Westport Fuel Systems Inc. (WPRT) Q1 2016 Earnings Report, Transcript and Summary

Thank you for standing by. This is the conference operator. Welcome to the Westport Innovations’ 2016 Q1 Financial Results Conference Call. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. [Operator Instructions] At this time, I’d like to turn the conference over to Ryder McRitchie, VP, Investor Relations, please go ahead.

Thank you Brock and good afternoon everyone. Welcome to our first quarter 2016 conference call. It’s being held to coincide with the disclosure of our financial results earlier this afternoon. For those of you who haven’t seen the release and financial statements yet they can be found on Westport’s website at www.westport.com. By a way of brief introduction, I joined Westport earlier this month and look forward to being a part of this team and building on the significant accomplishments over the past 20 years. I'm also looking forward to speaking with many of you over the coming weeks and months. Please feel free to give me a call or send me an email if you'd like to discuss your interest in the Company. On today's call speaking on behalf of the Company will be Westport’s Chief Executive Officer, David Demers; Westport’s Chief Financial Officer Ashoka Achuthan, and Nancy Gougarty, Westport’s President and Chief Operating Officer. Attendance on the call is open to the public and to media, but questions will be restricted to the analyst community. You are reminded that certain statements made in this conference call and our responses to various questions may constitute forward-looking statements within the meaning of U.S. and applicable Canadian securities law. And such forward-looking statements are made based on our current expectations and involve certain risks and uncertainties. Actual results may differ materially from those projected in the forward-looking statements, so you are cautioned not to place undue reliance on these statements. Information contained in this conference call is subject to and qualified in its entirety by information contained in the Company’s public filings. And except as required by applicable securities laws, we do not have any intention or obligation to update forward-looking information after this conference call. I will now turn the call over to David Demers.

Good afternoon everyone and thank you for your interest and support of Westport. 2016 is off to a good start through continued business cost reduction and resource realignment, Westport has moved our operating business to positive adjusted EBITDA despite the challenges in many markets. This achievement sets us up for strong scalable and profitable growth as oil prices rebound and as environmental drivers create new demand for our product. I wanted to touch briefly on four important developments during the quarter before turning the call over to Ashoka and Nancy for their detailed review. First, we announced an alliance with AVL late last year. AVL is the world's leading automotive engineering firm and they partnered with Westport to develop global adoption of our HPDI 2.0 technology. This alliance if off to a fast start and reaction has been very positive. Our core HPDI technology development program continues on budget and on schedule for release of our first production in ten systems to OEM customers later this year. Our timing appears to be very good. As AVL has pointed out, AVL’s powertrain engineering experience and testing solutions combined with Westport HPDI 2.0 technology will create great opportunities for our customers. We also completed the first of our non-core asset sales and we are in the late stages of completing the sale of additional assets that we expect will add more than $20 million of cash to our balance sheet soon. During the quarter, we announced a strategic investment program with Cartesian Capital and we’ve closed two of those three announced tranches. The third tranche will close with the Fuel Systems merger. Cartesian have been creative and collaborative partners and we welcome their support of our strategic plan. And finally, the impending merger with Fuel Systems which we now expect to close in the first week of June will dramatically improve our joint business portfolio and position us well for the future of OEM driven opportunities around the world. Although we had hoped to close this transaction earlier in the year, we are confident that there is widespread support for the merger from Fuel System shareholders and their Board and as you'll see in the proxy advisory firms have formally supported the merger as well. The Fuel System’s Shareholder Meeting is on May 31 and shareholders do need to vote again even if they registered a vote for the earlier meeting. As you know, Westport shareholders have already approved the merger. We look forward to continued development of our global business in 2016 and continued progress toward our mission of a transition from oil-based fuels like diesel and gasoline to clean and expense of natural gas. Over to Nancy and Ashoka, I think Ashoka is up first to take you through the numbers.

Thank you David, good afternoon everyone, I will be providing you with some highlights of our first quarter, our path to profitability and our cash position. As David noted despite continued weakness in the oil and gas sector 2016 was a positive first quarter for Westport. We continued our progress on bringing HPDI technology to market and decreased our cash usage reporting a 25% reduction in cash used from operating activities excluding changes in working capital plus dividends from joint ventures compared to Q4 of 2015. Revenue for the quarter ended March 31, 2016 was $24 million compared to $28 million for the same period last year. The decrease in revenue for the first quarter of this year was primarily related to reduced demand of our light-duty aftermarket products given the low oil price environment we are all faced with. Our HPDI 2.0 program is on schedule and on budget for commercial release to our OEM customers. The development programs are well into the testing and validation phase with the focus being on engine and durability testing and NGL fuel tank systems. Our investments in HPDI as you know are key to our future growth and success. Westport successfully launched its new combustion technology in Volvo Car Corporation's new Drive-E bi-fuel engine in the first quarter of 2016 in Belgium and Luxembourg. The new Westport system is available on the Volvo V60 models and we have plans to further expand the product offerings into other European countries. Our joint ventures which we don't consolidate are an important part of our business. Including our joint ventures, our total segment’s revenue for the quarter ended March 31, 2016 was $118.9 million, a decrease of 24% from the same period last year, largely due to weakness at our Weichai Westport joint venture in China. The Chinese economy and the continued weakness in truck market there has obviously had its impact on our joint venture. Revenue for the quarter ended March 31, 2016 was $29.9 million on sales of 2,436 units, a decrease of 47% over Q1 2015. Our equity pickup from this joint venture for 2016 was $0.2 million which is consistent with the same period last year, primarily due to aggressive operation expense management. Cummins Westport, the revenue was $65 million on 1,647 units for the first quarter of 2016, a decrease of 11% over the same period last year primarily due to lower domestic trucking and international volumes. However, our transit and refuse set markets continue to perform very strongly particularly refuse where the overall market shift to natural gas continues unabated. The growth in renewable natural gas is also helping this trend. Westport's portion of CWI net income for the first quarter this year was $1.8 million, a decrease of $69.5 million over the first quarter of last year. This was primarily due to the impact of lower revenue, and increased R&D spending in the first quarter of this year and favorable warranty adjustments in the first quarter of 2015. Moving on to our cash position, as of March 31, 2016, our cash and short-term investment balance was $24.6 million. Cash used in operations excluding changes in working capital plus dividends from our joint ventures was $11 million in the first quarter of this year compared to $14.6 million for Q4 2015, a sequential improvement of 25%. The merger with Fuel Systems which Nancy will comment on in more detail, along with the sales of our non-core assets and additional funding from Cartesian Capital as David referred to will further strengthen our balance sheet and liquidity position. Moving on to adjusted EBITDA and our path to profitability, I'm delighted to report that our operations returned to adjusted EBITDA profitability for this quarter compared with the loss of $1.4 million for the same period last year. This significant improvement of 102% is a result of operational improvement and cost management initiatives across all our businesses globally. Consolidated adjusted EBITDA declined 15.2% in the first quarter of 2016, compared to the same period last year. Consolidated adjusted EBITDA for the first quarter was a loss of $10.6 million, compared with a loss of $9.2 million in the first quarter of 2015. This decrease was mainly due to weaker performance at our joint ventures compared to the same period last year. Excluding the joint ventures, however, adjusted EBITDA for the first quarter of this year would have been a loss of $12.6 million versus $15.5 million for the first quarter of last year, an improvement of $2.9 million. We reduced our combined operating expenses by $0.9 million or 3.8% for this quarter compared to the same period last year, primarily due to the effective management of our engineering investment programs and strict cost discipline across the board. As mentioned in the press release, we will provide 2016 guidance after the closing of the merger with Fuel Systems. With that, I will pass the call on to Nancy to discuss operational highlights.

Perfect. Thank you, Ashoka. Good afternoon. As in the past, I am going to provide some operational highlights and priorities for Westport and then discuss the upcoming merger with Fuel Systems. So overall, in the past 5.5 weeks since we spoke to you last, Westport continues to move forward on our plans with a sharp focus on moving new products towards full commercialization, improving our operational efficiency, refocusing and rationalizing our product offering and reducing our cost. The macroeconomic and business headwinds in many of our end-market persist, but we see the results of our efforts as evidenced by our positive adjusted EBITDA in Westport operations, despite the lower volumes in the period. We look forward to working with the Fuel Systems as jointly drive for operational focus within the combined companies after the merger closes hopefully in the first week of June. As I turn towards our products and operations, let me start with HPDI 2.0. Our program continues and moves forward with multiple OEM. In the first quarter of 2016, our product passed key durability and performance test and we are and will continue to deliver next-stage components that will be installed on engines for next phase of extended on-road performance testing with our OEM customers. In parallel, to the engine development efforts, the off-engine system is also progressing. Westport and Delphi are on track in completing and further development production facilities to deliver the last generation of HPDI fuel injectors. This facility will allow us to deliver high-performing components in commercial volumes at significantly lower cost. As mentioned earlier, our partnership with AVL is growing momentum, both in facilitating new HPDI customer discussions as well as validating the benefits of our HPDI technology. Now, turning the attention to the joint ventures. CWI, Cummins Westport, following on a Ashoka’s, CWI is looking forward to the launching the sale of Cummins Westport ISB6.7 G engine and the Near Zero NOx ISL G engine later this year. These engines will address the need in the existing market and we look forward to their success. In terms of Weichai Westport, Weichai Westport experienced a sluggish Q1 due primarily to lower diesel prices and China market challenges. That said, our HPDI 2.0 program continues to move forward with engine development and activities for additional pilot trucks on the road later this year. In terms of Westport operations, overall, we are pleased with how our business operated given the lower volumes in the micro headwinds that we have had in the end-markets. Our team has worked hard to manage the business as well as seeing success and finding new markets for our product. Also one of our OEMs is a launching a new model with our components on it here in calendar year 2016. Across other product lines, we remain focused on driving cost efficiency. Aligning our cost to market volume, we are pleased with shifting asset light business model and believe we are very well-positioned to take advantage of the eventual market upturn. As mentioned earlier, I want to comment on the upcoming merger with Fuel Systems. From an operational and planning perspective, we continue to have our task force and functional meetings work in areas including, but not limited to sales, distribution and marketing, manufacturing, product range and development, direct material and purchasing, legal structure, IT, finance and tax as well as communication. We have used this extra time to our advantage and we are ready to hit the ground running from an operational standpoint. We are looking-forward to the opportunities to combine our systems and processes with high quality Fuel Systems assets. The merger will create a stronger company with greater scale, global reach and we expect to reach the $30 million of total annual savings in merger synergies by 2018, not including one-time costs. Though, from my point of view, the faster the integration, the better. With that, I will now pass the call back to the operator for questions.

[Operator Instructions] Our first question today comes from Eric Stine of Craig-Hallum. Please go ahead.

Hi, everyone. I just wanted to start with HPDI and the AVL agreement, obviously trending well here early. Maybe any thoughts on how the pipeline has developed since that agreement has been put in place. And then when you think about HPDI going forward, do you think the value there as with new OEMs for HPDI 2.0 or further penetration with existing OEMs or how do you view them?

Hi, Eric, that was a nice softball. How about we get the first customers and then we will talk about whether it’s better to get more partners or more penetration. To be serious, I think that what’s happened over the last couple of years has been strong development on the engineering side, which is reducing cost because reliability and performance are just as important as kind of first pick cost. As we have seen real breakthroughs in that front, I think we have given people ideas about that, but I think customers are going to be very happy with the resulting product. Our first generation was basically hand-built and hand-assembled and this product is going to be coming out of the world’s largest truck plants with a benefit of several years of development, as well as lower cost. So clearly, we would like to see all of those new partners be delighted with their launch volumes and grow beyond. I think the feedback we have had from – as we started to look now at early customers and where it’s going to get launched, we are quite excited about the demand. There is a lot of interest from customers, particularly in places that have strong greenhouse gas targets, this is going to be a very attractive product. And I think that people are losing sight of the fact, there is still a great economic argument, particularly in places that have expensive diesel fuel. So we are expecting a lot of interest out of this and we are seeing as a result pull through other OEMs. So expanding our current programs and getting strong customer demand after launch is priority one. Priority two, I think is to exploit the growing demand from the rest of the industry to catch up and have a natural gas product, because it looks like there is going to be considerable interest around the world just as a result of our work with AVL and as a result of the change in regulatory focus and the expectation that we are going to see, higher oil process going forward and continued cheap gas. So you heard that story I think, we are just heads down, we are going to deliver the product on time and I think our timing is actually going to be pretty good.

Okay. Just wanted the current thoughts there, maybe just turning to CWI, definitely hearing strong interest here in advance of the Near Zero 9-liter. Just thoughts on the 12-liter, I mean, people view that as being pretty important given that it's a larger part of the market, and hearing that that's right now targeted to 2018 for launch. Any chance that that gets moved up?

Yes, Eric, this is Ashoka. Yes, we are extremely excited about the Near Zero product and we have gone on record saying that we will see the launch in the second half of the year. I think the receptiveness has been extremely positive and I did mention we had a soft first quarter in terms of volumes, domestic truck volumes for CWI, but we think a part of that is also due to our potential customers holding off for the Near Zero product. So all in all, very positive news there and the development and launch is on schedule. Additionally, of course, we have the 6.7 liter, which we've had deliveries to the first, to our first customers in this quarter and that is going to provide continued impetus in a market that we haven't addressed in the past.

Okay. I mean in the 12-liter, I mean the 12-liter, is that something that I mean I think a tentative launch date for that for the Near Zero version is out for 2018, is there a chance that you can move that up, just given potential demand there?

I'll jump in, because I’m not on the board. So I can speculate and Jim Arthurs is in the room too, you might get Jim to speculate. I don't think we have announced a date for the 12 liter. There is speculation about it. The reason that we wanted to launch the 9 liter first is because we really think this is a bus and refuse product first. There is strong regulatory pressure on those segments and they could take advantage of some of the urban credits and the urban operating incentives for fleets, in places like Los Angeles, where there is increasing pressure to start to do something about NOx emissions and smog again. So we thought the launch product should be the 9 liter and I think that’s probably the right one. Truck fleets probably have less opportunity, both for, call it, NOx related incentives as well as, I would say, perhaps less concentrated NOx emissions, because they are moving around so much outside of the city cores, but the technology is quite applicable to both of the other engine platforms and I think the joint venture is going to be looking carefully at where the demand is coming and then put that technology on as part of our product refresh. No need to do it today on the 6, 7, but maybe in a couple of years, once the product is out there, it would be time for that. 12 liter I think is ready to go, and if it makes sense, we would put that with a product refresh. Jim, do you want to comment further?

Well, I’d just say on the 12 liter, absolutely critical product. There are kind of a few things that go into the product plan and we have our next board meeting. We’ll be spending a lot of time on the 12-liter product plan, you've got the Near Zero NOx opportunity, we've got on-board diagnostics that we have to have in place no later than the end of 2017, which is a not a trivial thing and then we've also got, after the engine has been in the marketplace for a few years, some opportunities to improve the product. So it's really a question of, do all of that at once and come out with one or do we do some stage releases and that's the sort of thing we're kicking around, but have not got anything that we will announce in the marketplace quite yet.

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

Good afternoon. On your HPDI 2.0, you said, released the end of this year, could you just outline the steps of what happened after that, how soon before those sort of put into production engines and what is your thinking on timing?

Sure. I’ll defer to Jim here. We’ll let him explain.

Okay. So, Rob, if you think about the process that we go through when you're talking about an OEM production process, so right now, where we are is the component, the injectors, the fuel tank systems, all the HPDI components are fully designed and stable where we know exactly what the production parts are looking like. We’re in the middle of doing performance and durability testing and reliability testing. The big one when you’re talking about heavy-duty trucks where they have 2 million kilometer lifespan is durability testing. There is no substitute for testing over a long period of time with trucks on the road. So we are in the middle of doing all that. We are also now in the beginnings of getting the high-volume manufacturing in place, so we've got equipment on order that will be going into the Delphi plant and there is a fair bit of work to do to get that equipment installed and validate that we can make the production parts exactly the same every time meeting all aspects. And then from the OEM's perspective, when they get our parts that are now proven and durable on the right design, they go through their own durability testing as well as their own manufacturing set of process and so we're -- later this year, really sort of starting that, they've got the components that they will go through their work, which takes a little while, so they are able to manufacture now for the first time HPDI product that comes off of the assembly line at an OEM engine plant and then an OEM truck plant.

Okay, good. And then I know you're not going to probably say the specific timelines, but what's the typical timeline from the part completion to sort of product in the market?

I think we've said, we have trucks that are going to be in customer hands in early ‘17, depending on which market we’re in. Now, Jim has been generic, I can tell you that the protocol varies from OEM to OEM and certainly there is different sensitivities around how much testing and then do you kind of release in a handful of customers or do you go to 100 customers, everyone has their own different protocol, which of course we’re not really trying to influence. So we want to get the parts to a consistent level that we're happy with and then we will release those to the OEM, and the OEM will release the product of their schedule. I think we’re looking forward to seeing genuine customer, real commercial sales over the next 12 to 18 months I say through our OEMs.

Okay, great. And then I think you said the 6.7 liter started to ship, could you give us a sense of the ramp there and the market opportunity you are going after in terms of size of units?

Sure. Well, the 6.7 is targeted to a couple of segments, school buses and call it, the straight tracks stock of urban delivery kind of trucks. To put in perspective the transit bus market that we have been and has been our first sort of core market, runs about 5,000 to 6000 transit buses produced every year and we've got about a third share of that business as Cummins Westport engines. The garbage truck business, which started a little bit later than buses is also around 5000 units a year and more than half of those today are produced with the Cummins Westport engine. Now, when you move to school buses, the type-C school bus, which is the common one, that's about a 30,000 unit per year market. So it's three times the size of transit buses and refuse combined. And then straight trucks is more like a 60,000 or more unit market. So these two markets are significantly larger than our traditional bus and refuse market, not as big as 240,000 a year class A heavy duty, but both really nice size markets and we think we have a good economic package and so on for those customers.

Okay, thank you for the great overview.

The next question comes from Jeff Osborne of Cowen. Please go ahead.

Good afternoon, guys. I just had two questions. Ashoka, I was wondering, can you just touch on the warranty adjustments that you mentioned, could you quantify that, describe what the nature of it was for? And then also I was wondering the Cartesian financing arrangement as the fuel system deal does not go through for whatever reason, is there any penalties or payments or reversals of any of the first two tranches sort of been set up?

Okay. Let me take your first question first. The warranty reversal had to do with the 8.9 liter engine. There was a significant warranty accrual in the first quarter of 2015, which explains a large part of the drop in income between 2015 and 2016. So that's the point I was making on the warranty accrual, it's related to the 8.9 liter engine.

Got it. I just want to make sure it wasn't affiliated with the 12 liters. Thanks.

No. It was the 8.9 and it was reversal in the first quarter of last year. On CWI, the -- I'm sorry, on Cartesian, yes, you're right, the third tranche is planned to close with the Fuel Systems merger, however, the first and the second tranches are completely independent and they're not impacted by any eventuality related to the merger.

Got it. Last question, I probably could look this up in the MD&A, but do you have any lines of credit that are untapped or any other liquidity sources in the event that it doesn’t go through?

We have some in Europe as we have disclosed in our MD&A and we have certain other sources that we are actively working on right now that will provide a meaningful amount of liquidity, yes.

Got it. I appreciate it. Thanks very much.

[Operator Instructions] Our next question comes from Pavel Molchanov of Raymond James. Please go ahead.

Thanks for taking the question, guys. I wanted to kind of compare and contrast CWI versus WWI specifically on operating expenses. In WWI, you’ve successfully cut a lot of cost keeping operating income reasonably good. In CWI, though, they have actually went up even as sales dropped. What explains the difference there?

There is a lot going on in CWI. As Jim mentioned, we have significant amount of development expenses related to the launch of the near zero product which is expected in the latter half of this year and Jim also mentioned the OBD or the onboard diagnostics requirements that all engines are required to meet for being able to be sold in 2018 and beyond and there is a significant amount of engineering cost related to that program as well.

Got it. And then kind of a policy question. 2016 is the first year in a while that the fuel excise tax credit is actually in place at the start of the year rather than change retroactively and I was wondering whether you are noticing any uplift in order flow or even just customer inquiries based on that continuity versus what it was, let’s say, 12 months ago?

Hi, Pavel, it’s Jim. I would say that if you look at our current natural gas customers who comes to Westport North America, I mean they are pleased as could be because their business case is for trucks they bought earlier are working out well and in the markets like transit and rough use that are well entrenched, this is definitely continuing those markets on growth paths. I would say in the commercial truck side where realistically in lots of way diesel fuel has been right down on top of natural prices if you just look at wholesale prices. The exercise taxes is nice, but it’s not enough to swing the bar for those customers for whom the economics is the sole determinant of what truck they buy. So we got lots of customers that are having buying gas trucks, they continue to. But for someone who is going to do it new right now, they are pausing a little bit on that taxes and enough to sort of swing them over. We do need higher.

Certainty certainly helps, but it’s not sufficient to make a business case on its and nor has it ever been sufficient. I think everyone is expecting oil prices to continue to creep and so these business cases are getting better and better. The certainty of the exercise tax is helping us in the sense of lot of the fuel providers, they are now able to have more certainty on fuel price quoting as well. So I would say it’s all good, but it’s some light switch effect where it’s suddenly creating huge demand. Generally I would say economic conditions have been predominant for us. The continued weakness in the resource sector and the oil and gas sector has really impacted everybody and so that overhang continues to be a damper for demand and again, once things get a little healthier we expect to be a big rebound in interest in natural gas vehicles. Difference around the world, I will just jump in because we do see the quite North American centric here. Conditions are quite different around the world and I think what you are seeing in our operating units and Nancy can jump in and verify this, is new markets are appearing as local infrastructure starts to get built, there are suddenly real improvements in opportunity and the team is jumping on it which is partly why we’ve, I think, done reasonably well in the phase of pretty substantial change in the market around the world with government and centers disappearing in lots of very traditional markets sort of traditionally very strong. We’ve been able to jump in new markets as they appear. And I think generally around the world conditions look bright over the next five years and that’s really what we are trying to do is position where it makes economic sense as well as position for the environmental regulations where the OEMs are responding.

Appreciate it.

The next question comes from John Quealy of Canaccord Genuity. Please go ahead.

Hey, good afternoon, folks. On the light duty aftermarket business, one of your competitors Landi had comments that I will paraphrase as subdued but stable in Europe. Can you comment on the underlying demand there especially given the pending merger with fuel systems that is more concentrated in that business line in that part of the world than you currently are?

I will let Nancy jump in.

Okay, not a problem. I would indicate that our business is really broken into two different aspects. One is an OEM business and one is an aftermarket business, so I think our business is a bit more concentrated than Landi on the OEM business and I would say that what we are finding and seeing is that the OEM business is that people are trending - more OEM manufacturers are offering a, I will say, either a biofuel or alternate fuel vehicle and so we are quite pleased where the OEM side goes. I would say, in the European market, relative to where we are in the independent after market and I am not in a position to comment relative to fuel systems, but we are - our business is holding up on that front. Now some of what I would say is the higher tech products and some of the products that we have, that have, I will say, high performance feature, we are finding those are moving quite nicely. We do see within the European market different circumstances for different countries, so I don’t think that we can paint Europe with one brush. I think the good news for us is with our direct sales forces as well as our distributors we are able to get the best out of each of the markets that we participate in Europe.

Okay, thank you for that. As a follow-up, perhaps for Ashoka, cash expenses life-to-date on the pending Fuels Systems merger, can you comment how much money you’ve spent so far trying to close the deal?

We have a reconciliation between net income and adjusted EBITDA and I think the number for the first quarter of this year was 2 million. It’s identified as one of the items that is - in addition to that we had approximately 4 million of costs last year.

Okay, thanks. I will take a look at that. Thank you, folks.

There are no further questions at this time, I would like to turn the conference back over to Ryder McRitchie for any closing remarks.

Well, thanks everybody for joining us today and as I said earlier, feel free to reach to our IR team if you’ve got any follow up questions and we will look forward to working with you in the future here. Other than that our call is now complete.

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