Thank you for standing by. This is the conference operator. Welcome to the Westport Fuel Systems 2nd Quarter 2018 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.
I would now like to turn the conference over to Ms. Caroline Sawamoto, Senior Manager of Investor Relations and Communications for Westport Fuel Systems. Please go ahead.
Thank you, and good morning. Welcome to Westport Fuel Systems' Q2 2018 conference call, which is being held to coincide with the press release containing Westport Fuel Systems financial results that went out yesterday. On today's call, speaking on behalf of Westport Fuel Systems is Chief Executive Officer, Nancy Gugarty and Chief Financial Officer, Mike Willis. Attendance at this call is open to the public and to media, but questions will be restricted to the investment community. You are reminded that certain statements made in this conference call and our responses to various questions may constitute forward looking statements within the meaning of U.
S. And applicable Canadian securities law and such forward looking statements are made based on our current expectations and involve certain risks and uncertainties. Actual results may differ materially from those projected in the forward looking statements, so you are cautioned not to place undue reliance on these statements. Information contained in this conference call is subject to and qualified in its entirety by information contained in the company's public filings. In particular, reference is made to the ongoing SEC investigation and related costs as described in Westport Fuel Systems' financial statements and Management's Discussion and Analysis.
I will now turn the call over to Nancy.
Good morning, and thank you for joining us for Westport Fuel Systems' 2nd quarter results conference call. For the last 2 years, we have been relentlessly focused on transforming the company into a profitable, sustainable organization. I am pleased that we have made considerable progress towards this goal. The culmination of our efforts in aligning our costs with revenue, optimizing our product portfolio, divesting of our non core assets, implementing manufacturing excellence initiatives and launching Westport HPDI 2.0 has led to this moment. In the past, we have guided that we would achieve positive adjusted EBITDA during Q2 of 2018.
We have delivered, and this is a huge milestone for us. Furthermore, With the launch of HPDI 2.0 in 2017, our R and D and capital expenditures have decreased significantly, further improving the company's cash flow profile. We ended quarter 2 with a healthy cash position of $51,200,000 which has been further strengthened by the recent completion of our compressor business sale for gross proceeds of €12,300,000 With increasingly today. We have a complete product offering that addresses a broad range of alternative fuels, including LPG or propane, natural gas and hydrogen. Our suite of products are quickly taking advantage of the changing market trends, such as higher oil prices, stricter emission regulations and customer demanding clean vehicles.
In the recent discussions with OEM partners, they said that they have seen a significant increase in CNG car registrations. In Germany, for example, they saw over a 600% increase year over year. Although it is still a relatively small market compared to diesel and gasoline car sales, they believe CNG could potentially reach 5% to 10% of the total fleet in Europe. We have come a long way, and we're ready for the next stage of growth. We can now seize evolving opportunities with our valued industry partners.
We are doing this by advancing our existing technologies and deepening engagements with industry partners, which will further strengthen our market position. For example, for the aftermarket business, we are investing in targeted R and D to stay pace with new technologies introduced by automotive OEMs. We are also investing in high pressure fuel systems. As As OEMs move from 350 to 700 bar hydrogen storage systems, we are developing higher pressure fuel system components to fit their needs. This higher pressure hydrogen product family is planned for 2019, and it will complement our portfolio of low pressure components in order to offer complete hydrogen fuel cell systems.
Another example is on our HPDI system. With higher performance of OEM engine platforms, Westport Fuel Systems is advancing higher pressure systems to support the powertrain efficiency improvements, specifically higher peak cylinder pressure. Furthermore, with this shifting landscape, the OEM market is primed for our Ready solutions, especially with the increased anti diesel sentiment as well as the heightened renewable energy mandates. In particular, we are seeing growth in our DOEM business, which is typically a leading indicator of growing demands for alternative fuel OEM products. With this growing OEM interest, we have recently hired an leader to lead our OEM activities, so we can best build on this momentum and accelerate the pace of adoption, particularly in the alternative fuel markets.
While we're really excited about the prospects of our existing business, We also need to make sure that we keep our eye on the future. This is about growing profitably.
Our R
and D activity will be much more targeted in nature. We anticipate our customers will fund these initiatives in partnership with us. We are carefully evaluating new opportunities and technologies that we expect to underpin future growth But we will do this in a very sustainable manner. I'm going to conclude with 3 key takeaways today. We are delivering on the targets we set out for ourselves, and we expect to sustain our positive performance.
We have reached an inflection point through our strong operational results with a suite of products that are quickly taking advantage of changing market trends. And finally, we're in a prime position to seize evolving opportunities with our valued industry partners by advancing existing technology and strengthening engagement with industry partners. With that, I will turn the call over to Mike to provide our Q2 financial details.
Thank you, Nancy. As you know, this is my first quarterly call since starting with Westport Fuel Systems in early June. I'm I'm really pleased to be joining the company as it hits this milestone of turning adjusted EBITDA positive. I've been immediately impressed by the talent of the Westport Fuel Systems team and the passion they have for what the company is trying to accomplish. I'm very optimistic about our prospects and believe that we are well positioned to become a profitable company, providing market ready products to support alternative fuel usage across all segments of the transportation sector.
I've had the chance to speak with all of our analysts and with many of our shareholders and look forward to meeting with more of you in the near future. I'll start with Slide 5 that provides a summary of our Q2 results. Note that the current and comparative periods have been adjusted to exclude the compressor business for which we completed the sale in July. Cash on hand at the end of the quarter was $51,200,000 and excluded the proceeds from this sale. As a side note, as a newcomer to Westport Fuel Systems, I've been really impressed by the company's ability to drive significant value from its assets since the 2016 merger with Fuel Systems, generating meaningful cash proceeds from the sale of the industrial, APU and compressor businesses, while also developing a streamlined and profitable portfolio of transportation focused businesses.
Now on to our financials. We closed the quarter with sales of $80,500,000,000 a net loss of $5,700,000 and adjusted EBITDA of 8,600,000 Operating expenses increased due to unrealized foreign exchange losses of $5,200,000 and legal expenses related to the previously disclosed SEC investigation, but these were partially offset by significant reduction in R and D expenses. As already noted, we achieved positive adjusted EBITDA in Q2 2018 delivering on our prior guidance for the quarter. This is a credit to Nancy and the entire Westport Fuel Systems team for Turning to Slide 6, we look at our transportation business segment. Revenues for the 2nd quarter improved by 37% to $80,500,000 as compared to the same quarter in 2017.
Sales also improved by 26% from the Q1. This was a result of stronger sales in almost all of our businesses, including the aftermarket, DOEM, light and medium duty OEM businesses, as well as from HBDI 2.0. Gross margins improved to $21,700,000 in the Q2 of 2018 from $15,300,000 in Q2 2017 and $14,600,000 in Q1 2018. We're seeing improvement in gross margin as sales increase and we leveraged the fixed cost basis of several of our businesses. The company is also seeing efficiencies through consolidation of its manufacturing facilities globally.
R and D expenses decreased 47% in Q2 2018 compared to the prior year from $13,600,000 to $7,200,000 in line with what we have previously mentioned publicly. We expected this decrease in R and D spend as we transitioned HPDI 2.0 from a product development activity to a commercial sales and marketing support activity. Going forward, our R and D efforts will now be more focused on supporting sales of our products in the marketplace, and we'll look to have customers support new R and D initiatives in partnership with us. As a result of our higher sales and tightening R and D spend, Adjusted EBITDA improved significantly to a positive $7,400,000 in Q2 2018 within the Transportation segment from a loss of $5,800,000 in Q2 2017 and a loss of $700,000 in Q1 2018. Now turning to Slide 7, we'll review the results of the Cummins Westport joint venture.
CWI recorded revenues of $86,900,000 in Q2 2018, an increase of $34,700,000 over Q1 2018 and an increase of $7,400,000 over Q2 2017. As we noted in the Q1 earnings call, CWI revenues were negatively impacted by pre buy activities that occurred in Q4 2017 in advance of the 2018 requirement for onboard Diagnostic compliant engines. It's great to see revenues bounce back so well in Q2. As anticipated, R and D expenses are trending lower and we expect these expenses to remain at historic lows going forward as the JV isn't anticipating any new major R and D projects going forward. Also, the reduction in corporate tax rates that was recently enacted in the U.
S. Should increase the after tax income for CWI. This should translate into higher cash dividends to both partners in the future. In Q2, CWI recorded net income of 15,500,000 or 18% of sales. And during the quarter, Westport Fuel Systems received cash dividends of 7,100,000 Turning to Slide 8, we look at our corporate segment.
As mentioned previously, R and D costs in the corporate segment are now only associated with protecting our intellectual property, including maintaining our patent and trademark portfolios. SG and A costs remained relatively consistent with prior periods, with the exception of legal expenses relating to the SEC investigation, which were a net $2,500,000 in the quarter. Turning to Slide 9, we show our cash walk. We started the quarter at $55,200,000 and ended with $51,200,000 It's important to note that our ending cash balance Due to legal expenses relating to the SEC investigation and the buildup of working capital as revenue and production increased during the quarter. Other significant sources and uses of cash were dividends from CWI were $7,100,000 capital expenditures were $1,700,000 this quarter, a significant decrease compared to prior quarters and principal and interest payments were $2,000,000 For the full year 2018, we're For the balance of 2018, we anticipate our financial performance to continue to be positive as compared to what we achieved in 2017.
However, it's important to note that we did benefit from some positive market dynamics and some seasonal trends in Q2 that may not be as strong throughout the balance of the year. As the year progresses, we expect to provide additional color to our shareholders on how we see the year turning out from a financial perspective. With that, I'd like to turn it over to the operator for questions.
Thank you. We will
now begin the question and answer session. Our first question comes from Colin Rusch of Oppenheimer and Company.
Thanks so much, Hans. Given the benefit that you had in the 2 in the second quarter and thinking about the guidance for the back half of the year, I guess, we'd like to really get some more granular information around the revenue breakeven level. Should we be thinking about You guys being able to breakeven with the revenue in a range of the $55,000,000 to $60,000,000 level. What other
I don't think we've done the analysis per se in terms of a specific revenue run rate that gets us to cash flow or at least I guess adjusted EBITDA breakeven. I would say that it would probably be higher than call it the $60,000,000 level Because we've seen that level for, call it, the last 5 quarters, plus or minus. So it's probably Higher than 60, definitely, obviously, lower than 80. But again, I haven't done the analysis to give Specific we can give you a specific number at this stage. I think key to that also, as you know, is things like Product mix would be probably the number one thing that I can think of in terms of what would dictate Kind of a range as it relates to that number.
Okay.
And then just a longer term strategic question because I know a lot of folks are going to ask about HP DI 2.0. Have you guys looked at moving into adjacent markets in terms of other fuel sources, obviously, with the core confidence around design and managing supply chain. It seems that you could move into the EV space or another fuel source without too much difficulty. Is that something that you guys are looking at considering at some point?
Collin, again, thanks I think that you can see that since as we have really looked at our portfolio that as We ended up keeping the hydrogen business. We think that that's very synergistic with our current gas business. And we always are looking at opportunities. We see ourselves as an alternative fuel company. So we don't see ourselves We have very, very strong competencies, I'll say, on gaseous fuels.
Great. Thanks so much, guys.
Thanks, Collin.
Our next question comes from Eric Stine of Craig Hallum Capital Group.
Hi, Nancy. Hi, Mike.
Hey, good morning.
Good morning. Congrats on the quarter and getting to your milestone. Maybe just on the transportation segment, Is there I mean, I know that it's all in one bucket, but maybe if you could just talk about the trends in that business. I mean, I would assume that in OEM, DOEM and aftermarket, it's pretty broad based. But I mean, this was a really big quarter.
So just wondering, Were there other things in there as well? You had the Algeria contract or development payments. And then maybe just some commentary on the contribution from HPDI?
Well, I'll answer kind of from a financial perspective, which is, we saw Uptics in sales pretty much across the board, Eric. So it wasn't one thing dominating This uptick, I would say probably the segment that showed the biggest increase quarter over quarter was the DOEM business. And maybe Nancy you can comment like you described within your prepared comments how The OEM leads potentially into OEM business.
Yes. So, Eric, Good morning. The I would say that from what we see is, as we have seen this anti diesel sentiment, there is a lot of, I'll say pull at this point in time to get vehicles into the showroom. By being able to offer a DOEM solution, which gives products that can get to the showroom on a pretty fast order. We have seen that, that market has been quite brisk.
I would indicate to you though that we're as we have seen across all our products, Oil prices and other things have obviously boosted some of our revenues. We're quite pleased where we are relative to the launch of HPDI, where we think that we have gotten good driver feedback. It's now in the hands of real consumers, and that's really a test of the product. And we think that the feedback and the And we get country incentives and those kinds of things understood that would benefit from HPDI product portfolio, and they would qualify that we're quite pleased with where we are in the launch. And again, I think as Mike said, very good for us in terms of this particular quarter that we saw Really opportunity of increased revenue across all different sectors.
So I think it's from our perspective, We're finding that this anti diesel sentiment and that kind of thing, consumers are just really looking for alternatives. And because of the ability of our Product and I'll say the nature of it and the cost of it, it seems to be One of the ones that is benefiting most.
Right. And so there really it sounds like there really wasn't the benefit of A large, whether it's that Algeria contract or something else, I mean, it was really broad based.
Right. Including geographies. Including geography, so pretty much across the board, barring maybe a couple of exceptions, Every country seemed to be having a positive quarter for us, which is obviously great.
Right. Absolutely. Okay. Then Maybe just turning to, I guess, follow-up on the previous question about how we think about the rest of the year. You So guidance unchanged, which I know at this time of the year is something that you typically do, you did last year.
But I mean you're also positive about year over year growth. So just I mean, just how to think about that because those two things don't necessarily match up. I mean, it's still fair to say, right, that Q3, are going to have your typical step down because of heavy mix towards Europe.
Correct. So, yes, so the reason why we haven't updated guidance is we still Are forecasting out the balance of the year and really still taking a view on a variety of things. I would say there Everything from currency. As you know, currency has impact our revenues and I know this is a number that folks Are often looking for, so sequentially from Q1 to Q2, the euro dropped I think 3% versus the U. S.
Dollar and that impacted negatively our revenues in Q2 by about $4,000,000 So obviously, we can't predict currencies, but we can at least take a view on them. The other one that's kind of, I guess, is a new one for us Given all the kind of political activity, international political activity, sanctions and Tariffs and all those types of things seem to be high on the list of people's minds and questions. So again, we don't see anything Near term that is impacting us significantly, but we again, we need to take a view in terms of what that's going to how that may impact us for the balance of the year. Seasonality, as you point out, Europe obviously kind of shuts down a little bit in August. So that's going to be impactful to Q3.
And then there are other trends. So we mentioned, DLEM has had a very strong quarter. However, As we have, model year change outs towards the tail end of the year, we need to figure out what our OEMs going to be doing. Are they going to continue to work with us on a D OEM basis or do they transition more to an OEM business line? So all those things taken in combination just means that we haven't actually been able to truly forecast out the balance of the year.
I think Next quarter, we will be able to provide a little bit more granularity in terms of what we're thinking about revenues for the full year.
Got it. I can appreciate that. Okay. Maybe last one for me. Just China, I mean, I'd love to hear kind of the WWI Volumes or whatever you can share there year to date, kind of your expectations for 2018?
And then maybe just an update on that market and HPDI, how you see that market playing out and also your potential there?
Well, Eric, certainly, we still see China as one of our most significant markets relative to natural I'd say that China continues to run strong and we don't have specific figures for you relative to WWI at the moment. But I would tell you that our discussions continue to understand how We're going to tap that market and being able to utilize HPDI in that market. We continue to work Again, as we look, I think that China is an important market for us and we're putting our energy there.
Okay. Thanks a lot.
Thanks,
Eric. Our next question comes from Rob Brown of Lake Street Partners.
Good morning.
Good morning.
Given kind of the dynamics in the market now, what's the latest on Other OEM interest in HPDI. I know you've always worked with other OEMs, but maybe just characterize where that's at and if there's been any uptick in the interest level or traction for new programs.
I'm so glad you asked that. I think that Rob, the interesting thing is I think that back in mid May, The European Commission has outlined a proposal relative to the new standards and targets for the CO2 reductions for Heavy Duty Trucks. I would tell you that just to give you some color on that, the proposed reduction is 15% wheel, what they call tank to wheel, reduction in CO2 by 2025 and 30% CO2 by 2,030. And they're going to baseline the OEMs here in calendar year coming up in calendar 2019 in order to strike the line of what 15% looks like. And I think that as we have Over the last several weeks as this regulation has gotten clearer and understood in the market, we have And have had quite depthy discussions with many of the OEMs.
I think that At this point in time, as you look at these regulations, it really their options are quite narrow. HPDI happens to be one of the products that is in that narrow option base for them. And so as you can imagine for the heavy duty trucking That is an area, especially in the Europe with these new regulations is
quite important dialogues going on. And I
think that you can And as you know, in mid September, we have the Hanover Truck Show and that's also a great opportunity for us Be able to push forward these discussions as well with many of the OEMs.
Okay, great. Thank you.
That's a good overview. Then maybe on the light to the automotive side, you talked about Europe CNG seeming to uptick in interest, but maybe just give us a sense of what's going on there. I know diesel is a big part of the market there. Is diesel sort of in your thoughts shifting to natural gas at this point in the light duty or maybe just some color on what's been driving that market shift?
I think it's several different things. First of all, We're seeing consumer views relative to buying diesel vehicles. They're not so keen on it. They're not sure what the That they're going to be able to recoup their cost out of it, as they try to resell it and that kind of thing. I think also they just in many cases, as being, I'll say, environmentally, I'll say, conscious in society.
They don't really want to take on And then in addition to that, we're seeing inner cities, ban diesel products. And again, as you Look at the options that folks have when you do that, natural gas and propane fall right into an area that are very acceptable for these inner city vans. So that allows them to take these vehicles into the inner city where the diesel vehicles can't. So, consumers, I think don't like the restrictions of buying a vehicle that then they can't, utilize fully. So That is one of the things that's uplifting the demand.
So most of it is just raw consumer pull. Obviously, having come of Europe just a couple of days ago. The prices are quite good for CNG and LPG in that market, significantly lower than that of petrol as well as diesel. That also from a consumer payback standpoint as They get the vehicle either in OEM or in what we call our aftermarket modifications. Their paybacks are Quite good on this.
So, we think that that's really what's uplifting, at least in our opinion at this point in time, what's uplifting the European demand.
Okay, good. And then final question on CWI, had a strong quarter. What's sort of your view On the sustainability of that and the profit contribution as well. Do you see that continuing to increase or is this a level that we should think about going forward?
I think, again, we don't really guide on revenue for CWI for obvious reasons. But I think if you look at Q1 for all the reasons we've discussed in the past, It was obviously a low quarter. Q2 was a great rebound quarter. So I think going forward, revenues in Q2 Q2 are more reflective of the ongoing reality versus Q1. And then per my prepared statements, I think Based off of the dynamics of lower R and D costs and lower tax rates that more of the revenue dollars should be dropping to the bottom line going forward for that business.
And I guess one other thing to add there is, I think that you've seen publicly that there has been announcements of sizable orders that are coming through with major fleets, UPS, etcetera. And all of that will We believe that a good portion of that will take place here in calendar 2018. So And
one of the things that we should point out is you may have Cummins had a recent recall, a pretty significant one. Natural gas engines were not part of that recall. So, I think CWI joint venture is not impacted by that.
Okay, good. That's good to know. Thank you. I'll turn it over.
Our next question comes from Jeff Osborne of Cowen and Company.
Hey, good morning, guys. Just a couple of quick ones here, maybe following up on Rob's question. Many of the CWI announcements have been for replacements of Fleets from 2014, 2015. A, can you confirm that? And then B, are you seeing any new fleets, just given the oil diesel pricing environment that we're in looking to adopt the technology.
I guess we would say that certainly we have a lot of interest. We've been a bit helped by California that this is quite unacceptable and so you'll see it in big distribution companies, but you're also we're also From my understanding, we're seeing it in other applications and other fleet buyers. So It's a broad based, I'll say, pull to the market. And So from that perspective, I think that as we have a full fleet of products, especially that run on renewable natural gas that have 0 emissions. We stack right up there with the electric and a very, very Reliable Product.
And I think that you can see through the change over the last years relative to the warranty numbers that We have been talking about and that kind of thing. We've got a good product CWI and we've got good market support. And like Like I said, with the fueling infrastructure that's in place, we're just picking up and the wins are favorable in this direction.
Makes sense. Just a couple of other quick ones. Mike, for you, the $2,500,000 of expense For the SEC investigation, I imagine that ticked up since the February subpoena. Is that the current was there any kind of surge spending this order or is that sort of the new normal of what the expense rate should be for the duration of the investigation?
For obvious reasons, we probably shouldn't be predicting specific costs associated with that. I would say that there was obviously a pickup in activity, which obviously spoke to the increase in that cost. But again, going forward, it's very dependent How the investigation goes.
Got it. But just as we think about you hitting EBITDA positive in the second half, are you backing out expenses associated with that or are you putting that in the model?
So as it relates to you'll see the table as it relates to our adjusted EBITDA that we do include that in the as an adjustment because we obviously don't believe that this is going to be a recurring cost over the long term for the company. The other thing actually to note is some of the costs associated with the investigation, legal and other. We do expect to be able to recoup some of those costs through our D and O insurance. So there is a kind of a leveler, if you will, as it relates to that. Obviously, we can't predict exactly what those recoup levels are going to be, but there should be some ability to get some dollars through our insurance.
Makes sense. Switching gears a little bit, I was intrigued by your comment that the delayed OEM business was the one that was up the most sequentially. I would have thought HPDI 2.0 was just given the minimal volume. Well, it
was up as well. I mean, it was up, but it was amazing how up our DOEM business. So, Dancy and I were just in Cresco last week and we see the activity in the parking lot in terms of cars coming in and cars coming out on a daily basis. She sits there and counts the number of cars. So it's that's not a reflection that HPDI is not growing.
Year over year HPDI probably is higher because we went from 0 to where we are now.
Speaking of my answer, I did describe sequentially. Anyway, so that's not a reflection that HPDI is not performing well. It's the fact that the OEM had such a stellar quarter.
Got it. And then can you just remind me maybe putting in 2017 in perspective, the mix of the legacy fuel systems business, What percent was OEM versus delayed OEM?
I don't think we provide that kind of granularity. Okay. Fuel Systems
did as a public company, but I wasn't sure if
I have the details there. Okay.
Yes. I don't Because 2017, we were blended, I don't remember making that split. So
Okay. Fair to say that delayed OEMs more than half the business?
No, no, no, no.
The largest segment of our revenues still come from the aftermarket business.
Got it. And is there a meaningful you talked about The delayed OEM transitioning to OEM, is there a margin implication of that? Obviously, it's more strategic with the OEM itself, but how does that impact Profitability either positively or negatively?
I don't think it has a major impact on it. I think that When you go to the OEM environment, one of the good things is that we have a more predictable schedule And those kinds of things. So it has, I'll say, a 26 week framing relative to what they're doing and that kind of thing. And I Also on the OEM side, once you get it in, they can cross with one engine, then any vehicle that uses that particular engine. We can get increased volumes in a quite quick way.
I think the other benefit that we've had on the OEM side is we've had A significant increase in terms of the content on the vehicle because they see Westport as the go to company across all systems. So We're sort of on the OEM side, we gain the benefit from volume, but we also gain the benefit for more content per vehicle.
Makes sense. And the last one I had for you, Nancy, is just can you you talked about the hydrogen uptick and greater interest there. Can you just be a little bit more granular as to what specifically you're providing into that ecosystem? Be helpful to understand that. Thank you.
Well, I would say currently the products that we currently provide are on the, what we call the low pressure head of the fueling system. And as we get closer into and Take the outtake of the tank. That's where the higher pressure products are really required. We have great position with a variety of different fuel cell folks that use our products. And as they are demanding the 700 Products.
We're right aligned with them. So this will allow us to not only have the low pressure side, but also the high pressure side of the System. And so we can continue to partner with them as their business grows. And I think that it's interesting, The hydrogen, as we look at it, that is one of the alternative fuels, like I said, that's
Perfect. Appreciate the detail. Thank you.
Thanks, Jeff.
This concludes the question and answer session. I would like to turn the conference back over to Caroline Sawamoto for closing remarks.
Thank you, everyone, for joining us today. If you have any follow-up questions, feel To reach out to the Westport Fuel Systems' Investor Relations team. Thanks again.
This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.