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Executives

Guy McAree

John William Sheridan - Chief Executive Officer, President, Non-Independent Director, Ex-Officio Member of Management Development, Nominating & Compensation Committee, Ex-Officio Member of Corporate Governance Committee and Ex-Officio Member of Audit Committee

Tony Guglielmin - Chief Financial Officer and Vice President

Analysts

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

Walter Nasdeo - Ardour Capital Investments, LLC, Research Division

Ballard Power Systems (BLDP) 2012 Earnings Call February 21, 2013 11:00 AM ET

Operator

I'll turn the conference now over to Mr. Guy McAree, Director of Investor Relations. Please go ahead.

Guy McAree

Good morning, everyone. Today's call is to discuss Ballard's 2012 operating results and outlook for 2013. With us today, we have John Sheridan, Ballard's President and CEO; and Tony Guglielmin, our Chief Financial Officer.

We'll be making forward-looking statements that are based on management's current expectations, beliefs and assumptions concerning future events. Actual results could be materially different.

Please refer to our most recent annual information form and other public filings for our complete disclaimer and related information.

Consistent with IFRS, our 2012 audited financial results reflect continuing operations following the sale of our material products division in January of this year. And we wanted to be more fulsome in our reporting relative to previous 2012 reports and our 2012 guidance, so we've also provided the results and commentary on a total basis including material products. Now, over to John.

John William Sheridan

Thanks, Guy, and good morning, everyone. As usual, I'm going to talk to the top line and Tony will talk to the bottom line 2012 results as well as 2013 guidance. And maybe just to warn you, at the front end, both Tony and I are working through colds here, so bear with us as we struggle with our voices here.

So as per the press release you saw, revenue results in Q4 and for the full year were consistent with our revised guidance, but that's not the story of 2012. 2012 was a tough year for Ballard and for our shareholders. And we had 3 distinct and very different phases throughout the year. Phase 1, we encountered weak revenue results in the first half of 2012 primarily from the softness in our material products division and in bus, with our bus frustrations compounded by the Sao Paulo Transit's decision to not move forward with its Letter Of Intent for fuel cell bus deployment in Brazil. Ultimately for the whole year, bus was $25 million below plan and material products was about $6 million below plan. So those 2 areas alone largely explain our miss relative to original guidance. So that was the first phase, encountering those headwinds.

Phase 2, in response to this weak revenue situation, as you'd expect and as we talked about, we hunkered down. We hunkered down with actions to address the top line and the knock-on impacts on the bottom line. Our primary actions included doubling down on backup power with the extension of our product line to include methanol fueled systems. We increased our focus on engineering services. We reduced expenditures on the development stage market segments of bus and DG, and we also made reductions and cuts more broadly in G&A and across the cost base. Phase 3 then, later in the year, was some of those actions starting to pay dividends, and I think you saw that in Q4. The fourth quarter results reflected a marked turnaround. Total revenue in Q4, while up only 1% year-over-year, increased 50% over Q3 to $21.3 million. This was led by growth in backup power and engineering services. And beyond revenue, there were improvements in the other key metrics in Q4. So relative to Q4 2011, gross margin improved 4 points to 24%, cash OpEx was down 10%, adjusted EBITDA improved 50% and cash consumption was only $500,000 for the quarter.

We also finished 2012 with a solid order book of $36.8 million and that excludes material products. This represents on an apples-and-apples basis, year-over-year, an increase of 15% relative to our $32 million order book. Again, if you look at that at the end of 2011 without material products. And more than half of the year on order book was comprised of backup power and engineering services.

This order book and the momentum in Q4 supports our outlook, which we feel quite bullish about for 2013. So here's some additional color on the Q4 results and our outlook by segment. Backup power, we have previously described this as an addressable market well in excess of $1 billion, a very significant global opportunity that we have just begun to address. With the addition of a commercial methanol fueled solution last year, we started to see real momentum and believe backup power has emerged as our key growth driver. I think the metrics support that. We shipped 399 backup power systems in 2012, 175% growth over 2011. 60% of those shipments were methanol fueled and 50% of those shipments were in Q4. So again, you get the sense of the trajectory.

As further insight into the market potential, in the short-term, we have already shipped more than 100 ElectraGen systems this year in January. And we have purchase orders in hand for more than 300 ElectraGen systems, including a significant number of Nokia-Siemens for Japan, systems for trial with a large U.S. carrier and units for customers in other international markets with a repeat commercial deployments including Indonesia and South Africa.

And there's also significant potential beyond those short-term order -- that short-term order trajectory with the opportunities we've mentioned before including the Norwegian node nonemergency services network; the work with China Mobile, that's in an early stage now in China; and Idea Cellular in India. We believe these could land late in the year and that would be an upside to our plan. Again, we're trying to take a much more prudent approach in terms of what we're baking into the plan and what's reflected in our guidance. So backup power will be the key driver in 2013 with expected growth well in excess of 50%. This means that backup power should represent about 40% of our total 2013 revenue base.

Engineering services, we've recorded more than $10 million of revenue in 2012 in engineering services compared to less than $5 million in 2011. Our Engineering Services contracts in 2012 were with both automotive customers, Daimler and AFCC, as well as nonautomotive customers, such as our work in the generator market with Anglo Platinum and work in the aerospace industry.

Turning to 2013 with engineering services. The expiration of the automotive non-compete agreement, it ended Jan 31 last month, has expanded our scope in the automotive area. So as such, with what we see in Engineering Services, we expect growth this year to be well in excess of 50%. That means then Engineering Services should represent about 30% of our total 2013 revenue base.

Turning to material handling. Our 2012 stack shipments to plug power increased 42% to 2,022 units building on a 29% increase in shipments in 2011. Now while the market demand dynamics for material handling in 2013 looks strong, there could be an impact on growth this year with plug addressing its financing situation. As such, we are discounting our material handling growth projections for 2013, assuming that shipments will be flat. This means that material handling should represent about 10% of our total 2013 revenue base. And again, we feel that's a conservative assumption, which leaves us an upside to our plan and an upside to guidance.

Looking then at the development stage markets. Fuel cell buses and distributed generation, again, disappointing results in 2012. And a lot of this is -- these earlier stage, as we call, development stage markets are dependent on government support. And in this environment, government support is weak to say the least. And we don't -- we're not banking on that situation changing significantly in the short-term. So we expect revenue in these markets to be relatively flat in 2013.

So assuming no growth in bus and DG in 2013, these 2 development stage segments combined would represent about 20% of our total 2013 revenue base. And again, we see that as a conservative assumption. So any growth in bus or growth in DG in 2013 would represent an upside to our plan and an upside to guidance. So wrapping up the top line picture, 2012 full year revenue, disappointing overall. But we took action in the year and repositioned. Some of those actions started to pay dividends in Q4, generating momentum exiting 2012. And that's underpinned the solid growth outlook for 2013. And again, to be led by growth in backup power and engineering services.

Now over to Tony on the bottom line.

Tony Guglielmin

Thanks, John, good morning, everyone. Now just as John discussed our top line performance comparisons that included material products, I'm going to do the same when I'm discussing our bottom line performance as well.

So as John mentioned, following the weakness we experienced in, what John described, as the first phase of 2012, we responded not only by shifting our increased resources to our key growth markets of backup power and engineering services, but we also took further steps to reduce our cost base. Now this has been a consistent with our ongoing focus on managing our cost base to align with our level of revenues.

So let it -- now in terms of our operating cost base in 2012, cash operating costs were $32.2 million for the year, an improvement of 18% from $39.3 million in 2011. And this was on top of operating cost reductions in 2011 of 7%.

In terms of gross margin, the other key driver to profitability, gross margin was 20% for the full year, a 2-point improvement over 2011 and 24% in Q4, up 4 points over Q4 2011 -- pardon me, it was 24% Q4 2012 rather. So with these improvements in gross margin and our operating cost base, adjusted EBITDA improved 17% to negative $18.5 million in line with our revised guidance for the year.

Turning to cash and liquidity in 2012. Cash used by operating activities was $28.1 million, a 15% improvement over $33.2 million used in 2011. This was achieved through a 16% improvement in cash operating losses as well as a 12% improvement in working capital usage.

And importantly, as we indicated throughout the year, we expected cash used in operations to be materially less in the second half of 2012. In fact, cash used in operations for the second half of the year was just $1.8 million compared to $26.3 million used in the first half of the year.

Now this reflected the strong Q4 revenue, as John described, as well as the ongoing cost reduction efforts and our aggressive working capital management.

As such, we ended the year with $12.5 million in net cash reserves. And again, we did fortify this cash position through the sale of our material products division on January 31 of this year.

So that's a brief recap of the 2012 bottom line results. But as I just referenced the material products sale, let me just reiterate the drivers behind the sale transaction before I turn to 2013.

First, the material products division was a noncore asset with more than 90% of its business not related to fuel cells; second, the material product revenue has been a drag on our revenue growth and it's been down about 25% since 2010; and third, the sale did fortify our balance sheet, adding cash reserves of $10.5 million.

And post-sale, we are now a pure fuel cell product and services company with a much sharper execution focus.

So with that, let me turn to our outlook for 2013 for the bottom line. In terms of gross margins, we expect to see continued progress in 2013 in gross margins through a higher portion of our revenue coming from engineering services as well as continued product cost reductions. In terms of cash operating cost, we expect to make further progress in reducing our cost base and are expecting cash operating cost for the year in the mid-$20 million range down from $30.3 million on a continuing operation basis.

And we expect to achieve this through the full year impact of the number of declining activities initiated in 2012. Implementation of ongoing SG&A reductions this year and continued reassignment of employees to our expanding engineering services line of business. With regard to cash, we expect cash use to be significantly reduced in 2013 as a result of improved adjusted EBITDA along with continued aggressive management of working capital. And one additional driver for reduced cash use in 2013 is that we will not be paying 2012 performance bonuses, and accordingly, there will be no bonus related cash payout this year.

As such, we anticipate exiting 2013 with cash reserves similar to the level at the end of 2012. So putting this all together then, based on our conservative approach to our 2013 outlook that John described earlier, our 2013 guidance for continuing operations is revenue growth in excess of 30% and adjusted EBITDA improvement in excess of 50%.

So that's our 2013 outlook and guidance. We're not, of course, going to provide any guidance beyond 2013. However, at the same time, particularly with the sale of the material products division, I thought it will be helpful to clarify our timeline to profitability. So with our expectations for continued improvement in gross margin and ongoing management of our cash operating cost base, we would then [ph] need to generate revenue in the low- to mid-$90 range in order to achieve breakeven EBITDA. Now based on our expected top line growth in key markets, as reflected our discussion today. We believe this level of revenue should be achievable in 2014.

So with that, we would be pleased to take your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] First question from Jeff Osborne of Stifel.

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

Tony, on the gross margin side, just given the mix engineering services, it -- I assume it's still kind of something with a two-handle that gross margins are expected to be for the year. I just want to get a sense of the scope of improvement that you're looking for there. And also on the cash guidance, when you talk about ending 2013 at levels as you exited 2012, I assume you're talking about the $12.5 million and not pro forma for the $10.5 million?

Tony Guglielmin

Yes. Jeff, that's right. So just to answer your second question, that's correct. So we ended the year with $12.5 million net cash. And broadly speaking, that's what I was referring to, somewhere in that range, yes, that's correct for the end of '13. And on the gross margin question, yes, you're correct. Yes, we'd be looking for gross margins for 2013, I'd say, in the low-20s. And it will be -- it'll move around a bit depending on the mix. But yes, that will be correct.

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

Okay, got you. Maybe just reflecting on the fourth quarter here. In particular, with the strength in backup, can you talk about which customer that was for? And is there still some deployment activity in the first quarter? How do we think about linearity for some of these segments throughout the year? Is it a back-end loaded year based on the order book you have now and some of the engineering services timing or more front-end loaded with some of the backup contracts you have in place? Any help you can have in terms of the cadence of the revenue line would be helpful.

John William Sheridan

Yes. A fair question, Jeff. So in terms of backup power to start with. Backup power, we're very pleased to see what seems to be building with a regular cadence. So the orders that we saw in Q4 are being replicated volume-wise in Q1 and our order book is firming up for Q2, the same way. So backup power, it -- for us it's a great business. It's a 10 to 12 week cycle time between order and shipment. And again, the more channels we develop, with the more markets, the stronger and broader that order book will be and the more regular the cadence. So that looks good in the first half. We don't see that as a big climb throughout the year. We see strong volumes in Q1. Hopefully, we can confirm that with you in April and we would think that would continue throughout the year. Engineering services, there could be a ramp there. But again, I think we're going to move forward with a pretty strong Q2 and it will be fairly level as we go Q2, Q3, Q4. Where we get into the ramp will be if as we execute on the opportunities in DG and bus, and hopefully, with the resolution of the plug financing situation and material handling. So as far as the core drivers we see now, the biggest drivers engineering services, backup power, not a big ramp. But overall, the revenue base for the, year as we've seen in past years, will ramp, we think, a little bit from Q1 to Q2 and on through the back-end of the year.

Operator

Your next question is from Walter Nasdeo of Ardour Capital.

Walter Nasdeo - Ardour Capital Investments, LLC, Research Division

I have a question. Given the volatility that you're seeing in your markets, the Brazilian bus order, the issues with -- not the issues, but what's going on with plug right now. What -- John, what do you see going forward as how the whole fuel cell market is going to continue to roll out? And over the course of the next couple of years, and I'm not talking about guidance, but just -- what are you seeing and what are you kind of looking at market-wise and growth in different segments of the market going forward?

John William Sheridan

Walter, it's good to talk to a fellow veteran here. It's a tough market and there's been a lot of uncertainties along the way. And there's been setbacks along the way as you've seen. And you know an early stage market that's capital-intensive, trying to replace cheap legacy, energy solutions, not easy, plus then we've had government challenges with faltering government policy support. And a broader volatile macro economy where customers are finding it tough to commit major CapEx. Again, the displaced cheap legacy solutions and to go with new more efficient clean energy solutions. So that's the backdrop, that's a challenge. Going forward to your question, I think part of what we're seeing is a bit of what we expected in the sense that when we've been talking for a number of years about this multi-market strategy, we wanted to be positioned in different markets to have an opportunity where the growth solidified, where the channel solidified, where we could go hard. It would've been unrealistic to think that all our 4 markets take off or that they take off in a similar timeframe. So the fact we're seeing DG and bus slower than we thought, and on the other hand, we're seeing real traction in backup power, particularly methanol now. I don't think it's a big surprise. And again, I think one of the things we've had to do and we're going to continue to do is to make sure that we have a strong focus to optimize and align the cost base to the revenue trajectory, as we understand it and as it develops. A couple of other things is -- I'd just say, without giving you a long, long monologue, one of the things we've always thought that was going to be significant, and I think you and I have talked about this before in the past, is when the bigger players, the global distributors, the global OEMs get skin in the game here. And while we've seen setbacks in 2012, we also started to see some progress at the end of 2012. And earlier this year, Cummins has made an investment in Relyon, ClearEdge acquiring UTC, even Anglo Platinum continuing strong support for what we're doing. You're getting some bigger players showing some commitment for the sector. Even on the automotive side, there's been more activity recently. So I think all of that is good. I think Walter, just to wrap up, it will continue to be a discovery exercise. Nobody's done this before in terms of commercializing this technology in the markets we're looking at around the world, but again, we do see progress and we just got to be I think, very quickly adaptive as the opportunity solidify to make sure we exploit them strongly. And again, not to be redundant but that's why we feel quite good about backup power and what we're seeing there.

Operator

This concludes the time we have for questions, I'll turn the conference back over to John Sheridan.

John William Sheridan

Thank you, operator. I hope my long answer to your question, Walter, didn't discourage any other questions. Again, we think this will be a very interesting year. We do see some significant opportunities and we're committed to exploit them and execute strongly. So we look forward to coming back to you in April to discuss our results for the first quarter. Thanks very much.

Operator

Ladies and gentlemen, this concludes today's conference call. You may disconnect your lines. Thank you for participating, have a pleasant day.

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