Hydrogenics Corporation (HYGS) CEO Daryl Wilson on Q2 2019 Results - Earnings Call Transcript

Aug. 12, 2019 2:11 PM ETHydrogenics Corporation (HYGS)
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Hydrogenics Corporation (NASDAQ:HYGS) Q2 2019 Earnings Conference Call August 12, 2019 10:00 AM ET

Company Representatives

Daryl Wilson - President, Chief Executive Officer

Marc Beisheim - Chief Financial Officer

Conference Call Participants

Eric Stine - Craig-Hallum

Jeff Osborne - Cowen and Company

Operator

Good day ladies and gentlemen, and welcome to the Hydrogenics, 2019 Second Quarter Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions]. As a reminder, this conference call will be recorded.

I would now like to introduce your host for today's conference, Mr. Marc Beisheim, CFO. You may begin.

Marc Beisheim

Thank you, operator. Good morning ladies and gentlemen, and welcome to Hydrogenics 2019 second quarter conference call.

With me today is Daryl Wilson, President and Chief Executive Officer. The company's second quarter Press Release and PowerPoint presentation are available on our website under the Investor page at www.hydrogenics.com. We also uploaded the report this morning on both SEDAR and EDGAR and would refer you to those sites for our disclosure documents. As indicated in our press release this morning, all financial references are U.S. dollars, unless otherwise indicated.

I would now like to provide a brief Safe Harbor statement. This call and the accompanying presentation may contain statements that are forward-looking. These statements are based on current expectations and assumptions that are subject to risk and uncertainty.

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

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

Daryl Wilson

Thank you, Marc. Good day and thanks everyone for joining us on Hydrogenics 2019 second quarter conference call.

We will focus today’s call on our quarterly earnings, but I wanted to briefly discuss our proposed transaction with Cummins. As you know, Cummins agreed to acquire all of our outstanding shares, other than the shares owned by the Hydrogen Company for USD$15 in cash. The Hydrogen Company, a unit of L’Air Liquide agreed to exchange its shares with Cummins in lieu of receiving the cash consideration.

The Board and an independent special committee of the board unanimously approved the transaction and recommended that shareholders vote for the transaction for a number of reasons. The consideration represented a premium of 21.6% over the 30 day volume weighted average price of our shares on the NASDAQ and 38.8% over the 90 day volume weighted average price for the period ending June 27, 2019, which was the day before the transaction was announced.

Any questions concerning the Cummins transaction should be addressed to our management team separately from this earnings call. We look forward to the upcoming August 29 special meeting when shareholders will vote on the proposal to approve the transaction with Cummins. With that, I’ll move to discuss our quarterly earnings. Please refer to the presentation on our website for today's discussion.

Beginning with slide three, let me review some highlights from the past quarter, after which I’ll provide additional information on our recent developments in our near term areas of focus.

Second quarter sales were $10.4 million, up 37% year-over-year as the company saw a significant increase in shipments within its OnSite Generation business, including for a previously announced fueling stations in Quebec. This facility in the first 700 bar public fueling station in Quebec and the first fully containerized 700 bars location in Canada.

The station is capable of delivering four consecutive fills for typical passenger vehicles, an average tank size of 5 kilograms of hydrogen, and handles approximately 20 vehicles per day. It’s another great reference site for us here in North America.

Gross margins were impacted by product mix and Marc will review this in a moment, but we ended the quarter with a solid backlog of $144 million. As noted previously, this quarter we were selected by the Halcyon Power group to supply 1.5 Megawatt hydrogen production facility in New Zealand. This is our first major win in the South Pacific at Halcyon owners Tuaropaki Trust and Obayashi Corporation looked to implement a hydrogen supply chain for New Zealand and Japan using Hydrogenics technology.

We are in the home stretch of our first commercial order with Alstom, which should constitute some 81 heavy duty fuel cell power module systems, and our plans for expanded production in Germany are well under way. I'll speak to this more in a moment.

But the big news this quarter as I mentioned earlier is the pending acquisition of Hydrogenics by Cummins. We believe this will be a game changing transaction which will position our company and our technology at the forefront of the burgeoning hydrogen economy, and we encourage all investors to vote by the proxy deadline of August 27, 2019.

Now turning to slide five, let me provide an update on our relationship with Alstom where we are moving towards commercial production of our first heavy-duty fuel cell modules. With the increasing amount of press coverage this year, regarding Fuel Cell Powered Trains, it's only a matter of time before Alstom is building a book of business that translates into orders for Hydrogenics.

We are not at the finish line just yet, but we're closing in on an initial customer contract for more than 80 Fuel Cell Power Module Systems, primarily to serve the Hydrail Commuter network in Germany. Such orders for delivery in 2020 would be the first under our 10 year exclusivity agreement, which as you will recall was originally valued around $50 million, including the supply of at least 200 engine systems, service and maintenance. We're pleased with our strong partnership with Alstom, and the future that we’ll build together in the Hydrogen Rail Powered space.

With increasing interest for such applications in Europe, North America and elsewhere, we remain very upbeat about this market and our leadership position in it, which should translate into accelerating growth in the quarters to come.

Turning to slide six, I just wanted to take a moment to summarize the outlook for the rest of the year, given our strong backlog in improving demand dynamics. As I just mentioned, rail applications are just now beginning to take shape, but such orders herald increasing interest for the hydrogen based trains of tomorrow. Our long standing relationship with Alstom and our proven heavy duty PEM technology position us for rapid growth in this space.

In China we continue to work with our many certified integrators to provide fuel cell applications, primarily for the commercial bus market there. As our investors are aware, growth in China has been adversely impacted by trade issues with the U.S. and general macro-economic forces which have caused near term investment disruption.

Obviously this does not change our long term view of the importance of this market which remains the clear leader in next generation mobility applications. In addition, our relationships with L’Air Liquide and Cummins should strengthen our position in China and open up new avenues for growth, and allow for more flexible partnership opportunities, as well as capital for rapid expansion.

Overall, the outlook for 2019 continues to be bright. We forecast significant year-over-year growth due to our current book of business and the diverse array of customers that we service. In addition as we enter the second half of the year, we've laid the groundwork for a very strong 2020.

Due to the burgeoning demand for an array of mobility applications, our partnership with Alstom and our increasing presence in Asia, North America and Europe, we are well positioned for strong growth and improving bottom line results. We'll continue to focus on cost discipline, working capital management and further efficiency improvements as we move closer to sustained profitability.

Before turning the call over to Marc, let me again thank all of our long-term investors for their passion and patience as we built this company to where it is today. I'm very proud of what we've accomplished, but even more excited for what the future holds. I look forward to seeing you at our special shareholders meeting and hope that you'll join me, the Board, and other investors in voting for the pending acquisition by Cummins.

With that, I'll turn the call over to Marc for a review of our financial results in detail. Marc.

Marc Beisheim

Thank you, Daryl. As shown on the slide seven and eight, we posted revenue of $10.4 million for the second quarter and $18.5 million for the first six months of 2019 versus $7.6 million and $15.8 million respectively for the compatible period in 2018.

The company posited significantly higher revenue within its onsite generation segment during the quarter, reflecting increased shipment. During the second half of 2019 we anticipate substantial growth across both business units, in line with our current backlog.

Gross margins as shown on slides nine and 10 were 12.9% for the second quarter and 28.2% for the first six months of 2019 versus 27.6% and 33.9% respectively for the comparable periods in 2018. The company's lower performance in the current year’s second quarter was due to both business units, with an OnSite generation reduced margins reflected the impact of a custom fueling station project, while within power systems results reflected warranty costs and the write-offs of obsolete inventory.

Turning to slide 11 and 12, our adjusted EBITDA loss was $3.3 million this quarter and $4.2 million year-to-date, versus $2.4 million and $4.1 million respectively last year, reflecting the revenue and margins previously discussed.

Slide 13 showed that the company's order backlog as of June 30, 2019 was $144.1 million of which we anticipate delivering approximately $60 million over the coming 12 months. During the second quarter we received $4.4 million of new orders and continue to bid on numerous project opportunities, including with Alstom.

On slide 14 our cash resources as of June 30, 2019 were $17.7 million versus $8.7 million at the beginning of the year. We continue to work towards being cash flow neutral as we scale the business and drive improved bottom line results.

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

Question-and-Answer Session

Operator

Thank you. [Operator Instructions]. And our first question comes from Eric Stine with Craig-Hallum. You may proceed.

Eric Stine

Hi Daryl, hi Marc.

Daryl Wilson

Good morning.

Marc Beisheim

Good morning Eric.

Eric Stine

Good morning. So I know it hasn’t closed the transaction, but curious you know over the last couple months or even as this process is kind of unfolded behind the scenes, how it has maybe changed your view of the mobility market opportunity, with their backing and then maybe as part of that obviously, given their market presence, maybe how you think that impacts your infrastructure business.

Daryl Wilson

Sure, thanks Eric. I think the engagement by companies like Cummins is a very clear signal of maturity in the hydrogen sector. So we've seen the growth in China, we’ve seen the growth in electric vehicles around the world and the developments based on battery technology have brought to light a number of the constraints with battery technology and the opportunities with hydrogen to become more clear, especially in the heavy mobility applications.

So our leadership in trains and trucks and buses are historically diesel applications and I think that we can bring efficient, effective and cost effective electrification solutions to these areas with fuel cell technology and recognition by Cummins that that time has come I think is a very, very positive signal for the hydrogen sector.

So there will be a steady growth period now I think in the coming years. There's lots of work to accomplish the integration platform by platform, so it will be steady-up. I don't expect a massive up-swing. These things are challenging to implement, but I think there will be a very steady upswing in the place of hydrogen within electrified mobility, and as I said especially in the heavy mobility areas for truck, train, bus.

So a very positive signal, and I think there are numerous other positive signals around the world for our hydrogen market. China of course is a lead market with significant volume up-take, but we see Europe coming much stronger now, and in the U.S., California has been a very strong market for us and I see that continuing as well. So on the whole very positive for mobility and this is just one more clear signal about where we are and where we're going.

Eric Stine

Got it! Okay and then just quick, last one from me, just turning on the train said, you know great to hear. I know you're not there quite yet, but very close to that aggregated order that you've been waiting for. I mean as that plays out, you've got things going on in other markets, the retrofit market in U. K. and Canada. You know just maybe how you see that playing out, especially if Alstom is really going to take that next step.

Daryl Wilson

Yeah, I think the key threshold condition is that what we have done in the past is working well and indeed it is and that's been widely reported in the press. There's lots of customers that experience the Hydrogen Rail system and daily use in Germany, and this first group of orders will all focus on this first platform, the Coradia iLint that we worked on with Alstom over the last number of years.

In other market areas there are other applications on other train platforms and so there's some developmental work to have the power train solution suitable for these other platforms and then we'll move through the first trials, the certifications, and then eventually the series production for those as well.

I think on the whole as I look back over the last few years, working with Alstom, this application has moved much faster and much more strongly than we ever anticipated. It’s an application where the value proposition of hydrogen fuel cells is well positioned against the incumbent catenary technology and now that we have a reference site, perspective customers from multiple jurisdictions, municipalities can come and see what Hydrogen Rail is all about and kind of catch the momentum that exists and the opportunities that exist with this application.

So this is an area where we see good acceleration coming in the coming years and we've done a tremendous amount of speed work together with Alstom in the recent years and this will lead to nice momentum going forward.

Eric Stine

Okay, thanks a lot. Best of luck going forward!

Daryl Wilson

Okay, thanks for all your work Eric. We appreciate the support of Craig-Hallum and the analyst there in very fairly reporting the prospects and opportunities of this business, and just want to say thank you for that today.

Operator

[Operator Instructions]. And our next question comes from Jeff Osborne with Cowen and Company. You may proceed.

Jeff Osborne

Yeah, good morning, guys. A couple of questions on my end. You certainly covered the train side there with Eric’s questions, but maybe Marc for you, can we just go over some of the moving pieces on the gross margin side. If I'm reading the SEDAR filing right, it looks like the warranty charge was about $560,000. I think you mentioned obsolete inventory as well as the containerized solution impacting margins. Is there a way to sort of peel back the onion on what the three items were, getting at truth naturalized gross margins without those one-time issues?

Marc Beisheim

Yeah with – as best as I can Jeff, but you got the three elements on the OnSite Generation side. I will say that our projects on balance were at our target margins and we talk around, you know the north of 20 to 25 range, but with the fueling station which as Daryl highlighted is a first of a kind in jurisdiction in Canada with commensurate, a little more heavy engineering and what you would expect, a lower margin. That diluted the quarter results, irrespective of the nice lift in revenue as that fueling station accounted for well over 50% of our revenue that quarter.

So I would say it’s what we expected, and the margins are actually coming in, just mildly better actually than what we had originally budgeted, even on that fueling station. On the power side, we are suffering – sorry, go ahead.

Jeff Osborne

I was just going to follow-up, is it the issue that because its 700 bar or containerized, just a naive question, but the engineering aspect of difficulties. Can you just flush that out a bit?

Daryl Wilson

Hi Jeff. When you start doing this in a jurisdiction that do not have familiarity in history, you have to educate the officials in multiple areas of responsibility and that leads to project delays that you know were not originally budgeted and extra labor work as we go through any open necessary issues. So it’s more a fresh start in the new jurisdiction that trips off the challenges.

In our experience in California and other places in Europe, once you’ve done the first one and the various authorities are well versed in the proper interpretation of the international codes, and standards and the applicability of their current local codes and standards, then it typically goes much more smoothly. So as Mark said, we anticipated something more challenging this first time around here in Canada.

Jeff Osborne

Makes sense.

Marc Beisheim

And then in regards to the Power Systems Group, Jeff, the delta quarter-on-quarter is entirely attributable to the two adjustments that we talk about there, truing up some warranty provisions and also as we tend to be ahead of some inventory obsolescence charges and not waiting to the end of the year when there's evidence earlier in an appropriate provision.

The other thing I would just comment is, at sub-$3 million of revenue, this quarter as well as the quarter comparatively, our margins are eating up a disproportionate amount of – to start fix manufacturing overhead and perhaps what I would point to is the year-over-year growth margins with respect to the six months and the kind of halo effect of very strong results in Q1 that continued service so well through the first half of the year.

Jeff Osborne

Got it, and I appreciate the detailed. Two other quick ones if you don't mind. One is on China, certainly you highlighted the trade in macro. I was just curious I guess that the revenue is not flowing through and delays in orders. But is there a delay in discussions with potential customers as well or is the narrative still proceeding, but just people aren't pulling the trigger?

Daryl Wilson

No, I think the general momentum is still there. I've often drawn attention to the phases of pilot trials and first-op prototypes and then scale up and most of the players that are active in the market up till now have been relatively small companies and when they start getting into larger volumes, they have more challenges in getting into higher levels of throughput. So that's being the phase change issue to be really ready to start doing decent numbers.

I do expect that those issues will get work through, and over the coming 18 months there will be you know reasonably decent demand. Sometimes perspective volumes are inflated in that market, as you know, but I think we will work through the capability issues to execute at a higher level.

And as I mentioned, this transition with Cummins I think is an important part of our market engagement with China as well. I Cummins has a very established network of joint ventures and partnerships in China already, many thousands of employees already there. So Cummins is a platform where we can work together in the Chinese market and established a very strong position with a lot of credibility in existing partnerships.

Jeff Osborne

Make sense. And the last one I had Daryl was on the – either for yourself or what Cummins are jointly are seeing. But you talked about the heavy duty market in trucking. Are you seeing anything in the Class 4 - 6 range or is most of the pipeline and discussions you are having on the heavier side in in the Class 8 segment.

Daryl Wilson

These discussions have shifted substantially in the last years. So there is a lot more focus now on what hydrogen can do, and a lot of work in identifying which parts of the trucking fleet make the best sense.

I won't get into detail by class, but whereas we’ve had you know the occasional interest in drainage trucks in California, I see much broader span interest now. You have major corporations focusing on zero emission, last mile delivery and decarbonizing their logistics pathways and so that's opening up a lot of other discussions in various classes.

And in some of these areas there's been attempts to execute with batteries and then the inevitable concerns around the long recharge time and the limited range and of course in heavier vehicle that range issue is compounded. So the truck discussion has matured very nicely in the last year in China and elsewhere and obviously that's an interest area for Cummins and their involvement in diesel applications in heavier mobility as well.

So I think there's some very good prospect for us in the coming years in the truck market across multiple classes.

Jeff Osborne

Good to hear. Best of luck as your move forward!

Daryl Wilson

Okay, thanks very much for your support over the years Jeff. Much appreciated.

Operator

Ladies and gentlemen, we currently do not have any further questions in queue. Thank you for attending today’s conference. This now concludes our program. You may all disconnect. Everyone have a great day!

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