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Westport Innovations (NASDAQ:WPRT)

Q2 2014 Results Earnings Conference Call

July 31, 2014, 5:00 p.m. ET

Executives

Darren Seed - Vice President, Investor Relations and Communications

David Demers - Chief Executive Officer

Ashoka Achutan - Chief Financial Officer

Nancy Gougarty - President

Analysts

Jerry Revich - Goldman Sachs

Ann Duignan - JP Morgan

Rob Brown - Lake Street Capital Markets

Nicole DeBlase - Morgan Stanley

Jeffrey Schnell - Jefferies

Vishal Shah - Deutsche Bank

Eric Stine - Craig-Hallum

Colin Rusch - Northland Capital Markets

Aditya Satghare - FBR Capital Markets

Operator

Thank you for standing by. This is the conference operator. Welcome to the Westport Innovations Inc. Q2 2014 financial results conference call. [Operator instructions.] At this time, I would like to turn the conference over to Darren Seed, Vice President of Investor Relations and Communications. Please go ahead.

Darren Seed

Thank you and good afternoon. Welcome to our second quarter conference call for fiscal 2014. It’s being held to coincide with the disclosure of our financial results earlier this afternoon. For those who haven’t seen the release and financial statements yet, they can be found on Westport’s website at www.westport.com.

Speaking on behalf of the company will be Westport’s Chief Executive Officer, David Demers and Westport’s Chief Financial Officer, Ashoka Achutan, and Westport’s President, Nancy Gougarty. Attendance at this call is open to the public and to media, but for the sake of brevity, we are restricting questions to analysts.

You are reminded that certain statements made in this conference call and our responses to various questions may constitute forward-looking statements within the meaning of U.S. and applicable Canadian securities laws, and such forward-looking statements are made based on our current expectations and involve certain risks and uncertainties. Actual results may differ materially from those projected in the forward-looking statements.

Information contained in this conference call is subject to, and qualified in its entirety by, information contained in the company’s public filings and except as required by applicable securities laws, we do not have any intention or obligation to update forward-looking information after this conference call. You are cautioned not to place undue reliance on any forward-looking statements.

Now, I will turn the call over to David Demers.

David Demers

Thanks, Darren, and good afternoon everyone. Q2 saw excellent progress in our business, with some key milestones in both our operational transition and our long term investment programs. As I said last quarter, 2013 was a significant transition year, as Westport shifted from our focus on market creation and proof of our technologies to product development sales and profit growth, now that OEMs around the world are shifting to include natural gas products in their offerings.

We told you that we had completed our transition work and that we had laid out three primary goals for 2014. Let me just reiterate those for you, and I’ll focus my remarks on those topics. Number one: positive adjusted EBITDA from operations by Q4 2014, and continued profitable growth in our joint ventures.

Number two is careful management of our investment programs to ensure that operational cash flow from Westport direct sales, as well as our joint venture dividends, will cover investment by the end of 2015 and allow Westport to achieve overall consolidated positive adjusted EBITDA.

And third, we have to deliver on contractual commitments to strategic partners in key OEMs, to develop attractive new customer relationships, and continue to help removing barriers to rapid adoption of natural gas as a transportation fuel around the world.

Moving to slide six, very pleased to report that our team has delivered on the first strategic goal two quarters early, with a strong move to positive adjusted EBITDA from operations. As you can see from the graphic, there’s been a consistent adjusted EBITDA loss of around $9 million per quarter from operations over the last two years.

Last quarter, we achieved a step change to a $1.6 million adjusted EBITDA loss from operations, and this quarter, we’ve achieved a $1 million positive adjusted EBITDA on roughly the same revenue base.

Very pleased that we were able to deliver this milestone ahead of schedule, and I now want to expand our guidance by confirming that we intend to achieve full year positive adjusted EBITDA from operations this year, in 2014.

Now let me remind you that our existing guidance calls for revenue of $175 million to $185 million this year, excluding our joint venture of course. Despite political uncertainty and macroeconomic challenges in many of our key markets, we believe this is still realistic, and we see continued growth from our existing product portfolio.

New products such as the Weichai Westport WP12 HPI system, the Westport WP580 engine management system, new models of Ford and Volvo vehicles, and the iCE PACK LNG tank system and LNG tenders in the oil business will deliver platforms for future growth in the operating business.

Now turning to the corporate and strategic investments on slide seven, as you know, Westport’s coinvesting with OEMs to develop a portfolio of new natural gas vehicle technologies and related systems and components. Since 2012, we’ve invested over $239 million into these development programs, in three major application areas: global trucking, automotive products, and off-road apps such as rail and large mine trucks.

We’ve also allocated a portion of this investment to advance engineering and capital expenditures. Now, these investments typically have a three to five-year development cycle from the start of development to actual sales. We are carefully managing these programs and allocating our investment capital to products and technologies that are designed to deliver high returns in the future. Of course, as this market develops.

Much of this expense is going to be incurred in 2014 and 2015, and with development of this broad portfolio of vehicle components, which includes spark-ignited dual fuel and HPDI engine systems for applications from forklifts to locomotives, and with fully integrated and intelligent fuel supply systems for CNG and LNG applications, we believe that we’ll be in a unique position by the end of this cycle to support virtually any OEM natural gas vehicle program in the near to middle term.

We think it’s important that in this next phase of the development of natural gas transportation, we have significant flexibility as markets and our customers gain experience with this new fuel. We need to balance investment in future product and technology with commitments from customers and partners and sales from existing products. By definition, really, this is the adjusted EBITDA positive that we’ve been talking about, and we intend to hit this balance point by the end of 2015, as I said earlier.

Now, let me wrap up by reiterating that 2014 is the beginning of our phase in the development of our long term vision of high-performance Westport natural gas vehicles in markets around the world. We’ve laid out a plan, we believe that the last two quarters demonstrate that the plan is realistic and working. I firmly believe that Westport and our shareholders are in the right place to take advantage of this global growth opportunity.

Thanks for your continued interest and support, and I’ll pass the call to Ashoka to run through the quarter financials.

Ashoka Achutan

Thank you, David. Good afternoon everyone. As David just mentioned, the second quarter of 2014 marked a significant milestone for Westport, as we recorded positive adjusted EBITDA of $1 million from our operating business units, two quarters ahead of guidance.

As noted on slide nine, this compares to a loss of $8.9 million in the prior year period and a loss of $1.6 million in the first quarter of this year. This year over year sequential improvement in adjusted EBITDA is the direct result of increasing our operational efficiencies, optimizing our product portfolio, and controlling our expenses.

I’ll now provide a brief overview of our second quarter results. For the quarter ended June 30, 2014, we recorded consolidated revenue, excluding joint venture revenue, of $40 million, compared with $34.9 million in the prior year period, a 15% increase.

The breakdown of revenue by segment is $24.8 million for applied technologies, $11.6 million for on-road systems, $1.5 million for off-road systems, and $2.1 million for corporate and technology investments.

Our consolidated gross margin and gross margin percentage for the second quarter were $13.6 million and 34% compared to $8.3 million and 23.8% in the prior year period. This increase in gross margin and gross margin percentage for the quarter is due primarily to product mix, service revenue, and our exiting production of the first generation of the Westport high-pressure direct injection, or HPDI, system.

Research and development expenses were $18.7 million for the quarter, compared with $23.9 million in the prior year period. Selling, general, and administrative expenses were $16.2 million for this quarter, compared with $20.9 million in the prior year period. These operating expenses decreased as a result of prioritization of investment programs and our exiting the first generation HPDI system.

For the second quarter of 2014, our net loss was $35.4 million, or $0.56 per share, compared with a net loss of $33.9 million, or a loss of $0.61 per share in the prior year period. Included in our net loss for the second quarter of 2014 is an unrealized foreign exchange loss of $8.6 million compared to an unrealized foreign exchange gain of $3.4 million in the prior year period.

Excluding this foreign exchange loss on gain, Westport’s net loss for the quarter was $26.8 million in 2014 versus a loss of $37.3 million in the same period in 2013. This represents a 28% improvement year over year.

Moving on to our joint ventures, Cummins Westport, Inc. generated $79.6 million in revenues during the quarter on delivery of 2,479 units, which is a 9% decrease over prior year period. This decrease is primarily due to the timing of international orders, which are typically uneven over quarters. Shipments in North America for trucking applications, however, increased by 22% for the quarter, compared with the prior year period, as a result of the strong demand for the ISX12 G.

During the second quarter, CWI’s operating performance was impacted by $10.2 million of warranty related adjustments, primarily related to the 8.9 liter ISLG engine, which reduced our EPS by $0.05 per share. Excluding this warranty impact, our portion of CWI’s net income would have been approximately $3.7 million instead of $400,000.

The CW team has made significant progress in identifying and resolving these warranty issues and we expect gross margins and net income to improve significantly in upcoming quarters.

Weichai Westport Inc., our other joint venture, generated $133.1 million in revenues during the quarter on delivery of over 11,000 units, which is a decrease of 11% over the prior year period. This decline in volume is primarily due to softer macroeconomic conditions, credit tightening, and higher natural gas prices in China.

Westport, however, continues to invest in China to capture the significant market opportunity there with the launch of the Weichai Westport WP12 engine, featuring Westport HPDI technology, the sale of Westport components to the JV and other vehicle OEMs, and the expansion of other product offerings with differentiated technology.

As of June 30, 2014, our cash, cash equivalents, and short term investment balance was $168.8 million. During the second quarter, cash used in operations was $28.9 million, compared to $23.1 million in the first quarter of 2014. This increase of $5.8 million is primarily due to investments in working capital to support product sales of products such as the Westport iCE PACK system, offset by lower operating expenses and lower spending on investment programs.

At the end of June, we extended the maturity date of our 9% unsecured subordinated debentures to September 15, 2017 and secured an additional CAN19 in debentures on the same terms, bringing the total outstanding debentures to CAN55 million.

We continued to make progress toward our goal of consolidated positive adjusted EBITDA by the end of 2015. As noted on slide 10, for the second quarter of 2014, our consolidated adjusted EBITDA was a loss of $17 million compared with a loss of $27.8 million in the prior year period, an improvement of $10.8 million, or 39% year over year.

To achieve this goal of consolidated positive adjusted EBITDA by the end of 2015, we will manage spending on corporate and technology investments so that by the end of 2015, such spending will not exceed the sum of one, our income generated by our operating business units, two, the earnings from our JVs, and three, contributions from our program development partners.

We are carefully managing our investment programs and methodically allocating capital to products and technologies designed to deliver attractive returns in the future. We believe this model will deliver great value to our shareholders as the market shift to natural gas inevitably plays out.

As outlined in the press release, we have added a new goal. While the path may not be linear, we expect that our operating business units combined will attain positive adjusted EBITDA for the full year ended December 31, 2014.

To conclude, we are reiterating our revenue guidance for the year 2014 to be between $175 million and $185 million, which represents a growth of 7% to 13% over 2013. This growth will be primarily driven by sales of new products such as the Westport iCE PACK system, the Westport WiNG Power System on 2015 model year vehicles, the Weichai Westport WP12 HPDI system, the Westport WP580 controller, and component sales to new OEM customers.

We believe that these new products will continue to power our growth in future years. With that, I will pass the call on to Nancy.

Nancy Gougarty

Thank you, Ashoka. Good afternoon everyone. As David and Ashoka have pointed out, the second quarter of 2014 marked a significant milestone for Westport, as we have recorded a positive adjusted EBITDA of $1 million from our operating business units. This is two quarters ahead of guidance.

This was achieved through improving our operational efficiencies and optimizing our product portfolio and controlling expenses. However, this is not without any headwinds. Major challenges in our applied technology business continued to be from Europe, particularly Italy, our largest market, which saw a significant drop in year over year revenues for the quarter. Growth in Russia has been flattened by weaker currency. However, China, our third largest market, continues to grow, but the growth rate has slowed from last year.

Our immediate focus in North America is prioritization of the investments and the return on product sales with the next phase of growth. With the expansion of our 2015 model year Ford vehicle lineup, we further solidify our position of having the largest Ford CNG product portfolio for the Ford QVM program.

I will now provide some operational highlights and initiatives. Final development of Volvo HPDI program continues at a high pace. Design of the new generation HPDI injectors with Delphi is also underway. We are now engaged in developing detailed manufacturing process and equipment plans for our dedicated HPDI injector production line.

HPDI and spark-ignited activities with other OEMs are progressing on many fronts, with a series of innovative products. We delivered the second and third LNG tender to Canadian National Railroads in Q2, while the stationary testing of our first tender continues at EMD. We are exploring opportunities in marine applications with focus on inland waterways, offshore serve vehicles - ferries- and LNG bunkering segments.

The Westport designed WP580 controller validation activities are substantially complete, and Tata vehicle production has commenced. To improve our operational efficiency, we have restructured the Beijing office, implemented a process of improving and training throughout the company, completed the consolidation of the Ford business in Dallas, implemented Lean manufacturing in Italy, and it’s progressing as planned.

To improve the cost and optimization of our product portfolio, we have identified a number of opportunities where we can supply our own components to the different products we have. For example, the Ford WiNG Power System uses components manufactured by Applied Technologies’ Italian operation.

The Westport iCE PACK LNG tank system uses the [unintelligible] regulator designed primarily for iCE PACK, but also used on other LNG products as well. We have expanded our vehicle lineup with the 2015 model year dedicated or bi-fuel CNG for the Ford Transit Connect. We have launched the bi-fuel CNG version of the Ford 150 featuring the Westport WiNG Power System.

We continue to focus on creation of shareholder value and making sure that we’re getting full value out of every dollar we spend. We are also working diligently with our OEM partners to satisfy their needs and their quest to participate in this market. We still have a lot of heavy lifting to do, but we’re on our way. Execution focus with accountability continues.

With that, I will now turn the call back to the operator to open the call for questions.

Question-and-Answer Session

Operator

[Operator instructions.] The first question is from Jerry Revich of Goldman Sachs.

Jerry Revich - Goldman Sachs

I’m wondering if you could talk about order trends in the applied technologies business, or touch on inquiries. It looks like the business has generally been flattish over the past 18 months. It sounds like you have a couple of new products maybe. Do you expect a pickup in the back half of the year?

Nancy Gougarty

I would say that what we’re finding is that the products that we have are doing quite well. We’re seeing significant uptake in many emerging markets. One of the things that we have run into a bit is some of the geopolitical activity that’s going on around the world, and some currency on that front. And I think some uncertainty in some regions of the world right now, we believe, has impacted some of the orders that we have seen in the second quarter.

I would say in general, our product portfolio continues to remain very strong, and we’re seeing quite a bit of uptake, not only on the individual components, but also on the activity, where people are buying full kit systems in order to do modifications on a full vehicle basis. And we’re finding that to be quite a successful piece of our business, and an area of focus.

Jerry Revich - Goldman Sachs

And Cummins Westport, in the press release you cited some delays in international sales. Can you just say more? Which markets was that? Do you expect to make up for those volumes next quarter, and in the press release, you gave us a North America shipments year to date. I’m wondering if you can share the North America year over year shipments in the quarter, if you have it.

Ashoka Achutan

International shipments have always been pretty lumpy, and while there can be no assurance about timing, we have no reason to believe that on a full year basis, it is going to be significantly different. So it’s purely a matter of timing. Towards the end of last year, we picked up a big chunk of international shipments, and there is no regularity to it.

Jerry Revich - Goldman Sachs

And the other part of the question? North America CWI shipments in the quarter on a year over year basis?

Ashoka Achutan

Yeah, the shipments are pretty much as we expect. The reaction to the ISX12G has been positive, and there have been no surprises there as far as we are concerned. We are seeing that customers typically are placing seed orders for five and 10 units to such point they are comfortable with the integration of the vehicle with infrastructure and with the support, but for the most part, all reactions we are getting on the ISX12 G has been extremely positive.

Jerry Revich - Goldman Sachs

And lastly, I’d love your perspective on the warranty side. We’ve been talking about Cummins Westport warranties for a while. Should we just think of these products as having structurally higher warranty rates than other products? Would just love your perspective. And if you anticipate warranties will come down based on the data at your fingertips, when would that be?

Ashoka Achutan

The good news here is the warranty is not related to the new ISX12 G engine. It’s primarily, almost entirely, I’d say, related to the 8.9 liter engine that’s out there. We have addressed the quality issues that we’ve found on the 8.9 in the production of the 12 liter, so we don’t expect the 12 liter to have the kind of warranty issues that we are seeing on the 8.9.

Specifically, the issues that we’re seeing on the 8.9, the CWI team has put in a tremendous effort to identify the issues and come up with a solution. We believe they have a solution on hand, and it’s just a matter of the effect of those, shall we say, repairs rolling out into the general population. So there is little doubt in my mind that these warranty adjustments will come down significantly in the upcoming quarters.

Operator

The next question is from Ann Duignan with JP Morgan.

Ann Duignan - JP Morgan

I just wanted to focus a little bit on the balance sheet. It appears that Nancy, you and your team have done a good job on the profit and loss side. But I was curious, on the balance sheet, it seemed like receivables went up quarter over quarter. Inventory days went up quarter over quarter, and payables went up quarter over quarter, in terms of days outstanding. Can you address that and tell us what’s going on there, and what we should expect going forward?

Ashoka Achutan

There is nothing systemic here. It’s essentially a matter of timing. One of the reasons you see an uptick in both inventories and receivables is we are wrapping up iCE PACK sales, and we had some collections on that, as well as some prepayments on inventories that we are building up to meet our delivery targets for Q3 and Q4.

Outside of that, there is a $2 million timing issue on Italy, which is also not typical, because we did have a ramp up of sales towards the end of the quarter. Again, nothing systemic, nothing extraordinary, purely timing, and it has to do with our ramping up of production.

Ann Duignan - JP Morgan

And then more a strategic question, on your locomotive department, with Caterpillar, I know you’re pursuing HPDI. GE is making big noise about pursuing dual-fuel and saying publicly that they believe that customers will prefer the dual-fuel option rather than natural gas only. Can you just talk about what you’re seeing out there, what you’re hearing, or what customer feedback you’re getting? Or is it too early to know which technology will win?

David Demers

There’s actually no question about this. EMD is also launching dual-fuel. I think everyone is keen to get their hands on something that uses natural gas. Dual-fuel, as you know, is going to have relatively low substitution rate, so this is not a technology that is going to be a long term deal, but it certainly can let people get used to the idea of running on natural gas. Until there is LNG infrastructure out there, though, the industry needs 100% diesel backup, and that’s the only way you can do that, is with some sort of dual-fuel technology.

So I think you should expect to see a few dual-fuel locomotives. I don’t know if you’re going to see thousands, but you’re going to see a handful, maybe in the next couple of years, and maybe a couple of double handfuls as people get their head around how they’re going to deploy this.

But long term, I’ve got no doubt you’re going to need high pressure and direct injection to deliver the kind of torque and power and fuel economy that the locomotive industry is going to need.

Getting all this in place is going to take years, though. So, let’s not expect anything magic. Our fuel tenders are going to support low pressure or high pressure. We obviously want people to have reusability among this capital investment, and so as the industry starts to roll out natural gas, these tenders are going to flow no matter what the locomotive technology is going to be. But long term, I fully expect that it’s going to be direct injection and high pressure that dominates the industry.

Ann Duignan - JP Morgan

So we’re talking about the next decade at least?

David Demers

Yeah, I’d say the rail industry is certainly longer term. You know this as well as we do. Certainly you’ve got a longer sense of what a short term or medium term time horizon might be. For a truck fleet, it might be a few years. For the rail industry, it might be a decade. So they have a lot of enthusiasm for going to natural gas and the lower-priced fuel, but it is going to take significant capital investment to get that LNG and get it rolled out. And there’s a product cycle that is fairly long. So we believe it’s a very interesting market for us, but for us, that’s medium to long term. It’s certainly not going to be the thing we’re relying on to get to profitability next year.

Operator

The next question is from Rob Brown of Lake Street Capital Markets.

Rob Brown - Lake Street Capital Markets

On the unit trends at CWI in the 12 liter, I guess I just wanted to get a sense, do you still think you’re on track for that 3% to 5% market penetration rate this year?

David Demers

The 3% to 5% does encompass the 8.9 liter applications in trucking as well as the 12. And right now, we’re still looking at 3% to 5% of the North American truck market, class seven and eight being natural gas. We can’t unfortunately break down individual engine unit sales, at the request of our partner, so the only thing we can say is we are still seeing this 3% to 5% trend of class seven and eight trucking in North America for calendar 2014.

Rob Brown - Lake Street Capital Markets

And then in terms of your reiterating revenue guidance, could you maybe just go through the buckets or rank order the drivers for the revenue step up in the back half of the year? What are kind of the things coming in in the back half of the year that will help drive revenue over what you’ve seen so far this year.

Ashoka Achutan

I don’t think we can give specific details, but the obvious one is iCE PACK. And as I mentioned, we are ramping up iCE PACK, and we are going to see a significant uptick in Q3 and Q4, which falls into the on-road segment. For the rest of the businesses, we’ve got off-road and ATG pretty much on track, and we expect to come through as guided.

David Demers

On-road system is really the only major brand new product availability. Obviously, we expect to ship some HPDI systems over the next couple of quarters to various markets around the world too. But again, that also shows up in on-road systems. So other than we can’t break down specific business units, on-road definitely has some of the bigger catalysts in it.

Operator

The next question is from Nicole DeBlase of Morgan Stanley.

Nicole DeBlase - Morgan Stanley

So just maybe starting with EBITDA, reaching breakeven operating EBITDA was a nice positive surprise this quarter. But you guys are now expecting full year EBITDA to be positive, which implies a continued step up in Q3 and Q4. So I’m just curious, clearly revenue is going up. Is that the key driver of EBITDA getting better? Or is there more cost cutting? If you could just kind of elaborate on that?

Ashoka Achutan

The revenues will certainly help. And again, I come back to iCE PACK, which will show improving margins as we have increased volumes of the product going out quarter over quarter. So it is primarily an increase of revenue, and also, to some extent, our continued controlling of operating expenses and operational improvements.

You know, as Nancy mentioned, we are seeing streamlining of businesses and process improvements in Italy. We are going to see some impact of that. We are already seeing the impact of consolidation of the Ford business in Dallas. There is still some, shall we say, residual effect of that that we will see. So that’s what we expect will get us to our full year adjusted EBITDA.

But I must caution you, this doesn’t necessarily mean that it is going to be linear. We do have challenges in the third quarter. It is a quiet quarter in Europe, as you know, with a lot of our customers being on vacation there. So I’m not suggesting that it’s going to be linear between now and the end of the year, but yes, we expect we will be adjusted positive EBITDA for the full year.

Nancy Gougarty

I think again, it’s all down to prioritization of activities, and with a strong decision at the top, with the leadership team getting together and ensuring that we’re making the right investments, and we’re putting our efforts against the right thing, what you can say is the team here is very focused on getting that done. We have major projects, and we have small projects, but all of them, collectively, together, add up, and I think that’s where our focus is, is just making sure that we are focused on big and small, and making sure that we’re able to get the best use out of every dollar and its value.

Nicole DeBlase - Morgan Stanley

And then secondly, maybe speaking of investment, your capex fell pretty dramatically this quarter. Can you just talk about the sustainability of the capex that you guys spent, or the potential for it to pick up from here?

Ashoka Achutan

Again, it’s not linear. We spent a little less than $5 million in the first half of the year. We’ve always expected our capex to be skewed towards the second half of the year, and we expect some of it will pick up, particularly with our Delphi development program on injectors picking up steam.

And we have some capex investment that we have committed in Italy, primarily related to the consolidation of our warehouse and some process improvement implementations, as well as some equipment for new products in Italy.

So no, the first half spend of $5 million is not indicative of what it is going to be for the rest of the year. I expect it will pick up significantly in the third and fourth quarters.

Operator

The next question is from Jeffrey Schnell of Jefferies.

Jeffrey Schnell - Jefferies

If you look at your R&D, can you talk about the opportunities you may have shelved or discontinued? Because it’s been coming down in the last couple of quarters. And any of those opportunities you can potentially bring back later on when the market is more developed?

Nancy Gougarty

I would say that what we have found - and we’ve taken the opportunity, and you can see it across the company, of looking at projects that we do have and understanding what’s going on. So as you’ve heard, we had a very heavy focus on iCE PACK, and what we have found is that we had some projects that were working in multiple regions. And what we’ve decided is to bundle them all together and to go to a fueling system approach that allows us to have similar products throughout the world.

So it’s not so much that we’re shelving products. We’re just trying to figure out how to consolidate them better and try to use the same resources around the world to build on them versus having each region do their own activity. We’ve found that has been quite successful. We’re bringing all the voices around the world together to get the specs done, but then having a very focused team looking at that, and then moving very quickly forward in order to serve all the markets. It’s a slightly different approach than we’ve had in the past, but we think that that is going to serve us well. And that’s one of the areas that has helped us on R&D.

Jeffrey Schnell - Jefferies

And then there’s been increased competition, especially in light duty, on the tank side. Is there still room for you to take out costs and drive down ASPs to get a better payback period for fleets?

Nancy Gougarty

To be honest with you, on the light duty side, it’s primarily in the CNG side, and I don’t think I’m the best person to respond to what the market sees. We have had very good success with the suppliers that we work with, in order for us to be quite competitive on the products that we’re offering, so I would guess that if the kinds of things that we’re seeing through our supply base are happening elsewhere, then I would say your theory is likely correct.

David Demers

I’ll jump in on that, because it is a theme that we keep hitting, that over time, the cost of the vehicles has to come down, just like the cost of fuel has to become more competitive. Everyone understands this, and 10 years from now, the market is going to be much more mature.

And I think this is good evidence of the maturation of the supply chain. We’re getting a lot more choice of suppliers who are building quality products and investing, because they see the market opportunity and they want to participate. So CNG tanks has come on very well over the last 18 months, I’d say, and we’re able to take advantage of that in our light duty products. We don’t make CNG tanks, obviously. This is a supply chain issue.

Same thing has to happen everywhere else, though, and that’s why we’re investing with people like Delphi on the fuel injector side. The goal here is to get volumes up and costs down, while still making a nice return for our shareholders. So we’re in the early days of this transition. The market 10 years from now, I think, is going to be a lot more competitive, but also going to be a lot more sizable, worth chasing.

Operator

The next question is from Vishal Shah with Deutsche Bank.

Vishal Shah - Deutsche Bank

I just wanted to understand your revenue guidance functions. Has anything changed? Has the mix improved or decreased? You said that applied technology order trends have been weakening. So can you talk about now, should we be thinking about the mix of business for this year? And is that part of the reason why the EBITDA performance was so strong in the second quarter?

Nancy Gougarty

Let me just try to take a shot at it, and I’ll let Ashoka take it from here. But if you look at where we were last year, as you know, we had our first generation HPDI product. And this year, we have introduced some new products such as iCE PACK. And I think from my perspective, that’s one of the strong contributors relative to where we are.

We have been able to introduce products to the market that we believe are quite competitive cost-wise, but also are well-honed in terms of their bills of material and their competitiveness relative to the cost of goods sold. So I would say those are activities that are taking place.

Ashoka Achutan

I don’t think the mix has fundamentally changed. And I think our Q2 performance has to do, quite simply, with strong operating margins on ATG. You’ll notice a significant improvement quarter over quarter in ATG. We had good product mix. Our efforts at rationalizing operations are beginning to pay off, and I come back to iCE PACK as it picks up volumes. And we will expect to see improved margins there.

Nancy Gougarty

Another point is, you know, you can see on the Ford product that we’ve introduced now a Ford 150 that’s now bi-fuel, and we now have dedicated. We now have the Ford Transit Connect. So I think you can see that as we move forward, our product portfolio is getting richer on lots of different fronts, whether it’s fueling systems, whether it’s truck offerings, or whether it’s technologies. And I think those are all things that are going to, you know, bear with us as we look at our revenue.

Vishal Shah - Deutsche Bank

And you mentioned that the growth rate in China is slowing down. Do you see any changes in pricing or margins in that market particularly?

Nancy Gougarty

I guess what I would tell you in China is, what we find in China is the price of liquid natural gas or CNG in the market has influenced relative to growth. And as you know, in China, there is some relative control of that price. So as that fluctuates, we do see some items. I would say in general, though, in China, in most cases we’re still seeing strong growth, but it isn’t the kind of growth that they had last decade. And I think that is true, regardless of what industry you’re in. So yes, it is still strong growth, but it’s just not as strong as it was in the last couple of years.

Operator

The next question is from Eric Stine of Craig-Hallum Capital Group.

Eric Stine - Craig-Hallum

Maybe just on Weichai, just wondered if you can give some commentary on how that pipeline is shaping up now that it’s been announced, finalized agreement, for a couple of months, with, I guess, you’ve got a few units hitting the road. But just your thoughts on that, and how that takes shape in 2015 and beyond?

Ashoka Achutan

I’m assuming you’re referring to Weichai HPDI W, the HPDI program. We expect to deliver about 30 customer validation units this year, and we expect that will happen. We expect that will be successful. Next year, we are probably talking, in big, round numbers, hundreds. And the year after that, you know, we expect that we could be sitting on a goldmine.

Nancy Gougarty

I guess just to add to the Weichai, at this point in time, I think that, as you know, in China, the infrastructure for the LNG and those kinds of things is one of the most developed markets that exist. So you can imagine that having the fueling infrastructure as mature as it is in that market really will lend itself, we strongly believe, to the products that they’re currently selling, but also in the introduction of this HPDI.

Eric Stine - Craig-Hallum

And maybe just high level, just turning to the WiNG business, you’ve clearly built out a pretty significant presence there. Just thoughts longer term? What do you think Ford needs to see before they think about taking that in house, and then taking it a step further? I know you acquired ServoTech as part of the BAF acquisition. Just thoughts on what kind of leg up that gives you as part of the process with Ford.

Nancy Gougarty

Maybe I’ll start with the second part first. I would say that we’re very pleased with, here we are, just one year into the acquisition of BAF last year, and we now have the operation fully consolidated in our Dallas facilities. We’ve found that the product, and the combination of the products that we had from the WiNG, and what BAF brought to us, as well as the kitting activity where BAF was very strong in providing kits to the market, really has served us well in the business.

I guess I’m not in a position at all to give you any sense of where Ford’s threshold is of where they bring it in house. So I don’t think I’m able to comment on that. I would say that we’re very pleased that we are in such a strong position with the BAF acquisition and our product portfolio lineup, that we do have the strongest portfolio relative to vehicle offering in this.

And I think that is serving us quite well in the market and is very helpful to Ford as they service their market and the variety of different customers they have. So I think we work quite well together, but I can’t speak to what Ford has on their mind.

Eric Stine - Craig-Hallum

Understood. And what I was getting at with ServoTech, as I remember, when that was part of Clean Energy, that that was a business that there was some access to Ford’s control software. And just some thoughts on what that means for you in terms of your relationship with Ford.

Nancy Gougarty

I would say that yes, the good news for us is that the combination of BAF, still continues to be part of their QVM. But you know, also, with ServoTech having the ability and the authority to touch the controllers is also powerful for us. And you know, ServoTech also is very strong in clean exhaust. So we believe all in all that the combination of the companies has served us, not only for Ford, but we’re finding that this is also being a nice entrée to some other customers in a variety of different ways.

Operator

The next question is from Colin Rusch from Northland Capital Markets.

Colin Rusch - Northland Capital Markets

I was just hoping to get a little bit of granularity on iCE PACK, unit shipments, bookings, backlog, just to help us understand this ramp a little bit better. We’ve obviously seen a few key announcements. I just wanted to get a sense of how you see it shaping up for the rest of the year.

Darren Seed

We’ve previously announced the order for roughly 900 iCE PACKs to be delivered over two years. That’s pretty much the run rate, the kind of agreement we’re working against. Otherwise, we’re not in a position, I guess, to publish backlog. Traditionally, working with OEMs and different suppliers, they just have a function of build slot commitments, which can be moved. So it’s very dangerous for companies, let alone public companies, to get into forecasting backlogs when build slots are such flexible items.

So unfortunately all we can comment on is just what we’ve already publicly announced as it pertains to iCE PACK. Sorry about that.

Colin Rusch - Northland Capital Markets

And you’re still expecting about half of that 900 will ship this year?

Darren Seed

That’s currently the goal, yeah. It was split pretty evenly between ‘14 and ‘15.

Colin Rusch - Northland Capital Markets

And can you give us a little bit of an update on where Volvo is? Have they started taking orders or indicated when they’re going to start taking orders for the 13 liter?

David Demers

I don’t think so. I mean, I’m looking around the table. Nancy, I don’t think there’s formal orders. I think Nancy said in her comments, you know, we’re working very hard, as everyone is. I think the opportunity in Europe is firming up really well. We’ve got a strong interest in LNG as a transport fuel, and as you know, Cummins Westport hasn’t had a lot of presence in Europe there, because the OEMs are much more vertically integrated. So Europe is, I think, looking forward to their first natural gas trucking products, and we’re keen to make that happen.

But there’s a lot of work to be done yet, and we will have the same sequence that you’ve heard us do before. There will be some customer trial units and there will be some early production, and then there will be a release for production. But that’s really up to Volvo to sort out.

Darren Seed

Yeah, the timing at this point is it’s Volvo’s call. It’s their product, in essence. So unfortunately it’s up to them to comment on timing.

Colin Rusch - Northland Capital Markets

And finally, can you just talk a little bit about traction in terms of increasing component sales into China? Have you been able to add any customers for any meaningful volumes going forward? And how do you see that shaping up? You mentioned that there’s been some reorganization in Beijing. I know this is obviously a great source of potential growth for you guys.

Nancy Gougarty

Absolutely. We see China as one of our growth engines. For sure, as I mentioned earlier, with the fueling infrastructure, we are getting pulled in lots of different directions, from a variety of different constituents in the market. The component side is certainly one of the areas that we’re seeing, but we’re also talking to a variety of folks that want to offer LNG/CNG vehicles of all sorts. We just talked about Weichai, obviously, on the light duty side.

I’m not in the position with any of those customers at this point in time to reveal who they are. I would just indicate to you that at this point in time there is a lot of activity. Our focus at this point in time and why we did some restructuring in China was partly because we want to get relatively close to our customers, and as you know, a lot of the customer base is in the Shanghai area. So we’re looking to utilize that area, because that puts us, in many cases, closer zone-wise to the customers who are doing these development projects.

Operator

The next question is from Aditya Satghare with FBR Capital Markets.

Aditya Satghare - FBR Capital Markets

One is, I wanted to make sure I understood the R&D investment criteria, as you think of 2015. And does that mean that once you get past this stage of investment we should see some sort of step down as you go past that period?

Ashoka Achutan

We have a pretty rigorous process. We have what we call the IRB process, the investment review board, that has a pretty subtle and methodical process of evaluating programs that are put forth for approval. So yes, when we look to a program, we look at the business case, we make sure that it meets our thresholds. We make sure it meets our hurdle rates. And more importantly, that it’s a substantial business.

So you know, it doesn’t necessarily mean that it trends down year over year. It’s on a case by case basis. Each program could have its own individual spend pattern. But at the end of the day, it doesn’t get our approval unless it meets the criteria I just mentioned and it supports our position of getting to adjusted EBITDA positive by the last quarter of 2015.

Nancy Gougarty

I think there’s also an opportunity, and we continue to find opportunities, where, with our technology and our technology lead in the market, that we have customers who are coming to us that are team with us, not a whole lot different than what Volvo does, and that we are able to team with them, which then helps us with the R&D spend activity.

So I think that’s a continuation, and I would say at this point in time we’re seeing a lot of activity. And again, as David said in his comments, the market is getting more and more ready. And so as this happens, folks are looking at their product portfolios and deciding where they are against this industry, and Westport is benefitting from that.

Aditya Satghare - FBR Capital Markets

My second question is on the WiNG business. Given that your offering now is pretty broad and it touches multiple segments, maybe on a high level, can you sort of talk about which segments you expect to see the fastest growth, and how does that business evolve over the next 12 months or so?

Nancy Gougarty

I would say just if you look at the amount of vehicles on the road, obviously the 150s and Ford 250s are the big users on the road. And to be honest with you, though we have a product portfolio that goes through all of them, no different than where Ford sees their volume, as those tend to be the areas we see our volume.

Operator

This concludes time allocated for questions on today’s call. I will now hand the call back over to Mr. Seed for closing comments.

Darren Seed

Just to thank everyone for their attendance at the call, and expect to see everyone back around the end of October for our Q3 conference call.

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