Thank you for standing by. This is the conference operator. Welcome to the Ballard Power Systems 2015 Q3 Conference Call and Webcast. As a reminder, all participants are in listen-only mode and the conference is being recorded. [Operator Instructions] At this time, I would like to turn the conference over to Guy McAree, Director of Investor Relations.

Please go ahead, Mr. McAree..

Thanks very much and good morning everybody. The purpose of today’s call is to discuss Ballard’s third quarter 2015 financial and operating results. With us today, we have got Randy MacEwen, our President and CEO as well as Tony Guglielmin, our Chief Financial Officer.

We are 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.

Today, Randy is going to provide his perspective on our year-to-date progress, including exciting developments in the China market and on the strategic partnership front. And then Tony is going to discuss Q3 performance across our key financial metrics. Then we will open things up for Q&A. So, let me turn the call over to Randy..

Anglo American Platinum; United Technologies; and now Nisshinbo Holdings. With that, I will now turn the call over to Tony, who is going to discuss Ballard’s third quarter financial results..

Thanks Randy and good morning everyone. I will start by discussing Ballard’s financial metrics for Q3 for each of our key markets, starting with revenue.

Revenue in the quarter was $16 million, down 22% from the same period last year, but up 43% from Q2 this year, confirming a trajectory that will result in revenue being back end loaded for the full year.

Looking at revenue in our two platforms power products and technology solutions, overall in Power Products we generated revenue of $9.5 million in Q3, down 8% year-over-year. In telecom backup power, revenue in the quarter was $500,000, a decrease of 88% year-over-year and the primary reason for the reduction in Power Products revenue in the quarter.

During the quarter, we did though receive a purchase order from Aditya Birla for 50 modules to be deployed in India. On year-to-date basis, backup power revenue is down 59%. Now in terms of the overall performance for this market, we had not expected significant revenue from backup power this year as we viewed 2015 as a foundation building year.

That said, we have been very disappointed in the results. As such, as part of our 2016 annual operating plan exercise that is currently underway, we are evaluating our continued investment and cost base in the backup power market. In Material Handling, revenue is down 5% to $3.4 million.

Although this represents a 27% increase over Q2, reflecting the growing demand for Plug Power GenDrive systems and plugs needed for fuel cell stacks. We expect similar demand in Q4.

In development stage markets, revenue is up 158% to $5.6 million year-over-year due primarily to heavy duty power modules and parts shipments to China under our contract with Zehe to support deployment of 33 new fuel cell buses as we announced and discussed in the second quarter.

And as Randy referenced, we are continuing to gain significant traction in the heavy duty motive market in China, with deals for fuel cell buses and trams that is generating revenue in the near-term and into 2016 and beyond. Turning to technology solutions, revenue in Q3 declined year-over-year to $6.5 million.

This was due in large part to the fact that Q3 2014, included $3.3 million in licensing contracts in China that we subsequently terminated, as well as the impact of the lower Canadian dollar on VW revenue as the VW agreement is priced in Canadian dollars. Despite this decline in the quarter, we remain very bullish on this growth platform.

We will soon have about 15 technology services contracts underway including VW, which is of course our largest. We also signed a follow-on contract in Q3 with one of our global automotive OEM customers. And we have also started technology services work in relation to the contracts in China. This will be reflected in results in Q4 and into 2016.

Gross margin for the quarter was 25%, flat year-over-year, although up significantly from prior quarters this year reflecting the contribution from the Heavy Duty Motive segment and technology solutions in the quarter. We anticipate gross margin in the 20% plus range for Q4.

Cash operating costs were higher by 20% compared to the same quarter last year at $6.7 million, but consistent with our expectations. The increase over 2015 represents higher research and product development costs, primarily due to a lower allocation of resources to technology solutions, with G&A and sales and marketing costs relatively flat.

We expect cash operating cost to be slightly higher in Q4 as we consolidate the results from the recent acquisition of Protonex. Adjusted EBITDA declined to negative $2.4 million compared to positive $0.4 million in Q3 last year reflecting the lower revenue and higher cash OpEx level in the quarter.

Net income in the quarter was negative $4.1 million compared to negative $2.4 million in Q3 last year. And earnings per share also declined to a loss of $0.03 per share in the quarter compared to a loss of $0.02 per share in Q3 last year. Cash used by operating activities increased 43% year-over-year to negative $4.1 million.

This was comprised of cash operating losses of $3.4 million and net working capital outflows of $0.7 million. And finally, in terms of liquidity we ended Q3 with a strong cash reserve of $49.2 million. This reflected net proceeds of $13.3 million from the equity financing that we closed at the beginning of Q3.

This cash position will be augmented by the $5 million strategic equity investment by Nisshinbo and the additional $9 million that we continue to expect by Q1 2016 as part of the next tranche of the VW transaction we announced in February. This will put Ballard in a strong cash position going into 2016.

So with that, let me turn the call back over to the operator to take your questions..

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Matt Koranda of ROTH Capital. Please go ahead..

Okay. Thanks for taking my question. I think you guys have already answered a lot of questions last month at the Analyst Day, so we will keep it a little bit topical with the first one. But VW announced earnings this morning. They have announced a greater focus on profitability. Their R&D budget is basically double a lot of other OEMs.

Just wanted to get your take, I mean is there any chance that your development agreement is at risk in the coming quarters, my read through would be that this is generally – it’s positive for you guys just given the headline risk at VW and the need for them to possibly redouble their efforts to develop alternative vehicles, but could we get your take on this?.

Sure. Matt, it’s Randy. Thanks for your question. I think we agree with you that overall, the developments at VW are – we expect to be positive for us. The contract we have with VW for the engineering services, it extends through March of 2019, so that’s locked in. There really are no termination provisions of any substance in there.

So that’s kind of committed revenue base. What we can see is that for 2016, we are expecting revenue to be fairly consistent with 2015 from Volkswagen. Beyond that, we can’t comment on what 2017 looks like, obviously at this stage.

But I do think that the developments at Volkswagen suggests that the industry as a whole, not just Volkswagen, will keep a very high attention and an increased focus, I think going forward and perhaps increased investment in clean energy technologies. And we expect fuel cells to be a big winner from that increased focus..

Okay, got it. That’s helpful. In terms of gross margins, it looks like a nice job this quarter on improving the gross margin sequentially. And you guys had alluded in the prepared comments, a 20% plus rate in Q4, but wanted to get your take on 2016.

Is 25% achievable in 2016 or are we looking at something more around the 20% mark?.

Yes, Matt, it’s Tony here. Obviously, you have heard us say this before, I will say it again, very much dependent on business mix and product mix going into the year.

I would say with the expectations for continued momentum in China in the heavy duty market and with confidence in the engineering services growth, I think it would be safe to say we will be north – certainly north of 20% going into the year. And obviously we will have a bit more to say in February, but think about something certainly north of 20%..

Got it, okay. And with regard to the China opportunity, just wondered if you guys could maybe discuss the latest with the pipeline of opportunities you guys are seeing now that you have got the Zehe stuff deployed or beginning to be deployed and the Synergy deals are done.

How are you guys using that as a calling card as you go to talk to other potential customers?.

So, Matt, I would say the announcements that we have made over the last two quarters have been a real catalyst for a number of very credible players in the China market, both for bus and tram now looking at deployments of their own.

And so we have had a – the phone ringing off the hook in terms of bus companies, systems integrators, drivetrain manufacturers who now see fuel cells as a credible opportunity in China and don’t want to be left behind and are quickly trying to figure out how they can participate in a meaningful way, and Ballard is I think their first call.

So, we have seen a lot of interest in the market. Our job is to qualify those potential partners and make sure that we are selecting ones that we can enjoy long-term partnerships that bring value to the company.

And we see clearly from the market interest there and the companies we are talking to, we see additional opportunities of the scale that we have seen with Synergy, with new partners and we expect to have announcements on that in 2016. We will have another announcement in 2015 in the heavy duty motive segment for China..

Okay, got it. One last one for me here and then I will jump back in queue. You guys have fortified the balance sheets over the last couple of quarters, more cash coming in from the VW licensing payment, the final remaining one you have in 2016. With that said, it looks like also in terms of acquisitions you have got the latest one under your belt now.

Could you talk about the pipeline of opportunities you are seeing on the acquisition front?.

Yes. I mean, I think we just closed the Protonex acquisition on October 1 and you asked the question about gross margin earlier and Protonex will certainly be a significant contributor in terms of improving gross margin overall for our business next year.

So, we are now substantially into the integration on Protonex and very pleased with the way that’s tracking. So, I think we will get through that transaction this year and look to 2016 for the next opportunity. We have opportunities in the pipeline of varying levels of maturity and advanced discussions, but nothing imminent..

Okay, got it. I will jump back in queue guys. Thank you..

Thanks, Matt..

[Operator Instructions] The next question comes from Rob Brown of Lake Street Capital Markets. Please go ahead..

Good morning..

Good morning, Rob..

Just following up on the China bus market, I know you talked about more partners, but how do you foresee the unit volumes kind of stepping out both with your current partner and future partners? Is it sort of that 300 units kind of chunks or will that ramp – do you see that ramping?.

I think with the existing partner, it’s important for us to get through delivery of the initial tranche of 300 and start looking at larger scale deployments with that partner as well. They are already talking about larger scale deployments. They move very fast in that marketplace.

And frankly, we want to make sure that we are executing well together, including our partners. So, we do expect to see more opportunity there, but I want to be cautious about suggesting that there will be large volumes from that – from our existing partners in the very near term beyond what’s already announced.

In terms of new partners, I would expect them to see a similar type of cadence, similar to Synergy, where you have initial deployment of a handful of units, 10, 20. In the Zehe case, in Synergy case, it was initially 33. And then you will see larger deployments behind that.

We certainly are having discussions of deployments in the 300 plus opportunity today, but I would like to see some of these partners get some smaller deployments done initially to make sure that the partnerships and the infrastructure and the programs that we put together work really well before we start scaling in larger programs..

Okay, good. Thank you.

And then on the telecom business, you talked about evaluating alternatives and sort of – what’s sort of your latest thinking there and what – do you have sort of a decision timeline where you start to make decisions?.

Sure. I mean, this in my opinion is a natural time for us to review all of our business segments. I have been here for a year now and we are also turning over into a new fiscal year. And so we made the commitment when I joined last year to invest in each of our business segments in 2015 and make foundational improvements in those businesses.

We have actually accomplished quite a bit on the foundational side in backup power this year, but it has not translated to the volume of sales. Our pipeline is I think about 4x as large today as it was in January, but converting that pipeline into firm orders has been challenging.

And so it’s a natural time for us as we start transitioning in 2016 and as I conclude the first year here to evaluate each of our businesses.

I would say that particularly as we add on businesses like we have just done with Protonex, we want to make sure that we have a portfolio of businesses that have attractive growth rates that have clear pathways for attractive gross margin.

And certainly, when you look at the acquisition criteria we have, that’s the type of criteria we need to assess our own businesses with in terms of our legacy businesses. So, we are assessing each one of our businesses here today as we are starting to look at 2016. And so everything is on the table..

Okay, great. Thank you..

The next question comes from Carter Driscoll of FBR. Please go ahead..

Good morning, guys..

Good morning..

Not to beat the China question to death, but if you think about – and I am not trying to put timeframe around it, but if you think about the great win you just had and let’s say you’ve got another 1 to 2 in, say 2016, of a similar magnitude, could you see – did that have a step function effect on gross margins? You have been in a fairly low capacity utilization level for several quarters now.

So, just trying to get a sense of where you might see say, 500 or 700 basis point jump from similar types of orders, because that seems to be the one area where you could get a very significant jump in unit sales relatively soon?.

Yes. So, I think there are two great opportunities there, Carter. One relates to obviously volume and the ability for us at Ballard to drive down our own supply chain cost based on volumes. So, that’s an intriguing opportunity as we start to see scale develop in this business.

The other opportunity is as our partners localize production in China and localize the supply chain in China that I think could be a very significant step function in terms of cost reduction, not just for our China assembled modules by our partners, but the ability for Ballard to take that supply chain and embed it in our Vancouver-based production activities for global markets.

And so we do expect to see cost reduction from volume and then cost reduction from Chinese localization that will enhance gross margins over time..

Okay. Nisshinbo – I think you mentioned in the prepared remarks that it may have an impact on your M&A strategy, if I read that correctly.

If so, does that – I mean, there might be a shift geographically or was it in the diversified number of businesses that they sell into, maybe a shift by end market or – and/or potentially another market for Protonex to penetrate with our power management solutions?.

So, just to clarify, the investment by Nisshinbo doesn’t impact our M&A strategy at all. I think that the comment we are trying to articulate was with the additional $5 million of proceeds that again better positions us for M&A, both in terms of the capital to execute M&A transactions, as well as being an attractive acquirer from would be candidates.

So there is no impact in terms of our strategic view previously described on the M&A strategy from the Nisshinbo investment..

Got it, okay. I think if you – if I heard correctly, you gave a number of active tech contracts that you are currently engaged with.

I don’t know if you – there is a number you have given before if you had, could you maybe put that in the context to what it had last year and last quarter?.

Yes. So yes, it’s Tony, Carter. We have discussed this on previous quarter’s call. We had about 12 under contract the last time we mentioned the number, so it is up slightly. But it’s been double-digit for sometime now..

Yes. I think just to put that in perspective, earlier this year, it was in the range of 12 and I think we are tracking around 15 currently..

Okay. And the number of engagements as well, I am assuming is also – I mean, potential engagements as well has increased commensurately or maybe put a magnitude on what you can see coming down the pipeline, maybe on a dollar number? Sorry guys..

Yes. I would say Carter, that the opportunities we have in the pipeline today, there are certainly more opportunities than they were a year ago. And more important that the quality of the opportunities and the potential long-term implication for the opportunities, I think is more powerful than what we have seen in our pipeline previously..

Okay.

And just my last question, the scope I know you can’t mention the OEM currently, but the scope of the work you are doing with the unnamed auto OEM, is that different than past work of a similar vein with other auto OEMs?.

It’s a unique scope of work that has not been duplicated with prior OEMs. It is a scope of work that I think will benefit other OEMs potentially in the long-term in terms of our – the learnings that come out of that..

But not necessarily leverageable beyond the agreement to other auto OEMs?.

We can’t really comment on that yet today. It will depend on how that partnership ends up moving forward..

Perfect. Thanks for your time. I will get back in the queue..

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

Thank you.

Most of my questions have been asked, just trying to get a sense of how revenues potentially shape up for 2016, should we be modeling for a heavier second half in 2016 as well or do you see some of these initiatives that you have undertaken so far this year start to contribute in a decent way in the first half of 2016 already?.

Yes. I mean historically we have seen revenue be back-end loaded as we see in this year as well. So it wouldn’t surprise us to see that again next year. I do think one of the key variables for 2016 and even as we move into 2016 is the timing for European and North American bus projects.

And there is a uncertain time period between the time contracts are initially awarded compared to when buses are deployed, so that variability in the timeline sometimes makes it difficult to know exactly when projects will get delivered.

But I would say for 2016 that the second half of the year, I would expect to see heavier weighted than the first half of the year..

Got it.

And in regards to Protonex, you mentioned you expect some contribution from the initiative in the fourth quarter this year, could you give us a sense of like what percentage potentially of revenues in the fourth quarter Protonex will be?.

We would expect Protonex to be in the range of $4 million to $5 million of revenue for Q4. The other thing that I want to comment on just with respect to 2016 revenue coming back to your initial question, the pipeline we have today and the order book we have today is significantly larger than it was at this time last year.

And so I think as we start looking at 2016 and we will have more to say on this obviously in early 2016 when we talk about the outlook, we have a lot more confidence in our – the revenue prospects for 2016 than we would have a year ago..

Got it.

And just last question on your reevaluation of the Backup Power segment, does the option include potentially just exiting that space altogether?.

Everything is on the table. We will make decisions for each of our market segments based on the best interest of the long-term shareholder value. So we are certainly looking at all options for the Backup Power businesses and in fact all of our businesses as we look to transition to 2016..

Thank you. That’s all I have..

[Operator Instructions] The next question comes from Jeff Osborne of Cowen and Company. Please go ahead..

Good morning. Most of my questions have been answered. I just had a couple more.

I was wondering on the backup side, can you discuss what the – it’s clearly the gross margins are challenged in that segment, but can you discuss what the annual OpEx is for that segment and what kind of the trend rate has been there since you started, Randy?.

Yes. The easy way to answer that without providing numbers is telling you the annual OpEx is not commensurate with the revenue and gross margin stream we have today. So the revenue has been disappointing this year and the gross margin has been disappointing as well.

And so when your revenue number and your gross margin number isn’t coming in where you expected, it’s incumbent upon you obviously look of the cost side. And so the cost side, this business is not paying for itself clearly today and that’s why we are taking a very hard look at it..

Got it.

And I may have missed this, but Tony did you discuss what the Canadian dollar impact was to OpEx in the quarter and then just how do we think about that given the environment we are in for Q4 and as you do your planning for ‘16, just what type of organic OpEx growth above and beyond Protonex we should be thinking about, assuming there is no change to the Canadian dollar from here?.

Yes. So it’s just that we have – we do provide some outlook. We do say that every – roughly every $0.01 change in the dollar is about $200,000 in terms of impact. So as you look about – as you look at Q3, it was about $1.4 million was the impact to the numbers in the quarter. So as you – so that’s kind of how that flows through to the bottom line.

Obviously, we – just in terms of our outlook and how we think about the dollar going forward, a couple of things we talked about the VW contract being denominated in Canadian dollars, which does impact the revenue, but most of the costs for the VW contract are in Canadian dollars.

So while it hurts us a bit on the top line, there is somewhat of a natural hedge, if you will in terms of the bottom line impact there. The other issue is we are – we do have an active hedging program on the Canadian dollar as we think about our go-forward strategy.

So at the end of Q3, we had put in place hedges through 2000 – roughly over a rolling 12-month period. So I would say we are about 30%, 30-odd percent of our currency exposure next year. At this point anyways, it’s hedged and it’s hedged at a not favorable rate to today. So we are actively monitoring that Jeff.

And we will increase our – we will manage our hedges accordingly..

Great to hear and I know you don’t like talking about materials handling units for obvious reasons, but can you just help us out for the quarter what was the bus units shipped and electric gen units, is that something you feel comfortable sharing?.

In terms of actual number of units shipped in the quarter?.

Exactly..

Yes. Let me just take that out for you while we are answering it. I would say it’s certainly up from Q2, so let me just grab that for you..

And maybe while you look at that, just for Randy given it sounds like you are in China recently, you have obviously got the China planning going on now.

Any thoughts with the customers or potential partners that you talked about as it relates to policy as they set out their 13th 5-year plan, what that would include for transportation?.

Yes, I’m sorry.

Could you repeat the question one more time, Jeff?.

You have got the government of China’s meeting this week to lay out their 13th 5-year plan which will be singed in the law in March.

And I guess I am just a bit surprised that there is so much active pipeline as it relates to fuel cell transportation, but before there is actually a law for buses and trains and what not to promote this, so certainly the governments supported this in the past and changed shifting from natural gas to other technologies over the past 12 months to 18 months, but as we discussed with local bus manufacturers in trains and tram partners is there any lobbying of the government as part of this planning process that’s going on now as it relates to supporting fuel cells in particular?.

Yes, so good question. A couple of points there. So this Friday, I am actually returning to China and will be there for I think about 11 or 12 days and will be attending as part of a BC Premier Trade Mission. And there is quite a bit of activity going on in the policy side right now.

And a number of the partners that we are involved with are very influential on the policy decision-making. And we expect to see favorable policy development in China that will be supportive of our business plan and supportive of not just fuel cell modules, but fuel cell fueling infrastructure as well.

So, I think the outlook from our perspective based on the data points we have is that there should be an improvement on subsidy regime in China for fuel cell deployments and that of course will be additive to our business plan. It’s not currently embedded, but if that occurs, that will quite helpful for us..

Great to hear that. That’s the only questions I had. Tony, do you happen to find those units, so there was…..

Yes, no, Jeff, we have it here. So, just in terms of units shipped in the quarter, so I will give you the two numbers. In the material handling space, we shipped a little under 1,600 units and that’s a combination of new and refurbs.

And in the bus segment, it’s – I will say the number of units shipped was 30, but I will remind you, of course, that the mix, even within bus who we used to be shipping – and when we said 30 that would have been all modules. We are now, as you know, shipping into China a combination of modules and kits.

So, within that 30, there is a mix of full HD7 modules as well as the kits that we shipped, there was about 25 kits that we shipped in the quarter, so 30 in total in the bus segment, then about – so just a little under 1,600 in Material Handling..

And de minimis in backup power..

Yes. And then just lastly given the back end weighting of the year, any thoughts on bus in particular for next quarter? I know you are not sure about ‘16, but I would think you would have a better line of sight for 4Q..

Yes, there won’t be as many – again, you may recall, we had shipped the balance. We had talked about the 33 that we delivered related to Zehe. Most of those were shipped in Q3. Q4 is a little lighter in terms of actual unit volumes.

Part of that is that much of the activity that isn’t ready, we have talked about is in the 30 and 60 kilowatt for the new contracts. So, there is some units going out in all sizes, but it will be a little lower cadence, a little lower volume than it was in Q3, but still a good quarter..

And then just lastly, sorry, I have got another one, but will you ship anything as it relates to India back up in 4Q? And if you were to decide to make some adjustments or even exit that market, is there any contract risk or penalties, clauses that would be as a result of that or would you fulfill everything you have signed today and whatever strategic changes you make would be longer term in nature?.

Yes. Well, certainly – so with the first question, yes, there will be some units shipped to India out of the 50 I mentioned earlier, those – a good number of those will be shipped in the quarter.

Again, these are the hydrogen units, so a relatively lower ASP, but certainly as we evaluate more broadly evaluate the strategies for the backup power segment, quite aside from our any commitments to the shipped product, we obviously have over 3,500 units in the field.

Not all of those of course will be under warranty, but we do have ongoing obligations to deal with that. So that will be part of our consideration as well..

Great. I appreciate all the detail. Thanks, guys..

There are no more questions at this time. I will now hand the call back over to Randy MacEwen for closing remarks..

Thank you for joining us today. We look forward to speaking with you again on our next call in February when we will discuss results for the full year 2015, along with our outlook for 2016.

That discussion will include a review of our plans to ensure alignment between cost and revenue expectation at each of our market segments as we work to achieve a sustainable business model premised on high growth, scaling and profitability. Thank you..

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