Westport Fuel Systems Inc. (WPRT) Q4 2016 Earnings Report, Transcript and Summary

Thank you for standing by. This is the conference operator. Welcome to the Westport Fuel Systems 2016 Fourth Quarter 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]. I would now like to turn the conference over to Caroline Sawamoto, Manager of Investor Relations and Communications. Please go ahead.

Thank you and good afternoon. Welcome to our fourth quarter and year-end fiscal 2016 conference call which has been held to coincide with the press release containing our unaudited financial results that went out earlier this afternoon. Our audited financial statements are expected to be filed later this week. We will also post the press release and a short presentation specific to this conference call that our speakers will be referring to on our website www.wfsinc.com. On today’s call, speaking on behalf of Westport Fuel Systems is Chief Executive Officer, Nancy Gougarty; Chief Operating Officer of the Automotive and Industrial Segments, Andrea Alghisi; as well as our Chief Financial Officer, Ashoka Achuthan. Attendance at this call is open to the public and to media, but questions will be restricted to the investment 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. I will now turn the call over to Nancy.

Thank you, Caroline. Good afternoon and thank you for joining us to discuss Westport Fuel Systems unaudited fourth quarter and year-end results. On the first call following the merger we provided our vision for the combined company and also presented some clear near-term goals. We have made good progress on these goals and have had a strong finish to 2016. However, we know there is more work to be done. The team is working with urgency and a level of activity that is unwavering. We recognize that we have been quiet since our Q3 call but as we said before this team wants to set clear expectations and will announce things when they are complete and not put out aspirational targets. We had a strong end to 2016 and in the fourth quarter our consolidated revenues were up 5.5% from third quarter due to some market improvements and also some capture of new market share in some regions through leveraging our increased scale, customer base, and global sales and distribution networks. We also made progress on reducing our operating costs. At the end of 2016 we had achieved annual cost savings of $19.5 million through a combination of manufacturing footprint optimization, material cost improvements, and reduced overheads. We've already achieved almost two thirds of our stated synergy targets of 30 million in the first seven months since we have closed the merger and we remain on track to meet our targets. I would like to thank all of the employees around the globe for their hard work and efforts throughout this quarter to achieve these results. Another area of focus is our working capital. On the last call I told you that global purchasing and supply chain group was formed in August. We finished 2016 with net inventory of $70.6 million, this is down nearly 30 million from our peak in 2016 and better than our initial projection. We can't control market trends, changes in government policy, or oil prices but we can control how we operate as evidenced by our operational improvements achieved in 2016. In the fourth quarter, we also completed our portfolio review. A reminder, this is a comprehensive review with a global taskforce looking at each of our products for their growth, future profit potential, competitive positioning, and how they fit into Westport Fuel Systems and the resources they need to succeed in terms of people, money, and opportunity cost. The result of this renewed focus is on certain aspects of our business especially transportation and automotive. Additional divestiture activities are underway but please remember that the timing is determined by what is best value for us and our shareholders. Andrea and Ashoka will provide more details in their comments. Today, Westport Fuel Systems is a company with profitable automotive and industrial divisions and profitable joint ventures. Our SG&A expenses are coming down to align with our revenue as will our major R&D expenses once HPDI is launched and generates revenue from commercial sales. We are meeting customer milestones for shipment of our first HPDI 2.0 commercial components to our launch partner later this year. And this is a major milestone for the Company. Our commitment to innovation and technology remains. OEMs continue to come to us because we are the global leaders in natural gas, technology, and development. Through these ongoing relationships coupled with our proven expertise we continue to see successful partnerships. However, customer funding and alignment with our core business is a requirement. One example is the work we're doing to develop next generation, high efficiency spark-ignited natural gas engines. These programs which are funded by OEM partners will have potential component in technology sales for years to come. In closing before I turn the call over to Andrea I just want to reiterate a couple of things. We know that there is more work to be done and we have the focus to get it done. We believe that we’re meeting the challenges head on with a clear path to unlock true value of our assets, technology, and people, and make Westport Fuel System a sustainable profitable company that delivers value for customers, employees, and shareholders. And lastly we remain laser focused on our goals and objectives as we enter 2017. With that I will turn the call over to Andrea.

Thank you, Nancy. Now starting on slide 5, to build on Nancy’s comments you can see the improvement in our adjusted EBITDA from our operations in 2016. We are seeing the benefits of our actions and look forward to building up on these in 2017. Turning to the operating segments seen on slide number 6. My comments, we compared a segment performance on a sequential basis. Automotive revenues were up 9.5% from $50.9 million in the third quarter to $55.7 million in the fourth quarter. Gross margins improved from 11.8% in the third quarter to 20.1% in the fourth quarter. The gross margin improvement in the quarter was a result of efficiency efforts and the product competitiveness improvement that had been implemented since the merger closed. The total improvement in sales was driven by market share gains in some regions, higher oil prices, and expanded product offerings. In fact we saw continuous strength in India market, Turkey, and improved performance in Eastern Europe while Western Europe and China remained subdued. The market in Argentina remains weak due to the sharp increase in natural gas prices and the loss of the ability to compete to the next quarter. We have already taken steps to reduce our fixed costs including combining the two companies footprints in that market. Or when we take positive actions to reduce our costs so we are at minimum at breakeven levels but be in a position to benefit if and when the market recovers. When thinking about our global automotive business remember that each market has its own characteristics, fuel price differences, government policies, and fuel infrastructure. Thus far in 2017 we are encouraged by the continued strength in India, Turkey, and somewhat improving outlook in Europe and Russia and South American markets such as Brazil and Ecuador. We have also recently launched new products including the global V90 Bi-Fuel Westport’s advanced natural gas technology. The V90 launched in Sweden has already expanded into key growth markets. The system combines Pressure Direct Injection and CNG port injection to deliver a seamless integrated, flexible, and efficient fuel system without compromise to the driver experience. Turning to investor segment on the bottom of slide six, as you can see sales increased 4% in the quarter while gross margin were effective 28% as in the third quarter of 2016 excluding an inventory adjustment occurred in the third quarter of 2016. We are continuing to see solid performance here led by the APU business in North America, fuel system components in India and the mobile and fleet management businesses in Europe. Our focus remains the operational footprint alignment and working capital improvements. I will now turn the call over to Ashoka.

Thank you, Andrea. Before I start I'd like to make sure that everyone is aware that the numbers I will be talking to are unaudited. The company will be filing its 2016 audited financial statements later this week on March 31st. The company and its auditors are continuing to finalize the evaluation of Westport Fuel Systems internal controls of our financial reporting and whether management's current plans and their implementation can be considered sufficient to alleviate doubts over the company's ability to carry on as a growing concern. The results of such analysis will be included in our 2016 audited financial statements and MD&A. Overall we had a strong finish to 2016. We saw significant improvements in our working capital management, we are realizing the synergies from the merger, and we ended the year with cash balance of 60.9 million up from 58.7 million on September 30, 2016. We have seen strong interest from multiple buyers for our non-core assets. We believe we are in the final stages of completing two transactions with different strategic buyers for some of our non-core assets but I would caution you that no transaction is closed until of course it is closed. Together these sales should provide a significant boost to our liquidity and further we are underway on additional non-core sales opportunities. We're also working with our investment banking advisors regarding our options around upcoming debt maturities. Moving on to guidance, with the expected non-core asset sales and through this transition period it does not make sense for us to provide guidance at this time. The goal of reaching adjusted EBITDA breakeven and then on to full profitability remains the most pressing target and we continue to take actions on every front to achieve this objective. To that end we will discuss guidance at our first quarter earnings call in May. Moving on to adjusted EBITDA for the fourth quarter of 2016 it was negative 9.1 million which is slightly weaker than the adjusted EBITDA in the third quarter due mainly to an accounting policy change related to warranty accruals at our Cummins Westport joint venture. And the receipt of an HPDI milestone payment that we booked in the third quarter. Please turn to slide 9 which highlights our Cummins Westport joint venture performance. Revenue and units shipped were up from the third quarter but were down from the fourth quarter of 2015 because of weakness in the international markets and ongoing headwinds from lower diesel prices and the weak truck market in the U.S. Gross margins for Q4 were lower than that in Q3 due to an accounting policy change related to warranty accruals. The transit bus market however remained strong particularly in California and we are also seeing an uptick in natural gas school bus demand from our recently launched 6.7 liter engine. The biggest event in the fourth quarter was the commercial launch of the Cummins Westport ISL G Near Zero NOx engine. We are seeing strong interest from many customers for this engine which is the first midrange engine to receive CARB low NOx certification which is 90% below current EPA limits. We think that this engine has the potential to be a game changer and according to a CARB study when fueled by renewal natural gas, a transit bus using this engine has total emissions equivalent to a battery electric bus powered by electricity generated by a natural gas power plant. Moving on to slide 10 which shows our consolidated SG&A and R&D expenses, as Nancy and Andrea noted we are continuing to reduce our SG&A and R&D costs as we take steps to align our costs with our revenues. R&D spending in our corporate and technology segment remained elevated much in line with our comments on prior calls with the bulk of the spending continuing to be related to our HPDI 2.0 program. This program remains on track for commercial launch of components to our OEM launch partner in 2017 which as Nancy mentioned will be a significant milestone for Westport Fuel Systems. Looking forward we expect to see similar R&D spending levels in the next few quarters but then dropping off considerably after we reach commercial launch. We do not see R&D cost or capital expenditures related to these costs ramp up again as new development programs kick off as these will be fully funded by our OEM customers as well as government agencies and other industry advancement groups. Moreover if necessary and if we are not seeing the expected achievement of HPDI adoption milestones, we have plans to reduce these R&D expenditures accordingly. Turning to the next slide which shows a walk of our cash from the third quarter to the fourth quarter. Starting with the cash as of September 30th on the left, we received 5.4 million from asset sales, 3.6 was from the sale of a portion of our interest in our Chinese joint venture that we talked about at the last call. And the remainder was various smaller asset sales from closed factories and other non-core items. Joint ventures, dividends contributed 2.6 million and our net borrowings were up 1.1 million. On the outflow side we spent 2.4 million in cash restructuring costs and 3.6 million in capital expenditures mainly related to the HPDI 2.0 program. Our cash used in operations was 13.5 million significantly offset by changes in working capital which contributed 12.6 million. And we closed the year with cash of 60.9 million. In closing I'm pleased to report that we have signed the refinancing of our 10.5 million senior revolver for five years at similar terms. Closing is expected later this week. We are in discussions with our existing debt holders and also working on other options with our financial advisors for the 40.5 million subordinated debentures that are due to mature on September 15th. We hope to complete two non-core asset sales that should meaningfully boost our liquidity position. We are in the final development stages of the launch of commercial components of HPDI 2.0 and we expect 2017 to be a transformative year for the company. We are excited about the operational achievements that Andrea spoke about and the associated adjusted EBITDA improvements in the second half of 2016 and look forward to building upon them. With that operator, I’ll now open the call to questions.

Yes sir, we will now begin the question-and-answer session. [Operator Instructions]. The first question is from Eric Stine with Craig-Hallum. Please go ahead.

Hi, so I just wanted to start with HPDI, you mentioned the spending once commercialized that should take a step down. I mean any way you can quantify the magnitude of that step down and just to confirm, that would be in addition to the 30 million that you've already called out where you've done 20 million of it, is that correct?

Well let me clarify the end of it and I’ll let Ashoka talk about HPDI. But you're right Eric, the synergies that we were talking about there just to go back and remind everybody when we did the merger we talked about $30 million of post merger synergies. $15 million was from the merger itself and another $15 million which was activities already underway at Fuel Systems to rebuild their business and do some restructuring. So the 19.5 that we referred to in terms of the capture of synergies is not that we're talking about here for HPDI.

Okay good, I mean anyway to quantify what the magnitude of the R&D step down will be once HPDI is commercialized with Volvo?

Eric, what I can tell you as I showed in our schedule, most of the corporate and technology R&D that you saw on slide 10 had to do with the HPDI 2.0 program. And once we reached commercialization of components later in the year you can expect a very significant drop off in that spend.

I think that Eric, the other thing is to mention is that as we have done across our technology now is customer funding is a big piece of this. So that is also -- so as we get -- if we do have spending we would expect it to be offset by revenues that would be brought in by a customer.

Got it, maybe now that your launch partner has come out and said that they plan late 2017, just curious what you're seeing, I mean that's been a long time coming, what you're seeing from other either existing OEMs or potential OEMs as far as HPDI, could you just remind us the number that you have right now in hand, that you've disclosed and then the number that you have not disclosed?

Okay, so I would tell you at this point in time that we still have significant amount of interest around the world relative to HPDI. I think that as you know with the Paris accord there's a tremendous amount of focus on greenhouse gas and CO2 and as you know that these relate to fuel economy and a variety of other I will say, ownership attributes that the fleets and those kinds of things are looking for. So yes, we are having quite a bit of interest and we continue to talk to people. I would also mention that we are also getting interest relative to our high efficiency spark-ignited. I think that again as Andrea says, each market has different characteristics and we're trying to lever all the different markets that we have and being able to build a portfolio to allow natural gas to be used and each of the markets have a different demand and different desire.

Got it, I mean any chance you can update kind of what you have4 disclosed -- customers you have disclosed and ones that you have in hand that you have not been able to disclose because the OEM will not let you?

I would say I'm going to leave you a little bit dissatisfied. I'm not really going to answer. To get you there Eric, I think that I can tell you that our interest is still lively and like I said we're working with a variety of interested parties around the globe. And I am from that perspective I'll leave it at that.

Okay, it was worth a shot. Just to clarify so, Ashoka you mentioned that you plan to guide in May, I mean I assume we should take that as that you expect to have your portfolio review wrapped up by then, is that fair?

That's reasonable Eric.

Okay, thank you.

We have a lot of things in play and we expect that some of them will have crystallized by then.

Perfect, thanks.

The next question is from Rob Brown with Lake Street Capital Markets. Please go ahead.

Good afternoon. I want to talk about some growth from market share gains in different geographies, could you give us a sense of sort of what those gains are and what areas you're seeing gains?

I'll turn that over to Andrea. I think that Andrea you can give him a good sense of that.

Yeah. Well let's say that we have gained market share in some of our important after markets market. So, in areas and countries, let's say that some examples be Italy for example, with older brands that are let's say acting on the market. And other markets where we see important market share improvement is Turkey. For example Turkey in what we call EMEA region so Europe Middle East and Africa is one of the biggest market in terms of conversion, car conversion, vehicle conversion in the aftermarket business. And there also we have seen some important market share improvement. So these are just also let's say Eastern Europe we have seen some let’s say good market share improvement even though in some market I have to say that Eastern Europe is more difficult to manage. There is more a bottom up measure of our sales force because not in all of the countries as you know in Eastern Europe there are -- future update.

Okay. Good and then under HPDI launch could you give us the sense of how the timeline rolled out there and sort of came to how you see revenue is probably considering the trucks and trucks get sold?

Okay Rob. Let me tell you this, all the launch and launch timing our focus has really been on the component timing or leaving all the launch in I’ll say activity to our OEM launch partner. So we're not going to comment on that. I would tell you from our perspective we do see that we will be launching the components and providing them to the OEM here in calendar year 2017. And how they are built and distributed and released to the market we'll have to wait for the OEM to provide that information.

Okay, good. Thank you, I’ll turn it over.

The next question is from Amit Dayal with Rodman & Renshaw. Please go ahead.

Thank you and good afternoon everyone. In regards to this 30 million cost saving target that we have should we expect all of it to be realized by the end of 2017?

Well, this is I guess this is what I can tell you on that, I mean I can speak to what we did in calendar year 2016. I think from my perspective as we set out to get this done bringing two companies together I have been quite impressed where the company has been -- what we have been able to deliver in such short term. As you know, as you get into the cost savings there are some things that you're able to capture quite quickly. However, some other things take quite a bit of time. I think it would be our intent is to capture it as quickly as we possibly can but, that said some activities because of the fact that it has impact on footprint, material savings, or even design changes all have their own timing. So it would be, I think it would be or we're hoping that we can capture it as soon as possible but to suggest that we will have it all complete in 2017, I would tell you our plans are definitely looking positive. But beyond that I really can't suggest that 100% of it would be fully achieved in 2017. And again I just want to make sure that you understand that in most cases this is run rate, these are annual savings amounts, okay.

Right, understood. And in regards to these non-core asset sales it looks like you have two dues that maybe closer than maybe all this. Could you give us the scope I guess in terms of the size potentially or any other relevant metric or even from a segmentation point of view that you guys are focusing on, just an update on that front in terms of what it is that we are letting go and what it is that we're keeping?

I would say that what we will tell you is that again against the portfolio we have deemed these assets to be non-core. I think that that's the first category that we would call them. We intend to keep our focus on transportation and automotive. We believe that they are significant in size and I'm not sure at this point in time sticking with my philosophy of not talking before they're done I'm going to hold off and let the -- as they get completed come back to you and give you all the details.

And maybe one question for Ashoka, how much more room beyond the initial targets that you've set for cost savings, etc are there and I know all of it will probably not materialize in 2017 if you're working toward that goal, but over the longer-term is there room for further improvements in working capital, etc. I mean with these non-core asset sales potentially materializing in 2017 and how would that change for you in terms of being in just a stronger working capital position?

Amit as you know in our business managing costs and looking for productive improvements is not a one-time event. I mean this is a business where we need to continually address our cost position particularly in view of the OEM expectations that we sell to. And what we have established within the organization is a program management process that I think will continue to deliver and develop cost savings out into the future.

Got it, that’s all I have. Thank you so much.

Sure.

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

Hey, good afternoon. A couple questions from my end, Ashoka I was wondering if you could just touch on the CWI gross margin and the warranty issues, was that on the 8.9 meter or 12 meter, what was going on there?

No, all it is Jeff it's a change in accounting policy. What CWI did was align their warranty liability calculation methodology and the policy to be in line with their parent -- with Cummins one of their parents I guess. So what that entailed was they needed to adjust for the margin in part that was included in warranty accruals. So net, net there is no difference. All it did was it adjusted the warranty accrual down in certain years and adjusted it up in other years. The ending warranty as of the end of December 2017 is still a good number and the correct number and there is no economic impact.

Got it, and then is that kind of the current run, I know you are not giving guidance until the next call but the current run rate, is that something that you would expect to consider a meaningful or a reasonable assumption on our part for 2017, just given the subdued pressure in the market that you talked about?

Well, May is not that far off Jeff. So, we will discuss this in May during our first quarter call.

Okay, I was assuming I guess CWI wasn't a non-core so I thought you'd be more forthcoming about that particular business unit but perhaps not. Maybe switching gears, can you talk about the HPDI 2.0, lot of folks have tried to get quantitative in partner comments but just maybe qualitatively can you just talk about, Nancy, what the actual punch list items are that need to be done over the next six to nine months for your partners to be able to effectively launch a vehicle particularly is all the validation testing completed, is your partner Delphi and others able to make this in terms of manufacturing, what are the actual obstacles that you need to overcome to launch the product?

Well I think that we're on our way. The good news is that we're going through both the customer gates as well as Westport gates and I think that those are all the gating events that are going on. So from that sense I think we're on track. As you get into these launch obviously supplier readiness and getting the suppliers ready and getting in our particular case our ability to deliver goods in those kinds of things are all the activities that are underway. So we're very much now in a moving into an operational phase in addition to tidying up all the final validation and certification requirements that we have in order to move our components to our launch partner. But, now we have quite a bit of activity going on in Andrea's group as well as in our supply base getting ready for them to start their production and to get parts and goods ready for the customer.

Got it, that's helpful. Maybe Ashoka back to you, any thoughts on some items that you can control like CAPEX, how should we be thinking about that for 2017?

Yes, we do have some CAPEX spend related to our injector manufacturing using our proprietary technology in 2017. Of course that is related to the HPDI 2.0 program. So once that is behind us we can expect a significant drop in our capital expenditure spending much along the lines of the significant drop that we can expect on HPDI development spending.

Is there a way to bracket that, is that $4 million, $5 million, $6 million, $10 million just between now and the launch or...

It's more than $10 million that are now in the launch Jeff.

Okay, that's helpful and then maybe on inventory, is there any more work that can be done there or is this kind of the red line in terms of inventory depletion?

I would tell you that we have undertaken and I think we talked about this in our quarter three, that we have undertaken some focus on this and what we have is what we call a plan for every part and what we're finding out through this methodology that this is serving us quite well. We’re going to continue to use that methodology because we think it will have continued applicability in our operations and will continue to give us the focus we need to have the right amount of inventory at the right place at the right time. So I still contend that this is going to be the right tool for us to use in 2017 in order for us to continue to build on what we were able to deliver in 2016.

Again the last question I had for you Nancy was just, I think relative to maybe 6 or 12 months ago some of the transactions that you've highlighted here these two maybe were slower to evolve so just maybe looking rearward I guess what have been some of the challenges in nailing down deals, is it price, is it partner due diligence, lack of comfort with the market, all of the above. Is there anything qualitatively I guess that you can reflect on over the past 2016 as to the challenges in getting the deals done and then I guess what gives you the confidence that these two will be done in the relative near-term?

I think there are a couple of things. First of all because we wanted to make sure that we had -- expected good shareholder value we went through in most cases that was a process by which we ended up on having multiple bidders and then we ended up on narrowing it down. And then as we have narrowed it down obviously we have -- the due diligence process is really what is taking time. We are working with each of the strategic buyers at this point in time to close out those elements that are due diligence. But as you can imagine going from a process again these assets as we were not even a year into this yet, getting an asset out to the market, getting -- going through a selection process and then getting that due diligence done and those kinds of things where we think that we have moved these through on a pretty quick basis. But we need a way till the deals are done in order for us to clear them, victory at the moment so they are with us.

Make sense, thanks so much, good luck.

Thank you.

This concludes the question-and-answer session. I would like to turn the conference back over to Caroline Sawamoto for any closing remarks.

Thank you everyone for joining us today. If you have any follow-up questions feel free to reach out to the Investor Relations team and thanks again for your interest in Westport Fuel Systems. Have a good day.

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