Westport Fuel Systems Inc (WPRT) 2009 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen. Welcome to the Westport Innovations fiscal 2009 third quarter financial results conference call. I would now like to turn the meeting over to Mr. Darren Seed, Westport's Director of Investor Relations. Please go ahead, Mr. Seed.

Thank you. Good afternoon, everyone. Welcome to the third quarter conference call for fiscal 2009. It is being held to coincide with the disclosure of our financial results earlier this afternoon. For those who haven't seen the release and financial statement yet, they can be found on Westport's website at www.Westport.com. Speaking on behalf of the Company will be the Westport's Chief Executive Officer, David Demers, and Chief Financial Officer, Elaine Wong, and the President and Chief Operating Officer, Mike Gallagher.

This call is open to the public and the media but for the sake of brevity, we are restricting questions to analysts and institutional investors. You are reminded that certain statements may be made in this conference call and in our responses to various questions, and may constitute forward-looking statements within the meaning of US and applicable Canadian securities law. 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.

Information contained in this conference call is subject to and qualified in its entirety by information contained in the Company's public filings. And except as required by applicable securities laws, we do not have any intention or obligation to update forward-looking information after this conference call. You are cautioned not to place undue reliance on any forward-looking statements. Now I will turn the call over to David Demers.

Thanks, Darren. Good afternoon, everyone. As usual, I'll lead off the conference call with my remarks on strategy and external conditions, followed by Elaine with her detailed review of the financial statements, and then Mike will give you an update on the heavy duty truck business and we'll open it up for questions.

I suppose I do need to start with a comment on the third quarter, we posted our second best revenue performance in the history of the Company on the back of two previous record quarters and that means we are well ahead of plan for the current year. Year-to-date revenue stands at about CAD96 million, and I don't think any of you will be surprised to hear that we expect to break the CAD100 million mark for the first time in our history by year end. If this was a normal economy, we would be confident that the business is developing according to plan and the strategy would be full speed ahead. But if you talk to the belief that history is much of a guide going forward. Elaine and I have been spending the last few months talking to our partners, our customers and advisors, and testing our business plan assumptions, and adjusting those plans in order to successfully navigate through this.

With your indulgence, I would like to spend a few minutes reviewing our strategic position, and explain why, unlike others in the transportation sector, we saw strong growth in 2007 and 2008 and we are still expecting strong growth in 2009. As a reminder and for those of you who are new to these calls, we said that we would build our long term goal based on a 30% compounded growth rate in annual revenue, continued profitability from Cummins Westport, and the presumption that as the heavy duty business matures, it will provide sufficient margin contribution to tip Westport into sustainable profitability and then profit growth.

For reference excluding the foreign exchange effect because of the volatility of the Canadian dollar over the past few years, if you go back to fiscal '07, that three-year compound growth rate with 30%, our three-year compound growth rate in fiscal '08 rose to 36%, has come on the back of recent strong growth. As we have demonstrated with [CWI], when we use our part and existing production and distribution assets, we can scale up deliveries rapidly without a corresponding increase in expenses and without large capital investments. Therefore, we expect to see sustainable profitability in our new businesses at a relatively small volume for this industry and then to see high leverage on the bottom line as sales continue to grow.

Now, some of have you told us that 30% growth is too conservative, particularly in light of the potential market size for heavy duty. And some, particularly these economic conditions are asking whether we are being too optimistic. The point I think we need to make is that we are focused on top line growth, but we also manage our gross margins, our SG&A expenses, and our case of investment in new programs and new technologies. These four variables all interact as part of the business plan and we have lots of levers we can manage.

There's still work we can do, but we believe our business plan is realistic and achievable. We think the CWI business is well established with more than 3,000 units of the ISL G engine shipped since its launch in 2007 -- the new market presence in India. We think CWI is well positioned for continued global growth. Our focus as a team now is on developing a heavy duty business to the same level of sustainability and profitability.

There's four key assumptions behind our plan. We discussed most of these, but I would like to comment on them in light of the current credit crisis. We don't really think that this crisis has materially changed any of our positions, but, of course, we are watching it.

First, we believe the long term driver for adoption of alternative fuels is going to be conventional fuel scarcity and the corresponding high gas and diesel fuel prices, particularly relative to natural gas. Transportation is completely dependent on petroleum-based fuels. And as we saw in 2008, that global system is simply hitting its natural production limits.

The IEA pointed out in November, that even with extraordinary capital investments, oil production increases will be a challenge. We don't believe the price spike last year was a fluke, but it's an early signal that demand and supply are dangerously tight. Although demand is now falling so is global supply capability. The result of this is that many large fleets are concerned about fuel supply and fuel cost as a strategic issue and there's a new sense of urgency about investigating alternative fuels.

Second, we believe that this opportunity is going to create a large scale market for alternative fuels. The dominant alternative fuel, of course, we think will be natural gas as opposed to alternatives such as biofuels or hydrogen. Natural gas is cheaper than oil. It's typically domestically available in large markets like North America, China, Australia. It has environmental advantages, including green house gas benefits.

Third, our strategy is to partner with companies with existing production and distribution assets. We work with them to establish parallel product lines to address the growing alternative fuel opportunity. We focused in the past on high fuel consumption fleets, like buses and trucks. And we have more than 50 global manufacturers of buses and trucks that now use our natural gas engines.

We see potential new markets everywhere there's an engine. For example, last month, you saw us announce our alliance with [ONBL] of Italy. And Hyundai from Korea is going to be delivering 2 and 2.4-liter alternative fuel engines under the Juniper engines brand name to manufacture industrial products like forklifts. Our business model continues to attract new prospective partners. We continue to see new opportunities as the global financial crisis forces those companies to reduce their risk, cut costs, but still try to position themselves for success as the markets emerge from the current turmoil. So things are still going very well.

Finally, we think the [east/west] market introduction strategy, even where we might argue that we can deliver an economic advantage with lower fuel costs, is still to focus on product launches in environmentally sensitive geographic markets where government programs and incentives require and provide financial support for adoption of natural gas fuels and fleets. Of course, government grants aren't an ideal foundation for long-term business growth, but they have allowed us to successfully demonstrate the performance of our products, scale up production and product reliability, so we can then establish a credible economic case to customers that don't have those government support opportunities.

How is Westport going to stand up in this economy? Can we stand this pace of growth? And what do we see in light of the rapid degradation end markets for transportation products generally? Clearly we haven't run out of market. There's still millions of diesel vehicles in these markets.

CWI and the Westport heavy duty unit shipped just a few thousand engines in 2008. Many of our customers are government fleets who acquire vehicles on long-term contracts with federal government funding. We believe most of those programs will be relatively unaffected by the credit crisis.

Last quarter, CWI announced the largest order in history with 3,000 bus engines going to Delhi Transit. We see considerable increase in capacity demand in transit fleets around the world. Several government infrastructure announcements are suggesting support for deployment of more new transit buses. On the trucking side, CWI has established a strong market presence in rescue and delivery vehicles in the last year or two, and this shows strong, long-term promise as well.

Nevertheless, we simply don't have clear visibility into 2009. Our industry works on an adjusted time basis. We don't have a backlog per say, this is nothing new. Growth opportunities clearly remain. We will closely monitor our results and we are going to tightly manage our expenses. We will continue to make investments in new products that we believe show strong promise.

On the heavy duty side, 2008 has been a very good year for this unit. We are still waiting for our beach head opportunity to mature, though -- plane/truck program at the ports in Los Angeles and Long Beach. It's been announced for sometime.

We now have a number of trucks in successful daily operation there and the L&G infrastructure is being built out. The port is going to need thousands of new trucks to meet its commitments. Their programs had been slowed by litigation and regulatory disputes, but we still expect the program to achieve its stated goals. And we have been using the delays to prepare for large scale factory production of trucks by Kenworth and Peterbilt, and to develop the markets outside of the ports.

I don't think anyone foresaw the current extreme market conditions in the diesel truck industry. Most analysts now are predicting continued shrinkage in the market for new trucks in 2009, after two successive down years in 2008 and 2007. Nevertheless, we need to point out that's not our market.

We are targeting a small fraction of those prospective truck fleets. Those who are looking to diversify away from dependence on diesel fuels or who have an environmental mandate that requires them to look at natural gas, and obviously, they will be fleets and have the financial and the credit capabilities to launch such a program in 2009. We think we have enough prospective fleets in that market the to support our growth plans.

It's also a couple of wild cards for our business prospects this year. First, there seems to be widespread support for a new US government stimulus incentive that targets energy security, including shifting heavy duty vehicles to natural gas. Second, we're seeing strong support for new carbon emissions, penalties and incentives, of course led by California. Both of these will further increase the value for of our products. Either program would establish significant new opportunities so we are keeping our eye on that as well.

Still, this remains a high-risk business plan in the context of the economy we are facing today. There's one thing that I hope everyone has learned in the past few months, it's that high returns are not possible without accepting corresponding risks. We believe that the risks are manageable -- known risks are manageable. Wherever possible, we are seeking to reduce our core risks through broadened diversified partnerships and diversified markets.

Right now, we think market risks are extraordinarily high and we are watching things very closely. Fortunately, we have a solid cash foundation. We have considerable scope to adjust our investment rate to pace it with sales growth.

We intend to preserve our strong cash position and to take any required steps to defer or eliminate program expenses if we see a change in the business prospects for these programs. To wrap up, despite the turmoil, we think we are on the right track. We intend to use this period to continue to strengthen our competitive position, while continuing to prudently manage our resources. I will turn the call over to Elaine to take you through the financials. Elaine?

Thanks, David, and good afternoon, everyone. The press release financial statements and management's discussion and analysis provide a considerable amount of detail, regarding our third quarter fiscal 2009 factory built and are posted on our website.

For the third quarter ended December 31st, 2008 consolidated revenue was CAD31.1 million on 824 unit shipped, compared to CAD19.3 million on 801 units shipped in the previous fiscal year, a revenue increase of 61% year-over-year. The increase in revenues primarily because of year-over-year increases in shipments of LNG systems and the effect of foreign exchange. Cummins Westport revenue was CAD25.8 million on 768 units shipped, up 38% from CAD18.7 million on 798 units shipped.

In US dollar terms, CWI revenue increased by 12% over the same period last year. Non-CWI revenues were CAD5.3 million, with 56 LNG heavy duty systems shipped, compared to CAD600,000 in the prior year when 3 LNG heavy systems shipped. For the nine months ended December 31st, 2008, consolidated revenues were up 70% to CAD95.6 million on 3,362 units in comparison to CAD56.2 million on 2,201 units in the same period in the prior fiscal year. Cummings Westport revenues are up 61% in Canadian terms or 54% in US dollar terms. We have also seen a 250% increase in heavy duty LNG shipments.

While we are pleased with the top line growth, we continue to caution listeners that quarter numbers can and do fluctuate significantly from period to period, and revenues can be impacted by a number of things, including timing of delivery of major orders, foreign exchange and product mix. Year-to-date revenue growth is ahead of our target locator of 30% on the consolidated revenues. I will remind everyone again, that quarters can be lumpy and the longer term multi-year view would be more appropriate for modeling purposes.

For the three months ended December 31st, 2008, we reported a net loss of CAD8.9 million or CAD0.28 loss per share. That compares to a Q2 '09 net loss of CAD9.1 million, excluding any net gains from the sale of long-term investments, as a ramp up of our production and sales and marketing activities starts to moderate. In Q3 '08, we reported net income of CAD7.4 million, which included a CAD9.4 million gain from sales investments and CAD5.9 million in tax assets recognized by Cummings Westport.

Year-over-year, CWI expenses were up CAD1.1 million in the quarter, primarily because of foreign exchange and increased R&D. Recall that the Canadian dollar was worth CAD1.02 US on average during Q3 of '08, versus CAD0.83 on average in Q3 '09. Non [CWI] operating expenses, i.e. Westport R&D and SG&A, increased by CAD2.3 million year-over-year, primarily as a result of activities associated with commercialization of our LNG systems for heavy duty trucks, such as production readiness and marketing efforts. Some of our costs previously associated with research and development activities are now in sales and marketing, as our efforts have been moving away from preproduction and demonstration support to field service and support.

In the quarter, CWI margins were 18%, negatively impacted by [warranted] adjustments related to the ISL G. Excluding the adjustments, margins would be have been 27%. CWI takes a conservative warranted accrual upon product launch and adjusts as necessary as more field experience is obtained over the warranty period, which generally takes two and a half to three years from the time it's shipped to the plant to the end of the [feeder] warranty period. The warranty period starts from the time when it goes in service, not when it ships.

In the quarter, CWI determined that taking an additional CAD2.4 million in warranty reserves or roughly an additional CAD800 per engine shipped would be prudent based on the ISL G field experience to-date. Year-to-date, CWI had made total warranty adjustments of CAD3.9 million, bringing its warranty reserve to CAD21.2 million as of December 31st, 2008. Additional reserves may be taken in the future if claims experience worsen. Or conversely if claim experience improves, as they are implemented in the field. This could bring warranties back into income.

We note that the ISL G engine remains a very popular engine with customers and CWI management expects that warranties will -- should moderate as launch issues are resolved. However, warranty may still fluctuate significantly in the near term. Non-CWI revenue margins were about 30% in this period. The higher margin was held by the higher Canadian dollars of sales remained when the Canadian dollar was weaker and inventory purchases made when the Canadian dollar was higher. Margins are likely going to be lumpy for at least a few quarters affected by low volumes and inventory adjustments from foreign exchange and cost of revenue -- in inventory.

For the nine months ended December 31st, 2008, we reported a net loss of CAD11.7 million or CAD0.39 per share, which compares to a net loss of CAD2.2 million or CAD0.09 per share in the nine months ended December 31st , 2007. Turning to the balance sheet, our cash and short-term investments at December 31st, 2008 totaled CAD88.8 million, compared to CAD22.9 million as of March 31st, 2008. Cash views and operations of capital expenditures for the nine months was CAD8.3 million, with the majority in capital expenditures related to our summary center and expansion of office facilities, both of which are now substantially complete.

Forecasting our business has always been a challenge and the external markets are right now facing some serious difficulties, creating even greater uncertainties. However, as David noted, we feel that we are well positioned to adopt to changing market conditions, given our strong balance sheet, Cummins Westport's continued revenue growth and our (inaudible) heavy duty. For 2007, we were focused on product launch and the product development. Our efforts in 2007 were focused on product launch and pretest project development. In 2008, it was volume production readiness and supply chain development, and somewhat the quality of cost reduction as well.

2009 will be focused on the business levers that will move us closer to the profitability, including margin improvement, efforts around cost reduction, quality improvement, volume shipment to the ports and expense management. Now over to Mike for an operational update.

Thank you, Elaine, and good afternoon, everyone. For my part, I will focus on some key developments in our heavy duty business, in addition to providing an update on the San Pedro Bay ports activities. As you have read in our financial statements and heard today, we did deliver 56 heavy duty LNG systems during the quarter and recorded CAD5.3 million in revenue.

Year-to-date, that's now at 126 units and CAD10.8 million in revenue, which is 350% of last year's revenue of CAD3.1 million through three quarters. 125 of this year's units were actually delivered in the last two quarters. That is 177% more trucks delivered than the first six quarters combined when the business was launched. I find it interesting also to note that the heavy duty revenue this quarter has now reached 20% of the CWI run rate. From a financial standpoint, we are making steady progress here. And you can see that this business is indeed gaining some momentum and beginning to show the signals we are looking for regarding early market entry and acceptance.

From a production capability standpoint, 2008 was the year of the OEM partner agreements for Westport. We negotiated three major OEM agreements which are now in place. And three major LNG truck production facilities are now coming online this year, at Kenworth North America and Australia, and Peterbilt. Kenworth made a decision to respond to the economic slowdown by shutting down its [Renton], Washington, truck plant. But I was very pleased to see Kenworth reconfirm its commitment to LNG trucks and to Westport by immediatly shifting the LNG truck assembly plant to its [Kenmax] operation to Mexicali, Mexico. This manufacturing facility is actually just across the US border from El Centro, California and as a result, we will benefit from its proximity to our key markets in southern California near the ports.

I was also very pleased to announce the new agreements with both Kenworth Australia and with Peterbilt in Texas late in '08. And I think the fact that both of these organizations were prepared to make these new financial commitments in the middle of the economic uncertainties is a very positive sign, both from the growth of our business and the attractiveness of our technology. Meanwhile, our new Westport assembly center which we opened last April has started our smoothly in recent months.

We are now assembling LNG systems there from our international supply chain of engines, injectors, pumps, tanks, fuel conditioning modules, et cetera. Combined with our OEM partner production systems, our assembly center approach and the beginnings of some volume growth, we have also been able to offer some significant price reduction to the end use customers, which is roughly 20% or better now compared to our early prototype of systems just 12 to 18 months ago.

I always like to give you my personal take on how the port LNG truck program is evolving, especially given my own personal involvement in working with that program for the past three years. It's no secret to any of us that the ports have faced several challenges in the form of lawsuits from both the Federal Maritime Commission and the American Truckers Association. These have delayed the collection of the all important new cargo fees and generally has caused a fair amount of confusion among the customer fleets up to now.

However I do believe we may be coming to the end of this period. The review period for the [FMC] lawsuit actually expires at the end of this week. And the ports have now set next Wednesday, February 18th at 8:00 a.m. as the first day for implementing this clean truck cargo fee program, which will collect CAD70 for every 40-foot container that moves through the ports. The expectation in the industry is that this is going to happen as planned. In fact, in late-breaking news yesterday, the APA released a letter expressing their support for the implementation of those cargo fees, noting that collection of the fee is an integral part of the port's environmental program.

The protest to make these fees may create about CAD1 million per day -- and that's per day in new funding to incentivize fleets to procure new clean trucks. In fact, the Port of Long Beach just put out a press release about a half hour ago to that effect. The ports have already banned pre '89 trucks as of October 1st last year and now entering the next stage of their program. There are still approximately 10,000 trucks in service that are being targeted for the clean trucks program for upgrade and/or replacement. Because of the ports progressive ban program and cargo requirements related to port trucks as well, we think it's quite possible that a significant fraction of those remaining targeted trucks may be replaced in this calendar year in 2009.

The ports have also created more recently a new alternative fuel truck working group whose mission is to present the alt fuel truck opportunity to port management later this month. That report is likely to lay out how the port could implement a 2009 alt fuel truck program, one which could help the port boards catch up to their commitment to have 50% of the new trucks be alt fueled. Implementation of this alt fuel truck program, as well as the new cargo fees, are obviously two critical steps in creating opportunities for Westport, both for our heavy duty business and also for CWI. We are doing everything we can to fully prepare for that.

As David mentioned, these days government funding initiatives, including but not limited to, the suggested US federal stimulus package are on everyone's minds also. And it does look like the stimulus package working its way through the halls of Washington may include some benefits for public transit as well as alt fuel and alt fuel vehicles. But it's not clear frankly at this stage, exactly where those monies would be spent in relation to natural gas trucks and buses. We are maintaining a close watch, not only on the stimulus activity, but on some fall-on legislation initiatives in Washington, that may offer specific new clean truck incentives.

David and Elaine have talked some about the overall global economic conditions and how they may or may not affect our business and operations. We are building our business in ways that aggressively prepare us for large growth opportunities. But at the same time, we are managing our expenses with discipline and focus to reflect those economic uncertainties around us. Our partners in global production are eager to ship LNG trucks in 2009, and look forward with us to filling those production lots that they have created.

I believe we have accomplished a great deal on this third quarter and in the months before that also, and then we continue to have some truly large opportunities in front of us. With that, I will now pass the call back to the operator who will open the call to your questions.

Thank you. We will now take questions from the telephone lines. (Operator instructions). The first question is from David Woodburn from [Equity]. Please go ahead. Your line is now open.

Thanks for taking the question. It is pretty basic and just wondering where the numbers from India show up in terms of the licensing revenue. Is that within the CWI engine revenue figure?

Yes, David, it's within the Cummings Westport revenue figures.

Do those units -- are those are included in the Cummings -- ?

They are not. The units are engines shipped -- full engines shipped.

Okay. And then on the warranty reserves, I think I got this. I think it's a boost to the warranty reserve as an ongoing -- for every ISL G going out, there's an additional warranty reserve being taken instead of just a one-time catchup.

The CAD2.4 million is an adjustment to the warrant liability, not necessarily to the accrual for engine going forward. It's still a catchup.

Okay. Perfect. Thank you.

Thanks, David.

Thank you. The next question is from Graham Mattison from Lazard Capital.

Good afternoon, everyone.

Hi, Graham.

I was wondering if you could talk about the engine shipments in the quarter which were from the CWI side, down a bit from prior quarters. Was that just a lumpiness, in terms of when they're shipping out. It seems given the orders that you've announced, there should be a pretty strong backlog.

We always caution the quarters are lumpy and so depending on when customers are taking the order, you will cut off periods at the end of the quarter. You can see quite a big difference in the volume shipments from quarter to quarter.

That's really just a customer timing at the end of the year?

Yes. It's customer timing. It depends when the OEM might be setting up for his -- when he's putting the engine in his truck or bus as well so when he is accepting delivery.

Got you. In terms of the average selling price of the engines, obviously the engines were -- the number was impacted a bit by currency. Were you shipping larger engines in the quarter or is there any change in terms of the product mix there?

Yes, there's a couple of things to the ESP. One is obviously, you mentioned, foreign exchange. The other one, as David alluded to earlier, the engine -- the CILs -- revenues are also in that product line. You will see those revenues in the product line, but they are not included in the units shipped.

Got you.

Finally, product mix does make a difference. The more ISL Gs, which tend to be the more expensive product, the more ISL Gs are shipping, the higher your ASP is going to be.

Last, could you give us an update on your joint ventures, particularly the [WayChai] joint venture and the European joint ventures, where those are?

You pointed at me. Come on, Elaine.

I could tell that you were waiting for the business license in China to be issued, but we think we are close.

I think -- what's interesting with WayChai is the Chinese government has brought in -- along with a lot of other world governments, new controls on money laundering and foreign investment. And so as a result, we got trapped in a three-level regulatory review of the investment in the joint venture that's now being cleared. I understand we're cleared now at all levels of the government. That would proceed.

Technically, the technical team has been organized. That's underway. The [worst point] of WayChai is quite enthused about the opportunity. But like everybody, their business has been impacted pretty profoundly by what's going on in the credit markets. There's a few distractions going on to the joint venture right now.

The European side also going well. We are in the proof of concept to work. I think generally around the world, people are accepting that we are going to come out of this crisis again, and worry about supply and diesel fuel supply. And therefore, the alternative fuel interest is higher than ever, so we are seeing lots of work.

All right. Great. I will jump back in queue. Thanks very much.

Thank you. The next question is from Laurence Alexander from Jefferies & Company. Please go ahead. Your line is now open.

Good afternoon. First question was, can you elaborate a little bit more on the details of your cost reduction efforts? And how they are tied to your priorities for cash flow management over the next 12 months?

Laurence, this is Mike. Are you referring to my comment on the product price reduction?

Yes. Yes.

Not relative to expense management.

Yes.

Yes, we have just been watching the developments. We said on a number of occasions that we intend to bring the cost of this system down, both with volume and with quality in systems improvements in the supply chain. We have been working at that.

But just reflecting back on where we were just 12 to 18 months ago, as we were rolling out first prototype systems, it had become clear to us. We have now pulled out 20% of that prototype systems cost already and we of course, continue. We have a number of initiatives underway, looking for ways to improve on that.

Do these initiatives translate into an increase in your R&D spend or is there a virtual circle where your ongoing cost drain is going to be reduced as well?

The R&D spend, of course, is across a number of programs, heavy duty, CWI, the new joint ventures, et cetera. But in the case of this issue, I will say a couple of things. There are R&D efforts going on around system cost reduction. Those might be incremental, say, to efforts a year or two ago.

On the other hand, the main driving programs for R&D spend within heavy duty has typically been certification programs for next generation engines. We are still quite active there as well around the 20-10 program. But I would see -- we are shifting our focus a bit towards putting more resources into cost improvement, cost reduction, because we think it can drive business and volume growth and profitability resulting from that.

I will just jump in for a second, Laurence. In terms of the spend rate and the resources, what we are looking to do is redeploy and refocus the resources that we have. 2008 -- calendar year 2008, we spent a lot of time in production ramp up and integrating our products to Kenworth trucks and in Peterbilt, et cetera. In 2009, what we want to do is focusing those efforts on getting the cost of the system down.

Okay. And then lastly, just to clarify the warranty on the ISL Gs, is that a warranty continuing -- is that rising or has -- do you get the impression from CWI that it has plateaued on a per vehicle basis?

It is a good question. I think because it is still relatively early days for the ISL G, you are still going to see volatility. Cummins expects it over time, once they go through a full warranty period.

And keep in mind the full warranty period is about three years. It takes six to nine months to actually get the engines from the Cummins factory into the bus or truck, and then into the customer's hands. Even though the ISL G was launched in mid-2007, you are probably seeing the first trucks and buses on the road early 2008. The planes are done in the quarter in arrears and so they probably have two quarters worth of data. It will be volatile, I would say over the next little while.

Is the data systemic or tied to one component in the unit?

No no. They look at the data across all the different pieces of the engine. They will fix the high dollar items first and put those fixes into the field as soon as possible and back into the production as well.

Thank you.

Thanks, Laurence.

Thank you. The next question is from Rob Brown from Craig Hallum Capital. Please go ahead. Your line is now open.

Could you just clarify the Kenworth OEM production? Is that still on track for kicking off in March?

This is Mike. The Kenworth truck production, I would say, it's still on track. We have shifted as you have heard, the location of the plant from the state of Washington down to Mexicali.

The actual truck productions from there will ramp up a pace with new orders from the port and elsewhere. It's hard to say whether that's going to be March or April or May. They will be ready to go in the spring. And they will be ready to ramp up quickly to meet whatever the demand is for those trucks.

Okay. And on that point, with the trucks be taking off, how long before you see orders come out once that fee starts? Obviously it's new, it's hard to say, but what's a rough gauge for that ? And can we expect a gap where there is shipments that come through the pipeline or how do we think about that?

I really wish there was an easy answer to that, Rob, but it's not a straight forward answer. The fees are one step in the program. February 18th, a week from today, that will start putting money in the port coffers that they can use to provide to customer fleets to procure clean trucks. But there is a process of lining up -- those fleets have to decide what they will do.

They know that come New Year's Day next, they will not be able to run their existing trucks into the port. The question is, what do they do about that? Some of them will probably go into other routes, because they don't want to buy new trucks. Some of them will buy new clean diesel trucks and some of them will buy new LNG trucks. Of those, they will, in some cases buy LNG trucks with CWI engines. In other cases, they will buy LNG trucks with Westport 15-liter HPVI engines.

But that process that I'm describing does take some time. We won't know how many trucks we're going to ship when until we have firm orders from those fleets and from Kenworth to buy our LNG systems. That could be weeks after that February 18th date, or it could be months, depending on decisions that those fleets make and the interaction with the ports around the incentive structure which is all on the table as we speak. You won't see anything before February 18th, I can say that with some certainty. That's a week away. We just have to watch the developments down at the port and the month, two months, three months out from February 18th, to see how fast that momentum translates into firm backlog for us.

Okay. Great. Thank you.

Thank you. The next question is from Ron Oster from Broadpoint Securities. Please go ahead. Your line is now open.

Good afternoon. Elaine, I was wondering if you could repeat what you said on the gross margins. I think you gave some numbers of what it would have been without the warranty adjustments.

Yes. Cummins Westport's gross margin in the quarter was 18% with the warranty adjustments -- was CAD2.4 million in warranty adjustments was 9% of the revenues and so if you -- if you make the warranty adjustments this quarter, they would have had gross margins in the 27% range.

Okay. Great. Thanks. And for modeling purposes, I think last quarter you mentioned a 25% to 30% gross margin. Is that still a good ballpark number? Are you using -- even with the warranty accruals likely continuing going forward?

The big wildcard is the warranty adjustment. If we didn't have the warranty adjustments this quarter, it would have been that 25% to 30% range. All right. It really depends on the field expense for the ISL G. But depending on what you assume, your guess is probably as good as mine in terms of how this -- how it will work the next couple quarters. But the 25% to 30% is probably still reasonable.

That doesn't assume any warranty adjustments -- the 25% to 30%.

That's correct. Yes, that's assuming their normal going rate.

And then Mike, I was just wondering what might give you some confidence that there's not going to be another delay on the fee starting on the 18th or another lawsuit or anything like that that might push that out once again?

Ron, it you followed us for awhile, you'd know that I have been loathed to express confidence until things actually happen at the ports because that process is so convoluted. Having said that, the fact that the American Trucking Association even yesterday, came out expressing support for implementing that fee next week is a radical shift in their position. They have been principle behind the delays to-date, so that that's big news. I think that's probably why the port of Long Beach elected to issue the press release an hour ago, announcing that this thing is really happening next Wednesday.

I have a high degree of confidence that the fees are going to be implemented next week on Wednesday in the morning. The questions that are still a little bit harder to use the crystal ball through are -- in the future -- you may recall that the ATA and the Maritime Commission had some other issues that they were worried about as well. There's -- they are still pursuing their legal possibilities around a couple of those issues. One of the larger ones being the port of L.A. mandate to phase in to employee drivers over a period of years.

We'll see some continuing legal action. It's pretty -- I would be shocked if this fee didn't happen next week in light of the ATA support now. But there could be some further twists and turns around other aspects of program over time.

Okay. And then David, I was wondering if you could maybe -- obviously your macro comments were not a surprise in terms of seeing some weakness. Could you maybe provide some more color with regards to the individual business segments, such as, transit versus refuse? Or where it is you might be seeing some relative strength or weakness versus the others?

We've been pondering over it. We have been talking to our friends at the OEMs and Cummins. That business is just carnage. There's no other word for it. Shipments of traditional diesel vehicles have almost stopped in a lot of factories and no one has ever seen it like this.

It puzzled everybody as to why are natural gas shipments are continuing with some strength. We are trying to explain it and rationalize it, but I think it's just what I said. They are different markets and they're going to different customers, and they're not as affected.

The corollary of that would be that anybody who is affected by credit, you would expect they either have a big problem if they can't buy new vehicles or they will be thinking whether they want to buy new vehicles. Those tend to be the smaller private fleets. We expect to see more softness in delivery fleets and things like that.

At the same time, a lot of those vehicles that might be producing have been going to the large government fleets and big delivery companies like UPS who are relatively -- I don't want to say unscathed, but they are relatively just pushing ahead on their plans. We have seen two completely difference responses in our partners and in customers. I'm sure you are seeing the same thing.

A lot of fleets are positioning for market share growth once the economy turns around. They are going -- this is a great opportunity to clean things up and weak competition will fall away and we'll be strong. Other people are just putting their head down and saying, let's wait for this to blow over and we go into survival. The world has changed a lot in the last four months.

I think we're going to continue to see very cautious buying of trucks in private fleets, particularly in the United States because credit is still very tight. That said, there's a big pent up buildup on lease returns. The fleets have done a very good job of shrinking very quickly. I think at some point in the next 12 to 18 months, we will see that turn around with a vengeance.

There is a big hope, let's say. Some of the industry analysts were looking at the 2010 emissions introduction as the signal for their pre-buy. Traditionally the year before a new emission standard sees a big upsurge in volumes which we saw in 2006. I think most people have given up on that idea. You never know if the markets improve toward the middle, end of the year, that might see some volume as well and get things going.

But none of that really applies to the natural gas market. As far as we can tell, our customers are pretty confident. They are moving ahead with their existing plans. The transit industry is seeing a lot of demand growth. I think CWI continues to have enough opportunities around the world to keep it busy and we have to see how it plays out.

Okay. Great. Thank you.

Okay.

Thank you. The next question is from Rupert Merer from National Bank Financial. Please go ahead. Your line is now open.

Good afternoon.

Hi, Rupert.

Should we expect to see a bit of a lag on the deliveries of the HPDI between now and when the port fees start to kick in and you start to see movement of the -- ?

You are cutting in and out a bit, Rupert. Can you repeat the question?

Yes. Sorry. Is that better?

Much better.

Should we expect to see a lag in sales on the HPDI between now and when the port subsidies start to kick in?

Well, look (multiple speakers)

Compared to what? We see a huge lag.

Let's say relative to the level you've seen in the last couple of quarters.

Yes, it's possible that you might, but I'm not sure yet. It wouldn't take much to bump us back up to these levels and much, much higher, right? It's true -- there are a few weeks of confusion that has to get sorted out on the implementation of the fee and how much money the ports want to throw at the fleets and their decisions around diesel versus LNG. I think on balance, this program is -- has got a huge potential for us for much more significant levels of orders and would more than compensate any delay that might cover a few weeks.

Okay. With regards to the CWI ASPs from the last quarter, can you give us a number for helping out on the modeling for the 768 units that were sold?

I'm sorry, give you a number?

An ASP. Yes. Do we know -- we know it was impacted by the sales into India.

I think if you take a look at the MD&A, we normally -- in the back of the MD&A, we have the quarterly financial data. What we give you in that is the units shipped by quarter. Now you've got to back out Cummins Westport and heavy duty systems over the last little while. We also give you the exchange rate. If you take the product revenue -- if you take the Cummins Westport product revenue and divide that by exchange rate, that will take you back to a US dollar amount, and you divide that by CWI shipments in the quarter which we normally give and the MD&A as well, you should get down to the ASP.

Now, with India, having start shipping -- I think back in December or January and it's expected to ship over the next four to six quarters, you can expect higher ASPs probably in the balance of this year and then into next calendar year. But that should give you an idea of what the run rate in Q4 was.

Okay. It didn't have a material impact on the ASP in the last quarter --?

If you compare -- I don't have the calculation in front of me, but if you compare Q3 over Q2, the difference of that would probably mostly be due to CIL-- due to the shipments, given that both quarters -- of ISL Gs otherwise.

Okay. I will do that. Just finally on warranty, how involved is CWI in the warranty issues related to our ISL G? Are you involved in the product improvements very heavily or is that mostly something that Cummins is looking after?

That's Cummings Westport. Cummins Westport does the product improvement. They do the current product report and they also overlook -- the supervise or warranty calculations as well, based on inputs from Cummings. But they are responsible for warranties and fixing the problems.

Are you seeing any warranty issues related to HPDI so far -- ?

I will say a word and then, Elaine, you can jump in, too. We are obviously early days on that, Rupert, as I mentioned. The last six months we've seen two-thirds or more of the total population that was on the road, hit the road. Early days in terms of data. We are watching it. We have some early data. But I don't think there's a -- I don't have any strong conclusions as to whether -- what that means yet, based on warranty accruals versus future potential adjustments.

Yes, I follow Mike's comments. The HBDI systems are much more recent into the field, like Mike said. We just started shipping the last couple of quarters and the volumes are much lower as well. There's 3,000 ISL G's shipped versus a couple hundred LNG systems. It will take awhile to get the field experience that we need.

We are excited to be getting the ones that did get out there the last two quarters, because it's starting to generate much more significant data than we had available.

We talk about warranty a lot. From a customer perspective, both the LNG system customers and also the ISL G customers are still happy with the products. These warranty issues are not as affecting the customers in any way.

We are trying to do -- I will weigh in on this a bit, too. It has -- it's obviously on everybody's mind. The two other issues on the HPDI side that I think are probably more acute than the CWI side, just because we are so rapidly evolving the product.

The HPDI product is not final by any means. It's continuing to go through development. Every time we launch -- a version 1.6 or 1.7 of a new component, as you can imagine, you are introducing new warranty risks and you restart the clock to see how the new version is doing. The warranty on the HPDI side is going to evolve.

The other factor, of course, is that we are -- our ambition is to be as good or better than diesel. Diesel expectations on reliability and durability are pretty phenomenal. That's where we are shooting for. We have a goal to get there. Even the diesel world, the diesel engines get introduced and the things improve over time and that's what we are expecting to do with our LNG engines. And there's some new components, the tanks, pumps, all of this integration work needs to be looked at carefully.

I would say overall, we are pretty pleased with customer feedback and I'm sure you have heard customer feedback. Customers are very happy. It's in operation. Things are fine.

We think that if we can reduce warranty -- if we can reduce service costs, that just helps our value proposition. The more we can push down that expense, the better our economic value proposition is. And as we evolve away from emission centric customers like the port, we need to see that strong economic value proposition. We need to be competitive or better than diesel. That's where we are headed.

Great. Thank you.

Thank you. The next question is from Eric Stine from Northland Securities. Please go ahead. Your line is now open.

Good afternoon.

Good afternoon, Eric.

I was wondering, could you just give us an update on the HPDI engine and progress made towards getting EPA 2010 certification. Then just also talk about the impact on your conversations with customers. Just the uncertainty over the diesel engines, whether it's the technology SCR versus EGR, the price and that sort of thing?

Yes, I will start with the HPDI part of the story. Of course, our engines today are certified to 0.8-gram [knocks] which is a third better than the '07 regs which they have to comply with. 2010 regs take that down to 0.2 gram knocks. We've had a product development in the R&D program underway for 12 to 18 months now, aimed at getting ready for that next generation system. That work, by the way is funded -- not funded, but co-funded at least, with CAD2.25 million US coming to us from the southcoast AQMD and the two ports -- the two San Pedro Bay ports.

That program is proceeding. It's going through its technical milestones. We still have all of this calendar year of effort continuing on that towards certification. But it is proceeding and meeting its milestones I don't have any reason to expect that it won't continue to do so.

On the customer side, Dave, you may want to jump in here as well. But on the diesel side, as you may know, every diesel manufacturer except for Navistar International has now decided to go with the catalytic SCR technology on the diesel systems and that includes our North American engine partner, Cummins who just shifted to that strategy about four months ago. That's made our program easier in some ways because it puts us consistent with what Cummins is doing on our diesel side as well.

We see -- frankly, the customers are not eager, as you might expect, to get into the new world of UREA and SCR systems, and extra tanks on trucks for different liquids, but they don't have a whole lot of alternatives even on the diesel side. I think people are just watching and waiting, as David has said. It doesn't appear to be the usual rush to avoid some of that headache with a big '09 diesel buy before that happens. I think people are just watching their pennies so carefully that they will just wait until 2010 comes and deal with it from there.

Okay. Thanks a lot. Just on the modeling side, just wanted to touch on the non-CWI margins. I would think we should assume this quarter, given the currency fluctuations, is a one-time thing and that 32.2% that should normalize a little bit.

Yes. Over the long term as we get -- depending what the Canadian dollar does, right. Just reiterate what happened last quarter was basically -- our inventories were purchased when the Canadian dollar was close to par. And then we were selling when the Canadian dollar was CAD1.20 to the US dollar, so you have a bit of an uptick right there. Going forward, depending on what you are modeling for exchange rate, you just want to be careful about it.

Okay. And then last thing, I will just touch on --

Eric, I should -- over the longer term, we would expect to see normal gross margins in the 30% range. Same as we've seen last quarter.

But we said before, we thought it might take a few quarters to get there, absent this currency help we got this quarter.

Okay. Thanks a lot. That's helpful. My last question is just on the Kenworth Australia announcement, if you could just update us, just on timing and target engine volumes for that.

Okay. That was pretty recent announcement about seven, eight weeks ago. We have already produced their first truck as a result of that agreement which we were excited about.

In terms of readiness for production, looking mid-year for production readiness. In terms of volumes, this is -- I talked about Kenworth North America, the volumes that they actually produce will be paced to new orders and firm backlogs. We don't have much visibility on that yet. But we could say that the volumes in Australia are -- it's obviously a smaller market than what we are looking at in the US. I think they do about 10,000 truck sales annually.

That's the total diesel annual new orders. We would be looking to start with some anchor tenant orders and then just start ramping up within that market over succeeding quarters. But really very little visibility on what might happen in the short term yet in Australia in terms of production.

Okay. Thanks for the update. I will jump back into line.

Thank you. The next question is from Jason Zandberg with PI Financial.

I wanted to ask you a question about Kenworth and this change in location for their manufacturing. You have touched on it a little bit earlier. I wanted to find out how that affects you in terms of your integration program, as well as your costs going forward.

As well as the costs you say?

Yes. Both integration and costs.

Okay. The reasons for the decision were simple North American truck market economic uncertainty, as Dave talked about his remarks. Kenworth found themselves with more production capacity than they had orders for.

They decided that Renton would be the place to shut. It was a coincidence that they planned to put their new LNG truck program there with us. But as I say, they pretty quickly decided to stay with the LNG truck program and move it to Mexicali.

In terms of the integration program effect, I would say not a dramatic effect -- just some transfer of engineering knowledge from Renton to Mexicali with the Kenmax staff. That's underway now. We do need to go through a couple prototype truck builds at Kenmax, as we had already done at Renton. I don't see any significant impacts on our ability to produce as a function of the pace of new demand. In terms of the costs, we don't have firm numbers yest, but I actually expect some help there for reasons you might expect which is Mexican labor is a little less expensive than labor in Renton, Washington. We think the truck price might come in a little less than what it might have.

We have a little help on shipping costs or transportation costs as well because we can now just drive the produced trucks across the border to the markets in southern California, which is only a couple of hours away from the plant. Whereas with the Renton deal, we are going to be spending more money getting the trucks into southern California.

Thanks.

Thank you. We have no more questions at this time. I would like to turn the meeting back to Mr. Seed.

Thank you, everyone. We look forward to seeing everybody on the year-end conference call.

Thank you. The conference has now ended. Please disconnect your lines at this time and we thank you for your participation.