Ballard Power Systems Inc. Q3 FY2022 Earnings Call

Thank you for standing by. This is the conference operator. Welcome to the Ballard Power Systems Third Quarter 2022 Results Conference Call. As a reminder all participants are in listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. I would now like to turn the conference over to Kate Charlton, Vice President, Investor Relations. Please go ahead.

Thank you, operator, and good morning. Welcome to Ballard’s third quarter 2022 financial and operating results conference call. With us on today’s call are Randy MacEwen, Ballard’s CEO; and Paul Dobson, Chief Financial Officer. We will be making forward-looking statements that are based on management’s current expectations, beliefs and assumptions concerning future events. Actual results could be materially different. Please refer to our most recent annual information form and other public filings for our complete disclaimer and related information. Before we discuss the quarter, I would like to provide an update on our Investor Day. Given scheduling challenges with our current priorities and recent additions to our senior leadership team, we have made the decision to reschedule our Investor Day to the first half of 2023. We will provide additional details early in the New Year. I’ll now turn the call over to Randy.

Thank you, Kate, and welcome everyone to today’s conference call. We made significant strides with our customers across various sectors in Q3, while also progressing our global manufacturing strategy and initiatives to reduce product costs. In Q3, we achieved $21.3 million in revenue, with about 57% coming from heavy-duty motive applications. This reflects our deliberate shift towards becoming a more product-focused company. Additionally, there has been a notable change in our revenue distribution across geographic markets from 2021 to 2022. Ongoing challenges and delays in the China fuel cell market have negatively affected our revenue for 2021 and 2022, concealing the growth we are experiencing outside of China. For the first three quarters of 2022, revenues in Europe, North America, and other regions rose by about 22%, while revenues from China declined by around 68%. In Q3, we secured new orders totaling $31.8 million, which improved our total order backlog to approximately $102 million by the end of Q3, primarily driven by orders from Europe, now accounting for over half of our backlog. Our backlog at the end of Q3 does not incorporate the letter of intent from Siemens Mobility for 200 fuel cell engines over six years. We are happy to share that we subsequently received a firm purchase order from Siemens for 100 fuel cell engines at 200 kilowatts each, which will significantly contribute to our Q4 order backlog. Our strategy focuses on developing PEM fuel cell technology applicable to various markets, where our technology provides strong value and the barriers to hydrogen refueling infrastructure are minimal. These markets include bus, truck, rail, marine, and specific stationary power generation sectors. We’ll provide a brief update on these applications. Our bus segment continues to show significant progress in Europe and the U.S. After securing platform wins with several bus OEMs over recent years, we anticipate these customers will provide stable repeat sales opportunities as transit operators deploy larger fleets to meet increasing mandates for zero-emission buses. This is reflected in our sales outlook, with multiple cities in Europe and the U.S. planning substantial deployments of fuel cell buses. There is persistent momentum in Europe for adopting hydrogen and fuel cell solutions, evidenced by recent announcements of extensive rollout plans across the continent. For example, transit operators in four European cities have planned to deploy nearly 300 fuel cell buses. Lacking carrier DPB is set to roll out up to 40 hydrogen fuel cell buses, and Polish transport operator MPK Poznan intends to purchase 25 fuel cell electric buses. These announcements complement existing plans from Cologne, Germany, and West Midlands in the UK, which aim to deploy 100 and over 120 fuel cell buses, respectively. We are confident that Ballard is well-positioned to support these initiatives throughout Europe, thanks to our robust relationships with OEM customers and end users. Similarly, the U.S. is witnessing a transition with California’s initial pilot projects now moving towards fleet deployment. For instance, Foothill Transit in California is deploying 33 fuel cell buses from bus manufacturer New Flyer, powered by Ballard fuel cell engines. This marks an exciting milestone as Foothill becomes the first transit agency in North America to fully deploy fuel cell buses as a mature product, rather than as part of a demonstration fleet. The 33 buses represent around 10% of their overall fleet. Supported by the Inflation Reduction Act and the Bipartisan Infrastructure Law, we are seeing a notable shift in momentum for hydrogen solutions in the U.S. We expect this trend to continue as initial capital allocations are made into 2023 for the $8 billion investment in U.S. hydrogen hubs. Looking at the truck market, we made remarkable progress this quarter. At the IAA trade show in September, we showcased our FCmove-XD concept engine for heavy-duty mobility, displayed in Quantron’s 44-ton fuel cell electric truck, which generated substantial market interest. During the quarter, Ballard received a purchase order from Quantron for 140 of these XD engines for deployment over the next two years. The rail sector also saw considerable activity this quarter, with our fuel cell technology providing a valuable zero-emission power solution for commuter trains on non-electrified lines. We entered two new geographic rail markets in Q3, announcing an initial order with train manufacturer Stadler for the first hydrogen-powered train in the U.S. and with Medha, a major rail systems integrator contracted by Indian Railways to develop India’s first hydrogen-powered trains. Alongside new rail customers, we’ve made significant progress in our multiyear collaboration with Siemens Mobility. Over the past four years, we have been developing a suitable fuel cell engine for the passenger rail market with Siemens. Following the quarter, we announced an order for seven trains and a letter of intent to supply 200 fuel cell engines over six years, including a purchase order for 100 of the engines. This represents our first commercial commitment and long-term supply agreement in rail, and we are eager to continue advancing this market with Siemens, which is now commercially selling Mireo Plus H fuel cell trains to European customers. This milestone is significant for both the industry and for Ballard. We also observe high levels of engagement in marine markets, particularly in our focus areas of coastal and inland applications. Securing DNV type approval for our FCwave product is a key differentiator for Ballard. We expect to initiate demonstration projects in 2023, including one of our flagship marine projects with a Norled ferry in Norway. In Q3, we identified increasing interest in the stationary power generation market. While still developing, we anticipate this segment will become a significant contributor to our business over the coming years. Now turning to key geographic regions, we have introduced our global manufacturing strategy, 'local for local'. We plan to establish scaled manufacturing of leading fuel cell engines and components within our main markets of North America, Europe, and China to support future growth patterns and volumes across our sectors. In Q2, we outlined our U.S. manufacturing plans with a new module manufacturing facility set to be operational in early 2023. We have also seen increased sales in North America, with revenue rising 80% quarter-over-quarter and 40% compared to Q3 last year. We expect sustained demand growth for our technology in the U.S. as announced policies, like the IRA, take effect over the next 12 to 18 months. In Europe, continuous policy support is evident, with the European Commission recently announcing over €10 billion for hydrogen projects, which will help lower the cost of low-carbon hydrogen, enhancing the competitiveness of our solutions. Under our 'local for local' strategy, we are continuously assessing manufacturing expansion opportunities in line with regional demand trajectories. We are confident in Ballard’s ability to capitalize on growing opportunities across European markets. Regarding China, we are optimistic about the long-term adoption of fuel cell electric vehicles for medium and heavy-duty applications. Our Weichai Ballard joint venture is developing fuel cell modules for the bus and truck markets, gearing up for high-volume production. The JV is beginning to see clear signs of advancement in the China fuel cell bus and truck sectors from both policy and market demand perspectives. We anticipate significant growth in the China market ahead of 2025 adoption targets, with a major surge expected from 2025 to 2030. We recently announced plans to invest around $130 million over the next three years in a MEA manufacturing facility and R&D center in Shanghai, supported by substantial incentives from local governments. This facility, strategically located at the Jiading Hydrogen Port within a key automotive cluster, will enable an annual production capacity of approximately 13 million MEAs, enough to supply around 20,000 fuel cell engines. This is expected to meet market demand in China, including from the Weichai Ballard joint venture for the bus, truck, and forklift markets, as well as other opportunities outside the joint venture scope. Planned operations for this facility are set for 2025. Together with our MEA manufacturing in Canada, this site is expected to meet our global MEA capacity requirements through 2030. Our investment aims to lower MEA manufacturing costs, align with China’s localization policy for fuel cell value chains, and strengthen the position of both the Weichai Ballard joint venture and Ballard in hydrogen fuel cell demonstration clusters and the post-subsidy market. We are also establishing an R&D innovation center at the same site to engage with China’s emerging local supply chain for fuel cell materials and components. I want to stress again that energy security is a top priority for China, as highlighted in the recent China 20th Congress. We view renewables and green hydrogen as significant beneficiaries as China accelerates its energy policy plans. We believe that China is on the verge of a substantial demand breakthrough as green hydrogen production and infrastructure expand significantly in the coming years, with our new MEA production facility coming online. Turning to our financial results for the quarter, we continue to encounter a challenging gross margin environment, which we expect will persist into next year. The downward pressure observed in Q3 resulted from a shift in revenue mix, the effects of pricing strategies, elevated fixed overhead costs, inventory adjustments, and rising inflation-related supply costs. We continue to forecast a challenging gross margin outlook through 2023 until production volumes increase and our product cost reduction initiatives are effectively implemented. Our guidance for total operating expenses and capital expenditures in 2022 remains unchanged, estimating between $130 million to $150 million and $30 million to $50 million, respectively. Our planned investment in China for 2022 is included in our current guidance range. The majority of the capital for the manufacturing expansion in Shanghai will be allocated between 2023 and 2024. We anticipate we will reach the upper limit of our operating expense guidance and the lower limit for capital expenditures for 2022. Given the macroeconomic landscape and in light of our 2023 operating plan, we are actively examining our ongoing operating and capital expenditure to ensure that we are adequately investing in our growth strategy while also tightening overall spending to manage cash flow. We are making significant progress toward our product cost reduction targets, aiming to cut our fuel cell stack cost by 70% from 2018 levels by 2024. We are currently ahead of schedule despite inflationary pressures. We will continue to pursue platform wins with customers across our key sectors. We believe Ballard is well-positioned with a solid balance sheet, industry-leading fuel cell expertise, and crucial partnerships with customers in our target markets. We are committed to making a substantial impact by offering zero-emission solutions to help our customers meet their decarbonization objectives. Now, I will turn the call back over to the operator for questions.

Thank you. The first question comes from Rob Brown with Lake Street Capital Markets. Please go ahead.

Could you provide some insight into what is driving the demand for the Siemens order in the rail market and the opportunities in that product category?

Yes, great question, Rob. What we’re observing in Europe is that commuter rail operators are seeking opportunities for decarbonization. In areas without electrified lines looking to shift away from diesel, the cost of the overhead catenary wire infrastructure is quite high. Consequently, we see a market with approximately 15,000 diesel trains needing replacement in Europe over the next 15 years, including around 3,000 in Germany. We're witnessing this transition, and Siemens is well positioned with their next generation fuel cell train, the Mireo Plus H, which they have been developing for about five years. During this time, we have also been developing our fuel cell engine. We recently demonstrated it at the unveiling of the train about a month ago, generating considerable interest in the market. We expect to see significant growth in this area. This is likely what has led Siemens to enter into a letter of intent with us for 200 fuel cell engines, and subsequently, a purchase order for 100 fuel cell engines due to the sales activity in their pipeline.

Okay, great. And then, on the China MEA facility, how do you see that CapEx investment rolling out? Is that weighted between ‘23 and ‘24 differently or is it pretty even?

Yes. I'll start with some initial comments and Paul can add to that. Regarding the capital expenditures, there are significant orders that need to be placed this year due to long lead times. The actual cash effects will mainly begin to be felt in 2023 and 2024, although some costs will appear in late 2022, which is already accounted for in our 2022 capital expenditure budget.

The next question comes from Aaron MacNeil with TD Securities.

Randy, as it relates to your MEA facility in China, you noted the capacity, the 13 million MEAs, 20,000 vehicles. I guess, I’m wondering what sort of productivity assumptions you think are reasonable, once the facility is operational in 2025? And then, what sort of data or news should we be keeping an eye out for to refine that view between now and then?

I think just with new facilities coming up, you’re going to see a period of time where things get optimized. We’re pretty excited about some of the initiatives we’re planning for that MEA production with some additional advanced manufacturing initiatives. So, from a utilization perspective, I’d expect it to be relatively low in 2025. But, as I mentioned earlier, we see a significant ramp from 2025 to 2030 in China, in advance of the 2025 targets that are out there, a number of cities and jurisdictions, provinces, and of course, nationally, there are targets for 2025 adoption. So, I think we’re going to see a pretty significant ramp from 2025 to 2030. I would expect utilization to be in the lower end of the range in the initial year, but it’s pretty significant adoption after that.

Switching gears a bit, Paul. In the past revenues have typically had a bit of seasonality, higher second half revenues versus first half of the year. I’m just wondering if that sort of anecdote holds, just given the decline in the 12 months order book this quarter. So, I guess, I know, you don’t give guidance on revenues. But even at a high level, should we see that sequential uptick in Q4, like we have in prior years?

We don’t provide specific revenue guidance. However, I can share the trends we have observed, particularly a shift in our revenue mix towards our products rather than technology services, along with declines in revenue from China. It’s difficult to rely on previous patterns continuing, not just in 2022 but likely in 2023 as well. We anticipate these trends will persist into 2023, with increased sales in Europe and North American power products. We expect a decreasing share of revenue from technology services, which are currently yielding lower margins. Nevertheless, we are acquiring new customers and entering into strategic contracts in technology services, with the aim of converting that into sales of power products and long-term revenue opportunities. To directly address your question, I wouldn’t expect past patterns to continue because our revenue mix is evolving.

Okay, makes sense. And I’ll jump back in the queue.

The next question comes from Rupert Merer with National Bank Financial. Please go ahead.

With the MEA plant you are building in China, you signed an investment agreement with the local government. And Randy, you highlighted there are some incentives from the local government. Can you give us some more color on what those look like?

The incentive package totals around $10 million, focusing on several areas such as capital expenditures and subsidized land costs. Additionally, there are opportunities for labor support, providing assistance across various cost categories. This comprehensive package was developed by the local government in the Jiading district of Shanghai after a year of collaboration with different jurisdictions on subsidy options, considering localization based on policies and regional clusters. Jiading is located in two of these cluster regions, which is noteworthy, as well as providing access to talent and research and development capabilities. Ultimately, we secured the most favorable package from Jiading District.

Great, thanks. And leading up to ‘25, sounds like you’ve got a little more visibility on how things can develop in the Chinese market. Can you remind us what the targets look like for 2025? And what needs to happen between now and then to kick start the market?

Yes, there are national targets as well as specific goals for provinces and cities. For instance, Guangdong aims to have a certain number of vehicles, particularly trucks and buses, deployed by 2025 and 2030, and similar targets are set for Shanghai and other areas. A key indicator of progress will be the scaling of hydrogen refueling infrastructure in these regions. Even during the challenging COVID period in China in 2022, fueling infrastructure continued to be developed, particularly in concentrated areas. I anticipate that in 2023 and 2024, there will be significant advancements in green hydrogen production, with active projects in China related to both green hydrogen production and electrolyzer scaling, alongside the rollout of fueling infrastructure to support larger fleets. Additionally, on the commercial front, we expect announcements for large-scale projects in different regions, such as a notable deployment of buses in Shandong. These are the types of developments we foresee over the next 24 months.

The next question comes from Mac Whale with Cormark Securities. Please go ahead.

Hi, Randy. I’m wondering with this local for local strategy, whether there’s a technology for overseas applications. I’m wondering if you could speak a little bit to whether there’d be a big cost advantage. Is that what you’re focused on? And if so, can you export, if there’s going to be sort of a tax impact there?

Thank you for the question, Mac. We are focused on designing our core fuel cell technology to be applicable across various markets and regions to achieve scale and benefit from both technological and cost advantages. On the technology side, we are observing rapid advancements in the supply chain in China. For example, we are testing and validating new materials and components for our manufacturing, which are part of our cost reduction efforts. It's essential to stay ahead in this dynamic market. We expect that a significant portion of our materials for engines and fuel cell modules, such as compressors and sensors, will increasingly be sourced from China. We are identifying the demand within China for our materials as well as leveraging our joint ventures to export modules and materials globally. Although there is an import duty on MEAs entering China, which will increase in the coming years, establishing domestic production of MEAs in China by 2025 will provide us a considerable cost advantage given these duties.

Okay, great. And then, following up, I’m not sure if it’s that related, but perhaps it is. It’s been a year now with Motive Solutions sort of under your management, I’m wondering, has the capabilities that brought resulted in the benefits you sort of expected a year ago? And how is that progressing relative to your original goals?

Yes, Mac, thank you for the question. I want to remind everyone that part of our goal is to simplify the customer experience and decrease barriers to adoption by integrating fuel cell engines into their vehicle platforms. We aim to collaborate with partners who provide various balancing components, like our work with Foresee Power for battery packs used in buses and trucks. We are also enhancing our in-house capabilities. The acquisition of Arcola Energy, now Ballard Motive Solutions, is assisting us in helping customers optimize their powertrains through substantial application engineering. Several customers have already received significant support and are engaging with us via Ballard Motive Solutions. Wisdom Motor, based in China, is exporting fuel cell buses and trucks globally, and we are supporting them with fuel cell engine integration. Similarly, we are providing extensive support to Quantron as they prepare to deploy fuel cell trucks into a growing market next year. These capabilities are effectively meeting the objectives we set at the time of acquisition.

The next question comes from Michael Glen with Raymond James.

Randy, regarding the investment in China, considering the existing joint venture there, is the increase in volume at the joint venture becoming more reliant on your ability to produce MEAs in China?

Yes. Michael, thanks for the question. It’s a very important point. It’s not by happenstance that our volume capacity at the MEA production facility planned in Shanghai matches very much the volume capacity for the JV from an engine perspective. And so, as I mentioned, the duties on imported MEAs will become a competitive disadvantage if we’re not in a position to supply the JV with local MEAs. So, this is a very significant development for the Weichai-Ballard joint venture to have low-cost domestic MEA access to MEAs, as well as doing it in a city, in fact, a district, Jiading that has exposure to two of the cluster regions. So, I think this is critically important for the JV. And we’re seeing significant end market interest at this time developing across the cluster regions now, as well as in Shandong Province. And we expect the ability to supply low-cost MEA to help the JV be competitive in the market.

And then, just on the order book, the number at the end of the quarter was $51 million, this is a 12-month order book. How do we use that number? Like what type of interpretation should we make about revenue over the next 12 months, when we look at that 12-month order book?

The key point for the quarter is that the total order book increased by 11% to $102 million, which is quite encouraging. This figure does not include the Siemens contract or the purchase order for 100 fuel cells from Siemens, which will be an addition. Regarding the 12-month order book, it decreased to $51 million, resulting in a net decline of 10. One major contributor to this drop was the shift of the remaining portion of the tech transfer agreement we have with the joint venture to a timeframe beyond 12 months. We are currently renegotiating the scope of that remaining contract but fully expect to recognize that revenue moving forward. The timing may vary over the next couple of years, with some expected to come in 2023 or 2024. Overall, we are seeing the revenue trends we discussed earlier in 2022 continue into 2023. We aim to add more strategic platform customers in both TS and product opportunities. The solid growth in the total order book is the most significant and encouraging point for me.

Yes, I’d like to add one point. One of the things that’s really encouraging to me is the ability of the Weichai Ballard joint venture to develop and design fuel cell modules for the bus and truck market. This capability has actually advanced much faster than we originally envisioned, requiring less support from Ballard at the joint venture level. Consequently, the product portfolio being developed by the joint venture has significantly shifted. We are currently evaluating how to support the joint venture moving forward with an expanding portfolio of fuel cell modules of various sizes and how we can incorporate that portfolio into the Ballard product roadmap. There’s a lot of important work ahead over the coming months with the joint venture to align the paired portfolios for efficiency, but the joint venture's ability to quickly design modules is very impressive.

Okay. Thank you.

And the next question comes from Alex Kania with Wolfe Research. Please go ahead.

Thank you for taking my question. Could you elaborate on the pricing strategy mentioned in your prepared remarks and how it relates to the competitive landscape, particularly in markets like China, North America, and Europe?

Yes. It’s a great question. Let me comment a little bit and just remind everyone kind of where we are as an industry. So there is lots of policy support in Europe, in the U.S. and in China for the adoption of green hydrogen. In the U.S. and Europe and particularly we are now starting to see advancing towards specific support for the applications. And so I think there is a recognition that there is a lot of policy and a lot of emphasis that’s been placed on the supply side for hydrogen, but not enough emphasis and policy on the demand side. And so, as a result of that, the end users still don’t have a strong value proposition when you are talking about hydrogen fuel cell engines and battery packs and storage, et cetera, that are in low volume for these applications. So, high cost, low volume. So, our strategy has been very deliberate to enable the end users to adopt early stage demonstration projects, to enable OEMs to develop their platforms and make investments with their platforms. And effectively, all parts of the value chain and the ecosystem really leaning forward on the cost structure in order to get these early vehicles out in the field, accelerate adoption, get field experience, and start moving from demonstration projects to scale deployments, which we’re now seeing with our Quantron order, and with our Siemens order, and with the bus commitments that we’re seeing. And so early stage still, but as we move to higher volume, and as our product cost initiatives take hold, we see cost reduction in excess of selling price reductions, which will translate to gross margin expansion, at the same time that we’re seeing better absorption of our fixed overhead cost structure. So, it’s been a very deliberate and strategic pricing strategy in a market where the value proposition is still emerging in low volume at high cost, and where competition, who are not as well positioned as Ballard are very aggressively trying to pursue platform wins.

The next question comes from Craig Shere with Tuohy Brothers.

So, apart from technology advantages, do you have a sense, given your new planned MEA facility in China and your Weichai JV, for just how much of the hydrogen equipment or fuel cell equipment domestic manufacturing, you’ll be representing in country?

There have been some interesting reports published regarding the total production of fuel cell technology globally at the end of 2021, and we expect to see something similar at the end of 2022 and 2023. There haven’t been many forecasts about what that will look like in 2025. Announced projects contribute to some forecast information. In my opinion, in the Chinese market at this scale, we will likely be one of the largest MEA manufacturers in China and also one of the largest manufacturers of fuel cell engines announced at this time. Other companies, like Johnson Matthey and Umicore, are looking to localize in China and have made some announcements. Different parts of the value chain are entering the Chinese market as well. However, when considering fuel cell engines and MEAs, this probably reflects the largest announced plans for MEAs, especially from international companies entering the domestic market. It is very challenging to obtain information on domestic companies that are not making similar announcements, particularly private companies.

Understood, definitely helpful. And my last question, do you have any rough thoughts or bookend outlook for the progression of perhaps a wind-down of Technology Solutions revenue in the ‘23 and ‘24?

Yes. If you kind of look at TS revenue over the last number of years, it typically until recently, has been around the $10 million mark typically. And you see that stepping down in 2022 as some of our key projects shift and in some cases come to an end of program, like the Audi development work. So, I do think you’re going to see TS comprising a relatively immaterial percentage of our overall revenue, as you look out to 2025 and beyond. But an important part of the revenue, and I say that because it’s seeding new customer relationships, and supporting the fuel cell dreams of customers that are looking to commercialize fuel cell technology and don’t have in-house capabilities. And transitioning them over time, like we’ve done are doing with Anglo, like we’re doing with Siemens, like we’re doing with other customers, to purchasers of our fuel cell engines, we see as an important seeding opportunity. So I would expect it to be below $10 million in revenue going forward. There may be periods where there are significant activities, but we don’t see that the size and scope of programs that we’ve had historically translate moving forward.

The next question comes from Jeff Osborne with Cowen & Company. Please go ahead.

Couple questions on my own, Randy. I was wondering on the gross margin trajectory, a lot of questions on that, and I’m sure it will come up at the Analyst Day as well. Just relative to the targets that you had laid out a year and a half, two years ago, at the prior analyst day at 20% to 30%, I was wondering, is the right way to think about the progression towards breakeven. And then ultimately, those goals out to the end of the decade, I believe it was entirely driven on revenue levels or mix, or is pricing a bit more of a headwind? I’m just trying to understand even getting from negative 20% to 0, what that looks like, and is that even achievable in the next 12 to 18 months?

Yes, sure. Great question, Jeff. And you’re right, we’ll have a lot more to show you on the bridge to stronger gross margins in the 2025, 2030 timeframe at the Investor Analyst Day, so look forward to that. Certainly, if you look at gross margins for this quarter, there were some one-timers I would characterize them as these types of things like inventory adjustments, when you’re in a very dynamic market with product changes and supply chain disruptions. It’s a difficult fact pattern. That could continue over the next year or two as well. But, I do think we’re going to see, as volume increases and as our product cost reduction starts to translate into production. So not just in the labs and in development activities and qualifying activities from materials, but actually moving those materials into production, we do expect to see significant cost reduction that’s going to help significantly. And as those volumes materialize, we’re heavily burdened right now with our fixed overhead cost structure relative to low volumes. So, we do see a pathway to more exciting gross margins that help imply a sustainable business model. And we’ll provide that bridge in more detail as we move out to the call next year as well as the Investor and Analyst Day. Paul, if there’s anything you want to add to that?

I believe you've touched on all the important aspects, Randy. Establishing strong strategic relationships with significant high-quality customers and collaborating with them on their initiatives is crucial. As we anticipate an increase in volumes, we expect prices to continue decreasing, but costs should drop at a faster rate, leading to expanded margins. Additionally, inventory management has been extremely challenging for all companies, especially considering the external factors like COVID, supply chain disruptions, freight costs, and longer lead times due to availability issues. On top of that, we are making strategic investments in new next-generation products, which will lead to some older parts becoming obsolete. This transition will impact gross margin percentages more significantly at lower revenue levels. Looking ahead, we continue to anticipate occasional revenue fluctuations, possibly even at year-end for our business. However, the impact of these on gross margin will diminish as revenues increase.

Jeff, one thing I want to add because you did ask about pricing too is that, we are seeing different pricing dynamics in different verticals. And I think that’s going to play out significantly as well, particularly as some of the larger opportunities in marine and stationary start to contribute more heavily in the revenue mix in the future.

So, just to follow-up on that point, it’s safe to say that trucking is the most aggressive of everything you focus on?

Yes. You are absolutely right.

Followed by bus and then…

Yes.

Okay. And then just a nitpick question, but could you quantify what the import duty is of MEAs from Canada into China? I’m just trying to get a sense. It sounded like you were sharpening your pencil on CapEx and OpEx for next year just in light of everything going on. And so, I guess the only pushback it would have is if that’s a relatively small number, maybe why not wait to ramp up China in 2026 versus ‘25 given the past two to three years have been a bit of a disappointment relative to the expense and time that you personally put into that facility with Weichai?

Yes. It's a valid point, and we had extensive discussions about the optimal timing for this investment. Currently, the import duties are quite low, around 3% to 5% for imported MEAs. However, we expect these rates to increase to 8%, 12%, and 15% by 2025, according to our gathered information. This is significant for a price-sensitive market like China. Therefore, we believe that moving forward in 2025 is the right decision based on these factors.

Remind me, MEA is what 40ish percent of the stack cost, give or take?

It’s about 60% of the stack cost.

60. Okay. Great. Thank you.

Yes. You’re welcome.

The next question comes from PJ Juvekar with Citi. Please go ahead.

Yes. Hi. Good morning, Randy. The IRA in the U.S. creates a significant tailwind with production tax credit and the $8 billion investment in hydrogen hubs, how would Ballard take advantage of that? And were there any plans or strategies that you put in place in the last eight weeks, since the IRA was passed?

Yes. Thank you for the question, PJ. We are actively collaborating with partners on hydrogen hub submissions and will find out next year where the hydrogen hubs will be announced. There is considerable discussion regarding the number and locations of these hubs, and it could be five, six, or possibly even more. We anticipate a high level of collaborative engagement in the upcoming weeks as hydrogen hub activities, including submissions and responses, will unfold throughout next year. Our involvement from the collaboration perspective is strong. We have a successful history of delivering fuel cell technology and modules across various applications. The bus market is a key focus, but we are also seeing significant interest in the truck market. Although we do not produce hydrogen or operate fueling stations, these applications require offtake. There is currently more activity than ever in both Europe and the U.S. regarding the alignment of hydrogen supply and application demand, leading to offtake commitments. This is where Ballard fuel cell technology can make a significant impact.

Thank you. And secondly, your strategy was to make MEAs in Canada, and then export them around the world, including Europe. And now that you will be exporting out of China, what is the competitive situation or where does Canada fall in the cost curve for MEAs? Thank you.

Yes. Just to be clear, we have a lot of flexibility in our MEA supply after 2025. So today, through 2025 100% of our MEA demand comes out of our MEA production capabilities here in Vancouver. After 2025, we have the option to supply global demands, not just China demand from our Ballard MEA facility in China, as that comes up. We also, of course, have the continued capacity here in Vancouver. So, I think this provides us a lot of resilience. Some markets may have preferences for local demand. And we’ll have to see how that plays out, as we move out to 2025 to 2030, but we think we have the right volume, aggregate volume, as well as the right flexibility in our business model, as we move out from 2025 to 2030 and the scaling that will occur across the verticals across the regions during that time period.

Randy, I guess, my question actually was, would Vancouver be much higher costs in terms of MEA manufacturing compared to China?

Oh, sure. I apologize for not understanding your point earlier. Vancouver is not a manufacturing hub. If starting from scratch, you probably wouldn’t choose the current manufacturing setup we have in Vancouver. We will maintain prototype manufacturing capabilities there. As we pursue larger scale, our advanced manufacturing efforts in Vancouver will also be leveraged in lower-cost regions. We are seeing significant opportunities for reducing both material and labor costs in plate and MEA production. In terms of localization in China and the advanced manufacturing projects there, we are establishing a highly automated MEA production facility that will yield cost benefits. Most costs for MEAs come from materials, with labor being a relatively small part. However, when costs reach a level where saving even small amounts becomes crucial, our MEA manufacturing facility will put us in a strong position.

Next question comes from Greg Wasikowski with Webber Research.

Randy, you mentioned that your combined capacity from the facilities in Vancouver and Shanghai will support your projected MEA demands through 2030. However, you are also exploring potential local facilities in Europe, which seems logical. I'm curious, if you move forward with that and announce a facility in Europe, how should we interpret the impact on your three existing facilities? Will there be lower utilization across all three, or could it result in a later production target for the smaller facility in Europe? I'm interested in understanding if this would be considered extra capacity.

Let me be very clear that we at Ballard are fairly vertically integrated in our manufacturing. So, we design and manufacture the MEAs. We just talked about we design and manufacture the bipolar plates. We design and manufacture our fuel cell engines. So, as we look at markets, one of the key questions we look at is what scope of work, what scope of manufacturing needs to go into that specific region. So, as we look at Europe, I think our current model is looking at manufacturing of fuel cell engines in Europe. I don’t see a need from a volume perspective, absent any mandated local MEA policies in Europe, I don’t see a need for us to scale MEA manufacturing capacity in Europe on top of our current plans. What we are looking at for Europe is a much lower CapEx investment around the fuel cell engines for the key markets where we’re seeing demand in Europe. So bus, truck, rail, and marine are the four markets. So, we’re doing that already today with some investment in our existing Denmark facility for the marine space. And as we look at the bus, truck and rail market start to scale in Europe, we’ll look at other markets, low-cost, access to high talent, access to end customers, access to OEMs, access to supply chain, and strong policy support and subsidy support from local governments. Those will be the variables we’ll look at as we determine the right scope of manufacturing and the right location and timing.

And then, for my follow-up, you mentioned you’re seeing pretty strong demand on the marine side. Is that purely from boats and vessels, or does that include some of the clustered infrastructure in the ports as well, like support vehicles or hotelling, et cetera? Or does that kind of roll into stationary power? Just curious how you’re seeing those demand clusters kind of develop and evolve here, and how you’re ultimately bucket them and plan on organizing them in your financials?

Yes. I would say the answer is yes. Across all those different opportunities, there is a lot of interest. And I want to caution, of course, it’s early stage interest, right? So, we still need to get marine vessels on water where we are providing propulsive power. But we do see applications for onshore power. This is a number of different regions that are expressing interest in this. So, there is a lot of engagement right now. This cool ironing opportunity, as it’s sometimes referred to as, is something that we see growing from 2024, 2025 onwards through 2030. But there is a lot of work that has to happen with these ports and with these clusters in Europe and in the U.S. for that matter and in China, where we expect to see a very large fuel cell marine market as well by the way. So, I think we are going to see marine applications develop in a number of market segments. And we are going to have to be very selective in which market segments our products apply to and our sales qualification process to make sure we are pursuing the high-value opportunities.

Got it. Okay. Thanks, Randy.

The next question comes from Kashy Harrison with Piper Jaffray Sandler. Please go ahead.

Good morning and thank you for taking the questions. So, just first one for me, with respect to the Siemens announcement, can you give us a sense of how to think about the dollar value of the purchase order? And then, part and parcel with that, when you expect to convert that backlog into revenue?

Sure. So, I think, kind of an easy way to think about it, Kashy, is that the metric that’s used in the industry overall is roughly speaking $1,000 per kilowatt. What I would say is, this is a rail application. This rail application has very onerous codes and standards, the shock and vibration requirements, packaging, et cetera. So, the rail market, you see a significantly higher selling price as a result of that. There is obviously significant higher costs associated with that as well. So, if you just did a crude kind of $1,000 times 200 kilowatts per module times 100 engines, you end up in the $20 million range. This is significantly higher than that.

Got it. We’ll look for that when you report next time. And then just maybe a question about the strategy with opening an MEA facility in China. How do you think about just the risks surrounding IP? And then, maybe just more broadly, how are you thinking about the geopolitical risk of opening a facility in China, just given the globalization trends we are currently seeing and rising friction between the east and the west?

Yes. I think it’s a very important question. It’s something we spend a lot of time, as you might imagine, assessing the geopolitical risk. And actually, in some ways, the geopolitical risk that’s really entrenched on the China side, their clear mandate to reduce dependence on imported energy and certain imported technologies, et cetera. And so, we do see renewable energy plan a very large portion of the grid mix in China, increasingly as you move forward. And we see hydrogen as a very key enabler for China to promote energy security. And so, we do see China as a long-term largest market for hydrogen and for fuel cells. And in order to play in that market, you need to make investments in country. If we look at our ability to assess kind of what the geopolitical implications are with assets in China, we got comfortable, as many other international companies are as well, at this time, I mentioned a few that are also investing at this time. You also have other companies like BASF, a large chemical company that’s making significant investments in China. So it is a risk and something we considered, and something that as we think about our other markets as well. Having production capacity in multiple locations, we think is going to be a very important risk mitigator to our business plan in the future, in ensuring we have business continuity, is critical. And so, I think this idea of having local for local, with the right scope of work in country, and making sure we have the opportunity to supply local demand with local production will be quite valuable.

Thank you. The next question comes from Craig Irwin with ROTH Capital Partners. Please go ahead.

So Randy, you guys have done a really good job on cost out over the last many, many years, right, leading the industry. Because of that, right, the technology and the approach. Can you maybe talk a little bit about that go forward on your 70% cost reduction goal? How much of that is dependent on further refinements to things like system design versus component selection and component sourcing and volume, which seems to be the emphasis of the conversation today, as you look at building out some new, very large, highly automated facilities?

Yes. We’re well along on this Craig, and thanks for the question. We have invested significantly historically in product improvements, while at the same time reducing product cost. And I think the work that’s happened over the last few years and will happen over the next few years will be the most important in the Company’s history, both from a performance perspective, as well as from a cost reduction perspective. And we see very encouraging new developments that were never contemplated in our 70% cost reduction, that I think will be very additive, not just at the MEA level but as we look at modules as well. We’re seeing significant development in the supply chain there for balance of plant components. So we’re very optimistic all around there. The 70%, 3 by 3 program, Craig, that you’re referring to, 55% of that 70% is already realized. So we have a very small portion to go here over the next period. So, we see a lot of confidence on getting beyond that 70%. We’re certainly tracking ahead of program at this time, and also some of these additional developments in 2022 that could have major cost implications for us, as we move forward as I said that were previously contemplated. I think this is going to be one of the strongest stories that the industry will have with this cost reduction of fuel cell technology.

Excellent, excellent. So, my follow-up question then is $1,000 a kilowatt was a sort of rule of thumb you used earlier in the call and that’s a number we’ve been tossing around, gosh, I think around 10 years at this point. Can you maybe talk about the opportunity for that to come down over the next couple of years as you maybe use a little bit of strategic pricing and balance the improvements in cost from margin versus customer price?

Yes. And to be very clear, it’s come down below that materially in the bus market already, and in the truck market. So, the strategic pricing that we talked about earlier isn’t at those historic, elevated levels. So, it’s happening already, but we do see and we’ll talk about this in detail at the Investor and Analyst Day, a really compelling pathway below possibly some of the DOE benchmark expectations for the truck market as an illustrative example. So, we’re very encouraged by what we see. And this will translate to not only pricing reductions for customers over the coming years, but more importantly, higher cost reductions that will enable, I think, material gross margin expansion.

This concludes the question-and-answer session. I would like to turn the conference back over to Randy MacEwen, CEO for any closing remarks.

Well, thank you for joining us today. We look forward to speaking with you next quarter.

This concludes today’s conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.