Westport Fuel Systems Inc. (NASDAQ:WPRT) Q1 2023 Earnings Call Transcript May 10, 2023
Operator: Thank you for standing by. This is the conference operator. Welcome to the Westport Fuel Systems First Quarter 2023 Financial Results Conference Call. As a reminder, all participants are in a 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 Ashley Nuell, Senior Director of Investor Relations. Please go ahead.
Ashley Nuell: Good morning, everyone. Welcome to Westport Fuel Systems’ first quarter 2023 conference call, which is being held to coincide with the press release containing Westport’s financial results distributed yesterday. On today’s call, speaking on behalf of Westport is Chief Executive Officer, David Johnson; and Chief Financial Officer, Bill Larkin. Attendance on this call is open to the public, 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. With that, I’ll turn the call over to you, David.
David Johnson: Thank you, Ashley, and good morning, everyone. I’m pleased to be with you today to discuss our first quarter results. Today, in addition to reviewing our Q1 results, we will be providing updates on our growing light duty LPG business and, of course, our heavy duty business, where our patented HPDI products and technology are poised to play an important role in affordably decarbonizing heavy-duty long-haul trucking. Also, we’ll share some observations and highlights from last week’s ACT Expo in Anaheim, California and from the Vienna Motor Symposium, which was held the week before last. Amid a macro environment that continues to be turbulent, we delivered year-over-year revenue growth of 7% to $82.2 million, primarily driven by increased sales volumes in many of our business lines, including delayed OEM, fuel storage, hydrogen, and electronics, as well as increased sales volumes in our independent aftermarket segment.
In the first quarter, we also delivered gross margin improvement in both our OEM and IAM segment, driven by pricing and higher sales volumes and an improving sales mix in our OEM segment. Westport Fuel Systems is a leader in the light-duty space, and demand for our clean, low-cost LPG solutions continues to grow in Europe and other markets, supported by the increasing price advantage for consumers, who can run on LPG instead of petrol, and can therefore save money every time they refuel at their local fuel station. The LPG price advantage is driving growth in key markets like Italy, Turkey, the Netherlands, and also in North America. And the cost of new cars continues to escalate consumers are looking for affordable alternatives, vehicles that are low cost to acquire and low cost to operate.
That’s an LPG advantage. Advantageous LPG pricing in major markets plays a key role in the decision to switch existing cars from petrol to LPG, and we have the products to enable this switch. Also, customers buying new cars are seeking affordable LPG-equipped models. OEMs are taking notice of growing consumer demand, which is expected to persist globally for decades. OEMs are acting now to commit to the future of LPG providing a significant runway for growth for Westport Fuel Systems. As we recently announced, we’ll begin production and supply of Euro 6 LPG system to a leading European OEM in Q4 of this year. This new business materially adds to our revenue and market share. Our LPG market share in Europe is currently about 35%. And with this newly announced OEM business, we expect to increase to above 50%.
As a reminder, the Euro 6 LPG system production and sales that begins in the fourth quarter of this year will run for two years, generating approximately €38 million over the contract period. The follow on Euro 7 business we secured will double this scope, generating approximately €40 million per year. We continue to experience growth in our delayed OEM business and expect this growth to continue. As a reminder, our delayed OEM businesses when we or our customers apply one of our LPG fuel systems to a new vehicle in advance of selling and delivering that vehicle to end use customers. More OEMs are taking advantage of our vehicle conversion capabilities. Volumes grew significantly this quarter compared to Q1 of last year due to strong demand from DR Motors, an Italian OEM that provides LPG fueled vehicles to the Italian and other markets in Southern Europe.
Moving to our heavy duty business. In the first quarter, we recorded a positive pricing adjustment for our HDI fuel system sold to our European launch partner. Our existing contract with our European launch partner concludes in early 2024 as the rest of the 2023 pricing is being negotiated. In the first quarter, HDI volume declined by 13% compared to year-ago quarter, primarily driven by unfavorable fuel price differential between LNG and diesel, which existed through all of 2022, causing fleets to reduce purchases of LNG fueled vehicles. As we discussed last quarter, production volumes lag vehicle sales volumes, and vehicle sales volumes lag fuel price changes. Now that LNG fuel prices have reestablished their advantage compared to diesel, we expect an improving vehicle sales outlook later this year and production and sales of HDI systems to follow that trend, again, with some timing lag.
Looking ahead, Westport Fuel Systems offers the solutions needed by heavy-duty OEMs to meet future emissions reduction requirements while delivering the performance, efficiency, and affordability that their fleet customers demand. As LNG pricing reestablishes a persistent advantage versus diesel and as emissions regulations and associated penalties for OEMs loom, there’s growing realization that affordable low-carbon solutions like HPDI are required to meet OEM CO2 emissions requirements and fleet decarbonization goal. HPDI is already reducing real-world emissions with thousands of vehicles on the road today. We’re confident we’ll continue to grow HPDI volumes through this decade and beyond. Earlier this year, our HPDI launch partner announced new trucks that deliver more horsepower, increased efficiency, less emissions, and an extended driving range using bio LNG.
As is typical with new product introductions, we expect this model change will result in lower volume near term and higher volumes later this year. In China, we continue to support Weichai as they work with their customers, the Chinese truck OEMs, to bring HPDI-equipped vehicles to their market. This includes demonstrations and field trials. We remain optimistic about the launch of production and sales, especially now that LNG prices in China have declined. China is the largest natural gas tracking market in the world by far and measured in terms of volume and market share and has stringent emissions targets that are supportive of both LNG and biomethane. LNG prices have been normalizing in China with prices just recently at a 21-month low, a significant drop from the elevated levels we saw last year.
We’re encouraged by the ongoing work we’re supporting and the improving market conditions. Similar to the rest of the world, we’re also building significant interest in China for our hydrogen HPDI offering as an affordable path to using zero carbon hydrogen in long-haul heavy-duty applications. Bottom line, our HPDI opportunity in China is significant using LNG and biomethane today and hydrogen in the future. Our business is on the right path. Clean, affordable transportation is in demand today, and we see that demand increasing into the future. High energy prices and challenging economic times tend to be tailwinds for our business. Transportation is not a discretionary purchase, especially for commercial vehicles. And we make clean transportation products that are low cost for OEMs to develop and industrialize and low cost for end customers to acquire and operate.
Photo by Juan Fernandez on Unsplash
Last week, at the expo in Anaheim, California, we showcased two fully functioning heavy-duty vehicles with our HPDI fuel systems for internal combustion engines. One truck fueled by low carbon methane, either fossil or biomethane and the other truck fueled by zero-carbon hydrogen. We helped ACT Expo attendees understand how with natural gas and renewable natural gas enables all the performance, efficiency, and durability of the diesel engines they’re used to with very little change to engines or vehicles, and yet all the low carbon and affordability benefits to enable a scalable solution. And with hydrogen and HPDI, performance and efficiency improved quite significantly, enabling an IC engine technology path for decades to come. Given the growth we’ve seen and a recent expansion announcement in China, we also displayed at Act Expo our 350 and 700 bar hydrogen components that support both fuel cell and internal combustion engine applications.
This follows fuel cell expos we joined in Germany and Japan already this year. We continue to generate significant interest from key constituents throughout our ecosystem, including OEMs, fleets, fuel providers, and more. Importantly and increasingly, hydrogen is considered the zero-carbon fuel the industry needs. We’re continuing to help the industry to understand that internal combustion engines with HPDI will play a critical role in transforming away from fossil fuels to clean and renewable fuels because HPDI is the most effective and affordable path. Two papers highlighting hydrogen HPDI were presented at the Vienna Motor Symposium, an industry event were the latest technological developments and product proof points are reviewed with our peers, engine and vehicle OEMs, and Tier 1 suppliers.
What makes this exciting for the Westport team is that these papers were each written based on engine dynamometer testing completed on two different engine platforms. Our work with Scania is well-known and the paper we presented with Scania outlines our success in demonstrating brake thermal efficiency of 51.5%, while achieving a 97% reduction in tailpipe CO2 emissions. The second paper published by TNO is based on research conducted using another European OEM engine platform and was focused on outlining the differences in power density, efficiency, and emissions between spark-ignited combustion and HPDI-enabled combustion of hydrogen fuel. TNO’s testing and analysis demonstrated that hydrogen HPDI clearly outperforms spark-ignited hydrogen combustion with respect to power and efficiency.
And doing so with HPEI requires minimal changes to today’s diesel engines. This aligns well with our own results and with the superior performance achieved today in the marketplace using HPDI with methane as compared to spark-ignited combustion of methane. The results are clear. Injecting hydrogen using HPDI on an internal combustion engine produces a highly efficient yet practical green solution for long-haul heavy-duty trucking. Overall, it was highlighted in Vienna that the heavy-duty trucking and other high-load hydration applications that required combination of power density, fuel efficiency, and durability can be challenging for technologies other than HPDI. For a certain segment of the transportation sector, near-zero carbon internal combustion engines continue to be evaluated as a key cost effective solution and our fuel system is well suited to applications requiring high and high fuel efficiency.
This, not surprisingly, has led to interest in HPDI and evaluation of HPDI by multiple OEMs. Affordable performance will drive adoption. The results announced at Vienna confirm that hydrogen HPDI offers lower CO2 abatement costs along with the high performance demanded by customers. Our hydrogen HPDI demonstration trucks continue to provide high profile and valuable evidence of the feasibility of HPDI fuel system-equipped engine, fueled with hydrogen to deliver high-performance, cost-effective decarbonization of heavy-duty vehicle applications. With that, I’ll turn it over to Bill to walk through our financials.
Bill Larkin: Good morning and thank you, David. In the first quarter of 2023, we generated revenues of $82.2 million, an increase of 7% compared to Q1 of 2022. In Q1 of ‘23, sales volumes increased in our delayed OEM, fuel storage, hydrogen components, and electronic products, along with increased sales volumes in our IAM segment, particularly in North America, Eastern Europe, and South America. However, we did realize a slight reduction in light-duty OEM sales volumes to our customers in India. Favorable price differential between LNG and diesel in Europe experience in the first half of fiscal ‘22 impacted HPDI volumes sold during the first quarter of 2023 to our European launch partner. However, this quarter’s volume decline was offset by an increase in the HPDI system pricing, as well as higher engineering services revenue.
The gross margin increased to 16% in Q1 2023 compared to 13% in the prior-year period. Reported net loss of $10.6 million for Q1 of 2023 compared to net income of $7.7 million for the prior-year period. Prior year period include $19.1 million gain from the sale of our interest in the CWI joint venture. During the first quarter of ‘23, we increased our research and development expenditures by $1.4 million compared to the prior year period, focusing on our HPDI technology and hydrogen components. Moving on to the next slide. In Q1 of 2023, we reported adjusted EBITDA loss of $4.5 million compared to a loss of $6.1 million the same period last year. The improvement in adjusted EBITDA loss is primarily due to the result of higher revenues and improvements in our margin.
Gross margin increased year-over-year to $13.3 million, or 16% of revenue, compared to $9.9 million, or 13% of revenue, for the same period in 2022. This improvement was mainly due to higher sales volumes across multiple businesses and positive sales mix in our delayed OEM business segment. However, our manufacturing costs continue to be impacted by higher material, energy, and labor costs as a result of widespread inflation and global supply chain challenges. These cost increases continue to weigh on our gross margin. The next slide, revenue for the first quarter of 2023 was $56.3 million compared to $51.8 million in the same period in 2022. The $4.5 million or 9% increase was driven by a significant increase in sales volumes and our delayed OEM business, as well as an increase in volumes in our fuel storage, hydrogen, and electronics businesses.
And we did see year-over-year decreases in sales volumes of light-duty OEM products in India and Eastern Europe. Late last year, we’ve been talking more about our hydrogen components business and the growth we are seeing, along with our expansion plans in China. We continue to see year-over-year revenue growth in the sale of hydrogen components of over 50% as compared to the same quarter in the previous year. We expect our hydrogen components business revenues to continue to increase when we begin production in China in 2024. The unfavorable fuel price differential between LNG and diesel in Europe in fiscal ‘22 negatively impacted our HPDI sales volumes to our European launch partner. In the first quarter of 2023, we saw a 13% decline in volumes, which was offset by an increase in the system pricing.
But recently, we’ve seen a return to more normalized pricing environment in Europe. We are encouraged by this recent trend in fuel prices, which we anticipate will be helpful in driving demand for trucks with our HDPI systems. As a reminder, our European launch partner earlier this year announced a new HPDI equipped engine with higher horsepower and extended range. As is typical in the release of new products, we predicted seeing a decline in sales of the current offering as customers opt to wait for the updated, more powerful option with extended range. This will have more of an effect on our top line given the current tight margins in our business and expect to see an increase in claims in the second half of 2023 with the launch of the newer product offering.
Also, in the first quarter of 2023, we saw significant improvements in reduction in our warranty claims and did not have an adjustment to our warranty provision outside of the normal warranty estimation process. This margin in the first quarter of 2023 was $8.1 million, which was a $3.1 million increase over the prior year period. Increased sales volumes in multiple OEM businesses, along with improved sales mix of the late OEM volume in HPDI system pricing, positively impacted our gross margins. This is partially offset by higher production input costs from inflation. Turning to the next slide, our independent aftermarket revenue for the first quarter of ‘23 was $25.9 million compared with $24.7 million for the same period in ‘22. Gross margin was $5.2 million compared to $4.9 million in the first quarter of ‘22.
The increase in both revenue and gross margin was driven by higher sales volumes to North America. We also realized an increase in sales in Eastern Europe and Argentina markets, which were partially offset by lower sales volumes in the Middle East and Africa along with higher production input cost. Looking ahead, support of LPG pricing continues to create a positive demand trend in Europe and will be an important area of growth for our company. In the years ahead, the fourth quarter of this year will begin production for our previously announced business with a leading European OEM for the supply of LPG fuel systems for both Euro 6 and Euro 7 standards. This business will significantly increase our OEM revenue. As a reminder, the Euro 6 delivery begins in Q4 this year and runs for 2 years, generating approximately €38 million in revenue over those 2 two years.
Euro 7 delivery approximately doubles the related revenues, generating approximately €40 million per year through 2035 and beyond. Finally, I’d like to touch on liquidity. Our cash position decreased by $14.2 million to $72 million during the first quarter of ‘23. Decrease was primarily due to net cash used in operating activities of $8.6 million, purchases of fixed assets of $3 million, and net debt payments of $3.5 million. Inventory levels slightly increased during the quarter, following delay in the shipment of products related to our , which these products will be shipped during Q2 of this year. Despite the increase in inventory in the quarter, work is ongoing to reduce our inventory on hand to free up cash, which will be a net positive for our balance sheet moving forward.
In the first quarter of 2023, net cash used in operating activities was $8.6 million compared to $16.9 million in the same period last year, an $8.3 million decrease. This is partly driven by changes in working capital, specifically in inventory, accounts payable, and accrued liabilities, and accounts receivable. We will continue to be prudent in how we manage our liquidity. As a reminder, we have outlined a prudent capital program for 2023 with about $12 million to $15 million focused on advancing our work with hydrogen and adding test cell capacity. Again, we invested about $3 million in CapEx during the first quarter of ‘23. I’d like to take a moment to provide an update on a few items that have occurred in April. On April 1st, we entered into an agreement with Cartesian to terminate the initial financing and consent agreements in exchange for mutual releases of any future obligations.
This included the release of the security interest in our HPDI 2.0 fuel system intellectual property. We paid $8.7 million, which results in elimination of the minimum future royalty payments totaling $7.9 million. On April 26, we announced that our Board approved a share consolidation on a 10-to-1 basis, which is expected to be effective in early June. With that, I will turn it back to David.
David Johnson: Thank you, Bill. Westport Fuel Systems products are critical to decarbonize transportation. And because our products are affordable, they can and will scale. As the world gets more serious about decarbonizing transportation, Westport is ready. 2023 is an important year for us as we focus on enhancing our financial performance, driving margin expansion, revenue growth, and technology development. While we’re pleased with the progress we demonstrated in Q1 of this year, we recognize that we still have substantial work in front of us. We know we need to deliver both financially and operationally, capturing efficiency, delivering revenue growth, increasing margin, and developing great products and technology are our priorities.
Our recently announced chief technology officer, Fabien Redon, will lead our team to develop and deliver clean alternative fuel system products from concept to customer, to the global transportation and off-road markets. And with that, I’ll turn it over to the operator to open the call for your questions.
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Q&A Session
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Operator: The first question comes from Colin Rusch with Oppenheimer. Please go ahead.
Colin Rusch: Thanks so much, guys. Could you talk a little bit about the competitive landscape for hydrogen with internal combustion engines? We’ve seen some announcements around spark-ignited solutions. Just want to get your sense of the maturity and relative, performance that you’re seeing and expecting from the two approaches?
David Johnson: Hey, good morning, Colin. Glad to talk on that topic. Thanks for the question. So, interestingly, I think everyone in the world sees the hydrogen opportunity, right? As you think about how do we get to a zero-carbon fuel, that’s basically the only one to the long-haul heavy-duty application. And I think everybody is realizing the challenges that remain with fuel cells. They’ll have a place, but that leaves the door open for the internal combustion engine, which has a tremendously well-established reputation and installed base around the world. But the vast majority are headed down the path of spark-ignited engines, I’ll say, as their first attempt. And what they are finding is that this is challenging. So, you know, we commented a little bit about Vienna Motor Symposium.
There were quite a few papers about spark-ignited internal combustion engine. But what this requires and what results from changing an engine into a spark node engine is really tremendous in terms of the effort required and rather poor in terms of the performance and results. So, basically, with our HPDI product, we eliminate those challenges. So, I think people are literally agog when they understand that we can apply HPDI to a diesel engine, change almost nothing, right? Not change the piston, no change to the air handling system, no changes to the combustion formula, the peak cylinder pressures, or any of the fundamentals of the engine or hardware of the engine. Just adapt our fuel system, run that engine on a diesel cycle, and have performance that’s better than the base diesel engine by 20% on power, about 15% on torque, 10% on efficiency.
And that sets us apart from the spark-ignited engines by a wide margin, which really is consistent with what we have today with HPDI and natural gas, where leading market magazines and journals have demonstrated that the products that use HPDI have a significant fuel efficiency and performance advantage in the marketplace today with natural gas and that advantage is accentuated as we go to hydrogen because of all the changes that are required if you choose a spark-ignited approach. And so, while people are trying spark-ignited, because it’s, I would say, relatively obvious try, the results are less than compelling in terms of the performance of the engine, the fuel efficiency of the engines, and the offer to the marketplace. In terms of how much you have to invest to create such a different engine in order to work with hydrogen and yet how simple it is with HPDI.
So, I think we’re well differentiated. And at ACT Expo and at Hanover last year, we were able to have these conversations and help people understand and then, again, at Vienna Motor Symposium. And so, we will continue to do that. So, we had team members at an important conference in Sweden just last week and will continue to help our customers understand the opportunity that HPDI present. And that manifests itself when those customers bring their engines to us and say, show us on our engine. And so, we’ve talked about the projects we have going already, and we think it’s a really exciting time for us to demonstrate that, that differential that we offer with HPDI that can’t be replicated with somebody else’s system.
Colin Rusch: Alright. Perfect. Thanks so much. And just a quick follow-up on supply chain, are you seeing a real easing to the point where you might be able to bring down inventories just from an overall level as we go throughout the balance of the year? That’s it for me. Thanks.
