent system operator was forced to ask businesses to curtail their use of electricity so demand could be met.

Our analysis of a dozen DFC units operating in California during that same period showed that they all continued to perform reliably allowing those locations to maintain operations while many other locations were required to reduce power usage.

I can't think of a more pointed real-market example of the benefit and value of our systems.

In Connecticut delays in the state's Project 100 bidding process pushed us back at least six months.

That process now seems to be firmly on track.

Tomorrow, in cooperation with our partners, we will be submitting over 40 megawatts of bids to the Connecticut Clean Energy Fund.

The Clean Energy Fund has announced that its project selections will be made on March 30, 2007.

Looking at Asia, Japan and Korea are both countries with high electricity costs and strong national programs to reduce greenhouse gas emissions and achieve higher energy sufficiency.

Combined with their environmental regulations and expanding government incentives these countries represent compelling markets for our products.

Japan has not yet corrected its electric pricing and sales have slowed.

However, we expect Korea to offset this slowdown due to the recently passed FuelCell incentive program.

In 2006 Korea enacted its first ever subsidy program to promote renewable energy technologies as part of a national carbon dioxide reduction effort.

Fuel cells running on either renewable biofuels or natural gas are eligible for up to $0.28 a kilowatt hour with up to 50 megawatts of generation qualifying for these funds.

The focus in particular is on megawatt-class power plants.

We're working closely with POSCO to capture the opportunity that now exists in the Korean market.

Finally, before I look ahead to the next fiscal year I want to call your attention to our government R&D contracts.

During the year we established a record setting mark of 56% electrical efficiency with our submegawatt Direct FuelCell turbine.

This is an important milestone in the development of the Direct FuelCell turbine.

Our next stage of development will be on larger designs with the potential to achieve 70% electrical efficiency.

Most recently, in the fourth quarter we entered into the first phase of $180 million ten-year Department of Energy project to develop a solid oxide FuelCell-based hybrid system.

We also have been authorized by the Office of Naval Research to complete a land-based demonstration of our ship service FuelCell power plant and to begin design work on a ship-based prototype.

Finally, the Department of Defense selected us to develop a cost efficient system for separating pure hydrogen from the gas that's produced by our FuelCell reactions.

The resulting gas can be sold today for industrial uses and in the future for hydrogen fueled vehicles.

As we look forward into 2007 we successfully laid the groundwork for pursuing the opportunities emerging in the marketplace.

We will continue to emphasize our cost-out initiatives, expand our presence in the California market and pursue opportunities in the emerging RPS markets.

This year we will apply the lessons learned in our DFC3000 cost-out to the DFC300 and DFC1500.

In our technology R&D efforts we are focused on developing and testing an additional uprate that will further improve the cost position of all our products.

Taken together, our achievements in driving down costs, positive changes in our business, the political and funding environments, and our success in extending our reach into specific markets leave us optimistic about the Company's future and our ability to capitalize on opportunities as they develop.

We have a product that offers a compelling value proposition in our chosen markets and believe that our fundamental advantages of efficiency and environmentally friendly technology will enable us to continue to increase our market share of the power generation industry worldwide.

As always we will keep you up to date as events warrant.

Now let me turn the call over to you so that we can take your questions.

Operator.

[OPERATOR INSTRUCTIONS] We'll take our first question from Stuart Bush from RBC Capital Markets.

Good morning, guys.

Good morning, Stuart.

Are you guys prepared to give any guidance for 2007 on revenues?

We don't really -- the only thing we have been giving guidance on, Stuart, has been cash flow at this point.

I am optimistic about sales in 2007, so I think we'll -- we will do better than '06.

Okay.

So what do you guys expect your cash burn to be in '07?

I'm expecting it to be -- there's a lot of things that could happen in '07, so it's not an easy question to just throw out -- throw out numbers.

We're expecting in March -- we've expected it for the last six months.

Unfortunately Connecticut has been delayed.

We're submitting over 40 megawatts of projects, and those projects would have somewhat of an impact on cash flow, if you look at our base cash flow for '07, we would expect it to be below '06.

So we would expect our cash flow to be below 60, plus the impact of Project 100 in Connecticut.

So speaking of Project 100, last quarter you had talked about the 4-megawatt Wallingford Project and how that was delayed but potentially could give some upside to the fourth quarter.

Where do we stand now with that?

We did not get the 4-megawatt project.

Ultimately what happened there is that the 4-megawatt was submitted into the first phase, or first round of the Connecticut 100 project.

In that, the state had not yet corrected, so all the projects in that phase had not yet corrected the fuel pass-through.

So at the end of the day I think that given the delay, given the review of the Clean Energy Fund, the DPUC really recommended to us is to back off of any submissions in round one and resubmit all projects into round two.

Round two was much more favorable economics.

The contracts are defined, the PPAs are defined, it's a vetted process at this point.

It's really thanks in some part to the 4-megawatt project that went in.

At this point we're just focused on getting our projects -- the due date is December 20.

We're getting our 40 megawatts plus into the pipeline and we would expect to hear back on that sometime in March.

Did you resubmit the Wallingford or is that project dead?

Well, what we're going to do is after we have got all the proposals in in this next round we'll come back out and give people some insight into how much we ended up bidding and who we bid with but since we've got pending submit over here we are just going to wait until after all the proposals are in.

You guys mentioned that you had $27.9 million in backlog at the end of the fiscal year.

How many megawatts does that represent?

That backlog is about 8.05 megawatts.

Last question.

Is the LIPA project dead or where do we stand on that?

Well, I don't know if you saw some of the recent activity but there was recently a press event with LIPA and KeySpan where they announced a restructuring of that project.

They were going to put it out to bid.

It is now going to be at a little different location.

They have set it up so that it is going to be a cogeneration project as well.

They want to capture some of the waste if it's available.

So what they've done is they took what went on in the marketplace, looked for a way to make the project more attractive by finding a different site and a different application, made a big deal about the announcement here just a few days ago and they are going to be sending the requests for proposals out shortly.

We expect to be bidding hopefully a pretty competitive offering into that round.

Do you have any idea on what the time frame for that type of project would be?

Not yet.

I think as the next couple of weeks unfold and we see what the actual RFP looks like we'll have a lot more insight and we'll let people know how they have structured it going forward in terms of timing and what size project they really want to do.

Thanks a lot, guys.

Sure.

Our next question comes from Sanjay Shrestha from First Albany Capital.

Good morning, guys.

Actually, it's [Graham Madison] in for Sanjay.

Have a quick question.

Just looking at the opportunity in Korea, in terms of the timing of that, is that something that could happen 2007, or is that more of a 2008 activity?

No, that's 2007 activity.

What we're working on right now is, while the incentive program has been passed and we've started to sell some units there, I think we've got four units there now, what we really want to do is broaden our relationship with our distribution partner there because it makes sense both in terms of accessing the market and also in terms of our own cost reduction efforts to move towards a balance of plant that is made in country.

So we're in discussions with POSCO on that right now and hopefully we'll have an agreement concluded here in the first quarter.

Great.

Thank you very much.

Sure thing.

Our next question comes from John Quealy from Canaccord Adams.

I don't want to ask you for too much information here but Connecticut 100 when you put in that bid tomorrow is this going to be the sort of 3250 a kilowatt type of range or can you talk about if you do get something out of Connecticut 100, say it's 10 or 15 megawatts, or whatever, can you just give a relative range for us, on whether it's volume enhancements on that cost per kilowatt?

Is it better than you've done in the past?

Can you just talk us through a little bit there as much as you can?

Let me give you a couple thoughts and Joe can add to it.

When we talk about 3250 that is at our current production rate what our next unit cost would be.

So if we're successful in Connecticut, for example, in, say, a 10-megawatt project our costs would come down from there because now you have multiple units, you have enabled the ability to do some volume purchasing and to do a little bit of global sourcing so that number starts to approach $3,000 a kilowatt, and if we get enough out of Project 100 it could actually dip below 3000 in kilowatts.

In terms of the federal tax credit for FuelCells, was that just extended for another year, or could you give us an update on that?

It has been through, I believe, both the House and the Senate and is waiting for the President's signature but it includes a one-year extension.

That's '08, then?

Yes.

Just a couple other things.

In terms of the news out of, I think it was Sierra Nevada this quarter, in terms of monetizing or taking the systems in-house from your side, any other potential guys out there that you have done some PPA stuff that are now looking to take the full ownership of it on and take that cash and property off your books?

There's not any that we're talking to right now, if market conditions change that situation may change, but right now that's the only one that we were actively pursuing.

We knew the customer would ultimately wanted to own the power plant once they had it running for awhile and were satisfied with how it performed.

We'll revisit what we're carrying on the PP&E line from time to time to see if there are other opportunities to do that.

Dan, remind me, how long was the time frame by the time they actually started operating the unit to when they decided to say, it works to satisfaction, we're going to take it on our balance sheet?

It was just over a year.

Last two.

Enbridge the first -- this is a step-down unit for the gas, is that right?

That's correct.

This is the first one -- we have been talking about this nor awhile -- what's the potential for more?

This is not a FuelCell, so to speak, hydrogen-related driver, in my view.

What's the opportunity there in '07 for you folks?

I think the opportunity is pretty strong because you have got a couple things going on.

One is you have got a new solution for the gas companies which they didn't have before, but you also have a product that is very well suited to these RPS markets.

So I think going forward what you are going to see, and some of the opportunities that we are bidding for the RPS programs, you are going to see proposals that include this gas pipeline application.

And my last question, I have asked you this one before on CO2 and monetization, or at least engaging customers in discussions about CO2 mitigation and monetization.

Can you give us an update?

Is there more interest internationally or domestically about capturing CO2 in terms of the contract or the opportunity for FuelCell signing or can you give us the flavor of how conversations have shifted if at all?

It's absolutely a factor.

In fact, if you look at Japan the last several orders we have announced have really been as a result of our efficiency and the role that we play in CO2 reduction for those companies.

What's happened now is with California passing CO2 legislation, it really starts to give us a competitive advantage versus some of the other technologies that are out there.

So we are starting to see people looking at how do they bring that into their decision-making process.

It's a very favorable trend for us.

Great.

Thanks, guys.

Our next question comes from Pearce Hammond with Simmons & Company.

The PPA that you had with Sierra Nevada, and they have taken that back is there any accounting that could provide you a benefit during this next quarter, and how do you account for that?

Well, the benefit is -- really what we have done is taken a 10-year cash flow stream and brought that -- you and really brought that forward.

And so that's the major benefit, cash is king, and we have been able to monetize that project.

What we get on a continuing basis going forward is that from a -- so in effect what we monetized was a portion of the PPA contract.

What we get going forward is we get a long-term service agreement with Sierra Nevada that will give us -- so what it does is it it really puts it back -- right back into the sale of equipment with an LTSA, so that's really the benefit of what we did here.

So you wouldn't have the gain during the next quarter?

No.

Okay.

And then what is the update on the MTU stake?

MTU is going through discussions with their new parent.

They are looking for some guidance in terms of what is the plan for their new owner, EQT.

Are they going to invest in the business?

Are they going to divest it?

Are they going to hold steady with where they are?

As you can imagine, when EQT bought MTU Friedrichshafen they bought a very large business, so they have spent quite a bit of time sorting through what is the business plan for is entire business they bought, not just FuelCells, and laying out a path for that entity to get ready for an IPO in the market place sometime in the future.

We've had discussions with our MTU counterparts as recently as last week.

They are as eager to know what the path forward is for them as we are.

It's just going to take time for it to unfold.

What sort of timing do you think?

To be determined?

I would expect that we're going to know something probably, maybe the end of the first quarter of next year or beginning of the second quarter.

It's pretty clear that the engine business, since that's the lion's share of what they bought, is really taking the priority in terms of their business plan for the IPO.

Great.

Can you refresh what's going on in Japan and why it's slowed down a little bit there?

Japan actually, we are seeing the same thing that happened in California about a year ago.

What we have got is a spark spread that is inverted, so you've got gas prices that have gone up, and utilities have got some ability to hold off passing those increased fuel costs through to their customers.

In California we saw that trend last about six months until finally the fuel prices started to result in electricity increases.

Japan is not quite as open a market from a utility standpoint so we think they have a little bit better ability to hold the electricity pricing but ultimately it has to start to flow through.

The utilities can't continue to absorb those costs over the long term.

What we have got is a near-term issue where higher gas costs haven't made it through to the retail price of electricity.

Great.

And then one last question.

In the press release you referred to higher aftermarket costs related to installed base.

Is that just because you have got a larger installed base of FuelCells out there, or is there something specific toll fuel cells that may have impacted them during this quarter?

Your first assumption is correct, Pearce, is that we have a higher installed base which has higher costs in effect following it.

The other thing that's happening to us a little bit is in this delay period, we really expected the -- you'd think we'd learn by now but we really expected Project 100 to come through last September, so we really geared up our production to transition over.

Meantime what we have done is we have built some extra submegawatt stacks for the future to support the fleet in the future.

We are coming to life end on our three-year stacks.

We put our first stacks out in 2003.

We are in 2006 going to 2007.

So some of those costs come through in the quarter ahead of revenue.

So a little bit of that is going on.

Plus you have some other costs coming through in terms of preparing for the RPS markets.

So for the next quarter we think that will mitigate some?

We think that that will mitigate somewhat, but really the next quarter is a similar transitional phase.

What you do have happening in the next quarter is some of our new -- the lower cost design sub megawatts that are coming out of production now, so some of those will start to flow through in the first quarter, which will actually reduce the cost ratio.

Great.

Thank you very much.

Thank you.

Our next question comes from Walter Nasdeo from Ardour Capital.

I have a quick question here on the 3250 per kilowatt.

What price are you expecting to sell the units that you produced at that level for, per kilowatt?

If you look at what we see in the marketplace, the -- about the $3,000 kilowatt range seems to be the market clearing for the big RPS kind of programs.

So as you can imagine, if we start to bid 10 or 20 megawatts of those we start to actually get to the point where that product becomes gross margin positive.

Got you.

Okay.

And then you were mentioning here about the production process improvements to increase efficiency and capacity.

What steps are you taking that are going to get -- to increase that capacity, and what is your expectation for capacity at your current facility?

Well, at the current facility we can produce 50 megawatts a year.

We have the equipment in place to do that.

As we would ramp the business up we would, of course, add additional shifts at our factory in Torrington.

The process improvements that we are doing are things like, for example, automation.

When we take a stack through its one-time conditioning process, we used to do that with a lot of the engineers watching the behavior of that stack as it got conditioned.

As we have done a lot of those we have now automated that with software so we don't have to have people watching the performance of the stack while it goes through the process.

So those are the kind of automation processes that we are talking about.

It's basically taking a business and getting it ready for volume and also for quality control to make sure that our production processes are very repeatable.

And that's at the current facility.

Yes.

So what's the expectation then for capacity, for that number of megawatts?

I'm not sure I follow your question, Walter.

Well, as you institute all these advances, where do you think that number goes to, from 50 to 70 to 100 to 1,000?

If you look at where the actual constraints are in our business, they are in some of the hot furnace lines in Torrington.

So what -- that actually ends up being the 50 megawatt a year constraint.

So the improvements that we're making in things like the [Inaudible] process don't increase the production capacity, they just make it it more cost-effective for us to put units through the facility.

Understood.

One quick question.

Over on your government and R&D contracts the last bullet there where you're talking about the efficient system for separating hydrogen from gas that is exhausted from fuel cells reaction, what type of amount of hydrogen would be in the gas that's emitted?

Is it a significant amount?

If you look at how our FuelCell operates, if you take natural gas or digester gas into the FuelCell, we only use about 25% of the hydrogen that is available in that incoming fuel stream.

So there is about 25% of the incoming fuel that would be available to be purified and separated for another use.

So you would do that internally then?

What we would do is we would use our FuelCell just the way we normally do but the waste gas that comes out that we, in the current configuration that we use to preheat fuel and water, we would actually take it through a separation process to strip the hydrogen off.

Okay.

Well, that makes sense.

Listen, I appreciate those answers.

Sure thing.

Our next question comes from David Smith with Citigroup.

Good morning, guys.

Good morning.

When you talk about gross margin?

I guess now it's above 3 to 1, but you said to get it to 1 to 2, what can we expect in '07 should be the appropriate range to model?

Would it be between 2 and 3?

Or 2.5 to 3, something more like that?

Yes, David, we're expecting really 2 to 3.

We see costs absolutely coming down.

The only thing that mitigates all the costs coming down, is that periodically in some of these spark spread regions we get a little bit of pressure on selling price, and we're still in the mode of -- we're still trying to get units into the marketplace.

So I'd say the range is going to be in that 2 to 3 -- let me just give you a couple of examples.

If last year we were selling our 6300 plus or minus units, if you're selling those at $2,500 a kilowatt, you've got a ratio of say, 2.5, maybe a little higher.

If you're selling at $2,100 you have got a ratio that's in the 3 range.

What our expectation is, going in '07 is that the submegawatt unit should be in that 4800 to 5200 range from a cost standpoint.

So you're roughly -- if you can sell them for 2500, if electric rates stabilize and everything then you're at a 2 ratio.

This is just on manufactured costs you're on a 2 ratio.

If you sell them at 2100 you're at a 2.38 ratio.

So to put a little room in the equation that 2 to 3 looks pretty good to us right now.

If you go to the megawatt plants, if we can break open the 2-megawatt market, if you could sell a $3,300 unit at $3,000 you're at a 1.1 ratio on that product.

If you sell a $3,000 unit for $2,000, your selling price was $2,000, you'd be at 1.42.

So that's what we really see and that's what we have been driving the strategy, and hopefully we can connect on Connecticut to begin with and get 10 or 20 megawatts there.

That's where we see the real opportunity to drive this down.

Makes sense.

As far as your average selling price, then, in the quarter, can you -- where are you at right now on those systems that went out?

The average selling price in the fourth quarter was really around the $2,500 range.

What we had is a combination of some early California units that took awhile to close that were actually in the lower end of the range.

Offset, actually, by a later California unit that we sold in, I think, the third -- third, into the fourth quarter, which actually, the selling price went back up.

So the average ended up around $2,500.

And then just lastly, circling back again on this aftermarket cost, is that anything to do with the way these things are operating?

It sounds to me like it might not be how they're operating.

For the most part what it is is that it's just, really, you have got 50 units now out in the marketplace, and we're starting to go through some of the stack replacement cycle on -- we're achieving the life expectancy and we're starting to go through some of the replacement cycle and some of those costs will be coming in.

But for the most part it's really, the units are working very well, the number of items that we have to resolve are diminishing.

Some of the costs -- on the early units we put out back in '03, '04, they probably still have some things that we continue to work on but the newer units are really performing at very, very high, in the 95% availability.

So you have some old fleet, fixer-upper that you're continuing to do, but the new fleets that are going out are performing very well.

Great.

Thank you.

[OPERATOR INSTRUCTIONS] Our next question comes from Jeff Osborne from CIBC World Markets.

Great.

Good morning.

Just a couple quick questions.

Most of them have been answered at this point.

Just wondering if you could help us handicap the potential success with the Project 100.

You seem to be throwing out the numbers 10 to 20 megawatts.

I was just wondering what the odds or the potential would be of narrowing that gap up to 40 megawatts, what you're bidding?

What needs to happen to win 30?

If we had a lot of visibility, I could probably handicap it pretty well, but what the state has done is they've laid out a program where there's 100 megawatts they want to see go in.

There's 85 megawatts remaining that hasn't already been awarded from previous rounds, and they have stated they are looking to have half of that come from FuelCells.

So there's a potential of 50 megawatts there.

Now, United Technologies is in Connecticut, so they are going to get their fair share of this as well.

I personally think we are going to do significantly better than 10 megawatts, but it is a public bidding process and we will see what comes out of it.

I think we certainly have a more attractive, more competitive bid than UTC, based on other things we have seen in the marketplace but we'll just have to wait and see how their selection process turns out.

I think 10 megawatts, I would expect it would be the low end.

I wouldn't be surprised if we got as much as 30 or maybe even more, but there will be an effort to make sure that it isn't just one company that benefits from this program.

Makes sense.

Great.

Thank you.

Just two other financial related questions.

Is any target with some of these process improvements and automation on the CapEx front for '07 I know you mentioned cash burn would be less than what it was in '06.

Do you have a CapEx target for '07?

CapEx, it will be lower than '06.

We really right now just focused on maintenance and some process improvement, so I am looking at a pretty low number, like in a 4 to 6 billion range.

The real item that will impact '07, is that as we see Project 100 coming along, the next thing we want to do is expand our manufacturing capacity up to 150 megawatts.

As Dan described before, there's really just a few bottlenecks that I think the furnace operations, I think the welding operation.

Most of our other processes are far in excess 50 megawatts of capacity.

So it's really bottleneck relief.

To go to 150 megawatts, just to throw a number out, is probably a 25, $35 million, somewhere in that range, exercise for us.

But that's really -- we're kind of really holding -- trying to hold costs where they are, let Connecticut 100 be the inflexion point, and then off of that build out capacity.

Great.

And just on that capacity, how long do you think that would take to add the capacity?

To get to the 150 is probably a 12 to 15-month process.

Great.

Just the last question, can you just remind us again of what your targets are of reaching profitability?

You hinted about it in the release, but just in terms of break-even at both the gross margin and the net income level?

I think publicly what we have been saying, and we're in the process of doing our '07 10-K but what we have said publicly, is that the gross margin profitability is 35 to 50 based on a mix assumption and that our profitability would be 75 to 100 megawatts based on a mix.

Just to put it in perspective, and -- I have been telling in investor conferences, and we have been speaking to a lot of investors recently, if we sold -- let's say we got all 2-megawatt plants, and we really hit the home run and the Connecticut scenario and we talked about how our next unit is going to cost 3200, we think we can sell them for about 3,000, so you're pretty much at gross margin profitability.

If you could do 40 megawatts at $1,000 a kilowatt, what I have below the line is about $40 million.

If I could do 40 megawatts and make $1,000 a kilowatt on the Company profitability at that point, if my mix changes and I don't quite have that kind of mix, if I did 80 megawatts at $500 profit, I'd have company profitability.

That's probably where -- that's kind of the dynamic how we view the business so it's really a mix related -- we have a pretty clear path.

Profitability should be helped by some of the subsidies now.

Most of the subsidy money to this point we have passed on to distributors and customers, but as our costs come down we should be able to capture some of that.

There's certainly a revenue enhancer on the federal tax credit.

We are picking up some additional sales value there, so it may actually help us hold some sales pricing.

So that's kind of the range of how we see the profitability equation taking place here.

Very good.

Thank you.

We have no further questions at this time.

I will turn the call back over to the presenters for any final comments.

With that I'd like to thank everybody for joining us today and for the great questions that we got.

And we look forward to speaking to you again next quarter to update you on the progress on Project 100 and the things going on in the marketplace.

Thanks again, and good morning.

Thank you.

This concludes today's teleconference.

You may now disconnect your lines, and have a great day.