Hydrogenics' (HYGS) CEO Daryl Wilson on Q2 2016 Results - Earnings Call Transcript

| About: Hydrogenics Corporation (HYGS)

Hydrogenics Corporation (NASDAQ:HYGS)

Q2 2016 Earnings Conference Call

August 3, 2016 10:00 AM ET

Executives

Robert Motz - Chief Financial Officer

Daryl Wilson - Chief Executive Officer

Analysts

Eric Stine - Craig-Hallum Capital Group LLC

Craig Irwin - ROTH Capital Partners

Amit Dayal - Rodman & Renshaw

Jeffrey Osborne - Cowen and Company

Carter Driscoll - FBR Capital Markets

Operator

Good day, ladies and gentlemen, and welcome to the Hydrogenics’ 2016 Second Quarter Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder this conference call is being recorded.

I would now like to introduce your host for today’s conference Mr. Bob Motz, Chief Financial Officer. Sir, you may begin.

Robert Motz

Thank you very much. Hello, everyone, and welcome to Hydrogenics’ 2016 second quarter conference call. With me today is Daryl Wilson, our President and Chief Executive Officer.

The company’s second quarter press release and PowerPoint presentation are available on our website under the Investor page at www.hydrogenics.com. We’ve also uploaded the report this morning on both SEDAR and EDGAR and would refer you to those sites for our disclosure documents. As indicated in our press release this morning, all of our financial references are in U.S. dollars unless otherwise indicated.

I would like now to provide 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 risk and uncertainty.

Actual results could differ materially because of factors discussed in today’s press release in the MD&A section of our most recent financial statements or in other reports and filings with the Securities and Exchange Commission, and applicable Canadian securities regulators. We do not undertake any duty to update any forward-looking statements.

And with that, I’ll turn the call over to Daryl Wilson. Please go ahead, Daryl.

Daryl Wilson

Thank you, Bob. Good day and thanks everyone for joining us for Hydrogenics’ 2016 second quarter conference call. Today, I will review our operations and outlook, after which Bob will discuss our financial results in detail. Please refer to the presentation on our website for today’s discussion.

Beginning with Slide 3, let me start by briefly reviewing some highlights of the past quarter, after which we will go into further detail about a few major developments and near-term focus.

I’m happy to say that revenue rebounded nicely in Q2 to $9.2 million, up 25% year-over-year and more than doubled that of 2016 first quarter. This reflects the timing of certain projects as well as the overall size of our backlog, which itself rose $16.2 million in the quarter, rebounding to a level of over $100 million. The backlog now includes our most significant orders from China to date, and we will speak about that in a moment.

Our gross margins this year are running over 20%, up around 800 basis points versus 2015, a trend we certainly see continuing. Just as importantly, we’re making steady progress on numerous projects already underway, while pursuing a large pipeline of attractive opportunities around the globe.

At the same time, we are aggressively working to finalize our groundbreaking power generation project with Kolon in Korea. I also wanted to point out that due to anticipated production requirements going forward, we recently took out a lease on an adjacent property here in Mississauga that will virtually double our capacity, allowing for much higher run-rates, as always we’re planning for the future.

Now, let me provide an update on Hydrogenics’ major opportunity this year with Kolon shown on Slide 4. As our listeners know, we’ve had a foothold in South Korea for some time now, and over the past year worked diligently to take our venture there to the next level. We’ve delivered our first megawatt of fuel-cell based power production late last year to demonstrate the viability of our PEM technology to turn excess industrial-waste hydrogen into electricity.

The plant has now logged over 5000 hours in operation with results exceeding expectations. The success of this early pilot rapidly grow drove the expectations to match the actual process need to handle a very large quantity of excess hydrogen amounting to 50 megawatts of power output.

Our technology and team are up to this job, but there are many attributes in bringing such a large project to fruition. As I’ve mentioned in the past, the program involves a number of participants, not only awesome Kolon, but the hydrogen producing refinery, a financing company and an entity bound to a power purchase agreement.

The dream is not to just to build a 50 megawatt facility, but to include a 20-year maintenance agreement so that all parties can see the long-term benefits of this momentous achievement.

As recently as last week, our management team was in Korea working with an insurance provider to help manage the project risk profile over the envisioned period of time. This is a first of a kind largest-ever hydrogen powered facility and as such requires a thorough thoughtful analysis of all provisions to ensure that the stakeholders are adequately covered in terms of risk management.

So here’s what we know as of now. The key parties want to move forward and the size of the project is at 50 megawatts and that’s still the most likely scenario. And finally insurance options are being considered that should help alleviate any long-term concerns by the parties. But it’s a difficult process and there’s no final structure just yet.

So while I’d love to tell you that we’re going to get the green light very soon, I don’t want to make any promises until we have received an actual order. For our stakeholders and shareholders, we have to get this deal right the first time, it’s a groundbreaking, potentially $100 million project that at the same time needs to be constructed for the benefit of all including Hydrogenics.

Now turning to Slide 5, let me review some of our energy storage applications and other large electrolysis opportunities. First of all, I’m pleased to announce our first major deal in Southeast Asia. Hydrogenics along with Phraram 2 Civil Engineering Company has been awarded a €4.3 million contract with the Electricity Generation Authority of Thailand or EGAT for a wind hydrogen project. It will be Southeast Asia’s 1st megawatt scale project for energy storage and include our turnkey applications to both generate hydrogen and use it as a power source.

Our ultra compact 1 megawatt PEM electrolyzer will convert excess wind electricity into hydrogen and store it. After which our Hydrogenics fuel-cell plant will convert it back to electricity, up to 300 kilowatts in demand as needed. It’s an example of the breadth of Hydrogenics turnkey technology and the increasing global nature of the demand that we are experiencing.

Our existing reference sites, including with E.ON, continue to attract a large amount of attention as we make progress illustrating the benefits of power to gas energy storage applications to a wide range of companies and enterprises that encompasses $80 million of near-term opportunities.

At the same time, we’re maintaining a constant dialogue with industry and regulators in Europe, where the changing EU renewable energy policies impact hydrogen feedstock and fueling options, and it’s expected to influence demand in the near future.

As a reminder, our next generation electrolyzers offer unique product platform for energy storage of almost any size and magnitude. Our modular PEM equipment is compact, efficient and scalable, which provides unique benefits for every type of application. We’ll soon be shipping our first systems in Toronto to the Enbridge 2 megawatt energy storage facility and this will also be the first to use our latest building block design.

So, we remain excited by the outlook within this portion of our business, and we are also optimistic about the possibility of some major business in Japan, and elsewhere through our relationship with Kurion. We hope to have more information to share in this regard relatively soon.

Turning to Slide 6, let me provide an update on our initiative fuel-cell mobility applications. I’m very pleased to have announced, we recently won another order, this one of significant size, in China. We’ve entered into a strategic partnership with SinoHytec a vehicle propulsion company based in Beijing for the development of fuel-cell power modules specifically designed for the Chinese heavy-duty market. These systems will be integrated into buses and trucks for several leading OEMs in China this year and next, with a contract worth some $13.5 million.

It’s worth noting that we previously supplied fuel-cell systems to SinoHytec for various prototype vehicles, and so this next up is very encouraging, particularly considering the estimated value of the entire Chinese market for such applications.

The country continues to have a strong commitment in tackling air-quality issues, which is driving interest in hydrogen zero emission transportation. And we believe that given our current relationships in China, including four major certified integrators, we have access to potentially $100 million or more of orders in the coming years. So far, we booked over $15 million of fuel-cell awards in China, which is higher than initially expected. But we anticipate this number to be dwarfed by future awards.

The country is moving rapidly to upgrade its transportation systems. We are pleased with the progress of our partners as they have undertaken first prototype bills, pursued government certification and commence supply chain development. There remains many hurdles in this market, including the development of fueling infrastructure, skill development, supply-chain development and traction with vehicle OEMs.

We have crafted a strategy that will respect the needs of local companies, the objectives of the Chinese government and the protection of our own interest. We’re also pursuing energy storage and fueling and other hydrogen applications in China.

We remain on track with regards to our $50 million Alstom contract in Europe, and expect to ship our first train-mounted power modules for testing later this year. And we’re awaiting approval in California on a number of fairly significant proposals that leverage our heavy-duty applications for trucks and buses alike.

Overall, we remain very optimistic about the near-term growth prospects for our unique plug-and-play mobility fuel-cell modules with a large pipeline of opportunities for which we’re well positioned.

Lastly, as shown on Slide 7, let me close again by stating that Hydrogenics is uniquely qualified to benefit from the emerging market across the hydrogen spectrum. We have the capacity to rapidly grow and we are in the position to do so, as our ongoing relationships with various programs would attest.

As earlier this year, Kolon remains our largest near-term opportunity, at 50 megawatts that would represent a significant revenue growth for Hydrogenics and would be the world’s largest hydrogen power plant, a ground breaking achievement.

And with regard to mobility applications, as I just mentioned, we’re seeing increased traction in China, while making progress elsewhere as this market continues to mature. We have an $80 million pipeline of opportunities for power to gas energy storage and we’re pleased to see some of this move into backlog in the past quarter with the order out of Thailand.

And finally, we continue to see potential for some very important work with Kurion on purifying hazardous waste water, as well as other projects around the globe. So while we have had some setbacks in terms of project timing, we’re excited about how the year is progressing and the outlook for the quarters to come.

Our technology offers the scalability needed to take hydrogen power to applications to the next level. Across the board and across the world, Hydrogenics is in the position to lead and demand trends are finally playing to our advantage. We look forward to seeing this dynamic environment change and accelerate in a very short period of time.

Now, I’ll turn the call over to Bob Motz, our Chief Financial Officer, who will review our financial results in detail. Bob?

Robert Motz

Thanks, Daryl. Good day, everyone. As shown on Slides 8 and 9, we posted revenue of $9.2 million and $13.5 million for the second quarter and first six months of 2016 respectively versus $7.4 million and $14.9 million respectively in the last year.

We posted much higher revenue in the second quarter of 2016 versus the prior year, due to increased shipments within our OnSite generation business. While the six-month comparison was slightly negative year over year, due to higher power system sales in the first quarter of 2015.

Our gross margins on Slide 10 and 11 were 19.8% and 22.4% for the second quarter and first six months of 2016 respectively versus 14.1% and 14.7% for the second quarter and first six months of 2015 respectively, reflecting improved product mix and higher overhead absorption.

We expect gross margin to remain higher for the foreseeable future based on the current mix of business in our backlog.

Turning to Slides 12 and 13, our adjusted EBITDA loss was $2.4 million and $4.4 million for the second quarter and first six months of 2016 respectively, reflecting the revenue in margins previously discussed.

Slide 14, shows that the company’s order backlog as of June 30, 2016 was $102.9 million, at least $28.9 million of which is expected to be delivered in the next 12 months. During the second quarter, we received $16.2 million of new orders, as Daryl mentioned.

On Slide 15, our cash resources as of June 30, 2016 were $13.1 million versus $24.9 million at the beginning of the year.

And with that, I’ll now turn the call over to the operator for questions. Please go ahead, operator.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And our first question comes from the line of Eric Stine with Craig-Hallum. Your line is now open.

Eric Stine

Hi, Daryl. Hi, Bob. Thanks for all the details on Kolon there.

Daryl Wilson

Good morning.

Robert Motz

Hi, Eric.

Eric Stine

Good morning. Maybe, you touched on this a little bit, but just circling back to policy in key markets. And I know it’s a bit of a moving target, but maybe an update on the fuel quality directive in Germany. I know that’s a big one and then are there - is there policy in any other markets that either add to or to detract from how you view the opportunity in some of your end markets?

Daryl Wilson

Yes. Thanks, Eric. So there are two levels in Europe to focus on. One is the EU and the other then are specific individual states with a particular focus on Germany. So we’re pleased with the progress at the EU level. There is a revised definition that admits hydrogen as a renewable fuel. So that’s very positive progress. And there is still some work to do around regulations that would credit the level of de-carbonization and the liquid fuel stream. But believe there is good progress there. And then also in Germany, which is kind of the lead market good progress.

And we’re seeing that progress translate into increase in confidence with project partners to move ahead with projects. And so, even in recent months there has been formal bids put in for both funded and unfunded projects that relate to the de-carbonization of liquid fuel.

So it’s still moving. It’s not as fast as we’d like, of course. But we see overall progress in the right direction.

In terms of other markets, we have not seen the specificity of policy that we have in the EU and Germany showing up elsewhere yet, but the level of activity around putting a price on carbon, on cap and trade systems, on carbon taxes is very significant and there is a number of websites that have been tracking this on a global basis.

And these types of policies will accelerate the focus on de-carbonizing liquid fuels. Normally, in developed countries about a third of the carbon emissions arise from vehicle emissions. And the only tool right now is to blend ethanol into gasoline to mitigate that carbon. And so, when we show up with an alternative, where renewable hydrogen could be used as part of the normal gasoline making process and remove CO2 from that process, these carbon pricing schemes and the interest of governments to make progress in this area, we believe are going to accelerate.

And the nice thing with the fuel quality directive is it’s a relatively minor area policy and easy to change. So there are not a lot of major regulatory adjustments that are needed. Once a government sees this as a viable pathway, we believe the uptake will be fairly quick. And, of course, we’re in discussions with various places in the world for this to happen.

So good progress, not as fast as we like, but now on multiple fronts, I think, things are moving in our direction.

Eric Stine

Okay. Thanks for that. Maybe just turning to power to gas, so your 80 megawatt pipeline and I know that as you said in the past, that projects move in and out of that, and it’s always changing in terms of the makeup. But maybe just an update on how you see it in terms of breadth, number of customers, maybe geographic makeup of that, and may be the size of projects you see in that pipeline.

Daryl Wilson

So one out, one in, in the last quarter, so the Thailand win comes out of that pipeline and goes into backlog, so that’s a positive movement in the right direction. But new opportunities have shown up, have been qualified and been added. So we’re still sitting at net 80, even though we took the Thailand project out, because it’s now in backlog.

Geographical mix is good. I think the evidence of this most recent project, perhaps unexpected for some, but it shows the geographical reach of the activity. I think we’re somewhere around seven countries. We’re somewhere around 12 to 14 projects. The remaining projects in are as high as 15 megawatts. The larger ones typically are taking longer, because they are just larger first-of-a-kind installations; but generally, not a huge change in the past quarter with the number staying at 80.

I think, ahead of that pipeline, so these are projects that are in concept, but have not been qualified to put in that number. There is increasing activity around large scale fueling. So you can imagine as Alstom is making progress in selling their train car units, we’re filling in with them to discuss fueling solutions.

And for the trains, because of the amount of hydrogen on the train, these would be fairly significant in the range of 15 megawatts to 25 megawatts. So there is some good activity there, but as yet that hasn’t hit the pipeline.

Eric Stine

Okay. Thanks for that color. Maybe last one for me. Good to hear about the facility capacity expansion there, just wondering thoughts around timing of completion. What the CapEx might be required in terms of equipment to do that. And then, maybe, where that would take your overall capacity once it’s complete.

Daryl Wilson

So leasing additional facilities is really a modest propositions, so our cost are not up substantially to build the projects for power to gas or for Kolon or any of these other things that we’ve been discussing. It does not require a large amount of costly process equipment. So we’re not anticipating a major bill for CapEx to fit out the facility, literally, we have some office adjustments and flooring adjustments to make in the front side of the building, but otherwise it has the requisite space and crane capacity et cetera to service us.

Essentially projects, like, Enbridge for power to gas require a larger layout area to build up the skid mounted units. We have sized a process equipment and skids for Enbridge to be ultimately a 5 megawatt facility. Although, it’s being initially commissioned as a 2 megawatt facility, but the physical size is substantial.

The initial train car units for Alstom are also at significant size and need more floor space than we’ve had. As you know, we’ve always maintained a very lean operations mentality and expansion of production capacity is very much a just-in-time focus item for us. But looking at our needs in the coming quarters, we decided now was the right time to grab an adjacent facility and double our floor space.

In terms of output, we could easily double our revenue from the Canadian side of the business with this additional space.

Eric Stine

Okay. And so, it sounds, like, I mean, that is a space that you can bring on pretty quickly in terms of functionality?

Robert Motz

Yes, absolutely. And in fact, I’ll just add a little bit. It’s almost adjacent to our existing facility here in Mississauga. It was a sublet of an existing facility, so there is really not a lot of CapEx that’s needed. And in fact, we mitigated the cost somewhat, because we did have some off-site storage that we’ve now sort of consolidated in this facility.

So it’s - and I guess the other thing too is the lease we structured with them is almost coterminous with the existing lease here at our headquarters. So that it gives us the flexibility to make decisions come - the fall of 2018, when both leases mature.

Eric Stine

Okay. Thanks a lot.

Daryl Wilson

Thanks, Eric.

Operator

Thank you. And our next question comes from the line of Craig Irwin with ROTH Capital Partners. Your line is now open.

Craig Irwin

Hi, good morning, and thank you for taking my questions.

Daryl Wilson

Hi, Craig.

Craig Irwin

Daryl, as you step back and look at the bigger picture, it sounds, like, you’ve learned a whole lot along the way on Kolon. Can you say, whether or not there is anything you might change as you approach additional large size projects over the next couple of years. Is there anything that you think that maybe you can guide the customer around that would allow an easier financing completion. Green lighting of a project that you’ve learned from this process that might feed into an improved rate of release from the pipeline in the future.

Daryl Wilson

Yes. Thanks, Craig. It’s a good question. When companies, like, are started to the very big steps of scale up, there is lots of challenges. It’s a first of a kind for us in our organization. It’s a first of a kind for the customer, first of a kind in the world, frankly. In this particular case, in the earlier months in the project, it appeared that all of the capacity and the financing structure et cetera was in order in Korea.

As things have matured and final authorization has been pursued, additional levels of risk management have been required. And I think, that’s a learning point for us. I know, you have extensive background in history with the renewable energy industry and you watch wind and solar projects grow up and scale in size. So I think, it’s a similar learning path. And some of the types of products and risk mitigation support that’s grown up around the wind and solar industry is now necessary, as the fuel cell industry scales.

And so we’ve been pleased to find that there are providers in the world who are familiar with fuel cell technology, including our own. And bringing them alongside into these kind of activities, as these projects scale has been a very positive development.

As I mentioned in our remarks this morning, our team was there last week with the insurance provider and going through all of the necessary details. I think, this is the key issue in learning point going forward as the industry scales, is risk mitigation around long-term performance is a - it’s a complex art. I think our friends in wind and solar have learned it well and actually nurture the development of the significant industry with multiple players.

And it looks like now we’re into that game too, which is I think a very positive thing. But each time we encounter that both ourselves and for our customers, it’s a learning journey.

Craig Irwin

Okay. The next thing I wanted to ask about is the cost out trajectory. So from your experience designing this project with Kolon, you have some pretty clear ideas about how to engineer the product to reduce costs, reduce the install costs, accelerate the install. Can you share with us, what the leverage is been in developing a 50 megawatt project versus a 1 megawatt project. And what you see is the potential runway over the next year or too, as you take your learning’s from this project and may be pursue others of similar character.

Daryl Wilson

Yes, again a good question. And as you well know, there is multiple layers here. So as that the main supply chain with our - in our industry matures and it’s not just our growth that’s driving that, but also the automotive and other applications and other competitors. That in itself is bringing about cost reduction, because our demand is growing. We can participate in those cost reductions and demand lower prices, because we have the scale contributions to offer.

There are decisions that we made internally, in terms of make versus buy, and what we do versus what the supply chain does. And those decisions have gone in both directions and so we’ve concluded to internalize some activity that was previously outsourced. And we’ve also decided to outsource activity that was previously was self-manufactured.

And in both cases we realize anywhere from 30% to 80% cost reduction. There have also been activities on the engineering side to simplify, so when you’re building a first of a kind prototype, there is maybe a large number of fasteners, a large number of parts, a large amount of complexity. And when you look at building many hundreds or thousands of that same article, there is suddenly a good focus on the engineering team to simplify the design and so we’ve had major benefits there, including cost reductions are upwards of 80%.

The other key part of the story is the importance of standardization. So we work for the last 10 years to standardize our product platforms, and that means that as we build more buses in China, or more power plants in Korea, or more electrolysis just in general. As we standardize the platforms, it means, these cost reductions migrate to every application and that’s very good margin support for us as we scale the business.

Naturally, we have to give up some of the progress in pricing, because customers expect lower prices with larger scale. But I’m confident that we’re going to stay ahead of that game in a nice way over the coming years, because of the work we’ve done in simplifying and standardizing our platform. So lots of aspects here, I think, you will understand that and the exciting thing is our business is now in this period, where we can enjoy the benefits of scaling.

Craig Irwin

Great. And the last question if I may. Over the last six months publicly, there has been some pretty significant movement on planned hydrogen refueling stations in both Japan and South Korea, and it seems that their goals are pretty aggressive as far as allowing for the refueling for the adoption of fuel cell buses and consumer vehicles.

Can you say whether or not this is something that you’re seeing as a material opportunity for Hydrogenics. And can you update us on whether or not this may be was included in the pipeline that you’ve been sharing with us. But you had obviously advanced knowledge and that would be the reason that we don’t see the increase pipeline as sort of external observers.

Daryl Wilson

Yes, a good anticipation again, Craig. No, none of this is reflected either in backlog or the pipeline for power to gas. There is some very good movements. I think, this is going to catch folks by surprise from the standpoint that the automotive industry principally led by Toyota and Hyundai are moving a fair amount of product into several markets and that’s creating fueling station demand. So in the last six months, we’ve been quoting 10 stations, 20 stations on block in various countries that’s a new experience for us.

Previously, they were one-off pilots demonstration projects and the size of the stations have been fairly modest for the number of cars to be serviced. Here in Canada, we’ve seen for the first time the federal government put up money for alternative fueling, including hydrogen fueling. And we’ve applied to programs here in Canada for fueling stations here. Several countries in Europe, and then as you mentioned Korea and Japan as well.

We have always clarified that this market can be served in multiple ways. And so our friends in the industrial gas industry often will have surplus capacity and will track hydrogen to relatively modest size fueling stations. And we will not have the opportunity to electrolysis, well that’s happening. But we have also been on uneven station infrastructure that does not involve our electrolysis product, but simply compression, storage and dispensing.

So this is a market that we see on the move. It’s hard to say, when the winds will appear, because there is a lot of front-end work again for first of a kind scale activity. But as I said in the coming year, I think folks will be surprised how fast decent volumes of hydrogen fuel cell vehicles are showing up and then the infrastructure following.

And probably California is the market in North America that will be most visible, already a plan for 100 stations and now even discussions for more. So a good development for us that is not been reflected in backlog or pipeline.

Craig Irwin

Thanks again for taking my questions.

Daryl Wilson

Thanks.

Operator

Thank you. And our next question comes from the line of Amit Dayal with Rodman & Renshaw. Your line is now open.

Amit Dayal

Thank you. Good morning, guys.

Daryl Wilson

Hi, Amit.

Amit Dayal

Hi. How much of the backlog is China?

Daryl Wilson

Sorry, I wasn’t clear on the question, Amit?

Amit Dayal

How much of the backlog is from opportunities in China?

Daryl Wilson

So we just recently put in the $13.5 million order and that would be the principle portion from China that’s currently in the backlog.

Amit Dayal

I understood. Thank you for that. On the operating cost side, we saw almost a $900,000 increase relative to last year and even the previous quarter. Are there any specific efforts this increase can be activated to and should we expect these levels for the remainder of the year?

Robert Motz

Yes, Amit, I can address that. First of all, the biggest increase in OpEx is in R&D. And a lot of that is the timing of gross R&D expenditures versus funding from various government organizations, whether it’s here in Canada, or in the EU, or in the U.S. And so a lot of that I would expect to normalize in future quarters to more what we would see in prior periods. We do have also year-over-year an increase of about $200,000 in SG&A, and that principally is related to sales and marketing activities.

We have increased our sales force in Europe and in Asia. So we will see a slight increase, but we’re still trying to trend from a cash operating cost perspective under that sort of $4 million is a quarter run rate.

Amit Dayal

Understood. Thank you. And I guess on the margin - gross margin side, we’re still seeing some pretty big fluctuations on a sequential basis. We’re modeling for a roughly mid-20% levels for the year. Do you feel comfortable with those types of expectations on the margin side?

Daryl Wilson

Amit, as you know, we typically don’t give forward-looking guidance, but the fluctuation you’re seeing is a reflection on mix, and I think, you did hear me say that we anticipate ongoing improvement in margins. Last year, we had a number of first-of-a kind projects that were sold at lower prices and more challenging for us, because of the first time experience. There is lots of that in the mix this year.

Engineering oriented projects typically have higher margins, there is more of that in the mix for this year. So I think, that we can look forward ongoing improvement. And then as we get into very large scale projects, as I mentioned earlier, the scale of those projects impacting the supply chain have a significant positive effect. And so we think the scaling the business would be also positive from a margin point of view from where we are now.

Amit Dayal

That’s all I have. Thank you so much.

Daryl Wilson

Thank you.

Robert Motz

Thanks, Amit.

Operator

Thank you. And our next question comes from the line of Jeff Osborne with Cowen and company. Your line is now open.

Jeffrey Osborne

Yes, thanks for the detail so far. I just had two questions. One, can you just update us on your expectations for the OnSite business, a little bit softer than we are expecting here in the first-half of the year. I think, you talked about on prior calls push outs and whatnot. Maybe what the expectations are for the second-half.

And then you gave a lot of detail on Kolon on the call, Daryl. But I was wondering, if you could just touch on Kurion. You made it - to come across as just stay tuned. But can you give us a sense of may be what some of the challenges are? What’s the discussions that you are having there, is it price, is it scope, is it comfortable with the technology? Any incremental commentary would be appreciated.

Daryl Wilson

Sure. So first of all on OnSite Generation, as I look at the sales to date in the pipeline for this year, I think, we can anticipate what has been a more normal year for us in the last five years, so not a high year, not a low year, but kind of in the middle. Industrial markets do fluctuate with the build out of new greenfield sites and expansions of plants.

And with a mixed economy that’s been a bit of a mixed bag in the last couple of years, but as I said, I think, our anticipation now is some normalization in that market. And so neither up nor down from what would be historical averages.

In terms of Kurion, you recall that in February, there was a major transaction where Veolia purchased the company. And that transaction is just on the way to final consummation and been the major focus with respect to the customer themselves. And so we’re not anticipating a big step until the sales complete and the first step of integration has been done.

But at the same time, we don’t see this as a disruptive change for our partner. It’s a very positive development in the application we’re pursuing in Japan is principally about water treatment. As you may know, Veolia is one of the largest water treatment companies in the world.

So I would say, the capacity to execute on this projects at a major scale has been dramatically enhanced by the acquisition of Kurion by Veolia, but that’s a major internal focus. With respect to the Japanese government and their decision-making - I am afraid, we don’t have a great deal of visibility that’s in the hands of our customer. But we do know there is activity in discussions and planning, and so there is progress but is very, very difficult for us to call the timing on the project just now.

Our hope and expectation is through the balance of this year. We have more to say on this development.

Jeffrey Osborne

Thanks a lot. And then, just one follow-up for either of you, for the Kolon, I guess discussion around the 20-year support agreement. Is there any thought that they may require you to post a cash collateral against the cost of the restacks in the future, pick some other fuel cell companies have to do that for 20-year support agreement that they have had, which is great to have that visibility. But obviously just given the balance sheet status, how should we think about that?

Daryl Wilson

Yes. So naturally this kind of thing comes up and you’re familiar with another large project. We typically remind customers that our principal contributions to these efforts are the technology and the know-how and how to execute on the project. We don’t come with a huge balance sheet to support these kind of activities. And so there is no surprise there going into this for many, many months. Our financial capacity is very visible and well-known.

There are reasonable demands that customers will make out of the cash flow with the project. And letters of credit, supporting deposits and things of that nature I think are fair again. But in terms of long term 20-year support, we’re saying that’s not what we bring to the project, and we expect other financial parties or as we mentioned today insurance type of facilities to support the long-term outlook of the project.

Jeffrey Osborne

It’s great to hear. I appreciate it.

Operator

Thank you. And our next question comes from the line Carter Driscoll with FBR. Your line is now open.

Carter Driscoll

Good morning, gentlemen.

Daryl Wilson

Hi, Carter.

Carter Driscoll

How are you doing?

Daryl Wilson

Good.

Carter Driscoll

Just a quick question on China, so one of your competitors obviously announced a partnership to localize stack production to supply modules there. Could you just kind of compare and contrast where you stand in terms of doing - or on the importance of doing so with your recent order with your partner in China, the timing? What type of capital commitments you need to put in place? What that opportunity would do? It seems like it is a basic requirement for operating in China these days. So any color there would be helpful.

Daryl Wilson

Sure, I think what you’re seeing from us is a measured approach. It’s a big country and I think it’s wise to have a number of partners to work with, much uncertainty as these things start out. So it’s important to be confident that partners are able to perform and deliver on their promises. And we’ve even seen already a mixture of very strong performance, in some cases weaker performance on other cases.

So I think we’ve hedged our bets a little bit and we’ll see how things develop. We understand the way we started is not necessarily the way we will end. So as we watch some of these parties mature in their capabilities and deliver on their market’s development promises, then we will need to support them in different ways. And that could involve localization of production and licensing, et cetera.

So I think a measured step-by-step approach with multiple parties, always protecting our intellectual property, always being very careful to understand who we’re dealing with and what their business interests are. All of these things are important parts of a prudent strategy in going into China. We’re delighted to see the progress that Ballard has made in this market. And it’s opening up opportunities in our industry, which is a very positive development.

And there’s lots of market opportunity there to deliver on. I mentioned several quarters ago in the last five years there have been 500,000 electric vehicles built and delivered just in the bus market in China. That gives you a sense of the magnitude of that market. The limitations of battery technologies and the challenges of charging et cetera have shown up. And now there’s interest in the differentiated value with the fuel-cell solution.

We’re a well-practiced leader in this area and we offer a very strong technology package. And we continue to get calls every week from more integrators, and various parties wanting to work with us in China. But I think we’ve taken the prudent step-by-step approach right now. Initially, when we signed our certified integrators in November, we said we expected $10 million in the near-term. Already that’s $15 million just six months later. I’m pleased with that result.

We said in the longer term this could easily reach $100 million. We still believe that. But there is practical work to it. It doesn’t matter if you’re in China or anywhere else in the world, if you’re building vehicles you have to go through the prototype design and certification with the governments and put mileage on the vehicle and make sure everything is in order.

So everybody has to do that job and we’re well advanced with our partners in doing the first prototype builds. And as I mentioned today, that $13 million order is a second-level. The first prototypes have been done; certified with the government, happen to be with one of the very large manufacturers in China. So I’m pleased with their progress and I think there’s lots of runway to go here.

Carter Driscoll

Thanks for the color, and congrats on getting to that next level. Maybe just really quickly, could you - is it a similar type of process you envision? Should your work with Kurion move forward in Japan? I mean, it’s typically been a market where again they require a local investment, if not direct partnerships. May be just kind of compare or contrast quickly between China and Japan.

Daryl Wilson

You’re absolutely right. Those expectations are there. And we have anticipated that aspect and we think that the house in order in that respect. It’s a little different in the first build here at the - the site in Japan is a single site and a very large development. And so that is different than putting vehicles in multiple places in China. As I said earlier, I think one of very, very positive developments now is the involvement of Veolia in the project.

They are well familiar with delivering very large water treatment facilities around the world and managing projects of this scale. And so, having them step up and see this opportunity and also the opportunity for deterioration of contaminated wastewater from nuclear sites around the world. I had mentioned before that this is not just about Japan. It’s about the establishments of a new standard for treatment of wastewater from heavy water reactors around the world.

And we’ve had discussions around how a product might be developed to serve those markets as well, which is very different than a single large site, so positive developments, but many factors of this out of our control and not entirely visible for us.

Carter Driscoll

Appreciate that. I’ll get back in the queue. Thanks for answering my question.

Daryl Wilson

Okay. Thank you.

Operator

Thank you. And I’m showing no further questions at this time. I’d like turn the conference back over to Mr. Bob Motz for any final remarks.

Robert Motz

Thank you very much. And this concludes the call today. I just want to remind everybody again of the Safe Harbor statement we made at the beginning of the call. And I look forward to speaking with everyone again around the first week of November when we announce our third quarter results. Thank you very much. Have a good day.

Operator

Ladies and gentlemen, thank you for participating on today’s conference. This does conclude today’s program. You may all disconnect. Everyone have a great day.

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