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FuelCell Energy, Inc. (NASDAQ:FCEL)

F1Q 2014 Earnings Conference Call

March 11, 2014 11:00 ET

Executives

Kurt Goddard - VP, IR

Chip Bottone - President & CEO

Mike Bishop - SVP & CFO

Analysts

Aditya Satghare - FBR Capital Markets

Jeff Osborne - Stifel, Nicolaus & Co

Rob Stone - Cowen and Company

Adam Krop - Ardour Capital

Operator

Good day ladies and gentlemen and welcome to the FuelCell Energy Reports First Quarter 2014 Results Call. (Operator Instructions). I would now like to turn the call over to Mr. Kurt Goddard, Vice President of Investor Relations. Mr. Goddard, you may begin.

Kurt Goddard

Good morning. Welcome to the first quarter 2014 earnings call for FuelCell Energy. Yesterday evening FuelCell Energy released financial results for the first quarter of 2014. The earnings release as well as the presentation that will be referenced during this earnings call is available on the investor relations section of the company website at www.fuelcellenergy.com.

A replay of this call will be available two hours after its conclusion on the company website. Before proceeding with the call I would like to remind everyone that this call is being recorded and that the discussion today will contain forward-looking statements, including the Company's plans and expectations for the continuing development and commercialization of our fuel cell technology. I would like to direct listeners to read the Company's cautionary statement on forward-looking information and other risk factors in our filings with the U.S. Securities and Exchange Commission.

Delivering remarks today will be Chip Bottone, President and Chief Executive Officer; and Mike Bishop, Senior Vice President and Chief Financial Officer.

Now, I would like to turn the call over to Chip Bottone. Chip?

Chip Bottone

Thank you Kurt. Good morning everyone and welcome. Please turn to slide 4, first quarter 2014 highlights. We achieved historic milestones with the on-time completion of two large high profile fuel cell parks of North America and Asia. Both projects are receiving worldwide attention from utility and prospective customers. It contributed to heightened interest and demand for ultra-clean distributed generation solutions.

POSCO Energy our South Korean partner is on schedule with the construction of its manufacturing facility at the same time our associates are continuing to implement process improvements at our North American manufacturing facility. These refinements will further contribute to lower costs and higher operating leverage while increasing our ability to meet growing demand.

Inquiries and activity levels are strong and our commercial organization is intensely focused on converting pipeline into backlog. My confidence level is high as we’re in final stage of closure on many attractive projects. The multi-megawatt projects involve large dollar amounts and multiple levels of approval so they take time to appropriately structure and complete. I will discuss our result and outlook in more detail after Mike Bishop, our Chief Financial Officer, reviews our financial results for the quarter. Mike?

Mike Bishop

Thank you Chip. Good morning and thank you for joining our call today. We turn to slide 5, titled quarterly financial highlights. FuelCell Energy reported total revenues for the first quarter 2014 of $44.4 million compared to $36.4 million in the same period last year. Product sales for the first quarter totaled $34.5 million, compared to $29.1 million reported in the prior year.

POSCO Energy ordered 3.7 megawatt of fuel cell modules during the first quarter of 2014 of which 3.4 megawatts were shipped and revenue was recognized. The final product and EPC revenue from the Bridgeport project was recognized during the first quarter of 2014 as that project entered commercial operations in December. Service and license revenues for the quarter totaled 5 million comparable to the prior year quarter. Advanced technology contract revenues totaled 5 million for the first quarter of 2014 compared to 2.3 million for the prior year quarter as revenue was recognized for the data center projects in Wyoming and it was an increased level of activity under the U.S. Department of Energy SECA, solid oxide fuel cell program.

Total gross profit was 2.2 million for the first quarter of 2014 compared to a gross loss of 2.3 million for the first quarter of 2013. The gross margin in the quarter was 4.9%, a continued focus on cost reduction is evident by comparing sales and gross margin sequentially as sales for the prior quarter were higher than this current quarter yet the gross margin percentage was lower at 12.7%. We continue to take cost out of our products and are diversifying the revenue mix.

Total operating expenses were 9.8 million for the first quarter of 2014 compared to 8.8 million in the prior year period. Research and development expenses increased year-over-year partially offset by lower administrative and selling expenses. The increase in R&D expenses reflected market development activity initiatives for Europe combined with continued initiatives to further reduce cost of multi-megawatt installation by consolidating certain aspects of the power plants to achieve economies of scale. These cost reduction efforts are designed to further improve the project economics for our pipeline.

Net loss to common shareholders for the first quarter of 2014 was 11.4 million or $0.06 per basic and diluted share. On an adjusted basis which excludes the net expenses related to the conversion of the 8% convertible notes during the period the adjusted net loss attributable to common shareholders totaled 9 million or $0.04 per basic and diluted share. This compares to 12.5 million or $0.07 per basic and diluted share for the first quarter of 2013.

EBITDA which is a measure of cash flow and is based on earnings before interest, tax and depreciation and amortization totaled negative 6.3 million, an improvement from the negative 9.9 million for the comparable prior year period as a result of lower cost from increased production volume and sales mix.

Now I will transition to slide 6, titled financial metrics. Cash and cash equivalents including restricted cash totaled 104.6 million at January 31, 2014. Net cash used by operating activities in the first quarter of 2014 was 5.1 million. Accounts receivable decreased from the prior quarter as we collected the final milestone payments upon completion of the Bridgeport fuel cell park. The fuel cell park was constructed on time and we have collected the receivables from the sale and installation of the power plants. Let me also highlight a strength of our business model which is that we now have a long term recurring service revenue stream from this project as we operate this plant for Dominion over the next 15 years.

The company completed a public offering of common stock during the first quarter raising approximately $30 million. Proceeds will be used to enable multi-megawatt project development and construction activity on our projects in the pipeline. Depreciation expense for the quarter was 1.1 million and capital spending was $800,000. Backlog totaled 327 million as of January 31, 2014 compared to 428 million a year ago and 355 million sequentially at October 31, 2013. Backlog includes product sales orders of 145 million compared to 260 million one year ago and 170 million at the end of the fourth quarter of 2013.

Service backlog was a 165 million at the end of the first quarter compared to a 150 million at January 31, 2013 and a 167 million at October 31, 2013. Advance technology contract backlog was approximately 17 million at the end of the first quarter 2014 compared to 18 million one year ago and 19 million at October 31, 2013.

Measured in megawatts product backlog totaled 95 megawatts as of January 31, 2014 compared to a 151 megawatts one year ago and a 107 megawatts at the end of the fourth quarter of 2013. During the first quarter we shipped 16 megawatts of fuel cell kits and fuel cell modules.

Project finance activity in the first quarter was strong. We have multiple paths to execute our near term projects in our pipeline including direct sales to utility and corporate customers as well as financing through long term power purchase agreements.

Our agreement with NRG Energy provides for deployment of our projects at customer site and NRG owns the asset and writes the long term PPA. We’re actively engaged with NRG on multiple megawatts of opportunities in our pipeline and are pleased with the progress that the partnership has made since signing our agreement last September.

In conclusion we’re well positioned for further profitable growth of the business. We expect continued cost reduction and leverage at our current 70 megawatt production run-rate and an improving revenue mix from increased activity in U.S. and Europe which will lead to additional margin expansion during the year. We’re targeting positive quarterly cash flow as measured by EBITDA by the end of 2014 based on anticipated order flow, improving revenue mix and continued cost reductions and leverage.

I will now turn the call back to Chip for further discussion of our operations and markets. Chip?

Chip Bottone

Thank you Mike. Please turn to slide 7, global operations execution. During the first quarter we maintained a 70 megawatt annual run-rate at our Torrington, Connecticut consistent with the third and fourth quarters of 2013. Based on our near term order flow projections we plan to maintain this production rate and will increase it as demand dictates.

Through reduced product cost and increased margins we’re continuing to automate and improve our manufacturing processes. For example during the first quarter of 2014 we implemented the use of an automated laser weld cell in our North American manufacturing facility in Torrington improving quality, increasing throughput and enhancing job satisfaction for our associates. Laser welding lowers cost and is faster than plasma welding so implementation of the laser weld cell equipment increases the annual capacity of the manufacturing facility. Previously we had been using plasma welding equipment to weld both the edges and the corners of the individual fuel cell components. We’re now using the automated laser weld cell on corners of the fuel cell components. Over the next year we will be replacing remaining plasma welding stations with laser weld cell in a staged manner.

POSCO’s new manufacturing facility in Pohang will use laser welding equipment exclusively as we implement best practices from the Torrington facility in the South Korean facility.

Previous process improvement such as these have already made it possible to increase the total annual capacity of the North American manufacturing facility to 100 megawatts with an [existing footprint development] [ph] an increase of 30 megawatts over the last three years. In addition these types of process improvements drive the margin expansion just discussed by Mike Bishop.

During the first quarter we announced the on-time completion of the 4.9 (sic) [14.9] megawatt Bridgeport fuel cell park and its acceptance by Dominion. This project is now in commercial operation and is delivering clean, baseload power to the Connecticut grid.

Dominion and the other stakeholders such as City of Bridgeport and the state of Connecticut are thrilled with the outcome and performance of this project. All are encouraging and supporting us to do more at other parts of the U.S. [and overall they are] [ph] using this type of project as a model on how utilities and large users should look at large scale distributed power generation.

The importance of executing on this project cannot be overstated. It provides high profile validation of distributed electric grid support delivered economically and cleanly. The project also showcases our ability to deliver and execute a broad and complex project with numerous stakeholders as three different electric utilities are involved in this project.

While prominent fuel cell parks like these demonstrate our clean energy solution suitability for grid support other projects are nearing completion and that will reinforce the attributes of our onsite distributed energy solutions. A 1.4 megawatt power plant installed at Hartford Hospital in Connecticut starts the commissioning process shortly. By early April, [the utility] [ph] is expected to begin supplying ultra-clean electricity to the hospital and steam to both the hospital and district heating system supplying buildings in the downtown area.

Our carbon neutral power plant installed at Microsoft's Data Research Project in Cheyenne, Wyoming is presently undergoing commission. Once operational we will demonstrate the effectiveness of using our fuel cell power plants to efficiently utilize on-site biogas to power data centers in this sustainable and zero carbon manner.

The fuel cell power plant installed inside the prestigious Fenchurch office tower in London’s financial district is expected to be commissioned in the second quarter of 2014. Construction on the office tower is nearing completion and the power plant will begin providing ultra-clean energy and heat for environmentally conscious tenants working in the complex. In February we announced completion of the world’s largest fuel cell park containing 21 of our fuel cell plants providing 59 megawatts of power to the grid and heat to a district heating system.

The installation was constructed in only 13 months by POSCO Energy and the fuel cell components produced in our North America facility. The project demonstrates the speed with which our scalable, distributed generation solutions can be deployed to reduce grid congestion and help utilities comply with clean energy mandates.

To meet growing demand for stationary fuel cell power in Asia, POSCO is constructing a state of the art fuel cell component manufacturing facility in Pohang in South Korea. Following a groundbreaking ceremony on November 22, construction is progressing quickly. The facility is approximately 30% complete and is on schedule. The facility will have a starting annual capacity of 100 megawatts and will have a total capacity of 200 megawatts. The capacity can be expanded as demand supports and the facility is expected to be operational in 2015.

The Pohang facility is being built by POSCO leveraging our partner’s strong financial resources. It testifies to POSCO’s long term commitment to the market and expectations for significant market growth in Asia.

Please turn to slide 8, localized manufacturing. This rendering depicts POSCO Energy’s growing manufacturing campus in Pohang in South Korea. The recent photo in upper right highlighted with a green border shows the progress of construction for the state of the art fuel cell component manufacturing building that is being built. When completed POSCO Energy will have the capacity to build the entire fuel cell power plant including manufacturing the fuel cell components and stacking them for complete fuel cell modules plus manufacturing the supporting balance of plant components. POSCO is also active in research and development working with us to further reduce product costs, enhance manufacturing efficiencies and target new markets such as the building applications market.

Please turn to slide 9, business activity overview. Our success with multi-megawatt fuel cell parks and megawatt onsite power projects is demonstrating to utilities and large well-known customers that fuel cell power plants are viable solutions of clean, efficient and reliable distributed generation that support the electric grid and enhance grid resiliency.

These projects now bring economic value to end users, project financers, other stakeholders and our company. As a result the landscape of our North American market is broadening with successful track record of talented teams and partners and access to lower cost of capital we’re very excited about our future and ability to drive the company growth. We’re actively bidding on utility RFPs, using fuel cell parks and Asian manufacturing points of validation.

The progress made to-date by executing on various strategic initiatives positions us well to pursue this type of large scale group support projects. In addition, we’re targeting onsite power generation applications in a number of states including projects with NRG Energy, under our co-marketing agreement. Our sales team has been very active with NRG, and our products are now part of NRG’s baseload distributed generation offering to their customers.

In Asia, Seoul City in South Korea continues to install new and renewable power generation as part of its [bold] [ph] plan to achieve greater energy economy, independence and safety. Using fuel cell components manufactured by us POSCO Energy will supply seven 2.8 megawatt DFC power plants for 19.6 megawatt fuel cell park to be constructed at a railroad depot. Configured for combined heat and power operation, the park will provide ultra-clean energy to the electric grid and useable high quality heat to a district heating system.

In the event of a grid disruption or outage the fuel cell park will provide power to the adjacent railroad depot. The fuel cell park is expected to be operational by the end of 2014. The power output in the park will be adequate to power approximately 45,000 South Korean households.

Solar counts for more than 10% of South Korea’s total power consumption, it generates only 3% of its power locally, less than 2% of it now from new renewable sources. To meet sustainability goals and power reliability expectations, the city has begun implementing it's forward looking one less nuclear power plant initiative. The purchase is to provide replace the power plant output at one nuclear plant with newer renewable distributed power generation including multiple fuel cell parks. The initiative will allow Seoul to become more energy independent and secure while generating electricity economically.

During the first quarter we sold two 1.4 megawatts and three 300 kilowatt fuel cell modules to POSCO. These modules will help our partner meet growing demand in Asia including the newly developed commercial buildings market. They are in addition to the monthly shipments under the existing 122 megawatt order signed in 2012.

We expect South Korea’s energy policies will expand the large commercial buildings market. Our fuel cell solutions are ideally suited to this market and attributes such as the economy of combined heat and power capability and clean and quite operation allow for installation inside buildings.

We’re progressing in Germany on a number of fronts and are witnessing growing interest from Italy, UK and Middle-East markets. To support our market development we have recently invested in some product development activities to address these specific market needs. We’ve increased our leadership role in Europe with several recent Board membership positions that’s in the EU.

Utility challenges in Europe are immense and we have significant interest in the solutions and business model that have already been introduced in North America and Asia. Our German based FuelCell Energy Solutions is being recognized as innovator and I expect we will see further order progress in 2014.

Among other strong commercialization potential our Advanced Technology Group is developing distributed hydrogen systems designed to reduce the cost of hydrogen for industrial fueling applications while providing the benefits of onsite generation. In addition to ultra-clean electricity and usable high quality heat our versatile DFC-H2 generates hydrogen at the point of use in a solution that is cost competitive and easy to save.

To showcase the tri-generation capabilities of our DFC-H2 for industrial applications we’re installing a DFC-H2 at our Torrington manufacturing facility by the end of 2014 under a program with advanced manufacturing office of the Department of Energy. Once in service in Torrington, the DFC-H2 will provide hydrogen to support our manufacturing processes while the high quality heat will contribute to facility heating and the ultra-clean baseload electricity will support a round the clock production.

With the [inaudible] installation, we will demonstrate the potential market for distributed hydrogen use for industrial processes [inaudible] economically, efficiently and cleanly by our existing technology. We estimate the potential size of the market for the tri-generation DFC-H2 at 1.6 billion in U.S. alone for both industrial and transportation applications. On-site production eliminates delivery expense a large part of the cost of industrial gases. In addition to multiple on-site product and revenue streams the DFC-H2 adds value through process flexibility as the owner can generate more hydrogen and less electricity or vice versa depending on which is more valuable based on local prices.

The DFC-H2 has been operating successfully at vehicle fueling stations in Fountain Valley, California since 2011 demonstrating it's sustainability for vehicle fueling market. In this application the DFC-H2 simultaneously generates ultra-clean energy than biogas or renewable hydrogen for vehicle fueling.

Please turn to slide 10, summary. We remain on track for delivering multiple megawatts of orders in 2014 as we push to EBITDA positive operations this year. On time multi-megawatt fuel cell park completion support our marketing outreach and validate our solutions and service offerings for a global audience. Utilities and other prospective customers are responding with a growing number of inquiries and solicitations.

Our product solutions are versatile, we have multiple market opportunities available that we’re selectively targeting which will lead to continued growth of the business.

POSCO is on schedule constructing its new manufacturing facility in South Korea. We’re maintaining a 70 megawatt production rate at our Torrington facility while making continuous process improvements, positioning us to meet demand from expanding markets in North America, Asia and Europe.

In closing I would like to thank our associates for the commitment and innovative spirit. I thank all of our customers, investors and stakeholders for your continued support.

Operator we will be happy to take questions at this time.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Aditya Satghare with FBR Capital Markets. Your line is open.

Aditya Satghare - FBR Capital Markets

I had two questions here. The Bridgeport power plant is one of the prime examples of how to implement large scale power plant. Now in terms of the conversations you’re having with the utilities now, what are some of the key barriers you think we have to overcome before we see some large scale adoption of power plants like this and what has changed in terms of that conversation?

Chip Bottone

Yes, so a lot of times particularly utility scale projects that’s 15 megawatts that was the first of its kind like that. It's financed and all those kind of things and I think there was a lot of people that wanted to see that done first and then go from there. So frankly we have had a lot of visitors to that site and having a place people can go to a point to detail makes the conversation a lot easier. Now having said all that then people say, okay, that’s exciting I understand the concept of distributed generation. We understand that you can be competitive in doing that. Let’s talk about projects. So it truly let us into a lot of different opportunities that are under development, it takes a little bit of time as I said to develop those opportunities but I know now that from a risk perspective that’s off the table for these people now. We can see it, touch it and see it and then from a financial perspective we can be more competitive in these solutions today.

Aditya Satghare - FBR Capital Markets

And second question was on cost reduction, so could you elaborate on some of the key steps you’re taking to sort of reduce cost especially as you look at global procurement options and leverage the POSCO relationship.

Chip Bottone

So I will give you a strategic answer than a detailed example. But one of the things that we recognize is that we needed to have a uniform global supply chain based on one common global technology platform and that was really critical to be able to achieve the cost reduction, frankly it lower volumes and people [long time] [ph] expect it. So that’s really what we have been working on and we’re seeing the results of that right now even though running at 70 megawatt rate as we have mentioned before we can see dramatic further improvements as we go from 70 megawatt and up.

So all of the basis, the same common parts with very diligent procurement process all of that is in place. So that’s happening as we speak. Now the second thing we’re doing obviously is looking to get leverage from the operation we have. So we have seen cost reductions frankly come on the product side [deeply] [ph] which is really a function of that supply chain work that our team has done a great job with increasing volume and of course we’re getting the benefit of leverage with that volume as well.

Operator

Thank you. And our next question is from Jeff Osborne with Stifel. Your line is open.

Jeff Osborne - Stifel, Nicolaus & Co

Really just two questions for me. Chip one is just six months into the NRG relationship, maybe just you seem pleased with the status of that and the activity level. But is there a way just in hindsight that you can kind of bring us up to speed as to what’s been accomplished thus far in terms of integration and training and I assume there is some leverage once PPA documents are drafted up for one type of customer that a lot of that is duplicative but given they don’t have experience in fuel cells, is that the challenge in closing business sooner rather than later there?

Chip Bottone

I will start then maybe Mike have something to add to that so it’s welcome and thanks for joining. None of these things happen overnight, right, I mean you mentioned training and there is some of that and as you know NRG has both an IPP business as well as a retail business which kind of fit with, kind of how we play as well. We always talk about two different models there. But that was exactly what you said. We did some education, we shared, okay, what about this customer? What about that customer? We had to develop documents like PPA documents. We’re working on frankly the optimal financial structure right now. It's not so much that we need access to capital, it’s how do we minimize the cost to capital on these transactions. So what I can tell you is that they are very supportive at very high levels of NRG.

They have people on the ground; our people go into sales calls with them jointly. Their logo, our logo is on the same proposal and they have added some real credibility frankly to some of these transactions we’re going to be closing here shortly. So not just in learning on both sides but just the fact that NRG is quite an experienced player particularly in power generation. So it has taken a little bit time that’s true, our expectation always was to take a little time but we need to do it right and we really are trying to set up a model financially and otherwise Jeff that’s repeatable.

So it takes a little time to get going. This thing has a lot of legs once we get it going and get it going right. Mike do you have anything to add to that?

Mike Bishop

I agree with what Chip said and the sales teams are working very closely together and that expense - so the commercial team, project finance teams from both companies are very active in as Chip said structuring PPAs and getting a model here that can be leveraged going forward.

Jeff Osborne - Stifel, Nicolaus & Co

I just had two more questions, one is as you look at the pipeline of utility projects that you’re looking to close this year and next. How do we think about the mix of kind of the sale of the hardware side and someone else is doing the EPC work versus the EPC development work being done internally by FuelCell Energy given the success that you’ve had in Connecticut?

Chip Bottone

The model that we have going forward is that we will do as much of that is practically possibly and that seems to be, that’s good for us from obviously a revenue perspective but the customers like it as well and certainly financers like one person to do the work. We have found out, we have learned a lot of things, we have done some engineering to make things easier to do over time and we can do it pretty efficiently with low risk. So our model really is about developing the opportunities, developing the right financial structure with the lowest cost to capital and obviously the best return for the end user and basically doing it when operating the plans for long periods of time. And that seems to be not just in the U.S. but we have introduced that model in Europe, Asia has that model, COSCO struggled with that model and that has accelerated things because it really gives people confidence that there is nothing that they don’t have to account for and allows them to reduce some contingency risk they might have in the past put in projects. The permitting issues go away, so from the timetable perspective it gives some certainty. So our model is to do it with our own team, not to say that we wouldn’t have local contractors do specific construction. But those will be people that we know we have done business with before.

Jeff Osborne - Stifel, Nicolaus & Co

The last question I had is just given the stock price performance recently a common request we’re getting from investors, how would you go about attempting to size the potential market. Obviously having baseload power at $0.10 give or take per kilowatt hour with where natural gas has today is very impressive but how do you answer that question for people looking at deferred data of new solar and wind being added. Those are slightly lower from a cost perspective but obviously have the intermittency issues that you folks don’t have.

So just looking for some advice on how you internally look at your 600 megawatt pipeline that you referenced on the last call relative to the total hunting availability of land that you can go grab sort to speak.

Chip Bottone

So there’s a couple things in there, number one is natural gas certainly has helped. I mean it did went up during the winter time but as you can see it's starting to come back down and if you look at the futures it's perhaps even lower than what we targeted to get into that $6 to $8 gas, number one. But really the price of the fuel is only 1/3rd of what we’re doing. So as we have focused on reducing the EPC cost and the financing cost and the period of installation which reduces the financing cost, all of those things have really attributed to us lowering the price that we can produce power for and be competitive to some of those other things.

Now a question may come up, can you compete with wind and solar? Frankly, we complement wind and solar. I mean some cases their prices might be higher in different parts of the world than they might be in a specific place but obviously we can put these plants where the utilities need the most which is the [low pockets and things] [ph]. So this whole utility model that we introduced a year ago, so we’re going after things like Bridgeport, has opened up the market a lot.

So candidly we’re seeing ourselves be competitive on these larger projects and in the past we have never even pursued them. So it's a little bit of an education process depending on the utility but we’re seeing more of that Jeff than less and now we need to close some of those and move on because those things are big and they span multiple years even. So we don’t want, we want to focus both on the on-site, behind the meter as well as be flooded with project opportunities and as it sits today we think the whole market is about $12 billion as we mentioned before as we add some things like the hydrogen thing which we said was 1.5 billion or so.

There is a little bit of an education process but we will be now be more competitive, cost to capital is coming down and I feel really good about us being able to compete in the future, or currently and certainly into the future.

Jeff Osborne - Stifel, Nicolaus & Co

Just one quick follow-up here, is there a way you can put it in perspective maybe without giving absolute numbers if you don’t want to about the cost of capital improvements relative to 18 months ago where you were in the teens, high-teens and your sub-10% now or just ball park would be helpful.

Mike Bishop

So yes, certainly over the past year and half and as we’ve gotten validation of not only what POSCO continues to do but also what we’re doing on the grounds here that [inaudible] supply that type of thing. We have seen project financing come down. I’m not going to give you an exact percentage but a couple of 100 basis points over what we’re looking at last year. We certainly feel like we’re very competitive in project financing offerings for our product.

Operator

Thank you. And our next question is from Rob Stone with Cowen and Company. Your line is open.

Rob Stone - Cowen and Company

I wanted to follow-up on the comment about recurring revenue from Bridgeport. How should we think about the service and license revenue run-rate now that Bridgeport is up and running and I’ve a couple of follow-ups also.

Mike Bishop

So Bridgeport is a great model for the company and really indicative of future service agreements. It's a 15 year long term service agreement that we have with Dominion. That revenue gets recognized over the period of the next 15 years from how that flows through the financial statements perspective. There is a portion related to this routine maintenance and operations that gets recognized readably over the term and then as we do module exchanges at five year to seven years, a larger portion of the revenue gets recognized.

Rob Stone - Cowen and Company

Was there much in Q1 from Bridgeport?

Mike Bishop

That project came online at the end of December so you really only have about one month of revenue recognition relating to that.

Rob Stone - Cowen and Company

So there should be a step up in the run-rate. My next question is on the gross margin outlook. Obviously one of the big drivers is going to be higher volume as these orders come in. How much do you think you can improve gross margin for some of the other cost reduction activities while you’re still running at the 70 megawatt run-rate.

Mike Bishop

So we see continued improvements in gross margin as I talked about in my script as we bring new orders online. Keep in mind as we add to our backlog now these will be complete power plants which can include EPC work as well. So you’re getting a benefit of the full power plant. As we model out the business we talked about EBITDA positive end of 2014 we’re looking at margins in the low teens as we approach that at the end of this year.

Rob Stone - Cowen and Company

And final question for Chip, you talked about a lot of orders that have been negotiated or imminent, final customer and/or regulatory approvals. Can you provide any color on what sort of regulatory hurdles there are and if that too is something that you can make kind of a repeatable activity. Thanks.

Chip Bottone

So let me just explain the process of it. It's not so much obstacles, what we try to do is first of all we don’t release or talk about things until we’ve everything signed off on money et cetera, et cetera and then we do the development work necessary. So as soon as we get a signed contract that we make public, we’re off executing that. So you can imagine that a lot of stuff has to be set up before you start that.

So when I mention things like regulatory process it's not necessarily a bad thing it's just certain sign offs has to be done but a lot of these projects really go to boards whether it's the municipality board, the university board or independent company boards because of the kind of dollars involved. So it's really more that process that I can say that we have projects developed, we have financing ranged, we have engineering done, we have site control that we’re waiting to just get through the process because that’s just you know the nature of the size of these projects. I mean the minimum project size is $5 million and more likely the projects we’re talking about per project without the service piece which doubles the revenue potential, is probably more in the range of 10 million to 20 million.

So it's not a problem, it's just time and that’s the way we like to run. That’s our business model. As once we get the contract we’re up and running, we coordinate very well in our production plan and as Mike said, the forecast.

Rob Stone - Cowen and Company

So can you comment it all on what maybe the cycle time is for just the regulatory approval part of it?

Chip Bottone

Is it really the biggest issue? Rob don’t forgot, most of the project - the projects we do really don’t have extensive permit requirements so on the regulatory side unless there is some significant interconnection which generally isn't when we do projects -- we’re not talking about transmission or major investment. That’s [surely not] [ph] the time, it's just really more the financial approval even in the case of power purchase agreement commitments from company boards, municipality boards and a typical from - you start some tomorrow till you get that go ahead, could be I would say no less than nine months and more likely 12 to 18 months. So that’s why we have got this pretty large pipeline because you develop multiple [planes] [ph] and then you kind of fit them in the timing slot.

Rob Stone - Cowen and Company

My final question is on the hydrogen generation, you mentioned a potential North American market opportunity. Is that something where you’re also seeing meaningful interest in markets like Europe for baseload plus hydrogen?

Chip Bottone

You’re exactly right. That number that we laid out there was not even Europe but in fact the interest in Europe is as high if not higher than in North America. We just happen to start in North America first because there was some interest particularly in California early on with hydrogen vehicles that then spread to basically onsite industrial gas. It's interesting, it's the same technology with some modification so it wasn’t a big R&D effort but it's a pretty significant game changer when you think about distributing hydrogen as compared to what typically happens today which is you produce it somewhere and put it in truck and deliver it in liquid form and then vaporize it.

So we’re going to get some partners that we’re working with right now on other projects that we have proposals in for on actually megawatt scale things as well. So these pilots are pilots, successful pilot so far but we expect that we have a lot of interest already in Europe as well as in North America.

Rob Stone - Cowen and Company

You don’t necessarily need to complete the demonstration in Torrington to see inbound opportunities off or?

Chip Bottone

No, exactly right, I mean the demonstration at Torrington is really about hooking them into the factory, in the furnace and the economics of it. From a technical perspective I mean we have got proposals in for megawatt scale projects right now that we’re under negotiation. So we’re not waiting on that.

Operator

Thank you. And our next question is from Adam Krop with Ardour Capital. Your line is open.

Adam Krop - Ardour Capital

Couple of housekeeping questions for me. I know you talked about 70 megawatts being maintained in the manufacturing facility, can you talk about your CapEx expectations for the year and how that may be affected by the new laser weld and just your expectations for 2014 would be helpful. Thanks.

Mike Bishop

Our CapEx expectations for this year are in the $5 million to $7 million and it's really a combination of laser welding as Chip talked about in this script and maintenance capital, really not a lot of CapEx spending, really minimal CapEx spending required to ramp further from where we’re today. We’ve 100 megawatts of capacity in our Torrington facility and currently we’re running 70 megawatts of annual volume.

Adam Krop - Ardour Capital

And then on the R&D expense for the year, should we expect that to kind of trend what we saw in the first quarter? Maybe step up a little bit as you’re kind of building out some of you’re the R&D opportunities that you’re talking about?

Mike Bishop

I would say R&D for the year will be around the level you saw in the first quarter. We’re really targeting you know total operating expenses for the year to look a lot like last year maybe up modestly during the year but operating expense profile similar to last year slight increase, really looking to get leverage out of the operating expense line this year as we continue to grow the business.

Adam Krop - Ardour Capital

Okay and then just lastly with the new share conversions, what should I be looking for, for total shares outstanding in the second quarter, is 218 million about the number that you’re thinking?

Mike Bishop

Total outstanding shares as of today is about 253 million shares and that includes the conversions and the offering in the first quarter. If you’re thinking about modeling weighted average shares that will be less, but that’s the current outstanding shares now.

Operator

Thank you. And I’m not showing any further questions in the queue. I would like to turn the call back over to Mr. Chip Bottone, CEO.

Chip Bottone

Thank you very much everyone for joining today and thank you for the great questions. Thank you for your support and we look forward to seeing you on the second quarter call here. Have a great day. Thank you very much.

Operator

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

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