Westport Fuel Systems Inc (WPRT) 2015 Q3 法說會逐字稿

Welcome to the Westport Innovations quarter-three 2015 financial results conference call.

(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 of FY15 conference call. It's being held to coincide with the disclosure of our financial results earlier this afternoon. For those who haven't seen the release and financial statements yet, they can be found on Westport's website at www.westport.com. Speaking on behalf of the Company will be Westport's Chief Executive Officer, David Demers; and Westport's Chief Financial Officer, Ashoka Achuthan; and Westport's Executive Vice President Heavy-Duty Engine Systems, Jim Arthurs. Attendance of 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 is 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 thank you for your interest and support of Westport. Q3 saw several important milestones, including the announcement of a transformational merger with Fuel Systems Solutions. So I'm briefly going to touch on what I see as the major strategic points during the quarter, and then we will turn the call over to Ashoka for the financial highlights. Nancy is traveling in Asia this week, so we have asked Jim Arthurs, who is Chair of the Cummins Westport joint venture, as well as EVP of our Heavy-Duty Business, to comment on the operational highlights.

So let's start with the Fuel Systems deal, the old which we announced on September 1st. I'm sure many of you have seen the draft F-4 filings and the story of this transaction from the Fuel Systems side, as laid out there. I think there are several significant benefits to the combination of Westport and Fuel Systems. First, the combined Company will be one of the largest in the alternative fuel systems industry, providing the global reach, scale, and expertise to compete effectively and ultimately grow and deliver strong shareholder returns as markets improve. Second, the combined Company will benefit from a strengthened balance sheet and enhanced liquidity and will be positioned for continuous investment and long-term financial stability. Third, consolidation will produce cost efficiencies. The transaction is expected to be accretive to the Company's combined adjusted EBITDA and earnings in 2016, excluding one-time costs, with annual savings and merger synergies expected to reach $30 million by 2018. And fourth, and probably most important, the transaction will combine our technology and expertise in medium and heavy-duty and high horsepower applications, with Fuel Systems core focus and development efforts in the light duty and industrial applications. The resulting combined Company will have unique technological expertise and product development spanning from passenger cars and heavy-duty trucks to locomotive marine and stationary power. Westport and Fuel Systems each bring long-standing relationships with key global OEMs, which will become strengthened as a result of this combination. As you've seen, we've now cleared the antitrust review processes, and we are now in a review period with the securities regulators. This timetable will mean that shareholder meetings are expected to be held in January and we will close the transaction shortly thereafter.

Before turning it over to Ashoka, I'd like to highlight three other items. First, as you saw over the past few weeks, we've completed a major milestone with (inaudible). With our production partners, we will be delivering B-level production design intent parts for innovative testing in the first half of 2016. We've concluded (inaudible) negotiations with our lead customers, and we're making excellent progress with several other OEMs. Collectively, this represents over 30% of the global production of diesel truck engines. Second, we saw the announcement of Cummins Westport's newest engine, a Near Zero emissions solution for buses and (inaudible) trucks. The market for this offering (inaudible) natural gas vehicles like transit buses will see NOx emissions that are indistinguishable at (inaudible) vehicles at much lower cost. And as the operator is using renewable natural gas, there's a large greenhouse benefit as well. This announcement has triggered significant interest over the world, as you an imagine.

Finally, I wanted to single out our Volvo car team, who completed development of the first gasoline direct-injection bi-fuel vehicles, which has recently resulted in the largest order in this team's history. Notably, the team has also reached profitability, even at the global production volumes, and we'd like to congratulate them. Conditions on the global economy remains volatile and low oil prices continue to stress many of our markets. But the more important fact is that in most markets spread between natural gas and conventional fuels remains attractive, and our business prospects remain strong. Sales of our current products, including the Cummins Westport joint venture, remain steady, and prospect for our new products are encouraging. We continue to expect to see revenue for 2015 between $110 million and $125 million for the full year, as we make progress towards our business [audit] and product launch milestones in 2016. Ashoka.

Thank you, David. Good afternoon, everyone. I will be providing you with some highlights of our third quarter, actions we have taken to address our expenses and cash position, and will then color our financial outlook for 2015. As David noted, we have completed another quarter of steady progress towards reaching our 2015 operational targets. Despite continued economic weakness in certain markets, Westport reported strong results in the Cummins Westport joint venture compared to last year, and achieved significant milestones with a number of global OEMs. Jim Arthurs will elaborate on this in his discussion of operational highlights.

Westport revenue from operations, including our corporate and technology investment segment, was $22.3 million for the quarter ended September 30, compared to $25.3 million for the same period last year. The 12% decrease is due to the impact of low oil prices on some our North American business, such as the Ford CVN business, weakness in our iCE PACK business, and the unfavorable impact of foreign currency translation from the euro to the US dollar. Revenue from European operations, including acquisitions, in fact increased by EUR4.4 million, but were relatively flat on a US-dollar basis. Westport is reiterating its revenue outlook and expects consolidated revenue from Westport operations and consolidated and technology investments to be between $110 million and $125 million for the year ended December 31, 2015. Cummins Westport, or CWI's, revenue was $82.4 million, on 2,343 units for the quarter ended September 30, 2015, an increase of 17% over the same period last year. Revenues increased on a year-over-year basis due to strong performance in North America in the core segments of transit and refuse. Weichai Westport's revenue, however, was $33.6 million on 2,992 units for the quarter ended September 30, 2015, on a decrease of 81% over the same period last year. General economic conditions in China has resulted in an industry-wide softness in truck demand contributing to Weichai Westport's weaker sales.

Moving on to operating expenses, Westport Consolidated reduced its combined operating expenses by $6.5 million, or 20%, for the quarter ended September 30, 2015, compared to the same period last year, primarily due to prioritization of investment programs, cost discipline, as well as the favorable impact for the foreign exchange translation from the Canadian dollar and the euro to the US dollar. Moving on to net income, our income from CWI improved very significantly during the quarter. Westport's portion of CWI net income for the quarter was $3.5 million, nearly a 3 point increase compared to the same period in 2014. This improvement was largely related to the resolution of warranty issues associated with the ISL G engine and the continued strength in sales and transit and refuse segments. For Weichai Westport, the net income for the quarter ended September 30, 2015 was $400,000, a decrease of 88% over the same period last year due to significantly lower units sold as a result of the reduction in industry-wide demand, as I mentioned earlier.

From a consolidated viewpoint, the third quarter ended September 30, 2015 resulted in a net loss of $37.4 million, or $0.58 loss per share. Included in these results are an $18.7 million goodwill impairment charge and a $5.5 million inventory write-down. Combined, these charges represent a $0.38 per share non-cash impact. Excluding these charges, our consolidated net loss would have been a loss of $0.20 per share.

Moving on to our cash position, as of September 30th, our cash, cash equivalents, and short-term investment balance was $42.1 million. Cash used in operations, excluding changes in working capital plus dividends received from our joint ventures, was $14.3 million, compared with $25.3 million for the same period last year, an improvement of 44%. Note that this [use of the] $14.3 million includes cost related to the announced merger with Fuel Systems solutions. Working capital changes generated $2.6 million this quarter. We have ongoing initiatives in place to continue improving upon our working capital performance over the upcoming quarters. We also have an active term sheet related to non-core asset sales and have additional strategic initiatives underway. Our target is to complete these transactions by year end.

Moving on to adjusted EBITDA and key steps on our path to profitability, adjusted EBITDA from our operations segment for the quarter ended September 30th was a loss of $1.8 million, compared with a loss of $5.4 million for the prior-year period. This was the result of operational improvements and cost management initiatives across our businesses globally. Consolidated adjusted EBITDA improved 56% in the third quarter compared to the same period last year. Adjusted EBITDA for the third quarter was a loss of $9.7 million, compared with a loss of $22 million in the prior year. This was due to overall improvement in our cost structure, prioritization of investment programs, and higher CWI net income to Westport. We are facing some headwinds from lower oil prices and economic turbulence in certain markets, but have made the necessary adjustments to be able to capitalize on opportunities as they arise and when industry conditions improve. We are making significant progress towards our goal of consolidated positive adjusted EBITDA by mid-2016, and I look forward to bringing you further updates on our progress in the next quarter.

With that, I will pass the call on to Jim Arthurs to discuss our operational highlights.

Thank you, Ashoka, and good afternoon, everyone. I'm going to focus on providing some operational highlights for the Company. Our operations team has completed another strong quarter delivering on targets on a variety of natural gas technology programs. Despite the economic weakness in certain markets, we continue to make a number of product announcements in the quarter, including the announcement of the dedicated liquid propane system for the 2016 Ford five-liter F-150 pickup truck. It will join our dedicated and bi-fuel CNG offerings with the Westport Wing Power System that we announced in May, also using a five-liter engine to provide F-150 customers with a wide range of alternative fuel solutions. All three systems will launch in 2016 and add to our full range of trucks from the F150 to F-650, offered through our QVM program with Ford.

We introduced the Cummins Westport ISB 6.7 G mid-range natural gas engine for the type C school bus market. This engine will also launch in mid-2016. As David mentioned, we certified the Cummins Westport ISL G engine to Near Zero NOx emission standards, to 90% below current regulated levels, and I will talk a little bit more about that in a minute. Finally, we delivered the first 2016 Volvo V60 direct injection bi-fuel cars to a key customer, Sunfleet in Sweden, and as you heard from David, we're seeing good growth in our Volvo car business.

In addition to these announcements, we made significant progress on our HPDI 2.0 programs, as we progress from design and development phases to final testing and validation. Our team is dedicated to continuing our advancement towards commercialization of HPDI 2.0 technology with a strong focus on component readiness. Since the announcement of the HPDI 2.0 system in September last year, we have worked with our development partners and suppliers to complete the design of all HPDI 2.0 components and to make good progress on testing and system validation. A key partner is Delphi, who is producing a fuel-injection system components. The latest generation of HPDI fuel injectors were developed under the joint development agreement we have with Delphi, and feature a new direct connected architecture and incorporate technology from both Westport and Delphi. The new injector provides higher performance, lower cost, and much easier packaging on the engine the prior HPDI systems. We've also developed a new fuel rail, which is the component that supplies fuel to the injector, and it incorporates both natural gas and diesel fuels into a single rail. This also provides lower cost and easier packaging than earlier generation designs.

Our HPDI 2.0 components, including these latest generation fuel injectors and fuel rails from Delphi, are undergoing engine and truck testing here at Westport, and will be delivered to OEM customers for the validation and testing early in the first quarter of 2016. We expect to deliver B-level of production design intent components to our OEM customers in second quarter of 2016. A B-level component is the final design component that uses materials from the production intent material suppliers, so this is the final stage before we get into manufacturing testing. They're used for vehicle integration engine testing and certification, and customer field testing. We're also working on our injector production facility to be located at a Delphi plant in the UK, with production equipment now on order. Full commercial production will follow in accordance with our OEM customer launch plans.

Cummins Westport had a strong quarter with significantly reduced warranty plans on the ISL G engine, and strong sales in the transit and refuse markets. Despite the current global fuel price differential between diesel and natural gas in North America, Cummins Westport's unit sales and revenue grew year over year in the third quarter and year to date. David mentioned the new Near Zero NOx technology that's being incorporated onto the 8.9-liter Cummins Westport ISL G engine. We've received a very positive reaction in some markets, particularly California, where this new technology that reduces emissions of oxides of nitrogen, or NOx, to 0.02 grams per horsepower hour, which is almost unmeasurable and 90% below regulated levels for heavy-duty and medium-duty vehicles. NOx is a toxic pollutant that contributes to smog formation and has negative health effects, and it's been getting a lot of news coverage lately.

California's Air Resources Board has defined our certified Near Zero NOx emissions level as equivalent to a 100% battery-powered truck using electricity from a modern combined cycle natural gas power plant. Equal to electric is what they say. This is a powerful statement and is getting a lot of attention. The Near Zero NOx ISL G also features closed crankcase ventilation, which reduces engine-related methane emissions by 70%, and the engine meets 2017 EPA Greenhouse Gas Emission requirements. What's even better, when fueled with renewable natural gas, which the ISL G is fully capable of using, an ISL G Near Zero NOx vehicle can deliver greenhouse gas emissions reductions of up to 80%; 80% compared to conventional petroleum-based fuels. This makes it one of the most environmentally friendly commercial vehicles available at a cost much lower than electric alternatives. Now some people may consider renewable natural gas as a niche fuel, but according to the Air Resources Board, the low carbon fuel standard reports in the first half of 2015, 42% of the natural gas used in transportation in California was renewable. We're very excited about this new technology and expect to launch the ISL G Near Zero NOx engine in April of 2015.

As Ashoka mentioned, at Weichai Westport, we faced economic challenges that have put downward pressure on sales. That said, our HPDI 2.0 development program continues to move ahead in China. We're delivering the latest generation HPDI 2.0 components at Weichai Westport right now, and we expect to have field-test units running in the first half of 2016 to complete validation and durability testing and for customer field testing. Overall, our third quarter has been very busy, and we are pleased with our progress across many product lines. At the same time, our team is keeping a watchful eye on expenditures and is ensuring overhead SG&A and R&D expenses are carefully aligned to ensure we meet our business objectives. As a team, we're pushing hard to meet our publicly stated goals on time and look forward to sharing with you the completion of further milestones to come. With that, I will pass it back to the operator for questions.

(Operator Instructions)

Laurence Alexander, Jefferies.

Hi, this is Jeff Schnell on for Laurence. Cummins Westport units are running about 6% above 2014 year to date, but that number would need to increase 25% sequentially to be flat on a unit basis year over year. Can you talk about what you're seeing on the demand side that gives you these expectations that maybe units could be more than flat year over year? And maybe what you're seeing into 2016?

I think Jeff, I know what we're not able to do, which is guidance, give guidance on Cummins Westport. I think, the only thing, unfortunately, we can do and provide is what we're seeing in the stability more so in the refuse market and the transit market. I think, so for this year, obviously, a lot of volatility in energy price, a lot of pressure. But from our side, it could be some international market effects, [muting] international sales. And don't forget Jeff, to, as we actually did last year, we did get some fairly lumpy orders, I know you're familiar with that term, from international orders. So obviously, our revenue is up, so there's a function of product mix and where the units are going. I think again, given that we don't consolidate the -- if I want to maybe stress the important point that because we don't consolidate the revenue, Cummins Westport, it really is about the income, and that income, it delivers. And as you saw in this quarter, we had a fantastic income from Cummins Westport. So that's obviously, we want to see the business maintain if not grow, but fundamentally we're happier seeing the net income than the positive effects on our income statement.

That's helpful, and if I can just expand on that. CWI gross margins improved, as you mentioned. Is this a fair run rate to assume going forward, or is there anything favorable or unfavorable that might impact this in Q4?

Yes, the gross margins impacted by warranty accrual reversals. So there is an element of that in the current quarter's gross margin percentage. And as we've always said, a mid-20% range is a reasonable expectation for gross margins within this business.

Great, thank you.

Thank you, Jeff.

Ann Duignan, JPMorgan.

Hi good evening, everybody. Can you just give us some more color on the inventory write-down? And on the impairment charge on the Italian business, can you just remind us how much you spent buying that Italian business?

I'll need to get back to you on the exact number, Ann, but it was -- what year did we buy it in?

2010. We will come back to you.

We will get back to you on that, but there was an 18.7% goodwill impairment. We essentially wrote down all the goodwill that was left that was related to that business. And yes, it is the Italian business. On the inventory, we took a $5.5 million inventory write-down. All it can tell you here is it was in the North American space, and it was after a thorough review of our carrying cost of certain inventories here.

Okay. And then, just separately on the Chinese business, we have been hearing from our Chinese contacts that the Chinese government is deemphasizing natural gas as a fuel, particularly in public transportation, and really trying to push for electric vehicles. Can you talk about that and the impact that might have on Weichai and your joint ventures over the near to midterm?

Ann, it's Jim. We don't really see that so much, and in fact, we hope our Near Zero NOx technology provides a better alternative to electric buses in emission-sensitive places like Beijing. And certainly for the heavier transport, which is the 10- and 12-liter Weichai engines that form the majority of our volumes, that's not going electric anytime soon. That will be LNG powered for quite some time. So we're not seeing that as being something that's affecting our business.

We also, Ann, directly to your question on government policy and shifting [sands there], that's definitely not -- we've actually seen the opposite. We've seen government activity that suggests, in fact, the opposite. They are still supporting natural gas and still want to see a significant portion of transportation go to natural gas by 2020 and definitely in the truck sector.

Okay. I will leave it there and circle back. Thank you.

We will come back to you, Ann, on the historical purchase price for acquisitions such as [Hammer and OBL].

Eric Stine, Craig-Hallum Capital Group.

Hi everyone. Maybe -- good detail and good progress on HPDI. Any way, to estimate or just thoughts on 2Q -- if -- it sounds like final design and components, maybe what you would expect if you're able to share what the time would be between manufacturing and then what that means in terms of a commercial launch. Is that something you an share or is that something still in the category of its up to the OEM?

Yes, Eric, we can't really talk about that. Our OEM customers are the ones that make those decisions, and we've got to go through lots of validation before they are ready to go. So I would suggest you ask them.

Right, okay. But I mean, at least the progress you've made in the announcement you had with Volvo, I guess that would imply sooner rather than later.

Yes, what we're focused on is our production readiment. So as I mentioned, we're into the product design is finalized now. We're just into durability testing and this particular type of steel exactly what we're using, getting the manufacturing capability in place. So we're heading down all that path. There's lots of work being done and we're happy with the progress.

Okay. Maybe just turning to the asset sales, you called it out that you still expect it by year end. Active term sheet, is that something where you've got multiple parties involved, or is it something where you've narrowed it -- narrowed the list quite a bit? And is it still $50 million, is that still the target by year end?

Yes, Eric. It's Darren. We are and have an active term sheet. We have a few parties interested in some non-core assets, so we have reiterated our line that we do expect to have something announced this quarter. So I think we're hoping here, obviously, we've only got a few weeks left, and we should be able to identify that shortly. And it's still the targeted amount. I think we still identified roughly $50 million in non-core asset sales. We've got some strategic initiatives we've got on the go as well, but they have progressed since our last conference call, and hoping here in the next two weeks or three weeks or a few weeks before Christmas you can see a press release.

Okay. And then, you touched on the additional strategic initiatives. Is that something that would be above and beyond that $50-million target that you talked about?

No, I think right now, Eric, we're just looking at them as multiple ways to hit $50 million for now.

Okay. Maybe last one for me, and this is just thinking about what fourth quarter looks like. You -- well, if my math is right, $32 million or so to get to the bottom end of the range, it's a pretty big step up. So just visibility you've got into that. And then also just thought process that you kept such a wide range. Are there things that potentially get you to the top end of that? Or what was your thought process there?

Eric, yes, your math is correct. It is $32 million that we needed to the get to the bottom of the range, and yes, we have a fair degree of visibility to get there and we expect that we will. No, no real magical secret to leaving the broader -- the higher end of the range intact. We just -- some of the events that we are working on and some of the programs we were working on tend to be a little binary and lumpy. So in the absence of better information, we decided to leave the range untouched.

And just consistency, Eric, for us, it's been very consistent for the last several years. We just don't change the range until there is absolutely a necessity to do so.

Right. Okay. Thank you very much.

Thank you, Eric.

Rob Brown, Lake Street Capital Markets.

Good afternoon. Could you talk a little bit more about the HPDI customers? I know you can't talk about them specifically, but what target markets are they going after and what's the timeline on other OEMs that you haven't announced? What's the thinking on when they switch over to HPDI?

Well, the target market is heavy-duty trucking. So in Europe and North America and China that's the core market we're going after. We have, as David mentioned, we've got work going on with OEMs that represent one third of the marketplace, and more to come. But we really can't talk about timing, as I said earlier. That's up to the OEMs.

Yes, and we've got the --

The commercial development programs are targeted both Europe and the US market, is that right?

Well, go ahead.

Europe primarily and China. Those are the first two.

That's what we publicly disclosed with the OEMs today.

Just clearly, the natural gas truck business in China is the biggest in the world and a big focus area for us. So we've got a great joint venture there that's the leading player. And in Europe, what we see is lots of countries in Europe where there's still a very, very strong differential between natural gas and diesel. So we've got lots of demands from customers in those markets for heavy-duty offerings at [06] levels, which really aren't available.

Okay, great, thank you. And then on the Q4 question, do you have a chunk of development revenue and R&D revenue coming in the quarter, or is it -- are you thinking primarily product revenue that makes up the step up?

In which quarter?

In the fourth quarter.

No, there is no service revenue of any significance.

That we expect.

Okay. Thank you. I will turn it over.

Thank you, Rob.

Jeff Osborn, Cowen and Company.

Hi, this is Moses on for Jeff Osborn. Where in the US are you still seeing solid diesel gas spreads, if any, with possibly more stable demand?

Well, the biggest thing right now where we are seeing the most growth for Cummins Westport is where customers are tying into the pipeline. So you can see prices online where you can see CNG and LNG prices that are posted prices at fuel station. But we have a lot of customers that are taking advantage of the gas pipeline that often runs right in front of their location. So you see CNG and LNG prices in the low $2 range, which is just cut right below where diesel is in a lot of markets right now. But we've got many customers who are buying their gas from the utility, compressing it themselves, and they are seeing natural gas pricing in the $1.30 diesel gallon equivalent range. So there's still a really good price reduction or cost reduction there. And so that's where we are seeing most of the activity in 2015.

That's very helpful.

John Quealy, Canaccord Genuity.

Good afternoon, folks. I'm sorry if you covered this, but in terms of the light-duty Italian write-offs, how does that product lines overlap or not with the pending Fuel Systems deal coming up?

There is very little overlap, John, very little overlap. Our focus is primarily on the OEM side of the market, and Fuel Systems still has substantial strength on the after-market side. In terms of curing and in terms of positioning within the light-duty space, we address different segments of the markets. So in our view, there is very little overlap. Quite to the contrary, I think we both bring in OEM, deep OEM, and after-market and disturber relationships that are complementary as well and will broaden our distribution base.

Okay, so the write-off was legacy OEM stuff, is that what it was?

Substantially, yes.

Okay. Thank you. And then lastly, in terms of the visibility for Q4 in the range, I understand the methodology and things like that, but can you talk about visibility in Weichai? I'm sorry, I think there was some mix things there, that the heavy heavy-duty side seems to be stronger again. I'm sorry, could you recap Weichai and visibility in Q4? Thank you, guys.

No problem, John. Actually it was in the product mix actually in terms of the bus sector is actually doing better for Weichai Westport right now. It's just the truck market, the heavy-duty truck market which took the brunt of the economic hit for the majority of this year. And it's obviously from visibility standpoint, we're probably looking to 2016 for better results.

This concludes the time for question and answer. I will now hand the call back over to Mr. Seed for closing comments.

Thank you so much, everyone, and we look forward to speaking to everybody in February or late February, March in Q1 --sorry for the year-end financial conference call. Thank you very much.

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