Hydrogenics Corporation's CEO Discusses Q3 2013 Results - Earnings Call Transcript

| About: Hydrogenics Corporation (HYGS)

Hydrogenics Corporation (NASDAQ:HYGS)

Q3 2013 Earnings Conference Call

November 7, 2013 10:00 AM ET


Daryl Wilson - President and CEO

Bob Motz - CFO


Philip Shen - Roth Capital

Dev Bihani - Byron Capital Markets

Graham Tanaka - Tanaka Capital


Good day, ladies and gentlemen and welcome to the Hydrogenics’ 2013 Third Quarter Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct the question-and-answer session and instructions will follow at that time. (Operator Instructions) I would now like to introduce your host for today’s conference, Mr. Bob Motz, Chief Financial Officer. You may begin.

Bob Motz

Thank you and hello and welcome to Hydrogenics’ third quarter 2013 conference call. With me today is Daryl Wilson, President and Chief Executive Officer. The company's third quarter press release and PowerPoint presentation are available on our website under the Investor Page at www.hydrogenics.com. We've also uploaded the quarterly report this morning on both SEDAR and EDGAR and would refer you to those sites for our disclosures documents. As indicated in our press release this morning, all financial references are in U.S. dollars unless otherwise indicated. I would like to now 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 risks 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 will turn the call over to Daryl Wilson. Please go ahead Daryl.

Daryl Wilson

Thank you Bob, good day and thanks everyone for joining us for Hydrogenics’ 2013 third quarter conference call. Today I will review our operations and outlook. After which Bob will discuss our financial results in detail. Please refer to the presentation on our website for today’s discussion. Beginning on slide 3, let me review the highlights for the quarter. Revenue rose 17% year over year to 9.2 million reflecting the strength of our power systems operations and our multiple year propulsion contract for fuel cell based car modules, we remain on track with this program and as our goals were in a moment, we have a strong relationship with the OEM heading into a busy 2014.

Our gross margin expanded by 800 basis points to 29.6% from 21.6% last year again driven by our power systems business. At the same time we booked 12 million in new orders across all of our applications and have a large pipeline of opportunities heading into the end of the year. We also recently announced the official opening of our E.ON powered gas installation in Falkenhagen, Germany and are now working hard on our next energy storage installation with E.ON using PEM technology in Hamburg. Overall we continue to do what we said we would do this year. Grow the top line results, expand margins, with the near term goal of attaining profitability.

Turning to slide four, a slide which some of our listeners have seen several times, let me just reiterate that Hydrogenics remains on track to attain the goals led out since 2012, the company is now at inflection point with our energy storage and power systems operations coming to represent a much larger share of Hydrogenics' overall business, we remain on track to become profitable at the 50 million revenue run rate, and at a 30% gross margin and we’re well on way this milestone achievement. We have what it takes to support rapid growth, scale up our operations and diversify our business space but we still anticipate full year revenue to be up over 30% this year versus 2012.

Now let me get into some more specific operational developments starting with slide 5, here we see our two megawatt powered gas demonstration plant with E.ON in Falkenhagen, Germany which was officially inaugurated August 28 this year, in a ceremony attended by dozens of industry and government officials, this facility actually went live in June and as I noted earlier, as I noted last quarter it represents the first direct injection of hydrogen into a gas pipeline using Hydrogenics technology. This energy storage installation uses surplus renewable energy to produce hydrogen and is already supplying 360 normal cubic meters per hour of hydrogen into the local natural gas distribution grid. E.ON is very pleased with the performance of this ground breaking operation and has actually been running television ads which included in Germany and as you can see if you have a moment to visit the link shown on our slide, in addition, one of the project partners Swiss Gas, along with E.ON are already marketing Green gas or Wind gas from the facility noting the benefits of using hydrogen as a clean, renewable resource generated from wind. We’ve also already been working hard on the next project for E.ON, a first of its kind PEM megawatt facility in Hamburg, Germany.

As a reminder this power to gas facility will use the world's first single PEM electrolyzer stack at a megawatt scale using our technology which will become a building block for future multi megawatt applications. Construction of this facility continues and we expect to see it inaugurated in the first half of 2014. Using our technology this installation will be the most advanced power to gas facility in the world and have the largest PEM electrolyzer installation using and producing hydrogen. All of this is part of the energy window or energy [indiscernible] program in Germany, which has broad political support across the spectrum and very strong popular support in the country. Admittedly this is a very different approach which is fueled by a very long term vision and multi-decades of investment in dramatically carbon reduced energy infrastructure. That’s what we’re about shifting power in a very whole new way.

Overall we continue to see growing demand for larger scalable energy storage worldwide and we’re working with Enbridge on the final details of a ground breaking facility in Canada. Enbridge is both a partner and investor in Hydrogenics and is committed to hydrogen based energy storage and we anticipate being able to provide new soon on plans for some very exciting applications in North America and beyond.

Slide six illustrates an easy way to think about power to gas applications and why they offer an attractive proposition for utilities. Power to gas facility which generates hydrogen excess wind, solar or geothermal power can release that stored energy whenever and wherever it is needed and be used for either power or heat or as shown on this slide. Once hydrogen is created it can be turned back into electricity through existing gas generation plans or used for vehicles, industrial applications or simply used on the grid.

Alternatively when mixed with natural gas that hydrogen can be used for your home -- your home water heater or for numerous other applications. The bottom line is that hydrogen allows for both flexibility and functionality. And energy storage facility that allows utilities to absorb surplus energy as needed, return the power when required and alleviate grid instability improving overall utility performance.

Today again we’re taking some time to review this important energy storage area to help our listeners integrate what we’re doing with what’s being communicated in the public media. The energy storage field is clearly heating up and we have a very important role to play. At the same time there are other solutions and technologies that are also getting attention. These are the technologies and not all competitive with our offering. We want to help our listeners understand the value and differentiate offering that we’re providing.

So as illustrated on slide seven the value proposition is indeed compelling. Hydrogen based energy storage offers multiple paths to value creation covering everything from grids’ balancing to scalability. Many storage solutions offer only one point of value and this can be a very [indiscernible] to adoption. By contrast as you can see on this slide we have multiple paths to deployment and multiple elements to our value proposition. Our recently opened project in Germany is an example of direct injection and here you can see on this slide that there are six elements of that value proposition.

We’re working with other customers in Europe and North America to ensure that these value elements can be realized in the electrical tariff system delivering benefits to grid operators and direct payers. We’ve already delivered fueling stations connected with this visions and here again multiple elements to the value. And we’re seeing a growing number of request for proposals from industrial customers where renewable energy based hydrogen can transform the hydrogen input of their process into a carbon free import.

On this particular path the EU is in the process of recognizing the value of the green path to liquid fuel enhancement and industrial products with a 4x incentive. This regulation is currently working its way through the EU parliament at the present time. The point is we have multiple paths to customer applications and multiple paths to value.

On slide eight we again show the value proposition of tying hydrogen based energy storage facility with wind generation. We have the ability to double the value of the wind installation by doubling the available on peak energy when delivered in a 3:1 ratio with energy storage facilities. On 100 megawatt wind operation that generates 58,000 megawatt hours of high value peak power we can deliver two times that amount of high energy peak power with the 32 megawatt energy storage facility.

So financially this means that the effective value of the $200 million investment in wind technology can be doubled with an incremental investment of just $32 million in power to gas technology. This clearly illustrates that energy storage should play a vital role in the expansion of renewable based power production and energy storage is necessary for long term energy management in these kind of systems.

Finally moving to slide nine we see a schematic of a typical power generation and transmission grid. There are many places through the grid or storage solutions can be deployed batter and fly wheel and other load management technologies can be deployed on a distributed basis for residential and commercial applications. There is a place for all of these technologies for sure.

Where we are serving is in the upper two applications bulk storage and in services. On these applications our scalable modular solution can be flexibly deployed for storage in very large quantities of energy for prolonged periods of time. The need for these kind of functions does not appear immediately as renewable generation is deployed. However as we’ve seen in Germany and now in California a multiple layered storage solution is required throughout the grid as the percentage of renewable generation increases.

I apologize we’re taking more time in these points this morning however I am tracking with the kind of questions that we’re receiving from investors and partners on these exciting applications as they continue to grow.

So now I would like to turn to Slide 10, and discuss some of the developments in our Power Systems division. As noted last quarter we completed our first order from CommScope earlier this year and now we're working with them on many potential new opportunities we expect to take shape in 2014. Orders this year have been somewhat hampered by soft capital spending by the major telecom providers on this particular application.

Instead they are dedicating billions of dollars to rolling out the new network features for the long term evolution or LTE technology which I am sure you’ve seen on your cell phone. Carriers are rapidly seeking to expend the 4G LTE to replace the outdated CDMA 2,000 networks. This year has shaped up to be a big year for high speed LTE with AT&T announcing plans to spend as much as 14 billion on network upgrades over the next few years.

So while 2013 has seen capital spending focused on this area CommScope and Hydrogenics feel that 2014 will offer many new opportunities for fuel cell based backup storage applications. One other important development is the movement towards the divestiture of tower infrastructure into separate operating units. We believe that this is a very important development which will being more perceived value to our solution which benefits the total cost of ownership for backup power.

Today large telcos have purchasing departments which tend to focus exclusively on CapEx. The operating value of our solution is not given sufficient weight in the procurement process, with aggregated tower operating companies the total cost of ownership will but much better appreciated.

The units that we delivered earlier this year have been well received and there is a growing need for a longer run reliable efficient backup power given the recent weather disruptions that the system has experienced. Large scale data center applications are also underdeveloped -- are under development and we anticipate sharing more about this in the coming quarters.

We continue to post great progress with our $90 million multi-year propulsion contract and we remain on track in terms of both milestones and deliverables. This cutting edge application has been a strong contributor to our growth this year and will continue to contribute in the coming years. As well continue to be recognized for our differentiated technology and power systems integration capability by many large prospect partners. So while I don't expect to announce another nice $90 million surprise, we do have the prospect for under growing growth and this type of technology development work which we are very good at.

Turning to Slide 11, I will briefly discuss our onsite generation business or more specifically those portions not related to energy storage. I have mentioned on earlier calls that we had a bit of a slowdown earlier in the year and delays in some geographic areas which represent the bulk of our business. Slowdown in the economies of Russia and Latin America and elsewhere has impacted order timing. But at this point we feel much better about our pipeline condition heading into the New Year.

As clearly a need for electrolyzers in many industries and we have a large number of RFPs that are currently being processed, so we're optimistic about this area of our business for 2014. We're also bidding on more fueling station opportunities some of which are tied to power to gas applications. Besides being a leader in hydrogen base storage, Hydrogenics is well recognized just by the sheer volume of fueling stations we have operational worldwide with more than 45 facilities delivered using our equipment.

We'll continue to bid opportunities in Europe and elsewhere expecting further growth in this market in 2014. In the mean time we continue to work on the fueling station awarded earlier this year by the Linde Group for a site in Bolzano, Italy and expect more units to be delivered shortly with the startup -- expect those units to be delivered shortly with the startup of operations planned for early 2014. Additional stations along the Bolzano-Modena motorway are planned for the future.

We remained focused on operating improvements on the onsite part of our business since gross margins have not been where they are expected to be and lower plant operating run rates through Q2 and Q3 have been impacted by our overhead absorption, but we have already taken steps to improve asset utilization and drive further efficiencies which will return those margins back to our target area, our target level as soon as Q4. When we look at the pipeline of deliveries 4Q and beyond we expect to be meeting our internal targets in the near-term.

Before turning the call over to Bob let me wrap up with a few things starting with Slide 12. Even with everything we have accomplished over the last few years and the increasing emphasis on energy storage by government and industry I am still sometimes asked the very simple question, why hydrogen and why now? Recently you may have seen an uptick in the press concerning hydrogen vehicles and hydrogen storage, and there is also been an uptick in critical comments about fuel cells from those who are currently enjoying the hype phase of their technology story.

I am thinking about our friend with the fast cars and I am pleased to say that our hype phase was over a long time ago and today we're delivering very concrete value from some very proven technology. So to summarize what we have been saying for some time now, let's look at the reasons why hydrogen is so attractive?

Hydrogen offers a 100 times better energy storage capacity versus other large box storage alternatives, hydrogen can be stored in a natural gas system offering almost unlimited storage capability. We’re also seeing increased demand for energy storage applications in Europe elsewhere with dozens of projects announced and more to come and we have partners to make this happen, by that I mean E.ON and Enbridge.

Hydrogen also has 10 times the energy density for mobility applications and one tenth of the emissions of carbon dioxide and other greenhouse gases. Hydrogen fuel cell offer a 600 kilometer driving range and fueling in minutes which is both convenient and cost effective. Near term we see a continued interest in using hydrogen for heavy duty applications including trucks and buses and at least five OEMs are in launch sequence for a large scale production of fuel cell vehicles between 2015 and 2017.

All in all hydrogen is much better positioned than batteries to meet our environmental efficiency and usage requirements for vehicles over the long term.

Turning to slide 13, in summary I’d like to wrap up by saying that we remain on track to achieve our near term goals including a path to profitability. Revenue growth this year will be greater than 30% and our gross margins are trending to 30% as well helped by our mix in the power systems division over the last 12 months.

We know that our margins need to continue to improve in the OnSite business but as I’ve already said we expect to reach our targets in the near term in that division. As we approach 2014, we feel very good about the future of Hydrogenics given our strong backlog, strong balance sheet and robust pipeline of contract opportunities across all parts of our business. We expect executing on a growth plant that is clearly taking shape and combined with our lean operations and focus on net margin expansion, we’re optimistic that the company will be profitable in the not too distant future. We are a global leader in the hydrogen space and our technology is well recognized as well as our brand and company image around the world.

So, from here on I’d like to praise our investors for their interest and their patience and I believe next year will be another good one for increasing orders, revenue and positives margins as we’ve already demonstrated. Bidding on larger and more complex opportunities, we’re focused on accelerating the move to a hydrogen based systems and energy systems, improving our financial results at the same time. We want to achieve strong growth, be profitable, generate solid cash flows and provide superior shareholder returns.

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

Bob Motz

Thanks Daryl, good morning everyone. So to briefly summarize the financial results for the third quarter and nine months ended September 30, 2013.

Turing to Slides 14 and 15, we posted revenue of $9.2 million and $31.4 million for the third quarter and nine months ended September 30, 2013 respectively which represented increases of 17% and 44% respectively over the prior year periods. The strong top line improvement was fueled by increased revenues within our power systems business segment, resulting from the Company’s contract for Integrated Power Propulsion Systems and for deliveries of fuel cell modules to our strategic partner CommScope that occurred primarily in the first and second quarters.

Our gross profit shown on Slide 16 was 29.6% for the third quarter an increase of 8 percentage points versus 2012, primarily reflecting improved product mix within the Company’s power systems business unit. For the nine-month period on Slide 17, the company’s gross margin was 29.8% up 11.9 percentage points. Again primarily reflecting improved product mix and higher revenue within the company’s power systems business unit.

Turning to Slide 18, Hydrogenics’ cash operating costs were 3.1 million for the quarter versus $4.7 million in the third quarter of 2012. This 34% decline reflects first of all a $1 million decrease in net research and development expenditures, related primarily to government funding recognized in the period and secondly a 0.6 million decrease in timing differences in SG&A cost year-over-year as well as one time compensation cost accrued in the third quarter of fiscal 2012 related to the improved business in that period.

For the nine-month period on Slide 19, cash operating costs were $10.4 million, versus $11.7 million in 2012 with costs as a percentage of revenue falling 20%. The year-over-year change is primarily due to 1.3 million decreases in net research and development expenses primarily attributable to improve government funding of our R&D programs.

Now, turning to Slide 20 and Slide 21 our adjusted EBITDA loss was $0.5 million for the third quarter and $3.7 million for the nine-month period reflecting the revenue margins and expenses previously discussed. In connection with preparation of our consolidated financial statements for the three and nine months ended September 30, 2013 we did identify and record and disclose adjustments that had the effect of reducing both our adjusted EBITDA loss and are reducing our net loss by 0.4 million for the three months ended March 31, 2013, and 0.3 million for the three months ended June 30, 2013, related to prior period corrections.

These are the period amounts identified relate to several items that are individually immaterial. The impact of each financial statement line item is summarized in that tables contained a note to our consolidated finical statements. We assess the amounts concluded; they were not material to any of our previously issued financial statements and are not expected to be material to our 2013 results either individually or in aggregate; how we did elect to revise our previously issued consolidated financial statements to correct the effect of the adjustments to the appropriate period. These noncash provisions do not impact cash flows for any prior period.

Slide 22 shows the Company’s ordered backlog as of September 30, 2013, which was 52.7 million and during the third quarter we received 12.1 million in new orders. On Slide 23, our cash resources as of September 30, 2013, were 14.6 million, a decrease of 2.2 million from the start of the year. This primarily reflects the 6.1 million of net proceeds from our underwritten share issue offset by cash used in operations and repayment of borrowings. Now, there are additional reconciliations for our investors in the remaining slides of the presentation.

Now with that, we'll turn the call over to the operator for questions. Please go head operator.

Question-and-Answer Session


Thank you. (Operator Instructions) Our first question comes from Philip Shen with Roth Capital. Your line is open.

Philip Shen - Roth Capital

Hi, guys, congrats on getting close to break even. So, I would like to start with your orders in the quarter, this is the first time I’ve seen you guys mentioned that you’re pursuing new orders for renewable energy storage, I am guessing its Power To Gas, I was wondering if you might be able to talk more about that in particular is it an Alkaline, Electrolyzer, can you talk about the number of customers, the number of units, any color on that would be very helpful?

Daryl Wilson

That’s actually the second order from E.ON. I think we press released it late in Q2, but the actual conditions to meet requirements for recognition or backlog occurred in Q3 and so it’s been incorporated in that block of orders. In total, the 12 million in new orders is a nice kind of coverage of the whole spectrum for us in Power Systems, in energy storage in OnSite Generation and so the mix that we're looking for as we go forward is to be hitting on all cylinders and getting contributions from all aspects of the business. What’s not in there is a large order for telecom backup, but there is certainly new fuel cell order including some telecom backup work. There is activity there for datacenters, energy storage as I have said in Electrolyzer so it’s a kind of mix that we like to see, so that we sustain stable growth as the growth level that we communicated.

Philip Shen - Roth Capital

Okay, thanks Daryl. Moving onto Power System and CommScope, I know you’ve talked about the LTE CapEx wave, do you have a sense that, that wave coming to an end at the end of this year so that the Telco will have more capacity to buy or invest in back solution and in particular what gives you confidence that the CommScope orders will start to roll in in 2014 versus 2013?

Daryl Wilson

This has absolutely been a huge preoccupation and in the past we’ve also had challenges with that these large companies been preoccupied with mergers and other things, so the prioritization of the capital spending has been primarily around supporting all those iPhone, iPads and Android devices that everybody buying which take a huge amount of capacity on the network system. So network capacity and speed been priority and all capital funding has been swung over in that direction. Working with CommScope we believe a focus effort in certain markets in the world within and beyond the U.S. will get us additional orders.

We are trying to grow this application which is new, but I think it is important to recognize that in aggregate there is well more than 5000 DC backup power installation around world on a fuel cell platform already, so it’s not like we’re just starting, we’ve got a good start. There has been some distracting delays. There are other markets in the world that they’re just getting going, so we remain optimistic for this application and we believe that our partnership with CommScope is a very effective task to market for our company. So as we have more good news to share, we'll be certainly out with it, but there is some work to do to swing the attention in this direction, especially in the US.

Philip Shen - Roth Capital

Okay, thanks and in terms of gross margins you guys posted a really nice gross margin of 29.6%, I think a lot of that was driven by product mix, can you talk to us about what you see for a product mix ahead and Bob if you can comment on, do you expect more gross margin expansion from here or do you expect this to kind of -- what are your expectations going forward on gross margins? Thanks.

Daryl Wilson

So I think, Phil you're seeing the results, we're concerned about the efforts on our part to meet our targets, that's I think the important management point, this morning we've communicated that we expect that to be corrected in the onsite generation division as soon as Q4, so our efforts I think could be paying off to meet our internal targets, certainly product mix makes a contribution, but going forward we don’t see a major change in mix that's going to take us dramatically up or down, so our expectation is that we maintain our target level performance going forward and of course we're always trying to do better than our targets, but I think we've been clear about what the targets are and I think you're now seeing the ability to execute on achieving those targets.

Philip Shen - Roth Capital

Great, one last question from me and I'll jump back in queue, can you provide some color on the timing issues that drove R&D and SG&A down, so, in particular can we think about this level of op ex going forward and if not, how should we think about op ex ahead.

Daryl Wilson

Yes, I can come on that Phil, the R&D issue is more the mix of funding contracts that we’ve got in play in the third quarter and in particular we have a number of contracts that are EU based where there's a very good portion of those contracts being funded through EU member agencies, so while the sort of the R&D spend is still relatively robust, we're getting a good recovery on that, so the net R&D expense is lower than certainly prior year, I would anticipate seeing that continue into Q4 on a run rate basis, I think it's too early to say whether that's going to continue into 2014 on that basis. The SG&A I think you're going to see on a year to date basis it's from a cash operating cost point of view I would anticipate seeing it run rate very similar to what we’ve seen in prior quarters in that, taking out the impact of stock based compensation, the run rate's been pretty steady, I don't know -- I certainly don’t anticipate any significant increase this quarter over quarter.

Unidentified company representative

And Phil, I'll just add, from a lean operating point of view as we continue to scale revenue, we don’t expect to scale these areas of the business even close by proportion and so as you're modeling the growth situation we should be looking at that kind of flat expenditures for the most part in those areas. We won't constrain our growth or our ability to deliver profitability by making foolish decisions in these area but generally we’re keeping those things under very tight wraps as we grow.

Daryl Wilson

And I guess the final thing I'd add, Phil is I guess if you look at that total R&D, year over year the third quarter this year was I guess on a gross expenditure basis was about a 1.3 million, last year it was 2 million but on a year to date basis, it's running on only about 10% less than last year, so again I think we’re seeing sort of a relatively good run rate but a much higher funding percentage versus last year.


Thank you, our next question comes from Dev Bihani with Byron Capital Markets, your line is open.

Dev Bihani - Byron Capital Markets

So, Bob just a quick clarification here, in your MD&A you talk about onsite generation projects totaling $10 million with [a lot of those] entering or are in process of entering in Q4, but I guess elsewhere in terms of talking about how the Q4 is going to shape up in revenues for onsite, you do guys talk about 7.6 million, can you just clarify the difference between the 10 million and the 7.6 million please.

Daryl Wilson

Yes, one of the things that we're seeing is that the 10 million is what is sort of in the pipeline expected to be released in Q4. One of the things that we found in the quarter was that because our onsite revenues are all on a completed contract basis we don’t recognize revenue until the product is shipped and accepted by the customer really depends on the terms of the underlying contract when revenue is recognized. And we had a number of projects that internally on onsite we expected to be realized in Q3 that have been pushed back to Q4. So my sense is that based on the expectations that we’re getting from the onsite group for deliveries in the fourth quarter that we see a higher number and 10 million is not certainly out of the realm of possibility.

Dev Bihani - Byron Capital Markets

Okay, thanks Bob. So on the same wavelength in terms of the backlog which is pretty robust and the book to bill ratio being greater than one which is always good to see in terms of the future revenue growth. Is there any kind of guideline approximately in terms of thinking as to whatever is the backlog ex-dollars is going to be burnt into revenue over a two quarter period, three quarter period or it’s a mix bag of multiple quarters and some of them being very neutral?

Daryl Wilson

There is always going to be a bit of a mix in terms of execution times typical onsite deliveries are somewhere around six months and so typically that backlog is turning over fully every six months. In power systems we do have the larger $90 million contract where we’ve moved a portion of that $90 million contract the firm order commitment portion into our backlog when we did that last year we did communicate that we expect and it would 24-26 month period for that portion and then you’ve got the turnover of power systems projects which again can be in the range of three-six months.

So I am sorry for the complexity I understand it makes your modeling job a little bit difficult. But those are kind of the lifecycle projects that we face today. You can see with the quarter at 12 million that tracking up toward a run rate of 50 million and certainly in the cards and we like the condition of the pipeline right now to sustain our continuing growth.

Dev Bihani - Byron Capital Markets

Thanks Daryl for the clarification. And just in terms CommScope I guess your slide here for this quarter talk about 500 to 1,000 units and we can see that obviously that still undergoing I guess the winter tests are yet to be completed some of the orders probably have been received and just to kind of clarify the 500 to 1,000 units statement in terms of a block of those many units. Is that how the rollout is expected to be with respect to CommScope? And if that is the case on an approximate basis will this not be approximately two times the total order that you guys revert, so it will be the same in terms of two times being in terms of dollar value going forward?

Daryl Wilson

So this is just the point that we’ve communicated to help folks understand the state of maturity. So CommScope will typically ship about 50,000 cabinets a year for battery and diesel backup applications. The normal order release to the major telecos is somewhere between 500 and 1,000 units. We certainly had inquiry levels and there have been orders in the segment of the business in the 500 to 1,000 unit range. So we’ve hit the point with our fuel cell technology where a full commercial order has been delivered or offered not necessarily by us yet but by others in this level of 500 to 1,000 units. So I think that’s a good indication of the level of maturity here and we’re saying -- what we’re working on is to see those kind of orders come through as well. Obviously this morning we don’t have any concrete news to communicate but those are the kind of order levels that we’re chasing.

Dev Bihani - Byron Capital Markets

And you guys talking about the 500 to 1,000 units being put year basis, right, from someone like CommScope?

Daryl Wilson

So we’re saying from any one telco at any one time and order quantity could be in the 500 to 1,000 units. At this point we’re not giving any guidance as to how many such orders we expect to get ourselves.

Dev Bihani - Byron Capital Markets

Now the tests are expected to be obviously completed I guess by January of 2014?

Daryl Wilson

Sorry that’s the test on the units currently delivered?

Dev Bihani - Byron Capital Markets


Daryl Wilson

No, this is commercial product going into commercial applications so there isn’t a test mentality about it where there is a need for longer run back up of four to eight hours in contrast to the battery solution in two hours the fuel cells now being deployed and of course everyone’s got to monitor the performance but it’s not a test in the sense so there is a pilot deployment it’s a commercial deployment.

Dev Bihani - Byron Capital Markets

I was talking about somewhere in the winter test, that part I was talking about. So the winter test have to have or the winter seasons that’s what I was referring to January.

Daryl Wilson

That work has been done two-three years ago. We would never be able to shift a certified product for this application unless we’ve spent a long time in the freezer. So we have a facility here for climate testing of our products from negative 40 degree Celsius to positive 60 degree Celsius which we need in India, it doesn't get that hot but 45 is been for sure. So all the products are certified to a broad temperature range before they are shift. So there is no again sense of winter testing even for these deployments.

Dev Bihani - Byron Capital Markets

That was great. One last question if you may for Bob I guess, in terms of the OpEx the overall and I look at it, the cash cost of 3 million but the delta on a year-over-year basis between the two components of OpEx namely the SG&A and R&D happen to be 1.6 million. And you said that some of it is being extinguished so the decrease has been because of the health in terms of sort of funding contracts from EU members.

Now beyond Q4 2013, what sort of a normalized OpEx do you expect to happen?

Robert Motz

On an R&D basis it's difficult to assess simply because we have a number of contracts that are time limited and going into 2014 they end and we replaced them with other and then we have other contracts and we have similar requests for funding arrangements. So it's difficult to assess on the R&D point of view. But on the sort of the cash operating cost point of view, having SG&A in the sort of 2.5 million per quarter is probably realistic and reasonable. With nominal growth, and when I say nominal, I mean low single digit.


Thank you. (Operator Instructions). Our next question comes from Graham Tanaka from Tanaka Capital. And your line is open.

Graham Tanaka - Tanaka Capital

Congratulations you are getting close to breakeven. Have you estimated what revenue level you need to be at breakeven? And then how steep of curve would there be on operating margins? You have given your sheers goals on gross margins. So at what point do you need for example the 30% gross margin to equate to say a 10% operating margin. Thanks.

Daryl Wilson

Answering the first part of that question, with some certainty in that. Our models have traditionally said and we have certainly signaled to the market that breakeven EBITDA will occur at roughly 50 million in revenue and a 30% gross margin. The second part of the question is more difficult to assess. I think that's breakeven EBITDA, so to get to a 10% net margin we really haven't sort of modeled it out and a lot of it is predicated on product mix between power and the onsite generation group. And in particular within onsite the roll out of power to gas which could have a different margin profile than the industrial hydrogen business.

Graham Tanaka - Tanaka Capital

What would be -- just so we can make our longer term projections, the sort of the incremental margins of the three major product areas, say one to two years out? Just to get a feel for the changing mix. Thanks.

Daryl Wilson

So the most mature part of the business onsite generation, we've worked through some challenges in the last year to get that up in 30% range. We never let up on cost reduction of course, but the marginal improvement capability there given it's a fairly mature business, will challenge for more but 30% is good and we might another five points I don't know. On the power systems business you have a mix issue, so when we’re delivering contracts for technology developments in engineering services, those obviously have very high margins. We have a good backlog of work ahead of us in that kind of area now.

We have the ability to hear more work of that nature and based on what I am seeing on firms contacting us and entering into agreements around that kind of work, some of our mix will always be very high margin work around technology development. I can't speak to the exact proportion of the total business that will be represented in that area but I don't see that going away for the near term. I see growing interest in the user fuel cells in power applications.

In the commercial recurring revenue areas such as DC backup for telcos or the data center work, we need to scale volume to line our manufacturing and we have quite significant capability to drive further cost reduction in that area, because while we have driven out a lot of the innovation elements of cost reduction, we have not driven out the supply chain and scale opportunities that exist there. And so moving the margins on in those projects I think is a strong prospect.

Now, those kind of projects today are individually are below our target of 30% and so some of this improvement I’m talking about goes into achieving our 30% margin, can we get on to 40 and 50, I’m not sure. But the strong focus is to see us at 30% gross margin on all of our products is kind of the minimum floor and you’ve seen disciplined to try and execute on that.

Finally on the energy storage area is a new area, we’ve got some very large serious partners who have caused us to look very seriously as a business model the projection of scale up -- the projection of expected costs in the business model and so we have a very realistic understanding where we are, where we need to be in two years, three years, five years and all I am prepared to say right now is we like our situation so we recognized that this is the opportunity that could scale most seriously for us in the long term, we're looking at multibillion dollar markets with very large players and very large projects but we’ve been doing the work at understanding how this segment of the business grows in scales and when I look at the kind of targets that the business model would suggest are required and I look at our ability to remove cost from the product as we scale both operations and product design I think there is very significant opportunities there and again I’m just not comfortable to start naming them, there's in that segment for various reasons.

Graham Tanaka - Tanaka Capital

Just to get a feel for these large markets, do you have to get the scale before you reach say a 30% company target margins, gross margins for energy storage, are you -- did they start out at a pretty decent profitability.

Daryl Wilson

We’ve seen a mix so far, it’s not our disposition to give projects away but we -- in early days we competed for some projects and one but I think there is a lot of maturity we’re seeing with the customers to understand these roadmaps, work with partners and not see us strangled and given a lot of difficulty as we scale the business. So, again I think we’ve got a realistic understanding of that. For the most part we’re starting off in a good place and then we see cost reduction and scaling helping us to remain in even a better place.

Graham Tanaka - Tanaka Capital

I guess since this is the area potentially larger growth, I’m just wondering normally when there is startups of large megaprojects to first two or three or four would carry lower margins just because it’s all new, is that the case pretty much, we’ll be kind of anticipating that so our expectation to get -- don’t get too high the first year or two?

Daryl Wilson

Yes, I think that it tends to be a little bit more challenged but we are seeing in some of these projects a mix of technology developments and pay for engineering services and service contracts associated with the contracts. So, those kind of additional items have mitigated some of that early challenge. It’s interesting that scaling this to say 20, 30, 50 megawatts is where the inflection and the cost profile occurs for the product and at utility scale it would be easy to see a single project of 20 megawatt. So we're not needing to wait five years for this thing to mature in the market to start delivering volume benefits from scaling up.

So, again I think we all understand that a new area which has substantial growth has a certain profile and I think the main message I want to communicate right now is we have a very realistic understanding of that profile, so cost targets today three years from now, five years from now, ultimate long term cost targets, that’s what our large serious partners are running models on right now and we’ve been quite transparent and cooperating with them to help them understand where is the business model now and in the future where is the cost profile now and in the future and I think we’re confident to communicate very positive outlook for our company in light of all that we’ve seen in a pretty sophisticated approach to this market.


(Operator Instructions). We have a follow up from Dev Bihani with Byron Capital Markets. Your line is open.

Dev Bihani - Byron Capital Markets

Just one quick question, just going forward on a medium term growth business, essentially the four variables that are going to play, the CommScope [indiscernible] being the major one and the third one would be this [indiscernible] of similar kind, so three of them as I see them. Just in terms of the energy storage and this is the only question I have is when you look at the three year time frame and there are two periods there in terms of the seven projects you’ve won in Germany which according to me in terms of operations have matured quite a bit for those guys to make decisions at least in the next year or two years' timeframe as to big do you want to be and I’m kind of alluding to your [indiscernible] 5 to 10 megawatt projects.

And then obviously [indiscernible], I mean, while you guys are working right now, I do not know whether the timeframes of these two players being in Germany as well as in North America, whether this as follow-on will be very quick or is it going to be measured, I do not know the differential between the two speeds but as you look forward, what sort of Intel are you getting from these guys in terms of growth and what are the risks that you see for the growth in case the growth doesn’t pan out to be as we all are expecting and where your R&D will be because if this is a new product R&D is going to go up in conjunction with that growth.

Daryl Wilson

So first of all the momentum is clearly in Europe and the reason for that is the degree of renewable energy penetration and the commitment and policy to renewable portfolio standards and the deployment of renewable generation is well ahead of North America and Canada, so we’re going to see the fastest move in Europe.

When you start to see television commercials showing up talking about the application and when we see the volume of request that we’re seeing, we’re looking at certainly for utility segment a fairly quick build up, but we need to manage our expectations here because it still is a utility sector and so going back to two, three years ago we had initial inquires on 1 and 2 megawatt facilities and you can see right now we’re delivering 1 and 2 megawatt facilities. And we have nice pipeline of perspective opportunities and many of those are setting stone the 1 and 2 megawatt line.

But now we’re kind of in the frame where 5 and 10 and more megawatts are showing up as what if we do this, how much would that cost, show us what the project would look like, when can you execute all those kind of questions. So the request level has already moved up to the next tier of 5 megawatts to 10 megawatts and even higher. It will take some time to digest and move to that stage, but again for the utility point of view much quicker than normal because the felt need for energy storage services and storage capacity on the grid is very significant in Europe, and so we do expect to see utility scale project showing up within the 12 months for sure.

In North America, we've been very encouraged just in the last three to six months. Here in Canada a good uptick in interest, we were in meetings just very recently with our Energy Ministry folks and talking about these kinds of things and the whole topic of storage is absolutely on the agenda and being folded into plans and there is a high degree of engagement on this subject. So, we're not starting from just zero right now. We’ve got some good momentum in Canada and it’s now two years ago that we secured interest from Ambridge and then the investment in 2012 from Ambridge and now working hard on launching a project there. So things are coming nicely but in North America we’re still going to be in the 1 megawatt to 2 megawatt kind of frame for some time.

In California, we had the announcement of 1.3 gigawatts of storage requirements, one of the reasons I was going through the slide this morning showing the different layers of the generation in the electric system if it helped folks understand that part of that 1.3 gigawatts is going to residential, part to distribution, part to transmission. So now we have a whole policy and a target in the state of California supporting storage and we’re absolutely working hard in that area and we’re starting to get some recognition that the solution has interest for California, I couldn’t have said that even three months ago.

So, I am very pleased with the momentum in the North America, but it is falling behind Europe probably in the two to three year range but the need is there in Texas, California, Hawaii and Canada. There is substantial need already for storage and the utilities are recognizing it. So a complex question, a long answer, I am sorry, but on all fronts we are very encouraged with momentum here and the maturity of the discussion around the storage, the perceived value around hydrogen storage and the recognition that the versatility and functionality that we’re bringing to solutions here has some substantial value in contrast to some other technologies which are difficult to deploy, take a long time to execute. Many of our advantages with respect to capacity and speed of execution are well appreciated by the utilities that we’re talking to.


I am showing no further question at this time. I would like to hence turn the call back to Mr. Wilson for any closing remarks.

Daryl Wilson

Well, again, we thank all our listeners this morning for tuning in and following our company. You can see that we remain very positive about the outlook. We believe that we are heading strive with the things that we said we would do and we do have confidence that we can continue to execute on our targets and deliver in this very exciting area of hydrogen technology. Thanks very much.

Bob Motz

Thanks everybody.


Ladies and gentlemen, thank you for your participation in today’s conference. This concludes today’s program. You may all disconnect. Everyone have a good day.

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