Westport Fuel Systems Inc (WPRT) 2013 Q3 法說會逐字稿

Thank you for standing by. This is the chorus call conference operator. Welcome to the Westport Innovations Inc 2013 third-quarter financial results conference call and webcast.

(Operator Instructions)

The conference is being recorded.

(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.

Thank you good afternoon. Welcome to our third-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 have not 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 at this call is open to the public and to media but for the sake of brevity we are restricting questions to analysts.

Your reminded that certain statements made in this conference call and the responses to various questions may constitute forward-looking statements within the meaning of US and applicable Canadian securities laws. 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, and thank you for your interest and support of Westport.

2013 is an exciting transition year for us as markets for natural gas vehicles are shifting rapidly into a high-growth phase. We're shifting our business focus and our operating portfolio from our proof of concept phase into our OEM model. We're also going to see the transition from our investment phase into sales and profits. To help you understand our trajectory, I'll run through some of the highlights of our current product scope, our market penetration expectations in key markets, our path to profitability and then targeted investments from our recent financing transactions.

As you can see from the press release, Q3 was a strong quarter with growth in both our joint venture businesses and in the Westport product businesses. We are up over 50% year over year in revenue for the quarter for Westport, CWI was up 70%, Weichai Westport was up 95%. Now as we rebalance our product portfolio, Cummins Westport's new ISX12 G is off to a great start this year. With the higher ratings that began to ship in August, we expect very strong growth in CWI and with this new product of the next few years. As more fleets adopt natural gas, this is all going to support rapid investment in refueling infrastructure.

On the refueling topic the launch of our Westport iCE PACK LNG Tank system is off to a great start with an order for 900 units over two years from universal LNG, as we announced this morning. I am sure most of you figured out that the engine in those vehicles will be a Cummins Westport ISX12 G, so it's an equally positive announcement for us on that front too. With the supply in iCE PACKs to our OEM customers, we're planning the launch of the 13-liter Volvo product with Westport HPDI for next year. Our stated long-term business model is to work with OEMs and their supply chains to deliver Westport content to the market. This gives both Westport and our partners are relatively capital-light and low-cost product development path, since we share much of the development and production cost over their current diesel product line. The proof of how this model works is clear with our two engine joint ventures. Although the joint venture structure is not an essential thing going forward, you can clearly see that Westport and our partners have been able to launch a series of new products with almost no new capital investment and with relatively low development cost.

As the markets for natural gas vehicles are in their infancy today, we expect that many more products are going to be launched over the next decade. This proven model maximizes returns and minimizes the risks to the [empire higher] value chain. Now as we said, we are currently working with a number of new OEMs to explore how natural gas versions of their current and future product lines could be of high strategic importance to them. We're moving quickly into specific product development programs with these customers. And as we announced last month, we expect to be able to disclose one to three new OEM relationships in the heavy-duty space over the next year.

On rebalancing our product portfolio to support this OEM production model, we will be transitioning our up-fit products to a combination of vertically-integrated products with our OEM partners and after-market kitting options using proven Westport technology and components. For example, the current generation of HPDI, which is on the Westport 15-liter engine, we still assemble that in Vancouver using an up-fit process. As we shift to OEM HPDI products we have agreed with Kenworth and Peterbilt that the last day for orders for the 2013 certification of the 15-liter engine is going to be November 15, 2013. Westport is going to continue to offer an HPDI solution for Australia in concert with Westport's fueling partners for the foreseeable future.

Westport is obviously going to try and deliver the best customer experience, and we are committed to the continuation of class-leading support for all of our customers. In 2014 we are going to leverage the service and support activities of our US operations to take advantage of logistics and to better support this US base. We are going to be unveiling what we call HPDI 2.0, the architecture for heavy-duty engines over the next few weeks. We've re-engineered the entire system to make it manufacturable, scalable, applicable to a broad variety of engines. And perhaps most importantly, we expect to see a dramatic decrease in system cost. As we have seen, there is a consensus developing around the world that natural gas is a desirable fuel for high fuel-use applications. Obviously trucking is the first example of that, but rail, marine and mining we've been talking about the last year or so.

In trucking we're still the very beginning stages, although it's quite clear that growth is underway. In 2012 we saw less than 1% market penetration for gas, we think it was about 0.75%, to be exact. So that's of the new classic truck shift in the US and Canada, under 1% were natural gas last year. We're out looking about 1.5% this year and of course Cummins Westport and Westport are about 100% share of the engines in those trucks. Westport and others share the off-ending components. But next year most people, and we concur, expect that the truck market is going to go to 4% to 5% natural gas.

On a base of 200,000 new trucks in Canada and the US, that's a significant shift in energy use. And over the next five years industry analysts are calling for 10% to 20 % market penetration in North America. Assuming that infrastructure investment keeps up, basic arithmetic tells us that even the low end of those numbers is going to yield great value for our shareholders. We believe the same pattern is now playing out in Asia and Europe and we're positioning Westport to take advantage of this opportunity. And then of course, we want to replicate that in other markets like rail and mining.

As you saw at the end of the third quarter, Westport strengthened our balance sheet to support specific investment opportunities. And we increased our future product portfolio and to maintain key components and equipment within the natural gas supply chain. To support the introduction of HPDI 2.0 components, we've developed relationships with several global supply partners, all of whom are going to be able to deliver us the scalable production we will need as this global market develops. We have allocated $40 million to $50 million, which will be spent over the next two years to invest in dedicated Westport equipment and tooling to be located within our production partners' facilities. This allows us to control our IP for some of the critical system elements, ensure that we have full understanding control of critical processes, and of course this investment will help reduce cost and increase quality.

We have also allocated $20 million to $40 million to support specific product development programs with new truck OEMs and this will be spent over the next three years. We do not expect this to increase our burn rate. Simply put, we expect programs that are now in the R&D phase will move into commercialization and as these new programs come in to development, we will be phasing old programs out. So we expect that the overall cash burn rate is not going to change significantly.

We announced a new program a few weeks ago that are targeting automotive OEM partners. We expect a number of automotive OEMs to be interested in this. Were going to develop a direct injection natural gas system that's going to align with the industry's introduction of direct injection gasoline engines. Direct injection of gasoline, of course, is delivering great improvement in performance and fuel economy. We believe this is going to be the future of natural gas as well, and direct injection natural gas will offer equivalent benefits. Finally, we are seeing a lot of interest in the use of LNG a fuel for marine vessels, so as part of the offering that we did the end of September, as you can see, we're allocating $20 million to $40 million to support product development in this area with our OEM partners.

Now Bill is going to take you through the numbers and lay out our path to profitability, but as you can see from the press release, I think we have laid out our trajectory quite clearly. We've established a meaningful scorecard that is going to let you track this path to profitability. The industry, I think, is growing beyond many, many people's expectations. I firmly believe that we and our shareholders are in the right place to take advantage of this new opportunity. So thank you again for your support and interest and I'll turn the call over to Bill.

Thanks, David, and good afternoon everyone. I'll begin with a brief overview our third-quarter results.

For the quarter ended September 30, 2013 we recorded a consolidated revenue, this is excluding our joint venture revenue of $46.5 million, compared to $30.7 million in the prior-year period, a 51% increase. Segment revenue for the quarter was $20.3 million for applied technologies, $17.8 million for on-road systems, $8.4 million for corporate and technology investments, $77.5 million for CWI, and $114.6 million for Weichai Westport, our joint venture. Our consolidated gross margin and gross margin percents for the third quarter $16 million and 34.4%, compared with $7.8 million and 25.4%, respectively in the prior-year period. The third quarter's gross margin was positively impacted by $9.9 million in service and other revenue earned at 100% gross margin.

Research and development expenses were $23.5 million for the third quarter, an increase of $7.1 million from $16.4 million in the same period last year. This increase is primarily due to our investments in new proprietary technologies and long-term product development, in addition to our development agreements with Volvo, Tata, GM and other OEMs, which are recorded in our corporate and technology investment segments. Selling, general and administrative expenses increased by $3.1 million to $19.4 million for the third quarter compared with $16.3 million in the prior-year period. For the third quarter of 2013 our net loss was $30.2 million or a $0.53 loss per share, compared with a net loss of $32.5 million or a $0.59 loss per share in the prior year period. Including the third-quarter net loss of $1.3 million net foreign exchange loss compared to a net foreign exchange loss of $7.4 million in the prior-year period. Mainly attributed to the movement of the Canadian dollar relative to the US dollar, which is unrealized. Excluding this impact, our consolidated net loss and net loss per share for the third quarter were $28.9 million and a $0.51 loss per share, respectively.

As of September 30, 2013, our cash, cash equivalents and short-term investments balance was $89.3 million compared to $135.3 million at June 30, 2013. On October 1 we closed our offering of 6 million common shares in the United States and Canada, and our cash balance after closing was $237.5 million. During the third quarter we used $46 million in cash, which included $12.4 million in debt repayments. Excluding these payments, cash use in the third quarter was $33.6 million. Also for the third quarter, our consolidated adjusted EBITDA loss was $19.5 million.

I'll come back in a minute to discuss the segment's financial [fine points], so let's pause and put this quarter's loss in context of our business in the path to profitability. We have been describing the Westport financial plan and our path from our current heavy investment phase to overall cash flow and profitability. We believe our business model can and will deliver great value to our shareholders as this market shift plays out. In the near term we are laying out specific metrics and milestones so that you can measure all of our progress. The path won't be a straight line, of course, but our progress should be very visible.

So to be clear, we're talking about two milestones here. First offering you adjusted EBITDA, which is defined as operating income less non-cash items. And this will shift from approximately $9 million negative per quarter this year to break even and positive by the end of 2014. We also are investing in long term product development at the corporate level and we'll have corporate and public company expenses to cover as well. We report these in the corporate and technology investment segment and you can watch our progress here too. We have averaged about $16 million per quarter adjusted EBITDA loss this year in this segment.

We are committing to manage the business so that by the end of 2015 our corporate investment portfolio and our other expenses, including long-term capital investments, will be covered by three things, internal operating income, income from joint ventures and expense recovery from our development partners. Obviously we expect that our current investment portfolio will contribute to our income stream. And as these investments roll off into production, we have options on the pace of new investments to ensure we can manage this goal. Therefore, we expect by the end of 2015 Westport will be positive adjusted EBITDA at the corporate level, and we believe the path forward to strong financial returns is clear.

Now I'll walk through each of our business segments, starting with the applied technologies business unit. Applied technologies revenue for the third quarter was $20.3 million compared to $20.8 million in the prior-year period. The $500,000 decrease is primarily due to lower sales in China and South America, partially offset by stronger sales in Russia and Poland. Gross margin and gross margin percentage were $6.5 million and 32% during the quarter, compared to $5.2 million and 25% in the prior-year period, respectively. Including the current quarter's revenue it was $969,000 of service revenue, which was recorded at 100% gross margin, since the related costs were recorded in R&D. Therefore product gross margin for the current quarter was 28.5%. Operating expenses increased $1.5 million to $4.9 million for the third quarter compared to the prior-year period, which is primarily attributed to a higher research and development cost for new products.

The on-road systems business unit revenues were $17.8 million compared to $8.5 million in the prior-year period, an increase of $9.3 million, driven by revenue generated from BAF and an increase in sales of HPDI systems. Gross margin and gross margin percent for the quarter were $1.1 million or 6.2%. Operating expenses for the quarter were $9 million, this is flat compared to the prior-year period. The corporate and technology investments business unit earned $8.4 million service revenue related to our development agreements during the quarter. Operating expenses increased by 49%, primarily due to higher investments in research and development activities on new and existing development programs, and additional resources to support market development initiatives.

During the quarter CWI earned $77.5 million in revenues and shipped over 2,400 units compared to $45.5 million and 1,588 engines in the prior-year period. The increase in revenues was led by deliveries of the ISX12 G engine and further increased by shipments to Asia. We continue to see high interest and demand for the ISXZ12 G engine. Operating income was $7.9 million or 10.2% of revenues compared to $7 million or 15.4% of revenues in the prior-year period. This decrease in operating income percent is primarily due to operating expenses increasing 53% to $9.8 million, which is driven by research and development expenses related to the ISX12 G, the development of the IP6.7 G and reliability improvements. And $6.6 million warranty adjustments for the ISL G recoded during the quarter.

Our portion of CWI's net income for the quarter was $2.5 million. We expect our portion of income to increases as unit volumes increase, and we realize improvements in our warranty experience. Also we expect CWI's revenues to exceed the 2013 baseline revenue target as defined in the amended joint venture agreement, where we will recognize 75% of the profits earned in excess of the baseline revenues, which will show up in the Q4 where we report as our share of CWI's income. Weichai Westport realized significant growth again in the third quarter of 2013. Third-quarter sales line grew to over 9,000 engines, an increase of 88% from the prior year period. Weichai Westport continues to penetrate new markets and build market share aggressively in China, therefore margins still remain in the single digits.

With that, I will now pass a callback to the operator to open the call for questions. Operator?

Thank you. We will now begin the Question and answer session.

(operator instructions) Laurence Alexander, Jefferies and Company.

Two quick questions. One is the wind down of the HPDI 1.0, what will be the run rate savings from doing that?

Good question, Laurence. I am not sure we can say. Obviously we're redeploying a lot of resources and that was what we were trying to say. We're going to be leveraging a bunch of our US production sites.

I think it's more accurate to say we're reconfiguring our US sites to support the OEM programs and get ready for OEM launch. But it's going to be across the product portfolios. We want to be [unsling]. As you know in the past we have done a fair amount of specific work for the product developed with Ford, for example, the products we have done with Paccar, the work we're doing with Volvo.

So what we're trying to do now is consolidate operations and Nancy Gougarty has joined us. She is working to get efficiencies and across the Company operating synergies so that we can start to make money, as opposed to losing money in that division. So I think it is fair to say you are going to see a lot of product change, a lot of movement of our operations.

And then overall that is going to support our path to profitability. But getting into specific product by product, what are we doing, I do not think that is really going to be very helpful.

But we'd still -- we made the comment, Laurence, we do expect to recognize some benefit.

It's all part of the path to profitability.

It's been such a flagship product for you, but also such a low-volume product, is it fair to say that probably the savings would be at least equivalent to one new incremental program, in terms of funding? Or is it less significant than that?

Just look at the losses we have racked up. I am looking at Bill here. But it is no secret that we have never hit the break-even point we've talked about for years on that.

It product is first-generation. The prices high. And certainly with the introduction of the 12-liter product that is built on the line and with iCE PACKS, that are taking advantage of 2.0, the product is high-priced. It applies well to high fuel-use applications like we're seeing in Australia where the price point make some sense.

But we just don't see the break-even point for that specific product. Is there going to be at next-generation product coming? Obviously that is what we would be pushing for. But in its current state I think the last time I looked, we were probably putting together operating loss of certainly tens of thousands per truck for every truck that we ship. Just to build it and supported it and have the fixed cost.

We're not going to be able to necessarily erase all of that fixed cost. And we're probably going to redeploy a lot of the resources but it is going to be allocated to places where we're making money. So I think it's going to have a very significant benefit on us.

And then very quickly, in terms of lumpiness, as you think about your cash burn for the next, call it two to three quarters, are there any significant factors that will affect the cash burn that are not just unit volume projections?

Yes I am not aware of any at this time, Laurence, as we look forward. And it's going to that goal by the end of 2014 for the operating business units. So for the quarter ended December 31, the BUs should be adjusted EBITDA positive.

Thanks.

Vishal Shah, Deutsche Bank.

Hi this is Susie Min for Vishal Shah. Thanks for taking the question. I wanted to get some color on the 15-liter. I know you've mentioned some nice orders this quarter. Some of your peers have been talking about a slow down through the rest of the year, and wanted to see how that jives with what you're seeing. And then, two, how that relates to you're stopping to take orders in a couple of weeks. And then I have a follow-up question.

Well obviously, Susie, this is a business decision. I think we've got the next generation coming or HPDI and that's a vertically-integrated product. Obviously Volvo's launching with it at the end of next year. I think this just came down to moving to the vertically-integrated solution.

Right now the first-generation product really was the Westport branded engine with HPDI, and we are moving to the vertically-integrated business model. In the interim, it will be a 12-liter Cummins Westport engine, which will be a great engine.

And by the end of next year should start to see some Volvo 13-liter product on the road with HPDI. Again, this is just a business decision.

We had some great orders come in. We had a good Q3 in terms of sales for the first-generation product. Ironically one of the best things I think we could've done was suggest we're moving to the next generation product, because it sped up a lot of business, which has been very positive for Westport for this quarter. I don't mind suggesting even the next quarter.

Okay great. I'm wondering if you guys can give us an update on how your sales agreement is Weichai is going, in terms of your June exclusivity agreement ending?

Bill is flying to China. No, I think it is going very well. Let's just start with that.

I think the market in China took a bump over the summer. A lot of people recognize that the Chinese government changed the pricing for natural gas for trucks because the volumes were rising so quickly.

Were not too sure what exactly is going on with the pricing diesel fuel and gas in China because it is controlled by the government. But as people digested that, volumes are back on the rise again. The demand for HPDI is strong.

I think the question between us and Weichai is just exactly where it is and how we are going to roll it out, and what is the price going to be and what's the volume going to be. I think it's a really exciting opportunity for both of our Companies.

And how long does it take typically -- what is the lead time that you would need? Is it six to nine months? Should we expect that sooner than later, given the time needed?

We have got --obviously there is the process going on here, Susie, we're not trying to be cagey. There is a large investment that we are making in key component capacity for HDPI 2.0 which obviously that is going to support Weichai's rollout. Between the time that that hardware gets onto the plant floor, we are using current equipment, which we're going to be effectively renting at a higher price. So a lot of this is a trade-off between price and scalability and volume.

We expect we will see low volumes, relatively low volumes, let's say. I think we are going to see some pretty healthy demand in China until we get these investments in place, so we can deliver the price point that we need in China. But this is going to be a global supply chain, and we want it to be scaling up to meet the demand that I talked about earlier.

That should give you a sense of where we think this is going over the next couple of years. Can I give it to you quarter by quarter? It's not meaningful. But we can deliver some trucks very quickly, and we will be in production soon.

Okay. Thanks, Dave. Thanks, guys.

Thanks, Susie.

Ann Duignan, JPMorgan.

Could you give us a little bit more color on the universal LNG announcement that you had this morning. I'm trying to visualize how is that going to work. I mean we looked at their website. It looks like they are based in China. Are these products that are going to get assembled here in the US and shipped to China? Can you put a little more detail about what exactly --

No, Universal is another entrant into the US market. There's been a number of specialists in China building LNG and they are moving operations into the US. So this is a US operation. It's for a US customer. This will be a US fleet.

And of course our traditional iCE PACK production will be here in the US. So no, it is just Universal, like others, are seeing the opportunity to invest in LNG infrastructure and they are out signing up fleets.

Their focus is more the private networks. They're not building a public station network as far as I know. They are building in-yard refueling for large fleets and obviously doing a good job of it, because they are capturing customers.

It's Darren. We've been precluded from mentioning the customer name and the OEM chassis. We do know the answer, it's just the customers have currently requested anonymity. But they are household names in North American soil.

(technical difficulty) We have had a lot of questions today so, Ann, since you kicked it off, I can wax on about this a bit. We have been seeing for a while that the LNG delivery system is really biased towards cold LNG, and so are the fleets.

The fleets are going to want to optimize range and performance, and so the colder the better for that. Part of what is happening here is that the fuel providers are biasing the OEMs toward a cold LNG solution by offering the hardware.

So no, Universal is not buying iCE PACKS, they are on behalf of their customer. They're saying we're going to deliver our cold LNG solution to guarantee that these trucks meet our spec. We're going to pay for the fuel tanks. This is part of the model that we've been talking about.

I think the industry is recognizing the benefit of this and the importance of this technology. I think you will see more and more of these deals that are being sponsored by the fuel providers. The OEM, the truck manufacturer, doesn't really care what the hardware spec is for interaction with the station, particularly when the station builder is specifying it. Does that make sense?

Yes, that is helpful. I could not logistically figure out in my mind why you would be shipping tanks to China. Okay.

Is there any risk on the tank side that would we get ourselves into the same issue that we had with the HPDI, in that your shipping engines from the OEM to a third-party location. You're putting your HPDI on them. You're shipping them back to the OEM. And a lot of the inefficiency in the logistics and the costs is what may be added to the lack of breakeven in that business.

Is there any risk of the same on the tank side? You're buying the tank. You're putting on all these pumps and hydraulic systems and then shipping it back somewhere. Should we be concerned about the profitability of that business?

No. Obviously, as we've said, iCE PACK is an HPDI 2.0 architecture. The idea is to share the volume with our HPDI OEM customers, and down-size it for SI with a different drive system. But it's the exactly same components. So we're taking advantage of the supply chain and the engineering cost reductions that we've made on HPDI 2.0 to launch this product. So no, we're going to see very healthy, we think, quality improvements, price improvements. And we can pass that benefit on to the customer.

And it's integrated at, I think, a different model for iCE PACK than, say, some of the standard solutions today where it's, I think, affectively almost all external integration. The iCE PACK really is dedicated for online and factory production at the truck plant. Whether it's Kenworth, Peterbilt, Freightliner or any other auto car, whoever the OEM is, iCE PACKs would get delivered to the -- model would be is that the iCE PACK system gets delivered to the OEM plant and integrated on the line.

And so your value add in the process is exactly what? Is it the pump design or the hydraulics or the packaging?

I am sorry, Ann, I don't think I heard question. Could you repeat it?

I'm trying to figure out what Westport's value add is then in the iCE PACK system.

I think you know it is our proprietary tank and pump combination. There isn't another automotive-grade pump that works, frankly. It's pretty simple. The tanks are manufactured to our specs as a result. So it's a proprietary Westport product, top to bottom.

Of course, the other advantage is that we understand the fuel flow rates that the engine needs and we can match the controls on the fuel system to controls on the engine, so the engine gets the fuel flow that it needs. And so the performance of the entire system is guaranteed by the fact that we know what the system needs. Linkages to the fuel station and cold LNG is, I think, another one of the system benefits we have talked about. I think it's really important at the end customer level to understand that the shift to natural gas is fully engineered from end to end. The truck is going to perform and take advantage end to end. What people care about is performance and fuel economy, and that is what iCE PACK is doing with trucks with the 12-liter engine. So yes, it's proprietary end to end.

Okay, that's helpful. Thanks. I'll get back in line. I appreciate it.

Thanks, Ann.

Rob Brown, Lake Street Capital Markets.

Good afternoon. You talked about your HPDI 2.0 roll-out steps coming. Could you give us a sense of what steps are coming and when the CapEx -- (laughter)

I think when David mentioned it in his script, Rob, it is basically being designed for manufacturing high-scale reliability, lower cost. We are making changes in our own supply chain and design and engineering of HPDI. I guess the finishing note is you may have to wait a few weeks to see the result.

Get some of the details.

Okay, but these should be things like manufacturing partners being announced, that kind of thing?

Yes that is fair. Yep.

Okay good. And then maybe another question you won't answer, but could you give us a sense of what the attach rate of the iCE PACKS will be to the 12-liter sales? What is the unit volume range is we can think about for this product?

I am looking at Darren.

It's a function of LNG in trucking applications doing more than 200 or 250 miles a day. I think there is a lot of discussion candidly about how much LNG in trucking is going to be shipped next year versus CNG. As you know we have still shipped the Cummins Westport 12-liter engine. It is going to do great.

I think in terms that the attachment rate, I will let you of the analyst community, the investment community, decide what you want to forecast the mix of LNG out of this 4% to 5% market penetration they have talked about. And then in terms of our attachment rate of the LNG, are we going to get 100% of the LNG system versus perhaps an industry standard offer? You're probably asking a little subjective question to us, Rob, we think we have got the best solution possible for LNG and spark ignition engines. I will wave the flag of subjectivity and say I think it will be a good attachment rate, based on how many truck applications will ship with LNG and longer haul.

And Rob you've seen our chart. We are trying to be completely neutral on this. Some of this is physics, but there is also a factor of local availability of LNG and fleet preferences. And some of it is whether the fleet is also running a big CND operation, in which case they're probably going to be biased toward CNG.

But as Darren said, we really see the dividing line of 200 miles a day. CNG above that point really starts to really get some challenges. We would expect the great majority of fleets that have higher mileage than that going LNG.

The overall mix on the 12-liter is anybody's guess. We've shared the industry these days as talking 50-50. Whether it's 60-40 or 40-60, I don't really care. It's our engine, I think LNG is going to be universal in high fuel-use applications like marine, and maybe even not a Marine. For the most part, you are not going to see LNG mining trucks, or CNG mining truck, rather. Or CNG for rail does not make a lot of sense.

You have to draw the line based on what you think fleet preference is. I think how we see adoption of natural gas in the short term, we are going to see lots of CNG because of those return-to-base fleets and urban fleets that get immediate advantage and the infrastructure barriers are lower. Over the next two or three years I think you're going to see a lot of LNG. It's just physics.

Much heavier mix that way, Rob.

Okay, thank you. I'll turn it over.

Jerry Revich, Goldman Sachs.

Can you talk about the Volvo HPDI timing? You mentioned by year-end 2014. I'm wondering if you would clarify, is that full-scale production rates? And give us some more context about how you expect the ramp to go.

Yes, hello, Jerry, it's Darren. The comp that we've been giving Volvo is the measure gave at the Mid-America Truck Show, was late 2014. When you get this close to product launch, to be really candid it's actually Volvo's call. We don't have the exact dates from Volvo.

Okay, thanks, Darren. In terms of the BAF acquisition, how much did it contribute to sales in the quarter? And can you share with us the HPDI sales contribution in the quarter as well?

Yes, I think we talked about this last quarter where we are not going to break down the individual businesses, so we will not be able to provide any color on that.

In terms of unit --

Is there another way we can try and answer the question, Jerry?

Yes, Darren, can you help us with the organic growth in applied technologies in the quarter? Or excuse me, in on-road systems in the quarter, backing out the BAF contribution?

Yes, I think yes. We had increase in HPDI sales and increase in contributions from BAF. This is the first quarter we actually start recognizing revenues related to BAF.

Right, so I didn't ask my question well. So if you were to back out BAF, what would the sales growth be in the quarter on a year-over-year basis?

(laughter) I think it's the same question.

I'm sorry, Jerry, we'll try. We're trying, we just can't break it out.

Okay. And as we think about your business stepping into next year, what are the major light-duty launches you folks have coming up? Or major product refreshes? Can you give us a quick update on the two or three biggest programs?

I think there's probably two to start out with and I'm looking at Dave and Bill for the others. You've got one is the Ford F150, which we still expect to launch in Q1 of 2014. And also the Volvo V60 program has started selling, and we are looking at an export market for that product over the next 12 months. Is there any other light duty? I think that's what we have on the table right now, Jerry.

Thank you very much.

Eric Stine, Craig-Hallum.

Hi, everyone, thanks for taking the questions. I know you are hesitant on the units. I am just curious, can you talk about maybe the magnitude within CWI of the 12-liter?

Last quarter you had a great CWI number and the 12-liter was very small. Should we think about this quarter in a similar way? Help frame us. And again, I'm trying not to ask about volumes, but just help frame our thoughts on that.

Boy, you really want the unit number, don't you? (laughter) I am looking at Bill. Give me a hint here. Volumes are going up, we can certainly say that. Is it fair to say we doubled quarter to quarter? Bill is nodding, yes you could say we have doubled.

Honestly we are really getting, I think, distracted by this. I think the real point is -- I said it. I'll say it again that this breakeven -- sorry, breaking into a market where we're going to get 4% or 5% market penetration for gas is really what has people excited.

So the story is not last quarter, this quarter. It's that I think everyone now believes we're going to see a market for natural gas in 2014 of 8,000, 10,000 trucks, which is a lot of natural gas trucks. And that has everybody scrambling to get their product plan together.

So the number to look for, I think, is are we going to be able to get to that 4% or 5% market penetration in 2014? And then after that, is it going to keep doubling in the US? If you do the math and look at China, we think we're getting pretty close to 5% in China, which is a pretty astonishing number in a short time too.

Europe, we are behind, but it is not unnoticed that natural gas is moving quickly in North America. And that's why we're seeing so much interest in Europe as well. So I think that the critical number is not the lamp. I can tell you 12 is going really well and volumes are growing and we are in full production as of August with the high ratings. And that product seems to be what people want.

So we are pretty confident we're going to have a strong year ahead with that product. Then a whole flood of new product is going to hit the market after that. That's I think, pretty safe to predict.

Okay fair enough, it was worth a shot there, but -- (laughter)

I gave you a point to play with, come on. (laughter)

That was good. I appreciate that. Turning to applied technology, something from the release. Wondering if you could give more clarity.

You talk about a new high-pressure natural gas system. I guess it's a tank valve and a filling valve. How we should think about that opportunity in terms of ASP. And then as much as you can share about these two European OEMs launched in Europe, maybe which markets in Europe, those sorts of things.

Sorry, the two European OEMs. I'm looking at Darren for that reference. Two European OEMs --

These are new products that they've been investing in applied technology.

Oh, in applied technology.

It's just, they're rolling out these new products that are OEM-quality, meet all the OEM requirements, packaging.

Yes, the tank valves and filling valves. I think we do expect applied technology to have some pretty good growth with just new products launching in -- available effectively somewhere is my guess the end of this year. And some products launching next year, we have not disclosed yes yet. I think applied technology has got some good growth in front of it.

Okay, so this is part of your plan, unseating existing players in the supply chain. This would be just the first of many, is that how we should think about it?

Yes, I wouldn't necessarily say we're unseating people. I think that the market, the OEM market, is just emerging, And what we want to be able to do is demonstrate a continuous stream of new products, that are higher performance, lower cost, better quality. It's pretty standard to automotive business. And the applied technologies group are focused on that OEM business.

We have got, I think, a very good presence with the automotive players that are doing natural gas. We want to expand our content and we want to, obviously, expand the model coverage, and expand the number of OEMs that we supply. Which would lead them directly into a complete system design with our on-road systems group. But the applied technologies group will sell stuff to anybody.

Okay. This is the last question for me. I know iCE PACK clearly focused on North America, but any thoughts on timing potentially spark-ignited opportunity in China?

There's lots of spark-ignited getting sold in China, I would not say iCE PACK North America.

No, at this time, we are looking at possible solutions, Eric, for future product launches. We're looking at partners right now and we'd announce anything of materiality when they're ready to go.

Okay thank you.

Colin Rusch, Northland Capital Markets.

Can you guys talk a little bit about the strategy for distribution of iCE PACK and why you're not selling direct to OEMs at this point?

We are selling direct to OEMs.

We are selling direct to OEMs.

Okay. And then the ULNG order is just aid on distribution at this point?

It's a little unique at this moment for that particular order, Colin.

Well, Colin, as I said to Ann earlier, what you need to think about here is that the feel provider working with the fleet is specking cold LNG and iCE PACKs. But the iCE PACKs are getting put on the truck chassis by the truck manufacturer. It's a trucking product, so we are not taking iCE PACKs and shipping them to Universal LNG.

This is not what's going on here. It's just that the fueling partner is specking it on behalf of the fleet. We are not telling you it's the OEM, and we're not telling you the fleet, but it will all become clear once you see this rollout. We do see that continuing.

I think that more and more of the LNG providers are going to be very engaged in specking cold LNG and iCE PACK, and being able to offer pricing and performance that takes advantage of that technology. And so you're going to see that model going forward. But the hardware itself is an OEM product, as Darren said. It is designed to be installed at the truck factory.

Okay, perfect. And then with the 15-liter, can you give us an update on where you are at in terms of discussions on a new partner for funding the next generation of the 15-liter product?

It's HPDI product we are talking about. I think -- I have got to choose my words carefully here. What we are seeing broadly across the trucking industry is a push toward higher fuel economy.

Higher fuel economy with lighter weight, comes with lighter weight. It comes with smaller engine displacements, which means higher power density for smaller engines.

If you look at the ratings, you're going to see higher power and torque ratings out of smaller and smaller displacements, which certainly in Europe, we are seeing a real migration in the trucking industry to much smaller engines that have the same performance output. What we are after is not another 15-liter platform.

What we are after is a broad range of engines that are suitable for trucking. More than that, I think we are going to have to stop. Let's just say that as you see the trucking portfolio around the world evolve, we want to see HPDI offerings in as many of them as we can do.

And I think, Colin, there's a bit of a misunderstanding by some of the media that people link the 15-liter as some inextricable link with HPDI. But HPDI's a technology platform.

It's what Caterpillar is working with, what Volvo is working with. Obviously we have disclosed publicly there are two OEMs we have been in development with so far on initial phase with just that, HPDI as a technology platform. So will there be future OEMs with HPDI? Absolutely. I think we are counting on it.

Will one of those products -- will HPDI be on a 15-liter engine? I think that would be a question for Cummins or for Dow, for Paccar or whoever is the current supply value chain today.

Where you're heading is something that would look more like a JV than it would look like a product that you --

I'll go on a bit on that one because it's come up a bit. JVs were great way to get started and minimize risk for those first partners. Guys like Cummins and Weichai, because you can kind of -- we are isolating the business. We're putting it off in a joint venture.

But I think more and more we are going to see a business model like we have done with Caterpillar and Volvo, where it's product by product, and there is a specific product. There's a product development agreement. We agree on cost and performance, milestones for a particular product.

We expect there will be multiple product development agreements with each of these OEM partners as we go forward. So the JV structure is not necessarily what we're going to replicate. I think you're going to see more of these contractual product-by-product deals, which have the same result.

In the end, it looks like the same financial deal. It just gives us a lot more flexibility with our partners on future, rather than going into corporate structure like a JV. I'm not ruling out JVs, I just think our expectation talking to our partners is they want a lot more flexibility.

Perfect. Thanks a lot guys.

Thanks, Colin.

Alex Potter, Piper Jaffray.

Following up on that last question then. With the Weichai joint venture, would you say that that is something that you guys might try to move away from, potentially restructure that in the same way that you've done with Volvo? Or do you think that JV has staying power?

I think what we have said about Weichai is two factors here. In the joint venture with the way we got the Chinese market for natural gas in particular, natural gas trucks and LNG got going. And the joint venture was a great way to get some visibility and start on that.

And obviously it is done really well. It's got a 30-year term. There is a corporate structure that we are a shareholder in.

But the primary path to market for Westport and Westport shareholders, the value creation, we think is really going to come as we start to deliver HPDI technology to the joint venture. Or deliver components to the joint venture. Or develop a Chinese iCE PACK or something that takes advantage of this new market for natural gas products.

The joint venture obviously has a value. Obviously those shares have a value, But our business model is to deliver this technology-driven, capital-light business model two OEMs. And that means Weichai Westport is becoming a Westport customer. That is really what we are pushing toward.

Okay. Then I was wondering also, one quick question, again, on this ULNG thing. For the 900 units of the iCE PACK, I was wondering if there's a -- do you have any take or pay agreement type of thing there, whereby they would get penalized for not ordering?

Yes, there is a -- it's a take-or-pay actually, Alex. Sorry we didn't put all that detail in the press release, but it is a take-or-pay with minimum commitments every year until we get to 900 units. They can obviously speed up the pace of integration. But there was also a function of making sure they had enough time to get the trucks integrated into the customer fleet and the infrastructure that was there. It was just more of a logistics timing than anything.

Okay, very good. Thanks, guys.

Thanks.

Matthew Blair, Macquarie Capital.

When the 350 horsepower version of the 11.9 launched, it seemed like a higher percentage went to CNG. Now that you have the 400 horsepower version out there, what is the breakout between the CNG and LNG?

Sure, I think it's all applications right now. I think we have touched on it. Right now the majority of the engines are going to be CNG today. Until we get our iCE PACK out there and start getting them integrated on trucks. So if you look at most of the CWI 12-liter engines that are being delivered, whether they are the 350 or the 400 horsepower, they're going to be CNG today.

It's a function of the shipments this year, Matthew. It's for calendar 2013, it's probably fair to say the first applications going out were more CNG-based. And to David's point earlier, if they're short-haul of return-to-base, refuse fleet short-haul trucking where, again, every night they can come home and get the efficiencies of having an overnight or depot-based refueling solution. As you get into 2014, I think you start seeing the longer-haul applications showing up, more than 250 miles a day.

And that's obviously what has got us very excited about the iCE PACK sales for next year. This year, could it be a high mix of CNG? It could be, for sure. Again I don't think it's an appropriate survey sample, being just calendar 2013, because most of these products are just coming off the line.

Sure, okay. And then, any thoughts on R&D for 2014? Given the recent equity raise, should we assume it's probably going up next year?

As we sit here today, we think our investment in research and development is going to be flat year-over-year. As we have talked about quite openly, is we are going to be having products that are going to be coming out of that product development cycle and put into the business units and be commercialized. We would expect to bring more new development programs into the investment pool next year. So we expect, when we look, sitting here today for next year, we expect it to be flat.

I think the other component, Matthew, is you've got our -- we have been using that term gross R&D. So the R&D number that we report, don't forget there is obviously a good portion of service revenue that's some number, I think it has been in the $10 million to $15 million range or so for this year on a run rate. I think next year, we would expect have some service revenue. That would be something else to consider too, is even if the reported R&D number is flattish, hopefully a portion of that is offset by the service revenue.

Okay, but you would probably have lower service revenue next year with the roll-outs of the Volvo HPDI engine?

I think that would be dependent, right now, Matthew. You are right that as Volvo drops into product sales, that will come out of R&D, but we're, let's just say, confident in that we have two OEMs we have been working with for the better part of a year on HPDI. If we're successful and we can turn them into development agreements, we maybe see some R&D out of that.

And I think to your other comments on joint venture structures, where those are less likely, Not only do you expect to see more product development-like agreements, but invariably the customers are less willing to give up a big share of the net income. And you're seeing more of a service revenue model, where the OEM partners are willing to subsidize or fund some of that R&D development, so that they can control a greater part of the value chain.

Very helpful thank you.

Pavel Molchanov, Raymond James.

Thanks for squeezing me in. You mentioned in the press release that gross margin on the new 12-liter was depressed due to lower launch pricing. How long do you think that will last?

Well it's all -- just be clear, it's all driven by the warranty pool that that we have on the 12-liter. Like with any new product launch, it is heavily burdened with warranty costs, so therefore it drags down the overall margins.

Typically it will take several quarters, as we start getting performance history on that engine to where we can start accurately predicting what that warranty is going to look like on that product out in the foreseeable future. It's going to take several quarters for that warranty experience to come in. We would expect that overall warranty accrual to start decreasing over time, and margins to improve.

Okay, so just to clarify, pricing at launch is the same as you plan to keep it?

Yes.

That was not the culprit. Okay.

It's just changing what that warranty accrual is. It's going to drive the margins.

Okay understood. I appreciate it, guys.

Thanks, Pavel.

John Quealy, Canaccord Genuity.

A good afternoon guys. So one question real quick, and I'm sorry if you touched on this earlier. In terms of iCE PACK warranty charges or ramp, how should we expect that to play? Is it going to be similar to the engine launches or less of an impact?

It's an existing product that's within our technology portfolio and we have a pretty good history on it. I would not expect significant warranty accrual on that system once we start launching and delivering. I think, as David mentioned earlier, we think we are going to make some good money on the sale of this product.

Okay. Then lastly, another one I apologize if you touched on it, but in terms of the traditional China market for medium- and heavy-duty diesel trucks, it sounds like that traditional market is slowing down and operating with fairly good over-capacity. Are you seeing any increased competition on the LNG, CNG side at all? Thanks.

I guess what is going on in the China market is not always obvious. From our data, things are roaring again in the truck business, So there might've been some lumpiness, but it is still a very strong market and continuing to grow pretty well. And natural gas continues to grow.

There are a number of players in the engine business, but Weichai is the dominant player in the truck business. Obviously we dominate in the natural gas truck engine business too. So we don't see any big change in that front. I think as we launch HPDI, which gives the joint venture an exclusive proprietary product that people can't match, that's just going to help its market share and its reputation.

Is there going to be more engine competition in China? There is no doubt. It is pretty straightforward these days to take spark ignition conversion kits and put them onto an engine. And so lots of people are doing that. But the high-performance end the high-reliability end with people like Weichai, we think we are going to continue to dominate.

Perfect thanks guys.

This concludes the time allocated for questions. I will now hand the call back over for Darren Seed for closing comments.

Thanks very much, everyone, for joining the conference call and we will see everyone in what we would expect to be February of 2014 for the Q4 and year-end wrap-up.

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