Thank you for standing by. This is the conference operator. Welcome to the Westport Fuel Systems Second Quarter 2018 Financial Results Conference Call. [Operator Instructions] I would now like to turn the conference over to Ms. Caroline Sawamoto, Senior Manager of Investor Relations and Communications for Westport Fuel Systems. Please go ahead.

Thank you, and good morning. Welcome to Westport Fuel Systems second quarter 2018 conference call, which is being held to coincide with the press release containing Westport Fuel Systems financial results that went out yesterday. On today's call, speaking on behalf of Westport Fuel Systems is Chief Executive Officer, Nancy Gougarty; and Chief Financial Officer, Mike Willis. Attendance at this call is open to the public and to media, but questions will be restricted to the investment community. You are reminded that certain statements made in this conference call and our responses to various questions may constitute forward-looking statements within the meaning of U.S. and applicable Canadian securities law, 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, so you are cautioned not to place undue reliance on these statements. Information contained in this conference call is subject to and qualified in its entirety by information contained in the company's public filings. In particular, reference is made to the ongoing SEC investigation and related cost as described in Westport Fuel Systems financial statements and managements discussion and analysis. I will now turn the call over to Nancy.

Good morning, and thank you for joining us for Westport Fuel Systems Second Quarter Results Conference Call. For the last two years, we have been relentlessly focused on transforming the company into a profitable sustainable organization. I am pleased that we have made considerable progress towards this goal. The combination of our efforts in aligning our cost with revenue, optimizing our product portfolio, divesting of our noncore assets, implementing manufacturing excellence initiatives and launching Westport HPDI 2.0 has led to this moment. In the past, we have guided that we would achieve positive adjusted EBITDA during second quarter of 2018. We have delivered and this is a huge milestone for us. Furthermore, with the launch of HPDI 2.0 in 2017, our R&D and capital expenditure have decreased significantly, further improving the company's cash flow profile. We ended quarter 2 with a healthy cash position of $51.2 million, which has been further strengthened by the recent completion of our compressor business sale for the gross proceeds of €12.3 million. With increasingly urgent demands for clean vehicles, we are well positioned to deliver market-ready alternative fuel solutions across all segments of the global transportation market today. We have a complete product offering that addresses a broad range of alternative fuels, including LPG or propane, natural gas and hydrogen. Our suite of products are quickly taking advantage of the changing market trends, such as higher oil prices, stricter emission regulations and customer demanding clean vehicles. In the recent discussions with OEM partners, they said that they have seen an significant increase in CNG car registrations. In Germany, for example, they saw over a 600% increase year-over-year. Although it is a still a relatively small market compared to diesel and gasoline car sales, they believe CNG could potentially reach 5% to 10% of the…

Thank you, Nancy. As you know, this is my first quarterly quality since starting with Westport Fuel Systems in early June. I'm really pleased to be joining the company as it hits this milestone of turning adjusted EBITDA positive I've been immediately impressed by the talent of the Westport Fuel Systems' team and the passion they have for what the company is trying to accomplish. I am very optimistic about our prospects and believe that we are well positioned to become a profitable company, providing market-ready products to support alternative fuel usage across all segments of the transportation sector. I've had the chance to speak with all of our analysts and with many of our shareholders and look forward to meeting with more of you in the near future. I'll start with slide 5 that provides a summary of our second quarter results. Note that the current and comparative periods have been adjusted to exclude the compressor business, for which we completed the sale in July. Cash on hand at the end of the quarter was $51.2 million and excluded the proceeds from this sale. As a side note, as a newcomer to the Westport Fuel Systems, I've been really impressed by the company's ability to drive significant value from its assets since the 2016 merger with Fuel Systems, generating meaningful cash proceeds from the sale of the industrial, APU and compressor businesses, while also developing a streamlined and profitable portfolio transportation-focused businesses. Now on to our financials. We closed the quarter with sales of $80.5 million, a net loss of $5.7 million and adjusted EBITDA of $8.6 million. Operating expenses increased due to unrealized foreign exchange losses of $5.2 million and legal expenses related to the previously disclosed SEC investigation, but these were partially offset by significant reduction in…

Thank you. [Operator Instructions] Our first question comes from Colin Rusch of Oppenheimer and Company.

Thanks so much, guys. Given the balance that you had in the 2 -- in the second quarter, and thinking about the guidance for the back half of the year, I guess, where we'd like to really get some more granular informations around the revenue breakeven level, should we be thinking about you guys being able to breakeven with the revenue in a range of the $55 million to $60 million level. What other levers can you pull to keep this streak alive on the cash flow?

Colin, thanks for the question. I don't think we've done the analysis per se in terms of the specific revenue run rate that gets us to cash flow or at least to, I guess, adjusted EBITDA breakeven. I would say it would probably be higher than, call it, the $60 million level because that we've seen that level for, call it, the last 5 quarters, plus or minus. So it's probably something higher than $60 million, definitely, obviously, lower than $80 million. But haven't done the analysis to give you a specific -- we can't give you specific number at this stage. I think key to that also, as you know, is things like product mix. It would be probably the number 1 thing that I can think of in terms of what we dictate kind of a range as it relates to that number.

Okay. And then just a longer-term strategic number because I know a lot of folks are going to ask about HPDI 2.0. Have you, kind of, looked at moving into adjacent markets in terms of fuel sources, obviously, with the core competence around design and managing supply chain. It seems that you could move into the EV space or another fuel source without too much difficulty. Is that something that you guys are looking at considering at some point?

Colin, again, thanks for the question. I think that you can see that since -- as we have really looked at our portfolio that as we looked at divesting, we ended up keeping the hydrogen business. We think that, that's very synergistic with our current gas business. And we always are looking at opportunities. We see ourselves as an alternative fuel company so we don't see ourselves totally boxed in, though we have very, very strong competencies I'll say on gaseous fields.

Great. Thanks so much, guys.

Thanks, Colin.

Our next question comes from Eric Stine of Craig-Hallum Capital Group.

Hi, Nancy. Hi, Mike.

Hey, Eric.

Good morning.

Good morning. Congrats on the quarter and getting to your milestone. Maybe just on the Transportation segment. Is there -- I mean, I know that all in one bucket, but maybe if you could just talk about the trends in that business. I mean, I would assume that in OEM, DOEM and aftermarket, it's pretty broad based. But this was a really big quarter. So just wondering, were there other things in there as well. You had the Algeria contract or development team. And then maybe just some commentary on the contribution from HPDI?

Well, I'll answer from, kind of, from a financial perspective, which is we saw upticks in sales, pretty much across the board, Eric. So I -- it wasn't one thing dominating this uptick. I would say probably the segment that showed the biggest increase quarter-over-quarter was the DOEM business. And maybe Nancy you can comment like you describe within your prepared comments, how DOEM leads potentially into OEM business?

Yes. So Eric, the -- I would say that from what we see is -- as we have seen this anti-diesel sentiment, there is a lot of, I'll say, pull at this point in time to get vehicles into the showroom by being able to offer a DOEM solution, which gives products that can get to the showroom at a pretty fast order. We are -- we have seen that market has been quite brisk. I would indicate to you though that, we're -- as we have seen across all our products, oil prices and other things have, obviously, boosted some of our revenues. We're quite pleased where we are relative to the launch of HPDI, where we think that it -- we have gotten good driver feedback. It's now in the hands of real consumers. And that's really a test of the product, and we think that the feedback and the order book there is pretty much what we expect. And we are continuing to see that as we move through the calendar year, and we get country incentives and those kinds of things understood that would benefit from HPDI product portfolio, and they would qualify that we're quite pleased with where we are in the launch. And again, I think, as Mike said, very good for us in terms of this particular quarter that we saw, really opportunity of increased revenue across all different sectors. So I think it's -- from our perspective we're finding that this anti-diesel sentiment and I think consumers are just really looking for alternatives, and because of the ability of our product and I'll say, the nature of it and the cost of it, it seems to be one of the most -- one of the ones that is benefiting most.

Right. And so there really -- it sounds like there really wasn't the benefit of a large whether it's that Algeria contract or something else. I mean, it was really broad-based?

Right.

Including geographies. So pretty much across the board barring maybe a couple of exceptions. Every country seemed to be having a positive quarter for us, which is obviously great.

Right. Absolutely. Okay. Then maybe just turning to, I guess, follow-up on the previous question about how we think about the rest of the year. You know -- so guidance unchanged, which I know at this time of the year is something that you typically do, you did last year. But I mean you're also positive about year-over-year growth. So just -- just kind of think about that because those 2 things don't necessarily match up. I mean, it is still fair to say right that third quarter you're going to have typical step down because of having mixed towards Europe.

Correct. So -- yes, so the reason why we haven't updated guidance is we still are forecasting out the balance of the year. And really still taking a view on a variety of things. I would say there -- anything from currency as you know, currency impact our revenues I know this is a number that folks are often looking for. So sequentially, from Q1 to Q2, the Euro dropped, I think 3%, versus the U.S. dollar and that impacted negatively our revenues in Q2 by about $4 million. So obviously, we can't predict currencies, but we can at least take a view on them. The other one that's, kind of, I guess -- is a new one for us, is given all the kind of political activity, international political activity, sanctions and tariffs and all those types of things seem to be high on the list of people's minds and questions. So again, we don't see anything near-term that is impacting us significantly, but we -- again, we need to take a view in terms of what that's going -- how that may impact us for the balance of the year. Seasonality as you point out Europe, obviously, kind of steps down a little bit in August. So that's going to be impactful to Q3. And then there are other trends. So we mentioned DOEMs had a very strong quarter. However, as we have model year change outs towards the tail end of the year, we need to figure out what are OEMs going to be doing? Are they going to continue to work with us on a DOEM basis? Or do they transition more to an OEM business line? So all those things taken in combination just means that we haven't actually been able to truly forecast out the balance of the year. I think next quarter, we will be able to provide a little bit more granularity in terms of what we're thinking about revenues for the full year.

Got it. I can appreciate that. Maybe last one from me. Just China, I mean, I'd love to hear kind of the WWI volumes or whatever you can share there, year-to-date, kind of your expectations for '18. And then maybe just an update on that market in HPDI? How do you see that market playing out and also your potential there?

Well, Eric, certainly, we don't see China as one of our most significant market relative to natural gas and especially relative to the usage of LNG and the trucking sector. I would say that what -- China continues to run strong and I -- we don't have specific figures for you relative to WWI at the moment. But I would tell you that our discussions continue to understand how we're going to tap that market and being able to utilize HPDI in that market. We continue to work forward on that. And as we get that culminated certainly we'll make sure that the market understands exactly where we are in that. Again, as we look, I think that China is an important market for us and we're putting our energy there.

Okay. Thanks a lot.

Thanks, Eric.

Our next question comes from Rob Brown of Lake Street Partners.

Good morning.

Good morning.

Hi. Given kind of the dynamics in the market now, what's the latest on other OEM interests in HPDI. I know, you've always worked with other OEMs, but maybe just characterize where that's at and if there's been any uptick in the interest level or traction for new programs?

Oh, I'm so glad you asked that. I think that -- Rob, the interesting thing is I think back in mid-May, the European Commission has outlined a proposal relative to the new standard and targets for the CO2 reductions for heavy-duty trucks. I would tell you that just to give you some color on that, the proposed reduction is 15% wheel -- what they call tank-to-wheel reduction in CO2 by 2025, and 30% CO2 by 2030. And they're going to baseline the OEMs here in calendar year -- coming up in calendar year '19 in order to strike the line of what 15% looks like. And I think that as we have -- over the last several weeks as this regulation has gotten clear and understood in the market, we have seen and have had quite depthy discussions with many of the OEMs. I think that at this point in time, as you look at these regulations, it really -- their options are quite narrow. HPDI happens to be one of the products that is in that narrow option base for them. And -- so as you can imagine, for the heavy-duty trucking that is an area, especially in the Europe with new regulations is quite important dialogues going on and I think that you can probably sense that the leadership team is spending a significant portion of our time in Europe having these critical discussions. And as you know, in mid-September, we have the handover truck show and that's also a great opportunity for us to be able to push forward these discussions as well with many of the OEMs.

Thank you. That's a good overview. And then maybe on the light-duty automotive side, you talked about Europe CNGs seeming to uptick in interest, but maybe to give us a sense of what's going on there. I know diesel is a big part there as diesel, sort of, in your thoughts shitting to natural gas at this point in light-duty or maybe some color on what's been driving that market shift?

I think it's several different things. First of all, we are seeing consumer abuse relative to buying diesel vehicles. They are not so keen on it. They're not sure what the -- that they're going to able to recoup their costs of it as they try to resell it and that kind of thing. I think also, they, just in many cases, as being I'll say environmentally, I'll say, conscious in society, they don't really want to take on diesel vehicles and then in addition to that, we're seeing intercities banned diesel products. And again, as you look at the options that folks have, when you do that, natural gas and propane fall right into an area that are very acceptable for these intercity bans. So we -- so that allows them to take these vehicles into the intercity where the diesel vehicles can't. So consumers, I think, don't like the restrictions of buying a vehicle that they can't utilize fully. So that is one of the things that's uplifting the demand. So most of it is just draw consumer pull. Obviously having come out of Europe just a couple of days ago, the prices are quite good for CNG and LPG in that market, significantly lower than that of petrol as well as diesel. That also from a consumer payback standpoint as they get the vehicle either in OEM or in what we call our aftermarket modifications, they -- their paybacks are quite good on them. So we think that's really what's uplifting -- at least in our opinion at this point, what's uplifting the European demand.

Okay, good. And then, final question on, CWI had a strong quarter. What's sort of your view on the sustainability of that? And in the profit contribution as well do you see that continuing to increase or is this a level that we should think about going forward?

I think -- again, we don't really guide on revenue for CWI for obvious reasons, but I think if you look at Q1 for all the reasons we've discussed in the past, it was obviously a low quarter. Q2 was a great rebound quarter. So I think going forward, revenues in Q2 are more reflective of the ongoing reality versus Q1. And then, per my prepared statements, I think based off of the dynamics of lower R&D costs and a lower tax rates that -- more of the revenue dollars should be dropping to the bottom line going forward for that business.

And I guess one other thing to add there is, I think that you've seen publicly that there has been some announcements of sizable orders that are coming through with major fleets, UPS, et cetera. And all of that will -- we believe that a good portion of that will take place here in calendar '18. So...

And one of the things that we should point out is, you may have seen that Cummins had a recent recall, pretty significant one. Natural gas engines were not part of that recall. So the CWI joint venture is not impacted by that.

Okay, good to know. Thank you. I'll turn it over.

[Operator Instructions] Our next question comes from Jeff Osborne of Cowen and Company.

Hey. Good morning, guys. Just a couple of quick ones here, maybe following up on Rob's question. Many of the CWI announcements have been for replacements of fleets from 2014 and 2015. A, can you confirm that? And then b, are you seeing any new fleets just given oil diesel pricing environment that we are in looking to adopt the technology?

I guess we would say that certainly, we have a lot of interest. We've been a bit helped by the folks at Clean Energy putting in their renew stations. We believe that in certain geographies, particularly California, that this is quite an acceptable. And so you'll see it in big distribution companies but you're also -- we're also -- from my understanding, we are seeing in other applications and other fleet buyers. So I think it's a broad-based, I'll say, pull to the market. And so from that perspective, I think that, as we have a full fleet of products, especially that run on renewable natural gas that have 0 emissions, we stack right up there with the electric. And a very, very reliable product. And I think that you can see through the change over the last years relative to the warranty numbers that we have been talking about and I got to think we've got a good product, CWI, and we've got good market support. And like I said with the fueling infrastructure that's in place, we're just -- we're picking up and the winds are favorable in this direction.

Makes sense. Just a couple of other quick ones, Mike, for you. The $2.5 million of expense for the SEC investigation, I imagine that picked up since the February subpoena. Is that the current -- was there any kind of surge spending this quarter? Or is that sort of the new normal of what the expense rate should be for the duration of the investigation?

For obvious reasons we probably shouldn't be predicting specific costs associated with that. I would say that there was obviously, a pickup in activity, which obviously, spoke to the increase in that cost. But again going forward, it's very dependent on how the investigation goes.

Got it. But just as we think about you hitting EBITDA positive in the second half, are you backing out any expenses associated with that? Or you putting that in the model?

So as it relates to -- you'll see the table as it relates to our adjusted EBITDA that we do include that in the -- as an adjustment because we obviously don't believe that this is going to be a recurring cost over the long term for the company. The only thing actually to note is some of the costs associated with the investigation, legal and other, we do expect to be able to recoup some of those costs through our D&O insurance. So there is a -- a kind of, a level or if you will, as it relates to that. Obviously, we can't predict exactly what those recoup levels are going to be, but there should be some ability to get some dollars through our insurance.

Makes sense. Switching gears a little bit. I was intrigued by your comment that the delayed OEM business was the one that was up the most sequentially. I would have thought HPDI 2.0 was just given the minimal volume.

No. It was up as well. I mean it was up, but it was amazing how up our DOEM business. Nancy and I were just in Glasgow last week, and we see the activity in the parking lot in terms of cars coming in and cars coming out on a daily basis. Nancy sits there and counts the number of cars. So it's -- that's not a reflection that HPDI is not growing.

Year-on-year, HDPI is probably is higher, because we went from zero to where we are now, but…

I think in my answer, I did describe sequentially. But -- anyway, so that's not a reflection that HPDI is not performing well. It's the fact that DOEM had such a stellar quarter.

Got it. And then can you just remind me maybe putting 2017 in perspective, the mix of the legacy fuel sources -- fuel systems' business? What percent was OEM versus delayed OEM?

I don't think we drive that kind of granularity.

Okay. Fuel Systems did as a public company, but I wasn't sure...

Always…

Yes. I don't -- because 2017, we were blended, I don't remember making that split. So...

Okay. Fair to say that delayed OEMs is more than half the business?

No.

No, no, no.

The larger segment of our revenues still come from the aftermarket business.

Got it. And then is there meaningful you talked about the delayed OEM transitioning to OEM. Is there a margin implication of that? Obviously, it's more strategic with the OEM itself. But how does that impact profitability either positively or negatively?

I don't think it has a major impact on it. I think that -- when you go to the OEM environment, one of the good things is that we have more predictable schedule and that kind of thing. So we are able to, I'll say, predict and schedule suppliers and those kinds of things. So it has, I'll say, a 26-week framing relative to what they're doing and that kind of thing. And I think also on the OEM side, once you get it in, they can cross with one engine than -- any vehicle that uses that particular engine, we can get increased volumes in a quite quick way. I think the other benefit that we had on the OEM side is we've had really significant increase in terms of the content on the vehicle because they see Westport as they go to company across all systems. So we're sort of on the OEM side. We gain the benefit from volume but we also gain the benefit from more content per vehicle.

Makes sense. And the last one I had for you, Nancy, is just can you -- you talked about the hydrogen uptick and greater interest there. Can you just be a little bit more granular as to what specifically you're providing into that ecosystem? It would be helpful to understand that. Thank you.

Well, I would say currently, the products that we currently provide are on the, what we call the low-pressure side of the fueling system. And as we get closer into -- take the uptake of the tank, that's where the higher pressure products are really required. We have great position with a variety of different fuel-cell folks that use our products. And as they are demanding the 700 bar products, we are right aligned with them. So this will allow us to not only have the low-pressure side but also the high-pressure side of the system. And -- so we can continue to partner with them as their business grows. And I think that it's interesting the hydrogen as we look at it, that is one of the alternative fuels like I said, that's quite synergistic with us because it has tanks and all kinds of things that we're very used to doing. So this is a good reapplication of our skill set.

Perfect. Appreciate the detail. Thank you.

Thanks, Jeff.

[Operator Instructions] This concludes the question-and-answer session. I would like to turn the conference back over to Caroline Sawamoto for closing remarks.

Thank you, everyone, for joining us today. If you have any follow-up questions, feel free to reach out to the Westport Fuel Systems Investor Relations team. Thanks again.

This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.