Westport Fuel Systems Inc (WPRT) 2014 Q3 法說會逐字稿

Thank you for standing by. This is the conference Operator. Welcome to the Westport Innovations' third quarter 2014 financial results conference call. As a reminder all participants are in listen-only mode and the conference is being recorded. After the presentation there will be an opportunity to ask questions. (Operator Instructions). At this time I would like to turn the conference over to Darren Seed, Vice President of Capital Markets and Communications. Please go ahead.

Thank you and good afternoon everyone. Welcome to our third quarter conference call for fiscal 2014. It's being held to coincide with the disclosure of our financial results earlier this good 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 Company will be Westport's Chief Executive Officer David Demers, with Westport's Chief Financial Officer a Chief Executive Officer, Ashoka Achuthan, and Westport's President and Chief Operating Officer, Nancy Gougarty.

Attendance at 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 US 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.

Thank you, Darren. Good afternoon everyone and thanks for your interest in Westport. Q3 was a challenging quarter on several fronts. As we continue the market transition plans that we have been working through over the past year. I will go through some of the short-term conditions that have affected our business and then of course a Ashoka and Nancy will highlight changes that we're going to be making as a result. That said, I want to make mere that we do not believe the long-term strategy for our business has been impacted and we're making good progress on our strategic plan. So these are course corrections not fundamental changes in direction or speed.

As we reported today Westport direct sales in the third quarter fell sharply year-over-year and sequentially from Q2. On an apples-to-apples basis if we adjust Q3 revenues to a baseline excluding R&D milestone payments and removing discontinued product such as the Westport 15 Liter, we see year-over-year revenue decline of 24%. This is still disappointing when we were looking for strong growth and we need to work to improve results. Our joint venture in China, Weichai Westport, saw reasonable growth particularly as we look at the year-to-date performance and it's on pace for a solid beat of last year's unit sales and revenue.

Cummins Westport had a much better quarter than in Q2 and we're optimistic about our position on warranty expenses for the ISL G engine going forward which was dampened earnings in that business over the past six quarters. Now we are looking hard at the market dynamics that delivered result and whether this is a one time blip or a new factor that we need to build into our plans going forward.

We haven't completely finished this analysis of course but I will run you through some of our preliminary deductions and Nancy will weigh in with her thoughts later in the call. Now, obviously we have been impacted by oil prices and we don't know where oil prices are going. Consensus today seems to be flat to slightly down through next year.

While the differential green natural gas and oil prices remains intact in most markets, since gas prices are down in the overall incentive to migrate to a new fuel is weakened in markets where are no incentives. In general, European alternative fuel products have been hit hard by reductions in government incentives, by the decline in oil prices, which, as a said, reduces incentives to look for change, but also generally softened economic conditions across Europe which have re reduced shipments of new cars.

This has reduced demand for our systems and components for many OEMs in Europe. However, China and India remain strong and growing markets and in North America we think fleets are moving forward and doing well. So add this up and we see a mix of stronger and weaker markets and we're rebalancing to take better advantage of the best opportunities. The sudden, and frankly, unanticipated drop in our product sales this quarter and our restructure costs hit adjusted EBITDA and our operating business fell from a CAD1 million positive adjusted EBITDA profit last quarter which we had celebrated as a major milestone for us in our transition plan.

This took us down to negative CAD5.4 million this quarter. We took immediate action in October to reduce operating expenses. We had a staff reduction of about 9% globally which will take effect in Q4. Executives across the Company have also accepted on average a 12% salary cut as of January 1st. Plus, dropping 2014 earned bonuses and 2015 cash bonus program completely in return for restricted stock units which will vest over the next three years.

For the record, Nancy, Ashoka and I led this process with a 15% salary cut. The executive compensation cuts will have a positive impact of about CAD7.4 million in cash savings next year. This combined with staff reductions and other immediate control measures add up to approximately CAD13 million in 2015. Now, independent of this short-term reaction as we have been telling you over the past year Westport has been continuously adjusting our long-term product development investments and prioritizing our program spending based on market timing signals and partner readiness.

We're still working with key global OEMs despite recent confusion in the capital markets around Westport and what's happening and we will continue to develop leading edge natural gas technology and products. However, we can focus and prioritize our investment spending to returns as does any business given the current situation in the energy markets. Now, we will see less net spending on new product investments in 2015 with three factors at play here. We're completing some major product programs such as our next-generation engine for Volvo cars which we expect will move from expense to revenue generation mode in 2015.

We're seeing strong engagement and interest from several prospective partners to co-invest with us on some new programs which will reduce the need for Westport to invest our own cash and enhance our returns. And third, we are postponing, re-timing or simply not making proposed investments where we think the market timing doesn't match up. For example, the off road business remains a compelling long-term opportunity for us, but we believe Westport can look to partners and customers for more support as this market develops over the next few years.

The timing of product adoption is going to be paced by long-term investments in LNG fuel supply so we're going to get a reasonably good read at how fast this is going. We just recently shipped the fourth LNG rail tender earlier this month and we will be working with customers to develop new orders in this area.

Now, during the quarter we did announce two major updates to our long-term product investment programs. First, we announced our new enhanced spark ignition engine, called the SI, which has been presented to several global OEMs over the past few month with the intention of developing medium duty dedicated natural gas vehicles with significantly higher performance and fuel economy than we see from conventional spark ignition engines in the marketplace today. Response to-date has been encouraging. We're seeking risk sharing commercialization arrangements with prospective manufacturing partners now.

We also announced a major shift in our HPDI programs with most OEMs as Westport and Delphi rolled out our jointly developed HPDI fuel injection system at the Hanover trade fair last month. This next-generation system, which we first announced in March of this year, will provide higher performance, durability and scalable manufacturing.

I think this is an exciting development that will encourage wider adoption of HPDI as a path to high performance natural gas vehicles. Now, this year we've seen continued growth in infrastructure development around the world and with have seen a very significant growth in the number of fleets who actually have some natural gas trucks in operation. Anecdotally, they tell us they intend to buy more next year.

We've also recently seen publication of long-term performance in offering costs from some of our early fleets such as Better Transport in BC. They reported three years of operation showing significant fuel cost savings, no impact on reliability or service cost and strong confidential in the future of natural gas in their trucking operations. Of course they recommended that fleets need to do their homework. The message from all this that we and our OEM customers is hearing is simple. Natural gas is here to stay.

Customers are asking OEMs to expand their natural gas product offerings to match the wide variety and the specialized features that are offered today in diesel and gasoline vehicles. More infrastructure is needed and customers are going to want a big expansion in services and support as they make this transition to this new cleaner and cheaper fuel. So overall, we see no reason to shift our views on the five year market opportunity although clearly the path forward is not a straight-line.

The industry is still growing beyond expectations of just a few years ago and I firmly believe that Westport and our shareholders are in the right place to take advantage of this new opportunity. Thank you four your support and interest. I will turn the call over to Ashoka to run through the financials, and then Nancy will discuss some of our operational priorities. Ashoka?

Thank you, David. Good afternoon everyone. Quarter ended September 30, 2014 we have consolidated revenue of CAD25.3 million compared with CAD46.5 million in the prior-year period. The breakdown of the CAD25.3 million is 18.2 for technologies, 6.6 for systems, CAD0.3 million for off road systems, and CAD0.2 million for corporate and technology investments. As David mentioned, however, it's important to compare apples to apples here and last year we had a significant payment from an OEM which we showed as service revenue and also had sales from our first generation HPDI system. When with you offset the services and HPDI revenue the comparison is CAD22.4 million for Q3 of this year compared to CAD29.3 million for Q3 of last year.

Continued market uncertainty around natural gas components, the discontinuation of the first generation Westport HPDI system, and lower sales of Westport wind power system products have impacted our revenue for the third quarter of 2014. Westport revenue, unlike that of our joint ventures, includes a wide portfolio of products widely disparate market including different geographies.

We see considerable variation in results across the portfolio and different sensitivities to external factors such as oil prices that affect diesel and gasoline prices at the pump, China is still looking well and India shows strong promise now that diesel subsidies there are shrinking. We are seeing significant impact on our business with OEMs in Russia due to the decline of the Rupee and the complexity of compliance with sanctions.

That said, we have new products coming online in 2015 which may turn that story around. I'm also happy to report that our global car business grew year-over-year and achieved positive operating income for the first time since its acquisition. In the US, Ford sales are visibly affected by the decline in gasoline prices to the lowest level in four years. Although it is true that there is still a big gap between gasoline and CNG prices, the incentive to aggressively shift to CNG is simply not as strong. The Westport (inaudible) product revenue which we expected would rise to replace and exceeds the Westport 15-litre HPDI revenue has been slower than anticipated to get market traction and the major order was excluded from our guidance.

I also want to point out for the period ended June 30, 2014 the Company corrected the accounting for a portion of the off road parts revenue that came to us with the bad acquisition last year. As a result, and in consultation with our auditors, the Company made an immaterial adjustment to total revenue for the six month period ended June 30, 2014 by CAD4.1 million from CAD82 million to CAD77.9 million. Offsetting this revenue reduction is corresponding reduction in cost of revenue for the same period by CAD4.1 million from CAD56.1 million to CAD52 million.

In addition, the Company combined parts revenue with product revenue for all periods presented. I want to stress here that the adjustments have no impact whatsoever on our revenue guidance, the consolidate the balance sheet, statement of cash flows, net loss or basic value to loss per share for all periods presented. Our consolidated gross margin and gross margin percentage for the third quarter was CAD8 million and 31.6% compared with CAD16 million and 34.4% in the prior-year period.

This decrease in gross margin and gross margin percentage for the quarter is primarily due to product mix and a reduction in high margin service revenue. Research and development expenses were CAD17.6 million for the third quarter compared with CAD23.5 million in the prior-year period. Selling, General and Administrative expenses were CAD15.6 million for the third quarter compared to CAD19.4 million in the prior-year period. These operating expenses decreased primarily as a result of our exiting production of our first generation Westport HPDI system and consolidation of facilities.

Our R&D and related investment spending will be closely monitored and should decrease as certain programs come to their successful completion and we continue to prioritize investments to the pace of market adoption and partner readiness. For the third quarter of 2014 our debt loss was CAD25.5 million or CAD0.40 per share as compared to a net loss of CAD30.2 million or CAD0.53 per share in the prior-year period, an improvement of 16%. Moving to our joint ventures, Cummins Westport, Inc. or CWI, generated CAD70.6 million in revenues during the quarter on delivery of 2,171 units which is a 10% decrease in volume over the prior-year period.

However, this decrease is primarily due to the timing of shipment of the ISL G for obligations and lower ISL G volumes in North American trucking applications in the quarter. When you compare CWI engine shipment year-to-date it increased by 11% to 7,130 units compared to the prior-year period. This is mainly driven by higher shipments in North America for trucking applications which increased 35% at year-to-date as a result of the launch of the ISX 12G. During the third quarter CWI's operating performance was impacted by CAD1.1 million of (inaudible) related adjustments primarily related to the 8.9-litre engine. This compares to the CAD15 million charge we had in the first quarter and the CAD10.2 million charge in the second quarter of this year.

Excluding this impact a portion of CWI's net income would have been approximately CAD1.4 million instead of the CAD900,000 as recorded. Clearly, the trend on warranty is headed in the right direction and the CWI team has made remarkable process in identifying and resolving the warranty issues and we expect continued improvement in gross margins and net income in the upcoming quarters. Weichai Westport, Inc., or WWI, generated CAD179.3 million in revenues during the quarter on delivery of 14,587 units, which is an increase of 611% over the prior-year period.

This is primarily due to Weichai's Westport's aggressive efforts in market creation activities. The gross margins are still indicative of a market creation phase and incentive based pricing, but this is a market where we see significant growth in natural gas sales and we will seek to leverage other technologies and products such as HPDI to do better financial returns going forward. As of September 30, 2014 our cash, cash equivalents and short-term investment balance was CAD130.2 million. During the third quarter cash used in operations was CAD31.4 million compared with CAD28.9 million in the second quarter of this year.

This increase of CAD2.5 million is primarily due to margin impact of lower sales. The Company's cash usage excluding changes in working capital is CAD25.3 million for the quarter. We continue to make progress towards our goal of consolidated adjusted positive adjusted EBITDA by the end of 2015. To help us achieve this goal we are doing the following. One, aligning investments and expenses to the pace of market adoption and partner readiness. This means carefully prioritizing our investment programs including deferral of non-core programs and methodically allocating capital to projects and technologies designed to deliver attractive returns in the future.

Two, right sizing the business structure and reducing expenses including executive salary reductions. The results of these efforts is a cost saving of more than CAD30 million in 2015. Three, increased contributions from Westport's operating business units. We expect to launch a number of new products such as the Westport 3.8-liter industrial engine, and as part of that natural gas system using the WV 580 ECU for the Russian OEM. We also expect higher ice pack sales and component sales to new OEM customers in the upcoming quarters.

Four, we expect to generate higher income from both our joint ventures next year. And five, we expect to earn additional service revenue from our development partners. To conclude, we are reiterating our revenue guidance for the year to be between CAD130 million and CAD140 million. We recognize that we are now at a new level in our business and revenue and have been adjusting our operations accordingly. We continue to firmly believe in our strategy, we remain confident in our ability to execute against it and expect our business model will deliver great value to shareholders as the shift to natural gas inevitably plays out. Thank you. I will now pass the call on to Nancy.

Thank you, Ashoka. Good afternoon, everybody. My focus will be on operating units for this call and then I am going to pass the call back to the Operator for questions. So with that let me get started on the on-road systems. Westport continues to have successful demonstration programs on our Westport Ice Pack LNG tank system with fleets in the US and especially for companies like American protein which have resulted in sales orders. Furthermore, we have had customers that we've had Hoops Trucking LLC continues to purchase ice packs for their natural gas fleets and expected delivery and operational activities of by the end of this year.

The Ford business. This is where Westport is the largest QVM, has faced some challenges due to lower gas prices. However, fleet management companies still have a very strong focus on our products. During the quarter in fact Westport delivered 40 shuttle buses powered by Westport's WiNG system to the Dallas Fort Worth international airport. Westport now offers fleets interested in the FORD transit van with the Ford WiNG system a free demonstration up to three months designated to give the experience and the benefits of operating on CNG.

Our Ford/Canada activities are also started showing some traction with the oil and gas fleets. As mentioned earlier, while starting from a small base our global car revenue has increased over last year and is helping to offset some of the reductions we've had in our Ford business primarily due to the launch of the Volvo V6 bi-fuel vehicle plus our continuing offering of the V70 bi-fuel. As we move into the applied technologies, in Italy we are focusing on lean activities and improving our cost structures.

We have seen some markets around the world present new challenges while other pockets are growing. We are covered our headwinds in our near-term financial update a month ago so I'm not going to focus on that. So let me take it from here. Earlier this month Russia's OEM gas unveiled a new generation CNG Euro Five vehicles. One of the models is the GAZ next CNG truck, has the new CNG YMZ 534, which was co-developed with Westport and manufactured by GAZ's engine plant. The start of series production is planned for the second half of calendar year 2015 despite geo-political issues in the country. In addition, GAZ has awarded Westport to supply their LPG system for their new Gazelle vehicle which will meet the requirements of Euro Five emissions standards.

Westport began delivering Westport WP580 engine management system, controller, is perhaps another term for that, to the companies in the US that specializes in aftermarket natural gas powered engines. The first five medium duty trucks were converted and are now running in Texas. In addition, the integration of WP580 EMS system is in the Tata motors 3.8-liter and 5.7-liter engines and is going as planned. With a bit of focus here on off-road, the fourth and final LNG tender was shipped to Canadian National Railways in early October.

The tenders and the two EMD dual fuel locomotives are expected to transition to Edmonton in the fourth quarter where they will begin their redeployment and running between Edmonton and Ft. McMurray.

Our long-term program with EMD continues and recently at the High Horsepower convention proved evidence that this market is moving to natural gas over the next many years. On to some core program development activities. Weichai Westport HPDI 12-litre engine recently received China 5 emission certification and is ready for customer field testing. We have the HPDI units ready for shipment and are working with the trucking OEMs. In specific, we are working with Shaughnessy Heavy Duty Automotive to produce the trucks.

Although HPDI trucks were recently tested in cold and hot testing and the system performed well. Development of the next-generation HPDI injectors with Delphi continues in the second set of prototype injectors will be delivered to us at the end of the November. The investment into 3.8-liter industrial engine is moving along and we are expecting customer trials in Q4. This is an example of some of our off-road activity. Our portfolio technologies, such as Westport HPDI, and enhanced sparked technology, enables high performance vehicle makers to lead natural gas products. We have the lead in technology and strong brands to stay ahead.

These challenging times have given us an opportunity to reprioritize our business and product development efforts to maximize our near-term success. Our strategic priority for the near-term through 2015 are clear. Although the path may not be linear the opportunities can be transformative for the Company. With that, I will close and pass it back to the Operator to open for questions.

Thank you. (Operator Instructions). The first question today is from Ann Duignan of JPMorgan. Please go ahead.

Good evening. Can you talk about the outlook into 2015 and beyond if all prices stay where they're at or even at trend lower which we believe they could do?

Everybody is look at me, Ann so I guess I get to take it. Yes. It's been really interesting watching the trajectory in oil prices and obviously when it's more important in our space is the differential between gas and oil, which seems to be pretty intact in most of our markets. Hasn't changed a lot because gas has been drifting down, too, you know. What does change is, call it, the psychological urgency around moving. So, I think that we are definitely seeing immediate impact on fleets like Ford pickup trucks. With gasoline approaching CAD3 it's not as urgent priority so sales are off, but they are they not going to zero either. What I was trying it allude to in my speech is that fleets that are moving to natural gas and have natural gas I think are quite determined to proceed ahead because it's clear they're going to be making money and so I think that discipline is going to push ahead.

It might be the pace of attracting new adopters that's going to slow down. We're certainly moderating our expectations on the frenzy going forward, but I think we always try to downplay some of the hype. We heard a couple years ago there's always been barriers toward immediate adoption in this market. I think this is just going to continue to carry on with people that are looking to save money. Very different dynamic in places like China and India where the opposite is happening. China has got some very strict directors so we see that accelerating pretty much as planned.

India is removing diesel subsidies. I think there are tea quite relieved that they're seeing some opportunity for recovery on this one. So there's markets where we are seeing the focus on natural gas being enhanced as well. So on balance where we're going to go is put our resources and our focus on the markets where we are seeing the most demand. I don't think that's too radical.

Ann, I might add, we usually do issue our annual guidance in February so I think we probably takes the next two months to look into some of the more commodity markets and see where it is in fact and come our conference for year-end and outlook for '15 in February, we will have a better position to give you then.

Okay. That's helpful. Thank you. And then just more of a philosophical question. I know you talked about eliminating some non-core projects, et cetera, but as I just listen to all of the activities that are going on globally it does seem like the business is still very fragmented and not really focused on what it want to be when it grows up. I know it's not an easy question to answer but when we hear about rail-cars, we hear about LNG tanks, European automotive components and we hear about activity in Russia and India and China. Can you talk a little bit just about five years out assuming oil prices stay where they are? I mean what is Westport going to look like five years from now?

Yes. Let me take that, Ann. As I mentioned in my talk, like our joint ventures, our products on are sold in disparate markets and different geographies and each have their own set of parameters and influences that impact the business. We know for instance that China is a tremendous opportunity for us and it would be foolish for us not to have a sizable presence there. The way I see it it's the nature of the beast. We are monitoring geographies, we are monitoring technologies very closely so that we will be in a position to place our bets at the right time and on the right technology and in the right geography. You want to and anything?

Yes. Let me just jump on that a bit, Ann. I think that what we've been trying to convey, which if it wasn't clear, our customers are the OEMs. We are talking about vehicle OEMs who make things that have wheels generally and our focus has been on people who make commercial vehicles, not passenger cars. So when you say we're unfocused, it kind of gets my, shackles up. Look, there's only a few dozen people who make those vehicles and we go where they tell us. If they think their market for their customers like Volkswagen says our customers are in China and we want our to do this product, that's our customer. So it's not a strategy where we're all over the world doing things.

We're working with customers like Ford or Volvo or Volkswagen they've all got different views of where natural gas makes the most sense for them and we do what they tell us. That's kind of it. Now, we happen to believe that virtually everybody in the world is going to need to paint their product line with natural gas over the next few years. They're all going to get it there eventually but right now our focus is on working with the people who are working with us today or who show up at our door saying I have a bright idea. And if that happens to be guys in Russia or Tata or in India, we see them as great customers. And try to make them happy. I think the question about where we are in five years, we've always said we think material market penetration does take a couple of product generations probably so our forecast for trucking in the US, which is (inaudible) where the people continue waiver on, is 7% to 10% market penetration or 20/20. We think we're doing good work on scenarios that suggest that's realistic and that the pace of infrastructure is realistic and that the spread of the idea across fleets of various kinds makes some sense. 7% to 10% is moderate. (Multiple Speakers).

Rail is one, honestly, it wasn't our idea, but actually very interesting business. Fairly concentrated. We've got a very engaged and excited customer at EMD and full on let's go. The part that we're playing with EMD is supplying the fuel because we have the pump technology that is necessary for those high performance locomotives to move. Obviously we don't build rail cars. We work with people who make rail-cars, but our contribution is the LNG intelligence and the fuel technology that can keep up with the locomotive. So it might look fragmented but at heart it's pretty straight forward. There as few dozen major manufacturers of engines that will use natural gas and that's what we're trying to turn into a business.

Okay. In the interest of time I will get back in line. I did have one other one if there's time at the end I will like it take it up. Thanks.

Okay. Catch you later.

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

Good afternoon. I was just kind of wondering about you could clarify where you're at with Volvo truck. I know you've said things have been delayed. We've heard Volvo say they've really pushed that or cancelled that in the US. Could you gist give us some color on really where you see the Volvo program at right now?

Well, having just come back from (inaudible), let's see. I would say that we continue to work with them as I mentioned in my short words that I gave that we are proceeding both on the powertrain side as well as on the truck development. We have completed the hot and cold test fleets with them and we continue to work with them in terms of readying the product for market. I think that from a North America market perspective they, at this point in time, our focus is really turned to Europe. We think that that's a great place to launch the product and to move it forward. So that's been the focus at this moment in time and if as mentioned also we are now working hand in hand with some other industry players such as Delphi to enhance the technologies and make sure that we have got the best products that we can head to market here on the HPDI offering.

Okay. And on Delphi could you just remind us again sort of when that product gets ready? The production line is set up and when the production line will be ready and your latest thinking there?

We have got several products with Delphi already so we're in production on a couple of variances and I mentioned that on the Phase III we have some parts that are coming here in the November timeframe so we've got two variants that we're relatively far along on and the other one that we're getting now eight samples on so that's progressing quite rapidly as well.

Thank you.

(inaudible) we made about a month ago, talking about the new injectors coming with Delphi. That's still probably another year or so out before those ones are ready for production. To answer your questions.

Okay, thanks. I'll turn it over.

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

Good afternoon. It's Matt Rivack on behalf of Jerry. I'm wondering if you can talk about order trends in the wholly-owned business and specifically whether or not you think they can ramp off the challenging third quarter level.

Just to clarify, Matt, you mean on the component level at our applied technologies business, is that right?

That would be helpful to start.

Okay. Well, this is Nancy again. I would say that our operations in Italy is really the core to the business at this point in time. What we're finding is we have had really successful growth in several regions. Our regions in South America, India and China are growing significantly. What we're finding is some of our traditional markets and even the markets that have geo-political issues whether it be Thailand or Russia are a bit at this point in time in quandary to us as we're trying to understand exactly what to do.

In Ashoka's comments he mentioned even in Russia what we are finding is the Rupee to the Euro is one deterrent and just the uncertainty relative to some of these market. So, at this point in time in the high growth markets we are getting our position increased and in some of our traditional markets we're at a point where we're looking at those businesses and supporting them and trying to make sure that we are getting our share of the business. But I would say at this stage of the game in calendar year 2014 we've had to take some of the challenges on and that's why last month as we talked in that report on our near-term financing that our near term financial projections we did make some changes to that.

Thank you. And then switching gears a little bit to the ice pack tank systems. Any update you can provide us on where the customer stands on the orders you mentioned which were going to be delayed.

At this point in time I'm not going to comment on those. We're still working through opportunities on those so we need to continue to understand what that is. My guess is as we get that clarified we'll send some signals out to the market as appropriate.

Perfect. And then lastly if you could just maybe touch a little bit on what drove the reduction in the Cummins Westport warranty adjustment in the quarter and then make what gives you confidence that these levels are sustainable here?

I will give it over to Ashoka and he can talk to that.

Yes. As I mentioned, there was a very significant reduction in warranty charge this year and if I remember the numbers CAD15 million in Q1, CAD10 million in Q2 and CAD1 million in Q3. If you recollect it's all almost entirely related to the 8.9-litre engine which had been seeing some significant quality issues. We have identified the root cause of the issue. The solution has been developed and the solution is actively being rolled out to the truck population out there on the roads. The feedback we are getting from those customers who had these repairs done and changes installed is that the problems have been addressed and management is extremely confident that the worst is behind them and we expect to see hardly any warranty adjustments related to this product going forward.

Thank you very much.

The next question is from Laurence Alexander with Jeffries. Please go ahead.

Hi. This is George dance sitting in for Laurence. 2015 is another transition year and I know you talked about this a bit but are there R&D programs that can be paired back and can you just quantify the degree of flexibility left on the cost side?

Yes. I mean I think I will start and David and Ashoka can jump but George you should see the effect in R&D into 2015 as some of these programs come to completion, the prioritization of investments. So it's reasonable to expect R&D as an operational expense to see that impact.

Okay.

I was going to say the 580 is a perfect example that listed that R&D work as being done this year so the roll out of both the GAZ and the (inaudible) vehicles is an example that we've got some other rollouts of other product portfolio as well so with that, by the time we close this year the 3.8-liter industrial engine is another example of that. So ,a lot of those projects are closing out this quarter and early part of next quarter and so our 2015 R&D expense will be reduced by the that load.

Yes. I wanted to clarify that the R&D expense is net. When we talk about reduced R&D expense we mean independent investment by Westport. I think what we want to see and what we are seeing is programs where we have partners or customers who are funding some of this R&D, or all of the R&D. So, although you might look at a gross R&D number of, call it, CAD80 million this year, I'm not saying that we will cut to something like 20 or 30 next year from 80, but you may see a lot more service revenue or service contribution that takes our net down to something that is sustainable. Obviously we're not going to hit positive EBITDA by the end of next year with the current R&D run-rate if we continue to invest on our own at this pace.

So it has to be a combination of programs that end and new revenue and gross margin coupled with more investment by other people in those programs where we're doing R&D effectively as part of a partnership or on contract and so we capital give you and awful lot more detail than that. We will obviously give you some more insight at the start of the year as to what we think 2015 will load at, but obviously there's got to be a pretty dramatic change in the nature of our R&D investment next year if we're going to hit the goal that we've been shooting for.

Okay, thanks. Just a little follow-up. You talked about a 12% salary cut across the Company. Have you seen any, particularly in your engineering staff, have you seen any attrition because of that? Thanks.

Yes. Sorry. If we misstated that. It wasn't across the Company. It's across the executive team. Call it Vice President level and above.

Ah. Okay.

For exactly that reason. I think we've got to be very cautious. We've got a lot of people working very hard and we can can do all kind of things around working conditions but cutting salaries in a competitive industry is usually a recipe for seeing higher attrition which is isn't what we need. So this was a proposal to the executive team and was really pleased and gratified that absolutely everybody stepped up and agreed and for the period in 2015 I think everybody is heads down on achieving our financial goals. So, there we are.

Okay. Thank you very much.

The next question is from Eric Stine with Craig Hallum. Please go ahead.

Hi. Thanks for taking the questions. Just to clarify on the warranty charge, so that is a catch-up of accruals of systems in the field, is that right? Is that how we should think about it?

Correct. That's how you think about it.

Okay. Just curious on visibility into when going forward you see taking lower accruals per unit and just thoughts of when you think its possible getting back to that 30% plus gross margin for CWI?

We're going to see the ongoing decline in warranty accruals. There's no doubt about. We're seeing it already this year and we are gratified by the results of the changes that have been made by the engineering team at CWI and I think the next few quarters will be ample evidence of improved warranty performance.

But you seem to be getting low close to the end of the catch-ups, right, for what is in the field?

Yes. In terms of gross margins it's product mix. I mean that makes a big difference in the gross margin performance of the CWI business.

Okay. Maybe just turning to China, curious how the pipeline is developing for the WP 12 as you get close to getting test systems in the field and then just curious with MS 4 standards coming on January 1st, just initial thoughts on pricing versus diesel trucks in the field?

Let me take the first half I'm not sure I have an answer for the second half for you, but I would say that we're really pleased that through the tension engine center that we were able to get our HPDI 12-litre validated for the Euro-5. As you mentioned they're looking to go to a China for version for regulating. So, to get all the way to China 5 does put us ahead of the curve and we're pleased about that. I would say in terms of your last question I am just not in a position to comment on that. The China market and where they are relative to pricing and I will say fuel, et cetera that's I'm just not schooled enough on that particular item.

Eric, to an your questions we still expect to have HDI systems rolling around China this year in China.

That's correct.

Okay. Maybe last one for me. Just on marine. This is an area that last year you identified as would be ideal for HPDI. Just curious whether we should look for something there or whether that's one of the R&D programs that maybe is being put aside?

I would say that we continue to talk and in some cases we have teamed up with some other companies to understand exactly where we could go on the marine. One area is for some of our customer interest for our ice pack we are looking at using that technology for the marine industry. I would say some efforts are going into that to understand exactly how we can do fuelling bunkers and those kind of things. So I would say more of that as we roll into calendar 2015 as that product gets more defined.

Okay. Thank you.

Next question is from Noah Kaye with Northland Capital Markets. Please go ahead.

Thank you very much. So you've mentioned a 9% headcount reduction that will start to impact in fourth quarter. Just in terms of the accounting are you going to be recognizing any kind of restructuring or severance expenses in the fourth quarter associated with that? And how do we think about that rolling through next year?

Yes. We will account for almost all of it in the fourth quarter so that's where you will see it.

So you will talk a charge?

Pardon me?

So you will, you do plan to take a charge?

That is correct.

Okay. And sort of above and beyond that, I think you alluded to it in several different programs winding down, but how much do you think you can really reduce out of possibility R&D over the next 12 months?

You know, when you talk about R&D you're talking net R&D.

Net R&D, exactly.

Yes. As David mentioned there are a number of factors that play into it. One, of course we have programs coming to their successful completion which will terminate. Two, we are prioritizing and calling if you will certain programs that we are aligned with the pace of market development, and three, most significantly, we will have partners contributing to our R&D programs in a significant way. Does that answer your question?

And just to revisit the introduction of the HPDI 1.0 I guess program into China. Can you talk a little bit about how we should think in terms of a pricing delta for this which is obviously going it be a higher performing system but likely a higher priced than what is currently being offered through the JV and how to think about an incremental payback on that?

From an HPDI 2.0, because that's what we're launching in China, so just to make sure. 1.0 is what the 15-litre was that we sunsetted last year so this is a 2.0 system which is very comparable to what we're offering to other OEMs worldwide. At this point in time for the first units that we're shipping out and we're looking to do, those are obviously under special pricing circumstances so at this point in time we're in I will say prototype pricing scenarios and working that because there's a lot of obviously built-in costs et cetera in those and low volume tooling. So, at this point in time we're going to make sure those products are running and sufficient and getting down the road as we then will continue to work on what we think series production pricing is.

Sure. And thanks for that Nancy but just to clarify, you say HPDI 2.0. Are these using the new generation of Delphi injectors or are these the legacy injectors?

They are using Delphi injectors but they are using a not what we call the Phase III but they're using a variant that is, I will say, a current generation of them and it is a product that is produced for Westport by Delphi. So we have been using the Delphi injectors even in HPDI 1.0 and Delphi has been our sole partner relative to the injector systems for the HPDI units.

And to clarify even further I guess, the 2.0 the next-generation Delphi injectors, those are co-developed and those are the ones that still are some timeout before they come to commercial production. I think somebody asked that earlier in the call but just wanted to clarify that generation is built by Delphi, but it is really under our Westport spec.

Yes and that's the one we used the in the validation of the China 5 variant.

Okay. Thank you so much for the color. Appreciate it.

(Operator Instructions). The next question is from John Quealy of Canaccord Genuity. Please go ahead.

Hey folks. It's Jim Moore, for John. For ice pack outside of the big order that got taken out of guidance it sounds like you're starting to see some better transaction. Can you just talk a little bit about how that product is performing, where we stand in terms of deployments and how we should be thinking about profitability? Thanks.

Yes. Several things I would comment is that we are definitely seeing traction. Our traction is coming from folks that we have been working with over time and as I mentioned Hoops Trucking is a company that has bought 15-litre HPDI 1.0 engines from us in the past and has had a good experience with us so, therefore, we have continued to work with them. So they are what I will call an early adopter that is working with us and they see the continued value but then we have customers on the other hand such as Kroeger and American (inaudible) that are I will say now new adopters that are coming and see very positive results.

Not only do we work with them obviously to outfit the truck but one of the things we have been doing is working with them on routings and those kind of things in order for them to ensure that they get the efficiency relative to the fuel and so what we're finding is that our relationship with the OEM truck builders to get it on the truck but also with the fleet owners in order to maximize it has been really the key to our success there. So, this close integrated relationship is something that we're going to continue and we think is going to have continued results in a positive way for us at Westport.

And there's also been an expansion on effectively application. The systems we have largely been selling to-date have been for on-road and I think there are some off-road. And Nancy alluded to marine as an application potentially earlier so there are other applications that should provide some growth on a year-over-year basis into 2015.

Okay. That's helpful. Appreciate it. And just last question for me. On the new enhanced spark engine for medium duty maybe you can just talk a little bit more about go-to-market for that and milestones we should be looking for?

Okay. On that, as we mentioned, we've got several OEMs that are interested. It's a product that since we did our press release which was in the mid-September time frame, we have really had virtually every corner of the earth come back to us and ask so we have been successfully marketing in obviously major markets China, Japan, Europe and North America. At this point in time I think our discussions are now in, I'll say, where we have had multiple meetings with several of them and that we would hope that we're quite hopeful that we'll be able to enter into a development phase with one of them, but I think that the interesting side for this product is that it is the amount of interest we have because of the performance characteristics as we outlined in our press release have really gotten people's interest and there as lot of opportunity in the medium duty space, which is where we think that this product fits the niche.

Thank you.

We have a follow-up question from Ann Duignan with JPMorgan. Please go ahead.

Yes. Hi. Thanks. Just on that very topic. Just to be clear, this new spark ignition or ESI that you're developing, - you would be selling just the spark ignition system or not the spark plugs but whatever enhanced spark plug system you have developed, you're not selling an engine with the spark ignition?

Ann, our work would be with an OEM that would allow us to outfit the engine with a spark ignited system, but in our product offering we would be offering the component tree, we would be offering the control system, and in some cases OEMs will want to do in their own production facility and run it down their production lines. And so in that case we will be working with them in terms of outfitting the truck, outfitting the engine and then potentially even kitting parts to them in order for them to do the assembly. In other cases customers have thoughts of how they would like to it differently.

Okay. And how would this compete or fit in with the Westport joint venture products?

CWI? I would say that this would be a competitive product with some of the offerings they have. At this point in time this particular product, as we said in the release, has some characteristics that has performance attributes that could get significant performance and allow a smaller size engine to behave more like a larger engine. So we think that this is really the value proposition that we're putting forward on that.

But conversely, Ann, it would be available to many OEMs. If any of the existing joint venture partners were interested there's no reason that we wouldn't engage with them. Just a function of first come first serve.

Yes.

Sure. And I appreciate that this would be available to integrated engine manufacturers, too. So okay. Good. Thank you I appreciate the clarification.

There are no more questions at this time. I will now hand the call back over to Mr. Seed for closing comments.

Thanks very much everyone for your attendance and we look toward to seeing everybody in February for the fourth quarter and year-end conference call.

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