SFC Energy AG (F3C) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and thank you for taking the time to join our earnings call here reporting first half year numbers and second quarter numbers. Together with Daniel, we will give you an overview of the business and financial performance. As Naturally, we will be happy to answer your questions and react to your comments afterwards in the Q&A session. For housekeeping purposes, we had a slight difficulty here on the IT side ramping up to or getting access with our standard system here. So we have to warn you, we are operating here on our mobile device. If there is any issue, please feed this back here to Andre our operators who we can react. So I hope you can hear us loud and clearly. And with this, yes, we start our presentation. Looking back at a very positive first 6 months of the business, showing significant growth and at the same time, a significant improvement of profitability, looking at the best 6 months in the company's history so far, which also leaves us with quite some optimism here for the remaining part of this year. If you look into, I'd say, the overall highlights, yes, growing sales revenue by almost 50%, 49.5% is the right step forward. But at the same time, double or more than double the adjusted EBITDA and increase the adjusted EBITD here by a factor of 6 and slightly more. I think it's a significant accomplishment here for us as a team. And I think it's at the end of the day also delivering on what we promised to all of you who followed that and we're confident together with us a year ago when we laid out the plan here in conjunction with our capital increase. Because what you look at is we are looking at an operational performance with a significant key parameters from a financial point of view, reflecting the delivery here on targets and above of the target. But at the same time, strategically, I think we have taken the next steps. And we went out to do the capital increase end of July last year, we had 3 elements where we wanted to allocate the funds as use of proceeds. Regional expansion, I think seeing the step in India also seeing the step in the U.K. There is -- we have the first checkmark here and we can take, let's say, initial boxes. Second element, further development here of products, higher power products, integration of further capabilities. To all of you who have already registered for our first Capital Markets Day here end of September and to those who are in the call right now and you want to register and follow our invitation, yes, we will be able to show you the first pilots of our higher power system. We will show you the next generation on the hydrogen product side and naturally also the full pallet here of our methanol products here with all their capabilities, including the cloud capabilities. So also on the development side, we are investing consistently. Well, as the third one, we also wanted to allocate some of the funds, some of the investment capital that we gathered into complementary M&A on the technology side, which I think the first step completed here end of Q1, beginning of Q2 with acquiring the membrane technology here from our long-term partner, Johnson Matthey and being on the way to integrate it. So operational and strategic development effect, we are showing that we are following the path, which we agreed with all of you. And we are delivering on what we feel is naturally a promise, but also an obligation we went into last year. Looking at the regional part, I will reference to the U.K. and the membrane production and technology a little later. But maybe the operational highlights here, yes, taking our Indian operation into, I'd say, full functionality a couple of weeks ago here in the presence of our Vice Chancellor Mr. Habeck, after only 5 months of full [app] work after signing the contract with our long-term partner, FC TecNrgy in the presence here of Chancellor Susan and Premier Modi in February. Naturally, we are happy about, let's say, the political support and also the attention. I think this gives us also a lot of awareness on the customer front and helps us on marketing and sales of our products in India, which is a big element. But besides the political support, naturally, it's the support of the customers. Within those couple of months here within the first 6 months of this year, we were able to acquire projects and programs of a value of about EUR 33 million, largest fuel cell order from the Indian Army Border protection forces taking our fuel cells out to have, let's say, autonomous and off-grid energy. And those orders are now being in execution. We are about to ship to our customers in the second half of the year, a big portion of those orders. And this again, naturally is the natural financing of our investment . Fast forward right now, expanding our customer base. We are working on projects here, especially in the civilian application from, I'd say, Indian railroad projects to smart city projects where at the end, conventional generators are replaced or are to be replaced in a broad sense. This whole step into India for us is one of the major elements also of our not only worldwide but Asian strategy, we are building up an operational hub that fulfills Make in India requirements. So local content is up is about 50%, which gives us access to a lot of government programs, we could not fulfill here delivering products from Germany only. And the second element, naturally, there's a massive investment in this national green hydrogen initiative by the Modi administration intending to spend about EUR 44 billion here on green energy projects, again, replacing conventional generators but also including green hydrogen production, and we are working on [RFQs] where we integrate, again, our fuel cell capabilities with electrolyzer capabilities there for civilian and non-civilian applications. Over time, yes, we expect to have about 100 people working there. And our midterm plan at the end is to generate about EUR 100 million revenue here out of the Indian market. Looking into the U.K., taking the opportunity here on, call it, a strategic alignment with our long-term partner, Johnson Matthey taking over the technology, but also then the production know-how for our MEAs for the membrane electrode assemblies, the most expensive, the most valuable component of a fuel cell here for our methanol product line, I think, helps us over time to solidify and strengthen our supply chain. But at the same time, I think, helps us to build out our competitive position on the technology side here in the methanol space, our leadership position here in terms of technology competitiveness. But then naturally, over time, also, we expect to reduce cost here by being able to drive this development in-house. Where do we stand? The lot for the factory is selected. Construction work is on its way. And the plan is to shift the assets end of Q4 and to get operational beginning of Q1 with our U.K. team producing then the membranes for the methanol product here directly. Capacity expansion in Germany. We are through in Romania, we already do assemble fuel cell modules. We do assemble energy systems. We are not where we wanted to be in total. So there is still, let's say, the one or the other government permit outstanding, which prevents us from, let's say, a full-fledged production. We expect to have this solved by end of this year and also complete there with is the capacity expansion here in Europe. Overall, I think looking at also an order backlog of about EUR 85 million here, end of Q2, we also see that the demand here and the dynamics in the market remain fully intact. So if we now look at, let's say, where we are in terms of the development of the sales in our 2 segments, we see that clean power management was catching up significantly in the first 6 months. Also in the second quarter, we see a growth here of about 60% year-on-year for the first 6 months. The one is solid order backlog with our large industrial customers there, but then also we saw an easening on the supply chain, which really hampered the results last year and impacted the business negatively. So a good catch-up compared to 2022. And I would not say a full normalization on the supply chain, but a real improvement. On clean energy, well, if you look at the growth here, about 45% growth demand dynamics fully intact and still here also the industrial applications are the drivers. Overall, this is about 2/3 of the overall segment's revenue. And if we look into what are the main drivers, this is still replacing conventional generators, mostly diesel generators or complementing battery solar combinations in the, I'd say, in our sig surveillance technology in data transmission. And on a regional level, yes, I think it is naturally a highlight to look at, let's say, to look at the growth rate here in North America being 72% and in Asia, 94% or almost 95%. If we look now into, let's say, North America from a country level, still, actually, the U.S. is growing at the pace of about 120%. We have a key customer that is driving this year LiveView Technologies, but we are diversifying this. So orders from other segments and other customers are incoming. But still, our home market in North America, Canada is also delivering a growth of about 60%. And the same, we should not neglect our home market here in Europe. We have growth rates between 31% and 37% in the core countries. So this is also according to plan. And naturally, we are starting at, let's say, a higher base number in Europe as well as in Canada compared to Asia and the U.S. And in Asia, about 95% growth, a big impact from India, but also a growth in the other countries we are operating in. If we also look into, let's say, end markets besides, let's say, the industrial markets, especially with our successes in India, we saw that the public security end market almost doubling. If we look, let's say, at the order side, I already mentioned this, we are looking at an EUR 85 million order backlog, again, an increase compared to last quarter compared to, let's say, half a year ago. And all of this, yes, helps us to look in an optimistic way into, I'd say, the remaining 4.5 months of this year. With this, I would like to hand over to Daniel to lead you through the development of earnings and looking into, let's say, the financial performance.

Thank you, Peter, and good morning, everybody. Thank you for joining the call. As Peter already mentioned, we've been able to expand our margins while growing. Let me dig into the reasons and the drivers of our margin expansion, how the cost develop. Basically, also, as Peter mentioned, it's pretty much executing on what we have laid out during our road show last year to the capital increase and keep on telling you when we see you taking advantage of operational leverage but also implementing what we consider good strategies for our products and our pricing. If we start with the group gross profit, you've seen in our release that the gross profit for the first half year amounted to EUR 22 million. That's a 62% increase significantly for the previous half year or EUR 8.4 million. If you compare them to the sales of EUR 57 million, this translates into a gross margin for the group of 38.3%. That is noticeably above the level of last year's half year gross margin, which was at 35.3% and it's also slightly above the full year margin of last year, which was 36.8%. And -- what is the reason for this increase of the expansion, it's pretty much the same as we had in the first quarter. We do see the full effect of our price adjustment that we implemented last year in both segments. But also, we see the higher level of revenue, which then also translates in relatively lower production overhead per unit giving us a higher gross profit. And we also see, and I mentioned that already during the first quarter that the higher cost of the little bit more expensive components, which we purchased last year and highly slowing inter-production still I repeat what I said during the last call, we will see some of these costs coming into Q3 and part of it also in Q4. But overall, the gross margin in both segments have improved. Looking at the Clean Energy segment, which tends to have a strongly have the higher gross margin. We are looking at a gross profit of EUR 17.2 million, which is 61% above what we see last year and translating in the 44.6% was more so very strong. Last year, we had a 40.1% gross margin giving. And you may remember that the rapidly increasing prices of components and logistics in the first half of last year. Also in the first half year, the product mix is a little bit more favorable. Still the segment grows and the segment profitability is driven by fuel cells for industrial applications. Peter already mentioned that also, these products tend to be higher power and also higher margin. But also in the first half year, we had a significant contribution of products in the -- for the public security sector, which also tend to be a very high-margin product. Still fuel or applications -- fuel cells for industrial applications, that's the right order of the words, account for approximately 63% of the segment's revenue. Clean Power Management also good to see we've been able to expand the gross margin from 4.1% to 25.3% and it's not a super high step but is a step in expanding the margin. mostly, this is really given that we've been able to implement the price increases. Looking at our EBITDA, very nice, very good. The EBITDA for the first half year was EUR 6.8 million compared to EUR 3.1 million. Let's look at the adjusted EBITDA, which, as you know, is our key KPI. I repeat this as we call, one of the adjustments that we're making. It's basically 2 is the -- we adjust our EBITDA for the provision and the income from the LTI, long-term incentive programs. stock option programs, and we adjust our EBITDA for the transaction expenses that we may have during a certain period. The impact on the reported EBITDA in the first half year were relatively low. It was EUR 500,000 compared to even lower number of EUR 52,000 in the last half year in the year of the last -- in the half year of the last year. Sorry about that. Transaction-related expenses much lower than last year. Obviously, we had a lot of cost and that incurred with the capital increase. So that compares EUR 254,000 in the current year compared to $1.1 million in the last year. If we look at the expenses for the LTI program, net of the income of the LTI program, we look at an impact of a cost of EUR 297,000 in the first half year, whereas we had income of EUR 967,000 in last year's first half year. So then when we look at the group adjusted EBITDA, really nice, we're looking at EUR 7.3 million, which translates into adjusted EBITDA margin of 12.8%. That is well above the level of the financial year 2022 as well as the first half year of 2022. What are the key reasons? I mean there's simple math behind it, but I had the math, there's also some rationale. Of course, the expansion gross margin expense is 3.1 percentage point, which had a big impact on the adjusted EBITDA. But then it's also the sales and marketing expenses. I will comment on that later. Sales and marketing expenses, I keep also repeating this is the largest position in our functional expenses. They account for approximately 40% of our functional expenses or operational expenses below the gross profit. And these expenses increased distinctively slower than the sales. So they account for 13.3% of sales in the first half year, whereas it was 16.4% in the last half year. That's really a big impact also G&A expense and R&D expenses, which increased lower had a contribution to the higher margin. Depreciation, amortization, we're getting to the EBIT. Total depreciation was EUR 3 million versus EUR 2.4 million in the first half year last year. That is higher than we had in the last year, 1/3 approximately of that MD&As IFRS 16-related. So that's approximately EUR 960,000. And the second biggest position in our depreciation is the depreciation of the capitalized R&D, which in the first half year was EUR 1.4 million. You see it's a little bit higher of what we normally have. That has to do, and I'll touch on that later that we made a $600,000 depreciation on an R&D project, I will elaborate on this in a minute. So there's then if we take the depreciation from our wonderful EBITDA, we're getting to the adjusted EBIT, which was EUR 4.4 million, representing a margin of 7.6%. Quickly, going into the operating expenses, already mentioned sales and marketing expenses, absolutely, the adjusted sales and marketing expenses have increased by 21%. So there are EUR 7.6 million compared to EUR 6.3 million. Still in relation to our revenue, I mentioned that before, it's 13.3% and compared to 16.4% in the last year. And our long-term goal of sales and marketing expenses in relation to revenue is anything between 12% and 13%. So we are on a good way there. The increase of the expense is really mostly personnel expenses, headcount increased to 87% from 83%. Also wages have increased and obviously, sales provision with the increasing revenues. R&D expenses, same logic as in every quarter, we're looking at total adjusted R&D spend. So what we really spend for R&D, irrespective of what has been expensed on the P&L. So the total spend of EUR 4.5 million compared to EUR 3.4 million. Those EUR 4.5 million are the EUR 2.8 million, which you see on the P&L. We capitalized EUR 1.5 million of R&D. And then we received approximately EUR 200,000 in subsidies. Increase of R&D spend of 31%. It's due, on the one hand, to the higher personnel expenses also. If you look at the headcount in R&D, we have built up significantly since last year, not only in Germany, also with our subsidies in Canada as well as in Romania and the Netherlands. And headcount is 86 compared to 64. So that is a significant increase. But also, as I mentioned, we have a depreciation of EUR 600,000 of a capitalized R&D project. Basically, in contest with refocusing our scarce, those scarce R&D and resources on the key project. It was a fuel cell accessory, and we will desire to go forward and really focus on the key project, higher power, Peter already mentioned it and a couple of other things that we're working on. R&D spend in relation to revenues of 7.9% compared to 9% in the previous year. Long term, same thing. We're looking at 6% to 7% of revenue, probably more at the 7% in the future. G&A expenses, adjusted G&A expenses have increased really significantly 43%. So EUR 7 million compared to EUR 4.9 million. Key reason is really, again, mostly personal, I'll be pleased the numbers at the functions and headcount, but also wages have gone up. And then also, we had a significant higher legal and advisory expenses. Among others, also for the AGM and regulatory items that really made this cost increase. That corresponds to 12.3% of our revenues compared to 12.9% in the last year. So basically on the level of last half year, our target is 12% to 13% of revenues. Quickly, also look at our balance sheet, especially our CapEx. Total CapEx in the first half year was EUR 3.9 million, you see that this doesn't exactly match the EUR 3.6 million in the cash flow statement that has to do with the fact that there are some prepayments and labor payments and deferred payments. The 3.9% really is the key driver was the investment in the near production that we made intangible asset -- tangible asset of EUR 1.3 million in the first half. The split between intangible investments, intangible assets and PP&E unchanged, about 2/3 is really investment in intangible assets, 1/3 is in PP&E. And the PP&E is mostly machinery and equipment also, to some extent, IT. So nothing really has changed with our CapEx spending. Cash and cash equivalents. I'm still looking at a solid cash position of EUR 59.4 million compared to the EUR 64 million we had at year-end. Financial debt has increased a little bit. We are looking at a EUR 5 million, nothing has changed in terms of the quality and still working capital line sitting with FFC Netherlands and FFC Canada that leads to a net cash position of EUR 40 -- EUR 54.4 million. Equity has increased with the net profit -- positive net profit that we have. The equity ratio is at the level of last year, at the year end 70%, is really driven by the net profit. Last look at the cash flow, we are looking, this is really the number we are looking at and then making sure that this is solid. The operating cash flow before changes in net working capital was EUR 7.3 million, so much higher than what we've seen in the first half year last year where we looked at EUR 2.1 million. The net working capital did increase but relatively to our sales development increased lower. Total net working capital increased by EUR 8 million, comparing to EUR 10.9 million in the last half year in 2022. What are the key components? Still the inventory that had increased by absolutely EUR 2.3 million, it is an absolute increase, it's a relative decrease. If we just take one of the quick KPIs, and we're looking at the day sales of inventories, 12 months trailing. We're looking at 279 days in -- as of end of June compared to 368 days at the end of last year. So you see that relatively inventory is decreasing. Accounts receivable, cash impacting were a big change, EUR 7.9 million by the end of June. It really has to do with the revenue provision in the second quarter, which was quarter back ended. We made approximately 50% of the quarter's revenue in June. So that automatically leads to a higher position of accounts receivable at the end of the quarter. Accounts payable also increased by EUR 3.8 million in that case. So that's also a decent increase in absolute terms, but also in relative terms, it's slightly lower than what we have seen. Other short terms of the receivable is mostly prepayments, taxes that we pay. The change was EUR 791,000. So that then it goes into a cash flow after change in net working capital of minus EUR 1.5 million roughly compared to minus EUR 8.9 in the last year. Cash flow from investment activities, I already laid out on that one, EUR 3.6 million compared to EUR 1.7 million. Financing activities, not a lot happening there. We're looking at EUR 300,000 worth us EUR 900,000 in the last year. So the impact of the total change in cash in the first half year was EUR 4.5 million, which leads us to a net cash position of EUR 59.7 million. I think these were the key points with regards to cost and balance sheet and with that one, I'll return it to Peter.

Thanks very much, Daniel. Now let's say, looking at what is ahead of us. I said before, I think based on the demand and the dynamics we are seeing in the market, and we are standing on the 22nd of August, so we have 4 plus x 4 month plus x here to go. We are looking, again, optimistically into the remaining part of the year. Looking into some of the activities, yes, on the hydrogen product side, we have now a broad pilot fleet out there. We are getting first operational permits here from -- our customers getting first operational permits, which in some of those projects really is the delaying factors, this is going to telecom, this is going to utility. We have the first fully decarbonized industrial site operating for more than 6 months together with Austrian partners here, Fronius Wolfgang, where a Solar PV electrolyzer fuel cell combination with H2, with a hydrogen gas station is operated by an industrial customer since 6 months on a daily basis. So I'd say, free hydrogen production and usage decentralized. This is, I think, a pilot we are naturally pursuing and trying to replicate here. We have our H2Genset, out there over the summer in all the different festivals, name it maybe the most prominent one here walking together with our partner, [indiscernible], but also another one in Northern Germany, where at the end, just for a data point, there were 100 diesel gensets operated over a period of 3 -- 4 days and on a daily basis, those 100 diesel gensets consume 20,000 liters of diesel with the respective natural CO2 footprint. So the idea of bringing the first hydrogen genset in there is recepted exceptionally well, and we expect this besides, let's say, construction sites being the main field of application for our H2 genset once the rollout starts. I've mentioned the higher power systems development and some other. On trading, we are going through the opening of the CARAVAN SALON here, the largest RV, the largest caravaning show worldwide to celebrate 20 years of EFOY, 20 years of fuel cells in Campervans. Also there, we expect to get some impetus on the business. Regionally, the U.S. is on the agenda. We are looking at different sites. We intend to take a decision still this year to be there near to our customers. So it's not we are going there because there is an incentive scheme with the IRA. No, we are going there to be closer in more proximity to our customer and if we then can recuperate some of the costs through subsidies, this is even better. M&A on the regional side in the U.S. do not expect anything, let's say, before 2024. But then we are also looking at some complementary technology as mentioned before, which might lead into, let's say, an M&A, but that's still opportunistic. Based on all of this, we have decided to narrow our range here for the guidance on the revenue side to the upper half from the EUR 103 million to EUR 111 million range to EUR 107 million to EUR 111 million range. And we have also done in a subsequent way based on our expectations on margins and profitability, the same here on the adjusted EBITDA and EBIT. Adjusted EBIT narrowing the range to the upper half for the EBITDA to a range from EUR 10.5 million to EUR 14.1 million and for the adjusted EBIT to range from EUR 5 million to EUR 8.6 million. With this, we are, I think, reflecting our optimism here, and we are committed to further deliver and before closing our presentation for those amongst you who have not yet registered for our Capital Markets, they do not hesitate to do this. This will be a first time for us. We make this a user experience stay with a lot of, let's say, practical examples here of the applications and really showing our product in operation. So the event is intended to be virtually but naturally also physically for those of you who are by chance in the Munich area here end of September we are happy to welcome you. And with this, we hand back to Andre and open the floor for the Q&A. Thank you very much.

[Operator Instructions] The first question comes from the line of Karsten Von Blumenthal with First Berlin Equity Research. Please go ahead.

Good morning, Peter. Good morning, Daniel. Congratulations to a strong growth or seems like everything works fine. You just mentioned that in your smaller segments. There are still some supply chain hiccups, perhaps you could comment on where the problems are there?

Good morning, Karsten, thanks for joining us. I think we are seeing a massive easening here as, let's say, most other industries we suffered from, let's say, a post-COVID supply chain challenges here over a period of 18 months with, let's say, countermeasures like increased stock levels. I think the stock level still help us to naturally cope with some of the fluctuations we are seeing there. We are seeing prices coming down significantly, almost to pre-COVID levels on the electronic part. But still, I think until we get to a fully normalized pre-COVID situation, we expect, let's say, the running quarter and maybe the next quarter to go by. And so far, no disruption, but some of it -- some of it, we are still leading to simply higher efforts on logistics, on short notice, purchases, but not a concern compared to last year and the year before.

All right. That sounds good. You have quite spectacular growth in Asia. Could you give us a bit further detail where the growth comes from? What about Japan, for example, that would be interesting.

So the major impacting factor, definitely, India, as mentioned, and I think it will remain to be the main driver also in the remaining part of the year but then together with our partners, Toyota, I think Japan is back to pre-COVID level. We had our quarterly management meetings also physically again, with the senior management here, Toyota Tsusho. I think this is back on track. Still the delay in Southeast Asia is there, although with our partner in Singapore, we had, let's say, first project wins already, and there are significant projects in the pipeline. So we expect Singapore to catch up in the remaining part of the year, respectively, first quarter, the second quarter of next year.

All right. Great. And Daniel mentioned this R&D project over EUR 600,000 depreciation. What exactly -- which project did you stop to refocus on key projects?

Karsten, it was a project. It was an accessory for a few cell and energy storage, accessory, which we started to develop a few years ago. There's good reason to do it at the end of the day. But as I mentioned, so its fuel cell related and there were good reasons to do that. But at the end of the day, we were really looking at the resources that we have, having some things have changed in the recent 24 months, especially as Peter mentioned, moving into higher power and moving much stronger into hydrogen. So we decided not to pursue for the pursuit of this project. And yes, then unfortunately, we have to also write it down.

And at the end you might recall this, we did develop some battery management system for, let's say, a complementary [ epi ] battery here for methanol products. What we see is that there is good product out there in the market. And at the end, it's a make or by decision focusing our R&D, as Daniel said, really on to the methanol and hydrogen fuel cell and part and not on, let's say, a BMS part.

All right. That makes sense to me. Last question, when we look into the global economy. China now has obviously some problems. Europe, especially Germany is quite weak in the Panama Canal, the shipments do not come through. Is there anything in H2 where you say that you could be hampered to grow?

I think when we look at our range rate now, we've really tried to factor in on the lower end of the narrowed guidance, all the risk factors we are seeing right now based also in the existing exist order backlog. So we feel confident we can deliver despite. And I'd say, an environment that naturally shows different elements of risks.

All right. Great.

The next question comes from the line of Thomas Junghanns with Berenberg.

I have 2 questions. Maybe we can go one by one. My first question is with respect to the hydrogen fuel cell business. Yes, that's a business going traction. How is business developing. Can you give us a little bit more color on this, maybe you can announce or disclose some numbers for example, of the split in terms of revenues between methanol fuel cells and hydrogen fuel cells or maybe in terms of the numbers of fuel sales being sold?

Thomas, thanks very much. Yes, as mentioned, I think we are seeing, let's say, the overall pipeline here growing the overall also pilot fleet growing if you want to see, I'd say, one of the limiting fact that I mentioned this before, this is -- this is where we see the biggest challenge and also, I'd say, not only for us but also for our customers to get those products are operational in terms of permit, which means getting local authorities being acquainted with the hydrogen technology, making sure that, let's say, all, let's say, the safety regulations are not only followed but are already, let's say, accepted. And this is where we see delays. If you look at some of the pilot projects take the telecom side or the telecom market, yes, in specific projects, our customers were waiting 3 to 6 months to get the permits for operations. So and this is, let's say, on the local authority level. And I was asked to also give my observations here to the highest political levels when traveling with them to India. And I mentioned this is one of the things feeding of the bureaucracy here. But then going back to the -- and this is not a German [indiscernible], this is, say, we are seeing this in projects here throughout the entire geography. And if we now look into, let's say, where are we in fielding, yes, still let's say, the vast majority here and also the unit numbers comes out of the methanol product range, which still is according to our plan. So about 90-plus percent is definitely still methanol. But then if we look in the pipeline, if we look into projects, just by the mere change in ASPs the hydrogen part of the business gets a continuously growing share here of our overall pipeline. And I think we will see this over the next couple of quarters still being, let's say, one of the major topics to make sure our customers are able to immediately take the product and operate it. So it's not that we are not able to deliver. It's really then the operational start-up.

Okay, understood. And my second question is with respect to your U.S. business, that in the H1 report that you are planning to establish a subsidiary in H2 in the U.S. Can you specify a little bit about your plans in the U.S.? Is this the planned implementation of setting up of an own sales force? Or do you plan first to set up your own service business?

Well, here, I think it's a step-by-step process, we are seeing the demand really growing at the fast pace we need to have our faces near to the customer. It's not sufficient to support them out of Canada to support them out of Germany. We have installed already first service guys in the field. And the plan here is to set up sales and service first which must not, let's say, entirely be a sales force that is supporting the customers directly this can also, let's say, support and integration and channel partners. But it is a decision within the upcoming weeks here in terms of location for own presence with sales and service. And then still, we are looking at potential M&A targets. The role model here is like we did it in Canada, looking at proper product integration capabilities that then would help us also to ramp up the local content and with this also then participate naturally then on some of the incentive teams but not before '24 to make this clear and manage expectations here. First, own sales service, customer proximity and then really assess potential M&A.

The next question comes from the line of Malte Schaumann with Warburg Research.

First question is also on the hydrogen parts. How much visibility do you have? Or when do you expect kind of to reach an inflection point when potentially authorities, but normalized when we got of commissions, et cetera, normalize, et cetera, so that customers can install the systems more quickly. Is that something. I mean visibility is probably not that high. But your base expectation be that this is something that should evolve maybe next year? Or will it be a longer process?

Well, that's definitely a tricky challenging question. Part of it is naturally a crystal ball. But the other part is yes, we are seeing our project pipeline. And we are seeing, let's say, a similar demand coming up here on a worldwide level. So this is not a German North American or, let's say, an Indian demand curve, there is this replacement need, felt, seen and translated into RHQs translated into tenders which we are answering to here in Europe, in India. And so it is, I think, still a project business. It is not at the maturity stage like, I'd say, our methanol business already where we simply have a number of repeat customers who are installing our products here on a weekly and daily basis and replacing them in a routine. But what we also see is that the size of those projects is increasing. And the question, when do we get to a point where we have, let's say, a TUV here or other certification bodies in a position to, let's say, take our product as standard replacement of generators. Yes, I think that's still something that will continue to be with us at least in the next year.

And is the kind of already maybe early experience, what's the average permission period is like -- I mean, you mentioned something like 3 to 6 months. So is that maybe a period we should expect currently for new upcoming projects?

Unfortunately, this is really depending on call it, local differences. So it's not something where you have, let's say, a country you have, let's say, in a Canadian and North American context, you have the fine marshal to talk to. You hear in Germany, you have, let's take the local authority, the [Land case] are responsible here to talk to, and this is what makes it really also still an effort for our customers. 3 to 6 months is really what we observed at this point in time, but I would not dare to say that this is the kind of standard.

No. Okay. Understood. And then on the -- also on hydrogen, when we discussed about, spoke about many interesting projects you have seen in our pipeline in the past. Are you able to call out maybe 1 or 2 or 3, which you would see as the most part or the most attractive maybe the most tangible ones looking into maybe the next 12 months or so which are at the top of your list?

We answered or we tendered in some RHQs here on the telecom side in Europe here from some countries like Luxembourg, but also, let's say, Switzerland and Scandinavia, and we are actually working on a couple of tenders where in India, together with [ FC ] technology, where at the end -- this is a rural electrification effort supported by the government run by utility companies, and you have to think of it like somebody wants a 1-megawatt electrolyzer, as somebody wants a 200 to 300-kilowatt fuel cell, the solar PV side to it and then making sure that in a certain landscape, there is not, let's say, a disruption in the grid year of 30%, 30%, 40% on a daily basis. So this is actual projects we are working on. And seeing the implementation speed in India, where we have no reason to question that there will be an implementation coming in 2024 from today's point of view.

Okay. Good. Then a question on the gross margin. I think with still with the Q1 call, I think you shared your expectation that maybe gross margins would temporarily subdued a bit due to higher sourcing costs for components last year. This turned not to be out the case was just product mix? Was there have been other things that supported the strong gross margin is despite volume, just volume and potentially mix?

Malte, this is Daniel. No, I think the answer you said is the answer. Of course, some higher cost components are already reflected in the bill of material and going to production right now. But we did have a rather favorable product mix in the first half year. As I mentioned, especially the defense portion still small in terms of total revenue, but that is a very, very high-margin product, significantly higher. And then we have a terrestrial area that has really contributed on the one hand side, on the other hand side, yes, we always said that the industrial products in terms of gross margin a little bit healthier. And then, for example, the consumer because they also got higher power and a little bit more functionality here and there. That's why a higher price is justified. So there is really the key point. And yes, of course, you know compared to last year, we took a hit because of the pricing, the adjustments that we made at the pricing is also now helping us to get back to a healthy cost portion. But to make a long story short, I'm answering to your short question, sorry about that. It is really a healthy product mix and, of course, a much higher level of revenue.

Okay. And what's the expectation for the second half of the year? I mean, seeing your pipeline, what do you expect a decline in gross margin to keep it at that level?

Well, if you look at how we move along with our guidance, there was a certain rationale behind it. It is, frankly speaking, what do we expect? We expect it most likely to contract a little bit. It kind of depends -- it really depends on product mix and how we will be delivering, but there's a contraction. I would not expect anything dramatic, frankly speaking, but there is movement in it.

Okay. Good. Question on the order intake. I mean that had been pretty strong in the first half with a book-to-bill of significantly above 1. In the first quarter, we had this multiyear project at PBS included probably in the second quarter some longer-range projects in India. What is in your pipeline? I mean, are there similar products expected to be -- in the pipeline for the second half? Or should we kind of expect kind of easing up the situation a bit slower order intake as you might have less multiyear projects?

There's definitely some of those multiyear projects still in there, whether I would not dare to, let's say, promise here. We are doing this in Q3, we are, I think, on a good way to get something really also then [indiscernible] of similar sizes here until the end of the year -- calendar year. And at the same time, I think what we see is, let's say, that we expect some decision-making on tenders we have outstanding, as mentioned on the hydrogen side as well as really the replacement and the recurring replacement business here on the methanol side.

Yes. Okay. That sounds good. And from the current order backlog, how much of that is expected to turn into revenues in the second half of the EUR 86 million?

Well, if you take the 86 million, a good 30 of it is already, let's say, intended to be delivered in the next year. Still with the level of consumption -- or with the level of usage we are seeing with some of the large customers, they are eating into the backlog faster than originally anticipated. On the power management side as well as on the fuel cell side. And in terms of, let's say, repeat business, I think Singapore is a good example here. Looking at, let's say, the usage of the product, we expect, let's say, the boiler security project being, I'd say, in a replacement mode as of Q4, well, latest Q1 next year.

Okay. Good. And then last quick one for Daniel. G&A costs. You addressed that had probably had been a bit higher in the second quarter of the year. So what's the expectation, especially on the G&A side then for Q3 and Q4 in terms of the run rate?

In terms of G&A, I would expect to have the same run rate as we had in the first half year, also in the second half year, there is no big change. The largest part is really personnel expenses. We don't see any change in headcount. Obviously, we would expect the headcount to increase a little bit, given that also IT is reflected in that headcount. And also, we all know that the regulatory environment is not getting lighter. Not that we are really employing and going after those things in the regulations, but there are things that we have to do and that we need to do and that really also increased a little bit the expenses for advisory legal and regulatory advisory. They will stay at the level that we saw them in the first half year and might increase a little bit.

[Operator Instructions] The next question comes from the line of Thijs Berkelder with ABN AMRO.

Thijs Berkelder, ABN AMRO of BHF. First question on India. So you signed more than 33 million of contracts what part of these contracts will be still delivered in, let's say, the second half of this year? And can you maybe also give a bit of flavor on the extra cost we should assume for the start-up of India in the second half versus the first half? A similar question related to, let's say, the developments in the U.K. What kind of extra costs should we assume in the second half versus the first half for getting production started? And maybe for now the third question is on the outlook. What should happen from a negative perspective to make you reach the low end of your guidance range?

Well, this is Peter. Starting with India, I think, yes, some of the initial shipments, we did some initial shipments now at the end of Q2 already for the first project in India, where still the final assembly is done now by our partner and the core products are coming from Germany. But if you then take, let's say, for Q3 and Q4 about altogether a good half of it and slightly more than half of the entire revenue really running into this year. There might be another, let's say, 25%, which we might ship or we will ship, we intend to ship, not mind. We intend to ship and we hopefully will ship before Christmas to our subsidiary in India for the final assembly then to be shipped to the customer within Q1. And then as remainder might run into Q2, but that's the biggest part of it really fully executed until end of Q1 2024, which is the schedule of the customer has given us, and we have signed up to, if there is a delay on the customer end, yes, we will accommodate for this. And before I hand over to Daniel on the cost side, maybe on the outlook side, yes, for the lower end on the revenue side, this is really -- the simple answer here is simply some delays amongst of it, India and some larger shipments to the U.S. that might slip out into Q1. And with this, I hand over to Daniel.

So when it comes to India and start-up costs in the second half year, we could be looking anything up to EUR 200,000. The key part really is rent expenses that will start or have start running as of first of July. So this is really it, we'll get employees on board or got employees on board as to the question is how fast we will wrap this up. Also, it depends a little bit on the regulatory [indiscernible] in India, getting all the typicals, et cetera. So this is sort of the range that we're looking at. When it comes to U.K. it's very similar. We're looking at a little bit of a lower cost here, but they could be anything up to 150,000. Once again, it depends on how fast people will get on the board, on how fast, we'll be able to equip the fab, and there's a little bit of movement in there, which not so much depends on what we're doing. It is really also in those countries getting permits, getting registrations to start operations and ramp it up fully. So this is really the impact. And then what could happen on the cost side in the second half year. And of course, currency is always an issue. There is certain movement in the U.S. dollar and the Canadian dollar that could incur additional cost. Also, obviously, one position is with the higher-priced components that we also have in there. Some of those components as Peter mentioned it, are going back in price and market price. So we have to write them down to the lower cost. This is something that could also happen on some electronic products, difficult to assess. And there may also be depending on how quickly we get people on board a little bit of higher personnel expenses here and there. We also made site to speed up, if possible, in running operations, some IT projects. So it's a number of factors. It's not just one factor, but a number of factors on the cost side that just gives us a range. Part of it is driven really by growth and now probably how fast we can or will implement it and part is obviously market when it comes to component costs and currency.

Okay. And then as a follow-on, working capital. Is it logical there to assume that we will see a release in working capital more likely in 2024 than in second half 2023 because of, let's say, India delivery around year-end?

We will definitely -- we'll definitely see link in working capital. once we also start shipping things to India and as we mentioned before, there's going to be a certain extent of double inventory initially to just secure the supply chain in India, the same accounts while we start production in U.K. of the membrane. There will be a higher level on inventory simply because also our value chain is getting extended. And that's the key thing. I think the absolute level will increase relatively as we have seen in the past half year we are going down and to the more normal levels if we look at the Q ratios.

Yes. Then on the regions, there was one sale in Rest of World in Clean Power Management was that Latin America, Middle East or Africa?

Is -- the sales to New Zealand. So Oceania.

New Zealand.

We might have about to introduce, let's say, Asia and Oceania. If this project really scales up, there are some topics the pipeline here.

Because the country like Israel is booked in Europe or in Asia?

This is where we have changed, let's say, a couple of years ago because this was in Rest of The World, and we have now, let's say, included this in our standard reporting. So the -- as you might recall, we had this in Rest of The World before. But this time, it's not Israel.

[Operator Instructions] There are no further questions at this time.

Well, thank you very much, Andre. Well, thanks, everybody here on our call for your interest and continued support. Well, as always, please do not hesitate to reach out to Susan, Daniel or myself for bilateral discussions and addressing questions. And again, as a [indiscernible], don't neglect our invitation for our Capital Markets Day. We will be happy to have as many of you participating as possible. We are planning a very lightly intangible program here, which gives a good experience on the -- and a good understanding, hopefully, on the technology. With this, we concluded and thank you very much for your time and attention.