U.S. Markets closed

Edited Transcript of HYG.TO earnings conference call or presentation 2-Nov-18 2:00pm GMT

Q3 2018 Hydrogenics Corp Earnings Call

Mississauga Nov 17, 2018 (Thomson StreetEvents) -- Edited Transcript of Hydrogenics Corp earnings conference call or presentation Friday, November 2, 2018 at 2:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Daryl C. F. Wilson

Hydrogenics Corporation - President, CEO & Director

* Marc Beisheim

Hydrogenics Corporation - CFO & Corporate Secretary

================================================================================

Conference Call Participants

================================================================================

* Amit Dayal

H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst

* Craig Edward Irwin

Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst

* Edoardo Di Giamberardino

* Eric Andrew Stine

Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good day, ladies and gentlemen, and welcome to the Hydrogenics 2018 Third Quarter Conference Call.

(Operator Instructions)

As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. Marc Beisheim, the company's Chief Financial Officer. Sir, you may begin.

--------------------------------------------------------------------------------

Marc Beisheim, Hydrogenics Corporation - CFO & Corporate Secretary [2]

--------------------------------------------------------------------------------

Hello, and welcome to Hydrogenics' 2018 Third Quarter 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 also uploaded the report this morning on both SEDAR and EDGAR and we'll refer you to those sites for our disclosure documents.

As indicated in our press release this morning, all financial references are in 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 statements.

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

--------------------------------------------------------------------------------

Daryl C. F. Wilson, Hydrogenics Corporation - President, CEO & Director [3]

--------------------------------------------------------------------------------

Thank you, Marc. Good day, and thanks, everyone, for joining us for Hydrogenics' 2018 Third Quarter Conference Call. Today, I will review our operations and outlook, after which, Marc will discuss our financial results in detail.

Please refer to the presentation on our website for today's discussion.

Turning to Slide 3. In the context of our third quarter discussion, I'd like to begin my remarks by taking a few moments to remind our audience about the general market conditions of the industry in which we operate. It's important because it's the way we, as management and our board, view the Hydrogenics investment proposition, and track the progress of our business. We are already known over the world as a leader in hydrogen-based energy solutions, but as with any disruptive technology, it takes time for new applications to be fully understood, appreciated and accepted.

Once that happens, increasing interest drives demand for such technology and propels the entire industry forward. That's where we are right now within the global hydrogen space. And in a few minutes, I will show you the evidence within our own business.

Major players, including large corporations, utilities and governments, are taking notice of these advances and the macro drivers related to both economics and environmental policy are further strengthening market demand. The value we offer to customers and shareholders is becoming more apparent every day, simply due to the fact that we have numerous projects already underway and products in use worldwide. Hydrogenics' fuel cells are now powering trains and regular public service in Germany. Many energy storage applications are up and running. And our technology is behind the largest fleet of hydrogen fuel cell-powered buses in the world.

As a matter of fact, a recent article by 13D Research referenced four of our projects while making a very strong case for investing in hydrogen. The world is taking notice, and we are busier than ever. Milestones are moving the market.

Our highlights for the third quarter are shown on Slide 4, and they bear this out. I'll review these after which I'll go into further detail about major developments in our near-term areas of focus.

Third quarter sales were $7.7 million, primarily reflecting the variability quarter-to-quarter in what's expected -- and this is expected in emerging markets like ours as we shift to greater number of fuel cell modules to China in 2017 versus so far in 2018. As I'll review in a moment, our outlook in China remains very positive, based on our strong market fundamentals, our alliances with a number of certified integrators, but purchase order timing remained somewhat unpredictable due to both business and political parameters.

We're ready to ship product there as soon as required and continue to work hand-in-hand with our customers to expedite order fulfillment. In the meantime, Alstom had an amazing presence in the recent InnoTrans Show in Berlin, showcasing the Coradia iLint train, with world's first hydrogen-powered rail vehicle using our heavy-duty fuel cell technology. We expect the first commercial orders from them soon. We also announced a range of new contracts during the quarter, highlighting our leadership across the hydrogen spectrum. From energy storage and fueling stations in Europe to fuel cell-powered heavy-duty trucks in California, our backlog remained significant at $132 million, and we're actively bidding on numerous opportunities to expand our product portfolio.

Now let me go over a few areas of major focus starting with Slide 5, and I'll look at our activities in China. Last quarter, I noted that we were disappointed with the low volume of shipments to China during the first half of 2018, but we expected to see a pickup in orders during the remainder of the year. There are a number of factors in the Chinese market that have impacted near-term decision-making or at the very least made demand timing a little less certain. Broadly speaking, the flow of incentives from the Chinese government to various OEMs and integrators has slowed and the build of infrastructure has also been an impediment. And while assurances were given in July of steady orders through the balance of the year, deposit commitments did not materialize. As we remain very firm on our payment terms, this has negatively impacted our shipments.

While frustrating, none of this is necessarily surprising. While our certified integrators in China are very committed to fuel cell-powered transportation, political priorities and other factors have affected decision-making on a quarter-to-quarter basis. This does not mean that our existing partners are not well connected or that they have lowered their enthusiasm for hydrogen as an energy source. However, in the near-term uncertainty around timing, supports our approach to work with multiple partners, and to make addition so that we can broaden our approach and reach to additional customers and integrators there, along with larger organizations, which are now showing increased interest.

The entrepreneurial phase of this market startup is coming to an end, and the engagement of bigger Chinese organizations is clear. In that vein, we are currently having a number of ongoing discussions with parties committed to elevating Hydrogenics to a higher level of penetration in China. The bottom line is that we now expect volumes to resume in the future and are ready to supply product in ever increasing amounts. We're working on expediting order flow from the three well-established customers we have, and we are actively looking to engage other significant players in the market.

We have people on the ground working to advance and accelerate our business there, and I myself often traveled to meet with high-level officials and company executives on a regular basis. Suffice it to say that we are as impatient as you, our investors are, and yet continue to be excited by the market potential and overall market dynamics.

I want to be clear that we are not impacted by the U.S./China trade war. And we can bring more to the country than any other provider due to our advanced technologies, broad portfolio and the experience we have in this space. I look forward to sharing with you the fruits of our efforts as soon as possible.

Now turning to Slide 6. The company has experienced increasing momentum across multiple applications. We announced this quarter several orders that cover the breadth of our hydrogen offerings. First, we noted that the company was selected for a 2.5-megawatt energy storage system connected to a 45-megawatt wind farm in Norway. The wind farm was already one of the most efficient in Europe, adding to our energy storage application will convert excess wind power into a captured resource for other uses on the continent. Notably, the so-called Haeolus system will be remotely controlled and monitored due to the harsh environmental conditions and lack of accessibility during the winter. It's a unique project and one totally suited to our experience and expertise.

We also announced that Hydrogenics will supply 6 hydrogen fuel cell power modules to GTI and TransPower in Southern California for a set of Class 8 Navistar drayage trucks to be deployed there next year. Hydrogenics heavy-duty fuel cells are now on over 30 freight and utility vehicles as well as 7 different transport platforms the world over. And this latest award validates our leadership in this area.

Lastly, we announced that Hydrogenics has been chosen to supply a large-scale electrolysis system to generate hydrogen at a fueling station at Wuppertal, Germany. The customer, a compressor manufacturer is building a 1-megawatt facility to cover the daily needs of over 10 hydrogen fuel cell buses operated by the local transit company, WSW. They've chosen to use hydrogen fuel cell buses over battery vehicles due to the high reliability provided, particularly in the steep terrain of the surrounding area. Surplus energy provided by a local waste incinerator will power the electrolyzer and generate over 400 kilograms of hydrogen per day. It's another example of an application that we are very uniquely qualified to do.

On top of all of this, we announced the opening of new facility in California to coincide with National Hydrogen and Fuel Cell Day. Located near San Diego, the site will focus on the integration of hydrogen fuel cell systems into heavy-duty truck and bus platforms for customers in California while also serving as a local support center for fueling energy storage and power system projects throughout the state and country. We wanted to make sure that we have a dedicated presence to serve the interest of growing hydrogen demand in one of North America's leading markets.

At the same time, we achieved a major milestone this quarter, with Alstom showcasing its fuel cell powered trains at the International InnoTrans Show in Berlin. The world's first hydrogen-powered commuter train, the iLint's, features our hydrogen PEM technology, it was actually used in the show for visitor transportation and then garnered great deal of attention and excitement. We couldn't be more proud of this historic event, which heightens interest in Alstom's groundbreaking offering. Publicly it's been reported that Alstom has already received orders for more than 30 fuel cell-powered trains and we expect additional purchase orders in our currently -- that are currently in the negotiation stage. It gives us great confidence in receiving our first commercial order from Alstom for delivery in 2019.

In addition, there has been a good deal of news about hydrogen fuel cell-powered electrification plans for existing diesel trains in the U.K., Canada and other markets. We're working hand-in-hand with our partners on many such opportunities as the industry significantly expands. I'll speak to this more in a moment, but the fuel cell-based transportation solutions are gaining momentum in municipalities the world over as a cost-effective, clean alternative to diesel or traditional line-based electrification.

We're actively bidding on opportunities in this area, fuel cell mobility as well as across our entire product portfolio. This increasing demand for fueling stations, fuel cell-powered production, mobility, backup power, energy storage, all areas where our expertise and leadership are unsurpassed. In fact, excluding China, we are currently bidding our projects worth in aggregate over $100 million in the trucking, aerospace, rail and fuel industries. We're focusing resources on these opportunities with the greatest potential, which can leverage our technology and lead to the scale-up of the business. Our staff is working round-the-clock and around the globe on some amazing applications using Hydrogenics' advanced engineering.

Slide 7 sums up what we are seeing in terms of overall market dynamics where we have here -- what we have here is an S-curve that's typical of any new technology as it's introduced and proven in the market. After initial customers are secured, the product develops a small following that leads to somewhat larger orders and technology improvements to make the application more efficient, less costly and more appropriate across a wider customer base. We've done this with our entire product portfolio. We've made our system smaller, scalable and more durable and cheaper to manufacture and sell.

And at the same time, we continue to reengineer our products to make them even more effective in certain applications like heavy-duty fuel cells designed for Alstom or for our long-term propulsion contract. Over time, product improvement and efficiency combined with market acceptance lead to larger orders and greater platform adoption as shown on the slide. Value creation requires that a new technology move through these hurdles, build credibility and continually advance the application. We're doing this across the board at Hydrogenics and let me show you some specific examples, starting with Slide 8. Here we illustrate the progress we've made in the rail space with our fuel cell power modules. Since getting the initial 100-unit order from Alstom a few years ago, we worked hand-in-hand with them to engineer a perfect heavy-duty solution in hydrogen and deliver the system on time. When the Coradia iLint -- with the Coradia iLint now up and running, we look forward to receiving our first commercial orders from Alstom.

We are a proven qualified supplier in the space and as I mentioned earlier, in the process of bidding on various rail applications in North America, Europe and elsewhere. We believe large-scale wins are just around the corner and that 2019 will be a very significant year in the sector. As a reminder, we currently have $47 million in backlog related to Alstom, tied to near-term production expectations.

Slide 9 shows an S-curve relates to what we now call PTX. We've previously often called this PTG or Power-to-Gas, but the reality is that description falls short of the size and complexity of this area. Power-to-X means X can be many things, from hydrogen gas in various forms as fuel or direct power, fed into the natural gas infrastructure or diverted for industrial use or use in fuel cell-powered vehicles.

We've been working in this space for years and already have many energy storage Power-to-Gas applications up and running, as shown on the right-hand side of the slide. We're in the process of bidding on much larger applications and believe the industry is at the cusp of scaling to significantly higher multi-megawatt facilities.

We look forward to announcing some major developments on the coming quarters.

Turning to Slide 10. Here, again, is the S-curve across another heavy-duty mobility applications trucks and buses. We've had a presence in this market for quite some time, not just in China, but in North America, Europe and elsewhere, with customers, including UPS, Scania, TransPower, Navistar, Siemens and New Flyer. I spoke at length earlier about the outlook for China, but we're also bidding on numerous other opportunities and have made heavy-duty fuel cell power modules currently being accessed by OEMs around the world. There's no reason to think that demand should not rapidly lead to orders in the thousands given our experience and leadership, the improving efficiency of our products and overall demand for cost-effective durable clean energy solutions in the heavy-duty mobility space.

Before turning the call over to Marc, let me just wrap up by emphasizing the value of our company and technology in the marketplace as shown on Slide 11. Even as we are sometimes unsatisfied as our investors by the slow pace of decision making in certain parts of the globe, we need to stay focused on the long-term potential of the industries that we serve and how that potential is rapidly expanding over time. If we look back just a few years ago, hydrogen-related applications were barely a blip on the radar. We and other companies like us only spoke about the future, not the present. But we can see that demand would develop someday, we didn't really know when or how the initial stages of the market with transformation would occur. Fast forward a few years later, and now, in 2018, the picture is very different.

As shown by our recent awards and those of our competitors, the market is beginning to dramatically expand. This doesn't mean the trajectory will be a perfect 45-degree angle or the demand will be easily forecast. The evolution of new technologies and applications is never smooth and continuous, but instead often as typified by project-based revenue cycles until adoption reaches a tipping point, and we're almost there. Countries and numerous industries across the globe now see the environmental and economic benefits of our technology. Alstom recently received great adulation and attention due to the launch of its fuel cell-powered trains in Berlin. And municipalities around the world are looking at that same technology to enhance their railways, preserve the environment and save money versus electrifying an existing track using over-head wire.

We've spoken in the past about the potential of this happening in Canada and elsewhere in Europe on major projects that are of a significant size, but there are similar opportunities elsewhere. And I've mentioned this earlier that we're bidding on even larger, more complex applications the world over, including near-term projects worth an aggregate over $100 million excluding China.

As we approach the end of 2018, it's worth reminding our investors that the end game is to be the leading hydrogen technology provider of the 21st century and we are positioned to do just that. No other company offers the same level of heavy-duty fuel cell reliability or the range of projects or scalability or the ability to store energy for numerous purposes, taking surplus power and converting into usable forms for cleaner, more sustainable planets. Whether it's China, Europe or North America, these technologies all work together, and industries that use hydrogen to run fuel cells will also need fueling stations and ways to generate and store hydrogen.

So while it's normal to sometimes lose patience with the unpredictability of the market, that's actually the way such markets often work, in fits and starts. Lower cost and increased efficiency come with scale-up of the key applications which is now underway and large nonlinear increases and valuation will happen in these scale-up phases. We remain very optimistic about growth in China over the coming months and quarters and in our first commercial order for Alstom and in numerous other opportunities, most of which we cannot speak about in detail at present. We also have a path to profitability, which we are committed to achieving. So again, we ask our investors for continued patience as we firmly believe they will be rewarded over time.

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

--------------------------------------------------------------------------------

Marc Beisheim, Hydrogenics Corporation - CFO & Corporate Secretary [4]

--------------------------------------------------------------------------------

Thank you, Daryl. Before I begin, let me remind our listeners that as discussed previously, prior period results have been restated to reflect the implementation of the IFRS 15 revenue standard, impacting year-over-year comparisons.

As shown on Slide 12, we posted revenue of $7.7 million for the third quarter of 2018 versus $12.1 million in 2017. OnSite Generation sales held primarily due to order timing, while our Power Systems business was down due to fewer deliveries to China as Daryl mentioned. We are expecting shipments to China to pick up, however, going forward, again, based upon our long-standing customer relationships and the strong long-term demand for heavy-duty fuel cell applications in that market.

Moving to Slide 13. On a 9-month basis, OnSite Generation sales were comparable with the prior period, whereas, the drop in Power Systems revenue attributes to slower China orders as previously mentioned. Gross margins shown on Slides 14 and 15 were 19.2% for the quarter and 29.1% for the first nine months of 2018, versus 24% and 21.2%, respectively, for the same periods in 2017. The improvement year-to-date in Power Systems was due to improved product mix and cost control through an ongoing focus on product standardization.

OnSite Generation had lower margins in the current quarter, due to lower revenue and a higher absorption of fixed overhead, but showed significant improvement on a year-to-date basis due to more consistent delivery of projects at target margins.

Turning to Slide 16 and 17. Our adjusted EBITDA loss was $2.5 million this quarter and $6.6 million for the first 9 months of 2018 versus $1.9 million and $6.1 million, respectively, for the same periods in 2017.

Despite lower revenues of $5 million year-over-year, the incremental EBITDA loss was limited to only $0.5 million, reflecting our improved gross margins and operating cost containment.

Slide 18 shows the company's order backlog as of September 30, 2018, was $132.1 million, of which we anticipate delivering approximately $55 million over the coming 12 months. During the third quarter, we received $8.1 million of new orders and continue to bid on numerous project opportunities. On Slide 19, our cash resources as of September 30, 2018, were $11.9 million versus $21.2 million, net of operating borrowings at the beginning of the year.

With that, I will now turn the call back to Daryl for some closing comments.

--------------------------------------------------------------------------------

Daryl C. F. Wilson, Hydrogenics Corporation - President, CEO & Director [5]

--------------------------------------------------------------------------------

Thanks, Marc. Before turning the call over for questions, I'd like to leave you with some closing thoughts to sum up the way I'm thinking about our business as we approach the end of 2018 and look out beyond next year. The evolution of new technology and their applications is typified by project-based revenue cycles, until adoption reaches an inflection point. The overwhelming body of evidence points to our industry and our companies being very close to that inflection point. Hydrogenics is uniquely positioned to capitalize based on the unmatched strength of our technology and the breadth of our product portfolio.

Our technology is reliably in service under contract with marquee customers in high visibility reference projects like that at Alstom. We have a sizable backlog, and new order flow was strong. We're busier than ever, bidding on larger, more complex applications the world over. While decision-making process at our stage of an emerging market can be protracted and uncertain and exacerbate quarter-to-quarter revenue variability, it does not impact the longer-term opportunity nor our confidence in seizing that opportunity. Our vision to be the leading energy hydrogen technology provider of the 21st century is within reach, and the consequent value in Hydrogenics has never been more evident.

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

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) Our first question comes from Eric Stine with Craig-Hallum.

--------------------------------------------------------------------------------

Eric Andrew Stine, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [2]

--------------------------------------------------------------------------------

Maybe if we could just start on the bid pipeline. Not sure if we're able to do this. If you could just talk about the mix across your business within that pipeline in just for context? I mean, it sounds like it's obviously quite a bit higher than it's been in the past, but maybe compare that to say a year ago or 2 years ago, just for context?

--------------------------------------------------------------------------------

Daryl C. F. Wilson, Hydrogenics Corporation - President, CEO & Director [3]

--------------------------------------------------------------------------------

Yes, Thanks, Eric. I think you hear from the tone that we are feeling very bullish and that the bidding situation is very strong. These are often now larger projects where the participants are coming at it, for maybe that, not the first time, but the second or third time, but they haven't done it at this scale. And so the whole decision-making cycle can be quite long. Notwithstanding that, you'll see on Slide 9 in a reference to power to X projects at 100 megawatts, 50 megawatts, 25 megawatts, 10 megawatts, those are good sized projects. And there is now serious intent to start moving ahead with things of this nature. There is a belief that the policy structure in the future and even the business case presently will support projects of this size. This is new and it's very encouraging. We're also seeing a rise in interest in heavy-duty mobility. One of the gifts from the Chinese development of battery technologies has started to show the limitations of batteries much sooner than we anticipated might happen. And now we're getting a lot of truck manufacturer requests to help them with electrification because they know batteries can't do the job, they thought there was nothing else, but now they are realizing hydrogen is a solution of electrification for heavy-duty transport. So the mobility area, the power to X area, are probably the most active right now and show the promise of the most immediate consummation.

--------------------------------------------------------------------------------

Eric Andrew Stine, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [4]

--------------------------------------------------------------------------------

Got it. And then just sticking with the pipeline, I do want to get to mobility, but just sticking with the pipeline quick. The power to X, is it fair to say that some of these and maybe towards the smaller end or part of that bid pipeline because I mean, if I think about 100 megawatts or 50 megawatts, that would account for basically the whole thing. So it seems to me that those are not in there yet, in that pipeline, but they're coming soon that you would be involved in those.

--------------------------------------------------------------------------------

Daryl C. F. Wilson, Hydrogenics Corporation - President, CEO & Director [5]

--------------------------------------------------------------------------------

That's right. Yes, your math is absolutely correct. So when I talk about the $100 million, I don't put the largest items in there, because, yes indeed, it would account for much too much of that $100 million. So -- but nonetheless there are engineering feasibility studies and close work and plant layout plans and all that sort of thing. I will say, as these things get larger, there is a mixture of heightened reality. So we've seen discussions around the world of projects onwards to 400 megawatts. When you peel behind that and look at how realistic the funding sources are in the support of those kinds of projects, we say, no, that's not so real. We might get there one day, but that's not real yet. But some of the other ones, the foundation of business case is much stronger. So yes, a mix, but we're not crediting the very large ones in the near term.

--------------------------------------------------------------------------------

Eric Andrew Stine, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [6]

--------------------------------------------------------------------------------

Yes. Okay. And then just on mobility, you mentioned, China and I know that's a big focus. But just curious in the EU. I want to know the consideration of the 15% reduction in CO2 for heavy-duty trucks by 2025? Just wondering what sort of an impact you've seen that have on OEMs, maybe how that shapes your view of also the fueling station opportunity?

--------------------------------------------------------------------------------

Daryl C. F. Wilson, Hydrogenics Corporation - President, CEO & Director [7]

--------------------------------------------------------------------------------

At the Climate Change Conference in California, a new dynamic became very evident that, while there is talk of policy migration and consensus, carbon taxes et cetera from government, major commercial entities are now bringing pressure to bear on the trucking industry. So IKEA made a major announcement that they would expect their last mile delivery in multiple cities to be zero emission by 2020. These are very bold demands on the trucking industry. And I think the writing is on the wall and I would say even in the last 6 months, we've seen a complete change in behavior from denial that these new technologies won't touch us, we don't need them, diesel will be around for a long time, to a very completely different behavior that says, we need to get on with this. And we need to investigate how to adopt these solutions, and we need to do it quickly. We've had a pretty steady stream of visitors here in the last 6 months, where this different mentality around diesel is very evident.

--------------------------------------------------------------------------------

Eric Andrew Stine, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [8]

--------------------------------------------------------------------------------

Got it. Okay. Maybe last one from me. Just in your presentation, I had not seen aerospace as an end market before, and you mentioned that briefly. Just curious, if you can give a little insight into how you're involved in the application?

--------------------------------------------------------------------------------

Daryl C. F. Wilson, Hydrogenics Corporation - President, CEO & Director [9]

--------------------------------------------------------------------------------

This is not new for us. We've worked in this area and had announcements in this area for quite some time. Initially, it looked quite small and experimental. I would say, it's fair to comment that it's getting more serious. Again, electrification as a theme has caught attention, and it's a particularly challenging thing to do with batteries. So it's just simply not enough energy to get an aircraft off the ground with batteries as the energy source, but there is with hydrogen. And there are multiple applications of hydrogen that we have done in the past and that are now emerging, which are very interesting. So yes, a lot more activity in this area and also marine, we're seeing increases -- increasing requests for proposals and we're actually winning some bids in the marine market as well. So this whole electrification theme is spanning out, it's not just vehicles on the ground, it's boats in the water, and it's planes in the air.

--------------------------------------------------------------------------------

Operator [10]

--------------------------------------------------------------------------------

Our next question comes from Craig Irwin with Roth Capital Partners.

--------------------------------------------------------------------------------

Craig Edward Irwin, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [11]

--------------------------------------------------------------------------------

So my questions are actually much more financial. The cash consumption in the quarter, you did have a sizable miss versus the top line, but you held onto your cash really well in the quarter, just $3 million in consumption. That's lower than what it's been for the past couple quarters. What do you feel about cash in the fourth quarter? Are we likely to see some progress from these levels that we saw in the third quarter on the revenue line? Does that help us with the cash position? And any other balance sheet items that we maybe need to keep an item on?

--------------------------------------------------------------------------------

Daryl C. F. Wilson, Hydrogenics Corporation - President, CEO & Director [12]

--------------------------------------------------------------------------------

Craig, I would turn your attention to the inventory area. So as we work toward our Chinese opportunities and other opportunities, we have accumulated a fairly significant inventory. And as we work some of that inventory off in the fourth quarter, you can see that transitioning to cash. So I think that's probably the most notable exchange on the balance sheet that we anticipated in the near term. Secondly, it should not be missed that managing the whole China situation is an important element of managing cash, and we have been very strict on how we manage shipments and payment terms and the fulfillment of payment obligations. So we don't put our cash at risk easily and we've had a lot of discipline around that. And then finally, there's always been a very lean mentality here to focus on what needs to be done and not spend more than we need to, because it's been my commitment for my entire time here to maintain a lean situation and keep our break-even point as low as possible. And that remains our commitment. And Marc joined us recently, as you know, and he has been reinforcing that discipline very nicely. So we respect cash as a very critical resource. We don't put it at risk. We don't mess around with it. And we think we're in good shape.

--------------------------------------------------------------------------------

Craig Edward Irwin, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [13]

--------------------------------------------------------------------------------

Great. So then just to talk through the scenario where -- if in the fourth quarter, the Chinese customers that you've been working with are unable to take the product by the end of the year. Is there any flexibility to bring SG&A and R&D lower than what you have now? Is this something that you've been evaluating? Or do you see that as just an unnecessary consideration at this time?

--------------------------------------------------------------------------------

Marc Beisheim, Hydrogenics Corporation - CFO & Corporate Secretary [14]

--------------------------------------------------------------------------------

So you're seeing us get ahead of it, Craig, honestly in Q3. As Daryl affirms and even though it precedes me I honor and adapt to very readily the corporate history of getting ahead of soft spots with measures that curtail the discretionary, focus on what's critical. And I'll just offer that, you saw that result, in the improvement of our cash operating cost in Q3. And that trend will continue as required as we move ahead in anticipation of China picking up. And may I also offer to Daryl's question -- answer to your previous question, keep in mind as the pipeline matures and manifest into orders and arguably our orders have been lower in the last couple of quarters, those orders come with deposits and that's an important part of the strong cash flow profile of Hydrogenics, and how it's done so well over the years in many respects. Despite the bottom line results year-over-year, we get significant cash upfront in our major orders. And that's an important part of our working capital going forward as we kind of realize and consummate some of the pipeline that's in play.

--------------------------------------------------------------------------------

Craig Edward Irwin, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [15]

--------------------------------------------------------------------------------

Great. That's really good to hear. So then last question if I may. Gross margins this quarter were pretty solid despite the delta on revenue, 29.7% on OnSite Generation, mid-20s on Power Systems. How do you feel these margins over the course of the next couple of quarters? Are these really a function of mix? Is there anything that, that was a one-time item that might have lifted margins this quarter? Or been a headwind, anything you would call out for us to understand the progression over the next couple of quarters?

--------------------------------------------------------------------------------

Marc Beisheim, Hydrogenics Corporation - CFO & Corporate Secretary [16]

--------------------------------------------------------------------------------

Nothing anomalous. In fact, what I would offer, and we used to use the term, and it hasn't surfaced today, but let me bring it up. It's really our operating leverage. We had low revenue and we safeguarded our EBITDA year-to-date compared until last year on the strength of our improved margins. What we've been signaling and what we've been demonstrating are the facts it is around more consistent project management on the OnSite side, it's about realizing the improvements on standardizing our product and cost containment on the power side. Once we get to scale and what happened in Q3 a little bit was we're absorbing, let's call it, fixed production overheads into a lower revenue base, when that top line moves, and we are only dealing with the variable element of cost of sales, there is no increase in our fixed operating. We have the capacity. And you start to see and you will see, we hope, those margins even improve as we move forward. Of course, it's always a function of our ability to negotiate the prices that we need, and our track record, and what's in the backlog right now supports very healthy margins going forward.

--------------------------------------------------------------------------------

Craig Edward Irwin, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [17]

--------------------------------------------------------------------------------

Great, that's really good to hear. Strong execution, I guess, in the difficult short-term environment. So look forward to the continued progress.

--------------------------------------------------------------------------------

Operator [18]

--------------------------------------------------------------------------------

Our next question comes from Amit Dayal with H.C. Wainwright.

--------------------------------------------------------------------------------

Amit Dayal, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [19]

--------------------------------------------------------------------------------

So a year ago, we were expecting to recognize revenues around $52 million based on the backdrop data provided at that time, but we're sort of well behind that number so far. Could you maybe please articulate what has driven the shortfall so far? Is it all China? Is it something else, a backlog that has not been realized relative to the data provided at that time?

--------------------------------------------------------------------------------

Daryl C. F. Wilson, Hydrogenics Corporation - President, CEO & Director [20]

--------------------------------------------------------------------------------

Thanks, Amit. Yes, go ahead.

--------------------------------------------------------------------------------

Amit Dayal, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [21]

--------------------------------------------------------------------------------

Has that backlog been lost or pushed out, just some clarification on what's going on?

--------------------------------------------------------------------------------

Daryl C. F. Wilson, Hydrogenics Corporation - President, CEO & Director [22]

--------------------------------------------------------------------------------

Right, so the entire shortfall is China related. If you take China out of all of our planning and budgeting and everything, we're absolutely on track. So there's been no variation anywhere else, and we've managed to plan in every other respect. I know the backlog is not lost. It is simply being pushed out. And as I tried to communicate in the presentation today, this is completely normal. When you're starting into new markets and those markets are scaling, it's not a "join the dots" every quarter kind of situation. There will be fits and starts. Investors and I would have reason to be concerned, if the whole market opportunity for some reason had been turned off in China. That's a different story. But what's happening here is it's got pushed out for very clear reasons. I also tried to explain that the smaller entrepreneurial partners in the early stage of the market are more vulnerable to these kinds of fluctuations. And what's happening in China now is they're moving out of that entrepreneurial phase into much larger plotted parties getting engaged in the market. So that reinforces the point that the demand is there, that the interest is there, the value proposition is there, and larger parties have the confidence to join in the game and get involved to drive things to a larger scale. We have a long history of working with large counterparties. So it's not new to us to scale into working with much larger parties. And we anticipate that, that can happen.

--------------------------------------------------------------------------------

Amit Dayal, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [23]

--------------------------------------------------------------------------------

Understood. Appreciate the color. In regards to your discussion around the inventory levels whatever we have built up for China, is it very China specific? Or can that inventory be used for other customers, or other applications?

--------------------------------------------------------------------------------

Daryl C. F. Wilson, Hydrogenics Corporation - President, CEO & Director [24]

--------------------------------------------------------------------------------

This is a question I enjoy. Our focus on standard product means that we have huge flexibility. And when we have a build and some change in the pattern of drawdown demand, we can do many things with our product because it is a standard product. So this is another asset that we have in terms of our operating approach and our product design approach. So whether it was power plants in Korea or buses in China or trucks in California or even aviation solutions or marine solutions, we're using this same basic product. And that means, when there is fluctuations in demand from one market segment, we can allocate supply capability to another segment. And this is also the benefit of having a breadth of applications that we're well -- have well developed and have a very strong reputation to service.

--------------------------------------------------------------------------------

Amit Dayal, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Technology Analyst [25]

--------------------------------------------------------------------------------

Got it. Just forward-looking backlog number, at least what you hope to recognize in the next 12 months, how much of that is China? And how much of it is maybe rest of the world? If you could give some high-level color on that?

--------------------------------------------------------------------------------

Daryl C. F. Wilson, Hydrogenics Corporation - President, CEO & Director [26]

--------------------------------------------------------------------------------

We have been quite conservative and modest now for almost 4 years. So it's common for numbers to be inflated or exaggerated from some market areas, for various reasons. We have always deeply discounted those kinds of forecasts and expectations. And the portion that we have in that at this point would actually be less than we did in 2017. So conservatism sometimes doesn't pay off in exciting retail investors, but conservatism serves us very well to dampen some of these fluctuations and make sure we keep our feet on the ground and do what makes sense in the business. And that's always been our policy and it remains the approach, including the current backlog and the current forecast of realization of the backlog. We also have customers where we have put a portion of a contract or an order in the backlog but not the whole story. And so we've held back recognizing that there is a degree of uncertainty or perhaps that backlog portion is further pushed out, and so it is not prudent to start incorporating big numbers to trump up the backlog and it is wiser to parse the intake to backlog based on realistic expectations. So that's always been our process, and it remained so, including the numbers we are publishing today.

--------------------------------------------------------------------------------

Operator [27]

--------------------------------------------------------------------------------

(Operator Instructions) Our next question comes from Edoardo Di Giamberardino with Woodpecker Capital.

--------------------------------------------------------------------------------

Edoardo Di Giamberardino, [28]

--------------------------------------------------------------------------------

My question is about the Alstom order, because I read that you say that this year you expect the production order coming from Alstom, but looking at some important German states they should decide to allocate trains next year. So I was wondering if you expect one order within this year, and there will be another order next year? What is the amount of order of Alstom coming like this year?

--------------------------------------------------------------------------------

Daryl C. F. Wilson, Hydrogenics Corporation - President, CEO & Director [29]

--------------------------------------------------------------------------------

Thanks, Edoardo. It's a good question. The first key point here is to understand that lead times in this particular segment are quite protracted. You have -- railway infrastructure requires often the building of railway quarters and track. In the case of this application, existing track is fine. There is no need to build an overhead catenary system. So out of all the railway applications because we simply are supporting a vehicles build with Alstom and not new infrastructure with overhead catenary. In comparison for the incumbent technology, it can move more quickly with hydrogen. There is the need, however, to build hydrogen infrastructure and that can slow things up to some degree. And so there is a high level of maturity on numerous bids in Europe and elsewhere. We're very pleased to see that significant progress has already been made. In some cases, there are particular challenges or impediments, but they are well identified and time has gone into resolving those. And so together with Alstom, we look at the need to serve customers. And we are coming now to the point where production must begin. As I showed in the presentation, our initial activity in this area goes back to 2015. So we've lots of years already under our belt. We're past prototyping. We're past the first series production vehicles. Those are on regular commercial service. So there's lots of good progress already been put in. And that bolsters my confidence that we're going to move into serious production very soon. Naturally, I'm not at liberty to speak for our customer. And so that's why I can't put a fine point on exact production plans, but from our side, we see very good momentum. And as I said in the presentation, we expect 2019 will be a good year for this application.

--------------------------------------------------------------------------------

Edoardo Di Giamberardino, [30]

--------------------------------------------------------------------------------

Okay. So just to be certain, the 100 trains -- retrofitting of trains in the U.K., with Eversholt should be included in the deal you have with Alstom, that's right?

--------------------------------------------------------------------------------

Daryl C. F. Wilson, Hydrogenics Corporation - President, CEO & Director [31]

--------------------------------------------------------------------------------

The U.K. application is interesting. It's actually a retrofit application. So these are vehicles that were not actually manufactured by Alstom, but the customer has come forward and said, we like hydrogen so much, we want you to put fuel cells on our trains. I can't get into details about this activity, again, not wanting to speak for Alstom. But I think it opens the specter of a retrofit market that was not initially contemplated. The initial order with Alstom for 100 vehicles is focused entirely on the Coradia iLint, which is a unique Alstom vehicle. And so what you're seeing here is the next step out into a different product realm and business model in retrofitting existing trains away from diesel and toward hydrogen for electrification. So some of the momentum we're seeing here is municipalities engaging with Alstom and this is why making such a big deal out of milestones today. When Mayors of cities and transportation department directors can go and have a ride on a train powered by fuel cells and it works and it's in regular public service, the level of confidence represented in stepping over that milestone is dramatic. It's kind of the moment that removes all doubt. When you can go and experience the product yourself and it's a completely normal experience, that's when you remove all doubt. And that's a very significant accelerator in the sales cycle. And I think the U.K. situation is an illustration of how far customers are prepared to go and saying, we want this technology now. And we want it on our existing trains if that's possible. And it appears that it is possible. There are also other developments elsewhere in the world that would require other types of hydrogen rail platforms and those are now under serious consideration and design effort is being put into them. And the resource allocation on this application is going up, not just inside Hydrogenics, not just inside Alstom, but there are engineering firms and EPC contractors that are now investing time at very deep understanding of what can be done with hydrogen. And there are procurement processes that are unfolding that specifically name hydrogen as an alternative tenable pathway that could be bid in the procurement. Again, this is why I am making a big deal about milestones today. When you cross this milestone of having real commercial product in real public service, it totally changes the game.

--------------------------------------------------------------------------------

Operator [32]

--------------------------------------------------------------------------------

I'm not showing any further questions at this time. I would now like to turn the call over to Marc Beisheim for any further remarks.

--------------------------------------------------------------------------------

Marc Beisheim, Hydrogenics Corporation - CFO & Corporate Secretary [33]

--------------------------------------------------------------------------------

There being no other questions, we thank everyone, for your time and attention, and look forward to engaging with you in the next few days. Thank you very much. Cheers.

--------------------------------------------------------------------------------

Operator [34]

--------------------------------------------------------------------------------

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. And you may all disconnect. Everyone, have a great day.