FuelCell Energy, Inc. F1Q10 (Qtr End 01/31/10) Earnings Call Transcript

Mar.11.10 | About: FuelCell Energy, (FCEL)

FuelCell Energy, Inc. (NASDAQ:FCEL)

F1Q10 (Qtr End 01/31/10) Earnings Call

March 11, 2010 10:00 am ET

Executives

Dan Brdar – Chairman, President and CEO

Joe Mahler – SVP, CFO, Secretary, Treasurer, and Corporate Strategy

Analysts

Burt Chao – Simmons & Company

Sanjay Shrestha – Lazard Capital Markets

Meghan Moreland – Ardour Capital

Mark Sigal – Canaccord Adams

John Roy – Janney Montgomery Scott

Operator

Good morning, everyone and welcome to FuelCell Energy's first quarter results conference call. Delivering remarks today will be R. Daniel Brdar, Chairman and CEO and Joseph G. Mahler, Senior Vice President and CFO. The earnings press release is posted on our website at www.fuelcellenergy.com and a replay of this call will be posted two hours after its conclusion. The telephone numbers for the phone replay are listed in the press release.

Before proceeding with the call, I'd 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 the U.S. Securities and Exchange Commission.

Now, we'll turn the call over to Dan Brdar.

Dan Brdar

Thank you for joining us this morning. Clean energy is increasingly driving today's global economy. The recent increase press coverage of fuel cells highlights the growing recognition that clean, highly efficient base load power generation is a critical part of the solution. Around the world, policy makers and power producers are seeking clean, efficient distributed power to reduce pollution, enhance their energy independence and create green jobs.

As the world's leading manufacturer of ultra-clean, highly-efficient fuel cells, FuelCell Energy has a unique first mover opportunity to capitalize on that demand. FuelCell Energy is the only manufacturer of commercial megawatt class fuel cells for base load generation.

Our stationary fuel cells are proving themselves in diverse markets around the globe from Asia to North America, where they've generated hundreds of millions of kilowatt hours of electricity. Driven to find solutions that are available today, not tomorrow, power producers, businesses and governments are looking to fuel cells to address their clean energy needs.

At the same time, our products are suddenly becoming more economical to manufacture. Our cost produced megawatt class fuel cells are now in production. These fuel cells are as versatile as ever operating on a variety of fuels, biogas as well as natural gas with the highest available electrical efficiency in their size category and with high operating availability.

With momentum in our key markets and a robust growing project pipeline, policy initiatives and rebounding credit markets will help convert this pipeline into orders. I'll say more about our company and markets after Joe Mahler, our Chief Financial Officer reviews the financials for the quarter. Joe.

Joe Mahler

Thank you, Dan, and good morning, everyone. FuelCell energy reported total revenues for the first quarter of 2010 of $14.6 million compared to $21.7 million in the same period last year. Product sales and revenues in the first quarter were 12.8 million compared to 19 million in the prior year quarter.

Overall product revenue was driven by the product's mixed changing from complete power plants in the prior year to primarily stacked modules in the current period. The company's product sales backlog including long-term service agreements totaled $84.1 million as of January 31, 2010 compared to $70.9 million as of January 31, 2009 and $90.7 million as of October 31, 2009.

Product margins improved over the prior quarter by $4.7 million driven by sales of lower cost megawatt class modules. The product cost and revenue ratio improved 7% to 141 to 1 in the first quarter compared to 152 to 1 in the first quarter of 2009. The ratio was negatively impacted by commissioning related cost in South Korea and lower sales.

Research and development contract revenue was 1.8 million compared to 2.7 million in the prior year quarter. Research and development revenue declined due to completion of the company's Vision 21 and Ship Service Fuel Cell contracts with the U.S. department of energy and the navy.

The company's research and development backlog totaled $11.9 million as of January 31 compared to $23.1 million as of January 31, 2009 and 14.2 million as of October 31, 2009. The air products contract we announced this morning will add to that backlog.

Net loss to common shareholders for the first quarter of 2010 of 15.4 million or $0.18 per basic and diluted shared improved 26% compared to the prior year quarter net loss to common shareholders of $20.7 million or $0.30 per basic and diluted share in the first quarter of 2009. This improvement was due to sales of higher margin products and companywide cost reductions.

Total cash in investments and U.S. treasures were $57.6 million as of January 31, 2010. Net cash used for the first fiscal quarter was $7.2 million compared to $23.2 million in the fourth quarter of 2009. Net cash has improved over the prior quarter from increased customer milestone payment as FuelCell Energy completed commissioning of a number of power plants in South Korea.

We continue to see cash use in the 10 million to 12 million range, plus or minus working capital timing per quarter. Capital spending for 2010 first quarter was approximately 600,000 and depreciation expense for the period was $1.9 million. Before I close, let me spend a couple of minutes discussing the results of the quarter focusing on sales margins and cost ratio.

Starting with sales, there were two primary drivers to the lower reported sales. We recorded sales for the same amount of megawatts produced in the current and prior quarters but the sales value was lower as we shifted from complete power plants to modules to support POSCO power. With approximately one-third less sales value for modules, you can get to the reported sales in the quarter compared to the prior year.

The second driver remains slow North American sales. Our expectation is that California, Connecticut and Canada should be driving growth. The completion of the loan guarantee process for 27.3 megawatts which has a potential project value over $135 million should begin to clarify the order pipeline.

At the same time, we see progress on the partnering financing front in California and continued progress on the regulatory front in Canada, all of which should enable order flow in 2010. Our back log remained strong at 38 megawatts or 84 million and we expect POSCO power to also add the backlog in 2010 as they placed their next order to support their production in the Korean market.

Dan will speak more to the markets in his comments. Moving to margin and the cost ratio, margin improved by $4.7 million over Q1 2009 driven primarily by lower manufacturing product cost which is a good result. The margins in the quarter were negatively impacted by the remaining Korean commissioning costs which are now resolved.

How the cost ratio reacts is interesting. We use the cost ratio to give period over period comparison, but the mechanism can sometimes not fully capture the results. In a period of lower sales like this quarter, the impact of items like the commission and cost can be magnified. For demonstration purposes, if you had revenue from complete power plants in the quarter instead of modules, the ratio would move 10 basis points lower with the same below-the-line cost structure. The conclusion, I draw, that our manufactured cost of modules and power plants are on target.

With our costs in line, we are focused on driving volume to enable profitability. Dan.

Dan Brdar

Thank you, Joe. In 2009, FuelCell Energy achieved important milestones that position us solidly for future growth. During 2010, we'll build on our success, continued on our path to profitability by aggressively driving down costs and increasing order flow in our key markets.

We're focused on converting our project pipeline in the backlog. Government initiatives in loosening credit markets are increasingly supporting these efforts. With our products generating clean energy and geographic markets like South Korea, California, Connecticut and Canada, we're beginning to expand in key vertical markets, grit support, gas distribution pipelines and biogas waste water applications. We'll expand geographically as well forging new partner relationships in Europe.

During 2009, we succeeded in putting our new cost reduced megawatt class products into production. Since the commercialization of our megawatt class products, we reduced the unit cost of those products by more than 60% reflecting our steadily improving cost to revenue ratio.

Our new 2.8 megawatt power plant is currently going through operational and third party certification testing and the first units will soon be deployed to customer sites. As production volume increases, further cost reduction will be achieved through expanded global sourcing, higher volume purchasing, more competition among suppliers and increased capacity utilization in our facilities.

Last year, we received orders for more megawatts of products than in any prior year in our history. Nonetheless, tight credits and North America slowed financing for capital projects of all kinds, including power projects. We continue to see evidence of improvement in the availability in terms of commercial project financing.

Multiple project finance entities are actively engaged with us, investing their time and money analyzing our projects and we're also working with our customers and distribution partners to help them secure commercial financing. Looking at our key markets, South Korea's low carbon green tech energy policy continues to drive fuel cell adoption in this part of Asia. It appears likely that the government of South Korea will enact an ambitious renewable portfolio standard or RPS.

The RPS successfully passed through the knowledge economy committee of the national assembly in February and is expected to be enacted into law by the full national assembly. The RPS will require electric power to be generated using clean energy technologies and will include stationary fuel cells operating on natural gas.

The requirement will increase each year to 4.3% of the installed capacity by 2015 and fully 10% by 2022. This equates to approximately 2800 megawatts and 7,000 megawatts respectively. The program, as submitted to the national assembly includes incentives for 2011 participants which we expect will drive 2010 orders.

Due to their rapid rate of growth, Asian economies like South Korea’s are experiencing a rising demand for energy to support their growing economies. Most of their fuel is imported and expensive and their solar and wind profiles are limited and this drive implying highly efficient cost effective solutions that operate continuously. Our fuel cells fill this need.

During 2009, we concluded a long-term licensing agreement with POSCO Power, our partner in South Korea, enabling them to manufacture, test and condition fuel cell stack modules using components supplied by FuelCell Energy. We're working with POSCO Power as they build their new fuel cell module facility next to their balance of plant facility in Pohang. The expansion is expected to be completed in the fall.

Our evolving relationship with POSCO Power provides domestic content that supports South Korea energy policies increases orders for components we manufacture in the U.S. and allows us to further reduce the cost of our products for the Asian market. During the last two years, POSCO Power has ordered 69 megawatts of our products primarily for our multi-megawatt FuelCell power plant.

More than 24 megawatts FuelCell Energy power plants are operating in South Korea, including our first six 2.4 megawatt DFC3000 power plants. These feed the electrical grid supplementing the energy produced by traditional central power plants.

At several locations, byproduct heat provides heating and cooling for nearby buildings. These installations show the role fuel cells can play for utilities, meaning grid support, fulfilling RPS goals and building out a smart grid using clean distributed generation.

Here in North America, we're witnessing a growing appreciation for the economic and environmental value of stationary fuel cells. More and more, energy efficiency is being viewed as a practical cost-effective way to reduce carbon emissions and conserve finite resources.

Reserves of natural gas, our cleanest fossil fuel are currently estimated at 100 years at the current rate of consumption. By using more efficient generators like our power plant the available life of that resource can be extended. As a result of expanded domestic gas production, natural gas is playing an increasingly important role in federal policy. Last week, Senators Graham, Kerry and Lieberman proposed energy legislation that incorporates new incentive for a variety of clean energy sources including natural gas. The bill is intended to achieve cleaner air, create jobs and further our energy independence. The Senators we’ve the initiative we have broad appeal to both liberals and conservatives alike.

California continues to be a leader in clean energy generation. It extended in its Self-Generation Incentive Program through 2015. Under this program, qualifying fuel cell projects are up to three megawatts are eligible for incentives of up to $4,500 per kilowatt when operating on biogas and up to 2,500 per kilowatt are natural gas. There's about $200 million in the program at this time and ongoing funding is expected to be roughly 83 million annually.

Many projects in our California pipeline are wastewater treatment facilities. Faced with declining tax revenues, municipalities have been forced to review capital expend just carefully So the extension of the Self-Generation Incentive Program offers municipalities a power incentive to move forward with fuel cell energy projects that would help them reduce their energy costs. The City of Tulare in California is using our fuel cells to generate power for its wastewater treatment facility.

During the first quarter, they city purchased the four DFC300 fuel cell unit that will upgrade the facility stacks of power output to roughly a megawatt or more then 40% of the electricity needed to run wastewater treatment operation. Our fuel cells are specially well suited for wastewater treatment facilities, food and beverage processing plants and similar combine heat and power applications.

In the process of generating electricity, our fuel cells produce high quality heat as a byproduct and operate on a wide variety of fuels, including bio gas. The heat produced by our fuel cells is used in wastewater facilities anaerobic digester or the biogas produce by digester is using the fuel cell to reach electricity. Systems like this can deliver an overall efficiency of 90% and reduce energy costs substantially.

California lawmakers are attempting to promote clean energy products with feed-in tariffs that will back power producers to export excess electricity back to the grid. A feed-in-tariff for power plants using renewable fuels was enacted last October and the California Public Utility Commission is working to set pricing with utilities and other regulators. Another feed-in-tariff for combined heat and power applications was also signed by the governor and it is expected to be implemented after the renewable fee-in-tariff.

While the feed-in-tariffs go through the implementation process, we expect that the credit will return to the market and the SGIP and federal investment tax credit will provide an attractive incentive for customers just to begin prior to the credit crisis. In addition, we're working with California utilities to implement cell purchase program where utilities would buy our fuel cells and cell the power to their customers. Although this initiative is in early stages, it has tremendous potential.

Our pipeline of projects in Connecticut will benefit from improving credit markets and government programs. To date, Connecticut's Department of Public Utility Control has approved 43.5 megawatts of fuel cell projects under the state's portfolio standard. We submitted applications for these projects to the department of energy's $6 billion loan guarantee program. We received official notice from DOE that over 27 megawatts of the projects received Phase I approval. We're now preparing material for the Phase II applications which we'll be submitting in the next couple of weeks. We'll keep you apprised of our progress.

In a parallel effort, we're also working closely with commercial lenders, for both individual projects and the entire Connecticut project portfolio. In February, Connecticut Senator Chris Dodd proposed two initiatives that could significantly expand the stationary fuel cell market. Senator Dodd proposed that $100 million be allocated to the 2005 Energy Policy Act to enable federal agencies to purchase fuel cells. He's also planning to propose legislation to increase the Federal Investment Tax Credit from 30% to 40%, up to $3500 per kilowatt for fuel cells in combined heat and power applications.

Fuel cell energy power plants provide increased power reliability, improved energy security and energy independence. The resulting demand for fuel cell power plants can drive increased U.S. manufacturing and create new jobs. A tax credit was in part responsible for attracting financers to fuel cell projects initially and an ITC increase will help projects in our pipeline.

In Canada, we're working in conjunction with our partner Enbridge to develop the large natural gas pipeline market. The government of Ontario ruled in September that gas distribution companies, such as Enbridge, may own and operate power plants that generate both electricity and heat including fuel cells, operating on natural gas, up to 10 megawatts per facility. We expect that the Ontario government will implement a revised feed-in tariff to encourage the installation of clean energy generation for fuel cells operating on natural gas.

Enbridge conducted assessment of the gas distribution system in Toronto, Northeastern U.S. and California and identified 250 to 350 megawatts of opportunities for joint projects. Currently, they are negotiating with the Canadian government for funds from the Green Infrastructure Fund to support 47 megawatts of DFC-ERG projects on their system in Toronto.

The $1 billion Green Infrastructure Fund is part of Canada's economic stimulus plan, similar to our American Recovery and Reinvestment Act to create green jobs by making investments in the country's infrastructure. The decision on the amount of funding is expected subsequent to passage of Canada's 2010 budget in the second quarter.

In support of these efforts and DFC-ERG opportunities under development in the U.S., this morning we announced the operating results of our first DFC-ERG pipeline power plant. The operating assessment was done by an independent third party who conducted an in-depth assessment of the unit operating at Enbridge's facility in Toronto. The report will be published later this year. But it concludes that the DFC-ERG achieved an average electrical efficiency of 62.5% and at times achieved over 70% efficiency under certain operating conditions. This level of electrical efficiency sets a new benchmark in the power generation industry and demonstrates the ability of the DFC-ERG to significantly reduce fuel costs and carbon emissions.

Europe is another exciting market opportunity for us. Our license agreement with our former European partner concluded in December and we're in discussions with potential new partners. Because Europe is a highly diverse market, in terms of energy demand and policy, we envision working with multiple partners. As we evaluate prospective partners, we are crafting a strategy that will consider Europe as a whole. Depending on the circumstances, we may partner with the distributors or form value-added reseller relationships like we have with POSCO Power.

Fuel cells were developed with support from the Department of Energy and our work with the government continues to be fruitful. In 2009, we received multiple contracts from the Department of Energy and Department of Defense.

In February, we were awarded $2.1 million from Air Products and Chemicals and the Department of Energy to demonstrate our DFC-H2 and state of the art refueling station at the Orange County Sanitation District wastewater treatment facility in California. The DFC-H2 combines our DFC300 Fuel Cell Power Plant within Air Product and Chemical's gas separation system to produce electricity and heat while co-producing pure hydrogen that can be used for transportation, utility and industrial purposes.

In this demonstration project, our DFC-H2 will use biogas from the wastewater facility to generate 300 kilowatts of power. The system also produces usable heat for the facility and efficiently co-produces up to 300 pounds of hydrogen per day, enough to support a fleet of over 100 fuel cell cars. While we're working under a $32.2 million DOE contract for phase II of a 10 year program, dedicated to developing megawatt class, coal-based solid oxide fuel cell power plants.

As many of you know, we have a 39% ownership interest in Versa Power Systems, a pioneer in solid oxide fuel cell development. Recent press coverage has brought a lot of attention to this part of our business. Together with Versa, our team has met all of its DOE milestones for technical performance and cost and is currently working on a scale up of other technology to 25 kilowatts.

The full scale model we're developing will be 300 kilowatts, incorporating a number of smaller units. This technology is important, because it has the potential to use one of our most abundant natural resources, coal, more efficiently and cleanly than any other power generation technology available today.

There's a growing commercial and government awareness of the will and value of fuel cell for distributing generation, because they're clean and quiet, highly efficient and produce power continuously, without the space requirements of solar and wind, our stationary fuel cell can be installed almost anywhere electrical power is needed. They eliminate the need for costly and efficient transmission infrastructure, add reliability to the grid and reduce congestion.

FuelCell also enable the evolving smart grid which require both smart metering and distributed energy sources. Today, FuelCell Energy's unique value proposition is more compelling and timely than ever.

Operator, at this time we'll take questions from our audience.

Question-and-Answer Session

Operator

Our first question is from the line of Burt Chao with Simmons and Company.

Burt Chao – Simmons & Company

Thanks for taking the question, guys. Congratulations on the results and cost reduction.

Dan Brdar

Thank you.

Burt Chao – Simmons & Company

First quick question, the product mix shifted to this quarter because you were selling your component as opposed to full systems, because of the growth of the POSCO orders. Going forward, what's a good way for us to think about the model that, from the standpoint of modeling revenue, is it going to be pretty consistent? I mean is there a forecast you can provide about mixed, or is it kind of going to be lumpy, depending on when those orders are actually going to realized, out of backlog?

Dan Brdar

It's going to be a little bit lumpy, but what you're going to see is we're currently in environment where because of the impact, particularly last year the credit crisis, was coming through the P&L in terms of what we're making, shows there's a hole in terms of the order flow of that we had last year for North America. Because remember, our lead time to produce equipment is about 10 months. We're seeing the credit markets improve and as we are progressing through things like the DOE loan guarantee, you'll see the mix more balanced as we start to add U.S. order flow. And then eventually, European order flow as well back into the mix. What you're seeing right now and you'll see also probably for the next quarter is a bit of an unbalance towards what we're making for POSCO, but we would expect longer term mix start to move to a 50-50 kind of mix.

Burt Chao – Simmons & Company

Okay. Great. And then also on the cost ratio, despite the charges you have to take with the commissioning, absent those charges, can you provide kind of what that number might have been, absent, the one time charges?

Joe Mahler

Let me break down – this is Joe Mahler. Let me break down the cost ratio for you. There's really the product cost side. Product cost included the commissioning cost that they include warranty cost. And then below that line is actually service costs that come through, so we support service costs. As I've said in past quarters, service costs right now is supporting our end of life stacks, the three year stacks that are coming through the cycle. We expect to continue to do that in 2011, a little bit of 2012. That probably adds somewhere in the 20 plus cost, 20 plus basis points to the cost ratio. And then you have in this quarter, the commissioning costs and the commissioning costs probably added somewhere in a 10 to 13 point range.

Burt Chao – Simmons & Company

Okay.

Joe Mahler

That's what it's looking like. Obviously, volume would help us too. I tried to talk to volume in the beginning of the call, so if you added a little bit of volume to the equation that would move the cost ratio. So, I think in the last quarter we talked about where are we trying to get to by the end of the year? We are trying to get to the 120 to 130, range. We think some volume will take care of that.

Burt Chao – Simmons & Company

Right. Okay. And then – But to get to a – okay. And then that is on target and if you get to the 120, 130 range and you kind of stay on target to get that positive EBITDA by 2011.

Joe Mahler

Yeah. I mean you need volume to get there.

Burt Chao – Simmons & Company

Yeah.

Joe Mahler

So you just need to push. We're very clearly, now, the units that we're manufacturing can be profitable. We're on the track. We need volume. You can really just jump on the model if you get volume in here and then you can get to this, the profitability targets. In the 10-K, we talked around 100 megawatts of throughput and this company is profitable.

Burt Chao – Simmons & Company

Okay. Great. And then one last quick question. With natural gas prices, initiative, except for the shale prices, U.S. natural gas prices, depending on who you ask, at least in the short-term are going to be somewhat in this kind of depressed level that we're looking at.

For other traditional renewal energies like wind and solar, that's obviously a big impediment, if you are looking at a great parity type scenario, how you guys think about traditional energy and traditional energy prices in relation to the adoption of FuelCells, given that it's not wide spread commercial option just yet, but you're getting to a point where more people are going to be thinking about it in just pure dollars and cents?

Dan Brdar

Well, there's two pieces to that. One is because we now have a much more abundant supply than we thought we would get a couple of years ago. What has happened is, the volatility that we have seen in past years seems to be quieting down and volatility seems tends to be an issue with commercial industrial customers, because they're not good at predicting what the long-term pricing looks like, so it's a risk they figure they have to manage somehow if they want to distribute generation.

That concern seems to be disappearing because everybody's becoming increasingly convinced, that because there's a surplus of supply, prices are going to remain low for an extended period of time which is a good thing. What it does in the near term, is it actually reduces the cost of electricity for generation from our units. So the gap that existed previously between us and other sources actually becomes compressed, because you don't see the utilities out there rapidly dropping their pricing because most of them have long-term supply agreements. It takes quite a while for them to show up. So what we're seeing is customers are now looking at our projects, running on natural gas, see a more attractive economic proposition just because of what's happened to gas pricing over the last year.

So I think it's actually, interesting for us from a competitive standpoint. Because when we look at our pipeline, much of our pipe line, particularly in places like California was overwhelmingly dominated by biogas a year ago. We're now seeing a return of lot of interest on natural gas-based projects as well. So we're seeing more balance in terms of those two types of applications because of the abundance and pricing of gas.

Burt Chao – Simmons & Company

Okay. Great. Thanks so much, guys and again congratulations.

Dan Brdar

Thank you.

Joe Mahler

Thank you.

Operator

Thank you, sir. Our next question is from the line of Sanjay Shrestha of Lazard Capital Markets.

Sanjay Shrestha – Lazard Capital Markets

Great. Thank you. Good morning, guys. A lot of great progress and a lot of different fun, first question on this, sort of the hybrid power plant, 60 plus percent electrical efficiency, I mean those are some pretty amazing numbers. Can you talk about what sort of reception are you guys seeing and how big could that translate into, as like your sales pipeline because even the best combined gas turbine doesn't even get nearly close to that?

Dan Brdar

Essentially, potentially a real game changer for us and for part of the industry that we're really working here for a couple of reasons. One is you got gas distribution networks all over the world. And it's a product that could be applied in any of those marketplaces, so it really is a global opportunity. The other significant piece of this is it actually allows the gas distribution companies to enter the power generation market, which they couldn't do otherwise, because, here they're actually putting a power generator on their own facilities to improve the operability of the gas distribution system. So getting the report out in terms of how this first unit is operated. Certainly been a driver for what Enbridge has been doing, working for the government, because they see the value will bring to their system. And I think that will just drive more adoption in the marketplace.

Sanjay Shrestha – Lazard Capital Markets

I think you guess did mention a number as a potential opportunity in Ontario. I am sorry, I didn't quite get that. What was that number again as to how big in a 43 megawatt or something like that?

Dan Brdar

There's 47 megawatts that Enbridge has submitted to the Canadian government in their Toronto facility. There's actually more megawatts than that, that's available in their system, but they've identified the first 47 that they're using as an opportunity to actually get some of the stimulus dollars from the Canadian budget and actually address some of their needs in their gas distribution system.

Sanjay Shrestha – Lazard Capital Markets

I have one follow up question to that, because I think – so what kind of the electricity price is sort of assumed in that sort of the proposal if you would? And then we can kind of back out as to, based on the efficiency and assumption on the price of gas what the system clearing price for you guys could be?

Dan Brdar

In terms of the dollars for kilowatt or..

Sanjay Shrestha – Lazard Capital Markets

But either, dollars per kilowatt or dollars per kilowatt hour. We can get to either once we have one.

Dan Brdar

All right. You are going to see this look similar in terms of what are pricing in the marketplace, its going to be in the $3,000 to $3,400 a kilowatt?

Sanjay Shrestha – Lazard Capital Markets

Okay. Perfect. So a couple more follow-ups if I may. So in terms of this phase I for DOE for Connecticut, it's about time. So when you talk about phase II. What exactly does that entail? Do you need to have an equity sponsor for the 20% of the sort of the funding before you get into phase II or help us understand that as to how does that whole process evolve? Because once you get that, I mean DOE stop I mean it would make the project even that much more attractive and the returns even goes up a lot?

Dan Brdar

Yes. I would agree. What phase II involves is you need an independent engineering report.

Sanjay Shrestha – Lazard Capital Markets

Okay.

Dan Brdar

You need an environmental assessment of the project. And you need a credit rating for the project. You don't have to have the equity pieces lined up to do that. It's really – they structured this in two pieces, so that the participants weren't spending dollars to get independent engineering assessments and environmental reports until they knew they were actually going to have a chance of success.

So the next couple of weeks, we'll be submitting for the projects that have met the phase I approval that engineering assessment, environmental assessment and credit rating. And then after that, they'll make a decision, they've indicated within 60 to 90 days. They've been pretty good at keeping their schedule. And at that point, you sit down and negotiate a term sheet with them.

Sanjay Shrestha – Lazard Capital Markets

Okay. One last question to you guys. In that backlog, you said there is lumpiness going forward. What would be the mix of system versus stack in that backlog number that you guys have provided. Maybe it's more for Joe?

Joe Mahler

Sanjay, in the current backlog?

Sanjay Shrestha – Lazard Capital Markets

Yeah. Yes.

Joe Mahler

Yeah. Most of it at this point would be modules.

Sanjay Shrestha – Lazard Capital Markets

Okay.

Joe Mahler

Okay.

Sanjay Shrestha – Lazard Capital Markets

Okay.

Joe Mahler

And the modules are all related to POSCO.

Sanjay Shrestha – Lazard Capital Markets

Terrific. Thanks a lot, guys.

Operator

Thank you. Our next question in queue is from the line of Meghan Moreland of Ardour Capital.

Meghan Moreland – Ardour Capital

Good morning.

Dan Brdar

Good morning.

Meghan Moreland – Ardour Capital

I was under the impression that most of the cost related to the commissioning in South Korea where were already absorbed in the fourth quarter. But obviously, some has leaked into this quarter. You mentioned it was all done. Is that for sure or are we also going to see some of these costs leaking into the second quarter?

Dan Brdar

No. It's all behind us. It – what you've got is the units actually went into operation last quarter and these are just trailing costs that come through. If you think about having to replace, for example, some of the electrical components, some are longer lead items, so that time they order, installed and there's a billing cycle behind that. So it's just trailing costs. That's all it is.

Meghan Moreland – Ardour Capital

So we can such as see an improvement in growth margin in the same quarter over the first quarter?

Dan Brdar

Yes. You would.

Meghan Moreland – Ardour Capital

Okay. And I don’t know if you already mentioned that but can you give us an update on the ASP per megawatt, now that we're moving from whole systems to modules to stacks?

Dan Brdar

Well, the modules represent about two thirds of the cost of our large power plant. ASP in the marketplace for a large power plant is about $3,000 a kilowatt sometimes a little bit more depending on marketplace. So the modules really represent about two thirds of that ASP.

Meghan Moreland – Ardour Capital

And then could you just give some color on yesterday's announcement regarding PG&E and SCE in California trying to have FuelCells for utility cells?

Dan Brdar

Yeah. We've actually been working with the utilities for quite awhile is part of helping them assist, where the utility fit in the generation mix. So there have been several projects they've been identified at a whole variety of sites where the utilities would own the units at a customer site. They're typically using colleges and universities as the host because they typically also have a good steam load for combined heat and power applications.

The utilities have submitted their proposals to the public utility commission. And I think what we saw in some of the proceedings is there was some objection to some of the costs the utilities were adding as part of their own contingency that significantly increased the cost of some of those. So what we saw was really a split decision between Michael Peavey, the head of the Public Utility Commission and the administrative law judge. And they're working through how to they address that, I suspect before it's offend and they will have the utilities takes some other contingency out in order for these projects to move forward.

But for us, it's a good sign because we've been working with them for awhile to get them to understand the benefit the FuelCells can bring to their system and it looks like they're increasingly convinced it's really worth them getting some units in, understanding first hand how they operate as part of their own assessment of – where to FuelCells fit in their product mix.

Meghan Moreland – Ardour Capital

So they were essentially adding their $4 million per megawatt and additional cost? Over your approximately $3 million per megawatt figure for the whole system?

Dan Brdar

They added quite a bit. Utilities are not paid to take risks. So their view is this is something we've never done before. We want a lot of contingency. I think they're also planning a fair amount of activity around it in terms of media and press events and just sort of public information disclosure, which I think adds to their numbers as well.

Meghan Moreland – Ardour Capital

Okay. Then the 27 megawatts that have passed the first round of the DOE loan guarantee program. That's something you're pushing forward on your own it seems like. Once you get approval is that something you're going to kind of spin off to another developer or is this something you're going to go forward with and develop on your own?

Dan Brdar

It's really a mix. The projects have other partners that are involved with them and once we understand with the final terms surrounding the – those products look like, because you have to negotiate a term sheet. We may turn them over to our partners, we may do them ourselves. It's really the function of what’s the level of loan guarantee is provide it.

Meghan Moreland – Ardour Capital

And what's been the hold up here. Obviously, financing has been difficult. But also I don't think any PPAs have been signed for any of the projects. Has that been the catch 22, getting the PPAs signed? Why has that not been signed? Because it's been over a year since a lot these were originally approved.

Dan Brdar

The PPAs for all the projects are signed.

Meghan Moreland – Ardour Capital

They are.

Dan Brdar

Are truly complete, ready to go looking for financing. The delay really has just been the delay in credit markets in general. And on the DOE side, it's taken awhile largely because they have just been inundated with project requests. So people that are looking topics that loan guarantee program.

Meghan Moreland – Ardour Capital

Okay. Then just lastly, the announcements regarding the ERG is obviously very positive. But this has still been the relatively small segment for you. Can you give us any kind of color on where this is going to go this year or if this is really going to get you on your way, the announcement of the efficiencies?

Dan Brdar

Well, I think it's important in terms of raising the visibility of it. But if you're looking what’s – what we are active in the pipeline, you've got four projects in the Connecticut activity that total probably close to 20 megawatts. That are all the same product design a FuelCell coupled with a turboexpander. You've got Enbridge perceiving 47 megawatt on their own system with the Canadian government.

And you've got – other utilities that Enbridge is working with to help educate them about the product as well. So it's looking like its becoming increasingly a pretty significant part of the pipeline that we've got. So getting the results of this out and published was something that both we and Enbridge thought was pretty important at this point in time.

Meghan Moreland – Ardour Capital

Thank you.

Operator

Thank you, ma'am. Our next question is from the line of John Quealy of Canaccord Adams.

Mark Sigal – Canaccord Adams

Hi, good morning, guys. This is Mark Sigal for John. I was wondering if you could just expand upon some your comment, you talked about regarding new European partnership moving forward and what the time table might look like there?

Dan Brdar

What we've found is to find good partners takes time and takes awhile for the parties to get know each other to actually spend time, working together seeing our units and seeing our factory. We're in discussion is actually now with multiple players. This is one of the things that we want to make sure that we pick the right partner, because if you look at what we've done for example, with POSCO, it's an indication of if you get the right partner, it can drive a lot of business for us.

Timing is really a function of how quickly we can get some of our potential partners to move. They are tending to be larger companies they are going to move slowly and they have do a lot of due diligence. And their approval process tends to be lengthy. But we're optimistic that as we get little bit further here in the year. We're going to have certainly one and hopefully multiple pretty good European partners lined up.

Mark Sigal – Canaccord Adams

Okay. Great. And then just turning to the Connecticut megawatts that are not included in the DOE loan program process? What's your expectations there perhaps from a commercial financing standpoint of timing there is? Are you still targeting something in fiscal '10 to develop or is that more fiscal '11?

Joe Mahler

Yeah. We continue to work the commercial financing side. Getting the loan guarantee is certainly a very good thing. We continue to work the process on it. We fully expect to get these projects financed. We're seeing some projects in the commercial financing markets. We're starting to see some players out of wind and solar. As those markets decline a little bit get very interested in the fuel cell markets. So we're hoping later in the year 2010, our initial focus is really on loan guarantee. We do have a parallel process, we would expect over the next several months to move those forward.

Mark Sigal – Canaccord Adams

Okay. Great. My last question is, how do we think about commissioning costs, I guess moving forward? Will those be lumpy or perhaps more linear just for modeling purposes. How do we think of that?

Dan Brdar

Well, what we've seen herein the last couple of quarters really is a one-time event. It represented basically getting multiple units conditioned at the same time that actually had some unique challenges, because we had basically a new product in country with new partners they hadn't seen before. And we had some issues with some of the electrical equipment that surrounded the fuel cell. So what we've seen here the last couple of quarters is not something that we expect to see repeated going forward.

Mark Sigal – Canaccord Adams

All right. That's very helpful. Thanks a lot.

Dan Brdar

Okay.

Operator

Thank you. Our final question is from the line of John Roy of Janney Montgomery Scott.

John Roy – Janney Montgomery Scott

Guys, can you hear me?

Dan Brdar

Yes. We can.

John Roy – Janney Montgomery Scott

So really, I mean you've answered a lot of questions and things are going pretty well. I guess the real question, what we're trying to assess is that when you look at the preponderance of the opportunities. What do you think is going to be the bulk of your business for 2010, in terms of the actual numbers? And what is really going to be the thrust? What's going to make it get going?

Dan Brdar

Well, I think the markets in general are going to get going as we experience some of this project financing reaching fruition. We've seen it in terms of what's happening in California. We've certainly seen it in Connecticut. As we get through either the loan guarantee process or the commercial financing. The pipeline there that's ready to move forward is looking increasingly like one that's eager to move. So we really want to just get through the last of this credit issue that seems to be lingering I think longer than everybody would like. Because the projects themselves are actually pretty far along, in terms of their state of development and the customers' ability to move forward.

John Roy – Janney Montgomery Scott

Dan, once you get approval, I guess the next question is how long until you would start seeing possible changes in either your production capacity or plans based on those or actual numbers? Because I know obviously it takes a long time for these things to get out the door.

Dan Brdar

Yeah. I mean our delivery cycle is about 10 months or so. Once we see – things going into backlog and as we get good visibility into those. We'll adjust the production run rate to respond to that. Because if you look at some markets like California, for example, they're actually time bound based under the self generation incentive program, on when they actually have to have their units in and operational. So we're going to let the market drive what that production rate needs to be.

John Roy – Janney Montgomery Scott

And if I remember correctly, you can ramp up fairly quick. If you need to do capacity without a whole lot of CapEx?.

Dan Brdar

We can. In fact, there's actually capacity there that can do up to 70 megawatts. So for us, it's really just a matter of bringing people on to ramp the capacity up.

John Roy – Janney Montgomery Scott

Great. Good going, guys.

Dan Brdar

Thank you very much.

Operator

Thank you. I'm showing no further questions in queue at this time.

Dan Brdar

Well, I want to thank everybody for joining us. And we look forward to speaking with you again next quarter to update you on how we're doing in the marketplace. Thank you, everyone.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may now disconnect. Everyone have a good afternoon. Thank you.

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