Ballard Power Systems, Inc.

fuel cell buses in Europe, they're expected to close in the first half of this year. These tenders should lead to subsequent order activity in this segment, driving deliveries starting in 2023 and through 2025. As an example, our customer, Solaris, recently announced that it has won an order for 52 fuel cell buses from Gustrau, Germany, which we expect to move in our order book later this year. We're also excited that we've onboarded three new bus OEMs with bus platforms powered by Ballard entering the market. Moving to the truck market, while revenues in this segment were roughly flat from the prior period, declining revenues from China during this period have masked the seven times growth we've seen in our truck market outside of China compared to Q1 2022. The majority of our revenues in the quarter were driven by European fuel cell truck market opportunities. Going forward, we anticipate revenue activity in this segment to accelerate in the second half of 2023 and in 2024, supported by our order book and sales pipeline. To be clear, the truck market is in the very early phases of fuel cell market adoption. However, we've seen a clear shift in the past six months driven by strong end customer interest in decarbonizing freight and a resulting increase in OEM's evaluating development programs for new heavy-duty truck platforms. There's a heightened understanding of the relative merits of fuel cell electric powertrains in meeting duty cycles with high-range, high-payload, or high-energy demand requirements. We believe our track record of proven safety, reliability, and durability, along with our product offering and roadmap, and our ability to support the integration of our products in fuel cell powertrains, position us strongly to bring substantial value to OEM customers and our shareholders. We continue to make important progress in the rail market. We successfully delivered modules to CP Rail for their locomotive projects. Our current order book for rail customers is weighted towards the second half of 2023, including anticipated deliveries to Siemens and Stadler. Additionally, in the near term, we expect a meaningful follow-on order from one of our rail customers as they start transitioning, deploying a greater number of fuel cell trains. Our marine vertical continues to see strong customer interest, and we expect to deliver the majority of our close to $5 million in order backlog this year. While we continue to make steady progress with our partners in the marine market, we also recognize that adoption is still early stage, and this will drive lumpy revenue from quarter to quarter. We're pleased to announce a significant deployment milestone. The MF Hydra, the world's first liquid hydrogen powered ferry, has now entered passenger service in Norway. The ferry is powered by two 200-kilowatt fuel cell FC wave modules and can carry almost 300 passengers, eight crew members, and 80 vehicles at a speed of 10 knots. As a result of the liquid hydrogen storage, the MF Hydra is able to sail up to 21 days before refueling and will decrease carbon emissions for this route by up to 95%. In our stationary power market, we received a follow-on order from a stationary power customer for 3.6 megawatts comprised of 36 100 kilowatt modules. This was the primary driver for our 25% increase in the backlog relating to the stationary power customers. We're very pleased with this order as we supported this customer as they began developing and demonstrating their stationary power units and this customer is now choosing Ballard as their supplier for larger production runs. For our emerging market segment, we note that this segment benefited from the Audi Technology Service Contract throughout 2022, which is now completed, a factor that will be a headwind for comparative periods in 2023. We're optimistic about the rest of year performance supported by a 25% increase in backlog compared to Q4, driven by orders from our off-highway and material handling customers. Of particular note is our customer first mode upsize their purchase order in Q1 from 30 to 35 modules for Anglo mining haul trucks with module shipments expected in 2023. Wrapping up our vertical based discussion, we want to remind everyone of our anticipated revenue split that we see approximately weighted 30% towards the first half of 2023 and the balance in the second half of the year. For the next portion of the call, we'll discuss our key geographic regions, including updates on policy and our performance in each market. Europe has been a consistent proponent of hydrogen policy for the past several years and has continued that support with a number of new developments. Perhaps the most promising development is agreement reached on the alternative fuels infrastructure regulation that will lead to the installation of one hydrogen refueling station every 200 kilometers along the main EU highways and in large European cities by 2030. This target is expected to result in 650 stations built with the support of EU funding, removing a key barrier to the adoption of hydrogen vehicle deployment in Europe. Europe is the largest geographic contribution to Ballard's revenues in Q1, consistent with Ballard's geographic revenue breakdown in 2022. orders from european customers are also the largest component of our order backlog and and order book accounting for approximately 62 of our total order backlog at the end of q1 in the u.s major policy announcements in 2022 will begin to create on the ground changes this year and in the next year starting with the high the hydrogen hub selections and the awards of low no funding to occur in Q3. Meanwhile, federal government agencies are working on finalizing the implementation of the IRA bill leading to clarity for project developers sometime later this year. To cap these tailwinds off, CARB recently announced its advanced clean fleet policy that will require all California commercial fleets of 50 or more vehicles to purchase 100% of new vehicles with zero emission powertrains by 2036. with initial purchase requirements beginning in 2025. In just over a year, the U.S. has leapfrogged to a leadership position in global hydrogen policies. We now see strong support across the value chain and ecosystem, including substantial support to develop the supply of low carbon, low cost hydrogen, combined with purchase price incentives at the state and federal level for fuel cell powered vehicles. We believe that these policies address many of the friction points in adopting fuel cell vehicles and look forward to the U.S. constituting a greater proportion of our business than in prior periods. An exciting accomplishment achieved in the quarter was shipping the first FCMove HD Plus module manufactured from our newly commissioned Oregon facility. This additional module assembly capability will enable us to better serve this growing American market while enabling our customers to take advantage of federal funding programs with Buy America provisions. We continue to assess opportunities to further strengthen our U.S. platform and what we expect will be a high growth market from 2025 through 2030. And now moving to China. As previously discussed, we believe China's fuel cell electric vehicle complicated policy environment continues to stall development of the fuel cell vehicle industry. And this has been evidenced with a year-over-year decline in sales volumes in China for the first quarter of 2023. We continue to be disappointed with the delayed adoption in the China market and low activity levels at the Weichai Ballard JV, which will weigh on our 2023 results. We are working closely with our Weichai Ballard joint venture to unlock growth in the China fuel cell bus and truck markets. Our management team has begun traveling to China regularly since the country reopened to international travel and will continue to work with policymakers to shape a more constructive environment. I'm personally traveling to China tomorrow and will be there over the next few weeks and will be providing an update on this topic at our Capital Markets Day in June. Now moving to our financials in the quarter. In Q1, Ballard delivered $13.3 million in revenue with approximately 70% of our revenue coming from heavy duty motive applications. While we're just continuing our reporting of technology solutions as a standalone offering, our product revenues represented over 70% of our revenues in Q1, further cementing our strategic shift as a technology products company. As we've discussed in our Q3 and Q4 2022 calls, continued gross margin pressure was partly affected by our pricing strategy to secure customer platform wins. The further downward pressure on gross margins in Q1 was driven by a combination of a shift in revenue mix towards power products, low absorption of our manufacturing overhead costs, increases in supply and labor costs, and inventory adjustments. While we expect challenging gross margin dynamics to persist into 2024 until our volume ramps and our product cost reduction initiatives move into production, We also see this quarter as a low point for the year, subject to one-time charges. We'll provide an update on our gross margin progression at our capital markets day. We reported total operating expense of $37.5 million in Q1 and capital expenditures of $11.6 million for the same period. We expect these levels of spending to be roughly flat each quarter for the rest of 2023, and maintain our guidance for total operating expense and capital expenditures. Given the macroeconomic outlook and rising geopolitical tensions, and in the context of our 2023 annual operating plan, we continue to review our spend carefully to assure we're appropriately investing in our growth strategy while also maintaining a strong balance sheet. We ended Q1 with $864 million in cash and no debt. Ballard is well positioned with industry-leading talent, fuel cell technology, and products for our market applications, key customers and partners across our target markets, a growing product order backlog, industry-leading deployment experience, and a strong balance sheet. We're confident we can deliver long-term shareholder value while making a meaningful impact by providing zero-emission fuel cell power for a sustainable planet. And with that, I'll turn the call back over to the operator, Sachi, for questions.

Thank you. We will now begin the question and answer session. To join the question queue, you may press star then 1 on your telephone keypad. You will hear a tone acknowledging your request. If you're using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press star then 2. We request all questioners to kindly ask one question and one follow-up only. We'll pause for a moment as callers join the queue. First question is from Aaron McNeil from TD Cowen. Please go ahead.

Good morning, and thanks for taking my questions. Randy, I can appreciate that you're going to get into way more detail on this at the upcoming Capital Markets Day, but I was hoping you could just give us a bit more insights into your pricing strategy, and specifically I'm wondering Are you pricing your products the way you are to compete just against other fuel cell providers or against a broader menu of zero-emission vehicles? And then I'm also wondering what you view as sort of a long-term gross margin target for your power products and what sort of product cost reductions you need to achieve to get there based on the prevailing pricing strategy.