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FuelCell Energy (NASDAQ:FCEL)

Q1 2013 Earnings Call

March 12, 2013 10:00 am ET

Executives

Kurt Goddard - Vice President of Investor Relations

Arthur A. Bottone - Chief Executive Officer, President, Director, Chairman of Executive Committee and Member of Government Affairs Committee

Michael S. Bishop - Chief Financial Officer, Principal Accounting Officer, Senior Vice President, Treasurer and Corporate Secretary

Analysts

Ajay Kejriwal - FBR Capital Markets & Co., Research Division

Sanjay Shrestha - Lazard Capital Markets LLC, Research Division

Walter Nasdeo - Ardour Capital Investments, LLC, Research Division

Jeffrey D. Osborne - Stifel, Nicolaus & Co., Inc., Research Division

Operator

Good day, ladies and gentlemen, and welcome to the FuelCell Energy Reports First Quarter 2013 Results. [Operator Instructions] As a reminder, today's conference call is being recorded. I would now like to turn the conference over to your host, Kurt Goddard, Vice President, Investor Relations. Please begin.

Kurt Goddard

Good morning, and welcome to the first quarter 2013 earnings call for FuelCell Energy. Delivering remarks today will be Chip Bottone, President and Chief Executive Officer; and Mike Bishop, Senior Vice President and Chief Financial Officer. If you have not done so, I encourage you to visit our website, register for email alerts and view our first quarter 2013 earnings release, as well as the accompanying slide presentation. Our website address is www.fuelcellenergy.com. A replay of this call will be posted 2 hours after its conclusion. The telephone numbers for the replay are listed in our earnings release. Once again, for those of you listening to this call via the dial-in phone number rather than via the Internet, management will be referencing a first quarter 2013 slide presentation that's available on the Investor Relations section of our website.

Before proceeding with the call, I'd like to remind everyone that this call is being recorded and that the discussion today will contain forward-looking statements, including the company's plans and expectations for the continuing development and commercialization of our Fuel Cell Technology. I would like to direct listeners to read the company's cautionary statement on forward-looking information and other risk factors in our filings with the U.S. Securities and Exchange Commission.

Now I'd like to turn the call over to Chip Bottone. Chip?

Arthur A. Bottone

Thank you, Kurt. Good morning, everyone, and welcome. May I ask you to please turn to Slide 4 titled First Quarter 2013 Highlights. We are expanding on the solid foundation for growth with increasing revenue, strong cash balance and executing on multiple project commitments on 3 continents. Construction is underway on the 14.9-megawatt fuel cell park in Bridgeport, Connecticut. The biggest domestic project in our history, FuelCell Energy is constructing this high-profile park for Dominion, one of the largest electric utilities in the U.S. Construction is also well underway on the 59-megawatt fuel cell park in Whasung City in South Korea. This project is being constructed by our partner, POSCO Energy, and is the largest fuel cell park in the world today. I'm encouraged by our strong global activity levels that are progressing to closure. The Dominion project in Bridgeport has generated tremendous positive attention due to our customer's industry standing and scope for the project.

As we continue to grow order volume in North America and Europe, our growing global installed base supports the services side of our business and is moving us toward our goal of diversity -- diversifying revenue by geography, market, customer and type. I just returned from meetings with POSCO in South Korea, and I'm pleased to see the strong pipeline of projects they are working on as well. Our record product and services backlog valued $428 million, includes a product backlog of 150 megawatts.

In response to growing order volume, we are ramping our production rate to 70 megawatts annually. This will yield higher margins, increase quarterly revenue as we deliver on our backlog and propel us towards company profitability. While we are pleased with most of our progress and market opportunities, we incurred some cost of revenue, an isolated manufacturing issue, that was not anticipated and impacted our margins. Mike and I will talk about that in greater detail.

I will discuss our results and outlook in more detail after Mike Bishop, our Chief Financial Officer, reviews our financial results for the quarter. Mike?

Michael S. Bishop

Thank you, Chip. Good morning, and thank you for joining our call today. Please turn to Slide 5 titled Financial Highlights. FuelCell Energy reported total revenues for the first quarter of 2013 of $36.4 million compared to $31.3 million in the same period last year. Product sales for the first quarter totaled $29.1 million compared to $26.2 million reported in the prior year. For the first quarter of 2013, service agreement and license revenues totaled $5 million compared to $3.4 million in the prior year due to the growing installed base plus license and royalty income from POSCO Energy. Advanced technologies contract revenues were $2.3 million for the first quarter of 2013 compared to $1.7 million for the prior year quarter. Versa Power Systems is consolidated into our results as of the acquisition date.

For the first quarter of 2013, a gross loss of $2.3 million was realized compared to a gross profit of $2.1 million in the prior year quarter. There were 2 primary drivers which contributed to the loss in the quarter compared to the prior year. First, margins in the quarter were impacted by an unfavorable product mix compared to the prior year as we -- and we incurred period costs related to the production ramp. This trend will reverse in the second quarter as the company is in the process of increasing the production rate by 25%, which will lead to higher revenues and expanding margins.

Second, the company incurred higher-than-planned warranty and aftermarket costs of approximately $2.1 million during the quarter as a result of a select number of fuel cell stacks being damaged in the assembly process. This isolated issue has been thoroughly investigated, process changes implemented and field repairs undertaken to support the limited number of customers impacted. Additional charges related to this issue are not anticipated.

Total operating expenses were $8.8 million for the first quarter of 2013 compared to $7.5 million in the prior year period. Operating expenses increased year-over-year as a result of market development expenses in the U.S. and Europe. This investment is expected to lead to increased backlog and revenue growth.

Net loss to common shareholders for the first quarter was $12.5 million or $0.07 per basic and diluted share compared to $6.7 million or $0.05 per basic and diluted share in the first quarter of 2012. EBITDA, which is earnings before interest, taxes, depreciation and amortization, totaled negative $9.9 million, which weakened primarily due to lower margin previously described. Again, we expect this trend to improve in the second quarter with lower warranty costs, increased production volume and a more favorable product mix.

Now I will transition to Slide 6 titled Financial Metrics. Cash and cash equivalents totaled $86.3 million at January 31, 2013. Inventory decreased nominally from year-end 2012. Raw material and work in process increased to support the production ramp while we began to allocate some of our finished goods to the Bridgeport project during the first quarter. We expect the remaining $6.4 million of substantially complete power plants will be converted into cash during fiscal 2013.

Subsequent to quarter end, on March 5, the company closed on a new long-term loan agreement with the Connecticut Clean Energy and Finance Investment Authority (sic) [Clean Energy Finance and Investment Authority] totaling $5.9 million in support of the Bridgeport fuel cell park. This loan will be drawn down during 2013 as working capital support during the construction period of this project. The principal balance of this loan will be repayable commencing on the eighth anniversary of the project's provisional acceptance date in 48 equal monthly installments.

Backlog totaled $428 million as of January 31, 2013 compared to $319 million at October 31, 2012. The components of this backlog include product sales orders of $260 million compared to $228 million at fiscal year end as the Bridgeport fuel cell park was added to backlog during the first quarter, offset by regularly scheduled fuel cell kit shipments to Asia.

Service backlog was $150 million at the end of the first quarter of 2013 compared to $79 million at October 31, 2012, with the increase primarily reflecting the addition of the service agreement for the Bridgeport fuel cell park. Advanced technologies contract backlog totaled $18 million at the end of the first quarter compared to $12 million at the end of the fiscal year as Versa contracts were added to backlog during the quarter. Measured in megawatts, product backlog totaled 151 megawatts as of January 31, 2013, unchanged from 10/31/2012.

During the quarter, we shipped 14 megawatts of kits to POSCO Energy, while the Bridgeport fuel cell park added 14 megawatts to backlog.

Before I conclude, I would like to confirm 2013 revenue and cash guidance provided last quarter. At the 56-megawatt run rate, in Q1, our total revenue was $36.4 million, which included $34.1 million of product sales, service and license revenues. As we ramp to 70 megawatts, we expect these revenues to increase to the range of $39 million to $43 million per quarter. Higher production levels and improved mix of complete power plants will improve leverage and lead to strong improvements in gross margins. 2013 quarterly cash balances will fluctuate based on working capital requirements, but for the full fiscal year, we are targeting a year-end cash balance of greater than $50 million.

In conclusion, our product backlog and financial position is strong and the company is well positioned for global growth. I will now turn the call back to Chip for further discussion of our operations, strategy and sales pipeline. Chip?

Arthur A. Bottone

Thank you, Mike. Please turn to Slide 7, Operations Update. The 70-megawatt ramp we are undertaking at our North American manufacturing facility in Torrington, Connecticut during the second quarter of 2013 represents a 25% increase over the previous 56-megawatt rate. The facility in its current configuration is capable of producing about 90 megawatts annually, so ramping to 70 megawatts requires the addition of some direct labor, but only minimum capital expenditures. The production ramp will yield higher margins as we gain operating leverage through supply chain volume and utilization of fixed overhead. The added benefit of this production increase is the creation of well-paying, flexible and sustainable advanced manufacturing jobs in the region.

I would like to add a few other comments regarding the outlined isolated manufacturing issue. Our business model, which is continuously monitoring and operating all of our power plants in the field, provided us with the ability to identify this issue. While unfortunate, we have revised and improved our manufacturing process based on our investigation and focus on continuous improvement. We have learned from this episode and expect it to be put behind us as we repair the last few identified stacks.

Finally, our integration of the previously announced acquisition of Versa Power Systems, a leading developer of solid oxide technology to be used in sub-megawatt stationary advanced military and storage applications, is going as planned. We purchased the remaining shares of Versa Power Systems to position our company to benefit from the large adjacent market opportunities that complements our commercialized molten carbonate products for megawatt applications. We are in discussions with some of our existing global partners and others to develop a global technology footprint and supply chain to commercialize this technology. Further details will be announced later in 2013.

Please turn to Slide #8, North American Market Update. Construction on the 14.9-megawatt turnkey fuel cell park in Bridgeport is on schedule. United Illuminating, the local utility that owns the electric grid in Bridgeport, is currently performing interconnection work involving 3 substations. In late February, we met with senior executives from Dominion at our manufacturing facility, and we then toured the Bridgeport construction site. The site work is proceeding on schedule. We are now preparing site pads for 5 power plants. The first fuel cell module will be delivered in April. It is very gratifying to see this vacant remediated brownfield site being converted into a valuable asset for the community and the project owner. Our sense of excitement about the project apparently extends to utilities employees as well because United Illuminating and Dominion each recently featured the project in their internal company magazines.

High levels of activity in our sales pipeline point to numerous near-term opportunities for new orders in multiple states. We are continuing to work on opportunities associated with 3 state-level programs in Connecticut. I am optimistic that seeing activity under the low emissions renewable energy credit program as there is clear need for the technology and the LREC program offers attractive economics. We have several megawatt-sized projects with a broad range of customers under development nearing closure and submittal in the program's next round. We believe that significance of closing the Bridgeport fuel cell park project will enable additional projects in Connecticut's Project 150 program. We're actively working on nearly 20 megawatts under this program with potential project investors. We continue to develop these projects to closure based on the experience and broad-based support established from the Bridgeport project.

The activity in California is at the highest level we have seen in the past few years. We have multiple large projects for universities, municipalities and industrial applications that are in the final stages of development. We have been selectively adding sales and support resources to take advantage of the opportunities in the market.

New Jersey has a new market expansion opportunity, very attractive to us in terms of financial incentives for clean distributed generation, with combined heat and power capability such as we offer. We've recently added resources and have originated a robust pipeline of projects for our megawatt-class solutions with large, well-known prospective customers. We recently announced a contract to demonstrate the tri-generation stationary fuel cell power plant near Vancouver, Canada using landfill gas as a fuel source. In addition to generated ultra-clean electricity, the plant will supply high-quality heat in the form of hot water to a greenhouse operator and renewable hydrogen for the vehicle fueling or industrial applications.

Few clean energy technologies developed today are capable of utilizing landfill gas on-site, making landfill applications a large potential market for our DFC power plants. As this project illustrates, our core technology is highly versatile and is unique in its ability to solve customers' energy and environmental challenges such as the safe and cost-effective disposal of landfill gas, while simultaneously generating multiple revenue streams. This makes an attractive solution across multiple vertical markets, gives it broad commercialization potential and supports revenue diversification.

Please turn to Slide 9, Asian Market Update. POSCO Energy is rapidly moving forward with the construction of the 59-megawatt fuel cell park in South Korea. Partial power production will begin this year and the historic park is expected to be completed and fully operational in early 2014. The photo in the accompanying power plant presentation shows a number of the 21 DFC3000 power plants that will comprise the finished park. Each will generate 2.8 megawatts of ultra-clean reliable power, plus heat that will be supplied to the district heating system. 10 plants are currently in the process of being installed. DFC power plants and fuel cell parks like these are helping South Korea utility companies meet clean energy mandates under the government's ambitious Renewable Portfolio Standard. The current RPS program is accelerating demand for fuel cell power plants due to its compliance requirements, both in terms of megawatts needed and financial attractiveness. As such, POSCO has a tremendous pipeline of potential projects in Korea and has also expand its activity in Asia. Multimegawatt fuel cell parks are showcasing the sustainability of our DFC technology for power grid applications, while illustrating the attractiveness of large-scale distributed generation fuel cell projects to developers, electric utilities, gas companies and investors.

We have just returned from South Korea, Friday, after a very productive and strategic meeting with the senior POSCO officers and leaders of POSCO Energy's fuel cell business. This partnership has tremendous growth opportunities in addition to the execution of our licensing agreement signed in late 2012, which includes the design of the fuel cell component manufacturing into Pohang, South Korea campus. Increased production volume gives us additional leverage with our suppliers, contributing cost reduction and we gain a second source of supply, while to income from Asian sales by POSCO Energy will contribute to our bottom line profitability.

Following the successful installation and operation of 2 demonstration units, POSCO has begun expanding its 100-kilowatt building applications program in South Korea. This program is an addition to the RPS program that has significant growth potential, and we just received the joint development contract to accelerate commercialization. This smaller scale unit uses the same fuel cell components as the megawatt class plants, growing volume for any of the DFC products will lead to product cost reductions for both FuelCell Energy and POSCO Energy.

Please turn to Slide 10, European Market Highlights. We are establishing an installed base, utilizing the direct selling and service business model and building market awareness in Europe with the help of our FCES, GmbH joint venture partner, Fraunhofer IKTS and business partner, Abengoa. Our strategy has involved seeing the market with high visibility installations, most recently with the stationary fuel cell power plant to be installed with an environmentally advanced 38-story office tower in central London as we announced in December. Another plant in London serving the Crown Estates is presently undergoing commissioning. Once operational, there will be a showcase installation due to its location in a building in the heart of London and is both a Class A office space and popular destination for shoppers and tourists.

Germany-based FuelCell Energy Solutions with administrative offices in Dresden and manufacturing operations in Ottobrunn is manufacturing components for the London plants. We will leverage European manufacturing capacity with additional European order volume.

In January, FuelCell Energy solutions entered into a multi-year service agreement for a stationary fuel cell power plant owned by ewz, one of the largest utilities in Switzerland. FCES will operate and maintain the plant from our European-based operation centers. Relationship with the European utilities such as ewz carry with them the potential for future megawatt-class sales. Although the financial impact of this contract may be small, it illustrates the large potential of European market.

Our European sales pipeline for megawatt-class power plants is growing. I've been meeting with members of the German Federal Government who value the attributes of our technology and are supportive of our efforts. I'm pleased with the pace of progress and optimistic about closing near-term opportunities.

We are in discussions with Fraunhofer IKTS leadership regarding further adjacent business opportunities and projects. We're also in discussions with Abengoa regarding expanded business opportunities that we outlined in our original agreement. These were both envisioned as a natural progression of our plans to penetrate both the European and Latin American markets.

Please turn to Slide 11, Summary. We are building on a solid foundation for global growth supported by our strong backlog and demonstrated by the construction of 2 major fuel cell park projects on 2 different continents. The production ramp will increase our revenues, expand margins and contribute to profitability. We are creating jobs and earning attention and support from government officials. During this process, we will stay focused on quality and continuous improvement. Our European presence expanded with another high-profile project in England, a service agreement with a major Swiss utility, plus production in our German manufacturing facility and we entered into a promising new market in North America with a landfill gas application in Canada. High-profile projects in Asia, the U.S. and Europe are catching the attention of prospective customers and policymakers. I'm encouraged by the strong activity levels in our global megawatt sales pipeline and optimistic about our continued growth prospects.

I want to recognize our talented team of associates for their achievements, and I sincerely thank our investors for their continued loyalty and support.

Operator, we'd be happy to take questions at this time.

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from Ajay Kejriwal with FBR Capital Markets.

Ajay Kejriwal - FBR Capital Markets & Co., Research Division

So a nice update on the Bridgeport project. I know it's a marquee project in many ways, and sounds like you're getting more interest from other customers. So maybe just provide any more color or anecdotes in terms of what you're seeing there. Are there any projects that you're now getting closer to signing the finish line?

Arthur A. Bottone

Yes, Ajay, this is Chip. I'll take that. We -- that was kind of a watershed thing. And there are other people, frankly, involved in that project that before we awarded it to Dominion. So I think the fact that Dominion got involved in that, we've had further discussions with Dominion about what could be the next projects. And in fact, Mike is working with other prospective financers on projects that we've got developed significantly along the line of what we did with Bridgeport. And that -- there's projects in both Connecticut, New Jersey and California that in most cases are a little bit smaller but still multimegawatt projects of interest to -- of size. But there's also some bigger ones. I can't exactly identify what they are just due to the competitive nature of things, but I will tell you that, that was a huge help in getting other people's interest and kind of knocking through the financing of it.

Ajay Kejriwal - FBR Capital Markets & Co., Research Division

Good. And then any update on the progress with the supply chain as you ramp up to 70 megawatts? Have you seen any bottlenecks in the supply chain or are they kind of ramping up along with you? And then have you been able to get any leverage on account of the higher volume?

Arthur A. Bottone

On the leverage side, first of all, absolutely yes. We continue to see those costs drop as we've reported it. The big part of the path to profitability for us is the product cost reducing. And we're seeing that actually come through with the increased volume. I mean there's some minor bottlenecks, but Tony and the team are managing through those, nothing that would stop us from going to the 70-megawatt level, which we're doing right now. The hiring to support that, if it's not completely done, it's well on its way. So we're pretty comfortable with where we are on that and then, of course, the next plan will be to go even higher. So we're careful. This minor manufacturing issue we mentioned here -- we put a lot of different process changes in place, so that won't repeat either. So we feel pretty comfortable with the progress we're making.

Ajay Kejriwal - FBR Capital Markets & Co., Research Division

Good. And then I like seeing the more detail that you're providing on the top line, you're breaking out in your segments, so that's helpful. Just maybe a little more color on the service segment costs, what's included in there? Did you include that warranty expense for the quarter in that line?

Michael S. Bishop

It's Mike. On the -- really, the warranty expense is divided into 2 lines. It really depends on the timing of when the unit was installed. So some of it is in cost of sales and some of it is in the service line.

Ajay Kejriwal - FBR Capital Markets & Co., Research Division

Got it. And maybe one last one for me before I pass it on. So the admin selling expenses, I know you've mentioned business development costs in the quarter, so how should we think about this line going forward? Is it more around the run rates around what -- where you saw last quarter or does it change from here?

Michael S. Bishop

No, Ajay, I'd say the total in the quarter is a good proxy for how to think about the rest of the fiscal year for that line.

Operator

Our next question comes from Sanjay Shrestha with Lazard Capital Markets.

Sanjay Shrestha - Lazard Capital Markets LLC, Research Division

A couple of question. So Chip, when you talk about significantly increased level of activity in markets like California, right, so what's causing that now? Is it the reduced cost and therefore, the economics? Or is it the financing being more available, or what's sort of driving that uptick in level of activity in multiple markets for you guys?

Arthur A. Bottone

I thought you would ask me that question, actually. Yes, so it's multiple things. It's, first of all, the market has transitioned to more of a financing market than a buying market. That's kind of a natural progression when you're building bigger and bigger plants. If you remember years ago, we did small plants and in 2010 and beyond, we've really been focused on megawatt plants. And so getting that in place wasn't the easiest thing to do and again as I mentioned before to Ajay, having a lot of projects financed now, both in California, with time on those projects and then, of course, Bridgeport was a huge help for that. The other thing is that we do have a new team out there that's doing a good job, and we're working from our references that we have out there. And then the last thing is we've been working on some policy things that are not necessarily dollar value, but things like some other things that would in the past be obstacles, interconnection, things like that. So I'd say that the lion's share of the driver is the financing, but I don't want to minimize some of the more tactical things that we had to achieve as well.

Sanjay Shrestha - Lazard Capital Markets LLC, Research Division

Got it. Okay, okay. Now when you sort of talked about this landfill project in Vancouver, right, this is obviously a pretty attractive opportunity specific to you guys. But when I think about the potential size of this market, how big could this market turn out to be for you guys?

Arthur A. Bottone

What's different about that project, I mean, that's a demonstration project. It's a small project. But what we look at here is that we're going to use the gas on-site. That's the difference, okay? So when you -- there's a lot of these landfill sites that are kind of landlocked, if you will, because they don't have the demand on the site, and you really have to get PPAs in place to basically get the economics attractive, so I wouldn't say it's certainly, I think, it's second to wastewater relative to the renewable market. It's fairly sizable. The question is, we have to be able to get the PPAs in place to make it happen. But technically is really what we're solving with this project in Vancouver, we can do this, which is really going to be helpful to people when they say, "Okay, where have you done it?" We can say we've done it.

Sanjay Shrestha - Lazard Capital Markets LLC, Research Division

Got it, okay. So 2 final questions for me then, guys. So the onetime warranty issue, which sort of negatively impacted the gross margin, so what was the biggest surprise element there as to that it happened and how have you sort of soundproofed your processing to make sure that it doesn't happen again? And as it relates to that, given it's a margin expansion story related to that question, how do I think about the margin embedded in your current backlog and how do I think about the contribution margin as you ramp up your capacity to 25%?

Arthur A. Bottone

Sanjay, I'm going answer the first part of your question. I'm going to ask Mike to answer the second part of your question. Let me just be clear, we're not happy about the incident at all, okay? We're not proud of it, but what I am proud about is the fact that our business model allows us to catch things like that, and we quickly fixed it. We've got things in place now that will prevent that from happening in the future, which we didn't have in the past. So like any industrial company, you kind of learn from things, and you move on and make sure you don't forget what you've learned. So I'm comfortable that we've got that. Relative to the margin, I'll let Mike comment on the margin going forward because, I mean, we'll see a significant positive change in the margin from what you saw this quarter.

Michael S. Bishop

Sure. So what I would say is clearly with this issue behind us and the ramp that we're doing in the second quarter, we're ramping up production by 25% in the second quarter during the course of the quarter. So when you think about revenues, you'll see a significant percentage increase in the 20% to 25% range and as we bring that ramp on and margins will expand as well with the warranty issue behind us with leverage from the factory and from the supply chain as well. When we think about the business model going out a couple of quarters, we're targeting margins in the double digit range. So we would expect nice expansion here during the rest of the fiscal year.

Sanjay Shrestha - Lazard Capital Markets LLC, Research Division

On top of the [ph] gross margin?

Michael S. Bishop

Yes.

Sanjay Shrestha - Lazard Capital Markets LLC, Research Division

Okay. Well one final question then, guys. So, Mike, I think you mentioned in your prepared remarks or it might have been Chip, you said you mentioned about additional source of financing, right? So as you go out and really look for the project for some of this highly attractive IRRs, project in Connecticut and other evolving markets. One, what is that discussion like now versus 12 months ago? And two, what is the biggest pushback you guys get in terms of getting access to that sort of the commercial debt if you would?

Michael S. Bishop

Sure, I mean, certainly, it's a much easier discussion now than it was 12 months ago. We made dramatic changes to the overall strategic standing of the company with significantly higher backlog. If you look at our backlog, we have backlog stretched out through 2016. We will be fully utilizing the Torrington facility. We have a second source of supply now in Korea with POSCO's investments in Korea. POSCO has made a significant investment into FuelCell Energy, 16% owner of the company. So those discussions with financiers go very well because you can see the long-term business model here. We expect to attract strong financing into our projects this year. We want to -- we are being careful. We want to work with a couple of repeatable, both customers and finance partners. We don't want to do a couple -- a lot of one-off transactions that can't be repeated. So we are really trying to design a project financing portfolio approach that works for us a long time and into the future.

Operator

Our next question comes from Walter Nasdeo with Ardour Capital.

Walter Nasdeo - Ardour Capital Investments, LLC, Research Division

Most of the stuff that I wanted to talk about has already kind of been touched upon. I do have one quick question on the assembly issue that you dealt with. Was any of it shipped over to Korea or was that mostly over here? And were there any issues as far as having to go and risk losing a customer over this?

Arthur A. Bottone

Walter, the actual period of when some of these -- these were cells -- I mean, in Korea, we ship cells or kits and then obviously, we make modules here. The period of time was kind of mid-2011 to 2012, and yes, we've got a variety of different customers that were affected, and we're working with, with all those at the same time. So I think everybody's circumstances are a little different, but we've got solutions in place for all those affected.

Walter Nasdeo - Ardour Capital Investments, LLC, Research Division

Okay. And then if I could just circle back to one of Ajay's questions about your supply line coming in with your ramp, and maybe you mentioned and I missed it, but have you -- do you currently -- are you in the midst of building a secondary and tertiary source of supply so that when you start ramping up, there's no issues with that?

Arthur A. Bottone

Yes, it's a great question. I mean, we -- early days is what we have here, we sometimes are self-sourced to certain suppliers just due to the technical nature of what the component was. Our operations team has worked real hard in trying to find multiple sources not just multiple sources, perhaps in low-cost countries as well. So I think we're in pretty good shape relative to that. I mean we have an extensive risk management process that we use on the supply chain, which looks at everything from financial to technical capabilities to session planning, what have you. So I think we're pretty comfortable with that. And that really wasn't the driver of this issue that we had that we just talked about. So...

Walter Nasdeo - Ardour Capital Investments, LLC, Research Division

Okay, good. And then when are you expecting to hit this 70-megawatt run rate? Is that going to be midyear or so?

Arthur A. Bottone

Yes, right now, Walter, it's -- we're looking for May 1, so, say, May forward, yes?

Operator

Our next question comes from Jeff Osborne with Stifel, Nicolaus.

Jeffrey D. Osborne - Stifel, Nicolaus & Co., Inc., Research Division

I just want to understand specifically what are you doing to get up to 70 megawatts? There's been a lot of discussion about the timing and why you're doing it, but what physically do you have to do in terms of added equipment or training of personnel? You mentioned that you're hiring some people, but what's the CapEx impact?

Arthur A. Bottone

The CapEx impact is really minimal, Jeff. There was really 2 things. It was the people, so we started recruiting for it maybe about 6 weeks ago or so. And that's well in hand, if not almost complete. There's obviously training that goes with that and some other adjustments in the shift duties and things. And then from a supply chain thing, that started as well because we can't -- it takes us several months to kind of build up the flow through the factory. So that's really what we're on with now and making sure that we're not -- we're maintaining both the necessary volume, but also that the quality of the different components that we need. So I think you've been to Torrington. We can ramp that once we have the people in place, and they're trained properly and then the supply chain responds as well. So we -- that all will be done as we hit that number in May.

Jeffrey D. Osborne - Stifel, Nicolaus & Co., Inc., Research Division

Okay, and how do we think about given that -- I don't believe you have expanded capacity in the recent future or at least since you've been there, Chip, in the past, and so how do we think about Mike's goal of getting kind of double-digit gross margins versus the typical teething things that most companies have as they expand capacity. Should we be pretty conservative from a gross margin perspective this quarter and even the quarter after that? And then it's really the final quarter of the year that should be kind of that proverbial hockey stick-up into the double digits or what's been the runway just as you have potential throughput issues or bottlenecks or slowdowns?

Arthur A. Bottone

So Jeff, I mean, that's a great question. I think you're spot on there. I mean, we had some inefficiencies built into this current quarter's performance. As a result of that I said we started hiring some people already and there's training involved and things like that. So we didn't get all the leverage because in some cases from an overhead spending perspective, we had to spend the money to get the ramp going. So I think Mike touched on that. I'm not sure what we called it, but I think we called it some inefficiencies during this quarter as a result of that. But that will flow through and with the 25% increase, I mean, it leverages up pretty nicely. So...

Jeffrey D. Osborne - Stifel, Nicolaus & Co., Inc., Research Division

Okay. So you'll start seeing kind of the leverage in the October quarter? Is that fair?

Arthur A. Bottone

No, you'll start to see it this coming quarter.

Jeffrey D. Osborne - Stifel, Nicolaus & Co., Inc., Research Division

You will see. Okay. I wasn't sure. In response to Walter's question, you said it will be done in May, so I wasn't sure if there's still teething issues now.

Michael S. Bishop

Jeff, it's Mike. So we'll have more volume coming through the quarter through the second quarter because we've already started the ramp in the second quarter. We won't be at that 70-megawatt rate yet until -- for a full quarter until Q3. And as far as margins, yes, we would expect margin growth in the second quarter. We'll get the most leverage as we get closer to the end of the fiscal year as folks are fully trained. And we are really taking the inefficiencies out of the system. So we'll see growth during the year.

Jeffrey D. Osborne - Stifel, Nicolaus & Co., Inc., Research Division

Perfect. And then just if we could switch gears quickly to Europe, how do we think about the financing environment in particular in that region, given the lack of kind of historical projects that you could point people to relative to the U.S. and Asia, is kind of question number one. And the second part of that is -- your facility in Dresden, I think you mentioned from a manufacturing perspective, what would be the CapEx requirement for that more likely, I guess, next year, next fiscal year, but what's the expense profile of that particular facility assuming some of these -- this pipeline activity actually converts?

Arthur A. Bottone

So on the activity, Jeff, as I kind of mentioned in my comments, I mean it's kind of the typical market entry model that we've seen elsewhere in the world, even in Korea and the U.S. where as we started with these smaller sub-megawatt type projects. If I look at the quote activity, I think and if they were here even our folks in Germany would say,"Geez, we didn't realize there was that much interest in megawatt-scale stuff." And part of that was because the prior people in the marketplace didn't have a product so it's pretty hard to sell something you don't have. So the facility that we have in Ottobrunn, which is actually in Munich, the office in Dresden is just kind of a where we have the -- it's an office in Fraunhofer's building where we actually have the company incorporated. But the Ottobrunn site, which is just a little outside of Munich, is where we have the manufacturing facility. That really can do sub-megawatt stuff modules and obviously balance the plant projects so that's what we're using it for. The CapEx is really minimal for what we need. It's -- we're operating, and we've done that because of the agreement that we have when we took the business over from the former owner. So our challenge right now is, how do we build the backlog of megawatt stuff and then that might drive some further CapEx requirement depending on how we do it, okay?

Jeffrey D. Osborne - Stifel, Nicolaus & Co., Inc., Research Division

Got you. And just in general, the financing availability in Europe, is that more constrained than the U.S. market?

Arthur A. Bottone

On all these projects, they're really purchased as we saw before. Right now, we started a dialogue about maybe financing projects, but financing right now due to the current incentive structure and the size of the projects really isn't the driver right now. It's more or less matching up the value proposition or the financials to the project itself. So I would say we're a little bit early for the financing aspect. In the future, would that come to play? Perhaps, but right now, that's not a constraint.

Operator

I'm not showing any other questions in the queue at this time. I'd like to turn it back over to management for closing comments.

Arthur A. Bottone

Well I'd like to thank everybody for their comments and attending the call today, and wish everybody a great day, and we'll talk to you on the next call. Thank you.

Operator

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the conference. You may now disconnect. Good day.

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