Clean Diesel Technologies' (CDTI) CEO Matthew Beale on Q4 2016 Results - Earnings Call Transcript

| About: Clean Diesel (CDTI)
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Clean Diesel Technologies, Inc. (NASDAQ:CDTI) Q4 2016 Earnings Conference Call March 31, 2017 4:30 PM ET

Executives

Cathy Mattison - LHA

Matthew Beale - Chief Executive Officer

Tracy Kern - Chief Financial Officer

Analysts

Matt Koranda - ROTH

Jeff Osborne - Cowen & Company

Operator

Good day, ladies and gentlemen, and welcome to the Clean Diesel Technologies Fourth Quarter 2016 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions]. As a reminder, today’s program is being recorded.

I would now like to introduce your host for today’s program, Cathy Mattison from LHA. Please go ahead.

Cathy Mattison

Thank you, operator. Good afternoon and thanks to everyone for joining us. By now you should have a copy of our results press release, which crosses the wires this afternoon following the close of market. A copy of the press release, along with other company information may be found on the investor page of the company’s website at www.cdti.com.

If you would like to be added to the distribution list or if you would like additional information about CDTi, you may call LHA at 415-433-3777. Speaking on the call today from CDTi are Matthew Beale, Chief Executive Officer, and Tracy Kern, Chief Financial Officer.

Before I turn the call over to Matthew, I want to emphasize that some of the information you will hear during management’s discussion today will consist of forward-looking statements that are predictions, projections and other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could differ materially because of factors discussed in today’s results press release, in the comments made during this conference call and in the risk factors section of our Form 10-K and other reports and filings with the Securities and Exchange Commission. We do not undertake any obligation to update any forward-looking statements.

And now, it’s my pleasure to turn the call over to Matthew Beale. Matthew?

Matthew Beale

Thank you, Cathy and good afternoon, everyone, thank you for joining us. As we mentioned in our press release earlier today. Emissions control is at the nexus of many key trends that are driving the global automotive industry. From regulatory standards, to hybridization, to autonomous vehicles emissions control is a major driver and conditioning factor for engineering and design decision that are shaping the future of the automobile.

CDTi sits at the confluence of industry trends with our low-cost catalyst formulations and pedigree as a proven Tier 1 automotive supplier, we are uniquely positioned to disrupt the prevailing industry order and its dependence on Platinum Group Metal or PGM catalyst. The automotive catalyst market is currently concentrate with a small handful of global manufacturers.

This industry incumbency derives significant revenue from the recycling and refining of PGMs. PGMs also happen to be one of the largest cost inputs for automotive catalyst. The industry spends an estimated 10 billion on PGMs annually and that spend is to a great degree dictated by the incumbency. The ability to deliver equivalent or better performance with significantly lower levels of PGM is a billion dollar market opportunity.

Our strategy to capitalize on this opportunity is simple. We aim to become the leading provider of enabling technology to the automotive catalyst industry. We will achieve this by first establishing important commercial traction among catalyst manufacturers in underserved markets and then by leveraging that traction to drive a catalyst design paradigm shift among global OEMs. We carry important commercial momentum into several key underserved markets in early 2017.

The North American heavy duty aftermarket is one such market where changes in regulation and a lack of OEM caliber product created opportunity for CDTi. As a first step, we launched our own line of DOCs and DPFs under the DuraFit brand name. Sold through a captive distribution network, the DuraFit product line is a recognized market leader in the segment and generated revenue around 5 million in calendar 2016. As a second step an addressing the market opportunity, CDTi establish itself as a technology provider to the segment by providing solutions for downstream distribution and manufacturing partners.

Earlier this year, we announced such a partnership with DENSO, a global leader in automotive aftermarket products. We have also completed supply agreements with two other partners that will be launching their own line of DPF and DOC products for their heavy-duty customers. We expect to exceed additional agreements of this type during the balance of 2017 and to establish CDTi as the reference technology in this $500 million market segment.

With the technology provider business model now active in North America, we are poised to deliver on the promise with the product category we anticipated when launching DuraFit. Our objectives in 2017 in this market segment are to continue to grow DuraFit brands and support the market penetration of our new downstream partners. Longer term we see enormous opportunity and growth in this market. CDTi establish its traction as a technology standard for replacing market DPFs and DOCs. Traction in North America is likely to translate into important international opportunities.

In today's press release we also highlighted exciting commercial wins for our powder business in China. The industry structure in that market plays to CDTi's strengths on several levels. As the world's largest automotive market, China is a highly-evolved ecosystem with a domestic manufacturing segment representing some 40% of the total market. Both at the vehicle and catalyst manufacturer levels, domestic players are strong and growing challengers to the global incumbents. There are numerous domestic catalyst manufacturers with excellent coating capabilities honed by serving a very demanding set of Chinese OEMs.

And then of course, you have increasingly stringent emission standards and their elevation to a matter of public policy in China as important drivers. This environment is ideal for CDTi's technology provider model, as you have domestic catalyst manufacturers that are quick to challenge the global incumbents in a need for lower cost catalyst technology to defend and grow market share. The need for technology combined with demanding existing customers and manufacturing capacity creates the ideal market context for CDTi's power capabilities.

We announced a partnership with a leading Chinese domestic coater, SPMC in late 2016. We have since entered commercial agreements with three other domestic coaters for the supply of our Bmars and SPG and DOC material systems. Overall our commercial efforts in China have gained important momentum as the industry prepares for the introduction of China 6 emission standards and we expect to conclude agreements with others during the balance of 2017.

Our current program timelines with these customers would result in initial revenue during Q4 of this year. While calendar 2017 revenue contribution may be modest, the annualized volumes available from 2018 onward are transformative for CDTi. The opportunity represented by the initial commercial roll out in China is significant. Through existing partners alone CDTi's technology has the potential to be deployed in two million vehicles per year.

With revenues per vehicle in the region of $5 to $10 depending on the configuration our current powder to coat revenue pipeline in China has become very meaningful. Visibility will continue to grow in the coming months. We have further developed a path to market as a technology supplier to global players that are well positioned to challenge the industry, pecking order, as it currently stands, both in China and internationally.

Our partnership with Panasonic began to generate initial revenue in 2016 and we expect that contribution to continue to grow during 2017 as retrofit funding flows increase in intensity. Of more long term strategic important to CDTi and to Panasonic, Panasonic is currently competing for Chinese commercial vehicle OEM business by deploying our DOC technology. Similarly we are pursuing OEM opportunities with Halder Topsoe on a variety of international markets.

In India our manufacturing partner SCIL continues to gain important momentum for OEM cost down programs based on our Bmars and SPG and DOC technologies. While powder revenue in India during 2017 is unlikely, we expect to have increasing visibility into 2018 revenues during the second half of 2017 as OEM validation milestones are achieved.

Our commercial efforts are now fully allocated to the new business model and the results just described are extremely encouraging. While the new model involves some measure of dependency on downstream partners, this is mitigated by the profound alignment of interest with our customers.

Our partners need technology to cost effectively meet new regulatory standards, defend existing customer relationships and ultimately grow and take market share from the global incumbents. As a provider of enabling technology to the emissions catalyst market our constituency is all market participants that need or want to compete with the global incumbents and that share the view that the industry no longer needs costly high PGM catalysts.

CDTi's skill set in this segment is completely unique and positions us together with our downstream partners to disrupt the current industry order and dependency on PGM catalysts. Again we believe that this is a billion dollar market opportunity.

Operationally CDTi has now completed its plans for definitively reconfiguring its manufacturing footprint in support of the advanced materials and high value catalyst strategy. We have agreed with Honda to pull forward production requirements for existing vehicles into calendar 2017. This agreement provides CDTi with important visibility into 2017 volumes while also allowing us to complete the rationalization of our production footprint by very early in 2018. Most importantly however, this will permit a significant reduction in manufacturing overhead and contribute to lowering our breakeven revenue threshold to be between 30 million and 35 million for calendar 2018.

To summarize, the key milestones in 2017 are as follows. Demonstrate consistent growth in our North American heavy-duty business both is DuraFit and is a technology provider and continue to establish CDTi, the reference technology in heavy-duty replacement market. Demonstrate powder to coat traction with initial revenue contribution in the fourth quarter '17 offering visibility into meaningful annualized revenue streams from 2018 onward.

Gain visibility into Chinese and International OEM programs of the global partner such as Panasonic and Halder Topsoe and continue to manage our operating expense run rate downwards to 3 million per quarter during the second half of 2017.

On that note, I’d like to turn the call over to Tracy for review the financials.

Tracy Kern

Thank you, Matthew. For the fourth quarter of 2016, revenue was 8.6 million compared to 9.7 million in the fourth quarter of 2015. Coated catalyst revenue was 4.9 million compared to 4.8 million. Coated catalyst revenue is generated from the sale of our high-performance catalyst which reduced emission from gasoline, diesel and natural gas combustion engine.

Emission control systems revenue was 3.4 million compared to 4.1 million. Emission control systems revenues are generated from the sale of products and our extensive line of heavy-duty applications including DuraFit, OEM replacement diesel particular filters or Diesel Oxidation Catalyst sold through our distribution dealer network and direct sales.

Technology and advanced materials revenue was 256,000 compared to 721,000. Technology and advanced materials revenue includes licenses and royalties as well as sales of our advanced material’s platform. Gross margin was 11% compared to 29%, the decrease reflects 1.1 million of inventory write-offs following the change of manufacturing strategy to an outsource model.

Total operating expenses were 9.3 million compared to 5.5 million in the fourth quarter of 2015. Breaking down operating expenses, SG&A was 3.2 million compared to 2.4 million, R&D was 0.7 million compared to 1.6 million, also included in fourth quarter 2016 operating expenses were the following items totaling 6.2 million, a goodwill impairment of 4.7 million, 0.7 million related to the final exit of the Canadian locations and 0.8 million of stock compensation expense.

Including seasonally higher costs in the first quarter, we anticipate quarterly operating expense run rate will be between 3 million and 3.5 million in 2017. Operating loss was 8.3 million, compared to 2.6 million in the same period last year. Net loss was $7.6 million or $0.69 per share, compared to a loss of $0.9 million or $0.26 per share in the same period last year.

Turning to the balance sheet, at December 31, 2016 we had cash of 7.8 million as compared to 3 million at December 31, 2016. In fourth quarter, CDTi completed a capital raise of approximately 10.3 million in gross proceeds through a private placement of common stock. And now for our guidance, we expect full year 2017 revenue to be between 32 million and 35 million. We anticipate gross profit margins to be between 23% and 25%.

Based on these assumptions, we are targeting breakeven on an income from continuing operations basis in the second half of 2017.

With that, I will turn the call back over to Matthew.

Matthew Beale

Thank you, Tracy. We are well on our way to realizing our vision for CDTi as a leading provider of enabling emissions control technology in the automotive catalyst market. Our capabilities align very closely with current industry trends creating and extremely exciting marketing opportunity for CDTi and its partners. We look forward to keeping you updated as we execute our strategy during the balance of 2017 and beyond.

With that operator that concludes our prepared remarks. We’d like to open up the call for questions please.

Question-and-Answer Session

Operator

Certainly. [Operator Instructions]. Our first question comes from the line of Matt Koranda from ROTH. Your question please.

Matt Koranda

Just wanted to start-off with the outlook, the 32 million to 35 million. Can you give us the breakdown between coated catalyst, emission control systems and then the technology and advanced materials components for the revenue?

Matthew Beale

Yes. I mean, the way I’d answer that, we’re not providing -- we don’t typically provide guidance on the segment level. But directionally, I think just to help you with the analyst I’d say that, the Honda during 2017, our current expectation is that we'll be flattish to a little bit down potentially, that would be, the way I'd look at that.

We expect now -- we talked -- we mentioned DuraFit, as well as the private label programs that we have. So we are expecting growth there, we expect that contribution to be significantly greater. In about 45 days we'll have our first quarter coming out and I think we’ll be able to talk more exclusively about the run rate we’re on, which we think will imply some good growth there.

Technology materials, again, that will grow probably as a percentage basis significant, but from a very low base, as a lot of the new revenues on the powder side are back ended in the fourth quarter.

Matt Koranda

Okay, got it. And then just in terms of the cadence of the coated catalyst revenue during 2017, I would assume that sort of tapers down during the year, just given that the setting Honda revenue? Is that a fair assumption and maybe just a little bit of color around that, Matt.

Matthew Beale

Yes. In the prepared remarks, we talked about having a program. We’re working -- the strategy there is to, together bring forward some of the production in out years and to complete some of our production obligations, essentially complete them all in ’17.

So I think when you look at that, that’s likely to mean pretty flattish revenue pattern in 2017 and really by 2018, it’s a little -- it’s tapering off -- it ends in essence. So 2018 will be without that same revenue stream.

Matt Koranda

Okay.

Matthew Beale

So very similar -- very, very similar pattern to ’16 and ’17 and then ’18 that -- it’s no longer there.

Matt Koranda

Got it. Okay. That’s helpful. On the gross margin guidance, it seems -- I mean, I guess, I was of the understand that when you strip away at some of the pass-throughs in the Honda business that you guys would show through sort of higher gross margins, but it looks like the gross margin guidance seems relatively conservative here. Maybe just a little bit of color around the gross margin outlook for 2017?

Matthew Beale

Yes. I think as we launch the -- in heavy-duty market as we talk about, we have the DuraFit business and then in addition increasingly we’ve deploy this technology provider model where we’re providing product technology components, it depends on the partner, and allowing partners to do a private label type of project.

There will be some start up associated with that. So it also depends on the parameter of supply. While we think there is a lot of growth there, as we get into programs with volumes that get beyond -- get into the thousands we'll start to have much more normalized margins that are consistent with what we're currently what we had achieved with DuraFit. So there is something of a -- part of that impact is the ramp really of those private label programs, which take a while to get started and to get to critical mass in terms of volume.

Matt Koranda

Okay, so those will be a drag on margins in '17, but you'd expect that component of the business to see expanding margins further out as volumes pick up, is that a fair sort of encapsulation?

Matthew Beale

That's fair, it's just they take -- there is a lot of setup involved it takes time to get them going, but once you get up into the four digit types of volumes, we're in a normalized state. It's not unlike what happened with DuraFit, if you will.

Matt Koranda

Okay, alright got it. In terms of sort of can you give us a sense for -- so I know you guys are targeting breakeven in the back half of '17 on a continuing operations basis. Do you mean the operating income basis or EBITDA, what's the metric you're using on that front and then just give us a sense for kind of cash burn in the first half as you ramp into that breakeven point?

Matthew Beale

Sure, we don't publish non-GAAP metrics, but I think we do try to -- we think about certainly internally we look at cash operating income, that would be the way that we think about it. So I suppose it's more akin to a measure that someone might refer to as EBITDA, but that's kind of how we think about that.

As it relates to the -- on the cash burn side, again, it's come down significantly as we've gotten operating expenses down, despite a somewhat messy fourth quarter as we complete all of the cleanup that was done in 2016, if you peel things back we are clearly down at that. We were down at that 3 million in OpEx and we'll continue to push that downward.

You know the burn which was in '15 and very early in '16, a $1 million, we think we've gotten it significantly below that. We had some seasonal swings in the first quarter in particular where we have a lot of expenses related to certain projects that we're working on as well as the audit. But I think we're down -- we're well below 500 kind of on a, I would say closer to probably 250 on a -- if you look at on a monthly basis and going downward, when we kind of normalize cash burn.

Matt Koranda

Okay, that's helpful. Maybe just one last kind of higher level question for you guys then I'll jump back in queue. In terms of the private label opportunity in the DPF market, I was just curious if you could help us understand your thinking around, I guess, for a long time you've been pursuing the DuraFit branded line that seemed to have had some success initially in terms of the ramp up.

What's the attractiveness of doing some of these, I guess, private label and distribution opportunities with customers in that segment, why pursue those rather than just continue to build out that DuraFit product line?

Matthew Beale

It's really about playing to our strengths. CDTi is not a downstream aftermarket distribution company, that's simply not what we do. There's a lot of guys that do that and do that very, very well at high volumes, DENSO being one of those.

Our ability to provide technology and product, anything from coated substrates through to finished product where we need to, allows us to focus on what we’re really good at. And I think the margin capability for us, particularly around doing our core coating technology is far more attractive. So we’re able to combine our technology with a strong -- a partner with strong downstream distribution and potentially also manufacturing capabilities, it's the perfect combination.

And so that’s really -- it’s not private label in the sense of low value. I mean these are going to be very high value programs in the context of some very focused efforts on the part of our partners with the existing heavy-duty customers.

Matt Koranda

Okay. Got it. I’ll jump in queue. Thanks guys.

Operator

Thank you. Our next question comes from the line of Jeff Osborne from Cowen & Company. Your question please.

Jeffrey Osborne

Just a couple of questions, on the OpEx run rate the 3 to 3.5, Is that including stock-based compensation or not?

Matthew Beale

It is including stock-based compensation, yes.

Jeffrey Osborne

Can you just walk me through then what the moving pieces are Matt, to get to that level in the second half of the year with the plain 0.9 million or so of R&D? I’m just trying to get a sense of where the cuts are going to come from relative to the run rate today?

Matthew Beale

Sure. I mean, we will get into the -- certainly with the K, there will be more details in terms of where expenses are and where they’re coming from. But stock-based comp in the fourth quarter was a high -- that’s not a quarterly number that we’re going to have in our going forward, it’s a slower number. I don’t want to get into forecasting stock-based comp, but I don’t think that -- the fourth quarter has represented.

So that, it's probably what helps you make the adjustment the most. But otherwise, it’s really in the -- R&D is going to -- will stay strong. Sales and marketing has come down pretty significantly, I think if you look at the runway we’re at, where we see additional opportunities are in G&A, and clearly as we get to the end of some of the OEM activity that we’re doing with Honda, that gives us further opportunities to reduce SG&A -- I mean reduce G&A specifically. So a lot of that will come from G&A. But I think if you kind of back out -- you think of that stock comp number in fourth quarter, that’s not as a quarterly number, this will all make sense.

Jeffrey Osborne

Okay, that’s helpful. And then speaking of Honda, again you mentioned, so I guess there is a couple of moving pieces here, my interpretation of your discussion of it was that, you approached them and you said, hey I don’t want to run this plant, so I’m going to try to accelerate production and then will you buy this from me. So I’m just trying to get a sense for your ’18 and ’19 commitments of whatever would have been the replacement market for the existing accuracy [ph] and we’re not.

So I assume there was some price concessions on that negotiation. Is that one of the reasons for the gross margin guidance where it is as well, or am I reading too much into that?

Matthew Beale

No, it’s not part of the gross margin guidance. And really just very simply, we’re again -- we were -- this is an orderly departure and this is something that we started talking about in the end of ’15 really, it's an orderly departure from this high volume, lower value activity. And we expect to conclude that by the end of the year. That will involve likely bringing forward production of -- for certain models that would have carried out in the future, we’ll likely pull forward production, and that something that we will work with our partner on. So that’s really how that works.

Jeffrey Osborne

I guess, it seems obvious to me that Honda would spend millions of dollars buying inventory for ’18 and ’19 vehicles. I don’t think that something that they would normally do with their existing suppliers, but perhaps I'm wrong?

Matthew Beale

I don’t -- I mean -- I think you’re characterizing it a little bit more, not dramatically. But the numbers remember, from ’18 on anyway, in fact from the ’17, this was a very small amount, it was a far smaller amount of volume that we were doing. So it’s not quite as extremely as you depict. I mean, the volumes anyway were at a far lower level, the residual volumes that were there.

Jeffrey Osborne

Okay. And then you mentioned the overhead with the facility and I'm completely on-board with the change in direction that you talked about for the last year, year and a half. But can you quantify the overhead for -- within the expense based today for the Honda program, that will be eliminated for 2018? Just as we look at the potential cost of goods sold improvement for next year?

Matthew Beale

Yes. I think we can -- what we look to do -- I mean, we think that we can drop manufacturing overhead by somewhere in the region of 1 million to another 1.5 million. So that brings it down to a level that again based on the model of doing the higher value stuff a lot more diesel coating activity would get us at the right level.

So that maybe in terms of getting to breakeven, when you kind of think about OpEx and you think about gross profit margin and then you throw into the mix an additional 1.5 million potentially of savings, maybe a little bit more, then it will help you get to your breakeven number there.

Jeffrey Osborne

Got it. That’s helpful. And then last one maybe is just more of a suggestion or maybe a discussion about disclosure for the company report, just how do you think about as Panasonic and your partner in India [indiscernible] look to get qualified with OEMs. Is there a metric that you can possibly share with us moving forward in 2017, in terms of the number of vehicle programs that they’re getting qualified into without naming names?

Just a total quantity would be helpful to get a sense of comfort that those partners are actually building momentum for 2018, fully recognizing that there won’t be a considerable portion of revenue for 2017, just given the qualification time. But any type of big picture narrative there, I think would be helpful. Is that something they would permit you to do?

Matthew Beale

Yes. I think, it’s obviously -- you obviously understand the sensitivity there. And I think we can do a little bit better. We were pretty exclusive is it relates to kind of some of our life duty partners, I think in the prepared remarks, regarding volumes. But on some of these OE programs, it is quite specific, but I think it’s a good suggestion, it's something we can take a look at and as the visibility for the programs comes on board without naming names, I think we'll be able to be far more explicit about what's involved, what the unit numbers are and obviously what it implies for revenue going forward.

So as we have greater visibility into these programs, I think we’ll be able to do just that. We could talk more generally about what we see as the heavy-duty market and opportunity there as well. But I think as the months go by here will be able to be quite granular about the -- certainly the impact in terms of volumes and revenue.

Jeffrey Osborne

Okay. Thanks so much. I appreciate it.

Operator

Thank you. [Operator Instructions]. And this does conclude the question-and-answer session of today’s program. I’d like to hand the program back to Matthew Beale for any further remarks.

End of Q&A

Matthew Beale

Thank you again everyone for joining us today, we look forward to keeping you updated on our progress. Good bye.

Operator

Thank you, ladies and gentlemen for your participation in today's conference. This does conclude the program, you may now disconnect. Good day.

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