Thank you for standing by. This is the conference operator. Welcome to the Westport Fuel Systems Third Quarter 2020 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 Christine Marks, Westport's Investor Relations Representative. Please go ahead, Ms. Marks.

Good morning, everyone. Welcome to Westport Fuel Systems third quarter conference call, which is being held to coincide with the press release containing Westport Fuel Systems' financial results that was distributed yesterday. On today's call, speaking on behalf of Westport Fuel Systems is Chief Executive Officer, David Johnson; and Chief Financial Officer, Richard Orazietti. Attendance on this call is open to the public and to media. The 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 the U.S. and applicable Canadian securities laws and, as such, forward-looking statements are made based on our current expectation 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'll now turn the call over to David. David?

Thanks, Christine, and good morning, everyone. Thanks for joining our conference call to review Westport Fuel Systems Q3 2020 results. This is David Johnson speaking. With me on the line today is Richard Orazietti. I sincerely hope that all of you, your loved ones are healthy and well and that you stay healthy and well. Last quarter we talked about strong signals for a green recovery in multiple jurisdictions around the world and stimulus spending to build a better more resilient and low carbon economy. I'm pleased to say the momentum has continued. Despite the ongoing impacts of COVID-19 and the challenges of a second or even a third wave, we are encouraged by signs of recovery in our sales volumes and signals of normalization across key markets. The pandemic has changed a lot of things. But the need for clean, economical transportation solutions and urgent action on climate change has not gone away. We've made meaningful progress on a number of our business objectives this year, including engine certification in China, growth in our Indian market and significant improvements to our balance sheet. Although, the global pandemic continued to have adverse impacts on business, in the third quarter we saw recovery compared to the second quarter, with sales rebounding significantly, resulting in an 82% revenue increase relative to the second quarter of 2020 and net income, once again, in positive territory. Customer demand for our aftermarket products and growth in our HPDI sales volumes were quite encouraging. Two of our three Italian plants are in higher risk zones, in which travel restrictions were imposed just last week. These restrictions are designed to limit people from traveling between regions; however, residents can still go to work and are doing so. Our plants are operating at normal capacity. At this time,…

Thank you, David. As David highlighted, consolidated revenue for the third quarter rebounded from $36 million in the second quarter to $65 million, driven mainly by growing HPDI sales volumes and a steady recovery in independent aftermarket sales since the reopening of our factories in Northern Italy. Year-over-year consolidated revenue was 13% lower compared to $75 million in the third quarter 2019, mainly due to lower independent aftermarket sales as customer demand continues to recover. The ramp in HPDI revenue continues to grow through higher sales volumes through our initial launch partner, partially offset by lower average selling price of HPDI components due to contractual price reductions and lower engineering service revenues compared to the prior year quarter. Gross margin in the third quarter decreased significantly by $7.9 million to $10 million, mainly due to lower independent aftermarket and light-duty OEM sales volumes, lower HPDI engineering services, and a one-time charge for approximately $1 million for a field service campaign. The decrease in margin was partially offset by a significant increase in HPDI sales volumes from the growing demand for clean transportation in long-haul trucking in Europe. Consolidated operating expenses of $13.2 million for the current quarter were $6 million lower than the third quarter in 2019, mainly due to the continuing austerity measures and government COVID-19 relief wage subsidies of $1.2 million. In addition we had an unrealized foreign exchange gain of $2.3 million due to the appreciation of the Canadian dollar. Net income was $0.8 million for the third quarter 2020 compared to $5 million for the same period in 2019. In addition to the impact of COVID-19, the third quarter 2019 results benefited from better margins including about $1 million in higher earnings from the CWI joint venture. Prior year earnings were also boosted by a one-time…

Thanks, Richard. To recap, we have made substantial progress on our business plan despite COVID-19 and we remain focused on a few key priorities for the last months of the years; the successful launch of HPDI in China, continued cost reduction, new light- and heavy-duty businesses in key market geographies, and the profitable growth of our light-duty business for the aftermarket and OEM channels. I'm confident in our team and we are committed to delivery. With that, I'd like to turn it back to the operator for your questions.

And we’ll now begin the question-and-answer session. [Operator Instructions] The first question comes from Eric Stine with Craig-Hallum Capital. Please go ahead.

Hey, David and Richard.

Good morning.

Good morning. I guess, with my questions -- I'll stick with HPDI. Just one thing I did want to confirm from your remarks. So did you say HPDI volume's up 50%? And if so was that third quarter year-over-year or is that year-to-date?

Yes, that's an annual figure just a rough number to give you an idea of the growth we're seeing from that business in Europe. It's quite exciting to us -- considering the COVID crisis that we all faced the shutdowns both ourselves and our customer, but to see the market come back with that strong return after a very good year -- last year of our first full year in 2019. So we're encouraged by that. It's really been a shining star for us as we look at the outlook for our business going forward into 2021.

Yes. And I mean I guess that implies given that Q2 was pretty much nonexistent that implies a growth rate even higher than that for the third quarter. Just curious when you think about that number how do you kind of break that down? I mean clearly you've got fleets that are as you said going from the 10s and the 20s to looking at orders of 100-plus. You've also got that the baseline was finalized. This was the first quarter, it's been finalized and curious if that means you're seeing more of a push from Volvo in the market maybe just how that breaks down in your view?

Yes. I guess as I try to pull back from the day-to-day and look at the broad picture of what's going on and then I try in my head to say, okay and if COVID didn't happen what would it really be right now because COVID's an externality of course that we all have to get through, but doesn't have anything to do with HPDI or trucks or freight. So when I look at that, we are launching a product that's a new technology for the marketplace. We are a standout product patent-protected. Nobody else really competes with us. And I think what we're seeing Eric more than anything else is this adoption cycle that I can remember talking about at my first days with the company which was when a new technology's introduced, especially a power train technology in the trucking industry and any market around the world, there's a significant adoption cycle where basically these are large capital purchases for fleets and they're going to buy one or two and try it out perhaps for an extended period before they buy more. And so I'm really encouraged by these 100-unit orders and kind of the little signs that we see in the marketplace because we don't get such rich data from our customer in terms of what they're doing and how they run their business; it's really their business of course. But the signs we do see and the volumes we do see and the growth coming back after the shutdown in Q2 are really compelling to us. And again I just point to the fact that you know really have one customer in one market and this is a technology that is delivering already and has the potential when it's delivered with the right biomethane fuel to be a net zero carbon solution that's affordable and realistic and delivers for customers. So to me the signs are very compelling and we're looking forward to getting beyond COVID and getting into 2021 and continuing that launch curve and growth of this important product.

Got it. And then maybe last for me, just turning to China. I mean I know you're waiting on now the vehicle certification. That's out of your hands, but confident that that's either weeks or months. Just curious from what you see what type of actions have been taken well certainly by you, but by Weichai and also by some of the truck OEMs. I mean is this something once that certification is achieved that you expect that volumes could start pretty soon thereafter? Or how do you see that playing out?

Yes. Of course a vehicle certification is an important step in the process. But then those vehicle OEMs will have to sell products and take orders from their customers' fleets in China. And I do expect there's an adoption curve there that perhaps could be a little bit more aggressive than what we have seen so far in Europe because the market is already well familiar with natural gas trucking in China with nearly 100,000 trucks per year being sold these days with our joint venture's spark ignited technology. Nonetheless, this is a new technology and so there will be a ramp curve and some conservatism even in China about taking on new technology and proving it out before buying 10s or even 100s of vehicles. At the same time, another key factor in that is we do expect multiple OEMs to come -- multiple truck OEMs to buy engines from our JV using HPDI technology and so that could make the ramp a bit more aggressive. So those are the factors in terms of the actual plans and scale and timing and we really are dependent on our customers to take those actions. But they're also global players and they see what's happening in Europe and they're familiar with our product and they're eager to have them.

Okay. Very helpful. Thanks.

Thank you, Eric. Good to hear you.

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

Good morning.

Hey, Rob.

Just sticking with HPDI in China, how many vehicles are being in the process of getting certification at this point?

Yes. Unfortunately, I can't go into the numbers of our JV's customers. So unfortunately, I don't have a number to share with you. But it's not a one-at-a-time activity I can confirm that.

Okay. That's helpful. And then on the margins they were pretty low in the quarter. There was some one-time stuff. But I guess, how much of this margin compression is sort of quickly turning around and how much is a result of the ASP decline and takes time for volume to ramp? And I guess where do you sort of see gross margins settling in over time?

It's a change -- hi, Rob. It's Richard. It's a changing thing. So we had significant margin reductions close to call it 30% over a six -- call it nine month period. And the idea always was those margins were going to be offset by cost reductions that were contractual in terms of increasing volume on the scale. So in terms of settling I mean, we'd like to be north of 20%. Right now, we're not there. The volumes are growing very quickly. So our European partner is doing well with the product so we're getting good line of sight. China is critical to this process. Just want to reiterate, we have a relationship with Weichai and it's very important for us with regards to being able to generate the sales volumes there to help us reduce the cost of producing our components.

Okay. Okay. Thank you very much.

You're welcome.

The next question comes from Colin Rusch with Oppenheimer. Please go ahead.

Thanks so much guys. Just continuing on, on this gross margin question and the cadence for it. Obviously, you're not providing forward guidance. But how should we think about the volume level that you need to get to before we start seeing some of that gross margin expansion? And I have a follow-up around the supply chain.

Yes, let me -- yes, why don't you handle that one Richard?

I do know the number. It's a question of confidentiality.

Yes. No, we're in a growth phase. And yes, we have the number, but we won't be sharing it today. Fundamentally, we need a second customer who needs our volume in China to come along to help us get the economy of scale to get the cost down to get the margin up. It's -- I would say a pretty straightforward relationship; it's easy to understand. But we'd love to see these things happen faster but there's work to be done in terms of getting the product to the marketplace and get the volumes up and the cost down. So that's an important part of our business plan. There are activities right now as we continue to work with all our suppliers and also work with our customers to get the volumes up and so we can achieve those economies of scale with the margins that we target.

Okay. Actually I'll take the supply chain question offline. But just in terms of the customer interest around hydrogen and the designs, you've identified or talked about the fact that you're already selling into certain programs around hydrogen based vehicles. But can you talk about the customer activity in the space, the design activity and how active you are in terms of building a pipeline of business in that area?

Yes. It's a great question. Thanks for asking Colin. So the hydrogen market in various parts of the world Europe being amongst them, but not lost on the Asia region or North America for that matter is very let's say exciting and interesting and there's lots of people doing work in labs, developing products and getting ready for the availability of a hydrogen refueling and certainly the advent of green hydrogen at scale. So there's lots of things to be done, but we are working today with the leading OEMs as well as their supply base so in some cases we're Tier 2 to a Tier 1 and providing them with prototypes and developing specific hardware for them on the fuel system side basically getting fuel from a tank to a fuel cell or perhaps also to engines in some cases, or some evaluation going on around the potential use of hydrogen in internal combustion engines. As I mentioned earlier in the call, we see an opportunity to leverage our HPDI technology with respect to hydrogen and really have a very compelling product. Our modeling looks very good to us like we should have something to offer the market that could have some significant legs and really offer some choice to the marketplace in terms of what kind of technology choices, including the potential of course to reuse existing engine architectures and yet develop a green hydrogen internal combustion engine that could have really excellent economics. So we look forward to sharing with the market more news on that as it develops and we have the data to share with you.

Okay. Thanks so much guys.

Thank you.

The next question comes from Sameer Joshi with H.C. Wainwright. Please go ahead.

Hey guys, thanks for taking my questions. Can you elaborate a little bit on the India opportunity, the consolidation that you had done there and like what levels of revenues or contribution as a percent of total revenues, do you expect from India and for the next few years?

Sure. Glad to talk about it. This is from our perspective a very important development. Let me just talk to kind of the general feel of what we're doing and the strategy and our operations there and I'll let Richard comment a bit on the numbers that we don't consolidate, so they end up kind of off the income statement in terms of the details. But in terms of our strategy so first of all the market in India has been a natural gas market for quite some time and they've been developing the infrastructure, so you're probably aware they're on the order of almost approaching 2,000 CNG stations across the country and they have a build-out plan for that, which is a national plan that's 10,000 stations and they're proceeding along that plan. Natural gas vehicles both light-duty and heavy-duty are already in the marketplace and we're supporting all the different customers that make those today and we see a tremendous opportunity to growth. And the impetus for that growth is not just the infrastructure, but the infrastructure coupled with the economics that are now fully in play because of the advent of the Bharat Standard VI emission standard. So that's the standard that's like Euro six. And what it causes is, I would say the dominant engine and fuel in India today is diesel fuel, but when you go from Euro six or Bharat and -- excuse me -- Euro four to Euro six or Bharat IV to Bharat Standard VI, there's a significant cost increase in terms of after treatment that really erodes the competitiveness of the diesel engine and therefore, puts a spotlight on natural gas-fueled engines. So, we have been in the market for a long time in India with a division name Rohan BRC…

Understood. Richard, were you going to talk about the revenue contribution?

Yes. Why don't we do that on our call separately?

Okay. And then, during the last quarter, you mentioned the ESG report and initiative up. Has there been any -- can you give us an update on that? And is there much interest activity on that front?

Sorry. Sameer, I missed the first part of your question. Could you say it again?

The ESG initiative, just an update on that.

Yes. So, we consider ourselves born and raised as an ESG company. The nature of what we do is, trying to clean up transportation around the world. And so, having a report to then chronicle, the work that we've been doing over the past decades and showing our progress on various metrics is something we're proud to have and we're pleased to release that report earlier this year. And so, we're committed to continually do that and to continue to build our positioning as a -- and I'll say it's not just positioning, but actually having people know through the best basis of our reporting about our ESG credentials if you will in the marketplace. So, that's an important part of what we're doing as a company.

Understood. I'll take my questions offline. Thanks.

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

Hey, good morning, guys. Couple questions on my end. I was wondering if you could just touch on the CWI margins. It's been a lot of discussion about HPDI. But can you just touch on what the moving pieces were sequentially on CWI?

The major difference, Jeff, was just because there was a greater proportion of the sales mix for engine sales versus parts, and that drives most of the margin difference. The joint venture tried to offset that with, we will call it just managing their operating cost. We're expecting that trend to reverse a little bit in the fourth question and get back to the more sort of normal margins that you would have seen in the first half of the year.

Got it. That's helpful. And then can you just talk about the linearity within the quarter? And the reason I ask is normally your day sales outstanding are less than 90 days. Obviously, last quarter was a bit of a challenge, and I would assume it was a backend-loaded quarter. But can you just touch on this quarter the receivables seen to be a bit bloated relative to normal time. So was that the stimulus on the pass car side kicking in or was HPDI backend loaded? Can you just touch on what drove the higher receivable account in terms as measured by day sales outstanding?

For sure. So the DSO is increasing specifically because of the European launch partner. So there's a sort of traditional 90-day and it depends on when a sale falls in, but that creates a little bit of a working capital pressure. You would have heard me mention, actually, that we increased the Unicredit facility. We don't track to our receivables, but we actually borrow against them and then when we collect money from the customer, we pay down the facility. So that's extremely cheap financing, but we increased that by $10 million because of the sales are starting to increase and we're paying our vendors 45 days. So we unfortunately have an asymmetry with regards to when we receive money versus when we're paying out, and so we're trying to address that with the customer.

Got it. Then I think you alluded in a prior question that pricing, as you have greater volume, pricing goes down based on predetermined contracts and you need China to kick in.

Yes.

Two-part question. Was it down 30%? I thought I heard that number. Was part one of the question. And part two is, is there subsequent break points? Like hypothetically if volume doubles or quadruples here, does it go down another 30%? I'm just trying to understand what the trajectory is, especially if China is slow to ramp up, for whatever reason.

They're contractual. They're time-based. So they're not volume-based with the customer, and that's the way they were negotiated back in the day to attract a customer. I guess there was a view and a risk that was taken. So there are some future ones, but they're small. The biggest ones have been taken already with a particular contract. So with regards to that, I think we're okay for the time being. So now the question is, how much volume we will get with the European customer and then obviously, Weichai, which things are progressing along that we have this $18,000 take-and-pay agreement that we're currently negotiating with them to figure out what's sort of the right cadence of what we will sell them to the JV.

Got it. And the last question I had was just, can you touch on, you alluded to in your prepared remarks stimulus. Can you touch on what you saw on the pass car side as it relates to either Germany or France or any individual countries that might have been bright spots in the third quarter?

Bright spots for us definitely the Italian market's a big one for us, which is roughly 20%. So that's where we're definitely seeing the recovery. We got a great distribution network and a sales team that sells into that. And we saw that recovery, it was quite significant from the second quarter. Effectively, Europe was almost comatose for quite a bit of it in the second quarter. That is coming back and it looked good, they actually had even a strong October, which was promising. The reason why we provided some caution in our statements is, because of the sort of resurgence of COVID-19 you would have seen. And throughout Europe, there's we'll call it people are taking a pause again just to stop the virus' propagation. So, Jeff that's our biggest concern right now, so it is doing well. Turkey for us is doing well; Russia as well as a market improved significantly. But it's very dependent more so right now on people's ability to go out and feel comfortable, and go to their local shop and buy one of our systems with regards to independent aftermarket.

Got it. Thank you. That's all I had.

Okay.

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

Thank you everyone for joining us today. If you do have any follow-up questions, please feel free to reach out to me and the Westport Fuel Systems Investor Relations Team. Thanks again for your interest in Westport Fuel Systems and have a great day.

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