Westport Fuel Systems Inc. Q2 FY2021 Earnings Call

Welcome to the Westport Fuel Systems Second Quarter 2021 Results Conference Call. As a reminder, all participants are in listen-only mode, and the conference is being recorded. I would now like to turn the conference over to Christine Marks, Westport's Investor Relations representative. Please go ahead.

Thank you, and good morning, everyone. Welcome to Westport Fuel Systems' second quarter 2021 conference call, which is being held to coincide with the press release containing Westport Fuel Systems' financial results that was distributed yesterday. On today's call, speaking on behalf of Westport Fuel Systems is Chief Executive Officer, David Johnson, and Chief Financial Officer, Richard Orazietti. 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 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. Actual results may differ materially from those projected in the forward-looking statements. So you're 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. I'll now turn the call over to you, David.

Thanks, Christine. Good morning, everyone. Thanks for joining us to review Westport Fuel Systems results for the second quarter of 2021. This is David Johnson speaking. Richard Orazietti is also on the line with me today. I'm speaking to you from our headquarters in Vancouver, British Columbia, which has experienced record-setting temperatures this summer and rampant forest fires that have claimed lives, devastating homes and families. Beautiful British Columbia isn't as beautiful as it should be. And we aren't alone; flooding and other extreme weather events have affected people around the world in Europe, Brazil, India, and China, just to name a few. The climate crisis has never been more evident, and the need for action from every sector of society is increasingly urgent. As a society, we really aren't having enough success in the face of this epic environmental challenge. Meanwhile, society's needs for transportation continue to increase, but the earth and humanity urgently need transportation to be much, much cleaner. That means each vehicle must be cleaner, and we need to produce, sell, and drive those cleaner vehicles. We must dramatically shift the mix of what we drive to clean transportation technologies. Scale is critical. And to be crystal clear, the so-called scale we're talking about here is 100 million new cars and trucks that are produced, sold, and put into use each year globally. And it's also the 1.4 billion vehicles that are already on our roads today. And so, to achieve scale on a global basis, we need clean transportation to also be affordable. Governments can't incentivize us to scale. California and the United States have been trying for decades; Europe is trying now. The U.S. Federal EV incentives of $7,500 per vehicle for the first 200,000 units sold by each manufacturer were a substantial incentive. Consider that just three major OEMs making and selling a combined 600,000 federally subsidized battery electric vehicles cost U.S. taxpayers $4.5 billion. And yet, sales are so far from significant in global automotive terms. Of those 1.4 billion vehicles on our roads today, battery electric vehicles are not even one percent. In the Netherlands, we have another recent example: Tesla's market share in the Netherlands was nearly seven percent in 2019. So far this year, Tesla's Dutch market share is less than one percent. A precipitous fall. Incentives fell away, and so did sales. Affordability doesn't just matter. Affordability is the key. It's the key ingredient in the other kind of sustainability, which is economic sustainability. Slightly obscured by headlines and article after article about the future of EVs and fuel cells is the growing success of Westport Fuel Systems right now. Our business is growing because our products are available now; they're affordable now, and they're effective at reducing CO2 emissions now. And with the increasing availability of renewable fuels, including the potential of green hydrogen, our path forward is clear. We're making a difference today, and our future contributions will be critical to delivering the global response to our environmental challenges. Our HPDI business continues to see strong growth in Europe. Today, Europe is our main market. And there, we see the combined impact of growing infrastructure, fuel prices that support increased use of clean fuels, and our available products. In Europe today, low carbon gaseous fuels are less expensive than high carbon gasoline and diesel, and these fuels are readily available from a large and growing infrastructure. In Europe today, there are more than 40,000 LPG stations, more than 4,000 CNG stations, and there are more than 400 LNG stations, and the station counts are continuing to increase. You can find great data at NGVA Europe's website as well as from other trustworthy resources. Other markets are on a similar path. China is leading the way. India and Africa are following Europe and China's lead, and North America holds great potential. Westport Fuel Systems is well positioned. Our goals are significant, and we're on track, despite COVID. We're seeing fleets adopting cleaner fuels and seeking viable solutions that dramatically reduce carbon emissions. We offer those solutions today, and the market is increasingly recognizing that our solutions deliver. They're clean, they perform, and they're affordable. So, while we're pleased with the recovery in our forward-looking growth trajectory, all of us are still looking to live with COVID and the COVID-induced supply chain disruptions that continue to ripple through our industry and marketplace. Semiconductor supply shortages remain a headwind for the automotive industry, including our business. While we anticipate that the microchip supply chain disruptions will persist into 2022, we expect an improving trend in the second half of this year. I'd like to draw your attention to a few highlights in the second quarter and provide a few market insights, then Richard will take you through a more detailed review of our Q2 financial performance. We had record revenues in Q2, up 135% compared to the same period in 2020, and the recovery trend sequentially over several quarters is encouraging, up 10% this quarter versus the first quarter of 2021, and up 56% in the first half of this year versus last year. Revenue was $84.7 million in the first quarter compared to $36 million in Q2 of last year. Net income was more than $17 million, driven by sales growth combined with a tax recovery just shy of $9 million and a gain on the acquisition of Stako of nearly $6 million. Stako, by the way, has been immediately accretive to our Westport Fuel Systems bottom line. We're thrilled to welcome our key numbers in Poland to Westport Fuel Systems. In addition to strong revenues in our heavy-duty OEM segment, sales in our independent aftermarket and light-duty OEM businesses recovered in Q2 from the impact of COVID-19 as compared to the same period last year when societies and our customers first experienced COVID-related lockdown. We ended the quarter with $106 million in cash and cash equivalents, including the gross proceeds of $115 million from our publicly marketed equity offering completed in June. We've positioned the company for growth, and we're investing in the development of our next-generation products. Overall, our business is growing from a solid foundation and our longer-term outlook is very positive. We have a fabulous and committed team and an excellent product portfolio, growing sales to global customers across the full range of transportation applications through both aftermarket and OEM channels. It's the right recipe to achieve our mid-decade goal of $1 billion in profitable sales. Our joint venture with Cummins is nearing the 20-year mark. Together, we've enjoyed a very successful partnership, and together, we have demonstrated that natural gas engines deliver in demanding trucking applications. Our joint venture is scheduled to end this year, and that leaves us with several potential pathways forward. Discussions are ongoing, but there's no definitive conclusion to announce today. If the joint venture ends and we go our separate ways, both partners will maintain full and equal access to all of the JV's intellectual property. Meanwhile, you'll note that our current HPDI customers are global OEMs that can more easily launch existing products into a new geography in a company that doesn't yet have HPDI products fully developed. The opportunity in North America is significant, and HPDI offers more performance, more efficiency, and the ability to use today's renewable natural gas resources and also future green hydrogen. HPDI's real-world benefits, both environmental and economic, are being demonstrated every day on European roads by thousands of commercial vehicles generating rave reviews from drivers to fleet operators. In the U.S. last week, the highly anticipated infrastructure bill was released, largely disappointing EV advocates. The original funding target of $15 billion was cut in half. The encouraging news is that low carbon and zero-emission spending received a massive boost of $7.5 billion with allocations specifically for hydrogen, propane, and natural gas stations. Alternative and gaseous fuel infrastructure continues to be built out in the U.S. and around the world, with more customers accessing natural gas or renewable natural gas. Companies like Amazon and UPS aren't waiting for technological breakthroughs; they're acting now to reduce carbon, and our clean transportation solutions are saving them money. This is just the beginning for North America. We believe the performance and the environmental and economic sustainability benefits of our products will help the market further develop and flourish. The market in China is massive and promising for Westport Fuel Systems. China is the global leader for natural gas trucking. It's the largest LNG refilling infrastructure in the world and has the most natural gas-fueled trucks on the road today. As one of the largest suppliers of natural gas engines in the world, our Weichai-Westport joint venture currently supplies leading commercial vehicle OEMs in China. Last fall, our joint venture with Weichai Power secured certifications for the WP12 natural gas engine equipped with HPDI 2.0. We've recently seen notification that vehicle certification has also been secured. In March of this year, we announced a co-investment agreement to expand the HPDI injector manufacturing footprint into China. Also in March, we announced amended agreement terms for the supply of at least 25,000 HPDI systems in China through 2024. This represents a significant increase in the minimum volume compared to our 2018 agreement. Last month, the Chinese government announced they will increase the use of natural gas in their overall energy mix from 8.7% last year to 12% by 2030, a 38% increase. This is a strong endorsement for the continued usage and reliance on natural gas moving forward in the world's most developed natural gas fuel trucking market. The foundations are in place. Multiple OEMs are working to integrate HPDI-equipped engines into their trucks and bring those trucks to the market. We're confident that HPDI-equipped trucks will enable substantial market growth in China, increasing the share of natural gas in the Chinese trucking market beyond today's already significant ten percent market share. Westport Fuel Systems looks forward to being part of that growth. Growth of HPDI today leads directly to the future of clean transportation, green hydrogen. Today, hydrogen component sales represent a small but critically important and growing part of our business. Using hydrogen in an internal combustion engine is not a new idea. Hydrogen in a spark-ignited IC engine has been consistently disappointing, with low power, low efficiency, and real-world performance challenges. In contrast, high-pressure direct injection of hydrogen, enabled by our patented proprietary HPDI systems, is a demonstrated solution. We demonstrated this with our HPDI fuel system just this year. Hydrogen HPDI is a game changer. Let me quickly review our accomplishments with hydrogen HPDI already this year. In January, we announced our project with Scania to develop their engine with hydrogen HPDI. In February, we published with AVL a paper detailing how an IC engine using hydrogen with HPDI offers a more affordable path than fuel cells for long-haul trucking applications. In March, we announced the successful demonstration of hydrogen HPDI, which you can see today and hear today on our YouTube channel. In April, we presented our results to the industry, showing that hydrogen HPDI offers the highest power density, improved efficiency, and is the most robust approach for using hydrogen in internal combustion engines for heavy-duty applications. Just last month in July, we announced our collaboration with TUPY and AVL to develop a highly efficient hydrogen internal combustion engine for heavy goods transportation. This collaboration aims at combining advanced materials and casting technologies with our patented HPDI fuel system. Hydrogen IC engines with HPDI offer not only high performance, high efficiency, and lower total cost of operations, but they also provide other critical advantages for OEMs and suppliers. Our solution enables the reuse of existing factory capacity for engines, drivetrains, and vehicles. We'll leverage existing engineering know-how and draw on current supply chains, while avoiding creating new sustainability issues related to the supply and recycling of precious and rare earth metals. Therefore, we're confident that HPDI has a long runway from natural gas today, through biogas today, and onto green hydrogen tomorrow. We believe hydrogen IC engines provide a compelling future for long-haul transportation, and others are starting to share our conviction. I'll give you two recent examples. In a recently published paper, the World Hydrogen Council has shown that from the total cost of operations perspective, hydrogen can become the most competitive low-carbon solution in more than 20 applications by 2030, including long-haul trucking. The McKinsey paper published in June confirms that hydrogen combustion will fulfill an important role by harnessing established technologies and supply chains. As a leading expert in managing gas fuel and the inventor of HPDI, Westport Fuel Systems is uniquely capable of leading the way with green hydrogen and transportation applications. Westport Fuel Systems has been at the forefront of the shift to cleaner, low carbon, and cost-competitive alternative fuels for transportation. We continue to remain devoted to the decarbonization of the transportation sector and the critical need to deploy scalable carbon-neutral solutions. Now, over to Richard for more detail on our Q2 results.

Thank you, David. As David described earlier, we had another good sequential quarter of financial results with record revenues of approximately $85 million, which were 135% higher year-over-year, driven mainly by the ramp-up of HPDI product sales and the continued recovery of sales volumes in our light-duty OEM and independent aftermarket businesses. The Stako acquisition also contributed $2.3 million in revenue since the close of the acquisition on May 30, 2021. The year-over-year comparisons to the second quarter of 2020 are somewhat overstated due to the severity of the pandemic's impact on our operations and those of our customers, who suffered through plant shutdowns and other social distancing measures last year. Nevertheless, the results do reflect the positive recovery and demand for our products, especially a promising outlook for our HPDI technology. Gross margin increased year-over-year to $15.7 million and a gross margin percentage of 19%, mainly due to higher sales volumes despite headwinds from the ongoing semiconductor shortages and supply chain issues. Gross margin percentage improved due to the recovery in higher-margin aftermarket sales volumes and also higher year-over-year sales volumes to our initial HPDI launch partner, including some higher-margin development work. Another positive result for the quarter was the continued performance of the CWI joint venture. Our equity income from CWI was $8 million, an increase of $4 million year-over-year, primarily due to the recovery in sales volumes from the impact of COVID-19 and also a $1 million tax recovery. Net income for the quarter was $17.2 million compared to net income of $3 million for the same quarter last year. The $14.2 million increase in earnings reflects the positive traction in our sales volumes across the businesses during the current period and the increase in income from the CWI joint venture. Net income also benefited from some extraordinary items this quarter. We recognized a bargain purchase gain of $5.9 million on the acquisition of Stako. We were able to acquire the business for less than its fair value due to the seller's interest in divesting their non-core LPG business. On another positive development, we recognized an $8.9 million tax recovery related to an Italian government COVID-19 tax relief program that allowed us to step up the tax basis of some of our Italian assets to increase tax depreciation and thus lower taxes. This quarter, our adjusted EBITDA was $6.2 million, which was comparable to the same period in 2020. However, as a reminder, adjusted EBITDA in the prior year second quarter included a $7.7 million insurance recovery related to a $10 million charge for a field service campaign for the replacement of a pressure release device recorded in the first quarter of 2020. Excluding the insurance recovery, adjusted EBITDA increased by $7.7 million, mainly due to the better performance described before. Now, turning to the operational performance of our business segments. Our OEM revenue for the current quarter was $53.1 million compared to $19.1 million for the prior year's quarter. The significant improvements in revenues were driven by higher year-over-year HPDI product sales to our initial OEM launch partner. Despite challenges from the global semiconductor shortage, production did improve in the second quarter compared to the first quarter. Further, sales volumes of our light-duty OEM, our delayed OEM, and electronics businesses are also recovering to pre-COVID-19 levels. The impact of COVID-19 was significant in the prior year period, which caused plant shutdowns combined with lower light-duty OEM sales to German and Russian OEMs. We expect to see continued growth in our heavy-duty business and improvements in the light-duty OEM business in the second half of the year. Clearly, the higher sales volumes drove an improvement in gross margin year-over-year in absolute dollars. Excluding the one-time $7.7 million insurance recovery, gross margin increased by $5.7 million year-over-year. This quarter, we generated a small operating loss of $3.4 million as we continue to invest in the development of our HPDI technology, and our sales volumes are still relatively modest and growing. As sales volumes grow, the profitability of HPDI will improve through economies of scale on production through our supplier network. Turning to our independent aftermarket. Revenue for the current quarter increased 87% to approximately $32 million compared to the prior year's quarter, primarily due to the general economic recovery from COVID-19 and the related shutdowns in April and May of 2020. Gross margin increased by $5.5 million this quarter to $8.5 million for a gross margin percentage of 27%. This improvement in gross margin was driven by higher year-over-year sales volumes. Although we were able to generate better sales volumes, the increasing sales mix to lower-margin emerging markets provides a significant opportunity for growth to Westport Fuel Systems, and the challenging recovery in Western Europe has challenged our margins. We expect continued improvement in our aftermarket revenues in the second half of 2021, but temper expectations due to the ongoing global shortage of semiconductors, which could impact the independent aftermarket business. Turning now to our liquidity. Over the past year, we have made significant strides in improving the strength of our balance sheet and liquidity to fund our business plans. Our cash position increased by approximately $96 million since the beginning of the year to $161 million. The increase during the past quarter was primarily the result of the marketed equity offering completed in June, partially offset by a $7.5 million payment of the royalty payable to the Cartesian group and other debt service. The marketed equity offering in June successfully raised $115 million and approximately $108 million net of transaction costs. The offering generated a lot of interest and was oversubscribed by numerous institutional investors in North America and Europe as well as retail investors. The Board, the executive management, and our largest shareholder all participated in the offering. The funds raised from the offering were a major step to support our growth at Westport Fuel Systems. They will be invested in CapEx to expand production capacity, in research and development for HPDI technology, to acquire bolt-on businesses like Stako with complementary capabilities or technologies to existing businesses, and also to further strengthen our balance sheet. We also continue to manage our debt profile to align the cash flows from our businesses to our investment plans. During the quarter, we refinanced a EUR7.5 million loan with UniCredit under the Decreto Liquidita program, maturing in 2027 that we announced to you earlier this year. We're also negotiating with our partner, Export Development Canada, to refinance our term loan and COVID-19 bridge loan into a long-term credit facility to support the funding of our HPDI technology, commercialization, and research and development. We received waivers from EDC to defer principal payments on the term loan and COVID-19 bridge loan due in June and July of this year, respectively, to September 2021 in anticipation of renegotiating the new agreement. We are very appreciative of the support and relationship with EDC, and this refinancing would be another significant step to bolstering our liquidity to fund our growth. With that, I would like to turn it back to you, David.

Thanks, Richard. Looking forward, not only are we optimistic, but we're committed to delivering. We expect continued post-COVID recoveries in markets around the world and continuously increasing demand for transportation. We also see continued regulatory and societal pressure for clean transportation and the persistence of the economic fundamentals that mean only affordable solutions can scale in a way that is meaningful in automotive and environmental terms. For Westport Fuel Systems, we're well positioned and expect growth in all our businesses, but especially growth of HPDI in existing markets, the launch of HPDI in new markets, and the development of HPDI for hydrogen with existing and new partners. I'm proud of our team and all of their efforts remain focused on our objectives in the challenging conditions we faced during the last 1.5 years. We're well positioned to continue meeting the market in gaseous fuels and believe we have the best team, technology, and partners to secure the sizeable opportunities ahead. With that, I'd like to turn it back to the operator for your questions.

Our first question comes from Eric Stine of Craig-Hallum.

So, maybe just starting on HPDI. And I just want to clarify, did you say that second quarter volumes did improve sequentially? And then also, would just love your thoughts on some expectations, obviously very bullish, but some expectations for the second half of '21 maybe versus what the run rate you had in 2020.

We have already seen sequential growth this year, quarter-over-quarter. I observe year-over-year growth in Q1 and Q2, even during the COVID period, alongside ongoing growth. Essentially, this product launch began a few years ago and is still progressing. The industry and global objectives significantly influence our business. For instance, in Europe, there is a requirement for a 15% reduction in CO2 by 2025. As this target approaches, we anticipate increased volumes as our key customers and others strive to meet this goal. I believe we are on a very positive trajectory, and we expect continued growth throughout this year and into the future.

And then maybe just transitioning to China, you've been waiting on vehicle certification for quite some time. I mean, anything you can discuss in terms of when you actually might start to see volumes, given that when you do, I would think that the ramp may be gradual for a couple of quarters, but then can be pretty significant.

I think you characterized it correctly. We expect to see a launch and we do expect to see volumes grow. The market in China is huge, as I've pointed out regularly. They're already in China having a 10% market share of natural gas vehicles, and that's a spark-ignited engine. So, it's like a tenfold kind of performance with gaseous fuel vehicles in China versus what we have in North America. And so, the market is three to four times larger than North America. And so we're really well positioned. Weichai Power is a great partner of ours. Our joint venture is doing excellently in the market with spark-ignited products. And when we're able to add and bring HPDI to that marketplace, we expect a really strong response because it offers improved performance, improved efficiency, and really nothing to be taken away from the fleet driver and the truck driver. That really reflects back on what we see in the market today in Europe, where basically HPDI is winning versus spark-ignited products because of its superior performance. And so, we expect a really important development for ourselves and for our partners in the Chinese market as HPDI launches.

Maybe last one for me, just on hydrogen. Anything you can discuss about the pipeline now that you've got Scania in-house, at least for a development agreement? You've had a number of data points in progress here. Anything you can share on the pipeline?

From our perspective, we've shared what we can in terms of actual mains and results and outlook. But fundamentally, I think the important big picture is that we've already demonstrated very clearly and brought to date with the marketplace showing that hydrogen with HPDI is super effective. It's a great solution. It's a great way to use hydrogen. It's a great way to use HPDI. So, the combination is really fantastic. And we expect that really to accelerate the progress of bringing HPDI into the marketplace for natural gas, for biogas, and for hydrogen over time as those fuels become more available. So, yeah, we think it's a really important part of our portfolio and our technical capability to respond to the future green hydrogen fuel capabilities.

Our next question comes from Rob Brown of Lake Street Capital Markets.

I would like to follow up on the European HPDI growth. You mentioned you expect improvement in the second half of the year. Are you noticing pent-up demand from supply chain issues that might be easing, or where do you see the demand growth in the latter half of the year? Additionally, how do you anticipate the first half will unfold?

So, general trend, which has played out since we launched. It's been a nice growth trend with volume growing quarter-after-quarter. One thing that's very frustrating for all of our shareholders and the investor community is not being able to see that in detail. We look forward to breaking that out in some detail in the future when we have more customer volume to aggregate and show. But fundamentally, there have been some constraints in the marketplace in the first half of the year that despite those we've still grown. And those constraints are related to all the supply chain shortages, which include microprocessors as we mentioned, as well as other materials combined with a pent-up demand that has residual effects from COVID that have impacted the marketplace globally, and certainly still in Europe. So, all those factors, we think, have been a headwind for ourselves and our customers. But our results are up and we expect that as those headwinds ease, whether it's COVID or supply, that the market will continue to grow based on the foundation of what is a better product and a response to both the customer demand and regulatory requirements. As I mentioned in the comments earlier, the key ingredient for all the things we bring to the marketplace to have cleaner transportation is their affordability. And you can read customer testimonials after customer testimonials in Europe saying that the trucks perform really well and that they save money. That combination is the perfect set of ingredients for success.

And then on the North American market, you talked sort of alluded to some activity there. How do you see that developing? What's your approach to entering the North American market with HPDI?

I think it's something that's truly important in this equation is the fact that the world of commercial trucking and heavy-duty engines for commercial trucking is supplied by just a handful of companies around the world that make and sell the majority of the product. All these companies basically are global. So our current partners are global OEMs. They have brought and are bringing HPDI to the marketplace in their home market. I think having done that offers the opportunity to expand to markets around the world, including North America. Clearly, the North American market has historically been a little bit slower to develop with natural gas and market share around the world in places like China and Europe, for example. And that's primarily due to the fuel price dynamics in North America, where that fuel price differential isn't as significant and isn't as persistent historically as it has been in other markets. So, I think that's an important part of the equation. We're really excited about the opportunity in North America based on the need from an environmental perspective and the effectiveness of our product to respond to that factor. We see companies that have made the analysis of natural gas in trucking in North America leaning forward and buying more and more, and shifting their fleets. We're expecting that will increase in the future as ESG requirements and societal demands and regulations and fuel price dynamics modify over time and get more and more in line with what we're seeing in the European and Chinese markets.

Our next question comes from Colin Rusch of Oppenheimer.

Could you give us an update on where you're at now with the HPDI for hydrogen testing and risk mitigation? Have you begun those tests fully, or are you still doing preparation work? What's the latest on that front?

So, our projects are proceeding. We have engines in the test cell doing work. As we develop results that we're able to share and as our customers allow us to share, we'll continue to bring that news to the marketplace as it becomes available. For us, development of hydrogen HPDI is an ongoing effort, supported by our own R&D dollars as well as with our customers' projects with partners such as Scania and TUPY and AVL. These are really meaningful and important developments, and for us, very exciting because it's moving onto this next fuel of the future, which is green hydrogen for transportation. Our results so far are very exciting, and as we have more to share, you can count on us to do so.

And then with the potential for adding in new HPDI customers on the natural gas side, because of the runway that you provide into hydrogen. Can you talk about the benchmarks that those customers are looking for before they would move forward with you guys on the natural gas side from the hydrogen testing?

I think the real question, Colin, is when do our customers make announcements, right? The business of developing engines and bringing them into production for any technology, including ours, is a multiyear activity, where we engage with customers, as we did with our lead customer in Europe and our customer in China many years ago. We need to develop the test cell; we need to develop new vehicles. This is a multiyear activity. As I've mentioned, announcements don't come in direct alignment with what's actually happening. So, I apologize for that; it's just the way it works in our industry. We look forward to seeing announcements from our customers as they grow ready to influence.

Our next question comes from Amit Dayal of H.C. Wainwright.

Has the COVID impact on the recovery process made any difference in historical seasonality? We typically see the fourth quarter being the strongest for you guys. Because of what has transpired over the last 12 months, should we anticipate any change in how some of that revenue gains plays out?

I think I understand your question about how does COVID and seasonality fit together. To me, it's a simple superposition. Can we just add the two effects together? I don't think there's any fundamental change in the seasonality of our business. A clear example that we control is in the month of August; we typically have our Italian holiday period, during which we close the factories for a couple of weeks. Of course, we'll continue to do business, but there is this drop in supply in the month of August. It always happens for us. And the second quarter tends to be a strong quarter, while the fourth quarter tends to taper off a little bit. Some of these trends and our seasonality are changing as the mix of our business shifts from being heavily reliant on aftermarket to more of a mix of OEM and aftermarket. We've talked about and published the results so you can see the mix between OEM and aftermarket. As we increasingly become an OEM business and a Tier 1 supplier to those OEMs, that seasonality will change more to an automotive focus as opposed to a consumer products focus. Meanwhile, with respect to COVID, that has affected the marketplace, though, I would say not so much on the heavy truck side, but there have been other supply-side challenges induced by COVID. You kind of have to do a little math and make the forecast on what you think the COVID effects are and how seasonality is impacted as the mix shifts. Fundamentally, the backdrop of all that is the need for clean, affordable technology and the growing necessity for new solutions. We do see this growing business, which is why we're excited to have another record quarter, and we look to more in the future.

And just one more from me. With this Cummins contract coming to an end potentially in December, is there a potential strategy to fill the gap from those contributions if the relationship does not continue?

We have quite a few additional alternatives. And of course, our business is global; it's not just a North American business. Our business is varied in terms of market segments we address. We see growth across all of our different geographies and product segments. HPDI is an important part of that. We think HPDI will play an important role in North America as the market continues to develop. Yes, there are many opportunities to backfill should our joint venture end as currently contracted. We're also continuing discussions with our partner about other alternatives and what might happen in the future, so stay tuned. As we have news, we'll share it with you.

And maybe sneak in one last one, sorry. How many customers for HPDI do we have?

We have the customer that's in production in Europe, we have the customer that has a production in China, and then we have two customers that we've announced that are developing hydrogen HPDI with us. One is a non-typical OEM customer; our partnership with TUPY and AVL. We think they have a path to market for hydrogen HPDI. So those are kind of four announced projects. I don't have any more announcements on that, but you can imagine we have other projects that aren't announced yet. That's just how the business works.

Our next question comes from Jeff Osborne of Cowen & Company.

Many of my questions have been addressed. I have a couple of clarifications. Regarding China, I thought you mentioned in your prepared remarks that they received certification. However, in response to Eric's question, you indicated they did not. I believed they obtained batch 344 certification in mid-June.

We found in the public domain some announcements of vehicle certification. We know those steps have been completed and we can reference them publicly. So, that's what has happened, and as we mentioned in my earlier remarks.

So, once you have that certification, you then need to get designed into a truck OEM. Do you have any sense in working with them that it's actually being marketed or sold?

These are announcements that we have to lead to our customers. But basically, the certification that's been achieved is both the engine certification, which our joint venture did last year, and then our customers are conducting the vehicle certification, which we have seen published in China. We know those have been achieved, and the next steps are on to the marketplace. These announcements will come from our joint venture and our customers, not from us.

And then how is the expansion in China with your manufacturing partner there? Is that up and running? Do you have the capacity to meet the agreement that you've extended through 2024, or can you remind us how that will work?

It's really important that we have made investments and are putting the equipment into place. That's a 2021 activity, and that will support the ramp that we forecast in the Chinese market. We have a long-standing partnership on our fuel injector with BorgWarner, and we're excited about this development and making the investments necessary to support the marketplace. It's happening now, and the capacity will be available to support the launch trajectory that we expect. This is our business; we put the best in place to support the ramp that we forecast and expect based on our customers.

Then I had a question on the hydrogen side. You mentioned performance of HPDI versus spark-ignited and you see similar trends with natural gas. Hydrogen with engines, as you indicated in your prepared remarks, has been tried for years. One of the challenges I thought was embrittlement of the hydrogen molecule into the metal itself, where it sort of diffuses into the metal. Is there anything unique about HPDI that would avoid that problem or can you talk about what embrittlement trends have been in terms of performance and measuring NOx and SOx with the various different tests that you've done with Scania?

I'm glad to talk about that. We are in this phase and you can tell from our announcements with both Scania, AVL, and TUPY that we need to do some work and actually develop the product all the way to production. The initial demonstrations we have done show the clear promise and potential of the fundamentals of the combustion system. We need to ensure long-term durability and that hydrogen embrittlement challenge, which is a real material science type challenge, is still to be fully addressed. I don't anticipate any problem to do that, but yes, we have to go do it. That's some of the work that is ahead of us still. I can't say it's fully solved, but I can also say that so far, our tests haven't identified any issues.

And just a follow-up on that, hopefully a non-technical question, but the intent is to allow the installed base to use this. So, there's no augmentation of the metals within the engine block versus you could avoid embrittlement by using different materials. But is that correct? The idea would be to upgrade existing natural gas engines to something greener.

I really don't expect this to be a retrofit activity. In other words, we're not going to pull a truck into a shop and change injectors and fuel systems into hydrogen, just like we don't take a diesel truck today and pull it into a shop and turn it to HPDI. The business of making engines for long-haul trucking is an OEM business, and I expect it to remain an OEM business. We'll develop the hardware that has the fuel injection system as well as the engine hardware and make whatever necessary changes are required to produce a product that customers can count on and that delivers the benefits we've already demonstrated with hydrogen HPDI.

Our next question comes from Mac Whale of Cormark Securities.

Just a question on long-term goals. David, you mentioned the profitable sales target mid-decade. In broad strokes, what would the segmentation and gross margin look like under that scenario? What are you aiming to achieve or think you can achieve on that profitable sales target?

Thanks for asking. The goal we've set for mid-decade to achieve $1 billion in revenue is not just a revenue goal, but also includes a 20% gross margin on our business in total. In terms of how this business will develop, we see growth across all our segments. Richard mentioned earlier some of the developments we're seeing in our aftermarket business in developing markets around the world in countries like Algeria, Egypt, and India. Our full suite of business will drive our success toward that $1 billion in revenue with the profitability we can be proud of. A key ingredient in that is the growth of HPDI from one product in one market with one customer to a product that's selling broadly around the world—China being next, then North America, and more OEMs as the hydrogen future starts to hit the road with our technology.

And then following up on that or maybe linked to that. On the hydrogen side, if investment in infrastructure and development along the cost declines for hydrogen do occur, what level of spend do you foresee sort of on an annual basis? Is this like a $10 million a year tax, is it $25 million? Can you just give an idea of what the next four or five years will require in terms of spending to get commercial?

I think the key ingredient in terms of spending going forward isn't necessarily on the R&D side—although we will continue investing in new products as part of our roadmap and business plan—but the bigger spend will be getting the capacity in place to grow and support our customers as more and more HPDI customers adopt the technology and follow their own launch and growth curves. Yes, I don't have specific figures to share with you, but we see relatively modest spending growth going forward—not some huge capital requirement to bake into a model.

And then just lastly, on the future of the joint venture. Are there details on how the roll-off would occur like in terms of, is there a stipulation that one partner buys out the other, or that you have to share in the rollover cost or anything of that nature that's available?

A decade ago, when we signed the current joint venture agreement, we did post that as one of our material agreements and filed it. The fundamental structure of that is all laid out in the agreement. The big question everyone is asking that we don't have an answer to today will be whether there will be any changes, and we'll just follow that formula. Yes, we can point you to that document so you can come up to speed on what the current agreement says.

Our next question comes from Eduardo de Jambin from the webcast.

Is there any sale of HPDI in South Africa or Australia, and what about HPDI in off-road applications? Any update?

Generally speaking, we have our business with our lead European customer, who is a global OEM, and they consider markets around the world as potential markets for HPDI. I can't go into any geographic specifics—that's their business, not ours—but we're pleased to support them as they investigate the opportunity for HPDI markets. In terms of off-road markets, we definitely see an opportunity there. This has been something that Westport Fuel Systems, from the Westport innovations days, has explored. There are opportunities; however, the commercial trucking and heavy-duty markets typically lead in technology, while off-road follows as a secondary market. We recognize that industries like mining are making significant pushes to clean up their operations and reduce internal combustion engine emissions to move towards cleaner, lower carbon technologies like ours.

Our next question comes from the webcast from David Douglas.

What is the true state of play with Weichai and Cummins? If not yet, when will we know a date certain? If neither is likely to come to fruition, what is the plan going forward?

I think we've covered this quite well, and while I appreciate the question, we are offering the state of play in this call and that is we have a joint venture with Cummins, which is scheduled to end at the end of this year. We're in discussions with our partner on alternatives to that ending, and if there is a change, we'll certainly announce it when we've come to a conclusion. The same is true with our partner, Weichai. When we have more news, we'll share that. Earlier this year, we signed a new agreement with Weichai, committing to the business and increasing the volume of at least 25,000 systems through 2024. The market in China and our partner are poised to bring HPDI to that market, so yes, we're excited about the future and eager as you are.

Our next question from the webcast comes from Charles Orensky.

Is your European partner also stressing its future of electric trucks? How long is that away? And it seems they're not interested in hydrogen. Any comments would be greatly appreciated.

We can read what you can read in terms of what our partner is doing in Europe. Broadly speaking, across the industry, including our lead partner in Europe, everyone is making bets and not putting all their eggs in one basket. Truck manufacturers are investing in a suite of technologies and there will be a mix of those technologies going forward. What I can point to is that the mix of natural gas and trucking has grown strongly in specific segments and will continue to do so. Better technologies like ours, which are affordable, will win in the end. This is the overall picture that I can provide.

Our next question is from the webcast from James Warner.

Are there penalties if Weichai does not meet the HPDI purchase goal of 25,000 units by the end of 2024?

Not really penalties, James, but like the contract we've signed is very similar in form to the contract you signed back in 2018, with our partners committing to buy a minimum of 25,000 units. The only question is what the purchase curve will look like to meet that 25,000 systems purchased by 2024.

Our next question from the webcast comes from Peter Wong.

Will HPDI 2 in North America require LNG infrastructure first?

At the engine, the fuel injected into our HPDI system is basically gaseous, not liquefied. We can run HPDI with a gaseous fuel system or with a CNG fuel system. Both options are possible for us. Today, in the marketplace for both Europe and China, we're bringing to market an LNG system. The reason we bring in LNG is that it’s a much denser form of natural gas, which gives you better range. It's really about the application. So, if you want to apply HPDI in an application that doesn't require a long range, you can use CNG or you can use more tanks of CNG. In the North American market, as you know, it's possible to put a back-of-cab tank system and have plenty of CNG, so we definitely see that as an option for HPDI in North America with a CNG HPDI option.

This concludes the question-and-answer session. I would like to turn the conference back over to Christine Marks for any closing remarks.

Thank you, and thank you, everyone, for joining us today. If you do have any follow-up questions, please feel free to reach out to us at the Westport Fuel Systems Investor Relations team. Thank you again for your interest in Westport Fuel Systems, and have a wonderful day.