Westport Fuel Systems Inc

Thank you for standing by. This is the conference operator. Welcome to the Westport Fuel Systems fourth quarter and fiscal year-end 2022 financial results conference call. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation, there'll be an opportunity to ask questions. To join the question queue, you may press star then 1 on your telephone keypad. Should you need assistance during the conference call, You may signal an operator by pressing star and zero. I would now like to turn the conference over to Ashley Newell, Senior Director of Investor Relations. Please go ahead.

Good morning, everyone. Welcome to Westport Fuel Systems' fourth quarter and full year 2022 results conference call, which is being held to coincide with the press release containing Westport's financial results distributed yesterday. On today's call, speaking on behalf of Westport, is Chief Executive Officer David Johnson and Chief Financial Officer Bill Larkin. Attendance on this call is open to the public, but questions will be restricted to the investment community. You are reminded that certain statements made in this conference call and our response to various questions may constitute forward-looking statements within the meaning of the U.S. and applicable Canadian securities laws. And as such, forward-looking statements are made based on our current expectations and involve certain risks and uncertainties. With that, I'll turn the call over to you, David.

Thanks, Ashley. Good morning, everyone. I'm pleased to be with you today to discuss our 2022 results for the fourth quarter and full year. Today, I'll be walking you through our key financial and operating results and our outlook for the roadmap to decarbonize transportation, that is, the need for and potential of clean, affordable, gaseous fuels. and our product fuel systems for LNG, hydrogen, CNG, RNG, and LPG. And I'll share some additional insights into our recent announcements related to hydrogen manufacturing capacity in China and our third OEM demonstration program for hydrogen, HPDI. Amid last year's challenging macro environment, our top line was slightly lower in U.S. dollar terms compared to 2021. As has been a repeating theme through 2022, the dollar-euro exchange rate movement masked the top line growth in euro, that we delivered at an operating level. Excluding the impact of foreign exchange, our business grew 9%, or $28 million. Our hydrogen components, fuel storage, delayed OEM, and electronics businesses all saw revenue growth in 2022 and have also started strong in 2023. The impact of foreign exchange and the Russia-Ukraine conflict masked some of the improvements we saw in 2022 in our aftermarket business, resulting in revenues down slightly this year in U.S. dollars. High CNG and LNG prices in Europe reduced our HPDI and CNG fuel system sales volumes in our heavy-duty and light-duty OEM businesses, while inflation, ongoing supply chain constraints, and warranty costs weighed on our profitability. Although we have no control over fuel pricing, we have put measures in place to improve our bottom line outlook for 2023 and beyond in the areas that we have the influence. I'll touch on these shortly. In our heavy duty and aftermarket businesses, we have work to do to enhance volumes and margins, supporting profitability going forward. Improving profitability by extracting efficiency internally is one of our biggest priorities in 2023. And later in the call, Bill will outline steps that are taken to address this. We continue to face industry headwinds and feel both prepared and poised to grow in the future. We believe that the strong LPG price advantage the establishment of natural gas price advantages versus petrol and diesel, and our continued expansion in new markets combined with support of global emissions reduction requirements will drive our business forward. Environmental, economic, and regulatory requirements will not stop or wait, and Westport is well positioned to respond. And further OEM conversations around HPDI with LNG and biomethane and now hydrogen HPDI in the future will drive growth and profitability. Wider felt impacts of rising inflation, supply chain constraints, higher utility costs, and fuel price volatility have continued to weigh heavily on our industry. As a result, recorded a net loss of $32.7 million for the year compared to net income of $13.7 million in 2021. Significant margin pressure combined with loss of equity income from the Cummins Westport Joint Venture weighed heavily on the net loss, as well as the impact of foreign exchange. 2022 was also a year of significant announcements with respect to advancements of our hydrogen HPDI fuel systems, new customers, and collaborations. I want to quickly highlight a few of those announcements from the fourth quarter. In November, we were awarded a program to supply Euro 7 LPG fuel systems to a leading global OEM, an add-on to the Euro 6 supply program we had announced earlier in the year, and a program that starts production in Q4 of this year and will have a material impact to our revenue from 2024 on. In December, we announced a collaboration with Johnson Matthey, a global leader in sustainable technologies to develop an emissions after treatment system for hydrogen HPI. Working together, we aim to create a zero emission solution for affordable and clean transportation that does not compromise performance or efficiency. As we look at the year ahead of us, I want to walk through our go forward strategy and how we're positioning ourselves for the future. will drive sustainable growth in our existing markets through a diversified portfolio of technologies, products, and services. This will be seen across all our business units. The strength of our diversified strategy was apparent in 2022 as our revenue before the impact of FX grew amid significant headwinds like the Russian sanctions and fuel price increases. Secondly, we aim to unlock new and emerging markets through the delivery of clean, affordable transportation solutions. This includes opening new geographies, but also capitalizing on the strengths we're seeing from our delayed OEM, electronics, hydrogen component, and fuel storage businesses. Third, we'll continue as we've done in the past to drive operational excellence and maintain our reputation as a tier one supplier with enhanced quality and reliability. Fourth, we'll extract efficiencies through prudent capital management focused on cost optimization and margin expansion. Each of these initiatives positions us to strengthen profitability across our business units. Listening to global markets, there's now an undeniably louder voice highlighting the need for a portfolio of options, recognizing it won't be a one-size-fits-all approach when it comes to the need to decarbonize transportation. Some are using the word eclectic and contrasting that with all electric. Clever rhyme, but also true. We have diverse technologies and fuels today, and we'll have more diversity in the future. Gas or fuels and our fuel systems will play an important and growing role in that eclectic future. A varied solution set that takes into consideration the differing needs of each application has always been our view. It's a welcome and needed change in the conversation at both the OEM level and from policymakers alike. This might be the beginning of a step change, which we can all stand to benefit from. While much of the talk still points to fuel cells and battery electric options, hydrogen internal combustion engines are emerging as an attractive alternative for the implementation of decarbonized transport. In recent months, the likes of Toyota, Tata, Kawasaki, Reliance Industries, Teneco, Volvo, and others have increasingly expressed this view, reducing the cost of replacing current power trains, but also maintenance costs compared to the fuel cell battery combination system. enables faster conversions for fleets. We know that as we move up to long-haul heavy-duty, battery electric may not be able to meet the payload, recharging requirements, and therefore hydrogen internal combustion engines is a very attractive proposition. LNG and biomethane are also making a name for themselves in the heavy-duty long-haul space. Trucking at its core is a conservative industry. It takes a while to prove concepts and to build the infrastructure that's happening now step by step. As an example of the growth we're seeing, Europe added approximately 100 new LNG stations this past year, reaching just over 600 stations in service now, a growth rate of 20%. LNG and bioethane offer clear climate upsides, remain competitively priced in many countries, and more importantly, using our HPDI fuel system, offer the driver the same experience as diesel fuel, all its power, performance, and reliability. To paint a picture of the momentum with biomethane in Europe, where the production of bio-LNG is ramping quickly, in Sweden last year, for example, 96% of all the gas used in transportation was biomethane. Unsurprisingly, Sweden has the highest market share of LNG trucks on the road. It's not just Sweden. Germany has been a dominant country with respect to biogas production for a while now, and other countries such as Denmark, France, Italy, and the Netherlands have actively promoted biogas production, with OEMs now on the clock to significantly decarbonize by 2025, and regulations proposed requiring reductions of 45% in 2030. Utilizing LNG and biomethane today is a clear option. HPDI using LNG meets the 2025 carbon targets already and is on the road in the thousands, putting us in a solid competitive position to capture this growth. When we think about the future of HPDI, we're looking at hydrogen as the fuel of the future. In our discussion with global OEMs at IAA last year, it was clear they're beginning to recognize that our hydrogen HPDI fuel system solution addresses the portion of the market not addressed by electrification and does so affordably. Gaseous fuels are a compelling way to address heavy-duty long-haul applications and HPDI offers the lowest cost to develop, the lowest cost to industrialize, and the lowest cost to operate. Again, we need a variety of solutions and can't rely on a single idea or concept to work for everything. It's just not realistic. The challenging LNG pricing environment and differential to diesel last year resulted in a difficult year for our heavy duty OEM business, resulting in lower volume than expected. These lower volume levels truly impacted our economies of scale and when combined with higher production costs drove margin pressure. In recent months, we're beginning to see a more favorable LNG price trend in Europe, with the fuel price returning to levels we haven't seen since 2020-2021. This more normalized LNG price is pushing the total cost of ownership back in the favor of LNG-powered fleets, and we remain encouraged by this price trend. Despite the macroeconomic environment, our European launch partner remains committed to the growth of HPDI. Recently, many OEMs have made public announcements supporting the need for several technical solutions due to the availability of energy and fuel infrastructure, which differs greatly between countries and regions, and also because the requirements for range, weight, and payloads will differ by use case. These statements have been supporting the future use of LNG and biomethane as a part of a multi-option effort to decarbonize transportation. This is exciting for us. We're at the beginning of the transition to cleaner fuels, natural gas, biomethane, and then hydrogen. This transition to cleaner fuels is also making its presence known in North America, as a Canadian industrial gas and engineering company has recently committed to evaluating Class 8 LNG power tractors in its long-haul operations, focusing on measuring performance, fuel savings, and other operational factors against its diesel fleet. Turning to Light Duty OEM, in 2022, we had several exciting announcements, including two major contracts with a leading European OEM for the supply of LPG fuel systems for both Euro 6 and Euro 7 standards through 2035 and beyond. The LPG vehicle market in Europe remains strong, bolstered by pricing advantage of petrol. In Q4 last year, LPG-fueled vehicle registrations grew by over 16%. This trend is also positive for our delayed OEM business, where we saw a 20% revenue growth in 2022, converting some 40,000 vehicles. a number we expect to grow significantly in 2023. In India, we were encouraged by the increased level of light duty sales to OEMs, yet that market has been negatively impacted recently by rising CNG prices. To add some perspective, the price spreads between CNG and diesel have decreased by 19% year to date. Despite the pricing environment, biogas and biocng remain a focus for the Indian government with recent announcements supporting the production and development of 500 new biogas plants and up to 5,000 biocng plants with a production target of 15 million megatons by 2023-24. This is still an important growth market for our company going forward. Our partner in China, Weichai, remains committed to the commercial launch of HPDI, as we mentioned in December at our Capital Markets Day. They recently took possession of nearly 100 HPDI units. A volatile LNG pricing environment has hampered the progress of this market. However, as pricing normalizes, it should be a boost towards a commercial launch and will update the market on this progress. We've talked a lot recently about our hydrogen components business, a business that grew gross profit by almost 60% in 2022 and continue to see strong growth. A few weeks ago, we announced our plan to invest up to $10 million to expand our global manufacturing footprint in China, supporting our hydrogen components business and other alternative fuel system technologies. China leads the world in hydrogen investment and infrastructure development and has a published ambitious objective of having 1 million hydrogen-fueled vehicles on the road in China by 2030. The new Westport facility in the city of Zhengzhou will begin operations in 2024 and include an ultra-modern manufacturing facility and a contemporary innovation center. Our hydrogen components have had a strong presence in China in the market for over 10 years. This announcement is truly a stepping stone to continue our hydrogen technology advancement and positions Westport to support a variety of applications using fuel cells and internal combustion engines using hydrogen for fuel. Globally, hydrogen continues to gain traction as governments, private companies, and policymakers continue their push for investment and support to solidify hydrogen as the fuel of the future. In Europe in particular, nine EU member states have called on the European Commission to include low carbon hydrogen produced from nuclear electricity in the EU's renewable hydrogen targets, stressing energy security and energy independence. As demand increases, pricing is expected to decrease, and refueling infrastructure increases both driving factors for adoption. With these in place, change can happen quickly. The roadmap for hydrogen is very encouraging for our business. Our components business provides all the necessities for both IC engines and fuel cells. Because of this, we stand to benefit broadly from all hydrogen applications in transport. When looking more closely at using hydrogen for heavy-duty transport, In February, the European Union made some significant announcements regarding potential heavy-duty vehicle emission standards and hydrogen internal combustion engines. For the first time, hydrogen IC engines were included in the list of technologies that would drive the shift to zero emissions. Though still a proposal, this is a critical step change from the earlier dialogue. We'll be monitoring these developments closely. And just last week, we announced another collaboration with the Global OEM to evaluate the performance efficiency emissions of the OEM's engine equipped with our hydrogen HPDI fuel system. This collaboration marks Westport's third major OEM engagement to date. Funded by the OEM, the work starts immediately and continues through year end. We look forward to updating the market further on the results of this ongoing evaluation work. Hydrogen mobility has now become much more substantial than just fuel cells, as hydrogen internal combustion engines are set to play an important role moving forward. Operationally, our independent aftermarket business performed well in 2022 amid a difficult macroeconomic climate. The impact of foreign exchange and translating results combined with lower sales in Russian Mark and lower volumes in Turkey and Argentina resulted in slightly lower revenue year over year. Despite these setbacks, in 2022, we were encouraged by growing volumes in both Eastern and Western Europe, and we're seeing recovery trends so far in 2023. The lower volumes in some of our key markets like Turkey and Russia tighten margins already impacted by higher production input costs. Plans are in place to address this, and we're working to get our margins back into a more acceptable range. Despite pronounced supply chain and logistics headwinds that are still lingering with our customers and partners daily, we expect a busier 2023. We started seeing recovery in Western Europe in the back half of 2022, and this trend is continuing so far this year. We'll look to enter new markets where the spread between petrol and alternative fuels is favorable. We have several open tenders that we feel confident we'll be able to acquire in both new and existing markets. A more normalized CNG pricing environment in places like India and Argentina will also be beneficial for us to grow market share and revenues. As the market leader for the LPG conversion of petrol direct injection vehicles, we've historically benefited from this position in Western Europe. As an example, in Italy, a developed market, we've seen conversions increasing as incentives for petrols rolled off, extending the price advantage of LPG. In new markets across the world, the need for LPG conversions providing customers a lower cost clean fuel option is increasing, and we're seeing an uptick in demand in countries like Poland and Turkey.