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Ballard Power Systems (NASDAQ:BLDP)

Q2 2013 Earnings Call

August 01, 2013 11:00 am ET

Executives

Guy McAree

John William Sheridan - Chief Executive Officer, President and Director

Anthony R. Guglielmin - Chief Financial Officer and Vice President

Analysts

Les Sulewski - Sidoti & Company, LLC

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

Operator

I will now turn the conference over to Guy McAree, Director of Investor Relations.

Guy McAree

Thanks very much, Joe, and good morning, everyone. It's the peak of vacation season, so we appreciate you folks that have dialed in, taking the time to listen in today and ask questions.

Today, we're going to be discussing Ballard's Q2 2013 operating results. And 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 a brief note that the sale of our noncore Material Products division on January 31 of this year, with that sale, all comparisons to 2012 are made on a continuing operations basis excluding Material Products. Over to John.

John William Sheridan

Thanks, Guy, and good morning, everyone. As you saw on our press release, Q2 results reflect continued strong performance, both on the top line and the bottom line. Q2 revenue was up 114% to $14.6 million. Gross margin improved 18 points to 22%. Adjusted EBITDA improved 49% to negative $3.3 million, and cash used by operating activities improved 58% to $4.7 million. These results and the momentum we have been seeing over the past several quarters are clear signs of the progress and the execution of our strategy. You'll recall, if you think back, we rebacked our strategy in mid-2012 to take further steps in the optimization of our cost base, to invest more resources, to steepen the revenue ramp in Telecom Backup Power and Engineering Services and enhance our positioning for broader value creation in development stage markets, and we put a particular focus on China and South Africa.

I'll now give you a bit of a sense of our progress in the quarter on the execution of this strategy, and then Tony will come back to the key financial metrics for the quarter.

So first, Telecom Backup Power. We posted significant growth in this market over the past 3 quarters. In Q2, revenue was up over 300% to $4.3 million. We shipped 177 ElectraGen systems in the quarter, of which 90% were methanol-fueled units, and about 1/2 of those systems were delivered to Nokia Siemens Network, NSN, for deployment in Japan.

Beyond the quarter, we also signed a supply agreement with Azure Hydrogen just last week for 220 ElectraGen backup power systems for the Chinese telecom markets. Again, that was just an order last week. That's not in our order book. That's not in any of these numbers. Those systems we would expect to ship in Q3 and in Q4.

As we've noted previously, this growing demand for ElectraGen Telecom Backup Power systems is related to 2 distinct value propositions. First, backup power for frequent often daily use in markets where electric grids are unreliable, for example, Southeast Asia and South Africa. And second, extended run time backup power for potential crisis situations, in which prolong grid outages could occur due to earthquakes, tsunamis, extreme weather, et cetera.

Our other key growth driver beyond Telecom Backup Power is Engineering Services. In Q2, we saw our revenue grow in Engineering Services 87% to $5.7 million, resulting from the ramp-up of our work on the Volkswagen contract. We signed the contract with Volkswagen in March, and this is now generating in the range of $4 million to $5 million of revenue per quarter. In addition to Volkswagen, we continue to work with AFCC and Mercedes-Benz, as well as nonautomotive Engineering Services customers.

Turning to Material Handling, we saw reduced volumes in the quarter with revenue down 27% to $1.5 million in stack shipments of 498 units. As noted in our press -- our May 8 press release, we were pleased to see Air Liquide make a $6.5 million strategic investment in Plug Power. This is a major commitment by Air Liquide to Plug Power and more broadly, to the fuel cell material handling market. It's obviously an important step in solidifying Plug's balance sheet. We would expect to see an increase now in fuel cell stack order volumes for Material Handling through the second half of this year.

Now I'll turn to our development stage markets beginning with bus. In Q2, we shipped 5 FCvelocity-HD6 bus modules, 4 of those went to Van Hool in Europe, leaving 2 more modules for shipment to Van Hool in the second half of the year under our current contract. In addition, we shipped 1 module to SunLine Transit Agency in California.

Also in the quarter, we signed an MOU with Azure Hydrogen for their fuel cell bus program in China. The scope for Ballard under this MOU would entail IP licensing, engineering services and component supply. As noted in our May 28 press release on this MOU, Azure has made a nonrefundable upfront payment of $1 million, showing a significant commitment by Azure to this initiative and to the partnership with Ballard. We are currently well under the contract negotiation stages now. So more to come on that front.

The other development stage market opportunity that I wanted to update you on today is our home generator program for South Africa. This program, heavily financed by Anglo American Platinum, is targeting the development of a continuous power system of methanol-fueled, low-cost, long-life continuous power system. This development program is proceeding on track with trials planned for next year. And in this quarter, the government of South Africa publicly endorsed the program and committed future funding support. So we're pleased to see that.

The program, more broadly, if we're successful, we see this program creating 3 different value streams: enabling cost reduction and margin improvement of our core ElectraGen Telecom Backup Power systems; secondly, opening up new telecoms markets for continuous power for base stations and off-grid regions; and thirdly, the headline target application itself, a low-cost home generator, a continuous power system that could provide electricity to some of the 3 million rural households in South Africa, households, which continue to struggle without electricity.

So in summary, good progress in the quarter on the execution of our strategy, both in our core commercial markets and progress and value creation opportunities in development stage markets. And with that, I will turn it over to Tony to review the financial metrics.

Anthony R. Guglielmin

Thanks, John, and good morning, everyone. As John mentioned, we had a strong Q2 with all key metrics moving in the right direction. So let me briefly review the results starting with the top line. Q2 saw 114% growth in revenue to $14.6 million, and 59% growth year-to-date to $26.9 million. This growth has been driven primarily by Telecom Backup Power and Engineering Services, which together accounted for 70% of year-to-date revenue, in line with our full year projection at the beginning of the year.

Our gross margin improved 18 points to -- in Q2 to 22% and 9 points year-to-date to 23%. These improvements relate to the growth in revenue from the Telecom Backup Power and Engineering Services markets in addition to our ongoing product cost reduction efforts. But to be clear, the biggest driver is the increase in high-margin Engineering Services revenue, and this will continue to help improve gross margin in the second half of the year.

In terms of cash operating costs, Q2 saw a 2% improvement to $7.1 million and a 6% improvement year-to-date to $15.3 million. So progress in the management of our cost base continues, and we still expect the full year cash OpEx to be in the mid-$20 million range, a year-over-year reduction of approximately 15%, and this is going to be driven by the full 6-month impact of the VW contract in the second half of the year as we continue to redirect our internal engineering resources from OpEx to COGS and the continued impact of other cost reduction actions taken through the past several months.

Adjusted EBITDA improved 49% in Q2 to negative $3.3 million and 38% year-to-date to negative $7.9 million. This is a result of the overall revenue growth combined with a stronger gross margin. And with further reductions expected in our OpEx base in the second half of the year, as well as continued improvement in gross margin, we expect additional improvement in adjusted EBITDA for the full year.

Earnings per share also improved in the quarter by 40% to a loss of $0.05 and improved 27% year-to-date to a loss of $0.14 per share.

Finally, in terms of liquidity, we saw a major improvement of 58% in cash used by operating activities in Q2 of $4.7 million. Year-to-date, we have seen an improvement in cash used by operating activities of 56% to $11.7 million. This was due to the improvement in adjusted EBITDA along with reduced working capital requirements. So with that, we ended Q2 with cash reserves of $25.8 million, and our cash reserves net of $2.7 million outstanding in our operating line for $23.1 million.

So then to wrap up, Q2 and year-to-date performance has been very solid on both the top and bottom lines, primarily driven by Telecom Backup Power and Engineering Services. In addition, we've made important progress for broader value creation in our development stage market with focused activities in China and South Africa. And we are confirming full year guidance for 2013 of revenue growth in excess of 30% and adjusted EBITDA improvement in excess of 50%. So with that, we would be pleased to take your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] The first question is from Gary Ferrari, a private investor.

Unknown Attendee

But where do you see the share price of the stock a year from now?

John William Sheridan

Well, that's an interesting question, Gary. And thanks for following the company, thanks for your interest in it. Maybe I can just give you a broader answer. We -- number one, we're pleased to see that the equity markets seem to recognize some of the progress we've made recently, so that's great. And as we look at the near term, we kind of see a situation where the core business, we think, quarter-by-quarter is proving in the trend results that we can get to positive EBITDA, positive cash flow and pretty solid growth. So that's kind of, if you like, Stage 1 to value creation. Stage 2 for a company like ours, I think will become increasingly clear to a lot of people there's some real option value we've got. We talked this morning in terms of development stage market opportunities. We talked about the MOU we signed in China. We talked about the work we're doing in Africa. And the whole fuel cell car world is coming back into the frame as well. So beyond the core business, beyond the strong metrics and Engineering Services, the good dynamics in Telecom Backup Power, what we think will be a recovery in Material Handling, we see some real option value in these other areas. So with that though, Gary, I won't get specific, as I don't think you'd expect me to, on any type of share price forecast.

Operator

The next question comes from Les Sulewski, Sidoti & Company.

Les Sulewski - Sidoti & Company, LLC

A question regarding -- some of the -- I noticed that, especially with telecom, that the emerging markets had seen a lot of activity in that major boost in sales in that sector. What kind of activity have you been seeing in North America? Is there a way to penetrate the markets here?

John William Sheridan

That's a great question, Les. And my background is in North America telecom, so it's something I'm kind of impatient with because you look at these networks today, very, very sophisticated networks that millions and millions of users depend on for connectivity. And if there's any type of crisis situation, the reality is most of those key network nodes on the wireless side are only backed up with about 4 hours of lead acid battery power when they work, when they're maintained. So we think there should be a big focus on network hardening. But to be clear, up till now, there's been fairly limited activity. One of the things we're excited by though is Sprint. So Sprint's got a major tender out. It's been out for some time. You may have looked at the details of it but others on the call probably haven't. The scope of that is really exciting if they proceed with that in its entirety, that they would look at network hardening of about some 600 sites a year over the next 5 years with 50% of those sites allocated for fuel cell backup power. So that could be about 1,500 sites. Now it's fuel cell in total, we think we're well positioned with our methanol product and our hydrogen product to take a significant share when Sprint moves forward. So that's, I think, a big indication of what could come. But it's also, to stay balanced in reality, it's about the only significant one on the horizon today and it's been moving fairly slow as Sprint works through the enormity of this program, so -- but we shall see. The other thing that could open up the market is, as you asked about, would be some regulatory-type push. But again, there's been some signs in the past, we'll believe it when we see it North America.

Les Sulewski - Sidoti & Company, LLC

Okay. And regarding the gross margin and then as the engineering side comes into fruition, what kind of gross margins can we expect moving -- leading up to that and I think, kind of once that's in place?

Anthony R. Guglielmin

It's Tony here. Yes, the gross -- yes, the Engineering Services business, as a business right now, is largely, of course, deploying our key engineering talent in selling hours. So from a margin perspective, as we've talked about in the past, we would say, it's going to be anywhere in the 40% to 50%, and it will be dependent on the nature of the contract. So as a segment, it's high-margin. In terms of what's going to drive the overall gross margin for the business, will be very much a question of business mix, alas as it always is for us. So it is our highest margin business. We would expect to, again, with the full year of VW next year, some additional activity we're doing in terms of some opportunities for licensing and so forth, we can see this being a growing part in terms of the percentage of our total portfolio. And that's really what's driving us into the high-20s this year, and we expect to continue to drive us in terms of total gross margins. So we haven't given any specific target for gross margin. We have set a long-term target of 30%. I think that's quite achievable, but we'll come back as we talk about '14 more in particular, but that's directionally where we see things going.

Operator

[Operator Instructions] Your next question comes from Jeff Osborne of Stifel.

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

A couple of questions on my end here. I believe on the last call you mentioned you would be shipping 8 bus units this year. You shipped 5 impressively here in the first or -- sorry, second quarter. How do we think about the mix between third and fourth quarter, just given that's also a pretty high-margin business segment for you folks?

Anthony R. Guglielmin

Yes, it's Tony here. You're absolutely right. The balance of the year to fill in that number, we have a couple of units to deliver to Van Hool to complete out that, the Aberdeen. And then we have one -- perhaps, one -- another opportunity to maybe fill in the gap, but -- so I think you're right. It's sort of in the 2 to 3 range for the rest of the year.

John William Sheridan

And just to add on, Jeff, we're not there until, but if we are successful getting the Azure MOU to contract stage, there would be some bus modules associated with that in the back half of this year.

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

You could build them that quickly then, if you signed that deal over the next couple of weeks or months?

John William Sheridan

Yes, we can. Generally, unless there's some supply chain issue, the actual assembly is a couple of months.

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

Okay, got you. That's helpful. And then, I may have missed this, but I think in past calls, you talked about what the 12-month rolling order book was. I was wondering if you could just give that number again if I -- maybe I didn't hear it.

Anthony R. Guglielmin

Yes -- no, we actually didn't mention it. It is in the materials, but the 12-month order book at the end of June was $42.9 million.

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

Okay. And then as I look at that, I assume that doesn't include anything with VW and that's all product-associated revenue?

Anthony R. Guglielmin

No, actually, so that would include the 12-month revenue from VW. So we would include Engineering Services as part of our order book. So it's product and Engineering Services.

John William Sheridan

Yes, Jeff, it's almost the flip side, the way it works. It's some of these product orders that we get, which can be quite substantiative like the Azure one that we received last week. Some of that never even gets into the order book as we report it because it comes in after the quarter end and it gets shipped before the next quarter end. Whereas, the longer-term Engineering Services contracts, that is programmed into the order book.

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

Okay. So as I look at that order book then and you kind of back out the $4 million to $5 million a quarter for VW, how do we think about the telecom piece of that? Is there still some Nokia stuff to go in Japan or is that all mixing over to China now?

Anthony R. Guglielmin

No. There is this material part of the order book is still in the backup power segment, more broadly. I wouldn't say -- China isn't part of that per se right now. The one order we have with Azure, as John mentioned, isn't in the order book, and that's going to be delivered before year end. So it's really across the markets that we're currently already selling into, so we expect to be delivering some more into Asia, Japan. We have South Africa. We do have a distributor in South Africa. So I'd say it's spread across our existing markets but I will say most of it in there, and as John mentioned, that the time horizon for orders are, frankly, in many cases quarter-to-quarter. So to look at it as a 12-month order book in backup power, it's probably better -- it's probably safer to say it's probably the equivalent. We'd probably deliver that out in a quarter or 2. So we don't have a lot in the second -- in the back end of that, and we'll start to fill that order book up on a rolling basis.

John William Sheridan

But maybe just to give you a bit of specificity to anchor that to your question, Jeff, think of the current order book as being 20% to 25% Telecom Backup Power.

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

Okay, that's helpful. And then any sense -- I mean, Les asked about the Sprint RFP, any sense -- I mean, obviously, it's dragged on a bit here. Do you expect a decision this year or is that something imminent or maybe still in the exploration stage?

John William Sheridan

Well, one of the things, Jeff, as you've seen, is sometimes we're not very good at understanding the time line on these major tenders in the fuel cell business. But we're close to Sprint and we think this is going to be quite short term.

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

Okay. That'll be great to see. Just 2 other quick ones here. Did the VW -- did that start April 1? So did you really kind of hit the true stride or run rate on that this quarter or is there a slight ramp in Engineering Services for the third quarter and we should think maybe margins are a little bit higher sequentially?

Anthony R. Guglielmin

Yes, the contract started -- we signed the contract 2nd week of March, I think it was or -- and then we did start to work. But in terms of the second quarter, we're not quite to the full run rate, but getting closer. There's certainly a bit of upside in the back half, particularly if you look at the second half of the year compared to the back half, but there's still -- we are almost at full run rate in Q2, but there's maybe another 10% upside of revenue.

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

Got you. And then the last one, John, you mentioned that -- I mean, it was great to see the investment in the Plug Power with your strategic partner there, and I know you can't speak for them but maybe just what the pace of dialogue is with potential customers about your comment about Material Handling improving in the second half. Do you see that liquidity was an issue in the springtime and things have turned the corner now that, that investment has been made and you would expect that business to accelerate or are you just kind of hypothesizing now that the investment is there and maybe just the level of discussion with potential customers is kind of flattish?

John William Sheridan

I guess a bit of both, to be honest with you, Jeff. If you back up in the first part of the year, it wasn't just the liquidity concern that might have slowed down progress on Plug's pipeline. It's a reality in a small company that, that diverts a lot of the management focus rather than being centric on customer and customer prospects. There's a lot of focus, obviously, on financing. So that didn't help the pace of the pipeline. But as we look at it now, Plug is making progress. We are starting to see that. And in our discussions with Plug, they seem to be quite positive. Their call is coming up, I think next week. So there'll be reporting firsthand on it. But you look at the business, they've got 44 site deployments already with 24 customers and a lot of those customers are big, blue-chip customers that have only deployed at a few centers, and some of them have hundreds of centers. So we're a bit, if you like, cautiously optimistic. We think Plug crossed an important bridge and we're in a kind of wait-and-see mode, but positive as we wait to that order trajectory pick up, which we think it will in the back half.

Operator

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

John William Sheridan

Thanks, operator, and thanks to everybody. As we said -- as Guy said earlier, rather, this is vacation time and everybody is busy on a lot of fronts. So we do appreciate the time you took to call in, and we look forward to continue to report on our progress. Thank you.

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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