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Executives

Kelly Frizzell - Interim CFO

Daryl Wilson - President & CEO

Analysts

George Santana – Ascendiant

Phillip Shen - Roth

John-Marc Bunce - Nomura

Orin Hirschman - AGI Investment

Lawrence Huntington - Private Investor

Larry Litton - Second Line Capital

Hydrogenics’ (HYGS) Q3 2012 Earnings Call November 8, 2012 10:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the Hydrogenics third quarter conference call. At this time, all participants are in a listen-only mode. Following management’s prepared remarks, we’ll hold a Q&A session. (Operator Instructions) As a reminder, this conference is being recorded, today, November 9th, 2012.

I’d now like to turn the call over to the moderator, Kelly Frizzell, the company’s Interim Chief Financial Officer.

Kelly Frizzell

Thank you, Valery. Welcome to the Hydrogenics third quarter 2012 conference call. With me today is Daryl Wilson, our President and Chief Executive Officer.

Our third 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 US dollars unless otherwise noted. I would now like 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 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 Wilson. Please go ahead.

Daryl Wilson

Thanks Kelly. Good morning, and thanks for joining us for Hydrogenics third quarter conference call. Today I will review our operations and outlook after which Kelly will discuss the financial results in detail. Please refer to the presentation on our website for today’s discussion.

Starting on slide three, let me just start by giving an overview of the quarter. Hydrogenics has had a great deal of positive news this year and the third quarter was clearly no exception. We secured the largest award in our company’s history worth up to $90 million over an expected period of 10 years. During this time, we will be designing and delivering proprietary fuel cell power systems, along with electronic converters, associated components and propulsion system software. This is a very important project for Hydrogenics and one that we've been working on securing for long period of time. As a matter of fact, we've been engaged in the development work with this OEM for the past seven years.

Our contracts represents the transition to full commercialization on the associated technology and what we’re providing is crucial to the success of the OEM in this particular product area. The customer has made an irrevocable commitment to a minimum number of deployments over a fixed period of time. Hydrogenics technology chosen for its demonstrated performance and reliability offers significant benefits for the life cycle cost, reduced maintenance and operational flexibility of this application.

The award includes an initial firm fixed price, exclusive design and manufacturing contracts valued at approximately $36 which is already being included in the company’s order backlog for the third quarter which was just ended. The award also includes an additional seven years of maintenance services and as the application is rolled out by the OEM, it could lead to additional future orders. However, due to the extremely sensitive nature of the customer and sales process, we cannot say anything more about this program and I wish I could as it’s the most exciting thing that's ever happened in Hydrogenics’ history but unfortunately it’s just not appropriate at this time per the customer’s request.

That said, we did receive 10.4 million as an initial upfront payment related to the award just this week in recognition of the long term nature of the contract and the confidential technology that's being supplied to the OEM in question. We expect to finish the first phases of the product development in 2013 with a good portion of the revenue related to the initial 36 million contract being reported in the next year as well.

In conjunction with this ground breaking order, Hydrogenics backlog rose to the highest level ever at 61.4 million up nearly a 150% year-over-year. At the same time, we continue to post strong revenue growth based on our existing backlog shipping 7.5 million in OnSite Generation orders during the quarter. This reflects both the ongoing demand for industrial electrolyser as well as for energy storage applications as I'll review further in a moment.

We exited the quarter with 9 million of cash on hand and then as I've mentioned, we received an additional 10 million for the just awarded contract, strengthening our balance sheet heading into 2013.

Now turning to slide four, let me review some of the broader themes for the business and our outlook. Obviously we are in the best position that we've been in, in years. Even aside from the significant $90 million order that we just received, we’re seeing consistent increasing demand across all of our end markets. We’re bidding on a record number of opportunities and our backlog is expected to continue growing in the quarter’s to come. Our industrial electrolyser business is running on all cylinders while at the same time, we’re seeing more and more interest by governments, utilities and industry alike for our hydrogen based energy storage solutions. In fact, we've won four orders thus far and have nine more additional projects in the pipeline so our activity level is extremely high. Not only is demand accelerating, but our win rate is the best in the business. Four of the projects we've already been awarded account to 66% win rate and there are 12 more planned in Europe alone including the nine that I've just mentioned.

We have also continued to work diligently with CommScope on a number of exciting opportunities for backup power which I believe should result in orders in the very near future. We obviously have a great relationship with CommScope and our fuel cell power systems offer a compelling backup power application particularly within the telecom space.

Lastly, as I said a moment ago, our balance sheet is being bolstered by the recent award and we believe this provides significant growth capital as well as financial flexibility for the future.

Now turning to slide five, let me go over our growth strategy in a bit more detail. Within our Power Systems group, we've had several major ongoing initiatives. We’re focused on discreet applications across a variety of industries including transportation and backup power and we’re in the cusp of moving substantially down the learning curve towards large scale commercialization. Up till now, it’s been no secret that our financial performance in this business has been spotty at best and we primarily made due with small orders on many of the demonstration projects. While that has certainly changed with the recent contract just signed and we’ll move further down the learning curve as we sign orders to our CommScope partnership which is seeing very high levels of activity. The bottom line is that this business which has never been seen volume production is now at a turning point. Due to both our existing backlog and our strong bid activity, we believe that a year from now the Power Systems business will be a large contributing portion of Hydrogenics operation and as such, a key driver of both revenue and profitability.

Within our OnSite Generation group, we’re also seeing very positive fundamentals. As I have said before, our industrial business is strong and steady and we’re selling electrolysers to all parts of the world including Russia, South America and Asia. We're taking market share from our rivals while keeping margins intact. At the same time, we’re being very active in the ongoing market for hydrogen fueling stations particularly in Europe. This business continues to grow due to environmental regulations and the increasing use of fuel cell powered cars, trucks and busses worldwide. We don't perceive any slowdown within this area and Hydrogenics is a leader in serving the market.

And last but certainly not least, our energy storage offerings are setting the standard for hydrogen based power management. We are the first to market with a cost effective, utility scale application and we’re working hand in hand with such leading companies as Enbridge and E.ON. For E.ON, we expect to deliver the first 2 megawatt project in December this year, another ground breaking achievement and we’re now bidding on applications ranging up to 10 megawatts in both north America and Europe and we see this area of our business growing substantially in 2013.

Slide six shows our overall business and where we’re heading quite rapidly. As I discussed in the past, we’re moving into a much stronger broader applications as we grow the business here and overseas. I would say that we’re nearing the end of the inflection transition period and we will soon be a company with three equally solid platforms energy storage, power systems and hydrogen generation.

Before turning the call back over to Kelly, let me reiterate that Hydrogenics is in the best shape that it’s been in years. Our backlog is at record levels. Our revenue growth is strong. Gross margins are up. And our hydrogen based applications are clearly in demand. We still have work to do in lowering costs as a percent of sales which we see happening with our substantial growth in the next year. We remain committed to achieving profitability as soon as possible and believe that as we said in the past, we should reach breakeven around the time we’re operating at a 50 million revenue run rate. That's certainly now in our line of site. We've kept our operations lean for years and our small staff has accomplished many great things but frankly the best is yet to come. The expected revenue acceleration going forward will lead to much better returns for our company and our shareholders and we’re working hard on new business opportunities preserving cash and building a backlog that will sustain growth for Hydrogenics in the future.

I'll now turn the call back over to Kelly, our Interim Chief Financial Officer who will review our third quarter financial results in some more detail.

Kelly Frizzell

Thanks Daryl. To briefly summarize the financial results for the third quarter and nine months September 30th, 2012, we posted revenue of 7.9 million and 21.9 million for the quarter end nine months respectively of 2012 which represented increases of 60% and 35% over the prior periods. The strong topline improvement was sealed by higher demand in our industrial end markets along with growth in energy storage, especially offset by weakening of the euro relative to the US dollars.

Our gross profit was 21% for the third quarter, an increase of 3.1 percentage points versus 2011 reflecting increased revenue and economies of scale. For the nine months period gross profit was 18%, a decrease of 3.1 percentage points primarily reflecting increased material costs. Cost reduction efforts are continuing through supply chain management and product design innovation in order to restore markets to target levels.

Cash operating costs were 4.7 million for the quarter versus 2.9 million in the third quarter of 2011 with such costs nearly equivalent as a percent of sales in both years. The year-over-year change reflects planned increases in our research and development efforts, focus on next generation energy storage product development. In addition, cost per higher marketing and commercial activities as well as compensation costs deriving from improvement and performance contributed to the increase.

Cash operating costs were 11.7 million for the first nine months of 2011 versus 9.1 million last year with cost as a percent of sales falling 2.8%. The year-over-year change reflects planned increases in research and development efforts, focus on next generation storage product development, additional marketing costs and increased compensation arising from improved business performance. Our adjusted EBITDA loss is 3.2 million for the third quarter and 8.6 million for the nine months year-to-date reflecting the expenses previously discussed.

The company’s order backlog as of September 30th, 2012 was 61.4 million up nearly 150% year-over-year. During the third quarter, we received 42.3 million in new orders, a 230% increase over 2011. Our cash resources as of September 30th, 2012 were 9.3 million, a decrease of 0.4 million as compared with the second quarter. This decrease reflects 3.6 million of cash used in operations, partially offset by a 2.7 million increase in non-cash working capital, 0.3 million of proceeds from loan advancements and 0.2 million of positive foreign exchange resulting from the strengthening of the euro relative to the US dollar. Subsequent to the end of the quarter in October 2012, the company received 10.4 million in initial payments related to the $90 million award previously announced.

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

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from George Santana of Ascendiant. Please go ahead.

George Santana – Ascendiant

I wanted to just clarify a couple of figures. You mentioned you’ve gotten 10.4 million in cash after the quarter or was it 10.2?

Daryl Wilson

Yes 10.2 is the correct number. There was given that exchange rates is 10.2 is the correct conversion.

George Santana – Ascendiant

Okay that's dollars or Canadian?

Daryl Wilson

That's US dollars, all the reporting is done in US dollars.

George Santana – Ascendiant

I think I am not sure, but did you provide a little color as to when you can expect at least the initial portion of the contract to be completed?

Daryl Wilson

There are many milestones in the contract George and we’ll be crossing through milestones literally in the coming months and booking revenue on the project. What we’re communicating here is the first fixed firm portion of the contract is valued at 36 million and we’ll be working through that substantially in the next 12 to 14 months. It’s probably 24 months to realize that full 36 but there is a significant block of it in the near term.

George Santana – Ascendiant

So most of it might be recognized by the end of 2013?

Daryl Wilson

We're not saying most, we’re saying a substantial portion in 2013.

George Santana – Ascendiant

And with such a large contract, should we expect to see operating expense at a new level or is this kind of a run rate that you can sustain?

Daryl Wilson

We’re not looking at substantial amounts of hiring to support the additional business that's coming at us. As you know, I have a lean manufacturing background from Toyota and a strong philosophy in that direction and so while there will be some limited hiring, we don't foresee a significant uptick in our costs in order to manage this significant order and also, as we anticipate moving into higher production volumes on fuel cell side, there may be some limited hiring from an operational point of view but not a major distortion or change in our cost situation.

George Santana – Ascendiant

So this is where we could really start to see some operating leverage in the model?

Daryl Wilson

We expect so yes, absolutely, that's the way we plan to run the business and we've been looking forward to this for some time and I think now it’s here.

George Santana – Ascendiant

You mentioned a little bit on gross margins but with such this new contract, what should our expectation be in terms of modeling out?

Daryl Wilson

That's always a little bit of challenge because our business mix covers quite a wide range of margin point, so it’s hard for me to put a pin in it. If I could do that for you, I’d love to help you. But we still think the situation across the spectrum of the products and services that we provide, that the margins range significantly. I think in the coming quarters, we’ll start to see some buffering or denting on the fluctuations, so we’re certainly looking for it an ongoing improvement in margins and as we’re seeing decent volumes in all three of the sectors that we talked about here, our margin situation should stabilize and improve which I think are both good things.

Operator

Our next question comes from Phillip Shen of Roth. Please go ahead.

Phillip Shen - Roth

First question as a follow up to the contracts. Can you provide us some details on the milestones or performance metrics required to secure the remaining or optional the 43 million in equipment and services?

Daryl Wilson

It’s a little bit difficult but let me go through it in concept Phil, so first of all we have the firm fixed portion of 36 million as you know and then the remaining portions are in mixture of commercial orders which we do expect the customer will be able to land and so there are product to build for the application in that segment. There are some options on further development aspects which would be elected at the discretion of the customer and then there are the service portions that there needs to be commercial product in the field in order to activate the service portion. So there is a number of different contingencies that drive that and I think that we've done the best and clearest job we can in distinguishing the 36 million firm portion and then as I say, various triggers, I wouldn’t say that there is high uncertainty as to whether these remaining portions will come in other than in timing, it is a 10 year contract in total and so exactly where they fall in the timing, would have some uncertainty but the activation of the individual components, I don't think there is a high degree of uncertainty.

Phillip Shen - Roth

I know you mentioned on the call that you can’t share who it is, can you give us a sense for where this OEM is based or headquartered by geographic region?

Daryl Wilson

Unfortunately not. This has been very clear and explicit instructions by the customer and I know that makes it hard. Any good reporting has the who, what, when, where, why of the story and I don't have any of that for you. I wish I did. We do understand that as certain confidential negotiations in the commercial space are concluded, the customer may free us up to talk more openly about this application and at that point we’ll be happy to answer many questions, but at this point, we’re saying all that we can at the moment, I'm sorry.

Phillip Shen - Roth

Okay, and actually just as a quick follow-up on that topic, do you have sense for when you can go public with this partner?

Daryl Wilson

No, that's contingent on I think confidential commercial discussions as the partners is having with their customers, and so we’re not in control of that side of things. But this is, as I say, not a new activity for us, we've been at it for seven years, a very reliable good partner for us. So while we can’t disclose much information, this is absolutely not a phantom situation. It’s very real. Our team is already working hard on the project and as time goes on, we will be able to say more but for now, I am sorry.

Phillip Shen - Roth

Can we move on to power and gas or power to gas? Can you give us a sense for how far out the larger revenue opportunities from commercial power to gas projects might be? Are we looking at a possible 2013 event or more likely 2014?

Daryl Wilson

First of all a word about momentum here. This particular application is enjoying tremendous momentum. Next week four of us will be speaking about this subject in four different countries, all in the course of one week. So the interest in power to gas and energy storage in hydrogen is moving very rapidly. Secondly there is a geographical distinction here, there is a huge amount of interest in this area so far in Europe and while we are developing some projects and concepts with Enbridge, our partner in North America, the momentum is not really the same as it is in Europe. So things are looking very good in terms of the activity and I've been here for six years and I've never seen the amount of pull on a particular application than I've seen on this particular application.

The initial projects that are showing up are typically in the one to two megawatt range, we've already sold projects in that size range. We’re delivering a two megawatt project in December to E.ON, but under discussion now are larger projects at five and 10 megawatts. Proper utility scale in this segment is in the 10 to 50 megawatt level. So my expectation is that during 2013, we will see this move to the next scale with the five or 10 megawatt project becoming active. So an important transition. And there are concrete discussions going on in projects of that nature now. So our goal and our desire is to close one of those in the next year. And start to establish this at its full mature scale during 2013. The one’s we've closed this year have more than a year lead time work behind them and so it does take time in new applications based to cut new ground, but our reputation now is well established as the market leader in the go to company. Our win rates in critical geographies such as Germany is very, very high and our expectation to start landing larger ones in the next year is very strong.

Phillip Shen - Roth

As relates to power to gas, as you think about this products, as you grow in scale and size, can you give us a sense for what you expect the cost of delivering 1 million BTUs might be in terms of hydrogen gas. That’s kind of a specific question but perhaps you can talk about in generalities as you grow with the scale.

Daryl Wilson

So, in this particular field, there are a number of different applications. So it’s not a monolithic situation where it always looks the same. There are power to gas where we’re injecting the gas in the natural gas pipeline system, power to gas systems were delivering hydrogen for industrial fuel or for vehicle fuel. There are now projects showing up with methanization of CO2 in bioplant operation. So there is quite a spectrum of applications here. Another I think very positive sign of a new industrial sector arising of critical application for hydrogen. Each of these have a different performance and business model profile and different requirements from the technology and while our base technology won’t change, some of the balance of plants and equipment with each of these changes. So it is hard to give one number. At this point for simplicity, I am saying that we’re talking about 1 million euros per megawatt is a reasonable assumption number. But like any new field, there is an expectation of learning curve developments and reductions in that cost and price situation and our projections with the various partners and projects that we’re quoting were fully able to meet the cost trajectories going on to the next five and ten years to meet full scale and also follow the pricing down and maintain positive and attractive margins for Hydrogenics.

So it’s a good situation with momentum. I am giving you a stake on the ground in terms of pricing today. But like any maturing business, we have to understand that prices won’t migrate downward and expectations will move down in terms of pricing. The critical issue is whether we can stay ahead of that from a technology point of view and enjoy a positive business situation for ourselves and we absolutely see that in our future.

Operator

Our next question comes from John-Marc Bunce of Nomura. Please go ahead.

John-Marc Bunce - Nomura

Can you maybe an indication of what the power size per unit is under that contract and then maybe you can give us a feeling of how you think that contract might look other contracts versus similar power, size, systems and is it going to be a catalyst to get other customers over the line?

Daryl Wilson

Again our hands are tied here. I wish I could say more. Probably the furthest I can go is on the larger side of typical pin applications and in the last seven years, our work on this program has absolutely yielded technology insights and developments which have been beneficial to the entire company offering. Because we’re now moving into a commercialization phase, I don't expect so much massive technical breakthroughs as may have happened in the last seven years but we focus on high reliability quality and cost performance and so there may still be some yield in benefiting our engineering for other applications in that respect. But as I say, moving this now in to full commercialization, the focus is on reliability and quality so that customer can enjoy good, reliable, commercial success on their side with the application and so it’s always good to learn in (inaudible) but the follow-through benefits for the company are not quite as strong as the first phase as in the last seven years.

John-Marc Bunce - Nomura

And then a couple of questions on the electrolysis side, as you’re starting to get greater number of energy, storage, power to gas type projects, maybe you can give us an idea of how the margins of these projects compare with the previous sort of industrial hydrogen side of the business. And then in terms of the actual projects on that side of thing, you said that those might be another (inaudible) energy source projects so planned. Maybe you can give us a rough idea of when those projects could be announced and delivered and maybe (inaudible) what you think your chance of winning those projects are. Should we be looking at a similar source of win rate as you have done historically or do you think things are maybe getting a bit more competitive in this power to gas and energy storage segments as we had in a good year or two or best time here over in Europe, something we've seen other companies also demonstrating systems, that will be applicable to this market. Thanks.

Daryl Wilson

Good question and a complicated one. First of all in the comparison between the industrial business and the power to gas application, today we've been delivering product which is more or less identical to the industrial application. This is an area where hydrogen exerts a very high reputation, many, many field references with customers that expect very high reliability. So in a sense, the projects are no different. And the price points also had the similar spectrum of margins to what we've seen in the industrial business. So if you look at our OnSite Generation business in totality, it’s reasonably indicative. As we start going to larger scale, there are some economies of scale and supply chain opportunity that arise that may indeed help us to improve margins. But you’re quite right. There are competitor offerings and challenges in this market space as well. So not having one of these additional projects, I can’t predict with any high degree of certainty how the margins are going to come in. but of course, we're working always towards target margins in the 30% range or better. So we’ll keep on doing our best and we’ll have to wait to see what the outcomes are.

When it comes to the competitive situation, we don't want to be arrogant. We've had a very good track record and win rate to date. The more references that we’re able to establish in this field, I think it only serves to attract more business in our direction. The key selling points that are helping us to win projects today are field execution capability, many of the clients on these projects and the partners on these projects are very sophisticated sometimes industrial gas providers and we have a very strong history and working with these kind of companies and delevering and executing on plan, on budget, on time with very high reliability and that's been a critical facet to distinguish ourselves in the market. We do face competitors who are in start-up mode, who have limited product in the field, and have not worked at the scale of these projects.

The other inflection point that we are going to see here is as the projects migrate to larger scale, we will be introducing new larger scale technology in the market which is very clear advantages. Sometime in the next year we will release product that delivers a megawatt from a single stack. We have competitors that are trying to deliver megawatt projects with 5-10-15 stacks.

We will be able to do that with a single stack, I think that’s a very strong competitive advantage. We also have intellectual property which is secured throughout Europe into Joan and North America for the application of grid stabilization services and energy systems involving hydrogen and we have been clear with people who have been asking for bids that we fully intend to defend that intellectual property vigorously and it is very strong position which relates to a significant proportion of the value involved in these projects for the customer.

So while I don’t want to be arrogant about our future win rate we are feeling very bullish about our position here. I think the recent history speaks well for us and I think our position is well protected now and we will be adding further dimensions that will be challenging for others to compete within the future.

John-Marc Bunce - Nomura

And then in terms of you know when you think these projects could be announced and built just to give an idea of the spreads of these and I think I remember you saying these some of these also the 5 to 10 megawatt range as well. Is that all right?

Daryl Wilson

Yes so if I look back in the last 12 months and say there has been about four projects that are been closed in our favor. I would expect and hope that we will see more than that in the coming year at the smaller scale. In the larger scale you know my target would be one or two next year, I can’t be sure of what the outcome will be there but certainly we will be working hard at get at least one off in the 5 to 10 megawatt scale if not more.

Operator

Our next question comes from Orin Hirschman of AGI Investment.

Orin Hirschman - AGI Investment

I know you touched (inaudible) but didn’t give a lot of guidance there but two questions one of the expense side, expenses were up dramatically from the typical quarterly run-rate and the quarter you just reported. Is that a new level of expenses or there was extra-ordinary stuff going on because it's certainly more than a $1 million greater than what’s been typical then I have a one or two follow-up.

Daryl Wilson

So as we clarified in the meeting already the drivers around the expense side. First of all have to do with some increased spending and support of larger scale power to gas applications. As we are looking at this market and realizing what we need to do and also looking at the moment in the market we are seeing, we need to be ready to deliver at much larger scale, very quickly first to market is very critical in these new applications spaces, getting the first critical reference sites that have a high profile is very important. I know this from my former business experience and so I have put a lot of pressure on the guys to move ahead with the product development, to scale up so there has been additional spending in that area.

And then on the selling and marketing side. Again seeing the market opportunity we have been busy, we have been traveling. We have been doing conferences, seeing customers all over the world and so that has increased our marketing and selling expenses. And finally in terms of the compensation side of this we do have a sales incentive program, we have not changed that in several years but it now looks like it will need to pay off on some of these higher performance levels. Nobody is walking away with any absorbent fee and ridiculous bonuses but programs that we designed four and five years ago now are having to have some payment.

So those are the things that led into the increased expenses. To your question I don’t see this as been kind of a sustained factor. There is a surge in the R&D spending that will be substantially done probably in the next six months. There is a surge in this marketing activity; we are going at a bit of a frantic space. I mentioned four of us are in four different countries with presentations next week. I don’t expect that that’s going to keep on happening. I think things will settle down a little bit.

So not the picture of an on-going situation. I think we have a very strong history here of managing a lean ship and haven’t changed my mind about that. So we will keep things in check.

Orin Hirschman - AGI Investment

Does that mean if we’re going – or can you quantify the bonuses in this quarter to get a better feel why we are going back down to 3.5 mode, 3.2 mode, 3.8 mode, 4 mode, 4.25 million mode. Just give us some idea and then I will lead into my next question after that.

Daryl Wilson

Yes hard for me to put a pin in it exactly, but as I say you’re seeing a surge now and I think things will settle down in the next quarter.

Orin Hirschman - AGI Investment

Okay and just in terms of trying to engage with the gross margin means we will be as you ramp here. Are we heading to a 25 to 30 type of growth margin or are we going to get stuck in the low 20s. Where can this company go in terms of getting a gross margin that you always wanted to get? Like what’s realistic?

Daryl Wilson

Challenging for me because I have a number of things scaling in parallel and what happens as you’re scaling is a lot of push and pull in the supply chain and some degree of uncertainty on the operation side. So we certainly have strong internal targets and our team knows what those targets are. We are certainly very active in our supply chain to assure our suppliers that there is an opportunity here to work with us that we need favorable pricing to support these major opportunities and if they want to make the trip with us they are going to have to treat us well.

We have been having good success in general with that pressure, whereas it's all going to turnout. I think we need a quarter too to see where it lands. So there is some uncertainty now but I have said repeatedly our targets in the vicinity of 30%. We have delivered in that range during the stable positive times in the past.

Now we move through this inflection time. I think there is a little bit of uncertainty as to where we are actually going to land but we will be pressing hard back into that 30% range.

Orin Hirschman - AGI Investment

Okay and finally just in terms of orders on the energy side. When do you really you get, what still needs to be demoed particularly with a new product or the new version of the product coming. What are you see is one or two landmarks before you can really begin to see you know really meaningful order flow beyond these initial orders.

Daryl Wilson

So as I said already there is good momentum and full from the market which is positive. These are new clients who will be demonstrating various business models in this application and it doesn’t take a great deal of time so it's not something that they have to have running for five years to have confidence as to how the whole thing is going to work out.

We’re talking 6 to 12 month time horizons for the initial customers to say yes it works, yes the business model works, yes we want to do more of this so I think that’s a very positive situation to grow this market. On our side, in the next year we will certainly deliver our megawatt level, single stack equipment and that will be the threshold for doing multi-megawatt from that platform. So I see that happening in the next 12 months which I think is an important milestone.

Those are probably the two, it's the customer experience with the business model and it's our ability to deliver at scale that can actually step up to project during the 10 to 50 megawatt range and those milestones improve points I expect will come in during 2013.

Operator

(Operator Instructions). Our next question comes from Lawrence Huntington, a private investor. Please go ahead.

Lawrence Huntington - Private Investor

You have given us some wonderful news. My question is whether you can see in your past two cash break even, whether you can see getting there without having to issue more common shares?

Daryl Wilson

So my main goal as a leader of the company is to bring the company to be profitable and I devote a lot of attention with the executive team to understanding how that’s going to happen and what’s going to happen. I think if you follow the company listen to us we’re very careful and conservative in our public assertions. We like to do more than we say and so sticking with that pattern I’m afraid I will probably disappoint you in terms of saying you know exactly when the point of profitability will be established but we have been fairly clear I think in the communication this morning with the order backlog and the growth in the business, it's in the bear term and it's something that’s visible for us now. In terms of the capital requirements over the last few months we have talked about this growth, we have talked about the need to fund working capital to support the growth.

We today talked about some additional cash that is come into us which I think is a very positive support. So if we ended the quarter with 9 million and we have taken in since the quarter another 10 million you can understand the balance sheet is now very strong but we don’t want to miss out on the momentum that’s hear and we talked also this morning about the growth in power to gas and the growth when it comes to our opportunities and telecommunications with CommScope. So we need to fund the working capital for those projects. We will be doing our best to do that without raising additional capital in the markets but if additional capital in the market is the right way to go then that’s something that we are willing to pursue.

So it's conditional really on working capital requirements and the pace of the growth. In the hydrogen area we are already seeing other players in the sector faltering because they can’t deliver operationally or they don’t have the financial means to deliver. I don’t want to see that kind of situation here and I think that the credibility and the delivery capability that we have shown over recent years means that we can’t endure this growth and be on top of it so we will only take in whatever capital is absolutely required to fund the growth plan but sitting where we are today. We are in very good shape, better shape than we have been in the long time and with the prospects that we have in the near term I think we are in a good balance.

Operator

Our next question comes from Larry Litton of Second Line Capital. Please go ahead.

Larry Litton - Second Line Capital

Yes just clarify for me something you said, $50 million that was a breakeven profitability, that’s breakeven cash flow in terms of a rough go.

Daryl Wilson

Yes that’s quite correct.

Larry Litton - Second Line Capital

That’s profitability or cash flow breakeven?

Daryl Wilson

That would be in the profitability yes.

Larry Litton - Second Line Capital

Okay and that’s on an annual rate correct?

Daryl Wilson

That’s correct.

Larry Litton - Second Line Capital

And I know we are not going to pin you down on gross margins and we talked about operating expenses but just putting apples and oranges together, I mean that certainly requires much more than a 30% gross margin. So I know it's a matter of mix, it's a matter of timing, it's a matter of maturity, and everything but it would have to be, if you do that you would have to be close to 50% gross margin it would seem.

Daryl Wilson

Again it comes back to particular mix as you say.

Larry Litton - Second Line Capital

Question on this Propulsion contract in the seven years of development and now the switch to commercialization, with the customer working in parallel development with other people or was really kind of a sole development relationship and it was just a question of us or nobody in a sense?

Daryl Wilson

Yes the latter, I would say nobody. We have had this experience with a number of important, very sophisticated clients. They will typically shocked the world and this particular client shocked the world eight years ago. They looked at all of the fuel cell technology that was available at that time. We were selected eight years ago. Of course as they came to an inflection point in the program they had the opportunity to look again and say are we going to continue? The reason we normally get selected and sustain these relationships is our engineering teams, are very capable when it comes to these partnerships and working in concert with very sophisticated clients. In our investor presentations we have often profiled some of these clients like Airbus and DLR and you know various others partners around the world.

Some of the leading technology players in the world. So it's our flexibility and the ability to work with their requirements that normally attracts them to Hydrogenics. Up till now frankly the size of the projects involved and the stakes involved have been relatively small. But I think what’s becoming evident here is we are able to lay the seeds of very important opportunities nurture and grow those seeds while they are sitting dark in the ground and one day they sprout up and become very important. And I think as a management team one of the important things we have done in the last five years is look at the opportunities facing this business and our skills and picked the right things to stay with and then one day things turn out very nicely as has happened in the last quarter and this is not a one off situation.

I think this speaks to the capability of the technology and the capability of the collective management team to nurture these kind of, find these things when the first confidence level and then nurture them into very significant opportunities. That’s what’s happening with power to gas and that’s what happened with the $90 million order, that’s what happening with CommScope and I think that really nicely sums up the profile of the confidence in the company.

Larry Litton - Second Line Capital

And in terms of this Propulsion contract and switching some development to commercialization. Was there a clear set of milestones? It was an accomplished as to why it's going to commercialization now as opposed to another five years of development, what was accomplished that triggered the switch in the customer’s mindset?

Daryl Wilson

Yes one dimension has to do with the technical success of the first program. We were given some very challenging target seven years ago. Frankly some of them we said that’s too impossible, we virtually got to impossibility on the impossible ones. We certainly passed all the ones that we committed to. This gave the client confidence and the technology and now at a mature stable platform that they can sell to their customers.

And then on the market side, as the profile of this particular application and its advantages have been sold into the marketplace, the clients are beginning to say yes that particular application is attractive to us. We would buy one of those, when can you deliver. So, things went well on the technology front and things have progressed very positively for the clients in the market.

Larry Litton - Second Line Capital

And lastly I want to just slip back and try to understand the business model. Can you talk about the business model if you were longer term? If this company gets to a 100 million or 200 million, at that junction I know it's a range still but what is the operating profit model, what is the gross margin profit model once you get to big scale.

Daryl Wilson

This is something that we are working on now, you know go back three or four years ago we were working on survival. Then we started to focus on profitable and now our attention is absolutely on that size range, in my business history I have worked in (inaudible) this evolution from you know mid-size at 50 million into a 100 million - 200 million plus. There are many challenges on the journey and those are absolutely the things that we are now turning our attention to and in our board meeting (inaudible) and that’s our aspiration.

Today I’m hesitant to release any details at all because I’m very much a guy who looks at the target that is in front of me now and puts everything into that. So our main focus now is to achieve profitability as a company and then build that platform in such a way that it endure these lanes at a 100 million to 200 million range.

Larry Litton - Second Line Capital

Let me just beat you up with one more question on this cross margin and just your statement that get back to the vicinity of 30% in terms of gross margin, did I see a structure that’s 24 million a year and I say $50 million notion of breakeven. So just explain to me what’s the difference between this 30% vicinity versus cost that are already on the books and are going to continue to scale a little bit. The need for 50% gross margin to breakeven at 50 million versus this 30% vicinity number. Can you reconcile that a little bit for me?

Daryl Wilson

So the infrastructure that we have today in our total cost situation does not have to change significantly as we go forward. So it's not like we have large plans, large fixed cost whatever but the infrastructure that we have today can sustain the business growing to 50 million plus. So that’s one dimension here, as I have already said we don’t see hiring a lot of people that to manage this additional business and on the supply side et cetera we are working very hard with the client.

So exactly what margins I can’t commit to today firmly it's something I need to be careful about but yes we see that we move this business to a profitable line when revenue start exceeding 50 million.

Larry Litton - Second Line Capital

But can you talk about an incremental gross margin if you will, once you get to a stable 30% is there an incremental gross margin of 60% - 70% or what’s the incremental gross margin once you get to some reasonable level?

Daryl Wilson

No those are not things that we are probably comfortable to talk about today.

Operator

I’m showing no further questions at this time. I would like to turn the conference back over to Mr. Daryl Wilson for any closing remarks.

Daryl Wilson

Okay once again we thank everyone for joining today and we appreciate all of the questions. I think it's a very exciting time for our company and we have very bright prospects ahead of us. And I think in our presentation today we have laid a good amount of evidence to give our shareholders and our customer’s confidence in us going forward. So we thank you for your interest and we look forward to updating you as we continue to make progress.

Operator

Ladies and gentlemen this does conclude today’s conference. You may all disconnect and have a wonderful day.

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