Westport Fuel Systems Inc.
Q4 2020 Earnings Call Transcript

Published: 16 Mar 2021

[Operator:]

Welcome to the Westport Fuel Systems Fourth Quarter and Full Year Fiscal 2020 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 Christine Marks, Westport's Investor Relations representative. Please go ahead.

[Christine Marks:]

Thank you, and good morning, everyone. Welcome to Westport Fuel Systems fourth quarter and year-end 2020 conference call, which is being held to coincide with the press release containing Westport Fuel Systems financial results that was distributed yesterday. On today's call, speaking on behalf of Westport Fuel Systems is Chief Executive Officer, David Johnson; and Chief Financial Officer, Richard Orazietti. 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 the U.S. and applicable Canadian securities laws. And as 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're cautioned not to place undue reliance on those statements. Information contained in this conference call is subject to and qualified in its entirety by information contained in the company's public filings.

[David Johnson:]

Good morning, everyone. Thanks for joining our conference call to review Westport Fuel Systems 2020 results for the fourth quarter and the full year. This is David Johnson speaking. With me on the line today is Richard Orazietti. Clearly, 2020 was a year filled with challenges. The COVID-19 pandemic challenged the global economy and created headwinds for our business. But there were also unexpected opportunities, and our global team demonstrated outstanding resilience in responding to both the challenges and the opportunities. In spite of the unprecedented events of 2020 it's gratifying to see that the world's demand for clean, low carbon, cost-effective transportation hasn't wavered. That continuing demand helped us to finish the year strong. Looking back on the past year, the impact of the pandemic was most severe in Q2 when we and our customers had to pause production due to the crisis. Q3 saw some recovery and the strengthening continued in Q4, lifting us to a record quarterly revenue. For the year, revenue was down 17% from our record 2019 full year revenue. Overall, nearly 90% of that decline was attributed to the COVID-related shutdowns in the second quarter. However, our Q4 record revenue was a 13% increase versus the same quarter in 2019, driven by a 32% increase in OEM revenue. Looking forward, we're poised for continued positive momentum in 2021, albeit somewhat tempered in the near-term by the lingering effects of the ongoing pandemic and by the global supply chain challenges the automotive industry is facing right now. Aside from the COVID-19 challenges, I'm pleased to report that we advanced each 1 of our 2020 business objectives, including especially sales growth in key market segments and geographies. And overall, we've strengthened the business with balance sheet improvements and cost reductions. In November, we announced new product development work with our current OEM partner to apply HPDI 2.0 to an updated base engine platform that take effect in 2020, the benefits of our HPDI solutions. Our targets for 2020 and for future growth include progress in China, where our joint venture with Weichai Power secured certification for the WP12 natural gas engine powered by HPDI 2.0. As 1 of the largest suppliers of natural gas engines in China, our JV currently supplies sparked natural gas engines to leading Chinese commercial vehicle OEMs, and they, in turn, serve the largest natural gas trucking market in the world. The WP12 HPDI engine certification sets us up to serve that large and growing market as vehicle OEMs complete certifications for their vehicle offerings with our engines. We've also seen growth in India. In 2020, we combined our business with our JV with UNO MINDA to better serve the market and to realize cost efficiencies. We can now offer a broader range of products to this growing CNG market.

[Richard Orazietti:]

Thank you, David. As David mentioned, our record revenues were higher, 13% year-over-year due to strong sales volumes from HPDI systems and a 7% increase in the euro to U.S. dollar exchange rate. We also saw a strong recovery in our light-duty OEM revenues during the quarter, an increase of 44% over the third quarter of 2020 due to sales in India and Russia. The strength of sales activity in the quarter was partially offset by a large onetime contractual price reductions in our contract with our initial launch partner in the fourth quarter of 2019 and lower year-over-year independent aftermarket revenues still recovering from the impact of COVID-19 on sales volumes. Gross margin decreased mainly due to lower margins realized year-over-year on HPDI systems. Lower HPDI engineering services and lower independent aftermarket sales, partially offset by the large increase in HPDI sales volumes. Net income benefited from $2.7 million in higher income from a strong quarter in our CWI joint venture due to lower operating expenses. And also a $5.3 million unrealized foreign exchange gain compared to $2.6 million in the prior year. We generated higher year-over-year adjusted EBITDA of $8.1 million, bolstered by strong quarterly performance from CWI and lower operating expenses. Our adjusted operating cash flow, which includes the dividends received from CWI, decreased year-over-year due to increased working capital resulting from a buildup of receivables on higher sales volumes and inventory for our heavy-duty OEM business.

[David Johnson:]

Thank you, Richard. To recap, I'm immensely proud of our team and the substantial progress we made on our business plan throughout 2020 despite COVID-19. In 2021, our focus will be on continued growth at scale in key markets. For HPDI, that means Europe, China and then North America. And for our light-duty business, profitable growth through the aftermarket and OEM channels in markets like Turkey, Russia, Egypt, India, and other cost-sensitive markets where our products resonate strongly that needs to deliver affordable transportation and reduce emissions. The market fundamentals are in place. Societal expectations and regulatory requirements, demand response to the need for clean, cost-effective carbon-reducing transportation and our products provide that response. They're developed, validated in production our efforts as well as innovation as Richard said, we think it's a good indicator that at the current rate of growth for HPDI and the heavy-duty OEM business will lead to expand production capacity and also fund growth potential of emerging technologies such as hydrogen HPDI. I'm confident in our team, and we're committed to delivering value for our customers and shareholders. With that, I'd like to turn it back to the operator for your questions.

[Operator:]

This question comes from Eric Stine of Craig-Hallum.

[Eric Stine:]

So just wondering if you can start on hydrogen. You've had a pretty busy start to the year. I mean, clearly, this started in 2020, but in terms of what you've shared publicly in the Scania announcement. Just curious what that has meant for your development pipeline. I know you've got a number of potential partners looking at LNG, but giving them the additional path to hydrogen. Just curious what that's meant.

[David Johnson:]

Yes. Thanks for the question, Eric. I think it's a really important dynamic for us because in the marketplace, there are customers, there are OEMs out there who thought, let's skip it and go straight to hydrogen. And I think now seeing that actually HPDI with hydrogen is not only a good solution, but perhaps a far better solution, 1 that enables them to reuse all their industrial complex that's already built. All the engine plants, all the transmission plants all that capability and know-how they have with respect to internal combustion engines can now be used with hydrogen based on our initial test results. Of course, there's work for us to do. But I think companies and OEMs that we work with are technically focused and engineering driven in terms of products, and the test results are very, very strong. I expect a further bounce when we get through a deal, all the test results that the symposium late next month. So it's, I think, a very important dynamic for us and changes the positioning of our product as a long-term viable zero carbon product for transportation and long-haul specifically.

[Eric Stine:]

Got it. And then maybe just sticking with HPDI and the current offering with your current partner, well, I guess, #1, I know you don't give out units, but anything you can share? I mean it seemed if I'm trying to back into some kind of a number. It seems like it was -- you did see sequential growth in the quarter. So maybe if you could confirm that? And then maybe just talk about with the baseline being set last July 1, I mean, how much has that been a part of the growth in addition to, obviously, fleets just starting to roll out more units?

[Richard Orazietti:]

Yes. I think there's a whole bunch of dynamics that play out there, are playing out and will continue to play out. And 1 of them is the regulation. Another 1 is, I would say, normal fleet adoption cycle with respect to new technology like HPDI is for commercial trucking. What we saw, clearly, we shut down and our customers shut down in Q2, and that included our lead HPDI customer in Europe. And that was a very slow and difficult time for us. But when Q3 started up and factories restarted. I think there's a clear picture, recognizing that a 13% lower revenues in Q3 versus 2019 and 13% higher revenues in Q4. And versus 2019. So I think this kind of trend of 13% lower, 30% higher, gives you a flavor for what was happening. And as we mentioned in our discussion, that call -- or that number was really driven by our OEM business. So with that, I think you can kind of, as you say, back into some analysis, but as you say, we don't talk about the details of our volumes unfortunately.

[Eric Stine:]

Okay. Got it. Fair enough. Maybe last 1 for me. You have talked about the investment. And it sounds like it's both some internal, but also doing some -- or some steps within the supply chain? I mean, is that -- should we take that as securing more capacity for injectors? Is it more on the tank side? I mean, maybe just dig into the -- into kind of all the things that you're referencing there, if you could?

[David Johnson:]

Yes. Of course, we sell a complete system from the tank to the injector and some electronics along the line. We have capacity challenges in various parts of the system. Injector is a big part of it for sure. We use 6 in every engine, of course. So that is -- we're excited about this challenge to our business to say, "Hey, you need to grow your capacity to respond to demand.” And thinking that at this point in time, we're servicing 1 customer in 1 market of the world and the potential for growth with respect to the Chinese market is really tremendous. We've talked about that this is already in the world the largest natural gas trucking market. And the infrastructure there is built out. We are, through our JV, the leading manufacturer of natural gas engines for commercial vehicles. And those are spark-ignited engines. And so when you bring the superior product of HPDI, which improves the economics for the operator, reduces the carbon footprint and we've already developed and validated in the European market. So we're looking forward to that launch and the volume curve that comes along with that. So we will be investing. We are investing in expanding that capacity and we think that's something that we've been looking forward to for some time and are glad the time has come.

[Operator:]

Our next question comes from Colin Rusch of Oppenheimer & Company.

[Colin Rusch:]

In China, can you just speak to the expected cadence of the ramp and what that might do to gross margins as you guys scale up from reasonably low volumes?

[David Johnson:]

Yes. The -- I think the speculating and forecasting the ramp is very challenging, but I do expect that we'll be able to witness that this year and hopefully soon. Basically, we have this opportunity with our JV to supply all the OEMs in China. We have a unique product that should be appealing to many OEMs in China. That differs from our European market where we have just the 1 OEM, and it's a vehicle OEM. And so that dynamic is different. And then it's also the largest market. So I do think -- and we're going into it with product that's had multiple years of experience in Europe. So there's more confidence globally in our industry around industry, around the product. So I think we can expect a steeper curve but yet at the same time, it's still a launch curve. So not a lot of specificity there for you, but I think it's important for us, and it is factoring into our equations with respect to growing our capacity to support that expected demand. In terms of margins, I won't make any specific comments at this point in time, but the key ingredient for us is to grow the volume to get the economies of scale that will improve our margins and launching in China is a very important part of that equation for us.

[Colin Rusch:]

Okay. And then can you just give us a state of the state on how you're thinking about the medium-duty market. Certainly, there's a lot going on all across the different class of vehicles. But as you have the potential to drive both natural gas and hydrogen, it seems there's probably an opportunity for you to creep into some different vehicle designs as you go forward. So just wondering where you're at with that opportunity.

[David Johnson:]

Yes. The medium-duty market is, I'll say, 2 things, more fragmented, and I'll say more economically challenged in terms of -- in order for the economics to work for or any fuel based product like ours where we're saving money every mile you drive, the more you drive the more mass you carry, the quicker you get your payback. So that's where in the medium-duty market, it is more challenging. There's more diversity of applications, which don't go very far at all and some of which approach kind of, I don't know, half the distance of long-haul. So quite a significant reduction. They also use the vehicles longer, tend to have longer cycles for their turning over the fleet. So I do think there are opportunities there. Clearly, that's on our radar. But I think actually, with HPDI, we could see the opportunity to move in the other direction towards mining and rail and other applications that are kind of bigger engines and really see excellent economics there with HPDI.

[Operator:]

Our next question comes from Rob Brown of Lake Street Capital Markets.

[Rob Brown:]

Just following up on the European market. Maybe if you could give some more color in terms of the demand drivers there. Are you seeing this -- any RNG activity in that market? Or is this sort of a cost savings-driven market, maybe just a sense of what the demand drivers are in that market?

[David Johnson:]

Yes. I think for sure -- okay. So we have just to be very clear, right? It's still trucking. So the economics are the supreme ingredient, I'll say, after you’re confident in the technology and the products to deliver the reliability, durability that the truck fleets expect. If you can't deliver their freight, it doesn't matter how efficient it is or how clean it is. So that's #1. #2 is the economics. And then I would say, in Europe, especially, there is a tremendous societal pressure and momentum with respect to greening transportation. And this works for us, both on the front of our current product with LNG as well as the potential for that product to respond to zero carbon hydrogen, green hydrogen in the future. So I think those dynamics are very much in our favor, and we're really happy to be with our partner in Europe and to have launched when we did and be able to ride this pressure in the marketplace and to do it on the basis of a great product. That delivers for the fleets and saves the money.

[Rob Brown:]

Good. And then on the capacity additions you're thinking about, could you give us a sense of the scaling there? Is it a doubling, tripling, kind of multiple of current capacity? Or how do you sort of see that overall capacity addition playing out in the next year or so?

[David Johnson:]

Yes. It's a really important parameter to manage for any supplier is to match your capacity with your demand as closely as possible. We don't want to be running any part of our manufacturing system or our suppliers manufactured system at 10% of capacity. And we also don't want to run into a bottleneck then we can't supply the demand that occurs. So that's the general equation. As we look at it, we are expecting multiples of growth because right now, we're moving from 1 customer in 1 market to 2 customers or maybe 3 or 4, when you think about the vehicle OEMs in China that we'll be able to serve. And so we're making those plans carefully. But there's also some challenge. So I think you can imagine that we'll be leaning forward a bit on capacity so that we can serve every unit of demand that eventually has come to us in the near term.

[Operator:]

Our next question comes from Amit Dayal of H.C. Wainwright.

[Amit Dayal:]

With respect to cadence of revenues in 2021, how should we think about the quarterly revenue that may play out given that you are seeing recovery in your segments, your HPDI is getting traction, but at the same time, there are some supply chain challenges that are also in the market right now? So any color on how to model for the next 4 quarters would be helpful.

[David Johnson:]

Yes. Absolutely, glad to kind of try to paint the picture a little bit of what we expect. First of all, we are still dealing with some COVID situations around the world. We're fully recognizing how wonderful the vaccines are, and we expect those to have an effect. But in the meantime, our factories in Italy, for example, and our customers around those factories and so forth and our distributors, they're in orange and red zones. And so that COVID impact is still with us. And we see that affecting our light-duty and our aftermarket business. On the heavy-duty side, we've seen a bit more stabilization, and you can see that the growth is coming through in kind of the fourth quarter. And we expect a good year for HPDI going forward. And then maybe the other thing that's important to mention is that, as you've heard from in the media, there are supply side challenges that all the OEMs are facing. And that includes us, and we're managing that on a daily basis to try and make sure that we can meet our customers' demand. But I think there is risk that, that could impact us and constrain us in some days, some weeks, hopefully not any month from achieving everything we want to achieve in 2021. I think we aren't back to full normal. And so kind of the normal seasonality you might see and expect it will be still perturbed by cope this year? And I think those are kind of the factors, at least that are on my mind with respect to the market outlook for 2021.

[Amit Dayal:]

That's helpful. And then Richard talked about some concessions on the margin front that may have been provided in the fourth quarter. Are these behind the company? And do we see gross margins bouncing back in 2021 relative to the fourth quarter?

[Richard Orazietti:]

Yes. The price reductions were made in the fourth quarter of 2019, and they were significant, and we saw sort of muted sort of the growth that we had, especially in the second half, going into the new year. There was a question with Weichai. We can't go into specific contracts, but there is -- we'll call that a little bit of near-term gross margin pressure that then yields to better economics as more volume starts ramping up and the numbers start getting significant, but we have contractual price savings with our supplier base.

[Amit Dayal:]

Okay. Just 1 last one, I guess, then. With respect to the China milestones for 2021, can you share any key highlights that we should be looking for?

[David Johnson:]

Yes. In China, I think we've made good progress. Of course, we had substantial delays through 2020 with COVID and other challenges with the certifications. But we expect to see the certification of the vehicle side shortly. And then thereafter, so through this year, start the project -- process of launch and production and sales. So we're looking forward to that, but I don't have any more specifics to offer you than that today.

[Operator:]

Our next question comes from Thomas Boyes of Cowen & Company.

[Thomas Boyes:]

Most have been asked, but I wanted to maybe just follow-up on the question about China just because, obviously, you're going -- the certification through the Weichai accomplished. The OEM level, how long do those tests usually take on their side? Is it different for everyone who's testing the engine? Or is most of them completed in, say, a quarter or something like that?

[Richard Orazietti:]

Yes. So I think the process is not a short process, but we are aware that the there are cases with specific OEMs where the testing is complete. So then it's just a matter of, let's say, getting the paperwork through the officials and having them bless it and issue the certification. And I can't comment on those timelines. It's challenging for us to see and it's also challenging for the -- for our JV and the OEMs to see into that process. But the testing is done at least in 1 .

[Thomas Boyes:]

Perfect. And then it was nice to see. I think as Amazon had ordered around 700 vehicles through the JV with Cummins. I was just wondering if you could talk maybe how that business is secured and how you're seeing potential discussions with other customers, just obviously given the rise of e-commerce from the pandemic, how that market has been.

[Richard Orazietti:]

Yes. I think it was a real promising report from Reuters about that order. Because I think what it says is that the fleets, large fleets in North America consider and according to the report are purchasing natural gas product to green their fleet. The economics in North America -- because our fuel prices are relatively low and the fuel price differential is not so great, the economics are more challenging and not as compelling. Nonetheless, you have a big fleet, whether it's UPS, they made their announcement previously. And now this report from Reuters about what Amazon is doing. These are really good signs that fleets are taking their responsibility with respect to carbon emissions very seriously and taking action and recognizing that natural gas is an important part and an important step, and it works for them in their fleet operations, where, again, even for Amazon, UPS or any other fleet in North America, the 1 thing is get the freight there on schedule. And don't pass up capability and reliability to try and get to low-cost or green. And so I'm real compelled and really excited about the opportunities in North America, and we look forward to the chance to bring HPDI to North America and go a step further than you can with this market for natural gas engine.

[Operator:]

This concludes the question-and-answer session. I would like to turn the conference back over to Christine Marks for any closing remarks.

[Christine Marks:]

Thank you, operator, and thank you, everyone, for joining us today. If you do have any follow-up questions, please feel free to reach out to us at the Westport investor Relations team hotline, and thanks again so much for your interest in Westport Fuel Systems.

[Operator:]

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