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Ballard Power Systems Inc. (NASDAQ:BLDP)

Q1 2013 Earnings Call

April 30, 2013 11:00 am ET

Executives

Guy McAreeDirector of Investor Relations

John Sheridan – President and Chief Executive Officer

Tony Guglielmin – Vice President, Chief Financial Officer

Analysts

Aditya Satghare – Lazard Capital Markets Llc

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

Walter V. Nasdeo – Ardour Capital Investments LLC

Operator

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

Guy McAree

Thank you. Good morning, everyone. Today's call is to discuss Ballard's Q1 2013 operating results. And with us today we’ve got John Sheridan, our President and CEO; and Tony Guglielmin, our Chief Financial Officer.

We're going to 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.

And just a brief note that with the sale of our non-core Material Products division on January 31 of this year, all comparisons to 2012 are made on a continuing operations basis excluding Material Products.

So now over to John.

John Sheridan

Thanks, Guy. Good morning everyone. As you saw in our press release, our Q1 results are clearly on track with the business outlook we provided at the start of the year. Our 2013 business outlook talked about growth in revenue in excess of 30% to be driven by Telecom Backup Power and engineering services and improvement in adjusted EBITDA in excess of 50% given this growth in tandem with increased margins and reduced OpEx.

Before I jump into the details on the Q1 results, given the major changes that we’ve implemented over the past few months as that might be helpful to start with that broader context with the review of the key actions that we have recently taken to strengthen our positioning.

So if we go back over the last few months starting first in August, we acquired the methanol fuel product line for Telecom Backup Power. Second in January, we sharpen our execution focus on fuel cell products and services by monetizing our non-core Material Products division which had recorded decline in revenue over the past two years. Third, in March, we strengthen our growth prospects by securing strategic investments from our partners in South Africa and China and by closing our milestone engineering services contract with Volkswagen.

And fourth, also in March, we fortified our balance sheet with an $8 million equity issue. So with this progress on these four areas, we have markedly strengthened our positioning, our positioning in terms of top-line, bottom-line and liquidity.

Now back to Q1 results, Q1 results confirm the turnaround we saw in Q4. Revenue was up 22% year-over-year to $12.3 million led by Telecom Backup Power and engineering services, our key growth drivers. Beyond the 22% revenue growth in the quarter, we delivered improvements in all other key metrics. Gross margin increased 3 points to 24%; cash operating cost down 10%; adjusted EBITDA improved 27%; cash used by operating activities down 54%; and order book up $7.5 million to $44.3 million.

Back to revenue growth, here are some color for the key market segments starting with Telecom Backup Power. As we stated on our outlook call in February, we expect Telecom Backup Power revenue to grow well in excess of 50% for the full year. In Q1, $6.4 million of Telecom Backup Power revenue in fact represented more than 400% growth. The key growth driver in the segment is our methanol fuel ElectraGen product line. We shipped 282 methanol systems in Q1 and have shipped more than 500 methanol systems since we added the product to our portfolio last August.

We also took over management of the manufacturing operations Tijuana, Mexico from IdaTech in January and we achieved a record production level of 215 methanol systems in Q1, which represents broadly about 25% of the ultimate plant capacity. So we’ve got headroom there.

More than half of our methanol system shipments in Q1 were delivered to Nokia Siemens Networks for deployment in Japanese Wireless Networks. The remaining shipments went to distribution partners for deployment in South East Asia, the Caribbean and South Africa.

Looking forward, Telecom Backup Power represents about 35% of the current order book and beyond that confirmed business in the order book, we see significant upside potential in a number of key geographical markets some of which we have talked about before.

Just quickly, Norway where requirement for extended duration backup power on the Nodnett emergency services network may offer some major opportunity, although that now looks to be more of a 2014 versus 2013 opportunity. India where the trial with Idea Cellular has been ongoing and we anticipate a next phase of the deployment later this year. The U.S. where we have just responded to an RFP from a major telecom service provider. In China, where our channel partner Azure continues to deploy systems for trials with China mobile.

Turning to engineering services in Q1, engineering services revenue was down year-over-year to $2.6 million. However that result reflects only a nominal amount of start up work on the Volkswagen program. Again, we just signed the Volkswagen contract on March 6. Engineering services revenue will ramp up significantly starting in Q2 as the Volkswagen programs swings into full gear. In Q2, we expect the Volkswagen program to be close to the planned run rate of about $4 million to $5 million per quarter and that’s the run rate we see over the four year life of this contract. So again that year is up in full swing in Q2. And beyond Volkswagen, we continue to work with AFCC and Mercedes-Benz Fuel Cell as well as non-automotive customers. So engineering services is shaping up to be the strong growth driver this year we expected. Material handling; market demand dynamics and material handling remain positive. In Q1 Plug shipped GenDrive systems to existing customers Lowe's and Sysco and Plug also received an order for 65 GenDrives from its new customer Ace Hardware.

Nevertheless, Q1 as week in terms of our shipments to Plug Power with material handling revenue down year-over-year to $900 million. This low result was expected with Plug Power focused in the quarter on addressing its financing situation. We expect Plug’s financing situation to get solidified, which in turn should lead a normalized growth in order volumes in the back half of the year.

So that gives you some color on our three key market segments and again just great way to summarize the top line picture, we’re off to a good start for the year, we’re on track with our business outlook, we’re on track with our guidance for revenue growth in excess of 30%.

Now over to Tony to talk about the bottom line metric.

Tony Guglielmin

Thanks, John, and good morning, everyone. I’m going to briefly run through the key bottom line metrics as well as cash flow and liquidity, so product gross margin, gross margin was up three points in Q1 to 24% driven by sales mix and higher overall revenue as well as our ongoing product cost efforts across all our platforms. In terms of operating costs, as we said on the outlook call, we expect cash OpEx to be in the mid $20 million range this year. With full represented a reduction in the order of 15% from 2012., The cash OpEx of backs once down 10% to $8.2 million in Q1 all over would have been reduced further, if not a one time expenses associate with the financing transactions and the VW contract that we concluded in the quarter as well as timing of IPO associated with some government funding programs.

However with these one time expenses behind us, we expect remain on track before you artex in the mid $20 million range. So with these improvement in gross margin and our operating cost the adjusted EBITDA improved 27%, the negative $4.6 million a losses also negatively effected by the same one time items that effected cash artex. Net loss improved 8% in the quarter to negative $7.9 million however the improvement would have been 22% to negative $6.7 million if not for a charge of $1.2 million in a relation to an agreement we reach with technology partners with standard up or EPC. This EPC issue has been a long standing, Steve with a Canadian government after the scope of direct royalty payment obligations from a government towards balance in 15 years ago. An exchange for this years final came in to EPC the negotiated settlement closes of the file and completely eliminates the obligation for any loyalty payments. And neither I’d say we’re very pleased with the resolution of this issue.

In terms of cash flow in the quarter, cash used by operating activities improved 54% to negative $7 million due primarily to the lower capital requirements the $7.9 million and consistent with our expectations for continued quarter-over-quarter improvement in the top line through the year, we expect cash used to decline significantly through 2013. In terms of liquidity as John mentioned, we fortified our cash reserves in Q1 by more than $20 million as a result of three transaction; first, the sale of the non-core material products division were up to $12 million; second, a strategic investment of $4 million by partner Anglo American Platinum; and most recently an equity financing with gross proceeds of $8 million.

Of the equity financing with investors knowledgeable in the clean technology space, further strengthen the balance sheet to position Ballard for the execution of our growth plan and achievement of positive cash flow. Also with gross proceeds of $8 million, we feel that the financing struck the right balance between ensuring a cash offer as we move forward while limiting the dilutive impact on existing shareholders. So with these transactions concluded, our expectation for year end cash reserves is now in the neighborhood of $20 million.

That’s a brief capital bottom line performance and liquidity and as a result we are confirming guidance for revenue growth in excess of 30% and adjusted EBITDA improvement in excess of 50%. So just to wrap up, we are off to a good start in 2013 with all metrics moving in the right direction, building of the turn in Q4 last year. Beyond the specific metrics, we are also very pleased to see progress in terms of key transaction such as strategic investments this year from our partners Anglo American Platinum in South Africa and Azure in China and of course the major engineering services contract at Volkswagen having a value of up to $100 million.

So transaction such as these that give us added confidence in our outlook not only revenue growth, but also value creation for our business in the medium to longer term. The VW deal alone would deliver up to $0.40 per share of gross margin over the contract period. So as a result, you’re wondering why, we have included a share consolidation item in our just released management proxy circular. This was included to specifically address the NASDAQ requirements with respect to the $1 minimum bid price rule for shares.

We believe that any reasonable valuation would put the company share price well and excess of $1, so the share consolidation item is only included in the proxy circular as a contingency, one that we do not expect we needed. But in order to keep continue driving value, we can rest assure that we will be keeping a vigilant focus on our immediate priorities of insurance continued top line growth, improvement in gross margin and prudent management of our operating cost base.

On that front, I spoke to timeline profitability on our outlook c all on February indicating a break-even adjusted EBITDA could be achieved with revenue in the low to mid $90 range. However with the positive impact that recent developments will have on gross margin and on cash OpEx notably the VW contracts, we now see break-even EBITDA achievable with the lower level or revenue in the mid to high $80 million range. As I said on the February call, we believe this level our revenues should be achievable next year. So with that we would be pleased to take your questions. Operator?

Question-and-Answer Session

Operator

Thank you. We’ll now begin the question-and-answer session. (Operator Instructions) The first question is from Sanjay Shrestha of Lazard Capital Markets. Please go ahead.

Aditya Satghare – Lazard Capital Markets Llc

Hi thank you it’s Aditya Satghare today for Sanjay. I had two questions; one is industrial question on the auto side of the business, and then question on the Volkswagen contract. So given some of the range limitations of electric vehicles, we see a number of automakers talking about the 2015, 2016 timeframe, wanting to introduce fuel cell vehicles. Can you sort of give us a sense of the discussions you’re having with multiple participants in the industry. And is there a potential to see more contracts like Volkswagen?

John Sheridan

Interesting question, so let me just back up one step if I could. So what we see broadly and we’re not the experts here the automotive OEMs are of course, but we speak to a number of them. And what we see broadly it’s a pretty standard commitment by all the automotive OEMs towards the electrification of the fleet. And the electrification of the fleet will the hybrids, plug and hybrids, battery electric vehicles and we think fuel cell vehicles.

So the question out there isn’t whether the fuel cells ultimately are commercialized in automotive applications or not the question seems to be what proportion of the fleet they would represent. And to your point what the timeline is? So in that regard to get to your question, again we’re not the experts, but what I pick up is that some of the more aggressive players like Toyota, still talk about 2015, 2016 for early stage introduction of fuel cell vehicles commercially. Others are attracting more on the 2017, 2018 range, Volkswagen feels on the other end it’s going to take longer, not necessarily because of the development of the fuel cell proportion system for cars, but because for the development of a hydrogen fueling infrastructure. So they are probably more in the 20-20 range. So it’s throughout out there.

And I think it will remain that way for a while. It will take some time to clarify what the injection points are actually going to be. And so the question about Ballard actually with the automotive non-complete lifting on at the end of January of this year, we've had discussions with a number of players. Volkswagen is our first contract in this new world, and we would see the potential for other contracts, development contracts of automotive players, probably not the magnitude of Volkswagen, but we do see the potential for other automotive contracts.

Aditya Satghare – Lazard Capital Markets Llc

Got it. And my second question to the extent which you can share, is there any, I mean how should we think about the program parameters with Volkswagen in terms of developing products maybe some sense of performance range of durability. Is there anything that you could share on those regards?

Tony Guglielmin

As you would probably expect, no, it’s a major contract for them in the range of $60 million to $100 million that’s a significant investment. They’re trying to catch-up with some of the other players, who have spent more money in this space. So they’re fairly protective in terms of their strategy with us for intellectual property development and specific milestones. More broadly though what I can tell you as you would expect the focus of the program is to really accelerate their fuel cell program and the prototype fuel cell stacks side. They’ve had a prototype for a number of years. We’re also going to work with them to design and manufacture their NextGen fuel cell stack. We’re doing a lot of work with them testing, modeling, failure analysis and so on. But sorry as far as the specific target milestones, I can’t go there.

Aditya Satghare – Lazard Capital Markets Llc

Tony, that’s all I had. Thanks a lot.

Tony Guglielmin

Thank you.

Operator

The next question is from Jeff Osborne of Stifel Nicolaus. Please go ahead.

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

Hey, good morning and thanks for taking my question. Just a couple of questions here, Tony, how do we think about the cadence of gross margins through the year? it sounds like, my impression I guess is that obviously you’ve got a step-up here in the engineering services that’s additive to the gross margin line as you indicated, but it looks like you’re expecting a pretty back-end loaded year on the material handling side and based on the trials that you talked about on the methanol side, also picking up through the year would be my expectation. and so how do we kind of offset those two lower margin businesses versus the higher, do you think you still have an opportunity to get in the high-20s exiting the year or is the peak of gross margins kind of in the summer time, and then things will tail off towards the tail end of the year?

Tony Guglielmin

Yeah. thanks Jeff, good question. There is no doubt, I think you hit all the moving pieces to this, which is very much related to the product mix quarter-by-quarter. So it’s certainly, as we move through the year, the Q1 was a good quarter on margin obviously a 24%. we do see some upside to that through the year, but certainly as we bring the VW contract at the end of full-year and in Q2 through Q4. but as we pointed out, there will be a slight offset to that as we see the ramp up in the back half, notably as we said in a couple of segments, material handing in Q1 as we alluded to earlier. So I would say yes, some upside through the year, we may see a little bit of variation quarter-to-quarter. But our projection for the year was still mid-20s with a bit of upside, I guess is the way I will describe it.

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

Okay. And then maybe more for John, I know you can’t speak for a partner or a customer in terms of Plug Power, but can you just remind us of the terms of the agreement, is there a take-or-pay aspect to that that’s annual or is it just some type of kind of soft commitment on volumes. I know you had a multi-year agreement I just forget the exact specifics of it?

John Sheridan

Yeah and you are right. Jeff, at the front end, I won’t get too specific. We’ve got a floor level of order volume that we’ve agreed with Plug to make sure we could add some reasonably efficient cadence in production. But the forecast volumes, we expect to, no there’s is not a take or pay there.

The other thing I just bring you back to Jeff just to make sure we are not misleading you as well, you had mentioned in your question to Tony about material handling being back-end loaded, what we said in our outlook was that given the issues with the Plug’s financing we were going to assume a year in our plan they share without really any growth that we expect to 2013, just to be flat with ‘12.

So our plan is predicated on that, our guidance is predicated on that, so if Plug does exceed with their financing, which we would expect they would, that could lead to an upside in the back end of the year. That’s what I was alluding to. But our core plan doesn’t reflect any big back end and loading, it’s just flat year-over-year.

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

You did more than $4 million post that you are running out of $4 million or so run rate now than you do substantially higher than that last year?

John Sheridan

No we were around $6 million. So we’re not up, we’re not much off that trajectory right now even at the low levels

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

Okay thank you so much.

John Sheridan

Thank you, Jeff.

Operator

(Operator Instructions) The next question is from Walter Nasdeo of Ardour Capital. Please go ahead.

Walter V. Nasdeo – Ardour Capital Investments LLC

Thank you. Good morning.

John Sheridan

Good morning Walter.

Walter V. Nasdeo – Ardour Capital Investments LLC

I just want to circle back a little bit on what Jeff kind of brought up. As far as the material handling goes and your projections, John I think you are little optimistic assume they are going to actually be able to pull that off, but let’s assume that’s negligible. What else are you doing in material handling to kind of makeup any lag that may come from plug and their current difficulties and then where do you see that going out into the future?

John Sheridan

Sorry Walter, within material handling or other markets?

Walter V. Nasdeo – Ardour Capital Investments LLC

Yeah, just material handling I like to get a little better understanding of where that’s going?

John Sheridan

Well, to be clear with you, our channel approach with material handling given the state of the market is dependent on Plug. There are some other players but frankly they are small players and they are players that aren’t generating much volume and at least in the short-term don’t have any significant growth ramp potential. So on the short-term we are very focused on Plug, working closely with Plug and we don’t need to debate here our views on the likelihood of financing, but in the short-term that market for us depends on Plug.

Now as we’ve also tried to make clear that market is not one of our growth drivers. That market is relatively small, proportionately for us in terms of revenue and in terms of margin. The big drivers for us and the more profitable drivers for us are Telecom Backup Power and engineering services.

The other thing just to make clear on the broad scheme of things, so the plan this year if I go back to what we said on February just to make sure we are being clear is we see very significant growth on the top line year-over-year and very significant improvement on the bottom line year-over-year driven primarily from Telecom Backup Power and engineering services alone. Material Handling, we think that will emerge in the back part of this year and into next year. Bus distributed generation, we are not counting on significant growth this year, that’s more of an option value play as that starts to develop over the medium-term.

As far as financing by the way, maybe we could talk offline it does sound like we’re a bit more positive than you, we’re also encourage to see Hydrogenics recently talking about their own financing. So, there are market windows out there, but we shall see.

Walter V. Nasdeo – Ardour Capital Investments LLC

Okay, well I appreciate it. Thank you.

John Sheridan

Thanks, Walter.

Operator

There are no further questions at this time, I’ll turn the conference back to John Sheridan.

John Sheridan

Thanks everybody, we appreciate your ongoing interest in our company, there is no shortages of challenges in the fuel cell sector, but as we said at the front end, we feel pretty good about the positioning changes we’ve made, we feel we’re now strongly positioned to create value and we do believe this is going to be an exciting year, so we’ll take a quarter-by-quarter though was Tony said, and we’ll be back to you in August to talk about our Q2 results. Thank you.

Operator

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

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