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Hydrogenics Corporation (NASDAQ:HYGS)

Q1 2013 Earnings Call

May 8, 2013 01:00 PM ET

Executives

Daryl Wilson - President and CEO

Robert Motz - CFO

Analyst

Jim McIlree - Dominick & Dominick

Operator

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Hydrogenics’ 2013 First Quarter Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct the question-and-answer session and instructions will be given at that time. (Operator Instructions) As a reminder, today’s conference may be recorded.

I would now like to introduce our host for today, Mr. Daryl Wilson President and CEO. Sir, please go ahead.

Daryl Wilson

Good afternoon ladies and gentlemen. Welcome to the Hydrogenics first quarter conference call. We are pleased to go through our Q1 results on the business side and then shortly Bob will go through the financial results in detail.

The company’s first quarter press release and PowerPoint presentation are available on our website under the Investor page www.hydrogenics.com. And we also uploaded the annual report this morning on both SEDAR and EDGAR and would refer you to those sites for our disclosures 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 you with 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 or filings with the Securities and Exchange Commission and applicable Canadian securities regulations. We do not undertake any duty to update any forward-looking statements.

Good afternoon ladies and gentlemen and thanks for joining us. Today, I will review the operations and outlook and Bob will discuss the financial results. So beginning on slide two, let me review the highlights for the quarter, another one with several important milestones and achievements. The company reported total revenue of 12.3 million and an increase of a 115% over 2012 and up nearly 25% sequentially versus the first quarter with strong performance in both our OnSite Generation and Power Systems business units.

At the same time gross margin expanded to 28.8% of revenue for 14% last year first quarter and up from 13.2% in Q4 reflecting improved mix and our commitment to achieving stronger operating results. We also booked over 7 million in new orders which Bob will review in a moment. We kept our backlog at near record levels at 55 million and our customer relationship remains strong and are expanding.

And we announced another order with EON this time for a PEM based megawatt energy storage system to be installed in Hamburg, Germany. We've also been recognized by the Cleanequity Monaco for Excellence in the Field of Environmental Technology Commercialization; quite an achievement that speaks to both our intellectual property and growing interest in hydrogen for energy storage applications.

Our listeners may recall that I was literally informed of this award midway through our Q4 earning's call at which point I rudely interrupted the call and left you and so again I make apologies for that disappearance on the last call. And last but not least we raised net proceeds of 6.2 million after the end of the quarter through a supplemental prospectus in the U.S.

This has not only provided growth capital and broaden our share holder base but will also facilitate improved trading liquidity in our stock going forward. This is 6 million in addition to the 12.2 million of cash which we ended in the last quarter with. So, we remain on track to be profitable we believe in the not too distant future with many things going in the right positive directions.

Turning to slide three, let me briefly review our post offering share composition. As you will see, we still have several major strategic partners who hold substantial equity stakes in the company CommScope, Enbridge and General Motors. These are long term shareholders with whom we collaborate from a technology point of view as well as partner in the effort to achieve market acceptance and commercialization.

We now have 8.8 million shares issued in outstanding of which nearly 57% are freely tradable. We feel very fortunate to have attracted many new high quality institutional investors with our latest round of financing and believe the Company’s balance sheet is quite strong.

Turning to slide four let me provide some additional color on the energy storage market. As I mentioned a moment ago, we recently announced another order from EON. This time for a first of kind PEM megawatt facility to be deployed in Hamburg, Germany. This 1 megawatt application will be based on our proton exchange membrane technology and be powered by excess renewable energy generated in the region primarily from wind.

This power-to-gas facility will at its core have the world’s largest single PEM electrolyser stack which will serve as a building block for future multi-megawatt applications. With construction slated to begin later in the year, the Hamburg plant will eventually allow EON to absorb surplus energy, return the power when required and alleviate grid instability improving overall utility performance.

Hydrogen produced can be stored in large quantities over long periods of time within the German natural gas infrastructure. Using our technology Hamburg will be the most advanced power-to-gas facility in the world and have the largest PEM electrolysis installation producing hydrogen.

In addition, this technology is very scalable and we’re now looking forward to much larger bids based on this type of application. This is one of the primary reasons we recently completed a capital raise given the size of the opportunities now within our reach.

We also announced last quarter the award of a major energy storage demonstration project in Belgium called Don Quixote, which will link an integrated hydrogen storage system to a refueling facility.

Overall in Europe thus far we’ve won six hydrogen projects including five in Germany and 18, of the 18 that are on the books planned for the country at this point and we expect that there are more projects to come. But the demand is not only in Europe. We continue to work with our partner Enbridge on potential applications within North America and we’re very pleased with pace of development here as well.

As we’ve said in the past hydrogen can be easily stored within the nation existing natural gas infrastructure or use for fueling stations as will be the case in the Don Quixote project. Enbridge is similarly looking at both types of end-use applications.

Turning to slide five, our Power Systems business is ramping up quite nicely. With CommScope we’ve already shipped several hundred units and nearly complete on this initial order in North America, but that’s just the beginning, we see increasing opportunities not only here but in Europe and Asia as well where backup power applications are gaining both interest and acceptance.

The time of kicking the tire so to speak on this technology is coming to an end and given our present manufacturing capacity, we can easily meet higher production volume and have started to see RFPs and blocks of greater than 500 or 1000 units. We have a number of bids in process and are at the same time working on larger telecom and datacenter backup applications.

Bottom line, we are very excited about this and see the future with CommScope as very positive but timelines and consummation of business in telecom can be somewhat unpredictable so exactly when this will happen is not immediately clear.

We also continue to show progress in our $90 million multiyear propulsion contract. We booked revenue on this contract in the quarter and the work is progressing very well against milestones.

Lastly, we’re bidding on various transportation applications on the bus, truck, and heavy duty transport space and we believe that it could be further news on wins here in the near future as well.

Slide six shows the overall update on our products and market. Markets within the energy storage space I’ve already reviewed our leading position in this expanding area highlighted by the recent win with EON using our PEM technology and the Don Quixote demonstration project. We are bidding on new and larger applications and expect to have a fairly steady stream of news in this area for the remainder of 2013. We are seeing markets in Europe, Japan, and North America showing growing interest along with Europe.

In our Power Systems segment our CommScope relationship is strong and leading to new business both here and overseas; we are pleased with the pipeline of backup power opportunities and believe that the market acceptance will lead to an acceleration of orders going forward. At the same time we continue to work on our large multiyear propulsion contract and everything is proceeding on plan.

And last on OnSite Generation business it is still leader in the field and benefitting from improving global economics we are bidding on numerous RFPs across the globe for manufacturing sites and hydrogen fueling stations and our growth is here fairly steady and predictable while bookings were a little light in Q1 we are seeing a good order flow for Q2 and we continue to work with a substantial of bid orders. So turning to seven I would like to reiterate where we stand today and as I said on the last quarter we are at an inflection point with our energy storage and power systems operation starting to represent a much a larger of Hydrogenics’ overall business we remain on track to become profitable around $50 million in revenue run rate and well on our way to this milestone achievement we now have additional cash support and our rapid growth in improved margins as we start to scale up operations.

Lastly before I turn the call over to Bob let me just wrap up with slide eight we had another good quarter with strong revenue in growth and margin expansion our backlog is solid and we are seeing increased demand across all of our business units particularly in regard to energy storage applications and fuel cell power modules. We are actively bidding opportunities across the globe with new and existing customers alike.

We believe the company is on track for another year of significant revenue growth fueling us toward profitability. With our balance sheet stronger than ever Hydrogenics is well positioned to continue on the path leading the world in hydrogen based energy technology. I am pleased that we have come this far and look forward to sharing additional news about our company in the hydrogen field in the quarters to come. I will turn the call now over to Bob Motz our Chief Financial Officer who will review our financial results in detail Bob?

Robert Motz

So to briefly summarize the financial results for the first quarter ended March 31, 2013. Turning to slide nine we posted revenue of $12.3 million for the first quarter of 2013 which represented an increase of 115% over the prior year period. The strong top line improvement was fueled by increased sales in the company’s power systems business unit. Tied to its contract for integrated power propulsion systems our power systems revenue also rose from the partial delivery of our order for fuel sub modules to CommScope.

Our gross profit shown on slide 10 rose to 3.5 million from 0.8 million in the first quarter of fiscal 2012. In addition the company’s gross margin as a percentage of revenue expanded to nearly 29% an increase of 15 percentage points year over year primarily reflecting improved product mix within the company’s power systems business unit. Also contributing to the gross margin increase was the effective cost reductions realized through supply chain initiatives along with the product design innovations in the company’s OnSite Generation business turning to slide 11 Hydrogenics’ cash operating costs were 3.8 million versus 3.5 million for the comparable period in 2012. Although cost as a percentage of revenue fell over 30% the slightly higher cost this quarter reflected increased marketing expenses and other costs tied to the company’s higher level of commercial activity as well as higher compensation cost related to the improved business performance of our Power Systems business segment. These higher costs were partially offset by 0.2 million of reduced R&D expenditures.

Turning to slide 12, our adjusted EBITDA loss was 0.8 million for the first quarter reflecting the revenue margins and expenses previously discussed.

Slide 13, shows the company's order backlog at March 31 2013 which was $55 million down from 60 million at year end but that's nearly a 120% year-over-year.

During the first quarter, we secured 7.3 million of orders for industrial gas and fuel cells applications as well as integrated power propulsion systems.

On slide 14, our cash resources at March 31, 2013 were 12.2 million. A decrease of 4.6 million as compared to the fourth quarter. This decrease reflected firstly 6.1 million of cash used in operations. Second, 0.2 million of capital expenditures partially offset by 1.4 million of operating borrowings and 0.4 million of cash from exercise one.

Now, particularly note that the 6.1 million used in operations, 5.3 million related to change in non-cash, working capital whereas 0.8 million reflected the negative EBITDA in the quarter. After the end of the quarter, as Daryl mentioned, we closed on the underwritten public offering of 891,230 common shares at a price of 775 per share which included a 116,250 common share issued pursuant to an overallotment option which was exercised in full.

After divesting the underwriting fees in costs, the company received net costs approximately $6.2 million. They are also additional reconciliations for our investors on the remaining slides of the presentations. So, with that we will now turn the call over to our operator for questions.

Please go ahead operator.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Jim McIlree from Dominick & Dominick.

Jim McIlree - Dominick & Dominick

Can you provide additional details on the splits in revenues in the OnSite business between what I will call uncharitably the legacy business versus the power to gas business, was most of it that legacy business?

Daryl Wilson

I would say in the first quarter virtually all of it with legacy business; what's happening with the power to gas projects is all coming in blocks and certainly have an impact in an individual quarter. We are not in a position where we are executing and delivering energy storage project every quarter yet. Of course that's something that we look forward to doing. And so we had substantial revenue from energy storage in Q4 last year but basically none in Q1.

Jim McIlree - Dominick & Dominick

And so is the next powered gas or energy storage project is that something that's a revenue event in 2013 or will this system that you're delivering later this year get recognized in 2014?

Daryl Wilson

We are just working through some delivery timing on existing and prospective orders right now and so there remains a possibility of revenue to be realized in calendar year 2013. But these things can fluctuate. We've also clarified in the past that some government funded projects, we have typically not treated as directly as revenue and credited the government funding portion of our project as an offset to our R&D account and so in the future and depending on the origin and the nature of accounting for the various projects and also our position and the commercial value streams. So if we are a supplier to a project and not a recipient of any government funding, it will show as revenue. But in those cases where we may be recipient of funding, we will see that transaction really executed within our R&D expense accounts.

Jim McIlree - Dominick & Dominick

And then I think you mentioned that the CommScope order is mostly delivered or has been delivered in Q1, or were you referring to as of today it’s mostly been delivered.

Daryl Wilson

Yes, so substantially delivered in Q1, there were some deliveries held over into the first couple of weeks of Q2 so there will be some further revenue there for Q2. The production started late in December last year and this was a significant order and a new challenge for us to deliver into the space. As I clarified before the fuel cell power modules are produced here in Canada, they were shipped to Mexico for integration in Mexico by CommScope and then they were shipped to the end-use customers. We met all of our internal production targets for productivity, quality, timely delivery et cetera, so we are very pleased with the overall effort and as I said there is some revenue that will travel into Q2.

Jim McIlree - Dominick & Dominick

Okay, and then finally on the large propulsion contract. I don’t know if you have mentioned how that is proceeding if that’s on track, on target, on budget etc.

Daryl Wilson

Yes, all on track. As we have clarified before this is a mixture of work involving development work, investigations and also product. So there are multiple different types of deliveries involved in these work. There is a very detailed schedule and milestone expectations from the customer and we deployed a full team to manage and do this work and we are fully on schedule and meeting all milestones to date and there is nothing at this point that would suggest that we are going to fall off schedule.

Operator

(Operator Instructions). Our next question comes from the line of John Ziegelman from Wolverine [ph].

Unidentified Analyst

So margins for the quarter are approaching 30% which is great but in your commentary on why you changed from where you were to where you got to, you talked about product mix. So my question is what’s the risk of product mix shifting so that margins move against us as opposed to for us, given the visibility of what you see in front of you?

Daryl Wilson

That’s a good question. In our Q4 call, we clarified that there were a number of things impacting our margins and that they would move more positively in the future so I’ll just walk through each of those. In our OnSite Generation division we had historically some issues around supply chain those have been rectified and projects going forward in the calendar year should benefit from better pricing on our input materials for the OnSite Generation division, so that’s something that’s improved and I don’t expect that it’s going to fall backwards.

Secondly, in terms of mix we had revenue with respect to CommScope and this is an area where it’s new for us to be in production for higher volumes of fuel cells with CommScope, it’s an area that as we book more orders and volume, we anticipate the margins will improve because our learning curve experience with managing that production and the supply chain should improve but the other variable here is the presence or absence of orders in the telecom backup space. And so there be some fluctuation with respect to that mix contribution. But in terms of margins we expect the learning curve will be positive.

And then finally by bringing in revenue now from the large propulsion order, we have a positive impact on our overall weighted average margins for the company and as we continue to progress on that work we believe that that will also be positive.

So that remains a question what else could send us in a negative direction. At this point I don’t see anything. It’s possible if we were aggressive, competitive bidding situation, and decided to go little sharper, things could settle down on one project or another. But that’s not my current expectation.

Operator

And our next question is a follow up from the line of Jim McIlree from Dominick & Dominick.

Jim McIlree - Dominick & Dominick

It’s really a follow up to what John’s question was. When I am looking at the gross margins, particularly on the Power Systems side, are you saying that as more of that mix, again just on the Power Systems side, comes from the propulsion systems biz, that large propulsion contract that the margins will; did you say improve or did you say anything about the margin just of that business as you get more of the propulsion contract coming in?

Daryl Wilson

So we have attractive margins on that contract and as that contract represents more of the mix, it’s certainly a positive factor.

Jim McIlree - Dominick & Dominick

How was that recognized? Is that a percentage of completion contract.

Daryl Wilson

Yes, that’s the only contract we have that’s percentage of completion. Everything else is, because we were basically building boxes, everything else is completely contract based upon – revenues recognized based upon the [inco] [ph] terms in such a contract.

Jim McIlree - Dominick & Dominick

The CommScope orders are either going out into the field, or in the field right now, kind of sounds like. So how long do they have to be out there and the customers get comfortable with it before you get another order from CommScope, assuming everything goes well in the field?

Daryl Wilson

Probably important to know that, well this order is directed at some key customers for CommScope; that CommScope does have multiple customers and so the flow and the experience of these various customers may differ. With respect to the current customer, don’t rightly know long they will do their evaluation. What’s interesting is the time of doing one, five and ten units in the segment are passed; and getting an order of several hundred units is already in the maturity state of the normal business flow. So when batteries and diesel gensets are shipped to Telcos for backup power purposes, the order quantities can range between a 100 to a 1000 and sometimes more at a time. They’re booking into an operation staging warehouse and then metered out on to the field with respect to the various changeover needs or Greenfield installations that that Telco requires.

So once we are into the range of hundreds of units going out in single orders it’s actually following the same pattern as diesel and batteries which is I think a very positive development. We are working at this scale on the pace of the normal incumbent technology. However we are the new kid on the block and so there is going to be some monitoring of how things went and reflection to the re-order cycle. It could be in the three to six months range but it’s very difficult to comment.

The only challenge here of course is the backup power units get actually very little use and so, if we’re talking about some sort of experience proof where these units are supposed to be in service that actually could be several years and we’re not actually waiting for that. I think that the learning point with initial deployments is how the installations have actually conducted themselves and so the experience is physically installing and starting up and commissioning the first units is the watch point.

Actual operation, we had unties in the field but didn’t operate at all for two years and that was not an (inaudible) for the telecom. So, how to call this exactly, I don’t know but we’re not just waiting and watching this one customer of CommScope there are other prospects as well.

Jim McIlree - Dominick & Dominick

And are you precluded in any way by your relationship with CommScope from targeting the telecom companies on your own or carry us on your own or other tower manufacturers.

Daryl Wilson

This is not an exclusive contract, at the time the contract was established back in 2010, we had some discussion with CommScope as to whether it would be exclusive and we decided not to do that and so we are free to pursue business through other pathways.

Jim McIlree - Dominick & Dominick

Let me ask one more. The tick up in SG&A for the quarter Bob, I’m not sure, did you say that that new level or there were something some extra things in there that should drop out in the next couple of quarters.

Bob Motz

No. There were some increased marketing cost, some of that is timing related it the marketing activities, trade shows and things that take place in Q1. We did add a couple of heads in power systems marketing group and in corporate but I would say of the tick up probably half of that is timing and half of that is permanent. But the one thing I would comment, if you’re looking at SG&A as opposed to cash operating cost, one component of SG&A is the stock based compensation where we have a number of our long term comp accruals relate to things like respected stock units and in the case of our Board members deferred share units where the payout is in cash but the amount of the payout is tied to stock pricing. So, in the quarter there was $400,000 that approximately increased comp that relates to the fact that we closed the stock price at December 31, at 675 and we had an uptick to March 31 and we had to revalue that accordingly.

Operator

Thank you. (Operator Instructions). And I see no further questions at this time. I’d like to turn the conference back to Mr. Wilson for any concluding remarks.

Daryl Wilson

Okay, well. We thank those of you who joined the call this afternoon. We also have a gratitude of appreciation for those new investors who have recently joined us and Bob and I will be more than happy to take calls if further discussion is required.

Thanks for joining us today.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This does concludes the program and you may disconnect. Everyone have a good day.

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