Ballard Power Systems Inc. (BLDP) Q4 2015 Earnings Report, Transcript and Summary

Thank you for standing by. This is the conference operator. Welcome to the Ballard Power 2015 Results and 2016 Outlook Conference Call. [Operator Instructions] I would now like to turn the conference over to Guy McAree, Director of Investor Relations. Please go ahead.

Thanks very much and good morning everyone. The purpose of today’s call is to discuss Ballard’s fourth quarter and full year 2015 financial and operating results. And with us today we have got Randy MacEwen, our President and CEO and Tony Guglielmin, our 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. On today’s call, Randy is going to review our strategic progress in 2015 together with the outlook for 2016 and Tony is going to discuss Q4 and full year performance across key financial metrics. And then, we will open up things for Q&A. Before we start though, just a quick note that Ballard is going to be attending several conferences in the next month. We will be at the 20th Annual ROTH Conference in Danapoint, California on March 14 and 15 as well as the Sidoti Emerging Growth Convention on March 31 in New York City. So, we may see some of you at those events. Now, over to Randy.

Thanks, Guy and welcome everyone to our Q4 and full year 2015 earnings conference call. Our 2015 results were broadly in line with expectations with the exception of another challenging year in telecom backup power. Beyond the financial results, 2015 was an extraordinarily important year at Ballard. We made real and measured progress in key aspects of our business plan. As a result, we are very excited about our setup for 2016. As you recall, in start of last year, we redefined our customer-centric business strategy with the introduction of two growth platforms, power products and technology solutions. In our power products business, we now have four markets that we address. Heavy duty motive, where we offer fuel cell engines for buses and trains; material handling, where we offer fuel cell stacks to systems integrators for forklift truck systems, portable power, which is our plutonic subsidiary, where we offer power management products through military applications and telecom backup power, where we offer methanol and hydrogen-based backup power systems for telecom applications. In our second platform, technology solutions, we offer bundled intellectual capital and intellectual property solutions for customers seeking to accelerate and de-risk their fuel cell programs. This two-platform approach provides our business model with diversification and resiliency as well as technology innovation and cost leverage. We delivered a number of landmark achievements in 2015 in each of our two growth platforms. These achievements position us strongly for growth and improved financial performance in 2016 and beyond. In heavy duty motive, 2015 was an historic year. Ballard has of course been actively engaged in heavy duty motive market, primarily for fuel cell buses for 25 years. During that time, the number of fuel cell buses deployed worldwide has been fewer than 150 in total, primarily for demonstration in beta trial purposes. So, 150 fuel cell buses doesn’t sound like a big number and it isn’t, but what is big is accumulative learning that Ballard has uniquely amassed during these 25 years. Ballard has unmatched field experience with our fuel cell engines deployed in 20 cities worldwide under different weather conditions, operating conditions and duty cycles, logging more than 8 million kilometers with more than 10 million passengers in deal revenue service. During this time, we have taken accumulative learning and used this to continue to improve our market approach and our product offering. We are now on our 7th generation of fuel cell engine and continue to put distance, real road distance between us and competitive offerings. We are seeing growing interest in fuel cell technology for heavy duty motive applications in China, Europe, the United States and Japan. Fuel cell technology offers safe mass transit solutions that enjoy full route flexibility, high daily operating ranges, fast refueling, smooth and responsive acceleration, high fuel efficiency, high passenger comfort and zero tailpipe emissions. Reliability continues to improve while costs continue to decline. On reliability, I want to highlight a Ballard an industry milestone that was achieved in 2015. There are currently 8 buses being powered by Ballard fuel cell engines operating in London, England. Last fall, the fleet leader of these 8 buses passed 20,000 hours of service, a major durability accomplishment. On costs, our new HD7 module, which we commercially launched in 2015, represents a cost reduction of more than 30% from the previous generation product and a cost reduction of about 65% in this product line over the past 6 years. In September, we announced the planned development and 2016 deployment of new 30 and 60 kilowatt fuel cell engines to adjust power solutions for smaller buses and for hybridization and range extension. We are pleased to report that initial engines were shipped in December. So, we are tracking ahead of schedule of these new product introductions with high market interest, particularly in China. On China, in 2015 we had an unprecedented progress year in our China heavy duty motive strategy. Indeed over the past year, we have signed up over $48 million in orders in China. And let me emphasize this to ensure there is no confusion, orders meaning real binding purchase commitments for new business in China, not otherwise, not supply frameworks. This includes $17 million for the deployment of 300 fuel cell buses, the largest announced fuel cell bus project globally in history. This also includes $9 million of new business in two programs for the development of fuel cell tram engines in China with CRRC, the largest manufacturer of rolling stock in the world. These programs are progressing and are on schedule. In addition, we announced an exciting strategic collaboration with Xiamen King Long, the second largest manufacturer of buses in the world. And just to put their scale into perspective, King Long manufactures more than 35,000 buses each year. You can compare that with the North American transit market, which typically has about 5,000 buses each year. We also have additional discussions underway with other major players in China’s large transportation industry. So, we believe the progress we made in China in 2015 will contribute to significant organic growth in this segment in 2016 and in future years. In terms of the longer term outlook for the China heavy duty motive market, next month, the Chinese government is expected to release its 13th 5-year plan, which despite the dampening of China’s economic growth rate is expected to include strong commitments to match transit infrastructure, air quality initiatives and the reduction of greenhouse gas emissions. The air quality red alerts in Beijing late last year have punctuated the importance of air quality in China. We are also seeing the strengthening support in both Europe and United States for commercialization of fuel cell buses. In Europe, there were soft commitments made first by the supply side in November 2014, when 5 major European buses publicly stated bus companies, publicly stated their expectation to deploy between 500 and 1,000 fuel cell buses on European roads in the 2017 to 2020 timeframe. This was then followed in June 2015 by a soft commitment on the demand side, where more than 30 bus operators committed to be customers for these fuel cell buses. As a reminder, in Europe, one of our partners Van Hool won European Union Funding under the 3Emotion program last year for deployment of 21 fuel cell buses. We expect to start delivering engines for these buses later this year with most of them being shipped in 2017 and into 2018. As part of the Horizon 2020 program led by the fuel cells and hydrogen joint undertaking, there was a call in January, the 2016 call with the bid deadline for responding agencies set in May of this year. The call is for a minimum of 100 fuel cell buses with at least three cities having more than 20 buses. Expectations are for these buses to be deployed in 2018. In the United States in 2015, we announced that Ballard will provide modules to power 10 buses under the LoNo Vehicle Deployment Program and expect most of these engines to be shipped this year. We are also part of various consortiums that have submitted bids under CARB’s AQIP program for deployments in the 2017 to 2018 timeframe. In Japan, there is a strong government commitment to hydrogen economy. On the private side, Toyota is leading the way. Toyota is expected to manufacture 2,000 Mirai vehicles this year. We believe that Tokyo 2020 Olympics will be a catalyst for fuel cell deployment in Japan. We are currently collaborating on a Japanese market strategy and look forward to providing an update on this important activity later this year. So to summarize, Ballard is a premier brand in the fuel cell engines for heavy duty motive. We have unmatched field experience, powering a large majority of fuel cell buses in operation today globally. And we are seeing market demand spikes for fuel cell buses and train applications in China, Europe, the United States and Japan. We expect to drive strong organic growth in the heavy duty motive market in 2016, ‘17 and ‘18 with significantly higher market adoption ensuing. Let’s move now to second of our four power products markets, material handling. In material handling, Ballard has been a leading provider of PEM fuel cell stacks for forklift applications. Today, there are now more than 10,000 fuel cell forklift trucks in the field, most of them with Ballard fuel cell technology. While we saw unit volumes from material handling increase marginally in 2015, revenue was down slightly due to product mix. In 2015, Plug Power, our material handling customer had a record year and expects continued revenue growth and new customer bookings this year. Plug has done an excellent job with its customers, communicating the productivity value proposition, refining their product offering and customer experience. This has translated in a strong growth for Plug including repeat business with discerning customers like Walmart. As you may be aware in the United States, the investment tax credit was extended for 5 years through December 31, 2021 for solar. And we expect an extension for fuel cell to be approved in the first half of 2016 as well. If passed, this will provide good visibility for the U.S. market through 2021. At Ballard, we are working hard to continue to be a long-term stack technology supplier to material handling systems integrators, including Plug. We have been working closely with Plug on production planning, field issues and data exchange. We are also working hard on business development activities with forklift OEMs, who are considering the development of purpose built forklifts. As evidence of this emerging scene, we would note the comments provided by Hyster Yale just last week, during their Q4 2015 earnings call, in which they discussed their Nuvera fuel cell subsidiary. Saying that they expect to achieve quarterly breakeven operating profit by the end of 2017 or early 2018 on a run rate of approximately 700 PowerEdge units per quarter at target minimums. So Ballard is well positioned in both streams of opportunity in material handling markets. We remain the leading supplier of PEM fuel cell stacks for systems integrators in the global material handling market including Plug and are very well positioned to support forklift OEMs, as they look to develop and deploy purpose built forklifts over the coming years. Let’s move now to the third of our four power products markets, portable power. We added this market our power products platform in 2015 with the acquisition of Protonex, which closed in October. Protonex has already deployed over 4,500 of its Squad Power Manager or SPM kits to the U.S. Military. We are the leader in this fast growing market opportunity. In late December, we received a $2.8 million purchase order for SPM kits for end customer U.S. Army Ranger. We expect similar progress in 2016 and we expect Protonex to contribute about $20 million of revenue in our 2016 fiscal year. We are also expecting Protonex to achieve milestone C on the path to have the SPM product approved, as a program of record status, at which point SPMs will become a standardized purchase requirement for the army. If achieved, as expected in 2016, this will trigger significant scaling in this business. We are also excited about the progress being made at Protonex under two manned, unmanned aerospace vehicle or UAV programs. One within situ of Boeing company, we are integrating a fuel cell into the scan eagle platform and the second with Lockheed Martin, where our fuel cell system is being used and integrated with their next generation Desert Hawk. Finally, we now turn to our fourth market segment in power products, telecom backup power. This market has proven to be very challenging to penetrate in scale. The introduction of disruptive technology in the form of capital equipment, based on a lifecycle value proposition in a slowing and consolidated industry has been challenging for the fuel cell industry including Ballard. While we made outstanding progress in 2015 on foundational work, we nonetheless had a very disappointing year in terms of commercial scaling. As communicated during our Q3 conference call, we initiated a process to explore strategic alternatives for our telecom backup power business including a possible sale, joint venture, rationalization or orderly windup. While we are in active discussions with a number of potential partners for strategic transaction, there can be no assurance that we will be successful in concluding a transaction. We will provide an update on our strategic review of alternatives for this business, as events require. Let me now pivot to our technology solutions platform. In 2015, we closed an $80 million landmark deal with Volkswagen and we believe this was the most significant IP deal in the industry in last year. I would note that we had another extraordinary year in 2015 in terms of our performance under our engineering program with Volkswagen, where we exceeded many of our targeted technology milestones. We believe that our team has produced the world’s leading automotive fuel cell stack and has also developed new proprietary technology that positions Ballard very strongly with the automotive industry. The fuel cell automotive space has continued momentum in 2015. In addition to our landmark IP deal with Volkswagen, last year Toyota opened a web portal for Mirai sales, Honda announced plan to begin selling the Clarity in Japan, SAIC or in China announced its plan to invest $7 billion in new energy cars in China, including the development of fuel cell cars. While our technology solutions work with a number of global automotive OEMs has reinforced Ballard’s premier position in PEM fuel cells for the automotive industry. In short, Ballard is go-to fuel cell partner for the auto industry. As we turn to our overall 2016 outlook, our visibility is much clearer than it was a year ago. We expect to grow revenue, improve gross margin, complete our review of strategic alternatives for the telecom backup power business and rationalize our operating costs. On revenue growth, we started 2016 on a very strong footing. Today, we have the largest sales order book in Ballard’s history with $58 million of that order book deliverable in year. This already exceeds last year’s revenue. And here our definition of order book is very conservative, only includes confirmed, contracted purchase orders for products and services to be delivered in 2016. So as an example, it does not include any forecasted revenue for Plug for Q2 through Q4, as we typically receive purchase orders from Plug about four weeks prior to the start of each quarter. In addition to our order book, the qualified sales pipeline is the strongest in Ballard’s history. And our sales team will be working hard to increase the order book and the pipeline for additional deliveries throughout 2016 and into 2017. On gross margin improvement, we will continue to be disciplined in our pricing, pricing for certain power products remains relatively flat year-over-year given the value of our offering and our strong market positioning. We are also making good progress in 2015 on improving our pricing for new technology solutions last year. We will continue this trend in 2016. On the cost side, we continue to reduce product costs to support broader market adoption and gross margin expansion. We also continue to improve operating efficiencies and should start realizing supply chain and operating benefits from increased volumes in heavy duty motive later this year. So to summarize, we expect 2016 results to show improved gross margin performance, given an improved product mix, with important contributions from portable power, technology solutions in heavy duty motive and a relatively lower mix percentage from material handling and telecom backup power, where margins have been tighter. Finally, on operating costs, the review of strategic alternatives for our telecom power backup power business will result in significantly lower costs for that business regardless of the outcome. So, as a result, we expect to have a leaner power products platform going forward. With a leaner business model, we have taken steps to rationalize our executive team and initiate management renewal. As a result, three executives; Paul Cass, formerly our Chief Operating Officer; Dr. Chris Guzy, formerly our Chief Technology Officer; and Steve Karaffa, formerly our Chief Commercial Officer will be departing the company March 31. Responsibility of the departing executives have now been assumed by internal personnel. So, David Whyte has been promoted from Director of Operations to VP of Operations, flattening and eliminating duplication in our operations reporting structure. Dr. Kevin Colbow is now Vice President of Technology and Product Development consolidating with his current responsibility for technology solutions. And Karim Kassam is now VP Commercial also consolidating with his current responsibility for Business and Corporate Development. These organizational changes eliminate three C-level positions through rationalization and consolidation, while providing opportunity for fresh approaches in these important roles without compromising our capabilities. We want to thank each of the departing executives. Each of whom has demonstrated dedication and commitment and has worked hard to ensure strong leadership pipeline in each of their respective organizations. Of course, each of Kevin, Karim and David are already senior management members in Ballard, so there is no burn-in period required. In total, between expected costs reductions in telecom backup power and our executive cost rationalization, we expect annualized cost savings in excess of $4 million effectively lowering our breakeven revenue model by more than $20 million. So in summary, the hard work and successes experienced in 2015 will drive revenue growth, cost improvement and gross margin expansions in 2016 and will help position us for future profitability. With that, I will now turn the call over to Tony who will discuss Ballard’s fourth quarter and full year 2015 financial results in more detail.

Thanks, Randy. Good morning, everyone. I will provide a brief review of key financial metrics for Q4 2015 and the full year and also provide some additional comments on our outlook for gross margin and operating costs for 2016. Our top line revenue was $20 million in Q4, up 28% year-over-year due to an increase of 37% in power products, including $3.4 million from Protonex in the quarter, as well as an increase of 12% in technology solutions. On a full year basis, revenue was $56.5 million, down 18% from 2014. This was due primarily to a 38% decrease in technology solutions. It should be noted, however, that in 2014, technology solutions did include $8.7 million associated with the licensing contract in China that was subsequently terminated. And in 2015, technology solutions revenue was lowered by approximately $2.3 million reflecting the exchange rate impact of the weaker Canadian dollar on the VW contract. Now, recalling that this contract is denominated in Canadian dollars as costs to deliver the program are largely in Canadian dollars. For the full year, power products revenue was up slightly by 5%, reflecting a 133% gain in heavy duty motive to $12 million partially offset by a 9% reduction in material handling revenue and a disappointing 57% decline in telecom backup power revenue to $5.7 million. Just a couple of comments on heavy duty motive, as a direct response, a direct result rather than our response to market requirements, there is now some additional complexity in understanding and tracking metrics for our heavy duty motive product portfolio. Until midyear last year, we sold a single product, the most recent of which was the HD7 power module, which we launched last June to replace the HD6 module. Due to demand from our customers with different power levels for buses and trams as well as to localize assembly, we have introduced a broader portfolio of heavy duty motive products. This includes the fully assembled HD7 power module, but also HD7 parts kits along with fuel cell stacks. We have also developed and are delivering, as Randy mentioned, a range of different power configurations, including the 30, the 60 and the 200 kilowatt configurations. This introduces an element of complexity in tracking revenue and gross margin impacts for this market. We will endeavor to provide more transparency into these metrics as we move forward through the year. Turning to gross margin, gross margin in Q4 was up year-over-year to 19%, reflecting a change in product mix to higher margin revenue from portable power products with the close of the Protonex transaction, along with the increased technology solutions revenue. On a full year basis, gross margin was up 3 points to 18%. For 2016, as Randy mentioned, we are expecting a strong improvement in gross margin. Overall, for the year, we expect to achieve gross margin in the low to mid 20% range. Cash operating cost improved to 1% in Q4 to $7.7 million due to lower research and product development cost partially offset by slightly higher general, administrative and sales and marketing costs. For the full year, cash operating cost increased 10% to $29.1 million driven by higher research and product development cost and by slightly higher sales and marketing cost, which more than offset a reduction in G&A cost. Our Q4 also included a full quarter of operating cost for Protonex. So, as we look into 2016, we do expect operating cost to increase over 2015 reflecting the addition of Protonex partially offset by the cost reduction activities Randy mentioned earlier. We would expect cash operating costs for the year in the range of $35 million excluding any one-time cost. We would also expect to see lower operating cost in 2017 once we realize the full benefit of 2016 cost saving initiatives. Now, we will provide more details on these cost savings and associated one-time charges during the Q1 call and as we execute on plans during the year. Turning to adjusted EBITDA, adjusted EBITDA improved 82% in Q4 to negative $2.9 million and for the full year, adjusted EBITDA improved 18% to negative $15.3 million. Earnings per share in Q4 improved 91% to negative $0.01 per share and improved 80% for the full year to negative $0.04 per share. Now, Q4 and full year EPS reflect the gain on the IP transaction with VW. Cash used by operating activities increased to negative $10.6 million in Q4 consisting of cash operating losses of $4.6 million and working capital changes of $5.9 million. For the full year, cash used by operating activities was negative $25.4 million consisting of cash operating losses of $19.3 million and working capital changes of $6 million. Finally, in terms of liquidity, we ended 2015 with cash reserves of $40 million. This included net proceeds of approximately $29.5 million from the IP transaction with VW, the July equity financing with net proceeds of $13.4 million and the November strategic equity investment of $5 million from Nisshinbo Holdings. Our liquidity position was further improved in Q1 of this year, with receipt of approximately $3.3 million from superior plus related to a final payment associated with the December 2008 restructuring agreement. In addition, the second tranche of the intellectual property transfer with Volkswagen Group has now been completed. We expect to receive payment in the amount of approximately $9 million during this quarter as previously communicated. As part of this deal, we also extended our engineering services contract with Volkswagen through the end of 2019. To sum up then, with actions we are taking to address our cost base including the backup power situation combined with the strong growth in heavy duty motive and a full year of contribution from portable power, we expect improvements in all key financial metrics both top line and bottom line in 2016. So, with that, let me turn the call back over to the operator to take your questions.

Thank you. [Operator Instructions] Our first question comes from Carter Driscoll from FBR. Please go ahead.

Hi, good morning guys. Maybe starting in material handling, obviously some positive comments, as you mentioned from some of the forklift OEMs, maybe you talk about where you stand more specifically in terms of engagements there, is it potentially an event in 2016 or 2017 and how that relationship would, if you could contrast it with what you have currently with Plug Power, maybe from either an economic perspective or unit perspective in terms of the opportunity? And I have a couple of follow-ups.

Good morning Carter, it’s Randy here. Thanks for calling. First of all, of course Plug has been a long-standing customer of ours and we expect to continue to provide stacks for Plug well into the future. And I think, we strengthened our relationship with Plug significantly over the past year. So that’s a positive relationship and one we are working hard to continue to strive to keep good market share. As you know, they are developing their own internal stacks as well to mitigate silver lines on Ballard. That being said, in terms of our approach for the looking outside of systems integrators and looking at forklift OEMs that want purpose built forklift trucks, we made very significant progress in my opinion in 2015, deepening relationships with companies that we think will be potential winners in the long-term, very strong branded companies that are aggressively looking at this marketplace. In terms of financial performance for 2016, we don’t see any material contribution there. We do expect to make good progress this year in signing up technology solutions arrangements where we can support one or more of those partners to provide with them services and help develop a product. The scope of that product we can’t comment on, at this time. But we are very optimistic about our outlook for this segment and think we are very well positioned given the 10,000 units out in the field, primarily with Ballard fuel cell stacks and these systems integration capabilities we have as well. So we are an ideal partner for any of these forklift OEMs that want to de-risk and accelerate their programs. We have made good progress and we expect to see more progress this year.

Okay. So if I am hearing you correctly, you wouldn’t see this necessarily flow through the product side, but it could potentially lead to some tech solutions business. So if that is correct and we would also talk about potential for some other contracts on the technology solutions side, specifically in the transportation side, I know you guys have been engaged with several auto OEMs for a while now, maybe an update there and any potential, I think you had talked about some IP developments with your Volkswagen contract, is that the IP that you would be able to monetize, does that fall within the bucket of what you had transferred over?

Great. So just to clarify, we do see technology solutions opportunities initially with forklift OEMs. We see that over time transitioning to product sales. Just want to clarify that, Carter. But in 2016, we would expect to see that primarily as a TS contributor. In terms of technology solutions, we now have 26 projects underway as we start 2016, which is a record number of TS projects that we are working against. Quite a few of them are fairly small, but it’s a very good position for us and offers some diversification for us, as we start the year. Included in those 26 projects are some blue chip global automotive OEMs in I think about 15 or 16 of our customers this year are repeat customers. So we are seeing customers that we have done business previously with, are now in the next phase of their contracts or their programs and we are making good progress with a number of them. So we do expect to see some additional announcements later this year in terms of developments with auto, fairly large auto companies that are looking to accelerate their programs, nothing we can share today. This is a market that the customers are very sensitive about disclosure and we want to respect that. Similarly, with your question with respect to VW, there is certain technology that Ballard develops and that we have access to for the Ballard opportunities and then there is a significant portion of IP that we develop that’s specific to Volkswagen Group and is for their benefit. We don’t provide the details on that in terms of how that breaks out.

Understood, it’s good to hear on the tech solutions side. Maybe you could dove a little deeper into your and I realize you can’t provide too many details today, about your strategic review of the telecom backup power, but maybe whether you see that there is specific assets that you will be able to monetize, if I heard you correctly or whether this is a review of your current customer relationships, maybe a little bit more detail as to how you expect this to unfold or what direction you expect the review to take?

Going through the process as we have talked to potential acquirers or partners for this business, what’s been very clear to those companies, as they have gone through their diligence process is a couple of things. Number one, that in – for fuel cell applications methanol-based solutions are the preferred option as compared to hydrogen. Number two, for methanol-based solutions, Ballard its hands down the premier player in the marketplace. So they all have concluded those two aspects, which help to understand the position we have in the marketplace. We have about 3,000 units in the field today, for telecom backup power about 2,000 of them are methanol-based and so the partners we are talking to see that as very attractive. Our sales pipeline is about 3x of what it was this time last year. And we have had customer calls, as part of the due diligence process with a number of potential partners and our customers have validated the pipeline and validated the go forward sales assumptions. So that’s been very powerful. So in terms of the process, we started the process in Q4 of last year, we are well along into the process and we expect to have an update at the Q1 call, at the latest. But there is nothing definitive, we can report on now. And we can’t be certain that a deal will close. But we have had, I think very good progress to-date.

Thank you for that color. Just last question for me and I will get back in the queue. Maybe you can talk about some of the more recent potential engagements are within China for your HD motive opportunities, obviously you had a number of very successful wins in 2015, which will unfold in terms of revenue in 2016 and ’17, maybe you just talk about the environment you are seeing today and we are minus again, about some of the drivers specifically to the Chinese market may be between subsidy aspect and what’s really driving it from a cost perspective, as you look at the supply chain as well?

Yes. So I mean clearly from the macro perspective, strong government support there. You think about government support, it starts obviously at the federal government, but it cascades down. And each one of the cities that we have been talking to, we have met with a number of cities, have very strong mandates on air quality. And those mandates, they take seriously. They are part of the bonus compensation for a number of senior people in the cities. So they are very focused on air quality initiatives. And they are also very focused on continued deployment and build out of mass transit infrastructure. So those two variables are very important. So as you see a slowing of the Chinese economy, we still believe, based on the data points we are getting there, that spend will continue in mass transit infrastructure. So that’s very positive for us. And that the political will for air quality, now greenhouse gas emissions is very real there as well. So the macro drivers are strong. Our competitive position, as we set up for that market is unparalleled. The Ballard brand is extraordinarily strong in this marketplace. I can’t underline that enough. And as a result of that, every time we are meeting with a city, every time we are meeting with a large bus company, bus OEM or systems integrators, they are very interested in working with Ballard. The key is to figure out a business model and a financial structure that works for all of the participants. We think we have done that with the program that we have, where we look at a licensing model that has local partners, localized manufacturing of our fuel cell engines and localized supply chain. And there are a number of benefits to do that, including lower cost as well as elimination of duties. So, those all help the economies. It’s also important to have a significant part of the fuel cell bus to have local content. And so we are seeing that the drivers are aligned with the business model that we have embraced and this business model for us mitigates some of the risk. So, we are not taking all the market risk, it’s very much shared, in much cases market risk put on some of the partners. And the business model we have doesn’t expose us any IP risk. We are keeping all of the core IP. So, we like the business model, we like competitive positioning, we like the micro landscape in China and we see growth occurring. We have obviously announced some significant projects and programs. We need to execute against those both for heavy duty bus as well as our two programs for tram. In addition to that, we would expect to see additional cities announce projects in 2016. We expected to win a significant part of that business.

Thanks for all the color. It’s a great opportunity for you guys. I will get back into queue.

We are pretty excited about it.

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

Good morning and thank you for taking my questions. So, Randy, couple of weeks back in Germany at AABC, couple of the senior development executives from VW were saying both publicly and privately to their friends that there seems expanded programs, new programs, all the resources they could want and a lot of pressure from the board to achieve results on their alternative propulsion, fuel cell, battery, hybridized electric vehicle programs that they have been moving forward. Now, I know many of the milestones and much of the scope of your agreement with VW was mapped out well ahead over the increased scrutiny that they got because of the diesel emissions issue. Can you maybe discuss whether or not there is potential to see accelerating participation with this increase over at VW? How you look at this as a potential driver for the next year or two?

We see this as a potential driver not just for VW, but for all automotive companies. We think that there is this diesel issue has really catalyzed the industry to make sure they are looking at clean energy solutions more seriously. And so we expect to see expanded spend for fuel cell vehicles and battery electric programs as well. I will give you an example. In China, S-A-I-C or SAIC has just raised $2.5 billion to invest in both smart cars as well as fuel cell vehicles, whether those were kind of the two use of proceeds for that special financing they just did. And so you have in emerging markets a number of automotive companies looking at developing fuel cell programs in SAIC’s case actually accelerating fuel cell programs. Coming back to VW, we don’t comment on the details of their programs. What I can tell you is that the milestones – the technology milestones we had in 2015, almost in all cases, we did much better than those milestones. And the program had an outstanding year again in 2015 and we expect similar strong results in 2016. I believe that Ballard has designed the world’s leading fuel cell stack based on the top 6 or 7 metrics. I think we have world records in many of those categories. Unfortunately, we can’t share the details with you, but we are very bullish on where that technology is of how that’s get deployed, we don’t have control over. We do have control over the technology team winning the milestones and we have done a very good job on that, which hopefully is an indicator of – as the progress is high, that’s the indicator of continued investment and accelerated adoption of fuel cell vehicles for our customers.

Thank you for that. My second question is related to the pipeline, you were really constructive in your prepared remarks on the qualified pipeline, what you are looking at for 2016. Can you maybe give us a little more color, maybe more quantitative view on the pipeline where it sits today versus last year? If possibly you can share with us the dollar value of RFQs that you responded to or expect to respond to this year and how this compares to prior years?

Yes. So I mean, the order book, first of all, as opposed to the pipeline, Craig my $58 million is a significant factor from where we were a year ago. And we didn’t provide the order book at this time last year, but it’s more than double where we were last year. In terms of the order book, when you look at the breakdown of the order book, it’s very heavily weighted for heavy duty motive. It’s just slightly over half of the order book in the heavy duty motive. And then material handling, portable and backup power, collectively make up about 20%. And then about 30% is for the technology solutions portion of the order book. So, we have a very good weighting overall from heavy duty motive technology solutions and the other components of portable. So, we are happy with the, I’ll call it, weighting of that. It is heavily dominated by China in the heavy duty motive this year. But I do believe that in 2017 and 2018, you are going to see fairly significant contributions from Europe and the U.S. with Ballard fuel cell engines going into some of those programs that I described earlier that we are currently submitting for.

Great. Then, as a follow-up there, maybe you can answer this question. If we were to look at the total opportunity that you are targeting in 2016, what portion would you say you have already responded to the RFQs and done the significant engineering and sort of development work upfront. It’s already in. We are waiting for the clock to tick a little bit there versus things where your sales and marketing force needs to get out there and actually submit the final proposals?

Yes, most of the business for heavy duty motive in particular, I think you are commenting on for this year is in hand. In terms of, is there opportunity to bring more business in this year? There is. That opportunity is fairly limited in terms of the scope set as well as the timing pressure, so, the opportunity that we would need to square away in the next 60 days. So I think the way I think about heavy-duty motive is that, that’s pretty dialed in right now. Based on the strong order book we have and additional order wins this year, we would likely see move into ‘17 and ‘18.

Yes, I was going to say to supplement, Randy mentioned a couple of specific RFQs in Europe and in the U.S., but those absolutely would be more about 2017, ‘18 revenue as opposed to generating anything in ‘16.

Great, thank you for that. My final question relates to the cost out programs, so you have had some pretty impressive success over the last few years reducing the cost of your products allowing you to offer your customers a more compelling purchase price and helping the margin profile of the company. Can you maybe share with us major cost out items you expect to accomplish in ‘16? What the potential schedule is or approximate timing is for those to roll in and how should we look at that from a modeling perspective?

Yes, it’s Tony here. So, as we – you may recall, we talked about it in our Investor Day back in October about some programs that we have currently in place, some of them going out over the next 2 to 3 years both in terms of air cooled stacks or liquid cooled stack or HD modules. So we are looking at anywhere from 20% to 35% cost reduction over next 2 years to 3 years. As far as 2016 specifically, there will be some cost reduction i.e. from a modeling point of view. There will be a portion of those. Now, it would be a significant year for us, we just launched of course the new HD7 bus module this year. So we – that’s really baked in for all our 35% on our cost reduction that we introduced in June of last year in our HD7 module that will be reflected in all of our deliveries in HD7 this year. But, as far as the air cooled and liquid cooled stack, most of that development work is ongoing. We will probably see most of that in ‘17, ‘18 timeframe as opposed to ‘16. Randy, do you want to supplement?

Yes. Craig, in addition to that on the operations side, we will see some scales start to materialize both in our heavy duty motive as well as our stack business this year. So we will see some benefits from volume later this year as a result of the large programs for heavy duty motive, as well as for these recent stack announcements, we announced the $12 million order for our fuel cell stacks in China. If you put that on top of our existing stack business including Plug Power that adds a lot of additional stack demand in year. So those are our key points. We will also have a different product mix this year. So obviously, Protonex will be contributing for the full year, heavy-duty motive will be a higher percentage of revenue. We expect to see a good growth year and a good strong year on gross margin in technology solutions as well. We have – as we add new customers, our pricing has – we have improved pricing, particularly in U.S. dollar pricing. So we expect to see strong gross margin improvement in each of those segments and they are heavier weighted than they were in 2015.

Thanks again for taking my questions.

Thank you.

The next question comes from Rob Brown from Lake Street Capital Markets. Please go ahead.

Good morning. Thanks for taking my questions. I think you said on your – did you say operating expense line should be about $35 million in 2016, I just want to confirm that?

Yes. Our cash operating expense, that’s right about $35 million, up from about $29.1 million in this year. So up about $6 million, which is again Rob is basically the full year of Protonex less some of the beginnings of the benefits of cost reduction that we have started to initiate, so about $35 million.

Okay. And does that include – I guess that includes cost reductions, but that doesn’t assume any sort of sale or anything of the telecom business, is that right?

Yes. That would be correct. Yes. How we resolve the issue on the telecom backup power could impact our costs and our cash OpEx, you are right. And I should just mention I know, it wasn’t necessarily the direct question, but I mentioned earlier and obviously there will be some one-time costs associated with some of the recent announcements and potentially in backup power, so that would be exclusive as well as of any one-time charges so associated.

So Rob good morning and thanks for the question. I will just add one comment as Tony alluded to, the cash OpEx cost could vary depending on what outcome we have with backup power. The $35 million range though does include assumptions we think conservative assumptions on the outcome on backup power. So we expect to be in that range and it would take an unexpected outcome to move the needle in a negative way.

Okay, good. Thanks for the clarity there. And then moving to Protonex, I know you have got a good pipeline there and you had a good order in Q4, but can you give us a sense of the size of the potential opportunities pursuing there and sort of the timeline could they hit in 2016 or are there you have opportunities?

Yes. So obviously, we had a very important announcement at the end of December for Protonex. We expect to see a similar type of announcement in the first half of this year, of probably higher scale than what we saw there. So that’s going to be an important driver for Protonex in 2016. And as well, we are working very hard as you know to achieve the program of record status. So we expect to see a very strong growth year for Protonex in 2016 in the $20 million revenue range and expect to see on the strength, particularly of the program of record achievement that we expect. We expect to see a very strong growth year in 2017 as well. So all indicators are that each one of our market segments are setting up very strongly, not just for 2016, but for scaling in 2017 as well.

Yes. Rob maybe just if I could supplement Randy’s comment because as I was just thinking about your question on Protonex and more generally Ballard. We didn’t comment, so I didn’t specifically on the cadence of revenue through 2016. But the Protonex situation is not unlike what we have talked about in the past, which is the profile for revenue for Protonex is here is expected to be waited to the second half of the year largely reflecting some of these pending announcements. That would be equally the same for Ballard. So just as you are thinking about our full year revenue, certainly it would start to look not just similar prior years, which is more heavily weighted to the back half. And again that would reflect and be – that would Protonex revenue would parallel that as well.

I might just add to that, as well Rob that historically Protonex has usually had a relatively strong Q3. The third quarter, typically the U.S. government budget obviously ends September 30. So they have usually seen orders come in Q3 as customers relieve some of the budget opportunity they have.

Okay, good. That’s good color. And then last question on the tech solutions opportunities in the material handling market, could you give us a sense of what the sizes of those are will those fit in your sort of current run rate, those be would be materially incremental?

For this year, at this point, I would just assume that relatively flat for those markets. So we expect to see the growth drivers, the heavy-duty motive obviously, full year Protonex and those are the two big growth drivers that we would expect to see in 2016.

Okay, great. Thank you.

The next question comes from Amit Dayal from Rodman & Renshaw. Please go ahead.

Thank you. Good morning guys. Just touching on your comments on the material handling side, I know we have made a lot of progress on the heavy-duty side in China, are we doing anything in relation to building market share on the material handling side in the Chinese markets that should probably be a larger market for you guys as well?

Yes. So to be honest with you China has not been a priority focus for material handling at this point. We do see Japan, as potentially very active [ph] market for material handling. But China has a middle market that we have invested in at this time for material handling.

Got it. And in relation to the HDM business in China are we setting up ground operations over there, you have mentioned that this is an 3-year to 5-year opportunity, if not longer timeframe, are we hiring people in China, what’s the operational side of the execution that’s taking place over there?

Yes. So we have had in-country resources for 2 years now. And we feel confident with the team that we currently have in a very near-term. We do have a hiring strategy in China, both for sales and market coverage as well as for application engineering and services. And so that’s included in our $35 million cash operating costs that we commented on earlier.

Okay, got it. And you may have touched on this, maybe if you could confirm the $58 million in order book, is this to be recognized in the next 12 months or is that a longer time period?

That’s a 2016 order book. Our order book is actually longer than that. What we – our profile in the $58 million is the 2016 calendar year order book.

Okay, got it. Thank you. We have a much stronger balance sheet, you are going to add more cash to it, you have had – you have made acquisitions last year, you are little aggressive on that front, are we still looking at that as the key part of the overall strategy?

So as you noted, thanks for the comment. We obviously strengthened the balance sheet last year and as Tony alluded to, more cash coming in, in the first quarter with the superior transaction as well as the second tranche from VW. So that’s a significant add, a non-dilutive add for our balance sheet in Q1. In terms of M&A opportunities, we are still obviously going through the process of proving out the value of our Protonex acquisition. We are very excited about how we are setup for 2016 with Protonex. The integration of Protonex is substantially complete. There are some additional modest integration activities in 2016. But we continue to look at ways to grow and scale our business and expect to be active in this market in 2016.

Got it. Thank you. That’s all I have.

Thank you, Amit.

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

Hey, good morning. Most of my questions have been already asked, but just a couple on my end, Randy. On the review itself, is there any sense that, that’s delaying purchase orders or just carrying customers off, you seem to be optimistic saying that pipeline was 3x bigger than what it was before, which I find a bit surprising, I guess?

Yes. No, it hasn’t impacted customer positioning. We have been very clear with a couple of our large customers, where we expect to see volume orders in 2016 on what we are doing and the opportunity that we are looking at could actually strengthen the perform for our customers. And so that’s the way we have been positioning with our customers.

Just going back to the comment about the pipeline being 3x larger, is there any – has that evolved over the past 6 months? Is there any potential for you to reverse your potential JV or divestiture of the unit, given what seems to be a perception of an improved macro backdrop of interest levels at least?

Yes. So Jeff, the sales pipeline is clearly much larger than a year ago. The names that we have in the pipeline are high-quality customers and in many cases repeat customers. The volumes in the order book though in the sales pipeline, it still implies hundreds of units in 2016 rather than thousands of units. So, I don’t see any change in our view in terms of what the best strategic outcome is for us for this market. I think this is a market that will require some continued investment over a number of years before it can be profitable on a standalone basis at least the way we have been approaching it. And we wanted to approach this with high-quality, high-reliability product with the right ecosystem build-out, with the right investment in terms of how we are approaching the market from the service perspective. We have made that investment and that’s part of what we are seeing with potential acquirers or partners as well is that they are attracted to not just the product we have in the market positioning, but also the good ecosystem development work we did in the past year as well. So, it is a strong pipeline. It doesn’t lend itself though to the thousands of units in 2016 that we would need to see to give us a business model here that’s attractive.

Got it. Just a couple of other quick ones here. When you referenced the order book, is that – as you define order book, is that similar to what you folks used to report as committed backlog, is it the same semantics issue or is there any kind of accounting difference between the two?

There is no accounting difference between the two.

Okay, got it. That was my assumption. And then lastly just on the one-time charge with the actions taken here, any sense of scope how big that would be and I assume there is no cash impact with the one-time charge given it’s mostly personnel and not facilities, but I just want to confirm that?

Well, obviously, in terms of severance cost or cash cost associated with that. So, there will be cash and non-cash components of charges, but we will provide more visibility at the strategic review of the backup power winds up.

Yes, you are absolutely right. Thanks, Randy. I’d just say there will be some – these are relative to the changes that Randy referred to at the organizational changes. Those will likely get reflected in Q1 and we will be able to comment that. The charges that relate to backup power will be – fundamentally will be a function of what transaction or what decisions we make will likely follow in subsequent quarters, but we will be reporting those as we have our information, Jeff.

It sounds good. I appreciate it, guys.

Good.

Thanks, Jeff.

The next question comes from Craig Irwin from ROTH Capital Markets. Please go ahead.

Hi, thanks. I just – I wanted to ask some of the housekeeping questions that haven’t been addressed yet. Looking at the P&L, the fourth quarter, you obviously had some pretty good execution on your cost restraint. You are spending money now to sort of taper down the size of the team a little bit, consolidate accountabilities. As we look at G&A over the course of ‘16, should we expect low growth, modest growth, will we be tracking at levels similar to last year, how should we be thinking about SG&A?

Yes, it’s Tony here. The way we – it’s a great question. So, in terms of over – I alluded to earlier kind of the top line number in terms of some growth in the overall cost base largely associated with the inclusion of Protonex. The way we report our cost is we back – we kind of do it by a functional basis, so you look at research product development, G&A and sales and marketing. So, we split our cost base into those three activities. So, as we think about the way we reported and where the growth is coming from, there will be growth in all three areas largely associated with the inclusion of Protonex. So, G&A will pick up, the G&A portion of Protonex similarly for research and product development. So, there will be some modest growth in all three of the reported areas, but they will largely all be more – they will be more reflective of the Protonex being additive to them. So, think about – think about as I say roughly $6 million cash op cost give or take, as Randy was saying, it will be somewhat dependent on where we land on telecom. But it will be across all three areas. If not for of the inclusion of Protonex meaning the Ballard prior to Protonex, we would have seen some modest declines in each of the three areas reflecting some of the initiatives that we are taking.

Great. And then if we could talk more specifically about R&D, your R&D spend in the fourth quarter was a little bit lighter than we would have thought, I know that there is sort of volatility from quarter-to-quarter and you had Protonex in there. Should we think about this as sort of a new starting level for growth or should we be comparing to last year?

Yes. The research – well, it was shown as research and product development. There is a couple of things in there that do create volatility. One is the recalling that the labor force that supports the technology solutions group is really the same pool of people. So, as technology solutions rises and falls in the quarters, we will see a lower allocation of cost into conference. So, it’s difficult to look at a pure run-rate. And the other one is the – is that there are some, wherever there is some recovery, some tax recoveries, for example, in the government recoveries, and particularly in Denmark, where there is government funding that flows through that, those will be the kind of critical areas in RPD.

Okay, excellent. Now, just turning to the cash flow, can you maybe help us with your expectations for working capital needs, I mean, number of us like myself publishing forecasts out there are expecting some pretty robust growth this year. Would you expect to be able to match payables with receivables or will there be a little bit more of a cash contribution into working capital? And then as a second part of the question, do you see CapEx being a material item this year or is it likely to be similar to last year?

Yes. Just in terms of overall working capital, there will be – we are anticipating some modest use of working capital this year. Part of it is very much related to the timing of deliveries, particularly in the China heavy duty. So, depending on how those hit the books in the second half of the year, we could see modest increase in working capital requirements. But again, it will be more timing related. But I think more generally our expectation is that we should be able to manage, manage working capital inventory. We end up with a slightly higher than planned inventory at year end and we do anticipate some reduction in inventory through the year. But net-net, a modest increase in working capital is the way I would describe it for the year.

Okay.

Yes, as far as CapEx, our historical CapEx spend recently has been in $2 million to $3 million range for maintenance CapEx, not anticipating much significance. We are looking at this year at an upgrade to some of our systems, financial systems and so forth. So, we would likely capitalize some of those charges. So, you might see some of that flow into CapEx. There is a special project. But well, we will have a bit more visibility on that, but from a core CapEx not much different from last year other than potentially some investments in systems.

Okay. And then last question, you mentioned inventories, right, are there any specific opportunities that you see on the balance sheet was the few million dollar increase inventories in the fourth quarter something that needs to be sustained, because of the new product line, frankly speaking for Protonex or are there opportunities maybe to generate a couple of million dollars of cash off the balance sheet?

Yes, it’s the latter. Protonex inventory is not a significant issue there. They are much more of a build and ship model. The inventory opportunity for us largely relates to the telecom backup power. We have been carrying largely because of our lower than expected shipments, our inventory levels in the backup power had been higher than we had expected. We would expect to move through some of that inventory in the first half of the year.

Great. And then last question, with the increased focus on cost reductions on sort of leaning out on some of the expenses a little, does this change your EBITDA level for breakeven. And can you remind us sort of a scenario that you envision as the probable EBITDA breakeven point for Ballard?

Yes. The short answer is it does, it will reduce our breakeven. Randy referred earlier on your revenue basis with some of the cost reduction we expect to bring even our breakeven down by over $20 million from where it would have been before the cost reduction. But to get to that magical EBITDA breakeven number, at this point depending very much on gross margin. As we think about ‘17 with the lower cost base meaning benefiting from the full run rate of cost reductions this year and the improvement in gross margin, we are probably somewhere in the $100 million, $110 million range, it would be kind of reasonable ballpark for where we need to get to. Again with some – obviously it will be plus or minus depending on your assumptions on margin, but something in that range for EBITDA breakeven.

Great. Thanks again.

Okay.

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

Thank you, everyone for joining us today. We look forward to speaking with you again in April, when we will discuss the results for the first quarter of 2016.

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