Ballard Power Systems Inc. (BLDP) Q3 2022 Earnings Report, Transcript and Summary

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. [Operator Instructions] 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 important customer progress across our verticals during Q3, while also advancing our global manufacturing strategy and product cost reduction initiatives. In Q3, we delivered $21.3 million in revenue with approximately 57% of our revenue coming from heavy-duty motive applications. This highlights the ongoing intentional shift in our business towards an increasingly product-focused company. We also note, there has been a significant a change in our revenue mix by geographic markets in 2022 as compared to 2021. Continued challenges and delays in the China fuel cell market have adversely impacted 2021 -- 2022 revenue, and have masked the underlying growth we are seeing outside of China. For the first three quarters of 2022, revenue for Europe, North America and rest of world is up approximately 22%, while China revenue is down approximately 68%. In Q3, we secured new orders totaling $31.8 million. This activity improved our total order backlog bring it to approximately $102 million at the end of Q3. The increase was primarily driven by European orders, which now make up over half of our total order backlog. Our backlog at the end of Q3 did not include the LOI from Siemens Mobility to supply 200 fuel cell engines over the next six years. We’re pleased to report that subsequent to the quarter we’ve now received a firm PO from Siemens for 100 fuel cell engines at 200 kilowatts each. This order will be reflected as a material addition to our Q4 order backlog. Our strategy is to develop PEM fuel cell technology and products that can be applied across multiple market applications, where our fuel cell technology provides the strongest value proposition and where the barriers to hydrogen refueling infrastructure are lowest. These markets include bus, truck, rail and marine, as well as select stationary power generation markets. We’ll provide a brief update for these applications. Our bus vertical continues to see important progress in Europe and the U.S. After having secured platform wins with a number of bus OEMs over the past few years, we expect these customers to provide sticky repeat sales opportunities, as transit operators begin to deploy larger fleets in the face of increasing mandates to transition to zero emission buses. This is now playing out in our sales outlook with multiple cities in Europe and the U.S. now planning the largest deployments of fuel cell buses in history across these markets. There remains strong momentum in Europe for adoption of hydrogen and fuel cell solutions. Recent additions indicate larger rollout plans across the continent. For example, European transit operators in four cities have announced plans to deploy almost 300 fuel cell buses. So, lacking carrier DPB is rolling out up to 40 hydrogen fuel cell buses and polish transport operator MPK Poznan plans to purchase 25 fuel cell electric buses. These announcements are in addition to existing plans from Cologne, Germany and West Midlands, UK plan to deploy 100 and over 120 fuel cell buses, respectively. We’re confident Ballard is well-positioned to participate in supporting these plans across Europe through our strong OEM customer and end user relationships. We’re seeing a similar transition in the U.S. with California initial pilot and demonstration projects are moving to fleet deployment. An example of this transition is Foothill Transit, a California bus fleet operator in the LA area, deploying 33 fuel cell buses from bus manufacturer New Flyer powered with Ballard fuel cell engines. This is an exciting milestone, as Foothill will be the first transit agency in North America to deploy fuel cell buses on a full deployment as a mature product versus a demonstration fleet. The 33 buses will represent approximately 10% of their overall fleet. Supported by Inflation Reduction Act and Bipartisan Infrastructure Law, there’s been a tangible shift in momentum for hydrogen solutions in the U.S. We anticipate this momentum to continue as initial capital allocations are made into 2023 for the $8 billion of investment in the U.S. hydrogen hubs. Now, taking a look at the truck market. We made exciting progress this quarter. At the IAA trade show in September, we unveiled our FCmove-XD concept engine for heavy duty mobility, displayed in Quantron’s 44 ton fuel cell electric truck. Our new product was met with significant market interest at the show. During the quarter, Ballard received a purchase order from Quantron for 140 of these XD engines to be deployed over the next two years. We also had a very busy quarter with respect to the rail market, as we see the value proposition of fuel cells and certain rail applications driving long-term adoption. As an example, our fuel cell technology offers a compelling zero emission power solution for commuter trains on non-electrified lines. We entered into two new geographic real markets in Q3. We announced an initial order to train manufacturer, Stadler, to support the first hydrogen powered train in the U.S.; and to Medha, a leading rail systems integrator contracted by Indian Railways to develop India’s first hydrogen powered trains. In addition to signing new rail customers, we made meaningful progress with our multiyear collaboration with Siemens Mobility, as noted earlier. Over the past four years, we’ve been developing a fit-for-purpose fuel cell engine with Siemens Mobility for the passenger rail market. Following the quarter, we announced an order for seven trains and an LOI to supply 200 fuel cell engines over the next six years, including a purchase order for 100 of the engines. This marks our first commercial commitment and long-term supply agreement in rail. And we look forward to progressing this market with Siemens Mobility, as they are now commercially selling Mireo Plus H fuel cell trains to European customers. This is an important milestone for the industry and for Ballard. We continue to see high engagement levels in our marine markets, specifically in our current target markets of coastal and inland applications. The achievement of the DNV type approval for FCwave product is an important differentiator for Ballard. We expect to see demonstration projects starting in 2023, including one of our flagship marine projects with a Norled ferry in Norway. In Q3, we continued to see growing interest in the stationary power generation market. While this nascent market continues to be developed, we expect the segment to become increasingly meaningful to our business over the coming years. Now looking to the key geographic regions. We recently introduced our global manufacturing strategy, “local for local”. We plan to have scaled manufacturing of leading fuel cell engines and components in our core regional markets of North America, Europe and China to support further and future industry growth patterns and volumes across our verticals. In Q2, we announced our plans relating to U.S. manufacturing capabilities with a new module manufacturing facility, which is on track to be in operation in early 2023. We continued to increased sales in North America with revenue up 80% quarter-over-quarter and 40% from Q3 last year. We expect continued demand growth for our technology in the U.S. as previously announced policies, such as the IRA, materialize over the next 12 to 18 months. In Europe, there’s a steady flow of news around continued policy support. Recently the European Commission announced more than €10 billion will be invested in the hydrogen economy in Europe. These projects will catalyze European market to drive down the cost of low-carbon hydrogen, making the total cost of ownership and value proposition of our solutions increasingly competitive. As part of our “local for local” strategy, we continue to evaluate opportunities for manufacturing expansion in the coming years to align with regional demand trajectories. We remain confident in Ballard’s position to take advantage of growing European market opportunities across our verticals. Moving to China, we have high conviction on long-term scaled adoption in China of fuel cell electric vehicles for medium and heavy-duty motive applications. Our Weichai Ballard JV continues to develop fuel cell modules for the bus and truck markets and is ready for high volume production. The JV is starting to see clear indicators of next steps in the China fuel cell bus and truck market from both a policy perspective and a market demand perspective. We expect to see significant growth in the China market in advance of 2025 adoption targets with a major ramp from 2025 through 2030. We recently announced plans to invest approximately $130 million over the next three years in an MEA manufacturing facility and R&D center in Shanghai. This investment is also supported by significant incentives by the local governments. This site is strategically located at the Jiading Hydrogen Port, positioned in one of China’s leading automotive industry clusters. This facility will enable annual production capacity of approximately 13 million MEAs, which will supply approximately 20,000 fuel cell engines. This is expected to meet market demand in China, including from the Weichai Ballard joint venture for bus, truck and forklift markets as well as other opportunities outside the Weichai Ballard JV scope. The facility is planned to be in operation in 2025. This facility in combination with our MEA manufacturing in Canada is expected to supply our global MEA capacity demand through 2030. Our investment is expected to reduce MEA manufacturing costs, align with China’s fuel cell value chain localization policy and position the Weichai Ballard JV and Ballard more strongly to participate in the hydrogen fuel cell demonstration cluster regions and for the post-subsidy market. We are also setting up an R&D innovation center at the same site to engage the emerging China local supply chain for fuel cell materials and components. I want to reemphasize this point. As reflected in the recent China 20th Congress, energy security is a top priority for China. We see renewables and green hydrogen as key beneficiaries as China accelerates its plan for strong China energy policy. We believe China is a market headed for significant demand breakout, as green hydrogen production and hydrogen infrastructure scales over the coming years and as our new MEA production facility comes on line. Shifting to our financials in the quarter. As we discussed last quarter, we continue to see a challenging gross margin picture, which we expect to persist through next year. The further downward pressure in Q3 was driven by a combination of a shift in revenue mix, the impacts of pricing strategy, higher fixed overhead costs, inventory adjustments and an increased inflationary supply costs. As previously communicated, we continue to see a challenging gross margin picture, which we expect to persist through 2023 until volumes ramp and our production cost -- product cost reduction initiatives move into production. Our 2022 annual total operating expense and capital expenditure guidance remains unchanged from $130 million to $150 million, and $30 million to $50 million, respectively. Our planned capital spend towards the China investment in 2022 is included with our current guidance range. The majority of the capital towards the manufacturing expansion in Shanghai will be distributed between 2023 and 2024. We currently expect to come in at the upper end of our total operating expense guidance range and at the lower end of the range for capital expenditures for 2022. Given the macro economic outlook, and the context of our 2023 annual operating plan, we’re actively reviewing our go-forward OpEx and CapEx spend to ensure we’re appropriately investing in our growth strategy while tightening our overall spend to reduce cash burn. We continue to make meaningful strides against our product cost reduction targets. Our product cost reduction initiative is to reduce our fuel cell stack cost 70% from 2018 by 2024. We’re tracking ahead of plan not withstanding inflationary pressures. We’ll continue our work to secure platform wins with customers across our core verticals. We believe Ballard is well positioned with a strong balance sheet, industry-leading fuel cell talent and technology and key partnerships and customers across our target markets. We believe we can make a meaningful impact by providing zero emission solutions for our customers to achieve their decarbonization goals. With that, I’ll turn the call back over to the operator for questions.

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

Just following up on the Siemens order in the rail market, could you give us some color on what’s driving that demand profile and how -- sort of the opportunity in that product category?

Yes, great question, Rob. And effectively what we’re seeing in Europe is the operators of commuter rail are looking for decarbonization opportunities. And where you don’t have electrified lines and you look at moving away from diesel, the cost of overhead catenary wire infrastructure is quite prohibitive. And so effectively, we see this market with about 15,000 diesel trains in Europe that need to be replaced over the next 15 years, including I think about 3,000 in Germany alone. And so, we’re seeing this transition occur, and Siemens is very well positioned with what they characterize as a next generation fuel cell train. And this train the Mireo Plus H, they’ve been working on developing for about five years and in parallel, we’ve been working -- developing our fuel cell engine. So, having demonstrated that, actually about a month ago, live at an unveiling of the train, a lot of interest from the market there and we’re expecting to see significant growth. I think this is what’s given Siemens the confidence to enter into LOI with us for 200 fuel cell engines and now a purchase order for 100 fuel cell engines given the sales activity they’re seeing 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. Maybe I’ll just offer some initial comments and Paul can supplement as well. In terms of the CapEx, there’s significant orders that need to be placed this year, given long lead times. But actual cash implications -- obviously, there’s deposits on key equipment, but the cash implications really start to hit in 2023 and 2024, materially. There’s some that will show up in 2022, late 2022, obviously, but that’s contemplated already in our CapEx spend for 2022.

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 give good revenue guidance. What I would say is sort of the trends that we’ve been seeing, and the change in the mix of our revenue that we’ve been seeing from more favoring, how our products and less on TS, as well as the sort of dynamics of lower revenue from China. I don’t think you can count on prior patterns to remain the same, not only in ‘22, but I think in ‘23, as well. So, we do see those trends continuing into ‘23, we see higher sales in Europe and in North American power products. We see a shifting in our lesser proportion of revenue in technology services, and even at lower margins, but we’re attracting in new customers, new platform strategic customers into TS type of contracts with the hope that we are going to translate that into power product sales and longer term revenue opportunities. So, I wouldn’t say -- just to answer your question directly, I wouldn’t say, you could count on past patterns being the same, because I think our revenue mix and how we are changing our revenue mix over time is changing.

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?

Yes. In aggregate, the incentive package is around $10 million. And it’s focused in a number of areas as you would expect, CapEx, some -- the cost of land is effectively subsidized. And then, if you look at some of the opportunities for labor support as well, we see basically support across all different cost categories. So, it was a very comprehensive package prepared by the local government there in Jiading district, Anting town in Jiading district in Shanghai. And this is the outcome of about a year working with a number of different jurisdictions on subsidy packages, and looking at where to localize based on the policies and the cluster regions. Jiading is actually in two of the cluster regions, which is quite interesting, as well as looking at access to talent, including R&D capability and then subsidy package as well. And so, we had the strongest package here 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. So, there are targets nationally as well as by province and by city. Typical, like Guangdong for example will have a certain number of vehicles, particularly trucks and buses that they want deployed by 2025 and 2030, similar in Shanghai, et cetera. And what I think you will see as signpost that that’s tracking is actually the hydrogen refueling infrastructure starting to scale in these jurisdictions. We’ve seen that even during a very challenging COVID period in China in 2022 that fueling infrastructure continues to get deployed and particularly in these cluster regions. So, I think you are going to see in ‘24 -- ‘23 and ‘24 significant scaling, both on -- green hydrogen production, there is a lot of activity going on in China on green hydrogen production, and scaled electrolyzer projects as well as fueling infrastructure getting rolled out to support larger fleets. I think that in my mind is important. And then, on the commercial side, you will see announcements in different regions of scaled projects. For example, we are expecting pretty significant deployment of buses in Shandong. So, these are the type of things that I think you can see 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 [indiscernible]? 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?

Yes. Mac, thanks for the question. Couple of points there. One is that we are trying to design core fuel cell technology that applies across the multiple verticals, as well as across the different regions to get leverage, and to have not only the Ballard technology advantage, but a unit volume, therefore a cost advantage. So that’s our strategy. In terms of the technology front, we are seeing a very fast advancing China supply chain across the value chain. And so, I can give you a couple of examples, for MEAs, plates and modules for components and materials that we have been testing and validating and introducing into bills of materials as we go forward as part of our cost reduction initiatives. And so staying on top of that very dynamic market is critical. And I do think that we will see a large part of the bill of materials in engines, fuel cell modules, where you see new compressors and humidifiers, and hydro recirculation blowers, pumps, valves, sensors, et cetera that will be sourced in the China market increasingly going forward. We are identifying the volume in China, both for our MEAs, but also at the JV level that we have the ability, of course, to at Ballard export modules from the JV as well as export MEAs globally and use those globally. So, while we’re identifying that this is a satisfying local demand for MEA going forward in the China market, we also have the flexibility to source those MEAs internally from our China operation and sell them globally. There is a duty on importing MEAs into China. That duties will increase over the next number of years. And so, as we get to 2025 and domestic -- Ballard domestic MEA production, having MEAs being produced in China will be a significant cost advantage, with the duties that will be introduced there.

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, thanks for the question, I think to understand too, just as a reminder for everyone, part of what we’re looking to do is to simplify the experience for customers and reduce customer adoption friction points by taking fuel cell engines on board their vehicle platforms. And so, part of our thesis there is to collaborate with partners that supply different balance of client components, like we’re doing with Foresee Power for battery packs for the same bus and truck applications as an example, but also the in-house some capabilities. And so acquiring what used to be our Arcola Energy, now Ballard Motive Solutions, is really helping us with customers to look at optimization of their power train, a lot of application engineering. So, a couple of customers, for example, have already received pretty significant support packages and are -- have engaged with us through Ballard Motive Solutions. Wisdom Motor is a company based in China that’s exporting fuel cell buses and trucks globally. We’ve been supporting them on integration of fuel cell engines into their vehicles. So, that’s a very powerful example. And similarly with Quantron, providing a lot of support for Quantron as they start deploying as early as next year, fuel cell trucks into a growing market opportunity. So, these capabilities are supporting customers, and are achieving the objectives intended at the time of acquisition.

The next question comes from Michael Glen with Raymond James.

Randy just in terms of the China investment, if we think about that investment in combination with the JV already in place in China, will the ramp in volume -- is the ramp and volume at the JV increasingly dependent on you being able 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 12-month, well, first of all, I’d say, I think that the key point for the quarter is that the total order book increased 11% to $102 million. So, I think that’s quite encouraging. And as we mentioned, that doesn’t include the Siemens contract, which we announced -- or the order -- the purchase order for Siemens with 100 fuel cells, that’s going to be coming on top of that. So I think that’s the first point I think about the order book. On the 12-month order book decreasing to $51 million to a net decline of 10, what was also included in there was the largest contributor -- one of the largest contributors to the drop was shifting out from the 12-month order book, the remaining portion of the tech transfer agreement we have with the joint venture. So, that was pushed out to the 12 plus month timeframe. We are in the process of renegotiating the scope of that remaining contract, but fully expect to earn this revenue -- that revenue going forward. The timing could be adjusted over the next couple of years, so we expect some of that to come into ‘23 -- for ‘23, ‘24 most likely. So, we are seeing -- what we are seeing overall is all of the revenue trends that we talked about earlier in ‘22, we see that continuing into ‘23. We are looking to add more strategic platform customers in both, TS as well as the product opportunities. And overall, I think the solid growth in the total order book to me is the most significant point and very encouraging.

Yes. I’d like to add one point there, Michael. 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. And so that has actually occurred -- ability to do it effectively at the JV level with less support from Ballard has occurred far faster than we had originally envisioned. And so, the portfolio of products being developed by the JV has shifted significantly. And so, we are in the process of looking at how to support the JV going forward with a growing portfolio of fuel cell modules at different size ranges et cetera and how we can actually incorporate that portfolio into the Ballard product roadmap going forward as well. So, a lot of important work to be done here over the coming months with the JV to streamline the paired portfolios for efficiency, but also just the capabilities of the JV to quickly design modules is very impressive.

Okay. Thank you.

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

Great. Thanks for taking my question. Maybe could you expand a little bit just on the thoughts on kind of a pricing strategy that you mentioned in the prepared remarks and maybe tie that in with just kind of overall how you are seeing kind of competitive forces -- competitors developing and maybe the various markets between 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?

Yes. There’s been some interesting reports published on the -- I’ll call it the total production of fuel cell technology globally at the end of 2021 and we’ll expect to see something similar at the end of ‘22 and 2023. There haven’t been a lot of forecasts on what that will look like in 2025. Obviously, announced projects get put into the mix with some forecast information. But I think in the China market at this scale, we will be, in my opinion, one of the perhaps the largest MEA manufacturer in China, announced at this time for MEAs. And similarly to JV the largest manufacturer of fuel cell engines announced at this time. There are other companies looking to localize in China, Johnson Matthey has made some announcements, Umicore has made some announcements. So different parts of the value chain are coming into the China market as well. But I do think when you look at fuel cell engines and MEAs, this probably represents the largest announced plans for MEAs, certainly from international companies moving into the domestic market, very challenging to get some of the plans on the domestic companies that are not making similar type of announcements, 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 relative 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 time period at the Investor Analyst Day, so look forward to that. Certainly, if you look at gross margins for this quarter, there were some one times I would characterize them as these type of things like inventory adjustments, when you’re in a very dynamic market with product changes and supply chain had disruption. 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 think you’ve covered all the key points, Randy. I think getting hold -- great, strong strategic relationships with large high quality customers and working with them on their programs, when we see the volumes ramp up, we do expect to see, when prices will probably still keep coming down, but we expect costs will come down at a quicker pace and that will expand margins. Some of the other -- the points that Randy made particularly around inventory management, I mean, it’s been incredibly -- for many -- for all companies, incredibly challenging time managing inventory when you think externally about COVID and supply chain issues and freight costs and even just availability leading to much longer lead times. And then combined with that and on top of that, us strategically investing in new products, new next generation products and moving these customers to those lower cost products, some older parts are going to become obsolete. So, that’s going to happen. I think the effect is certainly when you look at percentage of gross margin, the effect is kind of amplified when you have lower levels of revenue. I think as we look out further, we would still expect to see some revenue adjustments from time-to-time. We may even have some at year end in our own business here in the short-term. But, I think the effect of those on the gross margin will become less of us as revenues scale up.

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 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. So fair comment and it’s something we debated a lot, as you might expect in terms of what was the right time to make this investment. The duties are relatively modest at this time. So, kind of -- and it’s -- as all things are, it’s very complicated to give you a certain number, but I’ll just say, kind of roughly 3% to 5% right now for imported MEAs. But this is going to 8%, 12%, 15% by 2025, based on the information we have. And so, that is a major deal when you are talking about a very -- market that is very price sensitive in China. So bringing this on in 2025 we think is the right timing given what we see on that front.

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 last eight weeks, since the IRA was passed?

Yes. Thanks for the question, PJ. And we are actively working with partners in hydrogen hub submissions. So, we’ll see next year where the hydrogen hubs are announced. There’s a lot of debate on how many there will be and how those will -- where they will be. And so, there might be five, six, maybe even more than that. So we are expecting to see a very high-level of collaboration engagement here over the next number of weeks, as you know, the hydrogen hub activity, both in terms of submissions and responses, and iterations likely get filtered through next year. So, we’re very active on that from the collaboration side. We have a strong track record for delivery of fuel cell technology and modules in a variety of applications. And I think the bus market is one where people are focused on but the truck market is another one, we’re seeing a lot of interest in activity. And we’re very engaged on as well. Of course, we’re not involved in the actual production of hydrogen, or hydrogen fueling stations. But all of these applications require offtake. And so, there’s a significant, I would say, more activity than ever at this time, both in Europe and the U.S. on matching up hydrogen supply and application demand. So, there’s offtake commitments. And that’s where Ballard fuel cell technology can play a very material role.

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 the 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. Okay. Yes. Sorry, I apologize. I didn’t appreciate that’s the point you’re making. Certainly Vancouver is not a manufacturing center. If you had a white piece of paper and you’re starting things anew, you likely wouldn’t have the type of footprint we currently have in Vancouver. So, we will continue to have what I would call prototype manufacturing capabilities in Vancouver. And as we look for scale, our advanced manufacturing initiatives that we’re doing in Vancouver will apply to that scale in lower cost regions. So, we are seeing both in plate production and MEA production significant lines of sight on, not just material cost reduction, but labor cost reduction as well. As we look at in the localization in China and some of the advanced manufacturing initiatives there, we’re talking about very automated MEA production facility, which we’ll see some cost benefits, of course. Most of the costs for MEAs are materials. Labors are relatively modest portion. But every penny -- when you get to a point in your product lifecycle and your cost structure where you need to break pennies in half, we’re going to be very well positioned with this MEA manufacturing facility.

Next question comes from Greg Wasikowski with Webber Research.

Randy, you mentioned that -- and correct me if I misheard you here. But you mentioned that your combined capacity from the facilities in Vancouver and Shanghai will support your projected MEA demands through 2030. But then you guys are also doing the local for local looking for potential facilities in Europe would probably seem to make sense. I’m just curious, if you go through with that, if we see some announcement on a facility in Europe, how should we think about that effect on kind of all three, presumed facilities there, whether it’s lower utilization across this three, or maybe later production target in Europe for a smaller facility in Europe or something? Just curious how we should think about that if it’s kind of extra capacity, if you will.

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 you 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 sometime 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 [Technical difficulty] 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, lead 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.