Westport Fuel Systems Inc (WPRT) 2006 Q2 法說會逐字稿

Good morning, ladies and gentlemen. My name is Brianna and I will be your conference operator today. At this time I would like to welcome everyone to the Westport fiscal 2007 second quarter conference call. [OPERATOR INSTRUCTIONS]

It is now my pleasure to turn the floor over to your host, Ryan Thompson. Sir, you may begin your conference.

Thank you, Brianna, and good morning. Welcome to our second quarter conference call for fiscal 2007. It is being held to coincide with the disclosure of our financial results earlier this morning. 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.

As usual, the first part of this call will involve a prepared statement, read by Westport Chief Executive Officer, David Demers. After David's introduction and summary, Elaine Wong, Westport's Chief Financial Officer, will discuss the Company's financials. We will then conclude with Dr. Michael Gallagher, Westport's President and Chief Operating Officer, who will speak to Westport's development programs and operations.

Attendance at this call is open to the public and to media, but for the sake of brevity, we're restricting questions to analysts and institutional investors. Please identify yourself by name and company when asking questions. For anyone else to ask questions for who requires additional information, we would please ask that you call and talk to our Investor Relations department via email at Invest@Westport.com or by telephone at 604-718-2046.

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 know 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 actions, competitor pricing activity, expense volatility and other risks detailed from time to time in the Company's filings with regulatory authorities.

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

Thanks, Ryan, and good morning, everyone. Our fiscal 2007 is continuing to show strong growth and our prospects for the remainder of the year are very good. In a few minutes I'll turn this over to Elaine for her review of the quarter and a discussion of some of the important financial developments over the past few weeks. And as Ryan said, Mike will close the formal program with his assessment of the market opportunities and comment on how some of our recent announcements fit into our operating plans for this year and next.

But as you can see, the major elements of our strategic plan that we've been telling you about for the past few years are developing very well. First, Cummins Westport continues to deliver good financial results and with growing market success around the world. Gross margins continue to be strong. Costs have been well managed, so we continue to post profitable quarters. Cummins Westport's mission this year is to exploit the strong market conditions for natural gas vehicles that has emerged with the rapid rise in oil prices.

As you can see, only six months into the year, CWI has already exceeded the total profit it earned last year. This is a natural byproduct of our business model for Cummins Westport. Because we have relatively low corporate fixed costs, once we sell enough engines to hit our breakeven point, everything thereafter is pure profit and therefore, as the Company grows and continues to development its business, profits grow very rapidly.

With the completion of our two strategic financial transactions earlier this year, we're also in a very strong cash position. Although we have many initiatives underway around the world with many partners and more of these emerging, our focus is on two major opportunities.

First, heavy-duty trucks in North America fueled by liquefied natural gas. With the substantial federal and state incentives in the United States for low emissions vehicles, with the fuel cost advantage for LNG versus diesel fuel and with the emerging concern about climate change, we're in a unique position in this market with the only EPA and California certified engines for heavy-duty vehicles operating on natural gas.

We're now shipping trucks to customers in California and the major Los Angeles-Long Beach Port opportunity is immediately in front of us. Mike will comment on that in more detail.

We expect our heavy-duty truck business to grow rapidly this year and next. Of course in the near-term we face many operational and market [element] challenges, but I can assure you that the team has the resources and the focus that it needs to achieve our goals.

Our second major focus continues to be the opportunities in China. We've been working there for five years through Cummins Westport, of course, but we're optimistic that the market opportunity there because of the energy needs in China and because of the very heavy pollution in urban centers in China and the rapidly developing automotive industry in China, we believe that our technology offers great potential with the Chinese domestic OEMs. We believe that a relationship like this for us is both strategically important and achievable.

Our first joint venture in China with Beijing Tianhai Industries to produce LNG tanks is now operating and producing LNG tanks. Initially these are going to be used in our own truck program in North America, but we intend to produce generic LNG vehicle tanks for sale to vehicle OEMs, particularly in China, as the market for LNG vehicles emerges.

We're very pleased with our progress this quarter. We're making continuous progress in developing the market for natural gas vehicles around the world. Our new products and initiatives are progressing well. Our overall business prospects continue to strengthen and I think as you can see, our financial discipline is pretty visible.

I'm going to turn the floor over to Elaine, to take you through the financials.

Thanks, David, and good morning, everyone. The press release, financial statements and Management's discussion analysis provide a considerable amount of detail regarding our second quarter financial results and are posted on our website. This morning I will focus on some of the key highlights.

Consolidated revenues increased by $1.5 million to $13.7 million for the quarter, compared to $12.2 million this quarter last year. Almost all of that revenue was from CWI. Going forward we would expect to see new revenue streams from delivering HPDI systems for heavy-duty trucks.

Our net loss for the period was $1.8 million, a $1.5 million improvement from the $3.3 million loss for the period this time last year. The improvement was primarily the result of a $3.9 million gain realized on the sale of 45% of Westport Research, Inc. to Matco Capital Limited, offset by lower government funding and interest and accretion on the purchased convertible note.

CWI posted revenues of $13.4 million and $1.4 million net earnings, its eighth consecutive profitable quarter. We share 50% of those earnings with Cummins, Inc., our joint venture partner, so our share was approximately half of that, or $700,000. Common shares reflected a joint venture share of income from joint venture on the income statement and on the balance sheet.

On a year-to-date basis, CWI's revenues were $23.6 million, up from $22.2 million this period last year. CWI has started to ship kits to China and that revenue is included with engine revenues on the product revenue line. CWI gross margins in the quarter improved $4.8 million from $4.3 million for the same period a year ago.

Gross margin percentages were steady around 36%. Gross margin increased by over $1.8 million for the first six months of fiscal 2007, compared to the first six months of fiscal 2006, primarily because of higher revenues and improved gross margin percentages, with gross margin percentage increasing by 6% due to product mix and better warranty performance.

On the Westport side, we continue to invest in strategic market and product development programs based on the priority analysis and our strategic plan. Mike will speak further to our global heavy-duty truck program, our Australian on and off-road HPDI project, our progress with Isuzu and our China initiatives.

Our consolidated research and development expenses, net of government funding, for the three months ended September 30th, 2006, were $5.7 million compared to $4.1 million for the same period last year. This is primarily the result of lower government funding with the South Coast and NREL-funded project substantially completed and the work phase of our TPC program having ended at March 31, 2006.

We are in discussions with TPC to extend the work phase and we continue to submit claims to them, although we will not recognize the funding in our financial results until we have an approved extension in place.

We have also started creating accruing minimum royalty payments, which will be due on March 31, 2007, if the agreement is not renegotiated.

On the expense side, we continue to invest in product development for both HPDI and CWI SI engines, with R&D spending approximately two-thirds Westport and one-third CWI. On a year-to-date basis, cash use in operations was $7.4 million, up from $4.5 million last year. If we are successful in renegotiating TPC, we would expect to be able to reverse approximately $700,000 in royalties accrued to date and to be able to accrue another $1 million [that's still in] government funding. Excluding the impact of TPC, cash use in operations [inaudible] 2006 would have been around $5.7 million. The increase in spending is primarily the result of the lower government funding in the year and increased SG&A cost.

Our cash position itself has substantially improved. As discussed on the last call, during the quarter we completed two separate transactions to position ourselves for the commercialization of our key products and key markets around the world and for working capital purposes. The reorganization of Westport Research, Inc. and our partial sale of Westport Research to Matco Capital has resulted in approximately $11.5 million in cash before expenses in the following form.

First, we sold 45% of Westport Research to Matco for $4.2 million. Net of expenses, we realized $3.9 million on the gain of that sale.

Secondly, we have drawn $7.3 million against a limited recourse credit facility secured by a pledge by us of 4% of the shares of Research. We'll pay interest on the loan until December 31, 2006 at time plus-1. After December 31, the interest will be from Matco's account. The loan is repayable from the proceeds of the sale of our remaining 55% of Research.

We have also received the first tranche of $13.8 million from purchases. The convertible note has been bifurcated on our balance sheet between debt and equity as required by generally accepted accounting principles, with $1.2 million allocated to warrants and $5.1 million allocated to the conversion option. These amounts included other equity instruments under shareholders equity. The balance of $7.5 million is included in the long-term debt. The long-term debt portion of the loan is being accreted to its face value using the effective interest method.

For the first two years at least, interest is a non-cash expense payable on further notes to common shares of the then market price. We have the option after two years to pay in cash, shares or notes.

The strategic investments from purchase and the arrangement with Matco bring our cash, cash equivalents and short-term investments as of September 30, 2006, to $24.6 million, the highest is has been in two years, with substantial reduced cash usage. We are very pleased with the progress we have made in strengthening the balance sheet, positioning us well to take advantage of the market opportunities ahead of us.

On that note, I will now pass the call over to Mike.

Thank you, Elaine, and good morning, everyone. Since our last call three months ago, we have continued to make good progress on our business plan. We remain absolutely focused on generating strong and profitable growth at CWI, launching our first Westport HPDI product with LNG trucks in North America, launching our new LNG tank JV in China with BTIC and progressing some of our targeted new business initiatives.

I want to share with you today some of the operational highlights around these programs. I'll start with our heavy-duty LNG truck program. In the last 90 days since our call, we have received our first commercial orders from a range of customers, including LA International Airport, Prometheus Energy, Pacific Gas & Electric and Clean Energy. And the list of prospective orders and interested customers continues to grow.

We are now also beginning to see significant interest in our heavy-duty LNG trucks outside of the LA basin, as awareness of both the economic and environmental advantages of LNG fuel and engines increases.

On the environmental side, you may have seen Monday's release of the Stern Report in London, which for the first time takes a serious look at the possible economic impacts of climate change. And their conclusions that we are looking at a possible $7 trillion impact on global GDP if no action is taken to alter the course of the growing impact of global warming, is proving to be a real eye-opener for governments and the public around the world.

We believe our LNG trucks can help by reducing GHG emissions by 15 to 20% compared to diesel.

As mentioned in our last call, all these forces come together in southern California. The primary targets of our HPDI LNG truck launch continue to be the ports of Los Angeles and Long Beach. I talked to the Port last week and they expect to release their first RFP for fleet procurement of Westport trucks in the coming days and weeks. Their June 28th Clean Air Action Plan spells out specific actions to reduce air pollution from the 41,000 trucks that service those ports. The ports already have approved the money, up to $22 million, to buy and operate as many as 125 heavy-duty LNG trucks in this first RFP and they have plans to ramp this program up to over 5,000 LNG trucks in the next five years.

To get ready for this market demand in growth, we have put in place a number of partner and supplier relationships. The BTIC and Cryostar relationships that we talked about last quarter are very important here and we have also signed agreements with a key OEM to provide the base diesel trucks for the California program and with Cummins to provide the ISX engines.

I mentioned climate change a moment ago and we are now seeing that interest reach us in the form of expanded business opportunities for LNG trucks. In Australia, the significant fuel cost advantages, combined with growing customer interest, have caused us to reprioritize our efforts in Australia towards on-road applications of HPDI trucks. Meanwhile, we are continuing our discussions with both LNG fuel providers, engine companies and prospective mining customers with a view toward a possible long-term business opportunity around mining truck engine retrofit.

Elsewhere in Asia, our Isuzu technical program continues at its planned pace, hard at work on a number of milestones for the '06 program and I expect to have more to report on that program at our next call in February.

Finally, in China we are as busy as ever. We signed our new JV with BTIC in July and we now have a management team in place. We've manufactured our first prototype tanks and are gearing up to provide LNG tanks for our truck launch in California. We are also talking to energy companies and engine manufacturers in China, to explore how best to capitalize on our bus and truck LNG technologies and integrate them into the growing Chinese economy.

To help accelerate these discussions, we announced the appointment of Nick Sonntag to our executive team in October. Nick will be responsible for the growth and development of Westport's emerging businesses and opportunities in China.

So we have had a very active couple of quarters. A new joint venture in China, a supply agreement in Europe with Cryostar, the launch and first commercial sales of HPDI LNG trucks in California and the first sale in Sacramento of the new Cummins Westport ISL G engine, which will be certified at 0.2 gram NOx.

In addition, we've made progress on a number of business development initiatives and we have a tremendous amount of behind-the-scenes operational work going on in preparation for the California truck launch. And we did all this while generating our best financial performance in more than four years.

I'm very pleased to report that the Westport team remains absolutely focused on our principle strategic goals, which are growing our business, achieving profitability and then profitable scale-up of the Company to generate shareholder value.

I'll now pass it back to Ryan, who will open the call to your questions.

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

[OPERATOR INSTRUCTIONS] Bob Wallace at Raymond James.

On the prototype tanks that you're bringing in with BTIC, what is sort of the ballpark pickup in reduction of costs to the end-user?

I think that's something that we better classify as proprietary, Bob. We don't sell tanks individually right now. We're selling them as part of our package. Clearly there's a lot of interest in what are the cost reductions. Let's just say that we are seeing the cost reductions that we expected out of that, even in low volumes. And that's what's allowing us to offer the package at a price that we think is going to be economic in California.

Would it also be economic in China?

That's what I said, so they have to be at a price that our Chinese customers think is reasonable.

On that, Bob, the early tanks, as we said, are headed to California as part of the HPDI program. We don't have a HPDI LNG truck launch going on in China yet. We'll service initially, Chinese markets with spark-ignited tanks a little bit further down the road. But the initial HPDI program will be North America based.

Would these also go to Australia?

Yes, they could be part of the Australian heavy-duty truck program for sure, as well as anything that we might do in the mining sector.

My point is, you're making efforts to reduce your cost structure to the end-user and maintaining your margin, is that correct?

Yes.

Just struggling for one other question here. How many people do you have employed now?

We've got about 150 at Westport and another 45 or so as part of the Cummins Westport joint venture.

And what facilities do you have in China now?

We actually just moved into our own office space. I think we told you over the last few months we'd been sharing office space with friends in China, with some partners. But we just opened an official Westport office in downtown Beijing.

Thank you, that's all my questions.

[OPERATOR INSTRUCTIONS] Tom Astle with National Bank.

First of all, on HPDI, can you just--you mentioned five customers, I assume the orders are larger than five, multiple orders from each customer?

Yes, we see multiple orders. They're not material numbers. As I think we said earlier this year, we created a materiality level for announcing single orders, if they're in the $5 million range. And none of these are individually that big. The orders that we've received, in terms of actual purchase orders, are only about $1 million. But obviously, these are in fleets that we would expect to see repeat orders and there are a number of much larger orders, that as Mike said, are in the prospect list.

A lot of our work has been with the Port and that's going to depend on the release of this RFP, because the proposed incentives for the Port are so strong.

I would characterize these first orders that Dave's referring to as, each of these customers making an initial commitment to the technology with the possibility of significantly larger orders from each of these guys as they rollout the program with us.

When would you expect to recognize revenue for these orders, the missing orders?

We'll recognize revenue when the orders are delivered and these orders are scheduled to be delivered this third quarter.

Okay, that's good. And then just coming back to the LA ports, you mentioned the RFP, can you just walk me through that again? Is that an RFP for them to actually buy trucks? Are they subsidizing somehow for these trucks?

Yes, it's an RFP that we'll have to go through the details when it's in front of us, but our expectation is that it's a request for proposal from fleets, from truck owners and truck buyers, fleets in Southern California that operate trucks in and out of the port. And those fleets, upon committing to a number of X LNG trucks would receive from the port, incentive money to go to LNG. We expect that incentive to be quite significant as a percent of the total cost of the truck, the base diesel plus the LNG. In fact, we expect that incentive to be larger than our LNG incremental cost of our system.

Okay. And I think, Michael, you had said last quarter that you were hopeful that you would see orders for about 125, which you mentioned again today [are] the RFP over the next few quarters. Is that still basically on track from your perspective?

Yes, that's still on track in terms of port plans. And by the way, that's just the first port commitment, the first RFP. They've told me that they plan to follow that up with a second RFP a few months later for some larger number yet to be determined.

Okay. Now, the whole LA ports program is still subject to some funding events, is it not? Maybe you could just walk it through where the politics are right now?

If I knew where all the politics were I'd be a happy man. But the funding will be staged in pieces, if you will. So, our understanding is that the funding for this first procurement, around this first RFP, that's the $22 million I mentioned, is in place and has been provided by a combination of the Port of Los Angeles, the Port of Long Beach and the South Coast AQMD. So as far as I can tell, they have no funding concerns what so ever around that first 125 program.

After that, they will then need the next block of money for the second RFP. Funding for that will come from a combination of sources, including some from the annual port budget cycle. They'll be moving into a new fiscal year, I think, as part of that second procurement. And it's possible that there will be major new infusions of State of California money. That's partly dependent on the outcome of the election next week, around bonds for infrastructure development. So the Port's going to wait and see how that goes. If that passes, they're going to have money kind of pouring into their coiffeurs for this program. If that doesn't pass, they have some alternative plans in place around securing monies from their own revenue sources, which are quite large.

Okay, so we watch that for the next little while. And just, Elaine, on the expense line, can you help us out a little bit on forecasting maybe the R&D line and SG&A line? They're both more or less under your control except for the incentives.

I think on the R&D line, as you said, if you look at the gross R&D line, I expect we'll continue at about that rate. What we are hoping will change is the funding line going forward, as we negotiate with TPC, if we get the extension, we should see a much higher funding line coming through for the rest of the year. And so, year-to-date, the impact of TPC has been about $1.5 million or so. So if you kind of add that to the funding and double that, that's the funding we hope to get. But again, it is very much dependent on how things go with TPC and what happens with us with TPC.

Okay. And just SG&A, that went up quite a bit in the quarter. How do you see that going out?

SG&A, I think is going to actually be about the same rate going forward as well. As David mentioned, we have increased some of our spending on business development activities in China and in California as we ramp-up our activities there. So I think you'll see that about the 2Q levels or maybe even a little bit higher. That should be about it, actually.

Okay. That's it for me. I'll come back after everyone else.

Follow-up from Bob Wallace with Raymond James.

Sorry, I did remember. These are 2007-compliant, is that correct for the ones for California?

I'm not sure I heard that Bob. What was the question?

The engines for California, are they HPDI engines?

Yes.

They're 2007-compliant, is that correct?

That's not correct for the initial rollout. The initial rollout is the '06 engines, which are the ones we got certified in California three or four months ago for deployment. So, I would expect all the existing sales we mentioned plus this first Port RFP will be rollout of our existing certified '06 engine.

We are in progress to develop the '07 generation of that product. We'll certify that sometime next year and then begin to roll that out as well.

And then the 2010 comes out, is that correct, are they working on that?

2010, just around the corner, yes.

So that's being worked on at the same time.

Yes, although the primary effort today is the launch on '06 and getting ready to develop and certify '07. But some effort on 2010, but not yet a large R&D effort on 2010.

Would there be a chance that you would beat '07 requirements?

Yes, big chance. Our plans are to be lower than diesel on both NOx and particulate as we have historically been, which would mean that we come in well under the '07 standards.

Thank you, that was my question. Appreciate it.

At this time there appears to be no further questions. I'd like to turn the floor back over to Ryan Thompson for any closing remarks.

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 early February of next year, with the disclosure of our third quarter results for fiscal 2007. Goodbye.

Thank you. That does conclude today's Westport conference call. You may now disconnect and have a wonderful day.