Westport Fuel Systems Inc (WPRT) 2013 Q2 法說會逐字稿

Welcome to Westport Innovations 2013 second quarter financial results conference call and webcast. (Operator Instructions). At this time I would like to turn the conference over to Darren Seed, Vice President of Investor Relations and Communications. Please go ahead, sir.

Thank you and good afternoon. Welcome to our second quarter conference call for fiscal 2013. 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 statements yet, they can be found on Westport's website at www.westport.com.

Speaking on behalf of the Company will be Westport's Chief Executive Officer, David Demers and Westport's Chief Financial Officer, Bill Larkin. Attendance on this call is open to the public and to media, but for the sake of brevity, we are restricting questions to analysts.

You are reminded that certain statements made in this conference call, and our responses to various questions may constitute forward-looking statements within the meaning of U.S. and applicable Canadian securities law, and such forward-looking statements are made based on our current expectations and involve certain risks and uncertainties. Actual results may differ materially from those projected in the forward-looking statements.

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 and good afternoon everyone. As I said on our last call, 2013 is a transition for us as we see the rapid development of markets for natural gas in transportation. We are rapidly moving from our proof of concept and market creation phase of the last few years to full commercial operations with a broad product portfolio. As the numbers show we are seeing great progress in two key initiatives LNG trucks and the China market generally.

So truckings first. Launch of Cummins Westport's new ISX12 G is off to a good start this quarter, and with the higher ratings that are available this month we expect very strong growth in CWI with this new product over the next year. I think we have the right product at the right time to see a real break through that will establish LNG as major fuel for trucks around the world. We are still at the beginning in this market. We estimate we are at about 1% market penetration this year in LNG trucks. We will see a lot of new products entering the market over the next few years.

Later this year we will launch our Westport iCE PACK LNG tank system and, of course, the fully integrated next generation HDPI trucks will be coming from Volvo next year. Most analyst are calling for 5% to 20% market penetration in North American within five years assuming that infrastructure investment keeps up. But basic arithmetic tells us that even the low end of those numbers would yield great value for our shareholders, so we are pleased to say the start is behind us and we are confident in the growth trajectory over the next few years. We intend to continue to lead this industry with newtechnology and new products in partnership with the leading truck OEMs. China also continues on its spectacular growth with over 144% growth year over year so far in 2013 with our joint venture.

Our two other major market initiatives are first the light duty space particularly commercial fleet vehicles and Off-Road and in particular the rail opportunity. Our Westport WiNG products have established market leading positions for performance, quality and value in that light duty space with the merger with BAF and their product line in June we have a significant position in this marketplace and an attractive business model as we look at what we think significant global growth opportunity emerging over the next few years. Ford's announcement of the availability of CNG ready engines for the F-150 is just another example of how this is going mainstream. We believe we are positioned to deliver great products in this market. As we announced this afternoon we expect to begin shipping of the Westport WiNG F-150s in Q1 of 2014.

In Sweden uncertainty with the availability of government incentives slowed sales of our Volvo car business substantially in the first half of this year. But the recent announcement by the Swedish government that MGD credits will continue for three years has revived sales. The new V60 product has been very well received and in the short term this may mean some customers will wait for the new model, but I think the medium and long-term opportunity remains very promising. Our work with Ford and Volvo is under a long-term complete product business model where we sell an entire system, but we are also increasingly active in the light duty space with our Applied Technologies business where we supply components all the way and up to completely integrated systems to the OEMs.

The WP580 product announcement with GAZ this quarter. The system is also in development for Tata marks a new generation of price and performance of systems that are aimed at the light duty market. But in the not too distant future we expect a technology leap of gasoline direct injection engines become predominate around the world. We believe this offers an exciting new opportunity for natural gas, and we are working to launch next generation technology systems with key customers.

The third area I wanted to highlight is use of LNG in the rail industry. Interest continues to build in North American and around the world in this sector. We launch the LNG fuel Tender product this quarter first units will be going to CN Rail later this year. As you know we have been working with Caterpillar to develop locomotives and mining applications that use our HPDI technology for high performance and fuel economy that matches diesel. The programs are going well and we are seeing high commitment to building a LNG fuel distribution system that will be dedicated to these application and in particular the rail industry.

Now each of our joint ventures is position for great growth this year, and expecting more success in 2014 with products like the ISX12 G. We are in a position to capture our share of this emerging opportunity by leveraging our first mover advantage our technologies and our asset light business model. Our balance sheet has enabled us to continually invest in new products and innovative technologies that we believe will fundamentally change the transportation sector. As we launch new products and we shift our operation to support the newly emerging commercial businesses model, we expect the financial strength of our business will also become apparent. Look for operating profitability in our business units next year and continued profitable growth in 2015.

I will turn this over to Bill to go through some of the details.

Thank you, David, and good afternoon everyone. This year is a transition year for Westport as David has mentioned. But we continue to reiterate our expectations that our consolidated operating business units will all be generating positive cash flows by the end of 2014. Today our Applied Technologies business is generating positive cash flow. And we plan to launch new products that generate cash flow in each of our businesses.

Just to remind everyone about our asset light business model. We do not expect to make significant investments in facilities or equipment to support products we launch over the next few years. Also we expect our SG&A expense as a percentage of revenues to decrease overtime as we grow our businesses and top line. We expect the operating business units plus contributions from our joint venture interest to generate sufficient cash flow to cover our Corporate and Technology Investments by the end of 2015. We do have a few paths that can accelerate this time line by either managing the level of investment in new products and technology or increasing our revenues and contribution margin if we see an acceleration of the adoption of natural gas as a transportation fuel.

We are seeing a change in product mix with the launch of the Cummins Westport ISX12 G in trucking for which we have recognized the income stream only. We are negotiating supply agreements for Westport HPDI products in the China markets. There continues to be economic uncertainty in some of our key markets and the launch of the Volvo V60 is resulting in some customers deferring orders until the new model is delivered. As a result we are changing Westport's revenue outlook for 2013 this is excluding our joint venture revenues to $160 million to $180 million from the previous range of $180 million to $200 million.

Now moving on to our financial results for the quarter. So for the quarter ended June 30, 2013 our current quarter we reported consolidated revenue excluding our joint ventures revenue of $34.9 million compared $49.1 million in the prior year period. Our prior year period revenue included $14.1 million of service and other revenue including one time license revenue of $8 million. This is compared to $1.3 million this quarter.

As you may have noticed in our press release and regulatory filings we will no longer disclose unit break downs for our On-Road business due to competitive reasons. Our consolidated gross margin and gross margin percentage for the current quarter was $8.3 million and 23.8% compared to $23.1 million and 47% respectively in the prior year period. Prior year gross margin was positively impacted from the $14.1 million in service and other revenue earned at 100% gross margins. Research and Development expenses were $23.9 million for the current quarter an increase of $5.8 million from $18.1 million in the same period last year. The increase is primarily due to our investments in new proprietary technologies and long term product development in addition to our development agreement with global OEMs.

Selling and general administration expenses increased by $4.9 million to $20.9 million for the current quarter compared with $16 million in the prior year period. For the current quarter our net loss was $33.9 million or $0.61 loss per share compared with a net loss of $6.1 million or $0.11 loss per share in the prior year period. The increase in net loss is primarily due to reduction of service and other revenue, increased net investments in product development activities and higher operating costs to support facility expansion and resources globally along with our OEM development efforts. As of June 30, 2013, our cash and cash equivalent and short term investments balance was $135.3 million compared with $173.9 million at the end of March.

To wrap up here as new products launch and as critical mass begins to develop across our markets we expect revenue to become less volatile. We are reiterating our outlook for break even on EBITDA basis for our business units by the end of 2014 and for Westport by overall by 2015.

I will now pass the call back to the operator to open the call for questions. Operator.

Thank you. (Operator Instructions). The first question is from Laurence Alexander of Jefferies. Please go ahead.

Good afternoon. First question can you discuss a little bit the push back that you are seeing in order patterns. How are you seeing -- what is going to be the impact on the Volvo volumes in to next year? Are you going to get a bulge that will distort the first half of next year or is that getting pushed back?

You are talking Volvo car?

Yes.

It is one of these things where we really think there is strong market opportunity for each of these products, but there is always some short-term issues or challenges. In this case there was a lot of people waiting for that announcement of subsidies coming back. That was expected. But as we have talked before, people have this expectation that if it is coming there are not going to look stupid by buying a product when there is going to be a credit, so you immediately see that pause while people are waiting. Then we announce the V60.

A lot of people very excited about the V60 and they want to wait for that. So it is anyone's guess what the actual order patterns are. We need to get the volume up to the point where some of this stuff averages out. We want to get the product in to more markets than just Sweden, that is obviously going to have a big impact on smoothing the curve.

At this point it is so early that any small change in market sentiment is going to distort the number from quarter to quarter. So long term we think the product is going to grow in volumes substantially. And long term we think the quarter-to-quarter lumpiness is going to smooth out. But in the short-term you are going to see some ups and downs quarter-to-quarter. It is partly why we are not disclosing units by product this quarter.

I may as well flash that one out because I know it going to cause some concentration. But again part of this is because we think it is quite meaning less and at the same time it is giving pretty valuable competitive data out to specific markets. So what we want to do is try and aggregate some of these numbers to give people a little better indication in how to think about the future in a specific market and that is going to be based on the aggregate of a few products in a few markets so we can average some of this short term stuff out. Does that make sense, Laurence?

Yes. And then secondly on the cash burn, can you give a little more color on how you are thinking about that given the lumpiness in the business and if there is any risk for the 2015 target slipping and how Nancy might change that?

I will weigh in and Bill is itching to jump in too. I hope it is clear cash burn is down sequential. We expect cash burn to continue to decline for a bunch of reason partly as Bill says we are expecting more cash contribution from sales, what a great concept. Secondly, we have levers to pull on how much of our cash we are investing on our own. We know a lot of the our projects -- the quantum of projects we are working on is rising. There is lots of new project but a lot of these are being supported or fully funded by our partners.

So our cash burn from investments is also going to shrink as a percentage of new product development. So we are pretty confident that we are on track to do this. I wouldn't say we are going to have a completely smooth curve down to that cash flow break even, but we are comfortable the cash burn is dropping and that is going to come for good reasons that is more sales and more contribution to our expense line. Bill, do you want to elaborate?

I think if you look at where we are confident or comfortable with what we are communicating is we do see kind of a time line of where we are going to be launching these products (Inaudible). We have Volvo coming out next year which we have very high expectations plus several other new product launches. Which I think we have some visibility on what we think that revenue stream is going to be and the profit stream that is going to come from that.

As I mention we are not going to have to make significant investments in our facilities to produce and sell these products. We are going to be able to leverage our existing footprint while we continue to expand the top line which will drive all those earnings and margins down to the bottom line and help drive our cash flow to break even for all of our businesses.

Thank you.

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

Good afternoon. You mentioned a couple of reasons for the push out to revenue. on of which was the HPDI in China. I wanted to get a sense of what is going on there. Is that just timing of shipments or do you feel that there has been a delay in negotiations there?

Obviously we are not going to comment on negotiations or pricing or what is going on. I think it is a case we have always said there would be a handful of products going out in 2013 for early testing. We don't think that is going to happen in 2013 in any meaningful way. We still have units in the field for testing, but we are not going to see incremental revenues. So I do not think there is any change in the market sentiment. There is no change in the product plan. I think it is just a case of timing for when are actually going to launch and see revenue recognition in that market. So nothing to report other than that.

Okay. But based on the --

(Inaudible) because he is on the joint venture board. I think the point is if you look at what is going on in China which is very evident in the sales numbers and the growth numbers the demand for high performance trucks is very obviously this is going to be a very interesting market. Investment in infrastructure is well ahead of the investment rate even that we have seen in North American, and that has been going great. So I think the real challenge is getting the right long-term deals with everyone so that the distribution and support networks are ready for a major launch of the an important product.

Okay. But no end market demand issue there at all?

No, quite the contrary. We have seen a lot of the enthusiasm for it.

Okay, great. And then second question on the -- you talked about the 12-liter launching. It had a very strong launch and that may have pulled in some 15 liter or disrupted a little 15-liter shipments. But what is the long term demand profile you see for the 15 liter should that stabilize once the 12-liter is in the market or should that continue to be cannibalized by the 12-liter?

I will just reiterate what we have been saying for some time, really see the Class A truck market is going to need a wide range of products, different trucks, different engines to fit all the different segments that are in the market today. So there is no one size fits all product that anybody is going to see. We have been asked if we are going to see cannibalization of the 9-liter sales in CWI now that the 12-liter is out. Because as you know we have been pushing 9 liters into the bottom end of the Class A market.

I think what we are seeing in fact is that segment is going to continue and continue to grow and the 12-liter product is finding its own niche which really wasn't being properly served up until now. People were either buying 9 liters or 15 which weren't right. So the 12-liter market is substantial and I think it is going to do very well because it is available in a wide range of trucks, at a good price, good service. So that segment is going to do really well.

The heavy haul, long haul market is still above the 12-liter segment. So we might launch 400 horsepower with the higher torque rating this month, but there is still a segment above that. We think that is going to be served by HDPI products that Kenworth and Peterbilt are shipping today. It is also going to be served by the 13-liter Volvo HPDI products. There is going to be a range of products in that space as well.

I think the market demand for each of these segment is strong and going to get better, but the next generation products obviously benefit from better pricing, better services latest generation technology. The 15 as we have been saying for some time is now five years old, and it needs a refresh of hardware if it is going to be competitive for too much longer. I think people are recognizing that there is going to be a range of products that serves that product over the next few years too. Are we going to reinvest in it if the market demand is there and if our partners are there, of course, we will. But I think there is going to be a lot more in that segment two or three years from now too.

Okay. Thanks for the color.

Does that make sense, Rob? I realize it was lots of content.

That was perfect. Thank you.

The next question is from Ann Duignan of JPMorgan Chase & Co. Please go ahead. Morgan.

Hi, good evening. Just couple of follow-ups. You noted in the press release that part of the reason for lowering your revenue guidance was the delay in the (Inaudible) 12-liter, but why would that been in your revenue guidance? What am I missing? That was always part of the JV.

No, sorry Ann, that was how that came across. What we were saying is there was a delay in the expected production of the Weichai Westport 12-liter this is negotiating. It is going on right now for our products in China, for HPDI products in China. What we did say in the press release was that the product mix right now is heavily weighted to the Cummins Westport 12-liter, and to your point we don't recognize the revenue of that. Right now we have a strong product mix shipping 12-liter Cummins Westport engines where we recognize the income on our P&L but not the revenue. The change in revenue outlook to be clear was more about the pushing out our revenue in China and some other factors.

Okay. And just to be clear do you have a contract with Weichai for the HPDI or is this still in testing mode and they could turn around and say, yes , we like but it is too expense? Do we have a contract or too early to have a contract yet?

No, there is no contract with the joint venture yet. Obviously we had a contract to jointly develop the technology. We do not have a supply agreement where they say here is the price we pay for the components and here is the volume that we are going to deliver and that is what we are talking about.

Okay. Thank their clarification. And then on not releasing the heavy duty numbers anymore because of competitive reasons, I don't understand that. This was supposed to be your bread and butter. How are we supposed to figure out what the penetration rate is for the industry or how that business is doing? And I don't fully understand the competitive reasons since you really have had no competitors.

I think it is very broad product array that we are talking about here, Ann. If you look at the acquisition of BAF, we have all of our Ford products, we have all of the Volvo products and now we have all of the heavy duty product it just is not practical for us to breakdown units by product. What we are going to do and we haven't done it this quarter partly because we want to get your input on how we want to do this, is we do want to be able to show you unit shipments by segment, so whether that is LNG trucks in Class 8 or medium duty pickup trucks or something like that, that doesn't break out specific product units that does give I think you will agree, it does give very good competitive information in specific segments.

We do not want to be giving people our prices or margins by product that is just not realistic. So we are going to come up with some segmented disclosure that is more than we are doing. But frankly I think we give people a fairly transparent view of how these markets are going with the market segmentation data that we are disclosing and that should give people a pretty good idea of what is happening in the On-Road Systems business unit where these things fall, and we don't think there is a good reason for us to disclose product specific data. We don't see anybody in the industry that does that either. So we do want to come up with some aggregate numbers that make it easy for the financial community to do some modeling and expectation on things like market penetration, that is absolutely what we want to help you to do.

Well, we do get markets share data from Ward's on engine by class of engine. The HPDI I would argue is so important that, that would be important to give us at least units going forward.

We will take a look at how that gets disclosed.

Okay. And if I could sneak in one final one. Congratulations on hiring, I was going to say a female President and CEO, but I won't. I am just curious on Nancy's role when she takes over operations. Will she be given the scope and the responsibility to look at the strategic rational for some of Westport businesses or is she simply going to be responsible for making the best of what she is handed? And would she be able to look at why are we building components in Italy. Would she have the breadth and the scope to really look at the fundamentals of the manufacturing footprint and make recommendations?

That is exactly why she has jumped in, Ann. And you will be meeting her soon I'm sure so you can ask her that. I think she has a very broad scope. She has a great career in the automotive business. And I think she is pretty excited to be rolling up her sleeves and diving into it. That is exactly what it is about is how do we pull together all these different partners and suppliers and how do we optimize our own operational commitments to this in conjunction with our partners so that we really do something pretty interesting. So I think Nancy background and experience is exactly what we need at this time in our development and we are really exciting that she has decided to jump in.

I agree. I will leave it there. Thanks very much.

The next question is from Jerry Revich of Goldman Sachs . Please go ahead.

Good evening. This is [Rob McGill] on for Jerry. Can you say more about the warranty issues you are having on the 15-liter product? You have spoken before about being able to reducing the instant rates, so can you just expand on the issues that you recently had with that product what is driving the issues?

We are not going to get into specific details on here but very similar to what we experience in the CWI business we have a process that we have to go through our warranty experience and ultimately how does that translates into our accrual, so we have a very rigour process we go through on each quarterly basis. So through that process based on the warranty experience we had to go through and make an adjustment to our warranty which ultimately impacted our margins for the On-Road business.

It is a broad array just based on how these trucks are used their application very similar to what we are seeing in CWI. As we have talked about before the engine was originally designed for (Inaudible) transient and it is being put into other applications. And we are seeing some challenges based on that warranty experience we have had to increase our accrual. It is just a very similar process that we go through on our 15-liter, so it is nothing very specific that is driving that increase in the warranty provision.

Okay. Just on cash again, can you frame for us in this way your view of minimum month of cash you would like to have on hand just so we gauge how much you need to turn back R&D or at what point you think you would want to go to the market for capital?

As we sit here today and we look at our business plans going forward and we reiterated that we expect to be cash flow positive by the end of 2014 I think we have sufficient cash to fund our operations and we do have some levers to dial back that cash burn through reducing our investments in new programs or on the flip side is if we start seeing significant adoption or acceleration adoption of this technology we see opportunities to increase our cash flow. As we talked about we have several products we are going to be launching over the next 12 months which will ultimately be generating cash flows which will help fund the business going forward. I don't think there is any specific number. We continue to sit down every day or at least monthly and go through what our cash burn rate is and what do we see coming down the pipeline and adjust the accordingly if we need to.

You have some pretty strong income streams coming from the joint ventures, Robbie, which also help offset a fair amount of capital burn and usage there too.

Lastly, when do you expect to be able to utilize the Cummins facility, and wanted to know to what extent is your 2014 free cash flow target for the business unit how much that is driven by being able to leverage the Jamestown facility?

I don't think at the moment Robbie, we are talking the 12-liter Cummins Westport is built in the Jamestown expected to be built in the Jamestown facility. In terms of the 15-liter products that we had previously commented several quarters ago that there is an opportunity to do some production there at certain volumes and certain numbers were set. I think we just got at the right strategy now which is we will make sure we right size the production capacity for the product demand and as our belief the market is going to a vertically integrated solution we are obviously going to continue to push for a more vertical integrated solution with that whether it is in Jamestown or some other solution.

Okay. Thank you.

Next question is from Sanjay Shrestha of Lazard Capital Markets. Please go ahead.

Thank you. Good afternoon. Couple of questions here, first on Volvo 13-liter can you give us an update on the launch timing and any general uptick occurring there.

Probably not. Probably back half of 2014.

Would be a realistic expectation, Sanjay. Ultimately it is Volvo's call when you get this close to product launch, but they are not sharing the exact quarter they are launching it. The new launch will be very similar to ISX12 it is going to be slow graduated launch of the product into the market.

Fair enough. Along those lines. In terms of any incremental update you can share with us about the LNG tank opportunity, new customers, what sort of traction you are getting in the market, can you talk about that a bit more.

You are talking about the iCE PACK ?

Correct.

Actually very interesting. I think we started to talk about cold LNG and the need to really deal with the fuel demand from these bigger engines it has people really focus on this whole issue and the demand is really good. I think the surprise to a lot of fleets has been the complexity let's say of rolling out LNG. I think everyone just assumes that it is just another liquid. There are things to learn, there are handling differences, there are metering challenge there are all kinds of things to learn. So we have been rolling out quite a bit of training and showing people and bringing them up to speed on what these issues are.

I think once we through that people are quite enthused because it is very clear here is how we can make money at this. But the idea of cold LNG is creating a lot of value both from the people building infrastructure and from customers that are sorting how they maximize their range and performance. I think the product has been very well received. We are in testing mode. We are taking advantage of the fact that these are components that have been well tested in previous programs, but we have to get some miles on and some accelerated testing. We will be launching it later this year, but I think demand is going to be really good.

Okay, great. One final question from me. Obviously the 12-liter is going well and you have multiple things happening (Inaudible) looks like it is going to expand pretty rapidly and maybe (Inaudible) margins get better. When you talk about that EBITDA break even by 2014, right. On a very high level what is your general expectation, what are you thinking about on the 12-liter Cummins JV side, Weichai JV side and margin targets. Can you give us a big picture view of how do you sort the puts and take of getting to the EBITDA break by the end of 2014?

When we talked about EBITDA break in 2014 that is from our operating business, that is Applied Technologies, the On-Road business and we will start seeing some revenues from our Off-Road business (Inaudible) LNG Tender cars. When we talk about that, that is our current core businesses. We are going to expect our Applied Technologies business continue grow its top line. We expect to see increases from our existing Ford products or Volvo products as David talked about. We think based on how we look at the future we think we are going to see enough growth in these businesses where they are going to start to continue to leverage there existing footprint into there existing capacity that we are going to see sufficient cash flows from those business falling to the bottom line.

I will jump in on that because it is obviously a very live issue. And from a history view point what we talk internally in, what you can all see, is we went through this with Cummins Westport. It is still branded on a lot of people's memory. It took us sometime, it was not just the early market. The first products out Cummins Westport were transit buses and we weren't able to make a profitable business just on transient bus. But the second product (Inaudible) truck engine we were able to get enough critical mass that business has become profitability and continuing to be profitable ever since, funding all its own growth, funding its new R&D. Now we are in the trucking market based on that early discipline of getting that very early market segment to the point it where it was cash and break even and then generating cash.

We are trying to replicate that in each segment. As Bill said pretty carefully it is because we are focusing each of our management groups on individually getting to be healthy businesses, and that is we want the Applied Technologies funding its own R&D from cash flow. And we want the On-Road business to get going. It has lots of products none of which are really at the level we think is maturity, but it is moving long it is getting there. We are going to build that critical mass and get it to the point where it is going to be generating a lot of cash and doing very well, and then we expect the financial leverage to really kick in.

That is how we are going to do it. We are trying to be very disciplined about these individual businesses making sense and we will prune back where we need to and we will invest heavily where we see opportunities for short-term growth so this isn't a static thing. But we do think all of our business now have the opportunity to move out of this R&D stage to be commercial businesses and we intend to do that in the near term.

Now obviously break even is not success. What we want to do is generate really striking financial performance using this business model and on the back of this idea that natural gas is going to get some meaningful market penetration in big markets. I think everybody has their sights on two, three, five years out here's what the strategy should let us deliver. We are only going to get there if we push on quarter-to-quarter doing the things we need to do. Hopefully you see this year the evidence of that work and we will start to see returns very soon.

Good stuff. Thank you guys.

Next question is from Vishal Shah of Deutsche Bank. Please go ahead.

This is Susie Min in for Vishal Shah. Thank for taking the question. I wanted to get a little bit more detail on the 15-liter. I know you said you were not going to disclose volumes, but I think last quarter you had mentioned that you were expecting to at least exceed the 2012 levels. So I wanted to get a sense of how that is tracking and as you look towards the end of the year and then how On-Road revenue shape up in terms of the 15-liter as well as some of your other products and then would love to hear about your recent acquisition BAF Technologies Servo and how that fits into that. Sorry it is a bit of a long question.

I think short answer that is partly why we are not giving forward looking numbers on the 15 so we are not giving forward looking numbers on the 15. The real issue here is we think you have to look at what is happening in Class A trucks. We expect we are going to see revenue from iCE PACK which is a product that is targeted at 12-liter customers and the 15 is only available in Kenworth and Peterbilt. Peterbilt and Kenworth have also been launch partners for the 12-liter. Honestly we are quite indifferent at our, Bill and my, level whether it is a sale of Kenworth and Peterbilt with a 12-liter engine with an iCE PACK or a 15-liter system.

They really we are quite -- we are quite indifferent it is whatever the customer makes sense. I think we are going to sell more 12-liter with iCE PACK than we are 15. I think that is inevitable. Whether the number is meaningful or not should not make any difference we are going to see both the On-Road business and Cummins Westport benefit from the sell of LNG trucks. 15-liter products we keep saying is now five years old, and we have been saying for some time it is going to need a reinvestment at some point to give it another five years of life and whether we do that or Packard does that or Cummins does that someone is going to have to make that expense and we think there is lots of opportunities in the Class A market to invest in new truck and engines products. It is one that is on the list, but it certainly not something that is certain. We will play that out as it plays out in the marketplace and depending on what customers tell us they think they want to do.

Okay. And is it relates to the BAF Technologies and your acquisition how should we think about the Ford products and how that fits in to your entire mix for On-Road ?

The Ford business is obviously a core part of the On-Road business. We are working with other OEM with other business models as we have said there is a long list of names. The Ford business and the QVM program has been very successful in North America. I think Ford is quite satisfied with how it is working and of course, we investing heavily in that process and we think it is going to be a strong business. The decision to put our business and BAF together is something we have been talking to Clean Energy for some time.

It is no secret that Clean wants to focus on fuel and building out infrastructure and selling fuel and our expertise is engineering and vehicles and technology, so we think this makes a lot of sense and obviously there is going to be some synergies between the two operations and there is going to be some product line changes and we are going to apply our own procedure and technology so that product line will likely shift over the next 12 to 18 months. But directionally I think it give us some critical mass and I think a very successful business where we can collaborate with Ford to our mutual benefit. I hope that makes sense.

Yes. Okay, great. Thank you.

The next question is from Eric Stine of Craig-Hallum Capital Group. Please go ahead.

Thanks for taking the question. Maybe I can go back to one of the earlier questions and, David, you just mention it the product refresh for the HD system. I know for some time you have been talking about or working on right sizing the after treatment portion of it based on using 5% diesel instead of needing the whole system. Wondering where you stand on that. And then second part it is going to be hard to track going forward but where you stand in the cost reduction strategy.

Cost reduction strategy on that product. Big part of cost reduction strategy would be working with Kenworth and Peterbilt on just the straight logistics. As you know because you have seen it, it is a hand built engine today. We take an engine from Cummins in New York we ship it across the continent to Vancouver where we strip it down and put it back together and the we ship it to the Packard plant. So there is a bunch of rationalization opportunity but that would require investment in infrastructure and investment in product and doing some product engineering. And at this point the volumes are such that we are doing just fine with it the way it is.

To take it to the next level we would want to reengineering and to take it to the next level we would want to change the production strategy. So the real question is working with our partners at Packard frankly what do you want to do. And right now everybody is focused on launching the 12-liter. I think that was the right the choice of resources and the right place to invest our mutual time and energy. So we put a lot of engineering and time and work in getting those products out the door getting iCE PACK out the door. We are quite enthused about that opportunity.

15 is what it is. It is priced where it is. We have customers who are buying it. It is quite successful. Obviously we got a lot of benefit of getting those miles in the field getting the support and feedback from those customers. But we also have product from (Inaudible) coming up real soon now, so there is going to be competition for it. Those are all factors that go in the product planning process with all of our OEM partners and as much as we would like to do everything there are going to be choices to be made where we want to put our investment.

I think it is also no secret we have said over the next few years we think all of the OEMs are going to need vertically integrated product in their own product line and natural gas strategies for everybody are under examination, that is no secret. And we are working with a lot of different OEMs on those strategies. We just can't comment on what people are up to or what their investment priority is.

Last line I would give you I am looking at Bill as we have said quite clearly we don't think it is our place necessary to fund all the R&D for other people's products going forward. So our priority are deals like we have done with Volvo and Caterpillar where the product development expenses are being covered by our OEM partners. Put all that together I hope you have a very clear idea on where we are going.

I think in general, Eric, our costs are coming down. What we have said publicly too is our current HPDI system sale price is in the $45,000 and $50,000 range, and obviously we expect that number next year to be much lower on a different OEM as result of vertical integration and new generation and cost reduction activities. So there is no doubt prices are coming down call it pay back periods are improving. There is no doubt that is on track for the next 12 months.

Okay. That is helpful. And maybe this is not a number I know you have been asked this a few times, but just as far as volumes for the ISX12 G is that a high level kind of number just to know. I mean that was a big CWI number and I would think the 12-liter is a nice portion of that.

No, actually to give CWI credit this was the launch quarter and the 12 was not a material part of those numbers. It will be going forward. I think everybody has very strong expectations for that product. It will be the strongest product CWI has ever launched by a long shot. But no the core business is strong. The 12-liter engine got launched but I hope -- we are not lying when we said it was a constrained launch. It was small volume and we are getting a rolling start last quarter. First production was really March, April this isn't all that recent and we are just picking up with new ratings this August. By the end of the year we will at what we expect to be a commercial run rate capacity but that will higher than where we are at today. I am pretty optimistic going forward that we will see some strong growth in CWI with that product just because the demand is so high.

Okay. Just last one for me. So locomotive just curious how you think and I know this plays out over many years, but how you think this develops?. Do you think it is CN or BNSF that they do it and lead the market or do you think because the market is so interconnected it has to be on the seven Class 1 railroads that they have to do it together? Thank as lot.

Good question. As we got started on this and the first concept discussions with CN, as they have been working with us on a FTTC project for some time. It was a concept of a walled garden. You would have to have a corridor on LNG part of the business that was walled off because the railway do share all their hardware. So it has been really interesting to see that everyone is collaborating and getting together to rollout LNG across the system.

So, no. It's not going to be an overnight switch from diesel to LNG but I think it's going to come much more rapidly than people think. The economics are just so compelling and the opportunity to the rail industry to drop their operating cost so substantially. Frankly it's not as if we are talking about millions of units. We would have to change few thousand locomotors and build a few thousand tenders, but it's nowhere near the capital investments that we have been talking about in the trucking industry and the mini thousands of fleets and actors that we would have to get engaged to turnover the entire trucking industry. So, no, I think the real industries is very engaged in doing a rapid adoption of LNG across the system and that's very exciting. There is just nothing to report.

Okay. Thanks.

Next question is from Colin Rusch of Northland Capital Markets. Please go ahead.

It is Northland Capital Markets. Could you guys just talk about your working capital needs. You are launching a number of products. How much do you think you are going to need to grow working capital and how far along are you in establishing and working or the credit lines that you will need to support that?

Well, as we mentioned out, just talked earlier, we are an asset like business model. If you look at the CWI business they don't carry any inventory. So as they ramping up. They don't consume working capital. As we launched future products, we are working with suppliers and I don't foresee where we need to invest heavily in working capital to support the launch of lot of these products because we aren't physically building a lot of the components ourselves. So I don't perceive where we need to go and get discrete capital to go fund the working capital for the launch of these products in the future?

And just so I am clear, it sounded like, you said, particularly that you don't think you are going to need an additional capital to lead to the break even point. Did I hear that correctly?

Correct.

Okay, great, and then can you just give us a quick update on the marine opportunities and where you at with the development with those guys?

Yes, lots of talk in the marine industry. As you know, there has been LNG ships for quite a long time and those big low speed engines, it's pretty easy to build an engine that will run on LNG on that speed. It's more shifting that uses more of the engine types that you see in trucks and buses and offer an equipment that would see a real benefit for the technologies that we are talking about. I would say a very clear interest, particularly for things like tugboats and river and coastal shipping. the people who make engines for that market are all the same people that we know. So it's another very promising opportunity and products will need to be developed for that segment and as and when they are ready for announcement, you will be the first to know.

All right. So nothing really concrete. Just a lot more discussion, just to sum it up.

Nothing we can tell you.

Okay. Perfect. Thanks a lot guys.

Next question is from Matthew Blair of Macquarie.

Hi, good afternoon. David, on these new hours of service restrictions in U.S. trucking, do you think this is going to be a headwind for natural gas adoption because of lower utilization of the trucks? Or do you think it actually might help because range concerns would be reduced? Any thoughts here.

Actually, I think it's a bit the other way around. Certainly, what we are seeing from our fleets is that that's helping people to get more hours on the trucks because they are going with multiple drivers. So people are going fixed routes and home but that allows the truck to have a driver jump into the seat and keep it going. So most fleets are trying to up their utilization rates on the hardware while they drop their hours of service on the drivers.

So what we are seeing is a trend in the industry or at least in some of the leading fleets to put more miles on their trucks per year which is a great incentive to move to natural gas because as you know it's all about pay back on the mileage. So little mileage trucks or low hour trucks are not good candidates for natural gas. As the industry goes to higher hours on the hardware those are the places you are going to see natural gas adopted first.

So I think all of these issues are going to affect the overall business but you just can't argue with the economics of going with the cheaper fuel. So it's a question of who and where can we match up the infrastructure and the hardware with the economic need and that's what we are doing today.

Okay, thanks. Then, Bill, on the service revenue, given that it comes through your results as such a high margin line item, could you talk about your outlook here over the next couple of quarters as well as into 2014 and then could you also confirm the 2Q service payment. Was that from Volvo?

The two key Volvo payment.

We have multiple development agreements and the timing of that service revenue and the related accounting because really it's the accounting that's dictating on how we recognize revenue on each of these development programs which frankly is their difference. So, historically, we haven't given any guidance on what we think service revenue is going to be just because it could fluctuate from quarter-to-quarter, just depending on for using percentage of completion or for using milestone for accounting.

Well, that's sad. I think in the press release you can dig out a note that's says we have accrued. It's roughly $6 million this quarter. It is going to be refundable and that will get paid. I am reasonably confident at a milestone payment in the future, but we can't tell when or where because that's pretty confidential. It will be when it happens. But it wouldn't hurt to take $6 million and build it into the burn rate this quarter as there is a $6 million refundable that's going to come because that is really what's going on here.

We are trying to get our accounting lining up with our contractual process going forward because it really would make a lot more sense for us to accrue these expenses and get paid on a more regular basis but that really requires specific language in the contract to meet the accounting standard. So Bill is helping guide our corporate development guys on how to raise your contracts.

Okay, and then just to clarify, is the $6 million the total accrued service income that is yet to be paid out or is that just what was?

I will be careful. It is not this quarter. What we noted was that there is $6 million of expense that is expensed this quarter that we expect to be recoverable in the future. So yes, it creates for lumpy quarter-to-quarter financials that are hard to predict but again overall these programs we will see our R&D expenses refunded.

Okay. Thank you very much.

The next question is from Alex Potter of Piper Jaffray. Please go ahead.

Hi. I am going to ask another question on the 15 and I know you are probably sick of hearing it but I was looking over some of my notes and through some the old transcripts from multiple-multiple quarters ago and the tone on the 15 seems to have changed quite materially. Put yourself two years ago looking forward to today, would you say that the 15 or the HPDI has not met expectations?

No, I am not going to say that. The whole point of the 15 was to demonstrate that natural gas works in trucking. So I think it's been resounding success of that. I mean, remember when we launched this five years ago at the port in Los Angeles, it was a heavily subsidized environmental program, which was the first time people used LNG in truck. So that was step one and it was only five years ago. Then we agreed with Kenworth and Peterbilt that there were some customers outside the port that we can offer the product to but it was still the hand built product and that was 2010, 2011.

So that's what got us customers like Vedder Transport and UPS and Hackmann and that's been a tremendous experience. I think if you talked to any of those fleets, they would say, it's been a huge success at building awareness with LNG but I don't think we have ever said it was the last product to be held in the market or that it would meet all the needs of everybody. We are going to need a whole range of truck products, trucks and engines to meet the needs of this entire segment.

And I also think it's not fair to say that we have said that it's going to continue unchanged. Every product in this industry needs continuous reinvestment just to meet the ignition standards. So companies are always looking at where they put their R&D investment and this is not something that we can do our own because there are so many people involved in this specific product.

As the market opportunities expanded, we got way more places to look at where we are going to put our investment dollars as well. It used to be this was the product for LNG trucks but now we are spread across many different OEMs and many different platforms. Going forward, I think what we hope you got out today and what I hope I can pound home now, there is going to be a whole range of engines and truck products hit the market over the next five years.

That's a prediction, not some sort of disclosure. We are going to see every manufacture of trucks have to a product or they are going to lose market share. It's as simple as that. So that's the context that we are in now. I think we can declare victory on LNG and trucking. It's going to take a significant part of the market and now we need to let all the product planners and those different truck companies come up with what they are going to do to grab their share of the industry but the 15 liter product is what it is today and we are continuing to sell it and customers continue to buy it. I don't think we need to really get into a lot more detail in that.

Okay, fair enough and then, last question here. Again on the guidance, $20 million cut on the top and bottom line. Just wondering if you can get in a little bit to the puts and takes there. Presumably you are going to get some positive contribution from BAF that was not included in the original guidance that you gave last quarter. So is it fair to say that that's reflected in this guidance or is BAF excluded from it? Is it apples-to-apples or it there actually a bigger revenue cut than what it seem like that?

Well, I just want to jump in. We didn't see we changed bottom line. In fact, we are reiterating that the bottom line isn't changing. Part of this is product mix and part of this is, we will see revenue from a product like the 12 liter where we don't recognize revenues but we are going to see our contribution. So what we are seeing is the Westport revenue guidance we are taking down.

On BAF, yes, there hasn't been any guidance for sometimes. As I said, this is been in works for a while. So when we gave you revenue guidance for Westport, there wasn't allowance in there for BAF. So what we are taking down I think just what we said today is that we are pushing out revenue for shipments into China because that might going to happen this year, some of the product mix in some of the markets just because at the half, we are considerably behind on some of those specific markets like Volvo cars. So we are trying to give you the outlook but it's no big magic.

Okay, that's fair enough. I guess just the main takeaway there is that BAF, even though the announcement hadn't been or I guess the acquisition hasn't been announced, it was already included in the original guidance that you gave last quarter.

That is correct.

Okay. Thank you.

The next question is from John Quealy of Canaccord Genuity. Go ahead.

Hi, thanks guys. Real quick, if we can go to the light-duty side and I know you guys hate talking about legislative initiatives but last week an interesting bill was introduced in the senate to remove the cap on CAFE bonus credits. Who knows if it happens? But if it does it feels like the type of legislation that could make a late duty OEM really turn towards flex-fuel. Can you just editorialize on that for me? Thanks.

You're quite right. We have been concerned about consumer level subsidies because they are so difficult to manage. My rants about what's been happening in Sweden, I think, is reflecting that. It gets we get so distorting and so unpredictable that we have rather just deal with getting the product economically successful on it's own. But on things like CAFE rules and emission rules those are binary. The market must respond to those rules and if there is a tweak to the regulation that encourages OEMs to adopt natural gas, that's very powerful. It really would be.

And that's quite transparent at the consumer level. So that's doesn't have the same distorting effect. It has a much more long-term product planning effect. So we are agnostic on that. I can tell you we don't have big lobbying budget. So we are not in there really trying to push to dial on any of these initiatives, one way or the other. I think we need to let the regulators decide where their interest are and what they want to encourage.

I think it is clear, more and more, that people are seeing that natural gas is in the interest of many national governments, not just the U.S. government. Certainly lot of the state governments are encouraging the development of their natural gas resources. Those incentives, we think, are very pragmatic and practical and are less likely to be yo-yoing in consumer preference up or down, one way or the other. So we let that process play out. We are not counting on anything like that. I think in general, the OEMs are seeing market demand from their customers and that's probably the healthiest thing that we can hope for.

Thank you.

The next question is from Pavel Molchanov of Raymond James. Please go ahead.

Thanks for taking the question. Back to your comments about Ford. You are obviously excited about the F-150. How have the 250 and the 350 gone, I guess in the year or so that you have been selling into that market? And then secondly, I think the 450 and the 550 were in the works for this year. So if you could give an update on that as well?

Yes. 450 and 550 are just starting to ship and we are ready to go with the new Super Duty trucks for 2014 as well. So, no, I think market demand has been good. I think everyone is excited about the F-150. That's been something that we have had lot of request for and we are very pleased that Ford is adding that to the QBM program, because I think there is a lot's of people who want to buy a truck that they can drive on gasoline or natural gas and we would have a lot of customers talk about using it as an employee purchase option and use corporate refueling. F-250, F-350 are big trucks aimed at fleet use and the F-150 is a product that is very popular in a whole different range of markets. So we think it's going to incremental sales and we think it's going to be very successful as a QBM product.

And on the F-150, is there a geographic footprint where Ford is going to rollout first? Is it a mainly North America or it's going to go global right away?

It's North America. QBM is a North American program. We are announcing that it's available in both the U.S. and Canada at the same time. We are just going to start shipping products in Canada this quarter. So F-150 will be available anywhere Ford sells product in North America.

All right. Appreciate it guys.

This concludes the time allotted for questions on today's call. I will now turn the call back over to Darren Seed for closing comments.

Thanks very much everyone for joining the call, and we look forward to seeing everyone around the end of October, early November for the Q3 conference call.

Ladies and gentlemen, the conference is now concluded and you may disconnect your telephones. Thank you for joining and have a pleasant day. Good bye.