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Hydrogenics Corporation (NASDAQ:HYGS)

Q4 2013 Earnings Conference Call

March 7, 2014 10:00 AM ET

Executives

Bob Motz – Chief Financial Officer

Daryl Wilson – Chief Executive Officer

Analysts

Phil L. Shen – ROTH Capital Partners LLC

Eric A. Stine – Craig-Hallum Capital Group LLC

Sara Elford – Canaccord Genuity Corp.

Rob W. Stone – Cowen & Co. LLC

Jeff D. Osborne – Stifel, Nicolaus & Co., Inc.

Operator

Good day, ladies and gentlemen and welcome to the Hydrogenics 2013 Fourth Quarter Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder this call is being recorded.

I’d now like to introduce your host for today’s conference, Bob Motz, Chief Financial Officer. You may begin.

Bob Motz

Thank you, Tom. Hello and welcome everyone to the Hydrogenics fourth quarter 2013 conference call. With me today is Daryl Wilson, President and Chief Executive Officer. The Company’s fourth quarter press release and PowerPoint presentation are available on our website under the Investor Page at www.hydrogenics.com. We’ve also uploaded these materials as well as our Annual Report this morning on both SEDAR and EDGAR, and refer you to those sites for our disclosure documents. As indicated in our press release this morning, all financial references are in U.S. dollars unless otherwise indicated.

I would like to now provide a brief Safe Harbor statement. This call and the accompanying presentation may contain statements that are forward-looking. These statements are based on current expectations and assumptions that are subject to risks and uncertainty. Actual results could differ materially because of factors discussed in today’s press release in the MD&A section of our interim and most recent annual financial statements or in other reports and filings with the Securities and Exchange Commission and applicable Canadian securities regulators. We do not undertake any duty to update any forward-looking statements.

And with that, I’ll turn the call over to Daryl Wilson. Please go ahead, Daryl.

Daryl Wilson

Thank you Bob, good day and thanks everyone for joining us for Hydrogenics 2013 fourth quarter conference call. Today, I will review our operations and outlook, after which Bob will discuss our financial results in detail. Please refer to the presentation on our website for today’s discussion.

Beginning with Slide 3, I’d like to review some of our major accomplishments in 2013. It was clearly a great year for Hydrogenics on many levels, as revenue rose 34% to a record $42 million, gross margins climbed to 24.4% and we ended the year with a strong funded backlog of $57 million, representing orders across all of our business segments.

Management delivered as promised propelling Hydrogenics to the forefront of global hydrogen based energy applications, and at the same time positioning the company for profitability. The future looks bright.

As I’ll review further in a moment, we’ll see further organic growth in industrial electrolysis, anticipate an acceleration of orders for hydrogen fueling stations and we believe the market for energy storage will evolve and expand in the quarters to come. We also have many exciting things happening on the fuel cell side of our business where we serve mobility propulsion and backup storage applications.

Turning to Slide 4. Here is how we ended the year across our three product categories. We booked revenue of approximately $24 million in 2013, for industrial and fueling station electrolyzers, in a market which we judge to be worth about $100 million worldwide. Let me say, however the demand here is expected to rise in the years to come driven by anticipated fueling station infrastructure spending.

Our Power Systems unit, which provides fuel cells and integrated power modules also had revenue of approximately $18 million last year, primarily comprised of engineering development work for our long-term propulsion contract as well as shipments to CommScope for telecom backup applications. We currently believe this market is considerably worth more than $2 billion worldwide.

As energy storage still is a maturing segment for us, we have not broken this out in our reporting to provide more detail on this market, but we do view the market to be worth over $10 billion. We noted some major milestones last year in this part of our business and expect to even more achieve this year with orders picking up in the second half of 2014.

Now, let me get into some specific end market updates starting with our industrial OnSite business on Slide 5. As our listeners may recall this part of our business which generally rises and falls with global economic activity saw a bit of a pull back during 2013 due to the late orders across many of the developing markets which we serve. I’m glad to say that this inertia has to a large extend finally broken, which is primarily, why we were able to book some $12 million in electrolyzer orders during the fourth quarter.

Demand is returning and we are looking growth to robust performance in 2014 across this quarter part of our business, in area where we have more than 65 years of history. We remained the largest provider of electrolysis based hydrogen generation equipment for industries such as steel fabrication, glass production and food processing.

Moving to the fueling station market as shown on Slide 6, we are very upbeat about this portion of our business as well. Not only has Hydrogenics supply electrolyzers to 45 fueling stations worldwide, demand is accelerating due to moves toward mass introduction of fuel cell vehicles by many automotive OEMs. As we’ve pointed out on previous calls such global makers like Toyota, Honda, Daimler and Hyundai are laying out plans for large scale fuel cell hydrogen power deployments starting as soon as this next model year, with particular emphasis on Europe, Japan, Korea and California.

Hydrogenics has already been awarded four fueling station contracts in recent months and we believe this is just a tip of the iceberg. Our bidding activity is high and we expect our backlog in this area will continue to grow as the year progresses. We are a leader in this space and we are particularly focused on the link between fueling infrastructure and Power-to-Gas applications.

Now turning to our Power Systems business on Slide 7. I’d like to start with a review of our backup power applications. As our investors like me recall 2013 saw first significant commercial orders for fuel cell power modules for our partner CommScope, and those units several hundred are now actively deployed in the field. We continue to view this market very favorably and even though we didn’t see as many orders last year as we would have liked, primarily due to other capital spending priorities by the major telecom carriers. But we are addressing this situation in several ways.

First, we are working with CommScope to rollout strategies and accelerate the adoption of our fuel cell technology. So I think fuel cell versus batteries and diesel gensets becomes an easy and attractive choice after major storm or catastrophic events such as the Sandy or Katrina hurricanes. But it’s more challenging and discretionary sale during normal times, as purchasing managers don’t yet appreciate the long-term value that fuel cells offer. So we are working to address this by driving down the cost of our units to make them more affordable, versatile, and attractive.

We now offer five products across the power spectrum and we believe that CommScope is the right partner for this market. In addition, we are actively engaging to pursue the similar markets that can benefit from backup power, including large data centers and other locations, where energy integrity is absolutely necessary. We’ve made some major headway here with a few new customers, but it’s still early days in our marketing outreach efforts.

That said, we believe our fuel cell business will pick up more backup power orders in 2014. In addition, we’ve been lately active in bidding megawatts and multi megawatt fuel cell applications for continuous power production. As these proposals move ahead with new customers, we will be providing updates in the near future.

Slide 8 looks at other major fuel cell product development the large multiyear $90 million propulsion contract that Hydrogenics won in 2012. We recognized approximately $10 million of revenue on this contract during 2013. As we mentioned previously, this is a percentage completion contract and revenue will track required deliverables. We remain on track, both in terms of milestones and deliverables with the contract.

I met with this customer just recently and they are very pleased with all phases of the developments, but unfortunately, we are still not able to reveal their identity. I certainly hope this will change in the near future, although we obviously need to respect their interest and keeping this competitive information under wraps for the time being.

Now, I’d like to review the status of our emerging energy storage business, starting with Slide 9. In 2013, Hydrogenics took several steps to solidify its leadership position in the growing market for hydrogen based energy storage. We along with E.ON inaugurated and opened a two megawatt Power-to-Gas plant in Falkenhagen, Germany, which has been running very well since then, and has served as a showcase operation for the benefit of storing excess wind driven electricity. This also represents the first direct injection of hydrogen into a gas pipeline using Hydrogenics technology.

We follow that with another award from E.ON in 2013 for a 10 megawatt facility in Hamburg, Germany which will be the most advanced Power-to-Gas facility in the world, with the largest PEM electrolysis installation producing hydrogen. This is really expected to be delivered later this year will showcase our next generation technology, which will serve as a building block for future multi megawatt applications.

We also recently announced the micro-grid energy storage award in Northern Canada and expect soon to finalize our project with Embridge to build the first Power-to-Gas installation in North America. In the meantime, we continue to meet with various utilities around the world about potential energy storage applications. I’ve personally visited companies in California, Europe, Japan and South Korea about our technology and the feedback has been extremely positive.

As each of these new customers are learning about Power-to-Gas for the first time. There is an education process, which takes time and often there as many partners participating in project proposals. We’re very encouraged by the number of proposals in play and the stage of developments. As always, we’re hesitant to get specific about the timing of project announcements, but we see movement in the size and number of projects.

Two years ago, we were working on the first 1 and 2 megawatt sites, and presently requests have moved up in to the 5 to 15 megawatt class, with some requests even above that level. Recognizing the typical market selling price of approximately $1 million per megawatt, one can appreciate the significance of these developments.

Turning to Slide 10, we’ll look at three of the active jurisdictions for energy storage. In Germany, Ontario and California there are two and very important things taking place. First, the large amount of energy is already being provided by renewable sources such as wind and solar; and second, there are government mandates in place to invest in increased renewable energy with concrete targets moving forward. This translates to a greater need to find ways to store excess energy and use it at a later date, and hydrogen based energy storage is receiving growing recognition due to scale, modularity, cost and the versatility of the solution.

In Germany there are plans for large number of Power-to-Gas projects. California has continuing commitment to our hydrogen fueling and here at home, in Ontario, Canada, we have a call for at least 50 megawatts of energy storage in place within the coming years. This is real and Hydrogenics is poised to be a major player.

Slide 11, we show the infrastructure impact of integrating hydrogen generation from renewable electricity into the gas grid. Each of our focused markets have a very large natural gas storage capacity. If we take just 10% of that capacity and blend hydrogen gas, one can see that we’re storing very large quantities of energy.

The duration of storage can be days, weeks or months, and not only does the gas system serve as the large storage container, it also has a parallel transmission system, which provides a path for energy to be moved to where it is needed without incremental infrastructure cost. The point is that the Power-to-Gas solution has far greater capacity to meet energy storage needs than any other known solution.

Turning to Slide 12, we ask the question, “what if we use the entire energy system to address the challenges that are facing our grid system?” This shows the various ways that energy is used today and in our target markets there are now daily period of electricity surplus, which means an immediate home. But if electricity can help to reduce the need for additional natural gas or provide pure hydrogen for transportation purposes, just think how much more efficient the total energy system would be, and this is where major utilities worldwide no one understand that what we’re offering with Power-to-Gas, where they combined their gas system, electricity system and renewable energy deployment creates a lot of value.

An example of this is the E.ON in Germany where they can utilize excess wind energy to generate hydrogen, which is then pumped into the existing natural gas pipeline or separated out as pure hydrogen to fuel cell powered vehicles. This is happening today and will clearly grow over time with hydrogen playing the key role throughout every part of the value chain.

Slide 15 puts us in even better perspective. Consider you had a 40 megawatt Power-to-Gas project using our technology. This facility would produce 4.3 million kilograms of hydrogen annually, that’s an incredible amount of hydrogen considering the low mass of the molecule. Think about what could be done with that hydrogen. At fueling stations it could displace 4.3 million gallons of gasoline and power hundreds of fuel cell vehicles, or could be used for heating homes or for dispatchable power or for numerous industrial applications.

The bottom line is that we’d be taking power that would be otherwise be wasted or given away and turning into our resource for numerous applications with no carbon footprint. That’s the power of hydrogen technology.

On Slide 14 we can see the progress that’s being made in these target regions for its hydrogen-based energy storage and fueling. As you can see, there are concrete plans in place through fueling stations for grid balancing and for energy storage. All places Hydrogenics to play a leading role.

There is certainly more that needs to be done and additional regulations and commitments need to be finalized, but the building blocks are there for this to happen. And most importantly, there is a clear understanding of a need for these initiatives and the important role that hydrogen can play going forward. It’s an exciting time for us and for the industry.

Now, before turning the call over to Bob, I’d like to show you how far we’ve come as a company, starting with Slide 15. This graph illustrates what we’ve been saying for sometime about Hydrogenics’ operating leverage. We have a significant manufacturing capacity that can continue to ramp up revenue without major increases in our underlying costs. Over the past few years, our top line has grown at a 30% compound annual growth rate, but our SG&A and R&D expenses have remained somewhat static, leading to a steadily improving EBITDA margin level.

When you subtract out stock-based compensation expense our progress looks even better. And the bottom line is that we’ve consistently said that we’ll become profitable given gross margins of around 30% when we hit the $50 million revenue run rate. We haven’t changed that forecast and it’s clearly now in our line of sight.

Slide 16 shows our full backlog breakdown, which is larger than the contracted backlog that we normally speak about, because this includes those announced yet to be triggered by a large customer in addition to those announced or already booked firm. So our $90 million propulsion contract has been partially brought into the backlog, but obviously not yet fully.

This chart not only shows how well the company is positioned, but our visibility on future revenue as it illustrates that our business continues to evolve and diversify with growth coming from all segments of our end markets.

To wrap up, Slide 17 shows that Hydrogenics has not only accomplished a great deal on the last year, but is poised for even more impressive growth going forward. Several catalysts include the launch of our Enbridge energy storage project, the new PEM facility in Hamburg, expanding markets for energy storage worldwide, increasing applications for fuel cell-based back-up power and finally increasing demand for fueling stations driven by the aggressive plans of automotive OEMs. Momentum is clearly on our side.

Lastly, turning to Slide 18, let me just reiterate that Hydrogenics is on track with revenue growth and gross margin projections that we’ve talked about, which should drive a path to profitability in the very near future. We have excellent visibility into the year ahead given our robust backlog and we continue to address an active pipeline of business opportunities across all of our end markets. Just like last year, we expect top line growth to be at least 30% in 2014.

We remain leader in the energy storage space and we’re also well positioned to benefit from anticipated demand for hydrogen fueling stations in the years to come. We’ve excellent partners and enduring customer relationships who understand and appreciate the power of what we can offer in terms of both our technology and applications. So truly 2013 was a great year for Hydrogenics, but it still can be said that the best is yet to come.

Now I’ll turn the call over to Bob Motz, our Chief Financial Officer, who will review our financial results in detail. Bob?

Bob Motz

Thanks, Daryl. Good morning, everyone. So to briefly summarize the financial results for the fourth quarter and 12 months ended December 31, 2013.

Turing to slides 19 and 20, we posted revenue of $11 million and $42.4 million respectively for the fourth quarter and year ended December 31, 2013, which represented increases of 12% and 34% respectively over the prior year periods.

The strong top line improvement was fueled by higher demand within our Power Systems group and the impact of the full year of revenue recognition on our $90 million engineering services order offset by slightly lower revenue on our OnSite Generation business.

Turning to Slide 21, our gross profit was 24.6% in the fourth quarter, an increase of 11.1 percentage points versus Q4 of 2012. This improvement is principally due to the very low margin of 2.2% in the OnSite Generation group and Q4 of 2012, part of which was due to the delivery of the E.ON 2 megawatt energy storage system in that quarter that was intentionally bid at a lower than normal margin to give us the reference site that we needed for the Power-to-Gas business.

Full year 2013 gross margin was 28.4%, an increase of 11.8% from the 12 months ended December 31, 2012 and just below our target gross margin of 30%. Margins in OnSite Generation increased by 1.5% to 15.3% and margins in the Power group increased by 12% to 45.7%.

For fiscal 2014, we expect further strengthening in the OnSite Generation margins, given anticipated margins in current level of contracted backlog and our expectations in the sales pipeline. We also expect margins in the Power Systems group to remain above 30% in 2014 as ongoing revenue recognition in the engineering and services order should drive up overall margins in this business segment.

Cash operating costs were $2.9 million in the quarter, a decline of $0.7 million or 20% from $3.6 million reported in the fourth quarter of 2012. This decrease is all driven by decline in net R&D expenditures. Now, net R&D is a combination of our gross internal R&D expenditures offset by government funding. In the case of Q4 of 2013 our gross expenditures were actually fairly comparable quarter-to-quarter. However, funding was higher in Q4 of 2013 principally due to the value of funding received in the province of Ontario under the Strategic Jobs and Investment Fund agreement.

For the full year, cash operating costs were $13.5 million, versus $15.3 million last year, with costs as a percent of sales falling 16%. SG&A was relatively flat, increasing only $0.1 million. The remaining decline of $1.9 million is due to decrease in net R&D spend. This decline in $1.9 million is broken down between a $0.5 million decline in gross R&D and a $1.4 million increase in R&D funding from various government and non-government sources in Canada and the European Union.

As a result, our adjusted EBITDA loss was $0.2 million in the fourth quarter and $1.2 million for the full fiscal year, reflecting the revenue margin and expenses previously discussed. Note that effective this quarter we changed our definition of adjusted EBITDA to exclude stock-based compensation, both shares settled and cash settled performances of stock-based compensation. We believe that such a change reflects the better definition of adjusted EBITDA to measure the ongoing results of the corporation.

Total share-based compensation expense was $2.2 million for Q4 of 2013, an increase of $1.7 million from the $0.4 million reported in Q4 of 2012. For the 12 months ended December 31, 2013 share-based compensation was $4.9 million, an increase of $3.6 million from the $1.3 million reported in 2012.

Net loss for the quarter was $3.1 million or $0.34 a share. This loss was principally driven by the EBITDA loss of $0.2 million, a share-based compensation expense of $2.2 million, depreciation expense of $0.1 million and $0.6 million of finance losses principally derived from the revaluation and exercise of warrants.

Of particular note is the last of our warrants were exercised early in Q1 of 2014, and thus warrant expense for Q1 of 2014 would only reflect the remaining 69,072 warrants that were exercised in January. Further details on warrants can be found at in 12 of our consolidated financial statements.

Net loss for 2013 was $8.9 million, or $1.04 per share, compared to $12.8 million or $1.74 per share in 2012. The 2013 net loss is principally driven by the EBITDA loss of $1.2 million, $4.8 million of stock-based compensation expense, $1.8 million in warrant revaluation and exercise costs, $0.7 million in depreciation and amortization expense and $0.4 million in interest, foreign exchange and other financing expenses.

The Company’s order backlog as of December 31, 2013 was $57 million, up $4.3 million, or 8% from the levels reported at the end of Q3. During the fourth quarter we received $14.3 million in new orders.

Our cash resources as of December 31, 2013, were $13.8 million, a decline of $7.5 million as compared to the third quarter. This decrease reflects $0.7 million of cash used in operations combined with $1.3 million decrease in non-cash working capital, $1.3 million of proceeds from loan advances and $0.2 million in capital expenditures.

And with that, we’ll now turn the call over to the operator for questions. Please go ahead, operator.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from the line of Philip Shen from ROTH Capital. Your line is now open.

Phil L. Shen – ROTH Capital Partners LLC

Hey, guys. Congrats on the progress you guys are making.

Daryl Wilson

Thank you.

Philip L. Shen – ROTH Capital Partners LLC

I’d like to start-off with the energy storage business. As you look in your pipeline and your potential order book, what kind of technology are your customers more interested in? Are they interested in the PEM or the alkaline or is it a mix?

Daryl Wilson

So historically, Phil, we have to liberate the standard industrial equipment that we’ve been making for a large number of years with alkaline electrolysis, and some customers are showing a preference to have technology which has a long reference site history, and they’ve elected to buy our alkaline electrolysis. But as we move to larger scale projects, it’s very clear that PEM will be the preferred platform, and we’re seeing the interest in the future primarily focused around PEM technology.

In the backlog right now, we would have approximately $10 million of energy storage projects to deliver and the majority of that would be focused around PEM applications.

Phil L. Shen – ROTH Capital Partners LLC

Great. That’s great color. And of the $10 million in energy storage orders, when did that come in? Did that come in primarily in Q4, was there some orders in Q3 as well?

Daryl Wilson

Probably the last couple of quarters.

Phil L. Shen – ROTH Capital Partners LLC

Okay. And what kind of timeframe do you expect those orders to be delivered?

Daryl Wilson

I believe most of those will be delivered in the coming 12 months.

Phil L. Shen – ROTH Capital Partners LLC

Okay. Great. And can you talk to us about – I think in your prepared remarks, Daryl, you talked about the size of the potential orders going up 5 to 15 and even more megawatts. Do you have a sense for whether or not some of those larger megawatt orders could actually hit in 2014.

Daryl Wilson

We’re working very hard for that to happen, but as I said in the comments, there is an education process. There is a teaming process with multiple partners. So it’s always a little hard to call exactly when they are going to hit. Some of these current proposals have got more than 12 months working to them already. So, from our point of view they’re well baked and should hit sometime during this year. But again with complexity and large number of partners sometimes we end up delayed.

We anticipated, for example, the project in Canada might got off the ground before now, but putting all the docks on the fence has taken time. That one is very close we believe at this point and there’s others in Europe, I think are fully realizable from a closure point of view during this year, but just how big and how many it’s difficult to say right now. The key point is there’s been a shift from smaller projects to larger projects and that shows a momentum and confidence with end users, which we’re gratified about.

Phil L. Shen – ROTH Capital Partners LLC

Great. Let’s shift over to CommScope and the relationship there. We noticed that CommScope actually issued a press release just a few weeks ago on offering fuel cell backup solutions to their customers. So it seems like that’s a positive sign. Can you talk to us about perhaps that release as well as what kind of cadence of orders or revenues actually could we see from CommScope in 2014?

Daryl Wilson

So in this area I mentioned that we’re redoubling our efforts with CommScope. There had been kind of other spending priorities by many of their major customers and together with the senior management of CommScope we’ve agreed that we’re going to – in a broader new type of market more aggressively this year. There’s already been some activity and that’s what you’re seeing evidence of.

Typically in this area, releases for power backup are in between 500 and 1,500 units at a time. So their order size is attractive. We’ve certainly bid orders of that size over the last few years, but on a prioritized capital spending basis, they didn’t materialize. We’re hoping and expecting that some will this year. Even one or two of those, it’s a substantial impact to our overall business result. So, that’s what we’re working toward.

The other development with CommScope is activity in the data center area. There are many data center applications where CommScope has collateral technology to supply to their existing customers and so they now are featuring work with us on data center, larger power output applications as well.

So we’re pleased with the momentum and we will report as we make actual progress.

Phil L. Shen – ROTH Capital Partners LLC

Okay. Thanks Daryl. Let’s talk about your margin profile expectations, Bob, I know in your remarks you said, we could see some improvement in OnSite Generation, and I think power systems have more than 30%. First of all, I want to confirm that, what I heard and secondarily, what kind of improvement could we see in OnSite? What’s the magnitude? Thank you.

Bob Motz

To answer the question the target for OnSite, for the entire business has always been 30, and so we are looking at, what we can get in a blended rate for 30. What we are seeing in OnSite right now, in terms of the target margins for what’s in contracted backlog would get us pretty close to that. And then to answer the question in power, it’s really going to be a product mix issue between, how much revenue we’ve recognized in a particular quarter in the engineering services contract, which as you can imagine, being engineering services has brought higher than average margin profile, and then offset by the remainder of the power business, which could be anywhere from high 20s to low 30s.

Phil L. Shen – ROTH Capital Partners LLC

Okay, great. Thanks and I’ll jump back in queue.

Daryl Wilson

Thank you.

Operator

Thank you. And our next question comes from the line of Eric Stine from Craig-Hallum. Your line is now open.

Eric A. Stine – Craig-Hallum Capital Group LLC

Daryl and Bob, thanks for taking the question.

Daryl Wilson

Thank you.

Eric A. Stine – Craig-Hallum Capital Group LLC

May be just on energy storage, just thinking about this, were coming at it a slightly different way, I know that in the last few years it’s been a lot of heavy lifting in these key markets. And working with ISOs to get the mechanisms in place to monetize this, the various parties, so just some thoughts on where you stand in that process, and what it means for some of your key markets in terms of timing or how these markets develop?

Daryl Wilson

Thank you, Eric. Great question. We put some material up on Slide 14 to address this very important area. We previously mentioned that it’s not really the progress in electrolysis technology that’s the problem, it’s more getting the ability to monetize our market value. We’ve identified here in this presentation that Germany, California and Ontario are critical markets because they have high renewable energy penetration levels, and they have started to turn their attention to heavily towards storage. Obviously, Germany most intently, California with a call for 1.3 gigawatts is a very significant call for storage technology that’s now in play.

The interesting thing about California is they’ve been supporting hydrogen fueling for quite a large number of years, and there have been recent announcements for ongoing support on an annual basis to built hydrogen fueling stations. So in California, we see the link between Power-to-Gas, energy storage and hydrogen fueling is being the critical one. And it looks like we are getting all the support we need with a call for 33% renewable requirement on hydrogen fueling and support in general for storage projects.

I’m proud to say that our own jurisdiction in Ontario, Canada is leading the way when it comes to policy, and we’ve been very influential in getting this to happen. So we have an energy storage working group in this area and just last Thursday the local Ministry of Energy announced a plan whereby energy storage services could be contracted by the independent system operator. This to my knowledge is the first in the world.

So it’s not simply a call to put up demonstration projects, but it’s the complementary policy support, so that the value of those projects can be monetized. And we are just working with the Ministry of Energy to learn the details of this program announced just last Thursday. But it looks like it’s everything that we were asking for, and it creates now the business basis to deploy our hydrogen energy storage as well as other energy storage projects and actually monetize the value. These kind of things are also under development in California, Germany, but they have not reached the definition level that we have in Ontario yet.

But we see that happening over this year and it doesn’t seem to impede the progress of customers to work with us, develop projects that have been ready to launch. And we anticipate some projects will launch notwithstanding the policy status, so that the project is fully ready when the policy catches up. So good movement in this area and we are very encouraged.

Eric A. Stine – Craig-Hallum Capital Group LLC

Okay, that is great color. I appreciate that, maybe just to clarify, I think your answer to a previous question, you said that current backlog includes $10 million in storage, and I just want to clarify, you did say that the majority of those are PEM?

Bob Motz

I believe the large portion of what we will be doing forward including the backlog is PEM oriented, yes.

Eric A. Stine – Craig-Hallum Capital Group LLC

Okay, got it. So I mean clearly a little bit of that is the follow-on from E.ON, but I mean is it if you are willing to, is it possible to characterize how that breaks out in some key geographies or the remainder?

Daryl Wilson

I probably not going to get into kind of project disclosure here. The important thing to understand is that really today we are indifferent in the sense of what customer preferences are, so if a customer prefers to have the alkaline technology with its long history, because there is somewhat risk averse about trying something new.

We are happy to provide that, and as we look at larger projects and the quotations are noticed, typically there will financially advantageous to go with PEM technology. So both are available, both performed very well and both are meeting customer preferences and that’s kind of the state we are at now, as we go to very large scale it will PEM.

Eric A. Stine – Craig-Hallum Capital Group LLC

Got it, and would it be fair to say that of that what’s in backlog, that would include – I mean and that’s a number of customers that it’s not necessarily one or two customers in that. That is something that again it will be like E.ON, we are at initial stage obviously with plants for – with much larger plants.

Daryl Wilson

Generally, yes.

Eric A. Stine – Craig-Hallum Capital Group LLC

Okay, great. Last one from me would just be on the micro-grid the announcement you had within the last month or so. Just interested in that one because it does – it touches both sides of your business, energy storage and power systems to just how you think about the overall micro-grid opportunity. And is that something that going to market, is that something we should expect you maybe to be tied with an EPC firm or how do you go-to-market with that solution? Thank you.

Daryl Wilson

So there are large number of communities around the world who get their primary power from diesel. It’s still a fact, unfortunately and in those communities a integrated energy storage system with hydrogen and wind or solar energy makes a lot of sense. On that particular project that you are raising unfortunately there is still pending government announcements, we have to release the information, because it’s a significant order for us, but we have been kind of held back in disclosing all the details of the project pending government announcements details of the project.

But it is an example of a micro-grid in the more community areas and we do see a good deal of interest in that area. So yes, it can well be more in that announcements in the coming year, and yes, we have in active program to support that kind of solution, keep on perfecting and reducing the cost of our solution because it seems there is absolutely market demand for it.

Eric A. Stine – Craig-Hallum Capital Group LLC

Okay, that’s great. Thank you very much.

Daryl Wilson

Thanks, Eric.

Operator

Thank you. Our next question comes from the line of Sara Elford from Canaccord. Your line is now open.

Sara Elford – Canaccord Genuity Corp.

Daryl and Bob, just a few last for me, I’ll start with the easiest one. In backlog $57 million at the end of the year, could you just get me a sense of how much you might expect of that to be deliverable in 2014? I know there are large power system contracts, just have got some stuck that might extend beyond the next 12 months. But just trying to get a sense where you are or at for now in terms of expected deliveries and therefore for the current year?

Daryl Wilson

Yes, hi, Sara. I’m thinking it would be approximately anywhere from $35 million to $40 million.

Sara Elford – Canaccord Genuity Corp.

And then on, I guess just with what you’ve heard out of Ontario, in the last week. How much of that is critical to the timing of your project that everyone sort of waiting on with Enbridge. Is it keep the equation before moving ahead with the initial first project?

Daryl Wilson

It absolutely is, it’s kind of the last missing piece. I think Enbridge very astutely have said, if we are going to do this, it has to be meaningful, and they don’t want to merely do a demonstration projects. It needs to be a project where the deployment of the asset has some meaningful impact on the grid, from a technical point of view. So that speaks the scale, and it also has to be engaged in some way in the energy market. So it can actually see real life performance as an asset integrated into the economic system as well as the energy system.

So we fully supported that particular approach and we’ve been working with the government to establish policy of this nature and looks like we have all we need. So there is some final, this is the call from the government to enable the contracting. There is a commence period on their approach, which is a matter of weeks I believe, and then we’ll actually be a procurements call.

In this particular case, again I think the government took here wise approach, where they are looking at a variety of energy storage technologies, and is not necessarily a head to head competition, may the cheapest solution win. But they are looking for an array of solutions and we fully expect to be part of that family of demonstration projects that are engaged in the market as I’ve just said. And show the strength of the various technical solutions.

So it’s a very appropriate approach and we’re looking forward to participating in it over just the coming weeks in fact, and that will be the last to enable launching the project with Enbridge here in Ontario?

Sara Elford – Canaccord Genuity Corp.

And are there other project using alternative technologies to your point that they want to look an array of solutions. Are there others that have, I guess industry commitment in the form of an Enbridge as does hydrogen storage or that’s kind of remains to be seen at this point in time.

Daryl Wilson

It probably remains to be seen which solutions will come forward. I think we have a wonderful advantage in being partner with Enbridge. We’ve seen already the benefit of that relationship as we’ve worked on the policy side, as we work with other partners in the project.

So for us it’s been excellent to have may I say, a big brother partner, some of the other solutions may well have some partners with them, some of them are earlier stage technology companies that don’t have that kind of support, but we appreciate the support that Enbridge has provided to us, and while we focused heavily on initial project in Ontario together with Enbridge with activity in other areas in North America as well. We don’t want to stop at one here, we want to look at other opportunities as well and we’re working to mature those as next step projects in addition.

Sara Elford – Canaccord Genuity Corp.

Okay. And then just finally from me, on the pipeline of energy storage, you talk about a range of projects that you’re sort of seeing in the sort of 5 to 15 megawatt range. Are those with utilities or I suppose, the folks you’re working with these things on, are they follow-ons to demos that are either pending or already exist or in some cases are they with parties that have – this would be their first project and they’re simply moving directly into that kind of scale range?

Daryl Wilson

In [indiscernible] the large ones, most of them would be newer ones. So they are looking at this from the standpoint that there is already proof on the grounds. There is no need to repeat the 1 or 2 megawatt story, and there is confidence that, if this now makes sense from an economic point of view and in energy system point of view to move immediately to 5 or 15 megawatts. So that’s encouraging. There is also some work with existing and previous customers as well, but we are encouraged around the level of confidence is now being shown in the solution.

Sara Elford – Canaccord Genuity Corp.

And does the timing of those, I mean I know you kind of touched on this a little bit in your previous comments, but does really the timing of these things being awarded largely Hamburg on some of the policy mechanisms being in placed to really have these integrating into the system?

Daryl Wilson

Particularly in Europe the need for storage is now so obvious and the value of storage is so obvious that even where the policy environment is somewhat behind, there seems to be willingness in momentum to go ahead with project planning, development, justification and in some cases we expect as we have already seen in the case of with E.ON. There was no government policy support, no government funding even, so move ahead with first E.ON project. They just did it, because that’s the level of need that exist.

So I think depending on who the parties are and their means, we will see folks moving ahead, notwithstanding the policy situation. There is already so much surplus in Germany in particular and even here in Ontario, we had 9 terawatt hours of surplus that we gave away to Michigan, New York and Quebec last year.

So the size of the problem says, let’s get on with it, and that’s the kind of approach that we are seeing from our utility partners. As I mentioned earlier as the education process and the teaming process that’s tending to be the constrain rather than waiting on policy or certainly not waiting on technology that’s not the constrain.

Sara Elford – Canaccord Genuity Corp.

And then one final one from me, on these projects where again we are in kind of moving up into and beyond the 1 and 2 megawatt size, is it something that goes out to tender or not tender, but they are discussing this with multiple parties, you then need to bid on it, you are one of many parties in discussion around these types of projects or alternatively are they viewing as either coming directly to you and you’re working on that basis?

Daryl Wilson

I would say, it’s more common that we team up with that performance and go after projects pretty much alone. Our history in electrolysis gives us a strong advantage in that sense. We have a lot of industrial sites that we can point customers to say, we do this for a living. When they come to our facility in Canada or in Belgium and they see what we’re doing, they’re immediately convinced that we’re capable at an industrial scale, and so I would say, most of the larger proposals we’re working on now are solar source committed activities, which is very gratifying.

When it comes to procurements in this area, certainly we’ll face some competition. I don’t want to sound arrogant with this, but our capability to execute on these larger projects is pretty well unmatched right now. No one else hasn’t made road block to work with, and no one else has the history of industrial electrolysis that we have to win the confidence of customers to go ahead.

So we are leading. That’s something to be careful about. Leaders are always targeted to be overtaken, but this is a lead we fully intend to defend. There is lots more work that we have to do on ongoing cost reduction and positioning of the product, and so we believe we have the means to remain the leader for quite some time.

Sara Elford – Canaccord Genuity Corp.

That’s great. Thank you very much.

Daryl Wilson

Thanks, Sara.

Bob Motz

Thanks, Sara.

Operator

Thank you. (Operator Instructions) Our next question comes from the line of Rob Stone from Cowen and Company. Your line is now open.

Rob W. Stone – Cowen & Co. LLC

Good morning, gentlemen. Thanks for taking my question.

Bob Motz

Good morning.

Daryl Wilson

Good morning, Rob.

Rob W. Stone – Cowen & Co. LLC

I’m going to follow-up on Power-to-Gas and energy storage as well. Sometimes in emerging markets and new technologies a lot of effort in the early going or perhaps the higher cost is because each project or iteration with the stakeholders and regulators ends up being kind of a custom exercise. I was wondering Daryl, if you could comment on opportunities you see to standardize things like the design or the regulatory framework, other ways that you could turn this into a repeatable and faster to implement exercise? Thanks.

Daryl Wilson

Thank you. That’s a great question. And indeed it’s part of the DNA as a company and where I come from with Toyota that standard platforms are absolutely critical. If you don’t have that you can’t drive the cost down and cycle the learnings. And so we already have established and certified our megawatt platform, which gives us that foundation and as we’re quoting these projects, it’s not like we’re doing a whole lot of engineering.

We’re able to take what we have, put the pieces together, listen to any customer unique needs, which may impact the operation of the facility, but typically not the design of the facility and then we’re able to execute with, I think, in a very efficient manner.

On the business model side, there is currently more diversity. So we’re already tracking about six different ways to come at this story. We have staff dedicated to researching business models, coming up with innovative approaches and understanding the economics and the dynamics of operation. So this is an area where we are learning. Those learnings will be converted into standardized offering kind of know-how to our customers and we’ll be able to put our customers in a distinguished position to realize value from their operations. So, a great question, a huge focus for us and as you’ve pointed out, in an emerging application absolutely key staying on top.

Rob W. Stone – Cowen & Co. LLC

So related to that, Germany as you mentioned, is the market that has perhaps the most acute need and Germany was the pioneer in terms of subsidy policy and the [indiscernible] for solar. Is it possible that Germany might be the market that develops – framework to be things that could be then emulated in other jurisdictions?

Daryl Wilson

We would have thought so, but when it comes to policy being established, the California overall procurement for storage is probably the most thoughtful in the world. They’ve laid out storage programs which cover the different functions of storage in the system and create a policy around that, which is unique in the world.

And then, as I mentioned earlier, in Ontario we have both procurement and contracting mechanisms for storage that’s unique in the world. Notwithstanding the fact that Germany has the biggest need. I think we’re all aware that the extensive renewable engagement in Germany is world leading and they have found themselves in a place where no one has gone before with 24% penetration of renewables.

There is substantial issues that have arisen on account of that, but it doesn’t appear like the policy is going to turn around and back up. It’s gone way too far now. Even if Germany never built another wind turbine or wind or solar installation for the next five years, we would be busy for a long time dealing with the energy storage needs that already exist and we believe that there will be ongoing deployment of renewables as it’s evidenced that energy storage solution is going to be brought alongside to complement what’s already done.

So we are still waiting on the full coherent policy outlined in Germany, but we know there is a lot of work going on. And I think in typical German fashion there is a lot of very careful analytical work to do this in a thoughtful manner and some are looking forward to what they come up with and I think it will be something that will transport elsewhere in the world, but right now we’ve got more concrete action in California and Ontario.

Rob W. Stone – Cowen & Co. LLC

My final question on this subject is the emergence of fuel cell vehicle for consumer use seems particularly channelizing in the medium-term. Most of the projects you have in backlog or the things that you’re chasing in the next year or two, can you say roughly what proportion are related to injecting gas into pipeline versus doing hydrogen refueling?

Daryl Wilson

I don’t have immediate recall mentally of that tally. The important thing here is to realize that because there’s five or six different business model approaches to this, we have the ability to flex to the market need. So, in California it appears the ongoing support for hydrogen vehicles is a wonderful platform to bring the Power-to-Gas technology to California blended with fueling.

In Germany, we already have Power-to-Gas injection projects into the natural gas pipeline because the policy and business model will support that, we believe, in the future as does E.ON. So I think the key point is the flexibility of the solution and the variants that we have and we’ll play those cards as it makes sense in each market.

Given the number of projects in play right now, I don’t think we can make any assumption as to which one is leading or what the score is. The most recent addition to that was the project we announced in Denmark, where we’re involved with biogas methanization and that was the sixth application that we hadn’t yet announced and hadn’t yet had a project on. So at this point we got all the basis covered, having just added that one and we’re very pleased with the progress.

Rob W. Stone – Cowen & Co. LLC

Great. Thanks. A final question for Bob, if I may. You’re targeting 30% plus revenue growth this year. How should we think about the run rate of operating expenses and if you could comment both on the as reported as well as the cash part of that? Thanks.

Bob Motz

Yes. We’ve always said that our SG&A and our R&D is not particularly scale to revenue and I would expect that trend would continue. What we’re looking at in SG&A is modest growth, primarily in sales and marketing as we roll out our various platforms.

The one thing that we will look at from a revenue point of view is at some point in time, and we think it maybe in 2014, that we split out energy storage into a separate business segment, but that’s not going to have an impact on, I guess, OpEx, if you want to use that term. The challenge of R&D is the gross levels will remain relatively flat, but what we do forecast is some levels of funding and to the extent we can get that funding we would expect that our R&D would also remain relatively constant, albeit Q4 was somewhat of an anomaly due to a large funding program we got in the quarter.

So I would expect it to be more in line with prior quarters. And the issue with cash is not going to be more in OpEx plus gen [ph]. It’s going to be more around the working capital requirements to fund the business growth. Hope that answers your question.

Rob W. Stone – Cowen & Co. LLC

That was actually about the delta between cash OpEx and as reported OpEx. You’ve got some stock-based comp and some other things in there.

Bob Motz

Yes, and depreciation is – for our business, we’re not a capital-intensive business. So depreciation is not going to be a traditionally large component of our business. Stock-based comp is going to be completely variable to what’s happening in the market. And so, again, it’s not something we budget for in operations. We really look at what’s internal to the business.

Rob W. Stone – Cowen & Co. LLC

Okay. Thanks for taking my questions.

Bob Motz

Thanks, Rob.

Operator

Thank you. And our last question comes from the line Jeff Osborne from Stifel. Your line is now open.

Jeff D. Osborne – Stifel, Nicolaus & Co., Inc.

Hi, good morning, guys. Thanks for squeezing me in here. Just two ones. I may have missed this. The call has been a bit longer than usual. But, one, on the E.ON relationship, is there something that either you folks or they will be putting out there so that other utilities can look at success that you had with the new shipment, the PEM equipment that’s in place? The whole business model, the economics, payback period, et cetera, is that something that you’re in position to talk about?

Daryl Wilson

So the first site in Falkenhagen has a visitor center and a large number of people and many of our customers have visited that site. Although it closed in the wintertime, it will open probably this month again for visitors.

E.ON has been very open with the technology and the site story, but the positioning of the utilities for energy storage services is an important competitive front for them. And so they have not been so open about their plans for where the best value is and how they intend to pursue markets and applications and we found that with other customers as well.

This is the area where it’s a competitive opportunity for them and at this point they’re not cheering overly generously on that aspect. I do know as we work with them that it’s a very big focus area for them. They created energy storage business unit. It’s well staffed by a strong analytical team and working business models is a key focus for them.

Jeff D. Osborne – Stifel, Nicolaus & Co., Inc.

Excellent. And just switching gears, the last question is, can you just talk about regional. You mentioned the kind of reengagement with CommScope and on the telecom and data center side, but just regionally can you touch on the Telco RFPs that you’re seeing and how you see your prospects shaking out versus competition?

Daryl Wilson

We see the space becoming receptive again, whereas there was a low level of receptivity and no capital money to push in this direction we’re now seeing those discussions to be opened. I don’t want to get into details of who or how much or where, but there is evidence that the commercial situation has changed last year. We’re encouraged about that and of course we’re going to work very hard to gain our share. And the relationships that CommScope has within the telecom market is a tremendous advantage for us.

Jeff D. Osborne – Stifel, Nicolaus & Co., Inc.

Thanks a lot, Daryl.

Daryl Wilson

Okay. Thanks, Jeff.

Operator

Thank you. And I’m showing no further questions at this time. I would now like to turn the call back over to Bob Motz for closing remarks.

Bob Motz

Thanks very much, Tom. And once again I’d like to thank all participants on the call today. I’ll remind everybody of what the Safe Harbor comments we made at the beginning of the call and then just invite everybody to join us in our Q1 call in early May, as well as our AGM also to be scheduled for early May. Thanks very much everybody and have a great day. Bye-bye.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program. You may all disconnect. Everyone have a good day.

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