MANAGEMENT’S DISCUSSION AND ANALYSIS
This discussion and analysis of financial condition and results of operations of Ballard Power Systems Inc. (“Ballard”, “the Company”, “we”, “us” or “our”) is prepared as at May 2, 2012 and should be read in conjunction with the unaudited condensed interim consolidated financial statements and accompanying notes for the three months ended March 31, 2012 and with the audited consolidated financial statements and accompanying notes for the year ended December 31, 2011. The results reported herein are presented in U.S. dollars unless otherwise stated and have been prepared in accordance with International Financial Reporting Standards (“IFRS”). Additional information relating to the Company, including our Annual Information Form, are filed with Canadian (www.sedar.com) and U.S. securities regulatory authorities (www.sec.gov) and are also available on our website atwww.ballard.com.
BUSINESS OVERVIEW
At Ballard, we are building a clean energy growth company. We are recognized as a world leader in proton exchange membrane (“PEM”) fuel cell development and commercialization. Our principal business is the design, development, manufacture, sale and service of fuel cell products for a variety of applications, focusing on motive power (material handling and buses) and stationary power (backup power and distributed generation) markets. We also provide engineering services for a variety of fuel cell applications.
A fuel cell is an environmentally clean electrochemical device that combines hydrogen fuel with oxygen (from the air) to produce electricity. The hydrogen fuel can be obtained from natural gas, kerosene, methanol or other hydrocarbon fuels, or from water through electrolysis. Ballard fuel cell products feature high fuel efficiency, low operating temperature, low noise and vibration, compact size, quick response to changes in electrical demand, modular design and environmental cleanliness. Embedded in each Ballard PEM fuel cell product lies a stack of unit cells designed with our proprietary esenciaTM technology which draws on intellectual property from our patent portfolio together with our extensive experience in key areas of fuel cell stack operation, system integration, and fuel processing.
We provide our customers with the positive economic and environmental benefits unique to fuel cell power. We plan to build value for our shareholders by developing, manufacturing, selling and servicing industry-leading fuel cell products to meet the needs of our customers in select target markets. Our focus is on leveraging the inherent reliability and durability derived from our legacy automotive technology into non-automotive markets where demand is near term and focused on our core competencies of PEM fuel cell design, development, manufacture, sales and service.
Over the past five years, we have refined the Company’s business strategy to establish a sharp focus on what we believe to be key growth opportunities with near-term commercial prospects in our core fuel cell markets. During the last half of 2011, we refined the Company’s business strategy and established a new engineering services operating unit in order to leverage our expertise in fuel cell design, prototyping, manufacturing and servicing. This new operating unit offers a full suite of fuel cell engineering solutions for a variety of fuel cell applications and is recorded in our core Fuel Cell Products segment.
Page 1 of 23
To support this strategy, we have focused on bolstering and managing our cash reserves to strengthen our capability to execute on our clean energy growth priorities. In March 2010, we completed a sale and leaseback agreement whereby we sold our head office building in Burnaby, British Columbia in return for gross cash proceeds of $20.4 million and then leased this property back for an initial 15-year term plus two renewal options. In December 2009 and July 2010, we completed agreements with a financial institution to monetize our rights under a Share Purchase Agreement with Ford Motor Company (“Ford”) relating to our 19.9% equity investment in AFCC Automotive Fuel Cell Cooperation Corp. (“AFCC”) for an initial cash payment in 2009 of $37.0 million and a subsequent cash payment in 2010 of $5.0 million.
In March 2011, we completed a sub-lease agreement with Mercedes-Benz Canada Inc. (“MBC”) for the rental of 21,000 square feet of surplus production space in our specialized fuel cell manufacturing facility located in Burnaby, British Columbia. This sub-lease is effective from August 1, 2011 until July 31, 2019 and is expected to result in annual savings of approximately $1 million in real estate and related overhead costs.
In June 2011, we obtained a $7.0 million Canadian award agreement from Sustainable Development Technology Canada (“SDTC”) for the period from 2011 to 2013 to be used to extend the operating life and lower the product cost of FCgen™-1300, the fuel cell product that powers Ballard’s CLEARgen™ distributed generation system. This award is in addition to a $4.8 million Canadian award agreement from SDTC announced in 2010 for the period from 2010 to 2012 to be used to further develop fuel cell power module technology for the transit bus market.These awards are recorded primarily as a cost offset against our research and product development expenses as the expenses are incurred on these programs.
We are based in Canada, with head office, research and development, testing and manufacturing facilities in Burnaby, British Columbia. In addition, we have sales, research and development and manufacturing facilities in Lowell, Massachusetts and Hobro, Denmark.
We report our results in the following operating segments:
1.Fuel Cell Products: fuel cell products and services for motive power (material handling and bus markets) and stationary power (backup power and distributed generation markets) applications, and engineering services for a variety of fuel cell applications;
2.Material Products: carbon fiber products primarily for automotive transmissions and gas diffusion layers (“GDLs”) for fuel cells;
3.Contract Automotive: contract manufacturing services provided primarily for Daimler AG (“Daimler”). With the completion of our manufacturing supply agreement with Daimler in October 2011, this segment ceased to be an ongoing operating segment as of the fourth quarter of 2011 and is now presented for comparative purposes only.
Page 2 of 23
We made changes to the composition of our operating segments in the fourth quarter of 2011 to align to our current reporting structure. As a result, revenues of $0.3 million for the first quarter of 2011 previously recorded in our Contract Automotive segment relating to engineering services have been retroactively restated to the Fuel Cell Products segment.
RESULTS OF OPERATIONS – First Quarter of 2012
Revenue and gross margin
| (Expressed in thousands of U.S. dollars) | Three months ended March 31, | |||||||||||
| 2012 | 2011 | $ Change | % Change | |||||||||
| Fuel Cell Products | $ | 10,081 | $ | 7,280 | $ | 2,801 | 38% | |||||
| Material Products | 3,464 | 5,164 | (1,700 | ) | (33% | ) | ||||||
| Contract Automotive | - | 2,855 | (2,855 | ) | (100% | ) | ||||||
| Revenues | 13,545 | 15,299 | (1,754 | ) | (11% | ) | ||||||
| Cost of goods sold | 10,524 | 12,806 | (2,282 | ) | (18% | ) | ||||||
| Gross Margin | $ | 3,021 | $ | 2,493 | $ | 528 | 21% | |||||
| Gross Margin % | 22% | 16% | n/a | 6 pts | ||||||||
Revenues of $13.5 million for the first quarter of 2012 declined 11%, or ($1.8) million, compared to the first quarter of 2011. The ($1.8) million decline was driven by lower Contract Automotive segment revenues of ($2.9) million as a result of the completion of our manufacturing supply agreement with Daimler in October 2011, and by lower Materials Product segment revenues of ($1.7) million as a result of lower fuel cell GDL shipments. These declines in our supporting segments more than offset increased revenues of $2.8 million in our core Fuel Cell Products segment.
In our core Fuel Cell Products segment, first quarter of 2012 revenues improved 38%, or $2.8 million, to $10.1 million compared to the first quarter of 2011. The increase was driven by higher engineering services revenues a result of our increased focus on building our engineering services business, combined with improvements in our Motive power market and relatively flat Stationary power market revenues. Motive power market increases were driven by higher fuel cell bus revenues as a result of new shipments in 2012 to Van Hool NV, and by higher material handling market revenues as a result of increased shipments in support of Plug Power Inc.’s GenDrive™ systems. Stationary power market revenues were flat as increases in Dantherm Power backup power system shipments and work performed on the K2 Pure Solutions and Toyota distributed power CLEARgen™ fuel cell system projects, were offset by the decline in shipments of hydrogen-based backup power modules.
Material Products segment revenues of $3.5 million were down 33%, or $1.7 million, primarily as a result of significantly lower shipments of fuel cell GDL products.
Page 3 of 23
The following table provides a summary of our first quarter fuel cell stack shipments):
| Three months ended March 31, | |||||||
| 2012 | 2011 | % Change | |||||
| Material handling | 351 | 64 | 448% | ||||
| Backup power | 192 | 367 | (48% | ) | |||
| Other | 7 | 67 | (90% | ) | |||
| Fuel Cell Stack Shipments | 550 | 498 | 10% | ||||
Gross margins increased to $3.0 million, or 22% of revenues, for the first quarter of 2012, compared to $2.5 million, or 16% of revenues, for the first quarter of 2011. The increase in gross margin is driven by a shift in product mix to higher margin products and services and by increased overall revenues in all of our Fuel Cell Products product lines (except hydrogen-based backup power modules). These gross margin improvements more than offset the gross margin declines in our Materials Products and Contract Automotive segments as a result of lower revenues in those supporting segments. In our Fuel Cell Products segment, the gross margin improvement was driven primarily by increased work performed on higher margin engineering services projects at both Dantherm Power and Ballard, increased shipments of higher margin fuel cell bus units, and by our ongoing product cost reduction efforts across all of our platforms.
Cash Operating Costs
| (Expressed in thousands of U.S. dollars) | Three months ended March 31, | |||||||||||||
| 2012 | 2011 | $ Change | % Change | |||||||||||
| Research and Product | $ | 5,337 | $ | 6,306 | $ | (969 | ) | (15% | ) | |||||
| Development | ||||||||||||||
| General and Administrative | 2,992 | 3,019 | (27 | ) | (1% | ) | ||||||||
| Sales and Marketing | 2,325 | 2,452 | (127 | ) | (5% | ) | ||||||||
| Operating costs | 10,654 | 11,777 | (1,123 | ) | (10% | ) | ||||||||
| Less: Stock-based compensation | (955 | ) | (1,061 | ) | 106 | 10% | ||||||||
| expense | ||||||||||||||
| Cash Operating Costs | $ | 9,699 | $ | 10,716 | $ | (1,017 | ) | (9% | ) | |||||
Cash Operating Costs is a non-GAAP measure. We use certain Non-GAAP measures to assist in assessing our financial performance. Non-GAAP measures do not have any standardized meaning prescribed by GAAP and are therefore unlikely to be comparable to similar measures presented by other companies. See reconciliation to GAAP in the Supplemental Non-GAAP Measures section. Cash Operating Costs adjusts operating expenses for stock-based compensation expense, depreciation and amortization, restructuring charges and acquisition costs. | ||||||||||||||
Cash Operating Costs (see Supplemental Non-GAAP Measures) for the first quarter of 2012 were $9.7 million, a decline of $1.0 million, or 9%, compared to the first quarter of 2011. The 9% reduction in the first quarter of 2012 was driven by lower research and product development expense as a result of the redirection of engineering resources to revenue bearing engineering service projects, the aggressive pursuit of government funding for our research and product development efforts, and by lower operating costs in Dantherm Power as a result of our continued cost reduction efforts. Government research funding is reflected as a cost offset to research and product development expenses whereas labour costs incurred on revenue producing engineering services projects are reflected in cost of goods sold.
Page 4 of 23
As the Canadian dollar relative to the U.S. dollar was relatively consistent for the first quarter of 2012 compared to the first quarter of 2011, foreign exchange impacts on our Canadian operating cost base were relatively insignificant. A 1% increase in the Canadian dollar, relative to the U.S. dollar, negatively impacts annual Cash Operating Costs and Adjusted EBITDA by approximately $0.4 million to $0.5 million.
Adjusted EBITDA
| (Expressed in thousands of U.S. dollars) | Threemonths ended March 31, | |||||||||||
| 2012 | 2011 | $ Change | % Change | |||||||||
| Adjusted EBITDA | $ | (5,770 | ) | $ | (7,448 | ) | $ | 1,678 | 23% | |||
EBITDA andAdjusted EBITDA are non-GAAP measures. We use certain Non-GAAP measures to assist in assessing our financial performance. Non-GAAP measures do not have any standardized meaning prescribed by GAAP and are therefore unlikely to be comparable to similar measures presented by other companies. See reconciliation to GAAP in the Supplemental Non-GAAP Measures section. Adjusted EBITDA adjusts EBITDA for stock-based compensation expense, transactional gains and losses, finance and other income, and acquisition costs. | ||||||||||||
Adjusted EBITDA (see Supplemental Non-GAAP Measures) for the first quarter of 2012 was ($5.8) million, an improvement of $1.7 million, or 23%, compared to the first quarter of 2011. The 23% reduction in Adjusted EBITDA loss in 2012 was driven by gross margin improvements of $0.5 million primarily as a result of the 38% increase in Fuel Cell Product segment revenues, and by lower Cash Operating Costs of $1.0 million primarily as a result of the redirection of engineering resources to revenue bearing engineering service projects.
Net loss attributable to Ballard
| (Expressed in thousands of U.S. dollars) | Three months ended March 31, | |||||||||||
| 2012 | 2011 | $ Change | % Change | |||||||||
| Net loss attributable to Ballard | $ | (8,443 | ) | $ | (10,511 | ) | $ | 2,068 | 20% | |||
Net loss attributable to Ballard for the first quarter of 2012 was ($8.4) million, or ($0.10) per share, compared to net loss of ($10.5) million, or ($0.12) per share, in the first quarter of 2011. The $2.1 million reduction in net loss for the first quarter of 2012 was driven by improvements in Adjusted EBITDA loss of $1.7 million and by higher finance and other income of $0.5 million primarily as a result of improved foreign exchange gains on our net Canadian dollar monetary position.
Cash used in operating activities
| (Expressed in thousands of U.S. dollars) | Threemonths ended March 31, | ||||||||||||
| 2012 | 2011 | $ Change | % Change | ||||||||||
| Cash used in operating activities | $ | (15,065 | ) | $ | (14,158 | ) | $ | (907 | ) | (6% | ) | ||
Cash used in operating activities in the first quarter of 2012 was ($15.1) million, an increase of ($0.9) million, compared to ($14.2) million used in the first quarter of 2011. The increase in cash used by operating activities of ($0.9) million was driven by increased working capital requirements of ($3.8) million, which more than offset reductions in cash operating losses of $2.9 million.
Page 5 of 23
Total working capital requirements of ($8.6) million in the first quarter of 2012 were driven by higher accounts receivable of ($2.7) million as a result of the timing of revenues and the related customer collections which are expected to be skewed towards the last half of the year, increased inventory levels of ($2.1) million to support expected higher product shipments in the remainder of the year, and by lower accounts payable of ($3.3) million as a result of increased supplier payments made for higher fourth quarter of 2011 inventory purchases. This compares to total working capital requirements of ($4.8) million in the first quarter of 2011.
OPERATING EXPENSES AND OTHER ITEMS
Research and product development expenses
| (Expressed in thousands of U.S. dollars) | Three months ended March 31, | |||||||||||||
| Research and product development | 2012 | 2011 | $ Change | % Change | ||||||||||
| Research and product development expense | $ | 6,036 | $ | 7,298 | $ | (1,262 | ) | (17% | ) | |||||
| Less: depreciation and amortization expense | $ | (699 | ) | $ | (992 | ) | $ | 293 | 30% | |||||
| Research and product development | $ | 5,337 | $ | 6,306 | $ | (969 | ) | (15% | ) | |||||
Research and product development expenses for the three months ended March 31, 2012 were $6.0 million, a decrease of $1.3 million, or 17%, compared to the corresponding period of 2011. Excluding depreciation and amortization expense of $0.7 million and $1.0 million, respectively, research and product development expense declined $1.0 million, or 15%, compared to 2011.
The 15% reduction was primarily as a result of the redirection of engineering resources to revenue bearing engineering service projects, the aggressive pursuit of government funding for our research and product development efforts, and by lower operating costs in Dantherm Power as a result of our continued cost reduction efforts. Government research funding is reflected as a cost offset to research and product development expenses whereas labour costs incurred on revenue producing engineering services projects are reflected in cost of goods sold.
General and administrative expenses
| (Expressed in thousands of U.S. dollars) | Three months ended March 31, | |||||||||||||
| General and administrative | 2012 | 2011 | $ Change | % Change | ||||||||||
| General and administrative expense | $ | 3,065 | $ | 4,046 | $ | (981 | ) | (24% | ) | |||||
| Less: Depreciation and amortization expense | $ | (73 | ) | $ | (69 | ) | $ | (4 | ) | (6% | ) | |||
| Less: Restructuring expense | $ | - | $ | (958 | ) | $ | 958 | 100% | ||||||
| General and administrative | $ | 2,992 | $ | 3,019 | $ | (27 | ) | (1% | ) | |||||
General and administrativeexpenses for the three months ended March 31, 2012 were $3.1 million, a decrease of $1.0 million, or 24%, compared to the corresponding period of 2011. Excluding depreciation and amortization expense and restructuring charges, general and administrative expense was effectively flat compared to 2011. Restructuringcharges of $1.0 million in the first quarter of 2011 relate to a Dantherm Power leadership restructuring initiated in March 2011.
Sales and marketing expenses
| (Expressed in thousands of U.S. dollars) | Threemonths ended March 31, | |||||||||||
| Sales and marketing | 2012 | 2011 | $ Change | % Change | ||||||||
| Sales and marketing | $ | 2,325 | $ | 2,452 | $ | (127 | ) | (5% | ) | |||
Page 6 of 23
Sales and marketing expenses for the three months ended March 31, 2012 were $2.3 million, a decrease of $0.1 million, or 5% compared to the corresponding period of 2011. The 5% reduction in the first quarter of 2012 was driven by lower consulting expenses and the benefit of a corporate leadership restructuring initiated in September 2011, partially offset by increased investment in sales and marketing capacity in support of our commercial efforts.
Finance and other income (loss)for the three months ended March 31, 2012 were $0.4 million, an increase of $0.5 million, compared to the corresponding period of 2011. The following table provides a breakdown of our finance and other income (loss) for the reported periods:
| (Expressed in thousands of U.S. dollars) | Three months ended March 31, | ||||||||||||
| 2012 | 2011 | $ Change | % Change | ||||||||||
| Employee future benefit plan expense | $ | - | $ | - | $ | - | - | ||||||
| Investment income | 70 | 75 | (5 | ) | (7% | ) | |||||||
| Foreign exchange gain (loss) | 306 | (216 | ) | 522 | 242% | ||||||||
| Finance and other income (loss) | $ | 376 | $ | (141 | ) | $ | 517 | 367% | |||||
Foreign exchange gains and losses are attributable primarily to the effect of the changes in the value of the Canadian dollar, relative to the U.S. dollar, on our Canadian dollar-denominated net monetary position. Foreign exchange gains and losses are also impacted by the conversion of Dantherm Power’s assets and liabilities from the Danish Kroner to the U.S. dollar at exchange rates in effect at each reporting date.
Finance expense for the three months ended March 31, 2012 was $0.4 million, compared to $0.3 million for the corresponding period of 2011. Finance expense relates primarily to the sale and leaseback of our head office building in Burnaby, British Columbia which was completed on March 9, 2010. Due to the long term nature of the lease, the leaseback of the building qualifies as a finance (or capital) lease.
Net loss attributed to non-controlling interests for the three months ended March 31, 2012 was $0.1 million, compared to $1.3 million for the corresponding period of 2011. Amounts represent the non-controlling interest of Dantherm A/S and Danfoss A/S in the losses of Dantherm Power as a result of their 48% total equity interest. The improved performance in the first quarter of 2012 at Dantherm Power is primarily a result of improved gross margins as a result of increased higher margin engineering services revenues and increased shipments of backup power systems, combined with lower operating costs as a result of our continued cost reduction efforts which included a leadership restructuring in the first quarter of 2011. These benefits were partially offset by a restructuring charge recorded in the first quarter of 2011 related to the above noted Dantherm Power leadership restructuring.
Page 7 of 23
SUMMARY OF QUARTERLY RESULTS
The following table provides summary financial data for our last eight quarters:
| (Expressed in thousands of U.S. dollars, except per share amounts | Quarter ended, | |||||||||||||||
| and weighted average shares outstanding which are expressed in | ||||||||||||||||
| thousands) | ||||||||||||||||
| Mar 31, | Dec 31, | Sep 30, | Jun 30, | |||||||||||||
| 2012 | 2011 | 2011 | 2011 | |||||||||||||
| Revenues | $ | 13,545 | $ | 20,996 | $ | 20,602 | $ | 19,112 | ||||||||
| Net income (loss) attributable to Ballard | $ | (8,443 | ) | $ | (7,289 | ) | $ | (6,991 | ) | $ | (8,630 | ) | ||||
| Net income (loss) per share attributable to | $ | (0.10 | ) | $ | (0.09 | ) | $ | (0.08 | ) | $ | (0.10 | ) | ||||
| Ballard, basic and diluted | ||||||||||||||||
| Weighted average common shares outstanding | 84,566 | 84,549 | 84,548 | 84,456 | ||||||||||||
| Mar 31, | Dec 31, | Sep 30, | June 30, | |||||||||||||
| 2011 | 2010 | 2010 | 2010 | |||||||||||||
| Revenues | $ | 15,299 | $ | 21,083 | $ | 16,528 | $ | 15,526 | ||||||||
| Net income (loss) attributable to Ballard | $ | (10,511 | ) | $ | (8,998 | ) | $ | (5,559 | ) | $ | (10,411 | ) | ||||
| Net income (loss) per share attributable to | $ | (0.12 | ) | $ | (0.11 | ) | $ | (0.07 | ) | $ | (0.12 | ) | ||||
| Ballard, basic and diluted | ||||||||||||||||
| Weighted average common shares outstanding | 84,205 | 84,140 | 84,128 | 84,127 | ||||||||||||
Summary of Quarterly Results: There were no significant seasonal variations in our quarterly results. Variations in our net loss for the above periods were affected primarily by the following factors:
- Revenues: Variations in fuel cell revenues reflect the timing of our customers’ fuel cell vehicle, bus and fuel cell product deployments as well as the timing of their engineering services projects. Variations in fuel cell revenues also reflect the timing of work performed and the achievements of milestones under long-term fixed price contracts.
- Operating expenditures: Operating expenses were negatively impacted by restructuring charges of $0.4 million in the third quarter of 2011 as a result of a corporate leadership restructuring, restructuring charges of $1.0 million in the first quarter of 2011 as a result of a leadership restructuring in Dantherm Power, and by restructuring charges of $0.3 million in the third quarter of 2010 as a result of a 25% workforce reduction at Dantherm Power. Restructuring charges are recognized in general and administrative expense.
Operating expenses were negatively impacted in the fourth quarter of 2010 due an acceleration of depreciation expense of $2.3 million for equipment that was considered no longer in use or impaired. The $2.3 million depreciation charge was recognized in product development expense ($1.5 million) and general and administrative expense ($0.8 million).
Operating expenses also include the impact of changes in the value of the Canadian dollar, versus the U.S. dollar, on our Canadian dollar denominated expenditures.
- Gain on sale of assets: The net loss for the third quarter of 2010 was positively impacted by a gain on the stub period monetization of the Share Purchase Agreement with Ford of $4.8 million.
- Impairment loss on property, plant and equipment: The net loss for the fourth quarter of 2011 was negatively impacted by an impairment charge of $1.7 million related to the write-down of manufacturing equipment never put into use.
Page 8 of 23
CASH FLOWS
Cash, cash equivalents and short-term investments were $36.5 million (or $27.1 million net of Operating Facility draws of $9.5 million) at March 31, 2012, compared to $46.2 million (or $41.6 million net of Operating Facility draws of $4.6 million) at December 31, 2011. The decrease in cash, cash equivalents and short-term investments of ($9.7) million in the first quarter of 2012 was driven by a net loss (excluding non-cash items) of ($6.4) million, and by working capital requirements of ($8.6) million. These outflows were partially offset by net cash advances on our Operating Facility of $5.1 million and by convertible debt financing of $0.4 million to Dantherm Power by the non-controlling partners.
For the three months ended March 31, 2012, working capital requirements resulted in cash outflows of ($8.6) million compared to outflows of ($4.8) million for the corresponding period of 2011. In 2012, net cash outflows of ($8.6) million were driven by higher accounts receivable of ($2.7) million as a result of the timing of revenues and the related customer collections which are expected to be skewed towards the last half of the year, increased inventory levels of ($2.1) million to support expected higher product shipments in the remainder of the year, and by lower accounts payable of ($3.3) million as a result of increased supplier payments made for higher fourth quarter of 2011 inventory purchases. Working capital outflows of ($4.8) million for the first quarter of 2011 were driven by the buildup of inventory of ($5.2) million to support expected higher product shipments in the third and fourth quarters of 2011 and to accommodate the work needed to optimize facilities space in view of the Daimler sub-lease scheduled for the third quarter of 2011, and by higher accounts receivable of ($2.5) million due primarily to the timing of collections of our fuel cell bus and contract automotive product and service revenues. These working capital outflows in the first quarter of 2011 were partially offset by cash inflows as a result of higher accounts payable and accrued liabilities of $4.9 million due to the buildup of inventory in the quarter and accrued restructuring costs of $1.0 million related to the Dantherm Power cost optimization efforts.
Investing activities resulted in cash inflows of $11.5 million for the first quarter of 2012, compared to cash inflows of $7.6 million for the corresponding period of 2011. Changes in short-term investments resulted in cash inflows of $11.3 million in the first quarter of 2012 as compared to inflows of $6.8 million in the first quarter of 2011. Balances changed between cash equivalents and short-term investments as we make investment decisions with regards to the term of investments and our future cash requirements. Other Investing activities in the first quarter of 2012 include proceeds on sale of $0.4 million on previously impaired manufacturing equipment. Other Investing activities in the first quarter of 2011 include proceeds of $1.7 million received from MBC on the closing of the facilities sub-lease agreement, and capital expenditures of ($0.7) million primarily for manufacturing equipment in order to build production capacity.
Page 9 of 23
Financing activities resulted in cash inflows of $5.1 million for the three months ended March 31, 2012, compared to cash inflows of $0.5 million for the corresponding period of 2011. Financing activities in the first quarter of 2012 primarily represent advances, net of repayments, of ($4.9) million on our Operating Facility. The Operating Facility is used to assist with the financing of working capital requirements. Financing activities in 2012 also include proceeds on convertible debenture financing from the Dantherm Power non-controlling interests to Dantherm Power of $0.4 million. These financing inflows in 2012 were partially offset by finance lease payments of ($0.2) million. Financing activities in 2011 primarily represent proceeds on convertible debenture financing from the Dantherm Power non-controlling interests to Dantherm Power of $0.8 million, less capital lease payments of ($0.2) million.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2012, we had total Liquidity of $27.1 million. We measure Liquidity as our net cash position, consisting of the sum of our cash, cash equivalents and short-term investments of $36.5 million, net of amounts drawn on our $10 million Canadian demand revolving facility (“Operating Facility”) of $9.5 million. The Operating Facility is used to assist in financing our short term working capital requirements and is secured by a hypothecation of our cash, cash equivalents and short-term investments.
We also have a $3.3 million Canadian capital leasing facility (“Leasing Facility”) which is used to finance the acquisition and / or lease of operating equipment and is secured by a hypothecation of our cash, cash equivalents and short-term investments. At March 31, 2012, $3.0 million was outstanding on the Leasing Facility.
We will use our funds to meet net funding requirements for the development and commercialization of products in our target markets. This includes product development for fuel cells and material products, the purchase of equipment for our manufacturing and testing facilities, the further development of business systems and low-cost manufacturing processes, the further development of our sales and marketing, product distribution and service capabilities, and working capital requirements to grow our business.
At this stage of our development, we may record net cash losses as we continue to make significant investments in product development and market development activities necessary to commercialize our products, and make increased investments in working capital as we grow our business. Our actual funding requirements will vary based on the factors noted above, our relationships with our lead customers and strategic partners, our success in developing new channels to market and relationships with customers, our success in generating revenue growth from near-term product opportunities, our success in managing our working capital requirements, foreign exchange fluctuations, and the progress and results of our research, development and demonstration programs.
Our financial strategy is to manage our cash resources with strong fiscal discipline,focus on markets with high product and service revenue growth potential, license technology in cases where it is advantageous to us, and access available government funding for research and development projects. Our current financing principle is to maintain cash balances sufficient to fund at least six quarters of forecasted cash used by operating activities at all times.
Page 10 of 23
2012 BUSINESS OUTLOOK
We continue to have a strong outlook for 2012, with expectations for:
- Revenue of approximately $100 million; and
- Adjusted EBITDA of approximately breakeven.
Consistent with the past couple of years, we expect a majority of our 2012 revenue to be realized in the second half of the year driven by growth in our fuel cell products segment of at least 50% over 2011. Our business outlook for revenue in 2012 is based on our internal revenue forecast which reflects an assessment of overall business conditions and takes into account actual sales in the first quarter of 2012, sales orders received for units and services to be delivered in 2012, and an estimate with respect to the generation of new sales in each of our markets. Our 2012 business revenue outlook is also supported by our 12-month order book of $41.1 million at March 31, 2012 ($45.3 million at December 31, 2011). The primary risk factor that could cause us to miss our target revenue guidance for 2012 are delays from forecast in terms of closing and shipping expected sales orders, primarily in our Brazilian and European bus markets and in our backup power markets.
The key drivers for the expected improvement in Adjusted EBITDA for 2012 are expected increases in gross margins to approximately 30% driven primarily by aggressive product cost reduction efforts combined with the above noted overall increase in expected revenues and a shift in product mix to higher margin fuel cell buses and engineering services revenue contracts, supported by continued operating expense optimization and a resulting reduction in Cash Operating Costs (see Supplemental Non-GAAP Measures section) to the low $30 million range. Consistent with the expectation that a majority of our 2012 revenue will fall in the last half of the year, Adjusted EBITDA is expected to be materially improved in the last half of 2012, as compared to the first half of 2012. Our Adjusted EBITDA outlook for 2012 is based on our internal Adjusted EBITDA forecast and takes into account our actual results for the first quarter of 2012, our forecasted gross margin related to the above revenue forecast, the costs of our current and forecasted Cash Operating Costs, and assumes an average U.S. dollar exchange rate of 1.00 in relation to the Canadian dollar. The primary risk factor that could cause us to miss our target Adjusted EBITDA outlook for 2012 are lower than expected gross margins due to (i) lower revenues from forecast due to unexpected delays in terms of closing contracts and sales orders; (ii) shifts in product sales mix negatively impacting projected gross margin as a percentage of revenues; or (iii) delays in the timing of our projected product cost reductions. In addition, Adjusted EBITDA could also be negatively impacted by increases in Cash Operating Costs as a result of (i) increased product development costs due to unexpected delays in new product introductions or bylower than anticipated engineering services contracts or government cost recoveries; or (ii) negative foreign exchange impacts as a result of a higher than expected Canadian dollar. A 1% increase in the Canadian dollar, relative to the U.S. dollar, negatively impacts Adjusted EBITDA and Cash Operating Costs by approximately $0.4 million to $0.5 million.
Page 11 of 23
Similar to prior years and consistent with our revenue and Adjusted EBITDA performance expectations for the year and the resulting impacts on gross margin and working capital, we expect cash used in operating activities in 2012 to be materially higher in the first and second quarters of 2012, as compared to the third and fourth quarters of 2012. Cash used in operating activities in the first two quarters of 2012 is expected to be negatively impacted by the buildup of inventory to support higher product shipments in the third and fourth quarters, the payment of accrued 2011 annual employee bonuses, and by the timing of revenues and the related customer collections which are also skewed towards the last half of the year. We expect improved and positive cash flow from operating activities as well as positive overall cash flow in the second half of 2012 and expect to end 2012 with a net cash position of approximately $30 million. Our net cash position outlook for 2012 is based on our internal net cash position forecast and takes into account our actual results for the first quarter of 2012 and our forecasted net cash requirements for the balance of the year as a result of the above noted Adjusted EBITDA forecast and our expectations for working capital requirements, capital expenditures, and other investing, and financing activities for the balance of the year. The primary risk factors that could cause us to miss our net cash position outlook for 2012 are lower than expected Adjusted EBITDA performance as a result of the occurrence of the above noted risk factors, and increased working capital requirements primarily as a result of (i) higher than anticipated accounts receivable as a result of delays in the timing of revenues and the related customer collections, (ii) increased inventory levels as a result of unexpected changes in the timing and mix of expected product shipments; (iii) unexpected changes in the timing and mix of supplier purchases and payments; and (iv) unexpected changes in the timing and amount of expected government grants and the related contract payments.
Finally, we will continue our focus on maintaining a strong liquidity position. We ended the first quarter of 2012 with a net cash position of $27.1 million (measured as cash, cash equivalents and short-term investments of $36.5 million net of Operating Facility draws of $9.5 million). We believe that with continued focus on improving gross margin performance, managing our Cash Operating Costs and our working capital requirements, we have sufficient liquidity to reach profitability without the need for additional public market financing. However, we may choose to access additional capital under circumstances advantageous to the Company’s shareholders. To facilitate such an action, we filed a short form base shelf prospectus (“Prospectus”) in April 2012 in each of the provinces and territories of Canada, except Quebec, and a corresponding shelf registration statement on Form F-10 (“Registration Statement”) with the United States Securities and Exchange Commission, which has been declared effective. These filings will enable offerings of securities up to an aggregate of $75 million during the 25-month period that theProspectus remains effective.
Page 12 of 23
OFF-BALANCE SHEET ARRANGEMENTS & CONTRACTUAL OBLIGATIONS
Periodically, we use forward foreign exchange and forward platinum purchase contracts to manage our exposure to currency rate fluctuations and platinum price fluctuations. We record these contracts at their fair value as either assets or liabilities on our balance sheet. Any changes in fair value are either (i) recorded in our statement of comprehensive income if formally designated and qualified under hedge accounting criteria; or (ii) recorded in our statement of operations if either not designated, or not qualified, under hedge accounting criteria.
At March 31, 2012, we had outstanding foreign exchange currency contracts (qualified under hedge accounting criteria) to purchase a total of Canadian $5.5 million at an average rate of $1.02 Canadian per $1.00 United States, resulting in an unrealized gain of $0.1 million recorded in other comprehensive income. In addition, we had outstanding platinum forward purchase contracts (not qualified under hedge accounting criteria) to purchase 1,500 troy ounces of platinum at an average rate of $1,563 per troy ounce, resulting in an unrealized gain of $0.2 million recorded in cost of product and service revenues.
At March 31, 2012 we had the following contractual obligations and commercial commitments:
| (Expressed in thousands of U.S. dollars) | Payments due by period, | ||||||||||||||
| Contractual Obligations | Total | Less than | 1-3 years | 3-5 years | After 5 | ||||||||||
| one year | years | ||||||||||||||
| Operating leases | $ | 23,404 | $ | 2,514 | $ | 5,142 | $ | 5,484 | $ | 10,264 | |||||
| Capital leases | 21,823 | 1,919 | 4,195 | 3,556 | 12,154 | ||||||||||
| Asset retirement obligations | 6,264 | - | - | - | 6,264 | ||||||||||
| Total contractual obligations | $ | 51,491 | $ | 4,433 | $ | 9,337 | $ | 9,040 | $ | 28,682 | |||||
In addition to the contractual purchase obligations above, we have outstanding commitments $0.7 million related primarily to purchases of capital assets as at March 31, 2012. Capital expenditures pertain to our regular operations and are expected to be funded through cash on hand.
As at March 31, 2012, there were no other significant changes in our contractual obligations and commercial commitments from those reported in our Management’s Discussion and Analysis for the year ended December 31, 2011.
Page 13 of 23
RELATED PARTY TRANSACTIONS
Related parties include shareholders with a significant ownership interest in us, together with their subsidiaries and affiliates, our key management personnel, and our minority interest partners in Dantherm Power. Revenues and costs recognized from such transactions reflect the prices and terms of sale and purchase transactions with related parties, which are in accordance with normal trade practices at fair value. Related party transactions and balances are as follows:
| (Expressed in thousands of U.S. dollars) | Three Months Ended | |||||
| March 31, | ||||||
| Transactions with related parties | 2012 | 2011 | ||||
| Revenues | $ | - | $ | - | ||
| Purchases | $ | 45 | $ | 81 | ||
| (Expressed in thousands of U.S. dollars) | As at March 31, | |||||
| Balances with related parties | 2012 | 2011 | ||||
| Trade accounts payable | $ | 214 | $ | 84 | ||
| Convertible debenture payable | $ | 2,051 | $ | 782 | ||
| OUTSTANDING SHARE DATA | ||||||
| As at May 2, 2012 | ||||||
| Common share outstanding | 84,613,120 | |||||
| Options outstanding | 8,161,085 | |||||
CRITICAL ACCOUNTING POLICIES, ESTIMATES AND JUDGMENT APPLIED
Our consolidated financial statements are prepared in accordance with International Financial Reporting Standards, which require us to apply judgment when making estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, the reported amounts of revenues and expenses of the reporting period, as well as disclosures made in the accompanying notes to the financial statements. The estimates and associated assumptions are based on past experience and other factors that are considered relevant. Actual results could differ from these estimates. The following are our most significant critical judgments, all of which are related to estimation uncertainty. At this time, we do not have any significant critical judgments related to the application of our accounting policies that do not involve estimation uncertainty. These significant critical judgments related to estimation uncertainty are those judgments that require management’s most challenging, subjective and complex judgments, requiring the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods. These significant critical judgments, and the application of these and other accounting policies, are described more fully in notes 3 and 4 to the March 31, 2012 condensed interim consolidated financial statements and in notes 3 and 4 to the December 31, 2011 annual consolidated financial statements.
REVENUE RECOGNITION
Revenues are generated primarily from product sales and services in our Fuel Cell Products, Contract Automotive and Material Products segments. Product revenues are derived primarily from standard equipment and material sales contracts and from long-term fixed price contracts. Service revenues are derived primarily from cost-plus reimbursable contracts. Engineering development revenues are derived primarily from long-term fixed price contracts.
Page 14 of 23
On standard equipment and material sales contracts, revenues are recognized when (i) significant risks and rewards of ownership of the goods has been transferred to the buyer; (ii) we retain neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold; (iii) the amount of revenue can be measured reliably; (iv) it is probable that the economic benefits associated with the sale will accrue to us; and (v) the costs incurred, or to be incurred, in respect of the transaction can be measured reliably. Provisions are made at the time of sale for warranties. Revenue recognition for standard equipment and material sales contracts does not usually involve significant estimates.
On cost-plus reimbursable contracts, revenues are recognized as costs are incurred, and include applicable fees earned as services are provided. Revenue recognition for cost-plus reimbursable contracts does not usually involve significant estimates.
On long-term fixed price contracts, revenues are recorded on the percentage-of-completion basis over the duration of the contract, which consists of recognizing revenue on a given contract proportionately with its percentage of completion at any given time. The percentage of completion is determined by dividing the cumulative costs incurred as at the balance sheet date by the sum of incurred and anticipated costs for completing a contract.
- The determination of anticipated costs for completing a contract is based on estimates that can be affected by a variety of factors such as variances in the timeline to completion, the cost of materials, the availability and cost of labour, as well as productivity.
- The determination of potential revenues includes the contractually agreed amount and may be adjusted based on the estimate of our attainment on achieving certain defined contractual milestones. Management’s judgment is required in determining the probability that the revenue will be received and in determining the measurement of that amount.
Estimates used to determine revenues and costs of long-term fixed price contracts involve uncertainties that ultimately depend on the outcome of future events and are periodically revised as projects progress. There is a risk that a customer may ultimately disagree with our assessment of the progress achieved against milestones or that our estimates of the work required to complete a contract may change. The cumulative effect of changes to anticipated revenues and anticipated costs for completing a contract are recognized in the period in which the revisions are identified. In the event that the anticipated costs exceed the anticipated revenues on a contract, such loss is recognized in its entirety in the period it becomes known.
During the three months ended March 31, 2012 and 2011, there were no material adjustments to revenues relating to revenue recognized in a prior period.
ASSET IMPAIRMENT
The carrying amounts of our non-financial assets other than inventories are reviewed at each reporting date to determine whether there is any indication of impairment. If any such indication exists, then the asset’s recoverable amount is estimated. For goodwill and intangible assets that have indefinite useful lives, the recoverable amount is estimated at least annually.
Page 15 of 23
The recoverable amount of an asset or cash-generating unit is the greater of its value in use and its fair value less costs to sell. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. In assessing fair value less costs to sell, the price that would be received on the sale of an asset in an orderly transaction between market participants at the measurement date is estimated. For the purposes of impairment testing, assets that cannot be tested individually are grouped together into the smallest group of assets that generates cash inflows from continuing use that are largely independent of the cash inflows of other groups of assets. Cash-generating units to which goodwill has been allocated reflects the lowest level at which goodwill is monitored for internal reporting purposes. Many of the factors used in assessing fair value are outside the control of management and it is reasonably likely that assumptions and estimates will change from period to period. These changes may result in future impairments. For example, our revenue growth rate could be lower than projected due to economic, industry or competitive factors, or the discount rate used in our value in use model could increase due to a change in market interest rates. In addition, future goodwill impairment charges may be necessary if our market capitalization decreased due to a decline in the trading price of our common stock, which could negatively impact the fair value of our operating segments.
An impairment loss is recognized if the carrying amount of an asset or its cash-generating unit exceeds its estimated recoverable amount. Impairment losses are recognized in net loss. Impairment losses recognized in respect of the cash-generating units are allocated first to reduce the carrying amount of any goodwill allocated to the units, and then to reduce the carrying amounts of the other assets in the unit on a pro-rata basis.
An impairment loss in respect of goodwill is not reversed. In respect of other assets, impairment losses recognized in prior periods are assessed at each reporting date for any indications that the loss has decreased or no longer exists. An impairment loss is reversed only to the extent that the asset’s carrying amount does not exceed the carrying amount that would have been determined, net of depreciation or amortization, if no impairment loss had been recognized.
We perform the annual review of goodwill as at December 31 of each year, more often if events or changes in circumstances indicate that it might be impaired. Based on the impairment test performed as at December 31, 2011 and our assessment of current events and circumstances, we have concluded that no goodwill impairment test was required for the three months ended March 31, 2012.
WARRANTY PROVISION
A provision for warranty costs is recorded on product sales at the time of shipment. In establishing the accrued warranty liabilities, we estimate the likelihood that products sold will experience warranty claims and the cost to resolve claims received. In making such determinations, we use estimates based on the nature of the contract and past and projected experience with the products. Should these estimates prove to be incorrect, we may incur costs different from those provided for in our warranty provisions. During the three months ended March 31, 2012, we recorded provisions to accrued warranty liabilities of $0.8million for new product sales, compared to $0.1 million for the three months ended March 31, 2011.
Page 16 of 23
We review our warranty assumptions and make adjustments to accrued warranty liabilities quarterly based on the latest information available and to reflect the expiry of contractual obligations. Adjustments to accrued warranty liabilities are recorded in cost of product and service revenues. As a result of these reviews and the resulting adjustments, our warranty provision and cost of revenues for the three months ended March 31, 2012 were adjusted downwards by a net amount of $0.2 million, compared to a net adjustment downwards of $0.7 million for the three months ended March 31, 2011. The adjustments to reduce accrued warranty liabilities were primarily due to contractual expirations, reductions in estimated costs to repair, and improved lifetimes and reliability of our fuel cell products.
INVENTORY PROVISION
In determining the lower of cost and net realizable value of our inventory and establishing the appropriate provision for inventory obsolescence, we estimate the likelihood that inventory carrying values will be affected by changes in market pricing or demand for our products and by changes in technology or design which could make inventory on hand obsolete or recoverable at less than cost. We perform regular reviews to assess the impact of changes in technology and design, sales trends and other changes on the carrying value of inventory. Where we determine that such changes have occurred and will have a negative impact on the value of inventory on hand, appropriate provisions are made. If there is a subsequent increase in the value of inventory on hand, reversals of previous write-downs to net realizable value are made. Unforeseen changes in these factors could result in additional inventory provisions, or reversals of previous provisions, being required. During the three months ended March 31, 2012, inventory provisions of $0.1million were recorded as a charge to cost of product and service revenues, compared to $0.1 million for the three months and year ended March 31, 2011.
EMPLOYEE FUTURE BENEFITS
The present value of our defined benefit obligation is determined by discounting the estimated future cash outflows using interest rates of high-quality corporate bonds that have terms to maturity approximating the terms of the related pension liability. Determination of benefit expense requires assumptions such as the discount rate to measure obligations, expected plan investment performance, expected healthcare cost trend rate, and retirement ages of employees. Actual results will differ from the recorded amounts based on these estimates and assumptions.
INCOME TAXES
We use the asset and liability method of accounting for income taxes. Under this method, deferred income taxes are recognized for the deferred income tax consequences attributable to differences between the financial statement carrying values of assets and liabilities and their respective income tax bases (temporary differences) and for loss carry-forwards. The resulting changes in the net deferred tax asset or liability are included in income.
Page 17 of 23
Deferred tax assets and liabilities are measured using enacted, or substantially enacted, tax rates expected to apply to taxable income in the years in which temporary differences are expected to be recovered or settled. The effect on deferred income tax assets and liabilities, of a change in tax rates, is included in income in the period that includes the substantive enactment date. Deferred income tax assets are reviewed at each reporting period and are reduced to the extent that it is no longer probable that the related tax benefit will be realized. As of March 31, 2012 and 2011, we have not recorded any deferred income tax assets on our consolidated statement of financial position.
FUTURE IFRS ACCOUNTING STANDARDS
The following is an overview of accounting standard changes that we will be required to adopt in future years. Except as otherwise noted below for IFRS 9, IAS 32 and amendments to IFRS 7, the standards are effective for our annual periods beginning on or after January 1, 2013, with earlier application permitted. We do not expect to adopt any of these standards before their effective dates. We continue to evaluate the impact of these standards on our consolidated statement of operations and financial position.
IFRS 9 – FINANCIAL INSTRUMENTS
IFRS 9 introduces new requirements for the classification and measurement of financial assets. IFRS 9 requires all recognized financial assets that are within the scope of IAS 39 Financial Instruments: Recognition and Measurement to be subsequently measured at amortized cost or fair value. Specifically, financial assets that are held within a business model whose objective is to collect the contractual cash flows, and that have contractual cash flows that are solely payments of principal and interest on the principal outstanding are generally measured at amortized cost at the end of subsequent accounting periods. All other financial assets including equity investments are measured at their fair values at the end of subsequent accounting periods.
Requirements for financial liabilities were added in October 2010 and they largely carried forward existing requirements in IAS 39, Financial Instruments – Recognition and Measurement, except that fair value changes due to credit risk for liabilities designated at fair value through profit and loss would generally be recorded in other comprehensive income. IFRS 9 is effective for annual periods beginning on or after January 1, 2015.
IFRS 10 – CONSOLIDATION
IFRS 10 requires an entity to consolidate an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. Under existing IFRS, consolidation is required when an entity has the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities. IFRS 10 replaces SIC-12 Consolidation – Special Purpose Entities and parts of IAS 27 Consolidated and Separate Financial Statements.
Page 18 of 23
IFRS 11 – JOINT ARRANGEMENTS
IFRS 11 requires a venturer to classify its interest in a joint arrangement as a joint venture or joint operation. Joint ventures will be accounted for using the equity method of accounting whereas for a joint operation the venturer will recognize its share of the assets, liabilities, revenue and expenses of the joint operation. Under existing IFRS, entities have the choice to proportionately consolidate or equity account for interests in joint ventures. IFRS 11 supersedes IAS 31, Interests in Joint Ventures, and SIC-13, Jointly Controlled Entities – Non-monetary Contributions by Venturers.
IFRS 12 – DISCLOSURE OF INTERESTS IN OTHER ENTITIES
IFRS 12 establishes disclosure requirements for interests in other entities, such as joint arrangements, associates, special purpose vehicles and off balance sheet vehicles. The standard carries forward existing disclosures and also introduces significant additional disclosure requirements that address the nature of, and risks associated with, an entity’s interests in other entities.
IFRS 13 – FAIR VALUE MEASUREMENT
Under existing IFRS, guidance on measuring and disclosing fair value is dispersed among the specific standards requiring fair value measurements. IFRS 13 is a more comprehensive standard for fair value measurement and disclosure requirements for use across all IFRS standards. The new standard clarifies that fair value is the price that would be received to sell an asset, or paid to transfer a liability in an orderly transaction between market participants, at the measurement date. It also establishes disclosures about fair value measurement.
AMENDMENTS TO IAS 19 – EMPLOYEE BENEFITS
The amendments to IAS 19 make significant changes to the recognition and measurement of defined benefit pension expense and termination benefits, and to enhance the disclosures for all employee benefits. Actuarial gains and losses are renamed ‘remeasurements’ and will be recognized immediately in other comprehensive income (“OCI”). Remeasurements recognized in OCI will not be recycled through profit or loss in subsequent periods. The amendments also accelerate the recognition of past service costs whereby they are recognized in the period of a plan amendment. The annual expense for a funded benefit plan will be computed based on the application of the discount rate to the net defined benefit asset or liability. The amendments to IAS 19 will also impact the presentation of pension expense as benefit cost will be split between (i) the cost of benefits accrued in the current period (service cost) and benefit changes (past-service cost, settlements and curtailments); and (ii) finance expense or income.
Page 19 of 23
A number of other amendments have been made to recognition, measurement and classification, including those re-defining short-term and other long-term benefits guidance on the treatment of taxes related to benefit plans, guidance on risk/cost sharing factors and expanded disclosures.
Our current accounting policy for employee benefits for the presentation of pension expense and the immediate recognition of actuarial gains and losses in OCI is consistent with the requirements in the new standard, however, additional disclosures and the computation of annual expense based on the application of the discount rate to the net defined benefit asset or liability will be required in relation to the revised standard.
AMENDMENTS TO IAS 1 – FINANCIAL STATEMENT PRESENTATION
The amendments to IAS 1 require entities to separate items presented in OCI into two groups based on whether or not they may be recycled to profit or loss in the future. Items that will not be recycled, such as remeasurements resulting from the amendments to IAS 19, will be presented separately from items that may be recycled in the future, such as deferred gains and losses on cash flow hedges. Entities that choose to present OCI items before tax will be required to show the amount of tax related to the two groups separately.
AMENDMENTS TO OTHER STANDARDS
In addition, there have been amendments to existing standards, including IFRS 7 Financial Instruments: Disclosure, IAS 27, Separate Financial Statements, IAS 28, Investments in Associates and Joint Ventures, and IAS 32, Financial Instruments: Presentation. IFRS 7 amendments require disclosure about the effects of offsetting financial assets and financial liabilities and related arrangements on an entity’s financial position. IAS 27 addresses accounting for subsidiaries, jointly controlled entities and associates in non-consolidated financial statements. IAS 28 has been amended to include joint ventures in its scope and to address the changes in IFRS 10 – 13. IAS 32 addresses inconsistencies when applying the offsetting requirements, and is effective for annual periods beginning on or after January 1, 2014.
SUPPLEMENTAL NON-GAAP MEASURES
In addition to providing measures prepared in accordance with GAAP, we present certain supplemental non-GAAP measures. These measures are Cash Operating Costs, EBITDA and Adjusted EBITDA. These non-GAAP measures do not have any standardized meaning prescribed by GAAP and therefore are unlikely to be comparable to similar measures presented by other companies. We believe these measures are useful in evaluating the operating performance and liquidity of the Company’s ongoing business. These measures should be considered in addition to, and not as a substitute for, net income, cash flows and other measures of financial performance and liquidity reported in accordance with GAAP.
Page 20 of 23
Cash Operating Costs
This supplemental non-GAAP measure is provided to assist readers in determining our operating costs on a cash basis. We believe this measure is useful in assessing performance and highlighting trends on an overall basis. We also believe Cash Operating Costs is frequently used by securities analysts and investors when comparing our results with those of other companies. Cash Operating Costs differs from the most comparable GAAP measure, operating expenses, primarily because it does not include stock-based compensation expense, depreciation and amortization, restructuring charges and acquisition costs. The following table shows a reconciliation of operating expenses to Cash Operating Costs for the three months ended March 31, 2012 and 2011:
| (Expressed in thousands of U.S. dollars) | Three months ended March 31, | |||||||||||
| Cash Operating Costs | 2012 | 2011 | $ Change | |||||||||
| Operating Expense | $ | 11,426 | $ | 13,796 | $ | (2,370 | ) | |||||
| Stock-based compensation expense | (955 | ) | (1,061 | ) | 106 | |||||||
| Acquisition costs | - | - | - | |||||||||
| Restructuring charges | - | (958 | ) | 958 | ||||||||
| Depreciation and amortization | (772 | ) | (1,061 | ) | 289 | |||||||
| Cash Operating Costs | $ | 9,699 | $ | 10,716 | $ | (1,017 | ) | |||||
EBITDA and Adjusted EBITDA
These supplemental non-GAAP measures are provided to assist readers in determining our operating performance and ability to generate operating cash flow. We believe this measure is useful in assessing performance and highlighting trends on an overall basis. We also believe EBITDA and Adjusted EBITDA are frequently used by securities analysts and investors when comparing our results with those of other companies. EBITDA differs from the most comparable GAAP measure, net income attributable to Ballard, primarily because it does not include finance (or interest) expense, income tax expense or recovery, depreciation of property, plant and equipment, amortization of intangible assets, and goodwill impairment charges. Adjusted EBITDA adjusts EBITDA for stock-based compensation expense, transactional gains and losses, asset impairment charges, finance and other income, and acquisition costs.
The following table shows a reconciliation of net income attributable to Ballard to EBITDA and Adjusted EBITDA for the three months ended March 31, 2012 and 2011:
| (Expressed in thousands of U.S. dollars) | Three months ended March 31, | |||||||||||
| EBITDA and Adjusted EBITDA | 2012 | 2011 | $ Change | |||||||||
| Net loss attributable to Ballard | $ | (8,443 | ) | $ | (10,511 | ) | $ | 2,068 | ||||
| Depreciation and amortization | 1,594 | 1,467 | 127 | |||||||||
| Finance expense | 414 | 292 | 122 | |||||||||
| Income taxes | 37 | 113 | (76 | ) | ||||||||
| EBITDA attributable to Ballard | $ | (6,398 | ) | $ | (8,639 | ) | $ | 2,241 | ||||
| Stock-based compensation | 955 | 1,061 | (106 | ) | ||||||||
| Acquisition costs | - | - | - | |||||||||
| Finance and other (income) loss | (376 | ) | 141 | (517 | ) | |||||||
| Loss (gain) on sale of assets and property, | 49 | (11 | ) | 60 | ||||||||
| plant and equipment | ||||||||||||
| Adjusted EBITDA | $ | (5,770 | ) | $ | (7,448 | ) | $ | 1,678 | ||||
Page 21 of 23
DISCLOSURE CONTROLS AND PROCEDURES AND INTERNAL CONTROLS OVER FINANCIAL REPORTING
Our disclosure controls and procedures are designed to provide reasonable assurance that relevant information is gathered and reported to senior management, including the Chief Executive Officer and the Chief Financial Officer, on a timely basis so that appropriate decisions can be made regarding public disclosures. We have also designed internal controls over financial reporting to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with IFRS. During the three months ended March 31, 2012, there were no material changes in internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Our design of disclosure controls and procedures and internal controls over financial reporting includes controls, policies and procedures covering Dantherm Power.
RISKS & UNCERTAINTIES
An investment in our common shares involves risk. Investors should carefully consider the risks and uncertainties described in our Annual Information Form which remain substantively unchanged. The risks and uncertainties described in our Annual Information Form are not the only ones we face. Additional risks and uncertainties, including those that we do not know about now or that we currently deem immaterial, may also adversely affect our business. For a more complete discussion of the risks and uncertainties which apply to our business and our operating results, please see our Annual Information Form and other filings with Canadian (www.sedar.com) and U.S. securities regulatory authorities (www.sec.gov).
FORWARD-LOOKING STATEMENTS DISCLAIMER
This document contains forward-looking statements that are based on the beliefs of management and reflect our current expectations as contemplated under the safe harbor provisions of Section 21E of the United States Securities Exchange Act of 1934, as amended. Such statements include, but are not limited to, statements with respect to our objectives, goals and outlook including our estimated revenue and gross margins, cash flow from operations, Cash Operating Costs, EBITDA and Adjusted EBITDA (see Non-GAAP Measures) contained in our “Business Outlook”, as well as statements with respect to our beliefs, plans, objectives, expectations, anticipations, estimates and intentions. Words such as "estimate", "project", "believe", "anticipate", "intend", "expect", "plan", "predict", "may", "should", "will", the negatives of these words or other variations thereof and comparable terminology are intended to identify forward-looking statements. These statements are not guarantees of future performance and involve assumptions, risks and uncertainties that are difficult to predict.
Page 22 of 23
In particular, these forward-looking statements are based on certain factors and assumptions disclosed in our “Outlook” as well as specific assumptions relating to our expectations with respect to the generation of new sales, producing, delivering and selling the expected product volumes at the expected prices, and controlling our costs. They are also based on a variety of general factors and assumptions including, but not limited to, our expectations regarding product development efforts, manufacturing capacity, product pricing, market demand, and the availability and prices of raw materials, labour and supplies. These assumptions have been derived from information available to the Company including information obtained by the Company from third parties. These assumptions may prove to be incorrect in whole or in part. In addition, actual results may differ materially from those expressed, implied, or forecasted in such forward-looking statements. Factors that could cause our actual results or outcomes to differ materially from the results expressed, implied or forecasted in such forward-looking statements include, but are not limited to: the condition of the global economy; the rate of mass adoption of our products; changes in product pricing; changes in our customers' requirements, the competitive environment and related market conditions; product development delays; changes in the availability or price of raw materials, labour and supplies; our ability to attract and retain business partners, suppliers, employees and customers; changing environmental regulations; our access to funding and our ability to provide the capital required for product development, operations and marketing efforts, and working capital requirements; our ability to protect our intellectual property; the magnitude of the rate of change of the Canadian dollar versus the U.S. dollar; and the general assumption that none of the risks identified in the Risks and Uncertainties section of this report or in our most recent Annual Information Form will materialize. Readers should not place undue reliance on Ballard's forward-looking statements.
The forward-looking statements contained in this document speak only as of the date of this Management Discussion and Analysis. Except as required by applicable legislation, Ballard does not undertake any obligation to release publicly any revisions to these forward-looking statements to reflect events or circumstances after the date of this Management Discussion and Analysis, including the occurrence of unanticipated events.
Page 23 of 23