Westport Fuel Systems Inc. (NASDAQ:WPRT) Q1 2024 Earnings Call Transcript

Westport Fuel Systems Inc. (NASDAQ:WPRT) Q1 2024 Earnings Call Transcript May 9, 2024

Westport Fuel Systems Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning. My name is Ennis, and I will be your conference operator today. At this time, I would like to welcome everyone to the Westport Fuel Systems Q1 2024 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Ms. Ashley Nuell, you may begin your conference.

Ashley Nuell: Thank you. Good morning, everyone. Welcome to Westport Fuel Systems first quarter conference call for 2024. This call is being held to coincide with the press release containing Westport’s financial results that was issued yesterday. On today’s call, speaking on behalf of Westport is Chief Executive Officer and Director, Dan Sceli; 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 on this conference call and our responses to certain questions may constitute forward-looking statements within the meaning of the U.S. and applicable Canadian securities law. 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, Dan.

Dan Sceli: Thanks, Ashley. Good day, everyone. Today I will be recapping our Q1 results and providing color on our 2024 strategic priorities. I will also be sharing an update on the JV with Volvo and touching on the recently announced Zero Emission Vehicle, or ZEV, legislation. Then I’ll turn the call over to Bill to walk us through our Q1 results in more detail. So, touching first on our financial results, Q1 2024 revenues were down 6% year-over-year, primarily due to decreased volumes in our delayed OEM business as a key customer works through their existing inventory although we are seeing volumes begin to tick back up here in May. On the cost side of the equation, we have been aggressive in cost cutting and have begun to make changes.

As you will know, some of these adjustments will take time before we see the benefits in our financial statements. As I mentioned, at year end, nothing is off limits with respect to reducing expenditures. We have been reducing costs everywhere from the board level to the shop floor. I will dig into some examples of where we are seeing success and where we’ll be putting more pressure in just a moment. In my first three months in the role, I established three main priorities for 2024 and beyond, including, number one, driving success via our HPDI joint venture with Volvo, number two, improving operational excellence, and three, reimagining our hydrogen-powered future. To ensure that Westport creates value for our shareholders, we need disciplined operations that flow from a strong strategic plan.

These priorities are consistent with that need and are expected to elevate the performance and value of our business long into the future. As you know, we signed the investment agreement for our HPDI joint venture in Q1 and are in the final stage of formalizing the joint venture. We received approval of our competition filing earlier this week, great news and continue to work towards an expected closing in the second quarter. The investment agreement was a critical step and it solidifies Volvo and Westport’s commitment to accelerating the commercialization and global adoption of Westport’s HPDI fuel system for long-haul and off-road applications. We continue to work towards an expected closing in the second quarter with some administrative items still being still outstanding.

Once the JV is closed, this is when the real work begins. In our pursuit of profitability, cost cutting is not merely a priority. It’s an imperative. We recognize that sustainable growth relies on our ability to manage expenses. Therefore, while we are committed to driving top-line growth and operational efficiencies, our foremost focus remains on reducing costs at every opportunity. We have begun to act in a more disciplined way by identifying cost saving opportunities and making changes. In Q1, we incurred $1.5 million in one-time expenses related to severance and costs associated with setting up the JV. These costs will taper off following the closing of the JV. We have reduced senior management by six individuals and announced in our Information Circular we plan to reduce the board size by one.

We also plan to reduce board costs in general. Also, we closed the amended Westport Minda JV in 2024 in the second quarter and are progressing with a restructuring our presence in India, which is expected to improve our position in that business, to generating positive cash flows for the first time in years. Through strategic headcount reductions across the organization, we are streamlining our workforce to increase operational agility. In addition, we are decreasing our reliance on external consultancy, signaling a shift towards internal expertise and resource optimization, and initiating changes in our production lines to optimize manufacturing cost reductions. For example, in Italy we have brought in an experienced individual dedicated to operations, who with the team there is identifying areas of excess and plans and when and how to reduce the cost without impacting our ability to deliver.

Currently, we are evaluating all discretionary costs and so far I have updated our hiring policy to focus on limiting any new hiring to key positions only focused on ensuring operational continuity and have implemented travel restrictions to reduce expenses. The goal is to simplify the business and go back to the basics. Westport is fortunate to be part of a compelling industry in which alternative fuels are seeing increased support and investments. We are also fortunate that government policy in key jurisdictions like Europe and North America is heading in the right direction for hydrogen as a fuel source. Recently here in Canada, we saw the province of Alberta commit 57 million to the development of hydrogen power, along with a commitment from air products to build hydrogen refueling stations along a key transportation network in the province, demonstrating that hydrogen is essential to decarbonizing heavy-duty transport.

We are very well positioned from a strategic standpoint to be part of the hydrogen play as it evolves. In our hydrogen business, we are seeing this support take shape where over the past two years we have won seven development contracts or production programs for new 700 bar hydrogen products, complementing our current 350 bar and low pressure offerings where we have also added new programs although in early stages these programs will translate into $70 million in revenue by the end of the decade. With a focus on innovation and staying ahead of the market, we continue to add to and improve our product offering and are in production now for generation – the next generation 700 bars hydrogen regulators and are beginning on a new line of 700 bars hydrogen manifolds.

Recently, we saw new zero emission vehicle regulations out of the EU. Positive news for us and the industry. Our hydrogen HPDI fuel system is compatible with the new ZEV threshold of 3 grams of CO2 per ton kilometer. In addition, our Engine Management Systems for spark ignited engines and our hydrogen components for fuel pressure management and regulation, are clean mobility solutions designed and manufactured for a diverse set of zero emission vehicles with hydrogen fuel systems and components for both internal combustion engines and fuel cell applications. The ZEV label conveys valuable benefits to qualified vehicles and fleet operators. It is incentivizing adoption of the cleanest, highest performing vehicles across the heavy-duty transport sector aligning with Westport’s initiatives.

This opens the door for our customers and OEMs to receive incentives as well as funding and other regulatory benefits for incorporating our solutions. While this is a strong step forward supporting a hydrogen future, the continued competitiveness, affordability and growing availability of biomethane ensures that biomethane fueled heavy-duty vehicles will continue to make valuable contributions to the decarbonization of the transport well into the future. Finally, I wanted to touch on our current development projects featuring our HPDI fuel systems across multiple modes of transport. These initiatives represent more than just technological advancements. They embody our unwavering commitment to a brighter, greener future for generations to come.

These projects are long-term and ongoing. Therefore, I intend to provide updates or answer any questions about each project throughout their duration, although I may not discuss them in depth as frequently as we have to respect our customers’ confidentiality. Before digging into some of our key programs, I wanted to touch on our outlook in China. We remain optimistic on the Chinese natural gas vehicle market, which expanded to well over 100,000 commercial vehicles in 2023. And we continue to collaborate with our OEM partner in the Chinese market to provide an affordable, low-carbon solution in the future. The parties are currently discussing this work and the obligations of each party going forward. The engine development program continues to evolve and move forward.

Moving to our development programs, in November of 2023 we announced a collaboration with a leading global OEM in the rail industry. This partnership aims to adapt our hydrogen HPDI fuel system for applications in locomotives and related equipment used in freight and transit rail sectors. Given the size of these engines, the initial design phase is a large body of work and is currently underway. We anticipate the engine testing to occur later in 2025. In December, Westport announced a monumental development program with a global heavy truck manufacturer. This program focuses on adapting our next generation LNG HPDI fuel system to meet the stringent Euro 7 emissions requirements for heavy-duty vehicles. This $33 million project is funded by the OEM.

And as we work together to diligently integrate cleaner energy solutions into the transport sector. Lastly, we are engaged in a proof-of-concept project with a global supplier of power solutions for marine applications to explore alternative, sustainable, energy sources for maritime transportation. This project commenced in Q1 and explores the use of our HPDI fuel system fueled with methanol for marine propulsion. The testing of HPDI technology for use with methanol in marine applications is a natural extension of our HPDI technology. We expect that our HPDI fuel system with methanol will be able to provide similar torque, power and efficiency to diesel while also potentially reducing NOx emissions. Currently, the engine conversion is being planned with our OEM customer with the intention to run the engine tests later this year.

As we see it, HPDI is well suited for high horsepower, off road applications as the other low-carbon, zero-carbon competing technologies in on highway markets, including spark ignited fuel cell and battery electric, all have major drawbacks when used in demanding high horsepower applications. Spark injection systems have inherently lower fuel efficiency, which can be an acceptable trade off in certain on highway markets, but not in high horsepower applications where the annual fuel use is substantial. Battery electric requires charging time that doesn’t work with the daily runtime requirements in the high horsepower space. Finally, fuel cells could be a consideration, but high horsepower applications tend to operate at very high load factors, which is where fuel cell efficiency decreases.

We believe that high horsepower applications will be most effective when used with diesel cycle combustion, the option with the highest efficiency and durability. Therefore, changing the fuel instead of changing the fundamental technologies for these applications is the best option for decarbonization and functionality, and HPDI is the solution. With that, I will hand the call over to Bill, who will walk you through our financial results. Bill?

Bill Larkin: Great. Thank you. Good morning and thank you Dan. In the first quarter of 2024, we generated $77.6 million in revenue. This is a 6% decrease compared to the prior year period. This decrease is primarily driven by a decline in sales volumes in our delayed OEM and to a lesser extent in our fuel storage in our light- and heavy-duty OEM businesses. Partially offsetting these declines were increased sales of our electronics products and an increase in our independent aftermarket business, where we saw our sales increase in North American, Western European and South American markets. Gross margin decreased $11.7 million or 15% of revenue in the quarter. This down from $13.3 million, or 16% of revenue in Q1 of last year.

This decline is primarily driven by the reductions in the Q1 2024 revenues, which were partially offset by an improvement in sales mix to higher profit markets in our independent aftermarket business. Our adjusted EBITDA loss increased by $2.1 million to $6.6 million. In the quarter we had about $1.5 million of costs related to severance and outside services associated with closing the joint venture. Going forward, we expect to see a reduction in outside services once the joint venture has closed. OEM revenue for the first quarter of 2024 was $49.3 million, down $7 million compared to the prior year period. In the quarter, sales volumes decreased in our delayed OEM, fuel storage and light-duty OEM businesses. Our heavy-duty business sales volumes decreased, which were partially offset by higher engineering services revenue.

Sales volumes in electronics business increased, driven by higher sales to one of our key customers. Gross margin, our OEM business decreased in the quarter to $4.5 million, or 9% of revenue. This compared to $8.1 million, or 14% of revenue in Q1 of 2023. This decline is largely driven by lower volumes in our delayed OEM business, which traditionally have strong margins. As Dan mentioned, our key customer here entered 2024 with excess kid inventory and they were working through their inventory in the first quarter. As we mentioned on our year end call LPG fuel system deliveries to our global OEM customer began in the first quarter. However, we saw a limited impact on revenue as it is only a partial quarter of deliveries, which included a ramp up in production that is expected to continue throughout the year.

Independent aftermarket revenue for the first quarter of 2024 was $28.3 million. This is up $2.4 million compared to prior year period. Increased sales in North American, Western European as well as expansion of markets in South America, primarily in Mexico and Peru drove this performance. With sales declining in Africa and Eastern Europe. Our gross margin increased to $7.2 million or 25% of revenue compared to $5.2 million or 20% of revenue in a prior year period. This increase was driven by higher sales volumes and improvement in sales mix to higher margin markets. Starting liquidity, our cash, and cash equivalents at March 31, 2024 was $43.9 million. Cash provided by operating activities was $142,000 [ph]. This is a significant improvement over the same period last year, helped by continued reductions in net working capital.

Investing activities included purchases of capital assets of $4.9 million and financing activities were attributed to net debt payments of $5.8 million in the period. Looking forward, we have multiple projects and initiatives, either announced or underway that will have a positive impact on liquidity as we continue to prioritize solidifying our balance sheets. To reiterate Dan’s statement about cost, in our pursuit of profitability, cost cutting is not merely a priority, it is imperative. We’ve been identifying cost saving opportunities and making changes and we’re already seeing a positive impact of these cost reduction initiatives. With the full effects of these initiatives be more obvious in our financials after we close the joint venture and those one-time costs taper off.

All that said, we have a lot more to go. Moving forward, we will continue to be prudent our liquidity management and multiple steps are being taken to do so. And we will continue to do so what is necessary to ensure that we are adequately and fully capitalized. Thank you and with that I will turn it back to Dan. Dan?

Dan Sceli: Thanks, Bill. Finally, I wanted to close on a few key points. Westport is part of a compelling industry with a bright future and we are driven to make a material impact on the decarbonization of the transport industry. Although revenue was amiss this quarter, it wasn’t permanent and we’re making the necessary changes to optimize operations, cut costs and ultimately close on the HPDI joint venture. Our short term goal is to stabilize the business. Long term, we will be focused on building a sustainable and profitable future, driving our three key pillars with a culture of discipline and excellence will deliver the objectives we established. I want to take a moment to thank everyone for being here today. And with that, I’ll turn it over to the operator to open the call for questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Your first question comes from Colin Rusch with Oppenheimer. Please go ahead.

Colin Rusch: Thanks so much, guys. I appreciate the comments around customer inventories. Can you talk a little bit about what you’re seeing in terms of sell through on that inventory and when you think it’ll be fully cleared?

Dan Sceli: Bill, you want to jump in on that one?

Bill Larkin: Oh, sure, yes, no problem. So, we’re already starting to see those cells starting to pick up for demand. This is a customer that has just grown significantly in Italy – in Italian markets, and they’re going through some growing pains and so we’re there to help them. And through their process, they’re just – they procured too much inventory and they’re working through that. And we’re starting to see that come back online where we’re starting to see orders for those kid inventories we delivered and that’ll continue to ramp up in the back half of the quarter.

Dan Sceli: Okay. And that’s some very specific stuff. But yes, in general, one of the things that we have done is implemented a inventory committee, because inventory is one of our top priorities. Working capital, obviously, overall is a top priority for us and we are digging in and setting new targets to manage inventory better. Having a better connection between a customer order and a supplier order to be more disciplined in how we manage inventory overall.

Colin Rusch: That actually is a good – dovetail into my second question, which is really around working capital. So as you guys look forward, how big an opportunity is there over the next couple of quarters to generate cash from the balance sheet and the existing working capital exposure?

Bill Larkin: Great. I think we do. We’ve made a lot of progress, Colin, over the last, call it 12 plus months and improving our working capital, continuing to generate that and turn that into cash, but we still have a lot more work to do. As – we had a fairly significant reduction in our receivables during the quarter, which definitely helped from a cash flow perspective. But I think inventory is an opportunity for us to continue to reduce our networking capital, enhance our liquidity. And as Dan mentioned, that’s a high priority for us to go tackle that and try to reduce inventory, improve turns. But it’s going to be a team effort to drive down the inventory to levels that we can efficiently manage while we can still deliver on our customer demands.

Colin Rusch: Okay. Thanks so much, guys.

Dan Sceli: Yes, yes. Let me comment just a little bit more on that, because one of the things, when I talk about driving discipline in our business is making a lot of these, the processes, the routine and not the exception. Not seeing something and going, oh, boy, we got too much inventory in this. What are we going to do about it? We need a process that ensures that buildup doesn’t happen in the first place that we manage that balance between order from customer to order to supplier, and make it the routine, not the exception.

Operator: Thank you. Your next question comes from Chris Dendrinos with the RBC Capital Markets. Please go ahead.

Chris Dendrinos: Yes. Good morning. Thank you.

Dan Sceli: Good morning.

Chris Dendrinos: I guess, I wanted to begin here. You had some commentary in the prepared remarks around your China partner. And so I guess I wanted to go back to that. And specifically, I think you mentioned, you’re discussing the work and some obligations that each of you all have moving forward. So could you maybe discuss that in a bit more detail? What are the kind of commitments or obligations here from the parties, and maybe, how should we think about things progressing?

Dan Sceli: Sure, sure. Well, let me start with in terms of production orders. We have no production orders from them currently in the system. We have had more development orders for development on their engines, and that’s going to continue. We’re trying to work with them on planning and crafting where that development is going to go down the road.

Chris Dendrinos: Got it. Okay. Thanks. And then maybe shifting gears a little bit to the H2 opportunity, and you highlighted maybe $70 million of revs by the end of the decade, I guess maybe what’s sort of underpinning that assumption set? And then what’s the cadence? Or how are you guys thinking about the cadence of that opportunity? What are the kind of levers that would, I guess, accelerate that opportunity going forward? Thanks.

Dan Sceli: Sure. Yes. The H2 numbers we’re talking, these are the components that go into the hydrogen systems, and we’re selling to the big Tier 1s globally. And they have – we have been obviously working on development projects with them. And now we’re getting production purchase orders and prototype purchase orders to take those forward into production and on a number of OEM platforms. And what we’re finding is that the hydrogen components under GFI are qualified as the best globally. And so we’re getting a lot more opportunities than we can actually handle. And so as the hydrogen ecosystem evolves, these components are going to play a key role in ramping up production in the next few years.

Chris Dendrinos: Got it. Thank you. That’s everything for me.

Dan Sceli: Okay.

Operator: Thank you. Your next question comes from Rob Brown with Lake Street Capital Markets. Please go ahead.

Rob Brown: Good morning.

Dan Sceli: Good morning.

Rob Brown: Want to pull up on kind of the cost cuts. I think last time you talked, you were still getting into it. But do you have a sense on maybe the goals on the cost cuts ultimately, or a sense of when you can get to profitability?

Dan Sceli: Yes. So, I mean, our goal is, first, I’ll talk very generally about what I call flexing our costs. As you know, when you’re in the automotive and mobility markets, volumes can go up and down, and we need to have a underlying system, a disciplined system that flexes our costs with those volume changes up and down. What we’re doing right now, though, is stabilizing the business by reducing our cost to the level of the business we’re in right now, followed by a process or a system that will flex those costs on an ongoing basis, sort of like I mentioned on the inventory. We need this flex management to become the routine and not the exception. We can’t wait till the end of a quarter and see the numbers and go, okay, we need to do something.

It needs to be a day-to-day effort. But in the meantime, this first short-term goal is to get the overall costs aligned with the size of the business we have. Clearly, our cost and our overhead were far too high for the business we had, and we were making those adjustments.