Ballard Power Systems Management Discusses Q2 2012 Results - Earnings Call Transcript

Aug.14.12 | About: Ballard Power (BLDP)

Ballard Power Systems (NASDAQ:BLDP)

Q2 2012 Earnings Call

August 14, 2012 11:00 am ET

Executives

Guy McAree

John William Sheridan - Chief Executive Officer, President, Director, Ex-Officio Member of Management Development, Nominating & Compensation Committee, Ex-Officio Member of Corporate Governance Committee and Ex-Officio Member of Audit Committee

Tony Guglielmin - Chief Financial Officer and Vice President

Analysts

Jeff Osborne - Stifel, Nicolaus & Co., Inc., Research Division

Michael Cikos - Sidoti & Company, LLC

Walter Nasdeo - Ardour Capital Investments, LLC, Research Division

Operator

Hello, this is the conference operator. Welcome to Ballard Power Systems Second Quarter 2012 Conference Call and Webcast. [Operator Instructions]

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

Guy McAree

Thanks. So good morning, everybody. Today's call is for us to discuss Ballard's Second Quarter 2012 Operating Results. And with us today, we've got John Sheridan, our President and CEO; and Tony Guglielmin, our Chief Financial Officer.

We'll 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. For a detailed discussion of these statements and the assumptions used in generating them and the risks and uncertainties that could cause actual results to be materially different, please refer to our press release issued last night, our most recent annual information form and other filings.

You should note that Ballard reports financial results in accordance with IFRS. In addition, results are consolidated to include Dantherm Power, are also in U.S. dollars unless otherwise stated.

I'll turn it over to John Sheridan now.

John William Sheridan

Thanks, Guy, and good morning, everyone. Before we begin with our regular report out this morning, I'd like to take a moment to acknowledge what was a very sad event for all of us here at Ballard. Late last week, a long-standing member of our Board of Directors, David J. Smith passed away unexpectedly. David was a distinguished member of the legal profession, a commissioner at the BC Securities Commission, a very valued member of Ballard's Board of Directors and also a personal friend. So our thoughts and our prayers certainly go out to David's family.

Now moving on from that sobering note to the business at hand. As you saw in last night's press release, our Q2 revenues were significantly below expectations. This obviously put pressure on EBITDA and cash. But despite the low shipments and weak revenue, with our aggressive cost management and a pickup in sales booking activity, we posted a few positives in the quarter. The 12-months rolling order book at $54.4 million was up 32% from the end of Q1. Cash operating cost improved 28% and adjusted EBITDA improved 12%.

With those positive points aside, the headline story is obviously the disappointing revenue. So that's where I'll focus and address the obvious questions in terms of the weakness in the quarter, what that implies in both the second half of the year and what we need to do to deliver our guidance for the full year. Following that discussion on revenue, Tony will adjust our path to profitability, cash flow and liquidity.

So first, explaining the revenue weakness in Q2. Total revenue in the quarter was $10.3 million, down $8.8 million from last year. Part of the year-over-year reduction is the absence of the Daimler manufacturing contract. That contract concluded third quarter last year, you'll recall. And that provided $4.6 million in Q2 last year, so that's obviously significant to the year-over-year change.

As we have discussed, our plan had been to offset this loss revenue with strong growth in fuel cell products and moderate growth in material products. However, we did not deliver that plan in Q2. Material products in Q2 continued to be weak. Fuel cell products had limited shipments and backup power, and no shipments in the quarter in bus.

Drilling down in these 3 areas, material products revenue is weak at $3.5 million for the quarter. Two reasons for this, both of which are expected to recover in the second half: cover and friction material sales were negatively impacted by the timing of customer programs and inventory levels; and fuel cell GDL, gas diffusion layer material, shipment sale were down as well related to technical issues experienced by a third-party fuel cell customer. And again, both those factors are expected to turn around in the second half of the year.

Turning to bus modules. We didn't have any bus module shipments in Q2. We had discussed on our last couple of calls the challenges in advancing the Sao Paulo LOI into a contract. And then in June, of course, as you recall, we announced a reset of our full year guidance, reflecting the removal of forecast bus sales to Brazil this year. So we still see the potential. We still see the opportunity. We're still working on the opportunity, but we see that as a 2013 item, not 2012. And although there's activity in bus outside of Brazil, that slipped to the second half of the year. So no bus activity in Q2.

In backup power, we saw a decline in product shipments, which you noted in the press release, of 79% in Q2. And again, a pretty simple explanation, this was largely related to IdaTech and explained by the fact that IdaTech's principal shareholder had decided some months previously to exit the market. So as a result, IdaTech was not focused on sales and orders, and we had 0 shipments to IdaTech in Q2. Now that's changed, of course, with our recently announced acquisition of select IdaTech assets, so IdaTech becomes a key growth driver for us in terms of the methanol systems that we will now sell directly starting in Q3.

So if you put all that together, a weak Q2 on revenue but not related to any systemic issues across the business broadly but rather due to temporarily slow activity through April, May and June in material products, in bus and in backup power with IdaTech.

Now I talked about IdaTech a couple of times, so let me switch gears and talk about the IdaTech asset acquisition. And then I'll come back and talk about our expectations more broadly for revenue in the second half of the year.

IdaTech. We have acquired key IdaTech assets in return for 7.1 million shares of common stock. The assets, as you would have seen on the press release, include IdaTech's product lines, including its methanol-fueled 2.5-kilowatt and 5-kilowatt backup power systems, distributor agreements, customer contracts and customer purchase orders, as well the assets include a license for related intellectual property and inventory and certain property, plant and equipment. And to support this new methanol product line, we have also acquired 20 of IdaTech's 140-or-so employees.

Now more broadly, the deal has significant financial upside and strategic upsides for Ballard. So financially, we expect to realize around $5 million in additional revenue in 2012 through the sale of IdaTech systems, mainly for methanol backup power applications. And the deal will be accretive to 2012 EBITDA and 2012 cash. That's financials.

Strategically, with this deal, we now have methanol reformer capabilities and methanol-fueled backup power products. And of course, we'll rebrand that product line as Ballard. We acquired IdaTech customers, which include key global telecom service providers such as Hutchison Telecom in Asia and Vodacom in South Africa. And we acquired a well-established distributor network to support those customers. Also, their synergy with the work that we're doing in South Africa with Anglo American Platinum to develop a methanol-fueled home generator product throughout grid applications.

So again, strategically, now we're very well positioned with multi-fuel offerings, with offerings that deal with short-term backup power requirements, extended run time backup power requirements. And with the methanol reformer expertise, it will help us in the continuous power area as well. So a good deal for Ballard in the short term and longer term financially and strategically.

Now to come back to the results trajectory and expectations for the second half of the year. We continue to expect strong revenue growth in the second half, given the traditional second half ramp that you've seen in the past. The timing, the planned bus shipments, the IdaTech growth enabler I just talked about, the recovery in material products, the cadence in engineering service contracts and continuing growth in material handling, all of which are reflected in the jump in our order book to $54.4 million I talked about.

To give you a bit of color there on how fuel cell products will continue to that ramp in the back half of the year, starting with bus, we'd be -- we expect to ship an increased number of bus modules in the second half, some of which were deferred from earlier in the year. Four of these modules are destined for the U.S. market: Chicago, Connecticut and Palm Springs. Four modules will be shipped to Van Hool in Belgium for deployment in European bus programs, and there's a potential for additional bus modules shipments as well.

In backup power, the IdaTech quarters will be a growth driver starting in Q3, and you can expect to see press releases in the next few weeks in terms of some of the early orders there to key new customers. Beyond IdaTech shipments, we also expect additional growth from Dantherm Power sales of direct hydrogen systems in China, India and North America.

In engineering services. Engineering services activity is picking up as expected, with booked work in the first half now translating into revenue activities in the second half. And one of the key contracts there is the one I mentioned a few minutes ago, the home generator development project for South Africa. That project represents about $5 million in revenue this year, primarily in the second half.

In addition, as noted in our press release, we have recently signed new engineering services contracts in the aerospace and military sectors. Overall, we expect engineering services to generate approximately $15 million revenue in 2012, and again, mainly in the second half of the year.

And in material handling, just to mention briefly, while Plug Power has noted some deferrals in expected shipments into early 2013, Plug continues to demonstrate progress in order volumes, including the recently announced 72-system order for Mercedes-Benz.

For the full year in material handling, we expect 40% to 50% growth year-over-year in our stack shipments to Plug. That would roughly represent volume in the second half consistent with what we saw in the first half and as you saw in the press release, good growth in the first half of the year in material handling.

So to summarize, expectations for strong revenue growth in the second half of the year, evidenced by the jump in the order book to $54.4 million.

With that overview on revenue, over to Tony.

Tony Guglielmin

Thanks, John. So I'll first address the key drivers to the bottom line profitability, gross margin and cash operating costs. So gross margin was 15% in Q2 and 19% for the first half of the year, up 2 points from the first half of 2011. Looking to the second half of the year, the higher mix of bus and engineering service revenue through the remainder of 2012 will have a positive impact in gross margin, and we expect to see gross margin in the mid- to high-20% range for the full year versus our original estimate of 30%.

In terms of cash operating costs, during Q2, cash operating costs were $7.7 million, an improvement of $3 million or 28% compared to Q2 last year. For the first half of the year, cash operating costs were $17.4 million, an improvement of $4 million or 19% compared to the first half of 2011. And the reduction in Q2 cash operating costs was a result of a number of factors: a lower research in product development expense as resources were redirected to revenue-bearing engineering services projects, the pursuit of government funding for research and product development activities, a number of ongoing cost reduction efforts and a downward adjustment in the group compensation expense in the quarter.

So looking at the bottom line, the progress on our continuing cost optimization efforts more than offset the decline in gross margin associated with lower revenues. So adjusted EBITDA improved 12% in Q2 and 18% in the first half of the year.

As we look to the second half, we expect further improvement stemming from significant revenue growth underpinned by proportionately more higher-margin engineering service revenue and product cost reductions, combined with a reduced cost base. These factors will drive us to our guidance for adjusted EBITDA of approximately negative $5 million for the full year.

Looking at cash flow and liquidity. Cash used in operations was $11.2 million in Q2 and $26.3 million for the first 6 months. Despite the lower revenue trajectory in the first half, this was an improvement of 17% and 5% over the same period in 2011. The improvements reflected lower cash operating losses, offset by slightly higher working capital requirements in the first 6 months in anticipation of the revenue ramp-up in the second half.

So we close the second quarter with $15.2 million of cash reserves, net of the operating line, and anticipate slightly positive cash flow in the second half of 2012. We are also planning to strengthen our cash position through the sale leaseback of our material products facility in Lowell, Massachusetts. And we're working now to ensure positive EBITDA and breakeven cash flow in 2013 by resizing our operating cost base. Over the past several months, we have taken a number of steps to reduce our cash OpEx base. And this has been a multifaceted program, including a reduction in facilities cost, the restructuring of our corporate bonus plan, reductions in G&A and a 7% reduction in corporate headcount. These measures will reduce cash operating cost by $5 million to $7 million for the full year in 2013, taking cash OpEx to the mid-$20 million range next year.

To conclude then, while top line performance for the first half of 2012 was below expectation, we do anticipate growth through the remainder of the year being much improved and demonstrating a similar if somewhat more pronounced cadence than the past years. And this is supported by the order book of $54.4 million, driven by all fuel cells segment products.

Given these expectations, we have not updated the guidance provided on June 18 for revenue of approximately $85 million. Now this growing revenue, with the higher gross margin and lower cost base as mentioned earlier, will drive full year adjusted EBITDA of approximately negative $5 million in 2012. And lastly, proactive cost management measures have been taken to ensure costs are aligned with the top line trajectory to achieve our goal of profitability in 2013.

So with that, we would be pleased to take your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Your first question is from Jeff Osborne of Stifel, Nicolaus.

Jeff Osborne - Stifel, Nicolaus & Co., Inc., Research Division

I'll do a follow-up on the engineering services piece. And congratulations for the wins that you've had there, but what's the pipeline of additional awards that you think you'll be able to capture over the second half as you look for profitability for 2013? It seems like that will be an important piece of that plus the bus market coming back?

John William Sheridan

It is a good point, Jeff, and I'm just hesitating in terms of how deep I can go in terms of some of our negotiation activity and prospecting activities. Maybe just mention 3 things: So number one, the Anglo activity will continue through the first 3 quarters of next year. When I mentioned the $5 million this year, that is, of course, the 2012 number. So that's a key project. We're very pleased with the strong support and the close engagement from Anglo Platinum, so we see continuing activity there through 2013. Second point, we've been surprised and a bit encouraged -- well, I'd say significantly encouraged by the diversity of sectors that we've got engaged within what you saw on the press release, including military and a couple aerospace customers. Now what we're finding is there are a number of major OEMs, key global players that do see fuel cells applications as part of their future. But in some cases, it's a couple of years out in the product portfolio. So to be able to work with us on the development side in the short term, I think, is a really good fit. Thirdly, one of the areas we do see interest as well is in the automotive space. And I think there's been some confusion when we do talk about this wind-down in the contract manufacturing we had with Daimler, we have not exited our relationships on the automotive side. And engineering services is a good engagement area for us to get into that space as the whole fuel cell car area starts to finally become closer to significant activity. So engineering services, thanks for the question, is quite significant to us.

Jeff Osborne - Stifel, Nicolaus & Co., Inc., Research Division

Perfect. And maybe just following up on the bus market. Can you just talk on what was some of the reasoning for the delays in the domestic market here and also the Van Hool shipments into Belgium in the first half. I completely understand what transpired in Brazil, but maybe just talk about the orders you had in hand and why the delay there?

John William Sheridan

Well, Jeff, I wish I could give you a better answer, but it was kind of a singular factor. What we're finding in North America, it's principally the delays in getting approvals and then after approvals, the flow-through of the funding from the government authorities to the transit operators to us to move forward with the shipments. So, I'm afraid it's nothing more than that. In terms of the business more broadly, Europe still seems to be strong despite the multitude of ongoing economic crisis and sovereign debt concerns in Europe. There still seems to be good government support, EU support for clean energy, zero-emission public transit. So we're looking forward to finding out details of JTI support, for example, for 2013 for buses. There seems to be good activity there. North America seems to be weaker, which we anticipated. I guess, again, what we didn't anticipate was some of the timing complexities.

Jeff Osborne - Stifel, Nicolaus & Co., Inc., Research Division

Okay, just one last quick one for me, just following up on Europe. I think it was 6 months ago or so, you mentioned a large RFP in Norway. I believe it was similar to the TETRA system that's up in Scandinavia. Is that still in the works?

John William Sheridan

Still in the works. Again, what we seem to be finding in the fuel cell sector, and I guess it's not surprising, to be honest with you, tough, tough economic times. We're trying to build a business, commercializing a new technology. There are timing challenges with it. So the Norway TETRA network, we did identify as a big opportunity. We think we're well positioned because the primary contractor's, Motorola Solutions, we work with them with the TETRA network in Denmark. But rather than that becoming a fourth quarter item this year, it looks like that will become a first, second quarter item to start to roll next year. So we're active. In fact, we have key meetings coming up in 2 weeks on the project. If we are successful with the project, we would expect to get the contract later this year, but shipments would start in '13 and go through '14 and '15.

Operator

The next question is from Mike Cikos of Sidoti & Company.

Michael Cikos - Sidoti & Company, LLC

I had a question regarding the buses. In the prepared remarks, did you say how many were actually expected to ship? Was it 4 was going to Van Hool?

John William Sheridan

Yes, I didn't give you a total number for the second half, but I did reference 4 for the U.S. and 4 for Van Hool.

Michael Cikos - Sidoti & Company, LLC

Okay. And what cities were they shipping to in the U.S.?

John William Sheridan

Oh, in the U.S., Palm Springs, Chicago and Connecticut.

Michael Cikos - Sidoti & Company, LLC

Okay. And the expectation then -- or the shipments for those 8 buses, the 4 to Van Hool, and the 4 to the U.S., is that built into your current sales guidance?

John William Sheridan

Yes.

Michael Cikos - Sidoti & Company, LLC

And based on the delays that we've seen in the funding environment, because it seems like that was what you were pointing to for the North American delays, why would we expect that to get any better in this back half of the year with the current North American funding?

John William Sheridan

Okay. I probably wasn't clear there, so a couple different things. So the funding environment has toughened in North America and principally, the U.S. we're talking about. There's delays in it. So delays in the funding, the approval, the administration work, et cetera, have slipped Chicago, Connecticut and SunLine. We had expected those to ship actually in the first quarter and the second quarter. They now -- the funding is not in doubt. It's just the timing of the flow of the funding. So we're pretty firm on that. We don't see a risk there other than the frustration with the timing. In terms of bus, more broadly, we don't see big, big growth in the U.S. in terms of the current environment nor Canada for that matter either. So this isn't timing I'm talking about now, now shifting gears to talk more broadly about business potential in zero-emission buses. But in Europe and in South America, we still see very, very strong interest. So in terms of growth downstream, that's where we see the bulk of it. In terms of the risk in the second half, we don't see any risk with the numbers I talked about.

Michael Cikos - Sidoti & Company, LLC

Okay. And with the pickup that you're expecting in the material handling, is that all related to what's going on with Plug right now?

John William Sheridan

Yes -- well, sorry, let me start over and, Tony, you should jump here in a minute. But 2 things with material handling, what I tried to describe is good growth year-over-year, not as strong as we thought when we gave our outlook initially for the year. We see year-over-year now broadly being more in the 40% to 50% growth range. And then I tried to explain, and maybe I didn't do a good job of explaining it, Mike, the volume we had in the first half of around 1,000, we would see replicated in the second half. So in most of our business, we see a good ramp second half to first half. In material handling, we see it roughly the same volume but representing about 40%, 50% growth year-over-year. Tony, what did I miss there?

Tony Guglielmin

Nothing. I think you said it all. You captured it all.

Michael Cikos - Sidoti & Company, LLC

Okay. So from material handling, if I'm comparing first half 2012 to second half 2012 volume and revenue is going to stay about flat then?

John William Sheridan

Right. And as you saw on the press release, the shipments were about 1,000 in the first half, which are way up from last year. Last year, we had a very, very irregular cadence in material handling. This year, it's more steady.

Michael Cikos - Sidoti & Company, LLC

I see. Other question -- and sorry, I know it's a rookie question, but as far as IdaTech, were you actually selling products to them or was it a partnership?

John William Sheridan

We were supplying them with stacks, principally the 1020 air-cooled stack, and they incorporated that air-cooled stack into their system. So we had a pretty good supplier-customer relationship, but we were just a component supplier. So this is exciting for us now. We've got the end-to-end capability. We've got transparency with end-users. We've got contracts with distributors, so this is a big step for us. And thanks for the question, because the other thing for us, too, the ASPs of the stack versus the system are radically different, probably 6x to 7x.

Operator

The next question comes from Walter Nasdeo of Ardour Capital.

Walter Nasdeo - Ardour Capital Investments, LLC, Research Division

I wanted to just expand on the IdaTech acquisition. Now that you control kind of start-to-finish on that, is there any opportunity to try to go up and down as far as size goes? Now that you're going back or getting over into direct methanol -- into the methanol products, can you see yourself making smaller products to go right into different markets? Or you just kind of continue with what IdaTech has been developing over the years?

John William Sheridan

It's interesting. The sweet spot we thought was there, with the trend in electronics you'd be familiar with in terms of the wireless networks was moving more towards the low end in terms of 2 kilowatt. So we thought the 2 kilowatt, 5 kilowatt positioned us pretty well. I don't think you're going to see much application for that market below 2, but what I would add is we're getting some input from service providers and infrastructure providers looking for more shared infrastructure situations where they might be looking for 7.5-type kilowatts. So I think it's going to be more likely to go up rather than down.

Walter Nasdeo - Ardour Capital Investments, LLC, Research Division

Now since you're not just doing the stack on this -- in this product line, will you also be working with methanol cartridges or methanol delivery systems? Or is that kind of going to be outside what your plan is now?

John William Sheridan

It will be primarily work done by our distributors, but we'll be engaged with them. And the fueling here is methanol and water, so it's not cartridge per se. It's pretty easy and pretty efficient delivery of methanol and water.

Operator

[Operator Instructions] There's a follow-up question from Mike Cikos of Sidoti & Company.

Michael Cikos - Sidoti & Company, LLC

Just some more interest on IdaTech. From a dollar perspective, can you break out how much you were actually selling to them on a quarterly basis?

John William Sheridan

It was very uneven on a quarterly basis. But I guess, Tony, our plan this year would have been in the neighborhood of a couple million dollars of revenue for the year for the stacks.

Tony Guglielmin

Yes, certainly, I'd call it that, John, $2 million, $3 million in stacks.

John William Sheridan

And Mike, your question's a good one. And again, part of our optimism, we see in the second half of this year, revenue from systems alone, as I said, just the second half approximately $5 million.

Michael Cikos - Sidoti & Company, LLC

Okay. And the other question was the backup power. We said was down about 79% and part of that was related to the IdaTech acquisition. Can you explain or can you dig a little deeper into why we saw that decline?

John William Sheridan

Sure. And it's pretty simple in the sense that IdaTech, if you're not familiar with them, Mike, has had one principal shareholder who controlled their equity and also funded them on a debt basis. That shareholder, Investec, a financial institution, decided to exit the sector early in the year. At that point, the focus, as you'd expected, the IdaTech management team was more who they're selling to, what happens in terms of an exit. So it really put almost a stop on orders. It put a stop on our shipments of stacks to them. So with that going on in the first half of the year and the second quarter, in particular, there were no sales to IdaTech at all. Now that flips around to an advantage now. And again, as I said, you'll see press releases in the short term because we do see pent-up demand there from former IdaTech customers, now our customers. So you're going to see some fairly significant activity right out of the gate in the third quarter here.

Tony Guglielmin

Mike, I'll just to add a bit more color to it just in terms of the order of magnitude. IdaTech, as you recall, was our largest customer for fuel cell stacks as well. So the order of magnitude that you see in the decline was really largely or principally related just to the 0 sales to IdaTech. So you can attribute all of that largely to the IdaTech.

Operator

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

John William Sheridan

Thanks, operator. And again, thank you all for joining us in the holiday season here. We're very positive on second half opportunities, and we look forward to being back with you in a few months to report on our Q3 progress. Have a good day.

Operator

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

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