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Hydrogenics Corporation (NASDAQ:HYGS)

Q2 2012 Earnings Call

August 1, 2012 10:00 AM ET

Executives

Jennifer Barber – CFO

Daryl Wilson – President and CEO

Analysts

Noah (ph) – ThinkEquity

Jeff Osborne – Stifel Nicolaus

Matt (ph) – ROTH Capital

George Santana – Ascendiant

Larry Litton – Second Line Capital

Operator

Good day, ladies and gentlemen, and welcome to the Hydrogenics 2012 second quarter earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session with instructions to follow at that time.

(Operator Instructions) As a reminder, this conference is being recorded. I’d now like to turn the call over to your host for today, Ms. Jennifer Barber, Chief Financial Officer. Ma’am, you may begin.

Jennifer Barber

Thanks, Ben (ph). Good morning, and welcome to the Hydrogenics second quarter 2012 conference call. With me today is Daryl Wilson, our President and Chief Executive Officer.

Our second quarter press release, along with our PowerPoint presentation, is available on our website under the investor page at www.hydrogenics.com. We have also uploaded our quarterly 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 financial references are in US dollars unless otherwise indicated.

I would now like to provide a brief Safe Harbor statement. This call and the accompanying presentation may contain statements that are forward-looking. If 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 and the MD&A section of our interim and most recent annual 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. With that, I’ll turn the call over to Daryl. Daryl, please go ahead.

Daryl Wilson

Good morning, and thank you for joining our Q2 earnings call. With very strong financial results and several strategic accomplishments coming into place, Q2 was a very important quarter for Hydrogenics.

Revenue was up more than 100% over Q2 2011 and more than 24% on a year-to-date basis. Our backlog of confirmed orders is up 60% with the addition of more than $10 million of new orders in the quarter. This gives us clear visibility on strong results for the overall year with a projection of approximately 30% to 40% growth year-over-year in revenue.

We entered into a five-year joint development agreement with Enbridge for utility scale energy storage in North America. This agreement was accompanied by an equity investment of $5 million.

Enbridge is a very strong, innovative partner with significant experience and influence in North American energy markets. With a leadership position in gas markets and renewable energy facility deployment, Enbridge is the ideal partner to join with us in opening up the market for Power-to-Gas energy storage in North America.

Turning to Slide 4 in the presentation, we profile the ongoing growth story for the company. Again, we see the importance of the strategic announcements that were made in this recent quarter. Hydrogenics is now well recognized as the leader in the development of Power-to-Gas energy storage technology.

In addition to the relationship with Enbridge, we announced the sale of a two-megawatt Power-to-Gas facility for E.ON, the German-based largest gas and electric utility in the world. This is an important win for us, and just one of several wins in Germany. In the last year more than 15 Power-to-Gas projects have been announced in Germany alone.

In 2012 Hydrogenics has won more than 50% of the projects which have been decided, and while we do not disclose the individual project values, we can say that the overall benefit of these wins to Hydrogenics is in excess of $10 million in revenue in R&D funding. When considered against annual revenues in our electrolysis business at approximately $20 million in 2011, this is very significant indeed.

The compelling value of hydrogen technology is now widely recognized in Germany and we see very significant momentum. We will deliver the project to E.ON by December of this year, illustrating one of the competitive advantages of the solution, speed of deployment.

Competitive storage technology, such as pump hydro or compressed air, can take many years to approve, site, and build. We will deliver this project in just eight months from date of order.

In addition, the Power-to-Gas solution is scalable, flexible, fast responding, and offers unmatched energy storage capacity. These attributes have been thoroughly studied by several utilities and research institutes within Germany.

This has laid the foundation for numerous projects to be developed and the list is still growing. Our experience with industrial hydrogen projects, our patent portfolio, and our technology leadership in scale and efficiency are strong support to our ongoing leadership in this field.

Considering other segments of the business, we looked to hydrogen fueling. Recent announcements from several players in the automotive sector show growing momentum in hydrogen vehicles.

Significant production volume has been announced for 2014 and 2015, and this has been accompanied for new plans for hydrogen fueling infrastructure. In the last month, Germany announced a plan for 50 additional fueling stations.

Again, Hydrogenics is a leader in this space, having just opened the largest station in Europe in February this year, along with our project partners, Linde Gas, and the station’s owner, an electric utility, Vattenfall. While there are many paths for the delivery of hydrogen, the link between electrolysis and renewable generation is very compelling.

Sales in our industrial onsite gas generation business continue at a very good pace. We sell into a wide variety of geography with a very strong brand recognition. We have not seen any letup in the request for proposals or orders.

Finally, our partnership with CommScope for the deployment of backup power solutions in wireless communication continues to see a very good level of activity on requests for volume proposals. This is a fundamental differentiator for Hydrogenics. There is no other supplier of this solution, which has such a strong market partner, and with as much market influence as CommScope.

This brings credibility and confidence to customers for the execution of larger-scale orders. The wireless industry has had extensive trial experience with our units in the field, and these trials have performed very well, justifying the move to the next step.

Summing up the overall growth situation, we provided an image of what we see on Slide 5. The foundation of a strong, standardized product portfolio is in place. Up till now, this has yielded a business were 80% of our revenue has come from onsite industrial gas generation and 20% from technology development work for power systems.

We have now moved to an important period of transition and inflection, where solid evidence of growth is already coming in for the energy storage segment.

As mentioned above, we have the partners, the technology strength, and the market recognition to deliver on substantial revenue growth in this very important segment. Furthermore, we anticipate now the opportunity to grow revenue with our power systems partner, CommScope.

Based on the pipeline of sales prospects at the current time, we realistically see growing our revenue to double that of 2011. And beyond this stage, we see a profile for the company where the industrial, power system, and storage segments make up approximately one-third of the overall result, much larger than the current scale.

All of this background provides an obvious rationale for our announcement of a $25 million shelf prospectus for additional capital. Quite simply, we are growing. The working capital requirements of this growth will require the flexibility to access capital markets on an as needed basis.

Regulatory limits on the issuance of shares will restrict the quantum to one-third of the public flow in any 12-month period. The company remains committed to the pursuit of profitability in the near term, with a minimum possible dilution of shareholders in the process.

All of the signs point to a major power shift in the world of energy. The quest to move away from fossil fuel sources to local, clean, renewable sources continues unabated by general economic conditions. In fact, there’s growing awareness that a clean, renewable energy is a critical part to a more sustainable economic future.

Hydrogenics engineers and manufactures the products that have helped make this transition happen. Our power systems have a zero carbon footprint, our energy storage technology is enjoying global recognition by some of the biggest energy players in the world. This is a great time to be part of this story.

Jennifer will now take you through the financial results, after which we will be pleased to answer any questions you might have. Jen?

Jennifer Barber

Thank you, Daryl. I’ll just briefly summarize the financial results for the second quarter and sixth months ended June 30, 2012.

Revenues were $8.3 million for the second quarter, an increase of 113% versus last year and $14 million year-to-date, an increase of 24% over 2011 representing increased revenues for our onsite generation business fueled by growth in energy storage and increased demand within our industry and market, partially offset by the increase in the value of the Euro relative to the US dollar.

Gross margin of a percent of sales is 17.8% for the second quarter, a decrease of 12.2 percentage points versus the second quarter of 2011 and an increase of 3.7 percentage points over the first quarter of 2012.

For the six months of 2012, gross margin was 16.3%, a decrease of 6.2 percentage points versus last year, primarily attributable to the absence of $0.3 million in warranty reserve reversals recorded during the second quarter of 2011, combined with increased material costs in our onsite generation business unit.

Cost reduction efforts by supply team management and product design innovations are continuing in order to improve these margins going forward.

Cash operating costs for the second quarter were $3.4 million, an increase of 8% compared to the same period in 2011 primarily resulting from the absence of the $0.5 million reduction in the value of our post retirement liability in the second quarter of 2011.

Cash operating costs for the six months ended June 30, 2012 were $7 million, an increase of 13% compared to the same period in 2011 primarily resulting, as I just mentioned, from the absence of a $0.5 million reduction in the value of our post retirement liability in the second quarter of 2011 as well as a $0.3 million increase in selling, general, and administrative costs associated with overall higher commercial activity.

Our EBITDA loss is $2.3 million, an increase of 10% for the second quarter and $5.4 million, an increase of 8% year-to-date.

Our order backlog, as of June 30, 2012 was $27 million, up 60% year-over-year. During the second quarter, we received $10.1 million of orders, a 102% increase over 2011.

Cash resources on hand, as of June 30th were $9.7 million, an increase of $1.3 million sequentially versus the first quarter. This reflects $5 million received on the closing of our agreement with Enbridge in April as well as $0.8 million in proceeds from loan advances partially offset by $2.7 million cash used in operations and a $1 million increase in working capital.

Additionally, as Daryl mentioned, earlier this morning we filed a universal shelf prospectus. After the shelf prospectus becomes final and the registration statement is declared effective, Hydrogenics will be able to offer, from time to time, over a 25-month period up to $25 million of debt equity or other securities.

These US and Canadian filings are intended to restore Hydrogenics flexibility to access the capital markets to support anticipated growth and working capital, given that our prior shelf prospectus and corresponding registration statement on Form F-3 expired earlier this year.

With that, we will now turn the call over to the operator for questions. Please go ahead, Ben.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from the line of Colin Rusch from ThinkEquity. Your line is open, please go ahead.

Noah (ph) – ThinkEquity

Hey Daryl and Jennifer, it’s Noah. Colin sends his apologies from the road. Congratulations on growing the order book. I wonder if you could give us a little bit more color on the details of the book. I’m particularly interested about the number of customers and kind of the mix. You break it out within the segments, but just wanted to see if we could get a little more detail.

Daryl Wilson

Sure, thanks Noah. The bulk of the orders that have come in recently lie with the industrial gas onsite generation business. We typically do between 20 and 40 projects a year for industrial gas customers and it’s a very wide diversity of customers around the world, so there’s not typically a concentration in any one particular geography, or any one particular application.

We’ve sold jobs into Russia, China, Vietnam, India, into the Middle East, in various places in Europe, in Africa, so there isn’t a particular concentration geographically.

There are also a wide diversity of applications for generator cooling, fueling, other industrial chemical inputs where hydrogen is used, so not really a pattern. I’m not being helpful here, I’m sorry.

But it’s actually a strength of the business that there is not a concentration with the industrial gas customers.

Included in recent wins, of course, is the energy storage portion. And here, as I mentioned, we’re not inclined to give individual numbers for the energy storage segment, and also we do note that some of the projects that have come in recently have been funded government projects where typically we’ve taken a conservative approach and not recognized the project as revenue or in the order backlog pipeline because we typically from the counting point of view credit those R&D funded projects as offsets to our R&D expense.

So a little bit of a mixture, but I think this morning we’ve given a sense of magnitude here. The energy storage projects are worth an excess of $10 million, the ones that we’ve signed up so far.

That pipeline remains strong, and we see it growing to a very significant part of our business. At $10 million, as I pointed out, that’s half of our revenue in the electrolysis base in all of 2011, so it’s very significant.

And also, I would point out that we’re not done yet. There are other projects yet to win, and we believe that we are in a strong pull position on those. So it’s a very exciting time for us, and I think the mix of revenue sources for us has a good strong diversity, which we see being sustained.

Noah – ThinkEquity

Thanks, and just to build off of that, you really point out there’s not a lot of geographic patterns of concentration, but as you start to think about potential for Power-to-Gas, certainly there are a number of geographies that have a high and growing percentage of intermittent renewables. So can you talk a little bit about some of the geographies you see as kind of most promising in the medium term in the Power-to-Gas application?

Daryl Wilson

Absolutely. Germany of course, is the anchor point. As they lead in solar and wind, they’re leading in energy storage. As I mentioned this morning, 15 announced projects and we believe there are more to come, so there’s tremendous momentum here with a leadership position in Germany and we’re absolutely having a major stake in that.

Beyond Germany, there are other countries in Europe which have a high degree of renewable energy penetration such as Denmark, the Netherlands is looking offshore for extensive wind development, the UK now is moving ahead with very extensive developments.

All of these markets where they are pursuing high penetration renewables on a regional basis become outstanding targets for us because the intermittency of that energy generation creates concerns with the need for energy storage.

And our solution with Power-to-Gas offers both grid stabilization features as well as storage and energy transmission features, so all of those features are very attractive in markets with high penetration renewable deployment.

In North America, Hawaii, California, other states on the western side of the country where there’s high penetration of wind, and also New York State are targets and then in Canada, Alberta and Ontario.

We’ve also initiated discussions over the last year in Japan, and we expect some developments there. So, again with this Power-to-Gas solution we see a very nice broad reach. We also had communication just this morning from a country in South America with similar interests.

So our recognition for delivering this solution is high. Our capacity to deliver this at significant volume is also high. So, the traction that we’re talking about here is no flash in the pan. We think it’s a very significant trend.

Noah – ThinkEquity

Great, and one last question, if I may; you know, you mentioned that there have been material cost increases weighing a little bit on gross margin. How aggressive are you being right now with the supply chain to lower costs?

Daryl Wilson

Yes, thanks for that question, Noah. It has been a concern for us in this quarter and we’re happy to chat about it. In the period 2007 through 2009 we made a major shift in our supply chain toward Asia and Eastern Europe and those initial engagements made a major shift in our supply chain toward Asia and Eastern Europe.

And those initial engagements have come to their, you know, first term and we saw some very aggressive price increases come through I guess from the apparent confidence of some suppliers that they’ve been with us for a while and they can do that to us.

So we’re responding as quickly as we possibly can to resource, again, to lower cost but high-quality jurisdictions. We have also not let up on the area of innovation, so where we can just simply eliminate costs through innovating the design of our products, we’re very aggressive to do that, so that’s a second lever.

And we also believe that there is some prospects for some recoveries here in pricing of the product. So there’s three levers. We’re active on all three of them and we expect to work very hard through the balance of the year to recover this situation.

It’s always been our goal to have margins in the vicinity of 30% or better. We are still selling projects in that range but we have suffered some setbacks with the supply base and their shifting expectations.

I don’t think this is unique to Hydrogenics. But we must respond and, in fact, we are.

Noah – ThinkEquity

OK, well, thanks so much for the color and good lucky.

Daryl Wilson

Thank you.

Operator

Thank you. Our next question comes from the line of Jeff Osborne from Stifel Nicolaus. Your line is open. Please go ahead.

Jeff Osborne – Stifel Nicolaus

Great, good morning, Daryl, and congratulations on the results and the improving backlog. I just had two questions. One is on the financing of these projects in terms of what you’re doing in Canada and Europe.

You know, given the irregular nature of the production of gas and how you’re kind of banking that in the system, you know, how does the bank go about evaluating, you know, what the cash flow of the project would be?

And then in terms of kind of credit agreements or projects that would be built out, how do you expect that to be financed?

Daryl Wilson

That’s a good question. If I just take one nuance here, Jeff, in terms of us financing the projects, we typically are not getting engaged in this. We do have an option in the contract with Enbridge that we could participate in the energy storage project, up to 50%, so that’s an option that is our choice to play at a later date. But typically our customers are funding the projects and pursuing the financing returns.

In our discussions with E.ON and Enbridge, discussion that lasted more than a year in due diligence, there was careful attention paid to just how these projects will deliver in economic return and what the magnitude of that return might be.

In both cases, the major utility satisfied themselves that getting better than a normal utility rate of return is possible. They both see some impediments to realizing the full monetary value of an energy storage asset because we don’t yet have full maturity in any jurisdiction, including Germany, to deliver back the value of an energy storage asset back to the provider.

What’s encouraging and what encouraged Enbridge and E.ON I think is that the discussions around making that happen are now very active. Major utilities recognize that they have to have more flexible assets in the grid mix to sustain higher renewable generation.

And so given that there is value attached in energy storage, stabilization and transmission of renewable energy, there are active efforts underway now in Germany, elsewhere in Europe, here in Canada as well, to look at how we can be rewarded for putting these assets in place.

Obviously Enbridge and E.ON had enough confidence to move ahead with engagement with us and on projects believing that all this would come to fruition. They’ve seen that kind of evolution in time happen in the past.

The last thing I’ll comment here is that we have to acknowledge this is not a simple matter. There are multiple streams of value to be monetized in one of these projects. So the delivery of stabilization services is one stream of value where already there is pricing market and a way of rewarding that.

Holding energy in time and space, some markets enable the arbitrage game to be played. A unique attribute of our solution is that we can play that game for a very long time, up to seasonal energy storage and we also are able to play into a spatial arbitrage game where we’re able to move energy, for instance, from the north of Germany to where it’s needed in the south of Germany and, of course, there are price differentials to play there.

What has not appeared yet in the energy market is some sort of capacity payment. So the existence of a flexible resource on the grid as a flexible capacity resource, there is no way to reward that right now but there is acknowledgement that some sort of tariff structure needs to be worked out so that there is an attractive rate of return and the volume of assets grows.

What’s most encouraging is that in places like Germany and here in Canada, the amount of resources estimated to be needed is in the thousands of megawatts. And so this creates a very large market opportunity and with that market opportunity, a compelling need to sort out the economics and make it work.

So we’re seeing good movement here. There is still work to be done. But we have customers today, multiple customers who believe the return will show up and they will be able to finance larger-scale projects. I hope that’s helpful.

Jeff Osborne – Stifel Nicolaus

No, extremely, thank you. And just maybe either for yourself or Jennifer, the last question for me is just, you know, as this mix shift happens, you know, how do we think about kind of a cash flow profile of the company, margin, mix shift, you know, the onsite generation decreases as a percentage of revenue. What’s the impact margin-wise?

Daryl Wilson

So we tried to show that in the presentation today with the growth profile of the company. Our near-term expectation on mix is about a third power system, a third industrial hydrogen, a third energy storage.

The largest of those three markets by far is the energy storage markets. It will take a little time to rescale. The projects we’re doing now are in the vicinity of one and two megawatts which are really starter kits.

A typical energy storage project value to a utility is somewhere between 10 and 100 megawatts. And so as those larger-scale projects start to show up, it will have a very big impact on our revenues.

There is also a cost profile trajectory that has been in discussion within this hydrogen energy storage space. In my first discussions with some of these customers, they were very clear about their economic expectations.

Immediately I have confidence that we can meet those expectations and maintain attractive positive margins for our company. So the encouraging thing here is that the trajectory of cost expectations and the economics of the solution as it’s played out to deliver value for utilities, the story adds up for us and for the utilities.

And while we will see prices decline, we do have a technology cost reduction pathway which will follow the expected price declines and maintain positive, attractive margins to make this an attractive business for us.

Again, I point out that we’re talking about, you know, single megawatt projects now, tens to hundreds of megawatts in the future. That a (two) order of magnitude scale difference and, you know, reducing cost substantially on the back of the (two) order of magnitude scale difference is not all that hard to do, certainly something that I’ve got experience with doing in the past and I believe our technical team is more than up to the job.

Jeff Osborne – Stifel Nicolaus

Perfect. Thanks much.

Daryl Wilson

Thanks so much, Jeff.

Operator

Thank you. Our next question comes from the line of Philip Shen from ROTH Capital. Your line is open. Please go ahead.

Matt (ph) – ROTH Capital

Hey, guys, this is Matt in for Phil. He sends his regards. I just had a couple of questions for you this morning. Specifically with the INGRID project, I was just curious if we could get some more data points on milestones for the project, when you expect construction to be completed and whatnot.

Daryl Wilson

Thanks, Matt. Thanks for joining the call. So this is a project with Enel in Italy. It’s funded by the Joint Technology Initiative of the EU. It involves several Italian, French partners, as well as our Belgian facility.

In these EU projects, it’s required that there are multiple country participants. There are several innovative aspects of the project, so we will offer a new, larger-scale version of our electrolysis technology.

The French partner, McPhy, will offer some innovative, solid form energy storage technology that they’ve developed over the last several years. The utility operator will integrate the system with a large-scale PB deployment locally and be noting the dynamics of the system in a PB-rich environment, so many innovative aspects.

Construction will happen over the next 18 months to two years and then there is a steady period for an additional two years for a total project life of four years. And this is one of the projects where we’ve taken it in as a government-funded R&D support project, so we have not recognized the project from a revenue point in our backlog profile. But it will assist us in the ongoing reduction of our R&D costs, basically money that we may well have spent but now we have a project to support the expenditure of the money on R&D that is something that we would have done on purpose.

So a good project for us. It opens up the Italian markets and the Italian utilities to understand hydrogen energy storage and another data point for us in this overall journey.

Matt – ROTH Capital

Great, great. And so along those lines, your partnerships with Enbridge and E.ON, I know you guys were mentioning the possibility to scale up some of these system sizes and eventually get to something like on the order of 100 megawatts because that’s what any (ph) kind of system operators are looking for.

I just wanted to get a sense for sort of next steps after these megawatt scale projects. What are you looking at and how do you envision scaling up to that larger size eventually?

Daryl Wilson

Right, that’s a great question. We believe the basic building block has to be a megawatt level electrolyser. We are currently constructing the world’s first megawatt PEM electrolyser in our facility in Canada.

And so there is a lot of important work going on now to have the building block in place to reach the 100 megawatt scale. So I think, again, here we’re going to lead and we have a number of partners in our effort to deliver a very highly-efficient, large-scale responsive electrolysis technology.

Then there is the matter of the development of these gas plants, so dealing with, say, 10 megawatts. Now you have 10 of the megawatt building block electrolyser brought together with the necessary treatments, cooling and gas handling systems.

Again, we believe we have the partners to execute at that higher level. So the technology pathway here is clear for us. We are well advanced in our planning to deliver this kind of total system and, in fact, recently we’ve been saying to customers we’ve already done the single and two megawatt type of project, so our interest now has turned to selling a five or 10 megawatt project and actually deploying the know-how and the vision that we have for these larger-scale facilities.

So the trials that are going on now with these initial plans, we don’t expect to be overly complex from a proving point of view. We’re deploying things that we’ve done for a long time and our customers have confidence in the base hydrogen technology.

What they will be learning is the dynamics in the energy system and also the economics of how to realize a return on the project. These are not learnings that need to take a long time to come to fruition. So it’s an important period to mature the business model but we fully expect to be moving on with sales of larger plants in the near term.

Matt – ROTH Capital

Great, thanks. That’s helpful and one more thing if I can. You mentioned the potential for energy arbitrage opportunities, in particular seasonal opportunities that can come up as a result of your technology.

Can you talk about how you’ve been interfacing with utilities and trying to sort of figure out when they’re going to be implementing the seasonal and time of use tariff schemes/

Daryl Wilson

So it’s one of the unique attributes of Power-to-Gas that we can actually cross connect between the electrical system and the natural gas system. And the project with E.ON in Falkenhagen will do just that.

So we’ll be able to soak in two megawatts of electrical energy converted to gas and then put that gas directly into the natural gas system. What’s notable here is our partners are not simply electric utilities but they’re also very savvy when it comes to energy as gas and the trading and management of the economics of gas energy including seasonal storage.

So some of the business model attributes here are things that they’re very well practiced in and one of the ways we talked about this in a simple manner is to say these companies are already functioning as energy banks with seasonal energy storage capability and natural gas.

All we’re doing is adding a new currency to the bank. So if they used to trade in Euros, now they can trade in dollars or Yen or whatever currency we might be comfortable in talking about this morning.

But the point is that we’ve introduced a new currency attribute system where they already have operating experience and a system which already is built and paid for. So when we talk about seasonal storage attributes, we’re not talking about needing to build a whole lot of physical infrastructure.

We’re talking about using infrastructure that’s already there with a new currency, hydrogen, as a stored form of gaseous energy. So that’s one of the things that was very attractive to Enbridge and E.ON because it leverages a lot of know how that they have already and a lot of assets that they have already.

Matt – ROTH Capital

Great. Thanks, Daryl.

Daryl Wilson

Thank you, Matt.

Operator

Thank you. Our next question comes from the line of George Santana from Ascendiant. Your line is open. Please go ahead.

George Santana – Ascendiant

Hi, thanks for taking my questions and congratulations on the excellent progress in the second quarter.

Daryl Wilson

Thanks.

George Santana – Ascendiant

For the new Power-to-Gas business, is the market understanding sufficiently (again) so that the project development is with the end customer directly or does there still need to be additional development, let’s say, in legislation or regulations in your initial markets?

Daryl Wilson

So yes and yes in that we’re dealing with Enbridge and E.ON and Vattenfall and ENBW (ph) and various other utilities, these are the end customers from an energy management system point of view.

They would be the ones who would expect to monetize the value and operate these assets and that’s their typical business is to own and operate assets and realize a utility rate of return or better.

So we are dealing with end user customers. Some of the business model value is in the near term and some of it is yet to be realized. And so there is a need for some regulatory framework.

Of course, there are very mature frameworks which understand how to add a gas generation plant to the asset mix and incorporate it into the rate base and have it paid for as a utility asset.

But this class of assets in energy storage is somewhat new and so there are some adjustments going to be required to say, OK, you can put that kind of asset in the rate base and you can operate it in that manner and realize a utility rate of return using a storage-type of asset.

The nice thing is that we’re not pushing here by ourselves. There is significant pull, especially in those regions where they’re pursuing high penetration of renewable generation. So they now need these assets. They know that. In fact, they need them fairly desperately.

And we’re noticing, you know, a trend in some of these projects to say, you know, when can you deliver, we need this fast, we need to either learn how to do this and move on quickly to larger scale or we need to relieve a constraint issue in a particular region urgently.

So there is a nice pull here. If it was a matter that we had to push a whole lot of regulatory change to make this happen against the will of certain parties, that would be another matter. But I see a good pull here for the changes that are required.

George Santana – Ascendiant

So for the major markets that you mentioned, Germany, Denmark, Netherlands, UK, could you say, you know, even on a rough percentage basis how far advanced the regulatory structure is in each of the markets?

Daryl Wilson

That’s difficult and complex. I would say that somewhere around a third to two-thirds of the value may be realizable in existing structures and then, conversely, a third to two-thirds, there’s work to be done.

And typically the maturity of a market is already established with other attributes. So if you have, you know, a daily auction market for other power attributes as you might have in California, Texas or even in Germany, adding features to that existing, mature market which follows the needs of energy storage, is not all that complicated.

The new instruments in nature are not all that different than the instruments that they already have.

In other markets where there has not been an energy trading option or more sophisticated market, then there’s more work to be done to have a full mature business model that can be realized.

Without getting into too much complexity here, the other thing that’s notable is that there are multiple variants on how this technology is applied. So when we sold fueling stations in Germany, for instance, we’re selling them to electric utilities and part of their mindset here is still an energy storage play in grid stabilization. So it’s the very same thing. But the end use is for fueling of vehicles.

We are also seeing interest now in matching the Power-to-Gas technology with the methanization of biogas and now you’ve got a biogas, hydrogen, natural gas play emerging.

So the other reason we’re very encouraged about this is that it’s a rich portfolio of applications and many parties now are saying, hey, we want to do this variant. Can you work with us on this?

So it’s not so simple as to say there’s just one approach here or one size fits all. There’s actually multiple business models that are showing up, which, again, tells me that there’s real substance and momentum here.

George Santana – Ascendiant

That’s very interesting. Thanks for that. As we see some of these projects being developed, should we expect, even if it’s minimal, some equity participation by Hydrogenics? And concurrently, is there potential for incurring revenue with this business?

Daryl Wilson

So again, in the discussion with Enbridge, Enbridge extended the right to us and we accepted the option of participating as a partner in an energy storage project.

I don’t want to unnerve anyone about our ideas in this area. We understand that’s a very different business than our current business. We understand that it opens up from a build-own operate model recurring revenue opportunities, which can be very attractive.

But there is significant capital needs associated with that and risks associated with that. And so we would be very careful around what kind of project we would enter into. We would look at the risks, the returns, the capital requirements and then make some judgment as to how it fits.

In some way it would probably be partitioned from our current business, which is a technology and manufacturing business that we’re very good at. But if it turns out that there is substantial returns available in this total business model, which may well be the case, we’ve wanted to maintain the opportunity to do that kind of participation.

We already know that it’s being the death of other energy storage companies to bite off too much in this area. And so we don’t want to make that mistake. On the other hand, if there’s a major opportunity here, we’re keeping our options open to actually participate in it.

George Santana – Ascendiant

Thank you, Daryl, Jennifer.

Daryl Wilson

Thanks, George.

Operator

Thank you. (Operator Instructions) Our next question comes from the line of Larry Litton from Second Line Capital. Your line is open. Please go ahead.

Larry Litton – Second Line Capital

Good morning. Daryl, you talked about having 15 announced projects again in Germany. Are those yet to be awarded or are those including the ones that have been awarded?

Daryl Wilson

That includes the ones that have been awarded but the total portion awarded so far is relatively small and so there’s lots to still go after and we’re on it with very good recognition.

So you know, I’ve made the comment to some folks that with 15 hydrogen Power-to-Gas projects in Germany, I think that far outstrips the number of compressed air storage plants in the world and even the number of other energy storage technologies in terms of announcements in the last year.

I think this is a fact that is now well known. It’s certainly not recognized in North America or the United States, for instance, where there has been a slower uptake on hydrogen.

We see that changing. We had meeting with the DOE and the Secretary of Energy in April of – sorry, in May of this year. The Secretary of Energy is now on record saying that he’s changed his mind about hydrogen. He actually sees it has a role in transportation and energy storage and other attributes.

We have been working with the DOE, EPRI and NREL on looking at energy storage using hydrogen and studying the business models in applicability in North America. So we have a very solid start in Germany. 15 projects is a big deal.

We believe that there are more projects that are going to show up and then we’ve got a – the beginnings of rich discussion in the United States around this and, of course, we have our own discussion ongoing with independent system operators in the United States to see the momentum get picked up.

And most importantly, we have a very serious partner, one of the largest energy players in North America working with us to open up this market. So I’m very bullish on our prospects for North America. But meanwhile, there is a huge weight of evidence to pay attention to in Europe.

Larry Litton – Second Line Capital

And the size of those 15 projects, either in terms of energy or dollar value, approximately what is it?

Daryl Wilson

In that they have been announced but not actually closed, we don’t have the dollar value. Again, we’ve given a number this morning on a cluster of projects that we have won. Some of them are in Germany. Some of them are elsewhere.

But we’re already, with those 15 projects, dealing with a very, very significant amount of potential revenue and potential value for the utilities in Germany.

Larry Litton – Second Line Capital

But are these (on) one to two megawatt projects or how big are they?

Daryl Wilson

Again, we don’t give up our own pricing. You’ll hear numbers in the range of EUR1 million to EUR1.5 million per megawatt is a reasonable proxy.

Larry Litton – Second Line Capital

Great. So how many megawatts do these projects represent?

Daryl Wilson

Again, some of them have not been finally sized. So I have nothing to lose. I apologize here. But some of these are concept announcements where the concept has not been fully developed and the size of the project has not been fully developed.

So it’s not possible to give you a total number of value but, you know, they’re typically a megawatt or larger.

Larry Litton – Second Line Capital

OK, but you talked about prototypes versus scale. I mean, are any of these – do you suspect any of these would be large-scale projects?

Daryl Wilson

Yes, that’s a fair question. None of the 15 at this point have reached into the, you know, above five megawatts at this point.

Larry Litton – Second Line Capital

OK, fine. And I think you talked about a 50% win rate, which is unannounced projects, maybe, which is fantastic. But on the 50% that you’re not winning, could you characterize why you don’t win them? Is it price? Is it technology? Is it politics?

Daryl Wilson

I want to be fair to my competitors but, you know, typically they’re involving captive existing relationships that I could never penetrate. So if it was straight up competition on the merits, I think we have a fair shot at every one of them.

When they’re preexisting relationships or commitments to companies or technologies, then I don’t expect to win. I don’t waste the effort of trying to win. So I’m satisfied that the so-called losses are not really losses, so far. They’re things that we would never have had anyway.

Larry Litton – Second Line Capital

OK. And lastly I think you mentioned the idea of going to an electrolyser size of one megawatt as a building block. What are the current electrolyser sizes today?

Daryl Wilson

Typically industrial jobs for us are delivered at about one-third of a megawatt per unit. And given E.ON’s interest to move ahead with the project very promptly, we’re deliver six one-third megawatt units to make up a total of two megawatts.

But our typical size is about one-third a megawatt as our basic building block. So it’s a threefold scale up to get to a single megawatt. We’re doing that on a new technology platform which gives us some cost advantage, efficiency advantage and very significant scaling advantage, so it’s a 16 to one energy density improvement over our current technology.

So this is where my confidence comes from. As we scale this technology to meet the needs of larger-scale projects, we fully have the ability to deliver at a larger scale.

Larry Litton – Second Line Capital

Great, thank you.

Daryl Wilson

Thanks.

Operator

Thank you. And with no further questions I’ll turn the conference back over to management for any closing remarks.

Daryl Wilson

OK, thank you, Ben. We appreciate those who have been able to join on the call this morning. Recognizing that it’s summer time, if some folks were not able to get in and get their questions asked, by all means, give us a call. We’ll be happy to follow up with you.

Again, I think a very exciting quarter for us with some very strategic accomplishments and a platform for us to go on to some significant success as a company. And as I said already, these are things that, yes, they’re accomplished in the past but they’re the foundation for more wins in the future.

So stay tuned. I think we have more coming. Thanks very much.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may all disconnect. Have a great rest of the day.

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