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Quantum Fuel Systems Technologies Worldwide, Inc. (NASDAQ:QTWW)

Q1 2014 Earnings Conference Call

May 13, 2014 04:30 PM ET

Executives

Casey Stegman – Investor Relations

W. Brian Olson – President and Chief Executive Officer

Bradley J. Timon – Chief Financial Officer

Analysts

Eric Stine – Craig-Hallum Capital Group, LLC.

Carter Driscoll – Ascendiant & Company

Dan Trang – Stonegate Securities Inc.

Andrew Brown – Dougherty & Company LLC

Operator

Good afternoon. My name is Stephanie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Quantum First Quarter 2014 Earnings 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.

I would now like to turn the call over to Mr. Casey Stegman, Investor Relations. Please go ahead, sir.

Casey Stegman

Thank you, Stephanie. Good afternoon, everybody. We appreciate you joining us today. With me on the call is Brian Olson, Chief Executive Officer; and Brad Timon, Chief Financial Officer. The purpose of today’s call is to review the company’s financial results for the first quarter of 2014. Following the company’s remarks, there will be an opportunity to ask questions. The operator will provide instructions regarding the Q&A portion of the call.

Certain statements made during this call may constitute forward-looking statements within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on current market conditions and management’s reasonable expectations and assumptions as of the date of this call. Examples of forward-looking statements include our expectations regarding future revenues, gross margins, production capacity and the growth of the CNG market.

Various risks and other factors could cause our actual results to differ materially and adversely from those contemplated by the forward-looking statements. For a discussion of these risks and uncertainties, you should review the forward-looking statements disclosure in the earnings press release we issued today, as well as those contained in our periodic filings with the Securities and Exchange Commission.

The company disclaims any obligation or undertaking to disseminate any updates or revisions to any forward-looking statements made during this conference call to reflect any change in management’s assumptions, beliefs or expectations or any change in events, conditions or circumstances upon which any forward-looking statements are based.

With that, I’d like to turn the call over to Quantum’s CEO, Brian Olson. Brian?

W. Brian Olson

Okay, great. Thank you, Casey. So before I turn the call over to Brad for the financial review, I want to spend a little time highlighting the fundamental business accomplishments we’ve achieved so far in 2014 that enables Quantum to build and grow its business not only for today, but for the future.

These accomplishments are successes covering many aspects of our business, including the introduction of new products and systems, significant wins in carrying out our heavy-duty system strategy, delivering on the development and integration of storage and fuel system technologies. The successes build out of additional production capacity and strong order flow for new and existing customers. Overall, it was a solid quarter and demonstrated continued year-over-year growth in our business in achieving many accomplishments during the quarter that support our long term business strategy and growth.

Our natural gas revenues increased 82% during the quarter. Our operating loss narrowed 59%. Despite this growth and improvements in operating performance, I do want to mention our tank shipments were negatively impacted during the quarter by a couple of factors. First, overall heavy-duty natural gas engine sales were sequentially down during the first quarter. The market has seen new releases from engine producers indicating lower levels of nat gas engine sales during the quarter. Secondly, Quantum units during the quarter were impacted by the relocation of our test and validation facility.

During the year-end earnings call, I had mentioned that we were in the process of moving our tank test and validation facility from Irvine, California to Lake Forest, California. The construction and move have progressed well, but it did cause minor disruptions in products flowing at the rates we had hoped. This facility and relocation have been completed.

The consolidation of our test and validation process in Lake Forest right here on our campus will have tremendous long term development and production process benefits for Quantum. The completion of this facility is just one of many positive and extensive development that has inspired so far in 2014. And that is where I’d like to focus on these positive and forereaching developments and how it strengthens our position as a systems provider.

The beginning of 2014 has been strong for Quantum in terms of continuing to build for the future. Specifically, receiving new tank and system orders, solidifying key strategic industry relationships like the one with Ryder, expanding order flow, developing, introducing and commercializing new tank products, developing and introducing new CNG storage system products, completing and delivering complete fuel system technologies and continuing to successfully expand our tank production facilities.

During the year-end conference call, I referred to pillars being put in place and I want to elaborate on these pillars and what has happened so far this year as evidence of the strong foundation being built. Specifically, during 2014, we have secured approximately 15 new customers including companies like Ryder, Peter Bill, Swift, Kwik-Trip, McNelis and others, many of these customers are interested in moving forward with our fully-integrated, heavy-duty fuel storage systems. Later in this call, I will layout the specific impact it has on our top and bottom line.

Currently today, we deliver natural gas and tank system products over 75 companies. And our order flows so far this year included new orders from approximately one-third of them, representing approximately 9 million in new and order flow, and that does not include Ryder. We have a strong customer base and it has gotten stronger in the past four months. It will get even stronger over the next four.

These new relationships are an early indicator of the company’s ability to provide the industry with fully integrated OEM quality systems and at the same time diversify our existing customer base by leveraging our core system integration expertise in complete CNG Fuel Systems.

Quantum excels at the packaging and integration of components in the Fuel Systems solution and the industry has applauded our entry into this market and our innovation, and recognize that financial markets are still trying to digest the news on Agility’s new JV relationship for tank supply. And I’ll talk more about this after Brad’s review. But, revenues from Ryder alone could eclipse what we’re doing with Agility today.

We believe any one of these new major customers could have significant revenues by themselves that would be greater than what we supply Agility. These customers are interested in Quantum’s innovative back-of-cab CNG storage system offering end users a week savings of approximately 1,000 pounds, and at lower prices than what exist in the market today.

We began commercialization of this back-of-cab storage system, which has been engineered and developed based on incorporating lighter weight materials and using design concepts for optimized load paths, in order to minimize costs and weight. This back-of-cab system is showcased at the Mid-America Truck Show earlier this year and last week at ACT by Peter Bill. And also showcased by Ryder, our strategic partner and one of our largest providers of fleet vehicles in this country. This back-of-cab system along with our rail-mounted CNG storage system had been well received, and we have customized, configured and sold at several parties and expect demand to grow based on its light weight and highly innovative design features.

In terms of other new products and systems and other applications, we’ve received new orders from new customers for specifically designed products of the Canadian market. We have passed Canadian certification on two brand new tank offerings. And now, we have two new product offerings that we believe meet their growing needs for delivery vehicles.

Westport has issued at the follow-on tank order for the light duty program in a publically-indicated Quantum as their primary tank supplier over these specific program. We also finished validation and commercialization of another new product offering, a 21/86 back-of-cab collar-mount tank. We’ll be in shipment for this product during the final weeks of the first quarter. This complements our industry leading ultra light weight large diameter tanks and provides for entry into tank supply for back-of-cab system.

Year-to-date we’ve received multiple orders from multiple customers for this product, and believe this can grow nicely in 2014 and beyond. Additionally, during the quarter, we developed a second generation of a rail-mounted CNG storage module with application across several vehicles and markets. We completed development and delivered several pre-production units, advanced CNG fuel storage and delivery system for ZHRO Solution. These systems are coupled with ZHRO’s revolutionary natural gas injection, engine conversion system and are being used as part of a pre-production test fleet for on-road testing on heavy duty after-market trucks.

We have cleared production readiness under the GM Impala program, and we are completing the final emission certification under contract with GM. We expect units to begin delivering in the second half of this year. This is just another example of us packaging, assembling and delivering complete OEM level fuel and storage systems into the market. We have been doing this for two decades. As mentioned earlier in the call, we recently and substantially completed the relocation of our tank test and validation facility, we have now consolidated right here in Lake Forest next to our production and product developments efforts.

Finally, we have been successful in continued expansion of our tank production facilities, reaching current annualized production capacity levels of 15,000 units. We continue to make technology advancements in our product offerings that translates into weight saving, lower cost solutions and faster to market systems. This is not lost on the industry, we have received tremendous positive feedback on the storage systems we have placed into the market, Ryder is just the beginning.

We are well prepared and well positioned to move this company forward along our systems approach, and the industry has embraced our on entry into this market. I’m going to turn the call over to Brad in a second, and then come back and detail out the underlying economics of our systems strategy.

Brad, let’s move to the financial review.

Bradley J. Timon

Okay. Thanks, Brian, and good afternoon, everyone. The financial results of the first quarter of 2014 are as follows. We recognized $8.0 million of total revenues during the quarter. The revenues reported represent an increase of 82% above the total revenues reported for the same period in the prior year.

Revenues from product shipments amounted to $4.8 million, of which $4.3 million was related to CNG fuel storage tanks and systems and $0.5 million was related to hydrogen components and systems. After factoring in manufacturing overheads, we realized an overall gross margin of 24% on product sales for the quarter and our backlog of customer orders for CNG tanks and systems was approximately $15 million as of March 31.

Revenues from contract engineering services for the first quarter amounted to $3.1 million overall, of which $2.7 million was related to the development of CNG fuel storage systems.

Activities under engineering service contracts mainly related to (indiscernible) activities associated with the development of an after-market CNG storage system for heavy duty trucks on behalf of our customers ZHRO Solutions and activities associated with the GM Impala CNG passenger vehicle program. Looking at our development contracts on a combined basis, we’ve realized an overall gross margin of 40% on contract engineering services for the quarter.

Okay, moving on to operating expenses. Our operating expenses include costs associated with our internally-funded development programs and primarily consist of efforts to advance our CNG tank and storage module technologies. These expenses reported as research and development amounted to $1.5 million in the first quarter of 2014.

Our operating costs also include SG&A expenses of our Fuel Storage & Vehicle Systems segment and our Corporate segment. We’ve recognized a total of $2.6 million of SG&A expenses in the first quarter of 2014. Effective January 31, 2014 we vacated a facility located in Irvine, California, in accordance with a long-term lease arrangement that we amended back in 2013.

The closer of this underutilized facility will save the company approximately $80,000 per month in operating cost going forward. Our continuing operations generated an operating loss of $1.6 million for the first quarter, which represented an improvement of $2.3 million compared to same period in prior year.

Next, I’ll provide some comments on interest expense that has reflected below the line as part of non-reporting segment results. The net interest expense was $0.8 million in the first quarter of 2014. This expense represents both cash payments based on stated contractual rates and non-cash imputed rates associated with equity-linked characteristics and other contractual provisions of the debt securities. Approximately 70% of the expense reported for the first quarter was related to non-cash imputed interest costs primarily associated with the convertible notes issued to investors back in September 2013.

Next, I want to comment on fair value adjustments of our derivative instruments. During the first quarter, we recognized a net charge of $0.7 million related to the increase in fair value of derivative warrants. This share price of our common stock represents the primary underlying variable that impacts the value of the derivative instruments. A significant number of the warrants that are accounted for derivatives have now either been exercised or have expired to-date. Thus, we expect to recognize a gain in the second quarter of 2014 and then we expect to level off unrealized gains or losses on derivative instruments to be minor thereafter.

Okay, moving onto the results of our discontinued operations. As we have disclosed on previous calls and releases, we are actively looking for buyers of the remaining wind assets of Schneider Power. As a result of our intent to sell the assets, we classify the activities and balances of Schneider Power as discontinued operations held for sale. The most significant remaining asset of Schneider Power is the 10-megawatt Zephyr operating wind farm. Although we expect to find a buyer for the wind farm within the next several months, we continue to be patient and we will move forward on the transaction once we are comfortable that we have received a fair offer on the project.

Now, I’ll briefly cover the operating results of Schneider Power for the first quarter. Revenues of this segment amounted to $0.9 million which is all related to the operations at the Zephyr wind farm. Schneider Power incurred $0.6 million of operating expenses during the first quarter and a non-cash charge of $0.4 million recognized at the Zephyr project level. Interest expense related to the Zephyr project debt amounted to $0.3 million. The overall results of operations for Schneider Power amounted to a net loss after tax of $0.1 million for the first quarter. The overall impact of the results of our continuing operations and discontinued operations, which also includes the non-cash charge related to the derivate warrants that I mentioned earlier, resulted in a consolidated net loss of $3.2 million that we have reported for the first quarter of 2014.

Next, I’ll provide some comments on our balance sheet and our improved liquidity position. Our cash on hand as of March 31, 2014 was $16.4 million for continuing operations, which was lifted in part from net proceeds of $15.3 million from the closing of our public offering on February 20 and the receipt of $4.8 million of proceeds from the exercise of warrants during the first quarter. We did use a portion of these proceeds in February to pay down our revolving line of credit to zero that previously had a balance of $3.8 million.

As a result of the capital raised during the first quarter, our liquidity position is strong and we have more than sufficient cash on hand to fund our business operations and execute on our strategic initiatives.

Next, I want to spend a few moments to provide some additional color on our announcement last week related to our new arrangement with Ryder Transportation. Under the five-year arrangement, Ryder has committed to purchase 95% of their CNG fuel storage module systems from Quantum. The Ryder arrangement is a significant commitment on behalf of a large fleet operator and we anticipate that Ryder will represent on average somewhere between $20 million to $30 million of revenue for us on an annual basis.

Just to put that in context, our largest existing customer Chile Fuel Systems represented $14.2 million of our total revenues in calendar 2013 and $3.2 million of our revenues in the first quarter of 2014. As such the Ryder arrangement alone is a significant step in our strategy to diversify our customer base and leverage our core strengths of providing complete natural gas fuel storage modules and systems.

And now I just want to make one final comment on my end as it relates to guidance for calendar 2014. We are currently expecting sequential quarterly improvement in our operations as we move through the rest of the year and we are estimating that total revenues will be approximately $45 million to $50 million for the entire 12-month period. And with that I turn it back over to Brian.

W. Brian Olson

Okay, great. Thank you, Brad. So let’s a spend a little time detailing out the economics underlying our system strategy and especially how it relates to the market concern about Agility tank sales. First, I want to highlight the fact, we are continuing to ship product to Agility and expect to do so at least through the end of this year maybe longer.

Secondly, this could be one of the first times ever Quantum’s coming from a real position of strength and initiative versus maybe reactionary. We have so much strength in this area of storage system. Our design and engineering capabilities are industry leading Type IV tanks, the most storage efficient tank in the world. Our OEM level systems, our TS6949 quality level are employed in the Tier 1 OEM mindset and experience, yet Quantum has been well designed and constructed for the business opportunity ahead of us.

Thirdly, let me just reiterate, we have been a Tier 1 OEM systems provider for nearly two decades. This is not new for us. We have commercialized CNG vehicle and truck systems for OEM. We just have not been able to fully pursue the heavy duty market over the past two years due to certain non-compete restrictions Agility placed on Quantum.

As of last Tuesday, these restrictions are gone. We now have the ability to fully pursue the heavy duty market, and we will. As mentioned earlier, we have been working with certain OEM in major fleets over the past six months, but on a limited and restricted basis. We have them as current customers and we plan to expand these relationships.

In terms of the recently announced Agility Lincoln JV, we’ve had strategic discussions with Agility from time to time and had every opportunity to enter into some form of JV relationship with Agility. Our decision process around this was fully evaded at the management and board level. Quantum decision to not enter into this form of relationship was squarely based on financial metrics and the ongoing into the way restrictions this type of arrangement would’ve placed on Quantum and our ability to compete in the market.

If we would’ve entered into a JV with Agility, we’re just merely continue to sell the tanks on our existing restriction. We would not be able to work with the riders, with the swifts of the world or the OEM. We firmly believe the company’s systems approach in dealing directly with several key OEM and fee level customers offers better economics and stockholder value for Quantum. And that is why we made the decision we did.

Let me reduce this down to simple numbers. Let’s focus on 2015. We believe we can do a conservative basis around 2,500 heavy-duty OEM level systems in 2015. Ryder could be half this number and based on growing initial orders from other customers we’ve received, we believe, we can realistically hit 2,500 units. These units would have different configurations, three tank systems, four tank systems, maybe five tank systems that for simplicity, let’s say we have it around 30K per system that’s $75 million or so in revenues, at margins of high 20s or 30%, that equates to over $20 million in gross profit.

Let’s compare that to selling tanks with Agility through a JV. We sell the Agility 14 million of product last year as Brad mentioned, maybe that would have translated into $20 million in revenue this year. All goes well next year and we double that, $40 million assuming the same 25% to 30% margin gets the JV. Let’s say $10 million to $12 million of gross profit, which we split. Quantum gets $5 million to $6 million. Maybe I am able to transfer price favorably into some JV based on tank technology, so I get a couple of extra millions and omit $7 million to $8 million, $20 million under assistance approach, $7 million to $8 million under JV arrangement, that is only 2015.

Not to mention, I can realistically sell any other tanks into the heavy-duty marketplace that could not have under an arrangement with Agility due to the severe Agility and postmark of the prices of tank out of the market. Under the system approach, I can no restrictions. Under the systems approach, I can double my profits nearly out of the gate, grow the systems business across the diversified group of marquee companies and still we able to service other customers, integrator, OEM, fleets with tanks or systems, because I’m not restricted. The decision to not enter a JV relationship was carefully analyzed and assessed, it was based on multiple factors. But we believe, we reached the right decision and have confidence in our system’s approach. But more importantly, we have evidence it is working. Our future is bright and this includes the immediate future, 2014.

2014 is about delivering on the things we said we would deliver on, growth in CNG, pursuing strategic opportunities, developing commercial relationships and building on our systems and technologies. We provided guidance at the beginning of this year that we believe will significantly grow our natural gas revenues in 2014. We still believe this and now it involves sales growth for both tank units and systems and growth across a diversified customer base.

Further, we expect revenues to ramp this year on a sequential basis, very similar to last year wherein we believe each subsequent quarter this year will demonstrate sequential revenue growth with expectations to reach profitability by the end of this year. At the same time 2014 is about continuing to build the business for the future, investing in technology, expanding the position in our product portfolio, alignment, focusing on the fleets, other integrators that use there is a natural truck, leveraging our strength and our successes in capitalizing on our complete system’s approach.

When I hear fleets talking about moving toward a 100% natural gas fleet, it’s exciting. When I hear about truck OEMs putting all the necessary plans in place to gear up for higher natural gas vehicle production runs, it’s exciting. When I see Quantum unleashing innovation in the marketplace, it’s exciting. I’m excited about the growth in our business. I’m excited about our progress. And I’m excited by the energy being brought forth by Quantum’s employees. I’m excited about our future.

With that, we’d like to open it up to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Eric Stine with Craig-Hallum.

Bradley J. Timon

Hey, Eric.

W. Brian Olson

Hey, Eric.

Eric Stine – Craig-Hallum Capital Group, LLC.

Clearly, we’re hearing lighter and cheaper is a very big deal that’s resonating in the market. But could you just talk about some of the characteristics or operational attributes Quantum brings to the table, how that resonated with Ryder and maybe how that program played out?

W. Brian Olson

Yeah. Sure, Eric. I mean, maybe this is as good a time of any as to just how Quantum’s employee’s base. We have industry experienced top shelf and dedicated engineers, manufacturing engineers, project managers, technicians and quality engineers.

They have strong experience with vehicle OEMs, I underscore vehicle, because vehicle in this industry when you’re talking heavy duty trucks, that OEM level of vehicle experience is critical.

We have experience in commercializing vehicle system. We’ve been Tier 1 OEM supplier, like I said for 15 years to 20 years. We understand vehicle integration and technology. We have OEM level systems. We speak their language. We speak Ryder’s language. We speak OEM language. There is no substitute for that. There is no quick fix.

We are the only natural gas tank and systems provider that can bring this level of vehicle OEM and integration experience to the table. This is the type, quality, and depth of experience that attracted Ryder and it will attract others. We also have industry leading Type IV storage technology that I mentioned.

We can hold more liters per kilogram than any other tank manufactured in the world. Ryder likes this. They and others also like our ability to package an ultra lightweight complete storage system around it. We are manufacturers of natural gas products and systems, but an engineering thread runs through everything we do. This is important when you are servicing vehicle applications. OEMs are looking for this thread, Ryder was looking for this thread, and Quantum has a history of delivering innovation and delivering from an engineering standpoint.

Eric Stine – Craig-Hallum Capital Group, LLC.

Just sticking to that, I mean, when you think about all of the work with Ryder that preceded that agreement and then judge that versus the type of work that you’re doing with other customers now and you did call out some new ones Swift. Swift is one that comes to mind who had been going with a competitor. What kind of confidence or visibility does that gives you in to how fast those opportunities can come on?

W. Brian Olson

Yeah. I think, we’ll see some very early traction, where also 2014 is going to be about making sure that, we keep as lot of this stuff off appropriately, professionally and it gets sends into the market that that we think, meets the needs of several of these customers and we do ramping as move through this year. So between, we get the second quarter, there will be some outflows and systems out the door. Q3 will be much higher. Q4 will be much higher. We expect in Q3.

So there will be meaningful systems flow as we move through this year and track. We think there will be some good traction on some of these key customers. And that really sets up well for 2015. So we’re not sitting here waiting 2015. We will see that ramp occurs this year. We’ll see traction. I expect, we can announce a nice wind beyond what I have been able to announce in the market and we’re, we have just, like I said, we’re just getting started. The handcuffs are off.

The marketplace that we speak, like I said our entree end of the market. They embraced our innovation. They embraced everything about our systems approach. So we’re excited about ramp in 2014 and especially excite about what volume levels we can hit in 2015 and beyond. I think it gets real, real exciting to see a diversification across multiple customers that we can build up into the business in the next six to nine months. And then carry those customer relationship into 2015 and beyond and not have a customer concentration that you have marquee customer needs representing a 5%, 10%, 15% of our business that across multiple customers that are buying our systems going forward.

Eric Stine – Craig-Hallum Capital Group, LLC.

Yeah. Absolutely. Maybe last one from me. It was very helpful, how you laid out 2015 on the system side? Maybe, just on the tank side hearing some integrators out there are gaining share and what the potential is to sell to the trilogies’ and mainstays of the world above and beyond the systems, your contract revenue?

W. Brian Olson

Yeah. I think that world, that’s another world that opens up to Quantum, its good; it’s good that world has opened up. Yeah. There is more than just one integrator. We think there’s opportunities to work with other integrators that may not have the same level of angst over us being a real solid systems provider into the marketplace and I think that’s an opportunity amongst fleets, OEMs and clearly other integrators. We believe that and we know we know those providers had conversations with many of them at ACT last week, if not all of them.

And there’s opportunity to work together with other industry players, we’re just not going to move this company forward and then have our hands tied behind our back, we’re not going to move forward with arrangements that restrict us from being able to fully participate in the upside of this market. And so, we expect to be able to work with certain integrators, and clearly all the OEMs and fleets are falling within the world of opportunity that we can pursue going forward and that’s really exciting. I’m so excited about, we can finally go attack this market and raise in levels we’ve never been able to do and completely appreciate and have sensitivity to the falling stock price. At the same time I didn’t, I wanted to spend time with fundamentals on this call because these fundamentals are so critical and so exciting because we are so well-positioned to be able to really be a big player in this industry here.

Eric Stine – Craig-Hallum Capital Group, LLC.

Okay. Thanks, guys.

Operator

Your next question comes from the line of Carter Driscoll with Ascendiant & Company.

W. Brian Olson

Hey, Carter.

Carter Driscoll – Ascendiant & Company

Can you talk me about the non-compete, was there specific trigger, did you mutually agree to break it apart, was it triggered by tie-up with Lincoln, maybe just talk about how that came about?

W. Brian Olson

Yeah. And listen even at ACT last week had discussions with Agility. And as I mentioned earlier on this call and as I mentioned to Barry Engle who is the CEO of Agility and we continue to have very strong positive conversations related to, making sure there’s no disruption in the marketplace we have. We have communicated in a very fair sphere of wiliness to move forward with them purchasing tanks from Quantum. At the same time, we both absolutely agreed that there’s no more restrictions, and that was an agreement we made and clearly it’s a new dawn for Quantum.

Carter Driscoll – Ascendiant & Company

Okay. And maybe just shifting gears to capacity expansion, you said you had some 15,000 run rate right now, you still plan to get to 20,000 and then potentially 25,000, there’s potentially Agility slowing down, does that effect your capacity expansion plans and then may be your use of Tier 2 suppliers as well in terms of adding capacity?

W. Brian Olson

Yeah. Our guidance was to get to the 20,000 tanks by, I think September. A very little incremental capital we need to kind to reach that 20,000 level. So I think, we’re going to stay consistent with what we previously communicated to the market and our plan and target is still to get to the 20,000 units by September, and that’s consistent with what we’ve disclosed before and I think that’s to the extent of our comment that it relates to production capacity at this point.

Carter Driscoll – Ascendiant & Company

Okay. Maybe switching gears again to the light duty side, obviously you work with the Schneider Power. Have you seen other OEMs moving forward with some other programs and, and now maybe trying to get a sense of when you might be able to layer in some additional business from that portion of the vehicle segment?

W. Brian Olson

Yeah. We have announced, there is a second passenger vehicle program that we’ve been heavily involved with as a key supplier for the natural gas system. We’ve not disclosed the name and – without any granularity of really trying to identify when that could move into production, but we’re excited about the GM program. We’re excited about the second OEM on a passenger vehicle. And quite honestly, I need so much attention and focus because of what’s transpired over the last week-and-half or two weeks.

I feel like we’ve almost neglected the conversation around the full ZHRO Solutions and AGI, the heavy duty aftermarket opportunity, because that’s we continue to recognize very nice revenues on their program from a contract services. We are delivering the technology. We are delivering the systems, the software related to that program. So we believe we’ve executed very well on that.

We still anticipate that can generate meaningful upside revenues and just probably haven’t been baked into a lot of models and forecast. And we’re still monitoring those eventual and potential rollout of those units, but the passenger vehicle programs, the ZHRO Solutions program. There is other aftermarket programs we are working on.

We have a relationship with Real Time. The Real Time network, which is a very powerful industry association in heavy duty trucking that we have an arrangement with for delivering our systems into the heavy duty aftermarket, that’s something we’ve really haven’t addressed or talked about, but that’s an extreme relationship providing service outside of Ryder. The Real Time network, which is over 200 dealerships in this country and service lenders is a huge opportunity for us to leverage service centers and aftermarket support and continue that relationship and focusing not only on aftermarket, but focusing on heavy duty solutions now as well.

How exciting that that we can take this as complete absolute strong relationship we have with real time has over 200 locations that has been doing aftermarket, not all of them are doing aftermarket, but a lot of them and we see the opportunity, now to leverage that same aftermarket service support system for heavy duty OEM trucks as well. So it’s just a great opportunity beyond everything we can’t hit on this call, specifically related to heavy duty OEM market. This is certainly more faster than the aspect that we believe are going to positively impact our top-line and bottom-line going forward in that latter half of this year 2015, 2016 timeframe.

Carter Driscoll – Ascendiant & Company

And as if you could qualify, this is my last question. If you could maybe qualify it, maybe if not quantify, where you see the split between aftermarket and OEM evolving over let’s say the next 12 months and then maybe the next 24 months in terms of the impact to your top-line at a high level?

W. Brian Olson

Yeah. It’s a fair question, it’s a tough question. I wish just in broad stroke terms, what we are hearing about the heavy duty OEM market is we’ll continue to see that potential 3% to 5% adaption rate this year and I think Quantum can heavily participate in that continued adaption. So the heavy duty OEM market is a good driver I think into the next 12 months. I think that will represent more revenue for Quantum, but the same system, here is the beautiful thing Carter, the same systems we’re developing and have developed for the heavy duty aftermarket and now that we’re developing for the heavy duty OEM market, they’re all the same truck market.

They are all the same truck. I mean, it’s a beautiful migration of technology from one heavy-duty truck to another program he pays, we think both are going to be successful. We think we’re well positioned in both the distinct systems approach and module whether it’s rail-mounted, back-of-cab. We can do collar mount, we can do saddle mount, 21-inch, 25-inch, I mean we’re going to innovate new solutions. So we can attract both of those markets with the literally the same technology portfolio, and that is really good. We’re not like redesigning something for the aftermarket. It’s the same – it’s the heavy-duty trucks, and that’s the beautiful thing about the opportunity.

Bradley J. Timon

Yeah. And Carter, and our revenue stream – now our product revenue stream are very minor for aftermarket at this point. And aftermarket really should start to ramp a little bit by the beginning of the next year.

Carter Driscoll – Ascendiant & Company

Got it.

Bradley J. Timon

Does that help?

Carter Driscoll – Ascendiant & Company

Yeah, no that does. Thanks very much. I will check you back in the queue guys Appreciate it.

Operator

Your next question comes from the line of Dan Trang with Stonegate Securities.

Dan Trang – Stonegate Securities Inc.

Yeah. Thanks for taking my call – my question.

W. Brian Olson

Hi, Dan.

Dan Trang – Stonegate Securities Inc.

Can you give a little bit more color about why revenue is so stagnant in the past quarter?

W. Brian Olson

Yeah. You broke up there a little bit why the revenues...

Dan Trang – Stonegate Securities Inc.

Yeah. Was a bit slow, a little bit stagnant this past quarter? I’m sorry. It’s been a little bit choppy on my end, I think.

W. Brian Olson

Yeah. Let me – and I try to address that in the earlier part of the call, but let me just reiterate kind of the two factors. One, we did see heavy-duty natural gas engine sales down during the first quarter. So it’s just compared to like say sequentially fourth quarter of last year compared to the first quarter of 2014. There was just an absolute sequential decrease in engines hitting the market. And that – some choppiness, some lumpiness, it still doesn’t take away from the 3% to 5% adaption for this year. I think, we would continue to see some real opportunity to merge as we move through this year. So that was one factor.

The second factor was related to our test and validation facility, which we use for lot acceptance on the production process of tanks. And now having that facility here in Lake Forest is absolutely a win for us, but we just didn’t have access to it during the first quarter because of it was being developed, constructed, and just recently as we speak today, it’s really been completed. So that had some drag, not tremendous drag, but just some drag on the quarter as well. I think those are really the two variables that did impact that.

Dan Trang – Stonegate Securities Inc.

Okay. Regarding the decision and the Agility recent announcement, wondering did they go through a bidding process or what was your decision to decide, it was better for you guys to pursue a different path?

W. Brian Olson

No. I think, I had pretty much laid it out as well as I could. I think, the important think to not lose sight of it is, Quantum had opportunities. We have – when have been that’s really a bidding process. We had opportunities that where as I said very seriously assessed and evaluated and at the end of the day for the reasons I enumerated did not make sense for our stockholders and we decline to really advance that concept of doing that within Quantum based on those terms and conditions. So, the restrictions, the loss of the profit and the margin and it just did not make sense for our stockholders.

Dan Trang – Stonegate Securities Inc.

Fair. And then you did a good job of laying those things out, just wondering what kind of what the process was? One last question, regarding the Ryder agreement, wondering what geographic areas Ryder is currently in? I hate to ask you a question about another company, but just wondering what’s their footprint?

W. Brian Olson

Yeah. They have quite a solid footprint. I believe it’s approximately 800 locations across United States, service centers and maintenance centers, distribution, so that it’s just a tremendous footprint that is very, very kind of down to across the United States. So that’s not all, like I said not all 800 service centers to up and running on the get go others, obviously strategic ones that are going to be in the first fold, and then as this – as Ryder would tell you they’re very committed to natural gas vehicles and solutions, and that’s why they make such a tremendous partner for Quantum. We’re very excited about that relationship.

They have a tremendous footprint and they are a leader, and they’ve been very vocal for many years about their commitment to natural gas, and they have all the service centers there. And when relationship in with someone that buys truck, that are a user of truck, there is a lot of jockeying going on in this industry about this person hooking up with that person, and a JV over here and something over there, but Quantum is aligning themselves and creating strategic relationship with companies that are actually buyers and users of trucks, and that’s what is important to us, that’s meaningful customer taking product downstream versus it just being a jockeying for position.

And like I said, we are so strong across the tank and systems side. And that’s not the say, we wouldn’t look at certain strategic things to enhance and strengthen what we’re to have under one roof, but our focus up to this point has been alliances around organizations that could be purchasers and users of drugs and that’s how we get product into the industry.

Dan Trang – Stonegate Securities Inc.

Okay. Thank you.

W. Brian Olson

Yup.

Operator

Your next question comes from the line of Greg McKinley with Dougherty & Company.

W. Brian Olson

Hi, Greg.

Bradley J. Timon

Hi, Greg.

Andrew Brown – Dougherty & Company LLC

This is Andrew Brown in place of Greg.

W. Brian Olson

Okay.

Andrew Brown – Dougherty & Company LLC

Thank you very much for taking my call. So you’ve laid out the potential scenario for your fuel systems to offset the revenue loss from Agility. So again, I don’t want to harp on this. But given the ramp up that we saw in the tank business and acquiring customers for that segment and given that Agility is approximately 70% of the heavy-duty fuel system market right now, do you foresee another slower ramp-up period or how long would you expect until we would see this fuel system market to actually be able to surpass the lost Agility revenue?

W. Brian Olson

Yeah. I think we try to – we did try to clarify kind of the existing relationship with Agility. I think Brad said $14 million last year, I think I kind of took that step forward and said, maybe we got luck into 20 this year. I think what we talked about that one customer just Ryder not to mention all those other customers in a period like 2015, we believe kind of clip that. I think we are provided some clarity around 2014, it’s really nice year for us.

We backed off revenues a little bit, but it still a very, very nice year for us because of the systems starting to kick in to the course of this year, our opportunity to sell tanks to other parties. And so, 2014 is going to be attractive year. I mean the first quarter, the first quarter was attractive and we grew CNG revenues granted 153% last year and now we’ve just grown 82%. I know the 82% looks like, it’s not a 153%, but an 82% growth rate in your business and I think, we can hit whether it’s 60% or 70% or an 80% throughout this year.

That’s a nice year and at the same time everything we are doing about getting new customers, marquee, main customers during this year. We are building stock value in this company over the next a couple of years and whether that stock value is yielded here in the next couple of months or quarters, I really don’t know and I’m not that smart enough to figure out the markets completely. I do know I have unbelievable confidence, the underlying value we can build up in this company based on where we see it going in the next couple of years is absolutely tremendous.

Andrew Brown – Dougherty & Company LLC

Just one clarifying piece. The numbers that you gave for Ryder in terms of potential annual revenue of $20 million to $30 million, you could see that coming to fruition as soon as 2015?

W. Brian Olson

Yeah, units in 2014.

Bradley J. Timon

Yeah. It starts to ramp – the agreement is already in place now, and but the units begin to ramp in the third quarter and really you know ramp up occurred in the fourth quarter in 2015 and so yeah, we expect to see that very positively.

Andrew Brown – Dougherty & Company LLC

Okay.

W. Brian Olson

We have delivered systems – we have delivered systems and start to deliver more and like Brad said, it starts to really kick in towards the end of this year, but yeah it’s not going to be sitting around totally on her thumb, that absolutely we are moving the things forward at lightening speed and we feel good about the speed. We can move it forward and being able to deliver product into the market.

Andrew Brown – Dougherty & Company LLC

Thank you. In terms of ASPs for tanks, what are you seeing in the marketplace regarding current pricing? So as competitors like Hexagon Lincoln have their capacity, as you guys have gone from what was it for 4,000 at the beginning of 2013 up to 20,000 at the end of this year? Do you foresee any near-term declines in ASPs just from the increased supplier as an effort to increase adoption rates?

W. Brian Olson

Yeah. We’ve been actually – I think, we talked about this on previous calls Quantum has been very success on driving cost out of its tanks. We have made improvements and we pass certain savings on to our customers and then incorporating those lower cost tanks into a lower cost complete system and delivering as a companies like Ryder as Ryder is so attractive because we are providing the marketplace a lower cost solution.

I don’t – I mean, may hear a lot of CEO say that and may sound like it just like Bravado, like we’re going to deliver lower cost system and we are really delivering a lower cost solution to the market and its buying order magnitude and it’s attractive and it’s not only a tank cost and the ability for us to continue to drive cost out of our tank but the ability to dematerialize the system and being able to deliver a 1,000 pound lighter weight system into the market being able to provide that lower cost solution into the market with a system and a tank.

We believe is very important to adoption and we – you know we’re hoping because of these lower cost solutions that Quantum can introduce it will drive a healthier market, it will enable higher adoption and we’re excited about that.

Andrew Brown – Dougherty & Company LLC

See, you believe, we can get to those higher adoption rates after current ASP levels of whether it would be 4,000 for the tanks and 30,000 for the systems?

W. Brian Olson

It is not a 30,000 like I said that could be there a blender if three tanks, four tanks, five tanks they could be a blended and this is a ballpark figure, but yeah, there is opportunities for us to continue to drive cost out of these systems going forward and drive adoption and we’re already excited about the adoption rate right now based on where we’re already pricing it because the marketplace hasn’t very Quantum lightly and low cost aspect of that storage system.

Andrew Brown – Dougherty & Company LLC

Okay. Great. Last question from me before I turn it over here. So, it looks like product margins were down out a 160 basis points year-over-year. Any color, you can provide on the decline?

W. Brian Olson

Yeah. Well, the decline is mainly just because we have a larger footprint now on our manufacturing operations in the first quarter of this year. So as you see our throughput rates increase, you just get margins going back up. So...

Andrew Brown – Dougherty & Company LLC

Okay. Perfect. Thank you so much, guys.

Operator

At this time there, we reached the allotted time for questions. I’d turn it back over to management for closing remarks.

W. Brian Olson

Okay. Thank you very much. We appreciate everyone interest in our quarterly earnings call, continued interest and support of Quantum Technologies. We look forward to the second quarter earnings call. Thank you.

Operator

This concludes today’s conference call. You may now disconnect.

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Source: Quantum Fuel Systems Technologies Worldwide's (QTWW) CEO Brian Olson on Q1 2014 Results - Earnings Call Transcript
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