Westport Fuel Systems Inc (WPRT) 2006 Q3 法說會逐字稿

Good morning ladies and gentlemen. My name is Rahim and I will be your conference facilitator today. At this time, I'm like to welcome everyone to the Westport Innovations in fiscal 2006 third quarter financial results conference. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer period. (Operator Instructions). It is now my pleasure to turn the floor over to your host, Mr. Ryan Thompson, Multimedia Manager of Westport Innovations. Sir, you may begin.

Thank you, Rahim, and good morning. Welcome to our third-quarter conference call for the 2006 fiscal year. It is being held to coincide with the disclosure of our financial results. For those who haven't seen it yet, the news release is on Westport's web site at www.Westport.com.

The first part of this call will involve a prepared statement read by Westport's Chief Executive Officer, David Demers. After David's introduction and summary, Elaine Wong, Westport's Chief Financial Officer, will provide a breakout of the Company's financials. After that, Guan Saw, Cummins Westport's President, will review CWI's activities for the quarter. The speeches will then conclude with Michael Gallagher, Westport's President and Chief Operating Officer, who will speak to Westport's development program.

Attendance of this call is open to the public and to the media, but for the sake of brevity, we're restricting questions to analysts and institutional investors. Please identify yourselves by name and Company when asking questions. For anyone else who has questions or requires additional information, we would please ask that you contact our investor relations department via e-mail at invest@Westport.com.

This conference call may include forward-looking statements expressing Westport's expectations, hopes, beliefs and intentions on strategies regarding the future. It is important to note that Westport's actual future results could differ materially from those projected in such forward-looking statements because of a number of factors, including but not limited to general economic conditions, business and financing conditions, labor relations, government action, competitor pricing activities, expense volatility and other risks detailed from time to time in the Company's filings with regulatory authorities.

Now I will turn the call over to David Demers, Westport's Chief Executive Officer. David?

Thanks, Ryan, and good morning everyone. Our fiscal 2006 continues to develop well. Our fiscal Q3 coincides with Cummins Westport's year end. CWI has posted its sixth profitable quarter in its first eight quarters and its second full year of profitable growth. Year-over-year, CWI has grown sales by more than 25% and by more than 135% compared to three years ago, which is a compound annual growth rate of well over 30%. The growth in profits this year also demonstrates the high leverage that we can produce once sales grow past a breakeven point.

CWI has also made important steps this year to position itself for global leadership and for continued growth. Guan will go through these initiatives in more detail, but here are the high points in my opinion.

Technology leadership is the first one. With the new ISL gas engine, which will be available later in 2006, we've dramatically reduced nitrogen oxide emissions again, and at the same time we've significantly increased fuel economy. Targeted at the US transit bus and refuse collection fleets, we believe this engine will deliver lower total cost per mile performance compared to the best 2007 diesel engines, let alone the much more expensive 2010 emissions-compliant vehicles. For the first time, natural gas vehicles we hope will be cost leaders as well as environmental leaders.

On value leadership and with local manufacturing in India underway and in China later this year, this will materially lower the cost of fleets in those markets while providing a world-class natural gas engine. We've worked hard to achieve a high-quality product with the right manufacturing partners in each country and we will see the benefit of this work in 2006.

And finally with market expansion, new vehicles from new OEMs will inevitably lead to hire market penetration for our products. CWI now has 21 different vehicle manufacturers in China alone using our natural gas engines and has worked with new OEMs in other countries; in Europe, and in Asia, this year. CWI is also expanding into new applications, including forklifts and power generation this year.

Westport has also seen excellent progress in our other market development initiatives. Mike will elaborate on some of these, but again here is my high points. We're working hard with EDL in Australia to develop commercialization plans for HPDI engines to support LNG as a fuel for mining applications. That is liquefied natural gas for those of that are new to us. These giant trucks consume very large amounts of diesel fuel and the potential economic savings are pretty exciting. Of course, Westport cannot make this market happen on our own. We need to develop the business alliance that is necessary for success, including the negotiation of each partner's investment, both cash and corporate resources, and their share of the returns. We need to develop appropriate supply partnerships and customer support plans. After more than a year of work though, we don't see any fundamental obstacles to a successful program. If this case is concluded with our partners, we will be immediately undertaking development of these engines 2006.

Second, a critical element in our LNG vehicles both from a cost viewpoint as well as the overall vehicle performance and the customer experience is the fuel storage system. Our first technology joint venture in China will be our proposed 50-50 alliance with BTIC, the leading automotive natural gas fuel tank manufacturer in China. We hope to be producing the world's best vehicular LNG tanks in 2006 with this joint venture and we also expect these products to be the global price leader. These will be an essential prerequisite to the successful launch of HPDI vehicle, but we'll also be selling these storage tanks for conventional natural gas engine applications. We also expect that this venture will give us valuable experience in developing relationships in China, developing businesses in China, while minimizing our investment and intellectual property risks.

Our third initiative this quarter comes as a result of our successful program with HPDI highway trucks in Ontario along 401 corridor. Although we had hoped to launch commercial production of HPDI heavy-duty truck engines in 2004, market conditions and our partners simply were not ready. But ever since, we've been building those alliances and working hard to improve product reliability, lower cost to customers and wait for the right market conditions to appear. With the recent passage of the US energy bill, which incorporates up to $32,000 in tax credits for LNG heavy-duty vehicles and the LNG fuel credits that are included in the US highway bill starting later in 2006, the economics for early fleet adoption are substantially better. When you add in the high price of diesel fuel, the high price of oil, the world is in a very different place that we were two years ago. With the progress that we have made in developing suppliers and with the demonstrated improvements in truck reliability, durability and economics from our field trials, I think we're ready to look for larger scale deployments of HPDI trucks in 2006.

Westport has been consistent in our position on the future of transportation. We must move to natural gas as a primary fuel around the world. We, like others, look to hydrogen as a desirable future fuel for transportation and we continue to work with the world leaders to develop engines and vehicles that can achieve that hydrogen future. But there is no doubt that the path to hydrogen is a very long one. We're going to need many inventions to make this work in the real world.

The world cannot wait for hydrogen though. We must immediately reduce oil consumption and we must immediately reduce pollution in our cities. Transportation and vehicles are the primary culprit in both cases. We simply have no choice. Natural gas is the only realistic option that we have. Although hybrid electric vehicles and synthetic fuels have their place in the effort to reduce our dependency on gasoline and diesel fuel, their attractiveness lives primarily in the ability to allow us to continue to use conventional fuels. These are like light cigarettes -- they allow us indulge our addiction while we're pretending to cut back. These solutions are more expensive to produce and to deploy and the environmental benefits simply aren't significant.

Natural gas, on the other hand, has been part of our lives in developed countries for decades. Perhaps that's why we take it for granted. It is a very shortsighted society that would waste such a valuable fuel for low value applications like power generation or home heating when there are so many other alternatives. Fortunately, when the oil crunch comes, we can point to a solution that can be immediately deployed. We already have natural gas infrastructure in most of the world's leading cities and the capacity to deliver large amounts from vehicle use. Yes, this will need commitment and leadership to develop a parallel transportation fuel infrastructure, but the gap in price between oil and natural gas means that there's money to be made if entrepreneurial companies dive in and exploit that value gap between natural gas as an industrial energy sources and natural gas as a substitute for diesel or gasoline.

If there's one thing that we should all understand by now, it's that the low-cost solution will ultimately win the day. If we want to deal with oil shortages and dependence and urban pollution, the only realistic large-scale option we have today is natural gas. The world is realizing that this is inescapable, and that's why we're confident that with Westport's leadership and visibility around the world on this issue, we're on the right track.

Natural gas engines in vehicles are still very much a niche market. We must continue our work to develop new markets by working with our partners with governments and with leading fleet customers and by working hard to reduce our overall lifecycle cost and to increase overall solution benefits for end customers in our key markets, despite our small production volumes. But the environmental benefits of natural gas vehicles are incontestable. Our work on total lifecycle cost showed that we made considerable progress already. With sustained high oil prices, we can demonstrate these economic benefits to more and more customers. And as we work to develop higher global production volumes and reduce the related production costs, we expect it will be helped further by the fact that conventional diesel vehicles will face significant cost increases to comply with the top global emission standards and with the new introduction of high-cost low sulfur diesel fuel. So the gap should widen over the next few years and we should do very well.

Let me close by saying that, although we're pleased with our quarter and our progress this year and over the last three years at building a sustainable and robust global business, our position has never been stronger as we look ahead. We're pursuing many opportunities that are open only to Westport because of our unique technologies, our alliances and our market position.

Now I will turn the floor over to Elaine to take you through the financials for the quarter.

Thanks, David, and good morning everyone. For those that have not yet seen the news release, I will go through some of the financial highlights for the quarter which just ended December 31, 2005. I will remind everyone that Westport's consolidated financial statements are reported in Canadian dollars and our fiscal year ends March 31, 2006.

Comparing Westport's third fiscal quarter which just ended December 31, 2005 to the third fiscal quarter in the prior year, total consolidated revenues were down $600,000 to 8.6 million from $9.2 million. Net loss was 3.6 million, or $0.05 per share, down from $4.2 million, or $0.06 per share primarily as the result of lower expenses. Sales, general and administrative expenses were up $1 million in the quarter with Westport's increased business development efforts and higher sales and marketing expenses in CWI. Some of this related to the timing of expenses, particularly in CWI, but non-CWI efforts have also ramped up significantly. We're beginning to see some of the fruition of those efforts [from CTIC], [EDL] and other initiatives in China and North America that David had just talked about.

Increases in SG&A were offset by $1.1 million -- sorry -- were offset by a $1.1 million increase -- decrease in net research and development expenses. This was primarily the result of a $2 million increase in government funding in the quarter. Government funding can vary [consistently] from with to quarter, depending on the timing of milestone completions. However year-to-date, we have seen a 75% increase year-over-year in government and partner funding.

Depreciation and amortization was down $1 million compared to the prior year with assets becoming fully amortized and as we changed our estimates for the useful life of our equipment life over the quarter, i.e. Q2 '06. Most of our property, plant and equipment was acquired or built from 2000 to 2003 and we currently estimate that the remaining useful life of our facilities is approximately eight years.

Products revenues were down from $7 million to $5.1 million on 245 units shipped compared to 320 units in the comparable period last year. However, parts revenues were up 1.3 billion with the parts list renegotiated in the current fiscal year. Gross margin percentage was 43% primarily because (indiscernible) management has changed their warranty liability based on estimations based on recent claims experienced. As a result, warranty liability on the balance sheets and the cost of revenues were decreased by $1 million. A similar adjustment in the amounts of $600,000 was made in the same quarter of year.

Leveraging the (indiscernible) [warranties] process [of] personnel, CWI reviews its warranty liability and accrues on a quarterly basis and makes adjustments as needed. Warranty remains an inexact science and CWI has a limited engine population. However, with more history and products in the field, CWI has been refining its warranty estimation processes and trends in warranty claims shows CWI's products to be consistently reliable in quality products.

For the nine months ending December 31, 2005, total consolidated revenues were up by 30% to $31.4 million on 939 units shipped with product revenues up 24% and parts revenues up 46%. Net loss was $13.1 million was, down 22% from the same period as last year, primarily [into] higher revenues and lower expenses.

Turning to the balance sheet, we ended the quarter with $11.5 million in cash and short-term investments, down from 20.3 million at the start of the fiscal year. Having already reduced our operating cash consumption before changes in working capital by 65% from fiscal 2003 to fiscal 2005, we have reduced operating cash by another 36% year-to-date having used $6.7 million compared to $10.4 million in the same period last year. We are continuing to manage our cash very closely. Our cash usage is down and revenues are up. However, we recognize that to make the transition to profitability, we need to execute on the business development initiatives that are currently underway. We're working very hard to close deals with HEIC and EDL to deploy larger scale HPDI trucks in North America and we're looking to start negotiations with Isuzu on future intellectual property rights which would form the basis of future commercial agreements. If necessary, to get these deals done at acceptable terms, we will dispose of noncore assets to generate any needs of capital. We will also leverage our share of the returns from Cummins Westport and continue to seek industry, strategic partner and government funding to finance operations.

Cummins Westport has just finished its second fiscal year. Recall that the Cummins Westport, unlike Westport, has a calendar year end and reports in US dollars, which is consistent with what Cummins' reporting period is. Since we negotiated the JV with Cummins, this is (indiscernible) our second year, after finishing its first fiscal year slightly better than breakeven, (indiscernible) finish its second year with a profit in US dollar terms closer to $2 million on revenues of approximately $34 million, which were up roughly 25% from the prior year.

As Michael will speak to, our plan is to continue to build CWI's business and profits while developing second and third revenue streams for the near future. Now over to Guan for a little bit more on CWI.

Thank you, Elaine, good morning, everyone. As in previous quarters, I will be referring to our results on a calendar year basis and in US dollars. Please note that the Canadian dollar has strengthened by approximately 7% on average during the year from 2004 to 2005. I will be highlighting our fourth quarter financial results followed by a review of CWI's three geographic performance sales -- America, Asia and Europe. I will then conclude with an update of CWI's 2005 full year initiatives and our outlook for 2006.

CWI had a profitable fourth quarter, which is the fifth consecutive profitable quarter. In terms of our total revenue in Q4 2005, it was higher than the same period in 2004 by 3%, largely from increased bus sales. Full-year total revenue increased by 24.5% over the calendar year 2004. We told you last January that our goal was at least 20% revenue growth with substantially higher profitability, and we have achieved that goal.

Comparing our Q4 engine volume to Q3, you can see the effect of a timing issue where OEMs produce engines in Q3 2005 for calendar Q4 vehicle builds. This resulted in very strong Q3 sales, but this slowed in Q4. However, the lower Q4 engine revenue was more than offset by the increase in parts revenues. Looking forward, there will still be volatility in engine revenues from quarter to quarter, but CWI expects to further grow its business in calendar 2006 with another year-on-year growth in the range of 20%.

Americas -- CWI continues to ship engines to transit authorities, such as Los Angeles Metro, Phoenix, Washington Metro and also to engine [repower] projects and refuse fleets across North America. The recent interest in natural gas engines for airports, municipal street sweepers and port applications also provided CWI opportunities to sell into these market segments.

Highway and energy bill legislation in the United States that gives tax incentives for alternative fuel users will be implemented beginning in 2006. We believe that natural gas vehicle customers will benefit from this legislation in terms of lower capital cost and lower fuel cost, and that will improve the overall lifecycle cost compared to hybrid and diesel engines in all of our markets.

Asia -- Cummins Westport has sold engines to key transit customers in [the city of] Shijiazhuang, capital city of Hubei Province, about 120 kilometers from Beijing. CWI has also provided prototype units to another two new OEMs for their demonstration of a bus and truck. This is the first time CWI engines have been used by China OEMs in trucks for hauling natural gas in China. A total of seven OEMs by using CWI natural gas engines, which brings the total to 21 OEMs in China currently using CWI natural gas engines.

Dongfeng Cummins Engine Company Limited -- DCEC -- has begun work on a prototype [B gas] international, [BGI] engine [at our] BCEC. The localization of the B gas international engine in China has been well-received by a majority of Chinese OEMs as it will provide local OEMs with a reasonably priced, reliable natural gas engine for the first time. Imported natural gas engines with CWI will still be sold as the premium product in China. DCEC will also sell this new engine to its other parent, Dongfeng Motors, who is now the second-largest truck manufacturer in the world. This new engine will also be sold by CWI as a low-cost option in the markets outside China.

Demonstration CWI-powered cement mixers in Australia are also performing well. We expect to receive further orders from Australia. Thailand and Malaysia have shown interest in using CWI natural gas engines to power transit buses. CWI is working closely with OEMs to provide demonstration vehicles for these customers.

Europe -- Q4 was another good quarter for CWI shipments to Europe. With a recent award from Russia for best city bus, CWI is making headway to have Russian OEMs sourcing engines from CWI this year. In Q4, CWI also exploited opportunities in Pakistan and Turkey with other of our European OEMs and sold into Belgium and (indiscernible). During 2005, two new European OEMs produced buses with CWI engines.

Let me summarize the key initiatives that CWI has achieved for the 2005 calendar year. Number one, CWI and Cummins India Limited -- CIL -- launched the BGI product in India at the end of 2005. This represents the first CWI engine to be manufactured outside of the United States. This engine will be used by [Tada], India's largest vehicle manufacturer, to produce buses for the domestic market. CWI also plans to produce power generation products using this engine. Our agreement allows CWI to offer this engine as a low-cost option in other countries.

Two, CWI has completed its agreement with Dongfeng Cummins Engine Company Limited -- DCEC -- to localize its BGI engine in China, as we discussed previously. It is equally important for CWI to achieve high market penetration in China. We are on schedule to launch the BGI in the second half of 2006 in China.

Three, as CWI launches localization in India and China with low-cost products, our profit stream will come from the sales of production kits, sells of localized products and CWI involvement in the joint marketing of localized products. Imported CWI engines will still be offered as a premium product in China and India for customers that need our latest technology and highest performance engine.

Four, CWI is on schedule with its planned 2006 introduction of its new flagship engine, the ISLG. Initial emissions capability tests have shown that it will meet the 2010 emission level of our 2.2 gram per brake horsepower hour [not] with improved fuel economy.

Five, CWI will launch the [UL-4] emission standard B gas bus on schedule later in 2006.

Six, the CWI LPG forklift project was completed in Q4. Our customers purchased a number of these units in Q4. The product was well-received and this will generate incremental business to CWI.

Seven, CWI has begun work on several business initiatives that will leverage our current products to expand into other market segments. Similar to the LPG forklift project, these projects will provide long-term profitable growth. I will now turn the call over to Mike Gallagher, Westport's President and Chief Operating Officer. Mike?

Thank you, Guan, and good morning. I'm going to say a few words about what we're doing to commercialize the Westport program side of the business and progress our major initiatives in Asia, in Australia and in North America.

For the past three years, we have driven Westport cash burn down and CWI revenue up and progressed our technology positions to pre-commercial readiness. Our progress suggests that we're entering the next phase of Westport growth where we will begin to see new business revenue streams adding to growth and profitability currently provided only by the CWI business.

Since our last conference call three months ago, we have announced major new agreements on three of our programs with Isuzu, Ford and EDO, and we have accomplished significant progress with our other two programs -- LNG tanks in China and LNG trucks in California. We announced the new Isuzu development agreement in late December. They have committed, as you know, another $1.5 million Canadian to proving this year that our technology can be 25% more fuel efficient than the best natural gas alternative technology and we are now in further discussions aimed at creating a new intellectual property rights framework. This will form the basis of future commercial agreements between Westport and Isuzu.

Just two weeks ago, Westport and Ford also announced a new agreement with an initial $250,000 commitment from the Canadian government to expand our work together on hydrogen engines. Ford and Westport both believe hydrogen use in engines can be commercialized significantly earlier than other hydrogen automotive technologies. This program and its subsequent phases will develop the next generation of Westport hydrogen injectors for Ford engines and then demonstrate them on engines and prototype vehicles.

We also announced since the last call a new agreement with Energy Developments Limited with $150,000 Australian of funding. This money is being used to develop a joint business plan to commercialize our HPDI technology as a retrofit for diesel mine trucks. Those trucks now burn through $1 million a year in diesel fuel at today's prices. Since that announcement, our teams have been hard at work to finalize the business plan and funding arrangements. Once approved, Westport and EDL would jointly develop, manufacture and sell LNG retrofit systems to the major mining houses in Australia, which accounts by the way for 25% of the world's mining activity.

Our China initiative is also starting to pay dividends. As you know, in late August, we announced our letter of intent to form an LNG tank joint venture company with Beijing-based BTIC. We have now detailed a draft joint venture agreement between our two corporations. We hope to soon be starting up the new company and producing and selling high-quality, low-cost LNG tanks to automotive customers in China and North America. This would be Westport's second commercial revenue business JV company in addition to CWI and our first in China.

Closer to home, we have been aggressively developing our core business of HPDI for LNG trucks in North America, and especially in California. Over the past year, we have been refining our technology for trucks in partnership with the US DOE and the South Coast AQMD. A number of forces are now coming together to create some very significant interest in deploying larger numbers of our trucks in Southern California. Since our last call, the new president of the Port Commission of Los Angeles, David Freeman, has announced a major clean port initiative and an intention to move to natural gas. It is not widely known, but 25% of all of the air pollution in the L.A. Basin is being caused by the ports. We have been called in for discussions by the Port and the South Coast Air District to put a program forward that can help solve this problem and we're confident our technology is ready and we can do it.

Looking at all of this together, our programs with Ford, Isuzu, EDL, BTIC, the Port of L.A. and South Coast are all moving forward. It is clear that our business model is strong and it is working. Our cash burn is down 36% and our revenue is up 30% on a fiscal year-to-date basis. Looking out into 2006, I think we can expect to see the results of our work materialize in the form of new commercial agreements to commercialize Westport technology, and this will lay a firm foundation for new revenue streams and expanded Westport growth for years to come.

With that, I would like to turn it back to Ryan and open it up for questions from the conference call participants.

Thank you Mike. We have now completed the formal remarks of the call and are ready to take any questions that you may have. Rahim, could you please queue any questions?

(Operator Instructions). Youssef Abboud, Westwood Partners.

My first question -- you mentioned that if you need additional capital, you could realize some gains on selling noncore assets. Can you elaborate on that?

I think the most obvious one our balance sheet as we run through our balance sheet is probably our investments in clean energy. Clean energy is carried on our books for $9.1 million. We believe that there's significant value in the investment, both from a strategic perspective, which we can realize with or without ownership. And also just in the value of the business which has been growing significantly throughout North America. David, do you want to have anything to that? That would be the most obvious one, Youssef.

Okay, thanks. And second question on warranty. Now, is it one time off, or should we expect going forward the policy would be as in the third quarter?

I think warranty is -- warranty is one of these things that's really part of the normal ongoing business. We took a $600,000 adjustment this quarter last year; the adjustment this year was $1 million. There is a theoretical sort of very rigorous process. They start with the Cummins warranty department, they have internal service engineers to review it. There is a finance committee that reviews it. It is based on actual claims experience, and there's still a fairly limited engine population out there. But it is something that we look at quarterly. So I would expect that ongoing, there will be adjustments. I cannot comment on the direction or the magnitude of those adjustments going forward, but it is a fairly normal course of business.

And just (indiscernible) R&D, what -- warranty as a percent of [job] sales, what would be the range that you book usually?

We don't disclose the warranty amount for competitive reasons.

Right, okay. And on the LNG tanks venture in China, can you give us its timeline regarding when you're planning to start production? And you mentioned you were talking also to customers on that front. I mean, can you give us a sense where we're going on that front?

The tank venture proposal with BTIC -- Beijing Tianhai Industrial Corp. -- what I've said is that we've announced a letter of intent and now drafted the details of a joint venture agreement. It's hard to be too precise about timing, but I can say that the agreements are in the review process at the two corporations. So that will require an executive review, followed by a Board approval at each place. And following that in China, as you may know, there is a government approval of new joint venture companies that's a little hard to predict, but would be in the range of several weeks to a couple of months -- we expect two to three months. But we have said previously, and I would reiterate, that we hope to be -- have the company up and running and in fact producing and selling LNG tanks before this calendar year is out. So that is the target.

Thank you very much.

At this time, I'm showing no further questions.

Thank you very much, everyone, for taking the time to listen to our conference call. We hope to see you at our next conference call, which we expect to be in June with the disclosure of our fourth quarter and year-end results for fiscal 2006. Goodbye.

That does conclude today's fiscal 2006 third quarter financial results. You may now disconnect and enjoy your day.