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EARNINGS CALL TRANSCRIPT
EARNINGS CALL TRANSCRIPT 2015 - Q2
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Operator

Thank you for standing by. This is the conference operator and welcome to the Ballard Power Systems 2015 Second Quarter Conference Call and Webcast. As a reminder, all participants are in a listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions.

[Operator Instructions] At this time, I would like to turn the conference over to Guy McAree, Director of Investor Relations. Please go ahead, sir..

Guy McAree

Thanks very much and good morning everyone. The purpose of today’s call is to discuss Ballard’s second quarter 2015 financial and operating results. And today, we’ve got with us Randy MacEwen, our President and CEO; Tony Guglielmin, our Chief Financial Officer; as well as Paul Osenar, our President and CEO of Protonex Technology Corporation.

We’re going to 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 provide his perspective on our year-to-date progress including the strategic rationale behind our Protonex acquisition. Paul will then provide an overview of the Protonex’s business and finally Tony will discuss Q2 performance across key financial metrics. Then we will open the call up for questions and answers.

So let me turn the call over to Randy..

Randy MacEwen

Thanks Guy and welcome everyone to our second quarter 2015 earnings conference call. Our financial and operating results in Q2 were consistent with our messaging earlier this year and our pre-announcement on July 1. Consistent with prior messaging, we expect 2015 results to be heavily weighted to the second half of the year.

Tony will review our second quarter results as part of this call. When we started the year, we articulated our plan to deliver long-term shareholder value by making further foundational steps in 2015 on our journey to achieve a sustainable business model premised on high growth, scaling and profitability.

In Q2, we made significant progress on this journey. First, we announced our proposed acquisition of Protonex; and second, we announced new and important partnerships for fuel cell bus and tram opportunities in China.

Before we review the details of our exciting transaction with Protonex, let me first provide you with an update on our rapid progress in China. As you’ll recall, we previously identified the Chinese heavy duty motive segment including bus and tram as a key strategic market for us this year.

The macro drivers in China are well known including growing urban populations, a growing need for urban mass transit and a highly political will to address air quality and climate change. These macro drivers informed China’s new energy program.

One of the programs specific goals is to deploy more than 1,000 clean energy buses in each of the 48 participating cities.

Our China urban mass transit strategy is to collaborate with strong local partners that have market access along with leading manufacturers of new energy buses, leading manufacturers of trains and trams and progressive cities committed to clean urban mass transportation.

Our plan is to embed near-term, mid-term and long-term value streams in our deal structures. We’re designing Chinese partnerships and commercial arrangements and contemplate key elements. First, near-term sale of fully assembled fuel cell engines and ready for assembly module kits.

Near-term and mid-term technology solutions activities including licensing and engineering services to support localization of module production. Mid-term and long-term exclusive and recurring stack supply along with recurring royalty streams leverage to unit volumes and longer-term licensing opportunities for next generation products.

We’ve made considerable progress with this model already in 2015. In early June, we signed agreements with Nantong Zehe and Guangdong Synergy to provide fuel cell power products and technology solutions in support of planned deployment of an initial 33 fuel cell powered buses in two Chinese cities.

This deal has an estimated value of $10 million, the majority of which we expect to recognize this year. In addition to supporting the deployment of the initial 33 fuel cell buses, the deal signed with Zehe includes a non-exclusive license for local assembly in China of Ballard’s HD7 heavy duty power modules for using clean energy buses.

Ballard will also serve as exclusive supplier of fuel cell stacks for using these modules. Consistent with our Chinese strategy, we’ve also structured our deal to include an upfront license fee as well as future royalty stream.

Ballard and Zehe are initially collaborating with electric bus manufacturer, GreenWheel, in the city of Rugao in Jiangsu province. We have a similar deal with Synergy. Ballard and Synergy are collaborating with electric bus manufacturing Feichi in the city of Yunfu.

Also in June, we signed a framework agreement with Tangshan Railway Vehicle Company or TRC, a company that’s part of China Railway Rolling Stock, the world’s largest manufacturer of trains, which is the result of the recent merger between China’s CNR and CSR.

The framework agreement contemplates the development of a new fuel cell module that’s designed specifically to meet the requirements of tramp or grand transport vehicle applications.

Initial work is expected to involve technology solutions provided by Ballard to design and support integration of a fuel cell engine into TRC’s tramp equipment with a development in milestone of powering a GTV prototype in 2016.

We’re working hard to further penetrate in the high growth Chinese urban mass transit market and expect to have additional updates to share later this year. During the second quarter, we also made significant progress on our M&A strategy.

As previously communicated to accelerate our journey to sustainable business model with high growth and profitability in addition to our execution focus on strong organic growth, we’ll also be prioritizing strategic acquisition opportunities with a target business as assessed against the following acquisition criteria.

First, the target business is complementary to our customer-centric Power Products market opportunities and product portfolio. Second, the business adds $15 million plus in revenue to support our drive to achieve scale. Third, the transaction accelerates profitability.

Fourth, the business provides exposure to complementary investment themes and finally the transaction is financially accretive. On June 29, we announced we’ve signed a definitive agreement to acquire Protonex. You’ll hear shortly from Paul Osenar, the Protonex’s President and CEO, regarding the Protonex business.

First let me provide you with some insights as for the strategic rationale and benefits associated with the Protonex acquisition. We’re summarizing as diversification, growth, scale, and profitability.

In terms of diversification, with the acquisition of Protonex, we’ll add power management products along with small scale portable fuel cell products to Ballard’s already extensive Power Products portfolio. Paul will be speaking to the Protonex product portfolio and associate opportunities in a few minutes.

On growth, Protonex has enjoyed an overall revenue compound annual growth rate of 22% since 2011 and anticipates significantly higher growth in 2016. With respect to scale, Ballard’s consolidated revenue will show strong top-line improvement after closing.

We currently envisioned a consolidated revenue contribution from Protonex of approximately $5 million in 2015 and approximately $20 in 2016. And on profitability, Protonex generates high margin revenue.

For example 40% gross margin in its fiscal 2014, this gross margin profile will positively impact our bottom line accelerating our drive to positive earnings. I would also like to pause here and provide some context on the strategic rationale for our recent $15 million equity financing.

As we started 2015, we started a strategy to accelerate growth and sustainable profitability by scaling our commercial activities and pursuing complementary acquisitions. Our strategy was to ensure a strong balance sheet in order to one support larger commercial deals that require Ballard to have sound bankability.

And second, support Ballard’s positioning as an attractive acquiring platform for acquisition targets. To achieve this strategy, we set a goal to add $50 million of cash to the balance sheet in the first half of 2015. We plan to close two deals to fund our $50 million goal.

The first deal with the Volkswagen Group intellectual property transaction, which we announced in February, which will net about $38 million of cash. We also plan to complete an equity capital raise with gross proceeds of $15 million to close out our $50 million goal.

In reviewing our commercial activities in sale pipeline, we also recognized that the second half of the year was going to be extraordinarily busy as we advanced key commercial discussions and deliver products and services.

Our strategy was to clear the heavy lifting on the Protonex negotiations and complete our capital market activities in the first half of the year.

This enables a clear management focus on execution activities through the second half of the year, as I said including commercial negotiations, important operational activities, a successful Protonex integration and continued evaluation of additional attractive M&A opportunities.

So to summarize our balance sheet now allows us to focus on scaled commercial opportunities with a long line of sighting cash runway, will also enabling enhanced flexibility to rapidly respond to attractive acquisition opportunities.

We now have the Ballard corporate profile that presents as a bankable commercial partner for larger commercial deals and as a sound and attractive acquirer for complementary business. We are teed up for an exciting second half of the year.

So let me now turn the call over to Paul Osenar, who will provide more details of Protonex’s exciting business, customers, and growth prospects.

Paul?.

Paul Osenar

air force, army, navy, marines, the Defense Advanced Research Project Agency or DARPA and the Special Operations Command or SOCOM. U.S. Military is one of the largest consumers of energy in the world.

Over the past decade, the military has been focused on power and energy solutions in the phase of a proliferation of increasingly advanced electronic device has been used by the modern soldier on the digital battlefield where previous product consisted of analog batteries and power supplies with no network capability.

Today, the military requires more sophisticated solutions such as power management products. Also as we move forward, we believe that fuel cell products will play a growing role in power generation for the military, particularly given their low noise and low heat signatures. Together with high energy density extended runtime in a reduced way.

In addition, fuel cells achieved superior fuel to electricity efficiency of up to 55% compared to combustion systems with the maximum of just 35%. The net effect is minimizing fuel transport [indiscernible] and thereby saving lives and operational costs.

Our power management products have been an engine for growth of Protonex over the past several years. These products facilitate soldier’s ability to power a verity of key communication and navigation tools from a wide verity of power sources including solar, vehicles and fuel cells.

Our products increase mobility and flexibility for the soldiers thereby making them more efficient and reducing the need for fuel and battery transport.

Specifically a power management device manages and prioritizes battery usage, powers man worn and man-packable gear, recharges military and commercial batteries, optimizes alternative power sources, moderate power sources and loads, dynamically adjust to changing machine needs, automatically identifies connected devices and self-configures for optimal operations and logs all energy generation and usage for accurate machine planning and analysis.

Simply put power management device allows the soldier to power any device from any available power source. Protonex power management products include the squad power manager or SPM-622, which manages up to 150 watts of power from vehicle or solar sources in order to charge multiple devices at one-time for entire squad up to nine soldiers.

This product also provides a graphical display to show power trams and permit advanced configuration. Protonex has shift almost 4,000 SPM units to date, a significant number in the short period since initiation of field testing activities with the U.S. military. The Vest Power Manager, or VPM-402, meets the needs of the U.S.

air force, marines and army for power management at small power levels for use on an individual soldier. It could be linked with the SPM-622 along products to work and think, while supporting other handheld or man-worn devices such as radios, GPS and shot detection. This product has completed trails and we expect to see meaningful sales in 2015.

Protonex also received funding from U.S. Marines to develop the advanced battery charger, more cost effective and higher throughput device than legacy systems. This device is in early trail now. In addition, we offered several portable fuel cell type products in the subkilowatt power range, utilizing PEM and solid oxide fuel cell technology.

Protonex has focused on the development of high performance power systems for applications for traditional battery and generator solutions limit functionality. A key application for our fuel cell products is empowering unmanned vehicles. Unmanned air vehicles or UAV power systems are moving from flight administrations to deployable products now.

We have utilized our fuel cell technology to increase flight endurance of our batteries and increased reliability over traditional and small engines. In fact, our navy partner set an unofficial UAV flight record of 48 hours, an increase in flight duration of 13 times compared to the best lithium batteries of equivalent weight.

Rapidly growing interests in commercial uses for UAVs suggest that this will be an important application enabling significant growth as we move forward. Lastly, we have also SOFC based products that runs on propane fuel and complements existing battery and solar installations. This is currently in the early stages of deployment.

Form a financial perspective, Protonex has experienced a 22% top line compound annual growth rate, since 2011, with total revenue growing to $13.8 million in fiscal year 2014 which ended on September 30, 2014. We anticipate an increase in our growth rate as the U.S.

military adopts power management products as a standard requirement and also adopts fuel cell products to power the growing deployment of unmanned vehicles.

Over the 2011 to 2014 period, Protonex product revenue grew as a proportion of total revenue from about 15% to up to about 55% with the reminder of our revenue coming from contract and service work. Within the product segments, the vast majority of our revenue today comes from our power management portfolio.

We expect power management products to account for more than 80% of the total product revenue in 2015. And as I have already noted, we expect sales of power management products in the U.S. military to continue growing, laying the foundation for future sales of fuel cell products.

Most importantly, our gross margin for fiscal year 2014 was 40% and for the first time we generated positive EBITDA. Our strategic rationale for this transaction with Ballard is based on two factors. First, the ability of the team with a company for which our product portfolios are complementary.

And second, the team with a company that can add global sales and distribution capability in new commercial markets. Team with Ballard works for Protonex on both accounts. Our power management expertise can provide a critical means of opening market opportunities for fuel cell products within the U.S.

military establishment and we believe also for additional industrial markets. In addition, our focus on portable products below two kilowatts power is entirely complementary to Ballard’s focus on stationary and motive power products in the power range above two kilowatts.

Today, Protonex is relied on a modest scale and marketing organization, yet produce great product traction. Ballard has been investing in its go to market capabilities including the expansion of sales and marketing bench in a wide range of geographic markets.

This will be a tremendous benefit to Protonex as we expand into other adjacent markets and new geographic territories over the coming years. Let me also provide a brief update on the progress we’ve made since announcing this deal in June 29.

We have been diligently since the date on planning the integration of our organizations and that activity has been progressing on track and on time. I hope that I’ve addressed many of the questions in your mind and we’ll be pleased to answer other questions in the Q&A at the end of this call.

So with that let me turn the call over to Tony, who is going to discuss Ballard’s second quarter results.

Tony?.

Tony Guglielmin

Thanks Paul and good morning everyone. I’ll start by taking you through Ballard’s key financial metrics starting with revenue. As Randy mentioned, revenue in Q2 was $11.2 million, down 39% from the same period last year.

Looking first at our power products platform, overall for power products we generated revenue of $6.3 million in Q2, down 15% year-over-year. In Telecom Backup Power, revenue in the quarter was $3 million, an increase of 15% year-over-year driven by the shipment of 100 ElectraGen systems to RJIL in India.

In addition, we also shipped systems to customers in South Africa and Europe during the quarter. In material handling, revenue was down 34% to $2.7 million and this was despite – and this despite Plug Power projecting strong revenue growth for the year.

Plus has built up inventory of our fuel cell stacks in previous quarters for use in its GenDrive systems. And as such we do expect an increase in material handling revenue through the second half of the year.

In development stage markets, revenue decreased by 13% to $0.1 million year-over-year to $0.6 million with one HD6 module shipped in the quarter to the Stark Area Regional Transit Authority for deployments in Ohio. And despite a soft Q2 in bus, we do expect significant growth in the second half of the year.

In addition to the opportunities in China, that Randy discussed earlier, we expect to deliver an additional 10 modules in the U.S. through the FTA’s LoNo program this year, five additional modules for Stark Area Regional Transit Authority and another five modules for SunLine Transit Agency.

Also during the quarter, we signed a five-year extension to the maintenance contract for the 8-bus fleet for transport for London in the UK that will generate approximately $650,000 per year over the term of the five-year contract. Turning to technology solutions, revenue in Q2 decreased 56% of $4.9 million.

Similar to the first quarter, this decease was the result of our particularly strong first half last year, which included revenue from the previous licensing contracts in China that accounted for $3.2 million in Q2 2014 along with the cadence of the Volkswagen Engineering Services contract that was more heavily weighted to the first half of last year.

So looking to the second half of 2015, we do see revenue in technology solutions increasing driven by the VW program as well as new programs. This includes the recent signing of an agreement for a one megawatt ClearGen distributed generation system in France.

The first phases of this project will generate €1.7 million for Ballard as we apply engineering services and develop core components. This phase will commence in the second half of the year and will be completed by mid 2016; the second phase of work by mid 2016.

The second phase of work with an additional €1.7 million is expected to be completed in 2017, subject to Hydrogène de France securing necessary funding to complete the project. Gross margin for the quarter was 10%, down 15 percentage points from 2014.

Now, this was primarily due to the absence of the high margin licensing revenue in China as well as the overall decrease in technology solutions revenue in the quarter.

We do expect gross margin to improve significantly in the second half of the year in line with top line revenue growth combined with a shift and product mix to higher margin bus and a more significant contribution from technology solutions. Cash operating cost were flat to last year at $6.7 million.

Higher research and product development costs resulting from lower hour spent on engineering service given the cadence of projects were offset by a weaker Canadian dollar. As indicated on our last call, we expect cash operating cost to continue the run rate of approximately $7 million per quarter through the rest of the year.

Adjusted EBITDA in the quarter declined negative $4.8 million compared to negative $1.2 million in Q2 last year. Net income in the quarter was negative $7.3 million compared to negative $4.5 million in Q2 and earnings per share also declined to a loss of $0.06 per share in the quarter, compared to a loss of $0.03 per share in Q2 last year.

Cash used by operating activities increased 79% year-over-year to negative $5.3 million. This was comprised of cash operating losses of $5.5 million, partially offset by net working capital inflows to $0.2 million. In terms of liquidity, we ended Q2 with cash reserves of $41.2 million.

This was slightly higher than the range we indicated in our July 1st press release of a range of $38 million to $40 million. And as Randy described, subsequent to quarter end, we added an additional $13.6 million in net proceeds from the equity offering that closed July 7th.

This financing along with the addition of $9 million that we expect to receive by Q1 2016 as part of the next tranche of the VW transaction we announced earlier this year provides us with a very strong cash position with no debt and wants to execute on our aggressive growth strategy.

And lastly, a word on the closing of the Protonex transaction, as Paul mentioned, we are proceeding with integration and we do expect to close the deal in Q3 to allow time for the Protonex shareholders to vote on the transaction.

And as we stated in the initial press release of the time of the announcement in terms of this vote this deal does require support from at least 50% of Protonex shareholders.

All Protonex’s directors, executive officers and certain of the major shareholders in aggregate representing more than 55% of outstanding shares have entered into voting agreements under which they have irrevocably agreed to vote in favor of the transaction. So with that let me turn the call back over to the operator to take your questions..

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instruction] The first question is from Matt Koranda with Roth Capital Group. Please go ahead..

Matt Koranda

Good morning everybody and thanks for taking my questions..

Tony Guglielmin

Hi, Matt..

Randy MacEwen

Good morning, Matt..

Matt Koranda

So just want to start with the Protonex acquisition and the growth outlook there. What gives you guy’s confidence in the growth outlook is there a backlog that you could potentially speak to or maybe a pipeline of high probability opportunities that underpin this assumptions.

May be some of the new product introductions that Protonex is working on that gives you guys more confidence that you got good visibility into the good performance over the next year to two years?.

Paul Osenar

Yes, so this is Paul. The military we’ve been working with army in particular over the past several years and the introduction of the 622 and going to various field trailing stages and have relatively consistent order year-on-year from that as we find new markets for that.

And we don’t have orders outstanding for all of that product to-date but we have high confidence in the pipeline that we developed..

Matt Koranda

Okay, got it. And then in terms of just the approval process, will this triggers this year’s approval and any challenge is expected during that process.

Did you derisk it with them ahead of the transaction? If you could just comment a little bit on kind of what you need to do to close the transaction within the quarter here?.

Tony Guglielmin

Yes, hi Matt its Tony here. We of course we looked at all of these issues with none were identified so there are no particular issues that we’re – that is standing between now and closing in ALD [ph] U.S. military otherwise. The regulatory closed in the U.S..

Matt Koranda

Okay, got it. And then Randy I know you been quite active in China. May be you could just help us understand the current quotation in business development activity levels there have they changed it all over the last couple of months.

Just help bringing the opportunity here in the context of some of the macro weakness in the data points, we have seen that at China recently?.

Randy MacEwen

Yes, I would say, I’ve seen a disconnect between capital markets erosion in the last say, two months in China compared to the customer engagement in interest level. So the customer engagement interest level today is higher than it’s ever been and we’ve seen things accelerating in the last 60 days not slowing down.

So we expect to, all the announcements we made in June, we expect to have similar scale type announcements later this year..

Matt Koranda

Okay, got it. Great. May be one more from me here. You guys touched on it briefly in the prepared remarks but if you could just put a little color into the material handling piece of the business.

What do you think, maybe driving some of the lower shipments there aside from inventory building plug I mean are they indicated you that they are doing more with their in-house stack, is that kind of coming in greater than expected or if you could try to maybe put a little color into that for us that would be helpful..

Randy MacEwen

Yes. Matt, the thing I would probably highlight. Obviously plug is a critically important customer to us and our job is to provide them with higher reliability, high quality stacks at the right price and make sure we are managing the customer experience.

Well, I think we’ve done a – we’ve certainly done a good job at that over the last number of months typically last nine months since I’m joined the company. I don’t want to comment specifically on plug activities because we are publicly listed company and so I don’t want to comment on cadence or flow or what they might be doing internally.

But I will say we expect to see our revenue with plug grow going forward..

Matt Koranda

Okay, great. That’s helpful. And I’ll jump back in the queue here guys. Thank you..

Randy MacEwen

Thank you, Matt..

Operator

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

Rob Brown

Hi, good morning..

Tony Guglielmin

Good morning, Rob..

Rob Brown

Just wanted to follow-up on the Protonex business. Its little more clarity there, are the power management products now sort of standard equipment in the military or these still in the development stage or they moving toward more of a broader rollout.

Maybe you could help us kind of understand that the backdrop of what's driving demand in those products?.

Tony Guglielmin

Right, I don’t know, if you are familiar with the process by which the military adopt new technology. But it’s a multi-year process and we’ve been engaged with them since 2011 in that process.

So they are definitely rolling it out towards what I would call standard equipment but in the interim especially for the army, they are going to roll out a lot of volume prior to actually meeting what's call the program of record milestone. So we’ve been working with army partners for these last few years to get to that.

And I would see good progress to that – we hope for discontinuity in volume with the army customers as we pass that program of record milestone..

Rob Brown

Okay, and do you have sent someone that timing of that program of record milestone can happen or you – and start to predicting the future but you haven’t crossed it yet or when do you think it can happen?.

Randy MacEwen

Rob, I think we are looking at probably late 2016 but we can’t preach the post there..

Rob Brown

Okay. So you guys know that, that’s a good thing. Good background, and then in the China bus market.

I know you gave some timing in terms of the number of units the governments wants in the market but how do you sort of anticipate that showing up in your business, you’ve got the right partners in place when does it sort of convert to standard order flow and the ramping units in the China bus markets?.

Randy MacEwen

Yes, so again I think what we are trying to design in China is a strategy where we have near-term, mid-term, long-term cash flow streams to the sale initially of completed modules and kits.

Mid-term with opportunity to cell stacks with localization and significant technology solution support to help localize production and longer term of recurring royalty stream, so the structures and deals we have been contemplating and negotiating in China, contemplate those different revenue and cash flow streams.

We clearly expect to see additional opportunities signed up in 2015 that will have – I think material impact for us in 2016..

Rob Brown

Okay, that’s good.

Good color and then on the India telecom order, I know you delivered the first tranche, what’s sort of your thoughts on the timing and potentially the next tranche, it was another couple of hundred, or more units that might be in the pipeline, but what’s the timing look like there?.

Randy MacEwen

Yes, so Rob, we have delivered the first 100 units and those products have been received by our customer there RJIL.

The expectation is that they will start to install those units and get some initial feedback on how the installations process and support goes as well as some initial field data, so we expect to see the next tranche of orders, the total is contemplated to be 500 and 100 initially we expect to see the next tranche up to 400 secured later this year, in terms of when those projects will hit I think we probably expect to see the materialize in revenue in 2016, but we do expect to get the order this year.

I also want to identify to Rob that the as we mentioned at the start of the year, this backup power market does require kind of patients and investments and we are displacing and trenching combines and that can’t done overnight.

But we’ve done it on the things in backup power market already this year, I think we will lend itself to longer term growth. So we’ve kind of worked on the value proposition, the value proposition based on kind of total cost of ownership rather with – frankly a higher initial CapEx, but lower total cost of ownership over time.

And so we repositioned in kind of more strongly articulated our customer economic value proposition based on higher site reliability and availability in network carving, with more revenue to the customer and as I said lower total cost of ownership.

There is a few other things kind of foundational things we have done so far in the first half of the year in backup power that are worth noting so we developed and implemented a new channel program.

We have added now, I think 10 to 12 new channel partners that are better positioned for higher volume sales as we move forward these are partners are kind of bigger and more mature organizations that better understand slight design, optimization including with fuel cells, batteries, power management and cooling so they’ve got the right skill set, and stronger balance sheet and stronger market access to support larger scale deployments.

And we’ve had a significant training in the first part of this year with these channel partners and re-training of some existing channel partners.

And spend quite a bit of time strengthening our ecosystem for this supply of HydroPlus, which is our methanol blend fuel in 62% methanol and 38% water to make sure we’ve got the appropriate in-country fueling and service infrastructure. So there is a lot of activity that’s going on in the first half of this year, foundational activity.

And that means we today, I think, over the first half of the year have also signed some global master supply agreements with some very large players, some of the largest players in telecom. And that means, we now today have a sales pipeline and backup power that’s stronger than any point over the past few years.

So there is a lot of work that’s been done, India is just part of that story..

Rob Brown

Okay, that’s great review. Thank you, I will turn it over..

Operator

Next question is from Carter Driscoll with H C Wainwright. Please go ahead..

Carter Driscoll

Good morning guys..

Paul Osenar

Good morning Carter..

Carter Driscoll

Just moving over – moving back to China, just for second if I may. I’m trying to understand obviously you have a nice agreement for the initial 33 buses. Trying to understand if the growth in those two particular cities requires a new order to go beyond 33 buses is kind of a first part.

Second is as you grow into, how to address other 48 cities that China is pushing for the number of busses that they are targeting, you have to reengage different OEMs and the current OEMs engage other cities, just trying to get a sense of how long an engagement with the particular OEM typically takes and what your expectations are when you are trying to figure out beyond your current engagement? Or how you can scale in China..

Paul Osenar

Yes, so in China, the market is really local. Obviously there are some large OEMs that supply nationally there. But we do see that certain cities prefer in some cases local OEMs. So obviously that’s a factor we have to into account when we’re putting together effectively project syndicates.

But what I would say is that in China the market moves a lot faster than we see in Europe and North America. And so the OEMs are able to come on a lot faster than what we’ve seen in terms of market adoption in those European and U.S. theaters. So that’s I think a key factor in terms of shortening the sales cycle and the education cycle.

I think what’s really important is that the cities through a large extent drive what happens and its important to be linked with the progressive cities that view clean energy and clean air and climate change as key priorities and are focused on introducing clean energy, mass urban transit including clean energy busses.

And so I think we have partners in China that know the right cities and have good relationships with the right cities, and we are starting to see scaling there. So the 33 that you mentioned is a start, we see larger opportunities in 2016 including in existing cities that we are partnering with as well as new opportunities..

Carter Driscoll

Okay.

maybe shifting gears in the Protonex, in terms of engaging the military obviously it’s a protected process, but the different branches, can you share what you have done maybe with the army with some of the other branches of the military to speed up the adoption process or each of the different branches kind of its own, let’s say island, for lack of a better term?.

Paul Osenar

Yes, so our strategy with the military has been, long-term engagement strategy with the army because they represent the largest market, but clearly also the slowest moving on the markets there.

And so in the interim we’ve actually had a pretty robust engagement strategy with our organic sales team at the special operations community, and other lead, users people like the bomb disposal force, special operators across all sorts of different applications. So we have actually traction across a wide range of customers in the U.S.

already and actually some initial international customers in the soft community. We see the ability to expand not just internationally, but at other domestic markets outside just a Big Green army..

Carter Driscoll

And I would assume, Paul that the international engagements are under the outline umbrella in terms of technology sharing?.

Paul Osenar

They are, although I’d point out for those you who really kind of follow the military markets that, our power engine products actually have a [indiscernible] 99 designation, so we have very limited restrictions on our export, we basically can’t export to the bad actors on the list..

Carter Driscoll

Okay.

Maybe getting back to the Indian question, there are obviously other major [indiscernible] vendors out there, if you talk about the level of engagement there and then whether some of your new channel partners are specifically targeting, I’m assuming India has well, potential to move beyond GIL [ph]?.

Paul Osenar

Yes, from the RJL engagement was really to ensure we have the right infrastructure to support large scale deployments in China, so we worked on fueling, and worked on service and have signed up a local service partner there.

So we have other network operators in India that were advancing through our sales pipeline and hope to see those crystallize into firm orders in 2015 for 2016 deployment..

Carter Driscoll

Are there any specific new channel partners you can share with us that might be recognized by names?.

Paul Osenar

We haven’t announced they yet, so, I think, we need to wait on, making sure we’ve got approval from them to do that..

Carter Driscoll

I think last question is at Paul. I think rather you had a fairly novel approach to stack assembly versus some other companies that.

I guess some trying to get at not specifically, but other – it’s a level of technology sharing that you think can go on between Ballard and Protonex, whether that so I would see here is just obviously traditional within the marketplace. In terms of either redesigning or doing down in the cost curve for stack with modules itself..

Paul Cass

Yes, so Protonex was founded at looking at PEM stack technology in particular, it have a pretty robust suite of patent around novel feeling and assembly process. It’s something that we work with other companies in terms of trying to leverage larger stack designs in our manufacturing process.

And we do see some opportunities with the Ballard team to kind of cross-pollinate there.

And we haven’t really guide into details in terms of what – how impactful that is to overall on stack resistance cost, but from everything we’ve seen it should be a positive impact and I think more broadly we are excited about collaborating with the Ballard technical team on full integration systems, power management, software, bring some of our existence capability to the Ballard team..

Carter Driscoll

Thanks for the time. I’ll be back in queue..

Paul Cass

Thanks, Carter..

Operator

[Operator Instruction] The next question is from Jeff Osborne with Cowen and Company. Please go ahead..

Jeff Osborne

Hey, good morning Randy, and Tony, and Paul. Just a couple of question from my end. Maybe just starting with Protonex, if I heard you right, I think you said 45% of revenue in fiscal 2014 was service and 55% was product to equate to about a 40% gross margin.

Can you just talk about the dispersion line of gross margins between services and development contracts relative to your product revenue?.

Randy MacEwen

Yes, so I mean similar to Ballard in the template you would see, our services revenue is typically higher margin than our product revenue. Ultimately in the product we expect to be able to command up 40% gross margin or better.

As we have a mix of products out in the marketplace, obviously that at lower volumes in earlier introductions you may not be actually able to get that whole 40% gross margin. But ours is a pretty margin business owing to frankly with the length it takes to engage some of these customers..

Jeff Osborne

Just for Tony from a modeling perspective, if probably safer to assume 30% gross margin on the 80% of revenue coming from products in 60%..

Tony Guglielmin

That’s a consolidated about the mid-term but a good way to go..

Jeff Osborne

Okay, just want to double check. And then maybe for Randy or Tony or whoever wants to jump in, certainly softer as here for obvious reasons and Volkswagen that you talked about just the 10% gross margin and how should we think about the profile of the Indian Telecom in particular as the other 400 units are announced.

Are these positive gross margin or barely positive and what can you do to improve that?.

Tony Guglielmin

Yes, so solar backup power gross margins as we talked, but more generally have been somewhat lower largely to do with this, frankly I absorbed overhead, just given low units.

So the fact that there are so many units growing through India will have the overall gross margin profile for backup more generally, but more specifically to the India deals, they are positive gross margin.

There are the first units replace fairly aggressively, but still at that positive margin and we would expect to see improving margin as we more product through India. So positive now and helping the overall story as well..

Jeff Osborne

Is there a cost out design story that maybe articulate more at the Analyst Day as part of that, as a volumes ramp up, or is this more just an absorbed overhead issue with aggressive pricing?.

Tony Guglielmin

Yes, so the answer to the question – yes, we will be actually at the Analyst Day on October 1, we are going to actually spend a fair bit of time of laying out our cost reduction go-forward strategy including backup power, but just answer the question specifically yes, we are doing back up power, we later this year and going and then actually we are looking for specifically cost reduction both in the staff side as well as in the system side, we are inspecting the launch, a new version of E3 next year, that we will have a more common platform, module platform providing in, but that will see further cost.

We will get more in the detail on that next year that will really help margins more so in 2016 than 2015..

Jeff Osborne

Okay, good to hear. I will look forward to it. And then the last question I had just another kind of margin question is just on the China bus market.

How should we think about the initial units in the China relative to the Stark and SunLine deals and some of the staffs you have done with Van Hool and other partners? And more western economies, is pricing pretty aggressive on these initial deals and as Randy articulated your early mid and late stage cycle, are you hoping to make it up in the mid and late stage as a royalties and other financial structures kick in at a higher margin profile to makeup for weakness up front? Are these more similar consistently priced with European and U.S.

bus orders?.

Randy MacEwen

Yes. So they are consistently price and we will see similar gross margin as we see in the Europe and North America..

Jeff Osborne

It’s good to hear. Thanks so much..

Randy MacEwen

Great. Thank you, Jeff..

Operator

This concludes the question-and-answer session for today’s call. I’ll hand the call back over to Randy MacEwen for closing remarks..

Randy MacEwen

Great. Thanks for joining us today and most if not all of you have received our recent save the date e-mail regarding Ballard’s Investor and Analyst Day being held in New York City on October 1. During that day, our executive team will be reviewing a number of key topics in detail and we’ll be engaging in discussions with attendees.

The event will be webcast, so you have the opportunity to participate either on site or remotely. More details on this event will be available in the near future. We look forward to your participation. We also look forward to speaking with you again in October, when we discuss our third quarter results in 2015. Thank you again for joining us..

Operator

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

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