Westport Fuel Systems Inc. Q4 FY2021 Earnings Call

Thank you for your patience. This is the conference operator. Welcome to the Westport Fuel Systems Fourth Quarter and Full Year Fiscal 2021 Results Conference Call. Please note that all participants are in listen-only mode and this conference is being recorded. There will be an opportunity for questions after the presentation. I would now like to hand the call over to Christian Tweedy, Westport's Investor Relations representative. Please proceed.

Good morning, everyone. Welcome to Westport Fuel Systems fourth quarter and year-end 2021 conference call, which is being held following our press release yesterday of Westport Fuel Systems' financial results. On today's call, speaking on behalf of Westport Fuel Systems is Chief Executive Officer, David Johnson; and Chief Financial Officer, Richard Orazietti. This call is open to the public and the 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 the U.S. and applicable Canadian securities laws, and as such, forward-looking statements made based on our current expectations and involve certain risks and uncertainties. With that, David, I'll turn the call over to you.

Thanks, Christian. Good morning, everyone. Thanks for joining us to review Westport Fuel Systems results for the fourth quarter and full year 2021. 2021 was a good year for Westport Fuel Systems. Despite lingering COVID restrictions, supply chain challenges and rising commodity prices, we continued our recovery from COVID-19. We set a new annual revenue record of $312 million, driven by the strength of our OEM business, which was up 31% year-over-year due to record HPDI system sales, combined with strong light-duty OEM sales, especially in India. Our profit improved year-over-year, and we look forward to further improvement as our production increases and economies of scale and operating leverage are realized. In addition to the positive financial results that demonstrate our resiliency in the face of global challenges, during 2021, we also made significant progress developing and positioning our company for future success. For example, our purchase of Stako. Completed in May of last year, Stako based in Słupsk, Poland, is a world leader in LPG fuel storage systems. Their comprehensive product portfolio adds to and complements our existing product lines and manufacturing capabilities. Stako's products serve the OEM and independent aftermarket as well as other markets like recreational vehicles and material handling applications. And we recognized a $5.9 million gain on the purchase. In 2022, Stako will contribute a full year of operating results to our P&L. Another 2021 accomplishment was the strengthening of our balance sheet by way of an equity raise and by restructuring our debt to lower costs and to align repayment terms with our business plan. And with the successfully negotiated exit from Cummins Westport, we've further strengthened our cash position. Also, in 2021, we had our initial demonstration of hydrogen HPDI. This technical success has led to new hydrogen HPDI projects with Scania, AVL and 2P, and as announced in February, now also with Cummins. In our view, the demonstrated capability of HPDI is a hugely important development for Westport Fuel Systems, dramatically improving the potential for our near-term and long-term success with HPDI. And internally, in 2021, we brought the company together into a single global organization so that we're poised to bring all our capabilities to all our customers and markets around the world with efficiency and effectiveness, enabled by unlocking synergies throughout our global team. Despite the various challenges we've faced over the last 2 years and despite the challenges we face today and the new challenges that will come tomorrow, fundamental market drivers continue to support a positive outlook for Westport Fuel Systems. The climate crisis is still a priority. Clean air is still a priority. Affordable transportation is still a priority. COVID, supply chain problems, inflation and even war, none of these diminish the challenge we face to keep the world moving without fouling the air and endangering our lives, our climate and our planet. We owe this to society and to our children. Global transportation is responsible for roughly 1/4 of greenhouse gas emissions, so we must continue to use all available options to clean the air and to reduce CO2 emissions from transportation. We must do so quickly and effectively. To move quickly, we need clean technology now. To be effective, we need scale. To achieve scale, we need practical affordable solutions. Westport Fuel Systems’ products are affordable, effective, practical and available now. Our strategy stands on three pillars that enable progress towards our financial goals of $1 billion in revenue, 20% gross margin and 10% operating margin. First, principled growth. Growth that's realized through a diverse portfolio of technologies, products and services delivered by a team that's focused on doing the right thing in the right way and making a difference in our world. We're focused on satisfying the demand for clean, low emissions transportation in Europe, India, North America and China. As we've done in the past, we'll continue to complement our organic growth by adding products and scale through relevant M&A activity. Second, quality and reliability are fundamental to our performance as a leading Tier 1 supplier of clean, affordable fuel systems. We must reliably deliver high-quality products with higher production efficiency to enable low costs and to achieve the scale necessary to make a difference in our world and for our stakeholders. Third, through innovation and technology, we deliver transportation solutions that power a cleaner future. Advances in our HPDI fuel system technology, including HPDI 3.0 and hydrogen HPDI will lead to growth and prosperity, including the ability to reuse our customers' capital investments in manufacturing supply chain infrastructure while achieving their goals to satisfy their customers' needs and government regulations while reducing carbon emissions. Ultimately, the foundation for our strategic pillars is the continued strength of our organizational capability and a focus on operational excellence. Our people are at the heart of what we do. We are one company working together to deliver valuable impactful products and services to customers around the world, enabling an affordable transition to a decarbonized transportation sector. In the marketplace around the world, we continue to see evidence that clean, affordable gas are a growing part of the transportation marketplace, even in or rather, especially in challenging economic times. LPG, CNG, LNG, biomethane and soon, if not already, hydrogen, will add resiliency to our global transportation system and do so cleanly and affordably. Global emissions regulations demand clean vehicles. Customers demand practical affordable vehicles. Let me share a few examples. Markets are responding right now by adding more refueling infrastructure like in Europe, where the number of LNG stations doubled in just the last 2 years. Today, there are 521 LNG stations, according to NGVA Europe, and the fuel in those refueling stations is getting greener as biogas continues to grow. More than 1/4 of the gas used in road transportation in Europe today is from renewable sources. Likewise, in India, we also see compelling growth for natural gas vehicles. Infrastructure there has recently doubled to more than 3,200 stations and the government continues to champion their plan to reach 10,000 stations within this decade. OEMs in India are dropping diesel engines and moving to natural gas at a rapid pace. Westport Fuel Systems is well placed with the right products to support the growing demand. Another example, government support. The European Union has just recently added natural gas as part of its taxonomy, a significant endorsement that can help make the EU more efficient in the use of energy and more resilient to energy price spikes while providing affordable and clean energy to end users. Another form of government support, incentives. We observed in Italy late last year that the Italian Transport Ministry announced a decision to confirm, increase and expand incentives for the purchase of LNG trucks. The decree for highly sustainable investments makes EUR 50 million available to transport companies through 2026, exclusively for the purchase of new ecological alternative fuel vehicles, including LNG trucks. Another one, renewables. We have seen encouraging biogas developments in the past few months. In Germany, the share of biomethane supplied at its stations has reportedly reached 80%, moving towards 100% in 2022. Swedish Biogas, a leading provider of biofuel in Scandinavia, saw increased sales to the haulage sector of 145% in 2021 compared to 2020, citing a 30% to 35% price differential for heavy-duty trucks, a significant cost reduction and a solution available here and now for long-distance heavy transport that wants to switch to fossil-feed transportation. And finally, ultimately, market share growth. Earlier this month, the European Automobile Manufacturers Association, that is ACEA, published vehicle registration statistics for 2021. Alternative fuels, which include natural gas, LPG, biofuels and ethanol accounted for the vast majority of the alternative powered trucks sold across the EU in 2021, with a total market share of 3.6%, up 40% from 3% in the prior year. While at the same time, the registration of hybrid electric trucks was down 55% versus the prior year. We're seeing a growing number of stories and advancements like this in our space, creating a very encouraging outlook for our product portfolio. OEMs without LPG, CNG or LNG options today are at a disadvantage that our clean portal products can help them overcome. As you know, HPDI has been and will be a critical part of our path to growth and profitability. Let me point out some of the key developments. First, production and sales of HPDI 2.0 continued to increase as evidenced by our top line growth and increasing weight of our OEM businesses, which reached 62% of our revenue in 2021. Second, we're developing HPDI 3.0 for our customers. This next step for HPDI enables use of HPDI with next-generation engines that use higher working pressures to reach even higher efficiency and higher performance. Third, we're developing HPDI with hydrogen. This combination of our technology with green hydrogen offers more power, more torque and more efficiency than an internal combustion engine fueled with either natural gas or diesel. We've demonstrated and documented this performance, including the economic advantage that hydrogen HPDI offers as compared to fuel cell technologies in heavy-duty long-haul applications. Hydrogen HPDI lengthens and broadens the appeal of our proprietary HPDI technology, reaching all the way to a zero-carbon green hydrogen future that so many are pursuing today with massive financial commitments from both government and private sources. We're pleased with the developments we've already concluded and those we have underway and look forward to sharing more data with you later this year. In the meantime, I'd point you to the white paper analysis we recently posted on our website showing our expectation to achieve 52.5% brake thermal efficiency using hydrogen HPDI on a state-of-the-art 13-liter truck engine. This 52.5% BTE figure corresponds to a 5% reduction in energy consumption relative to the same engine platform operating with diesel fuel. This is a significant development. This will make internal combustion engines with HPDI the best way to use green hydrogen for long-haul heavy-duty transportation applications. I'd also like to provide an update on China where HPDI-powered vehicle models have been certified and field trials are ongoing. We're continuing to work with our partner to launch our HPDI 2.0 product successfully with their OEM customers. Multiple OEMs are working to integrate HPDI-equipped engines into their trucks to bring those trucks to market. We're confident that HPDI Group Trucks will enable substantial market growth in China, increasing the share of natural gas in the Chinese trucking market beyond today's already significant 10% market share. Westport Fuel Systems looks forward to being part of that growth. We are in parallel continuing our discussions with other potential partners in China as the interest in HPDI, particularly hydrogen HPDI, is growing in China, too. Just recently, China National Petroleum Corp. launched a roadmap for the country's energy sector to meet goals of carbon peaking by 2030 and carbon neutrality by 2060. They forecast a transportation energy mix, including hydrogen at 23.7% and natural gas at 10.7%, a strong endorsement for these two fuels. Before Richard takes us through the financials, let me address the proverbial elephants in the room, I'm talking about Russia, Ukraine and fuel prices. You may have noticed in our press release that the Russian market is relevant for us, representing 10% to 15% of our light-duty business through both our aftermarket and OEM channels. We expect this to be directly affected by the conflict and have already seen the beginning of those effects, including reports of shortages affecting production and delayed processing of transactions through the financial systems. In addition, the contract in Ukraine seems likely to further exacerbate the supply chain issues we face as well as put pressure on fuel availability and pricing. I want to call out three factors that don't all point in the same direction, making the near-term future rather unclear. First, higher fuel prices. Commodity fuel prices are up dramatically, including crude oil and LNG. Higher fuel prices tend to be positive for our business as it intensifies the search for products and technologies that can reduce fuel expenses. Gaseous fuels have often been the remedy for high diesel and high petrol prices. Second, though, fuel price differentials. When gaseous fuel prices are lower than petrol and diesel, then our market strengthens. When gas fuel prices are higher than diesel and petrol, then this is a headwind for us. We're seeing both effects now. In some markets, for some fuels, we have an advantage. While in others, we have a disadvantage. Of course, what matters is what drivers see at the pump, which has some relation to commodity prices. Third, volatility. As prices change, market participants can pause their decision-making waiting to see what the new normal will be. This is categorically unhelpful to all of us. While it's hard to predict the future, especially these days, we remain confident that our products will continue to deliver and expand our market share in response to the persistent need for clean, affordable transportation. We saw this through COVID, and we expect to keep seeing it through current challenges. We're keeping our focus on this long-term outlook while we work to mitigate the near-term challenges as we have successfully done before. So with that, let me hand it over to Richard.

Thanks, David. In the fourth quarter, we generated revenues of $82.7 million, which decreased year-over-year by 1.4%. The decrease was mainly attributable to slightly lower heavy-duty OEM sales volumes and a contractual price reduction to our initial OEM launch partner. Lower heavy-duty OEM revenue was partially offset by the addition of fuel storage revenues from the acquisition of Stako in the second quarter this year. The fourth quarter was challenging for gross margin as we generated $9.3 million, which was a decrease year-over-year of 28.5%. Besides the impact of lower heavy-duty OEM sales volumes and the price reduction, gross margin was pressured by lower sales volumes affected by the elevated and volatile fuel prices, lower margin sales mix to emerging markets in both light-duty OEM and independent aftermarket, and higher material costs resulting from global supply chain disruptions and inflation. Net income was $5.4 million for the quarter, an improvement of $1.3 million year-over-year. The CWI joint venture had a stronger-than-expected fourth quarter, generating $15 million to our account, which primarily drove the increase in net income and was partially offset by the lower gross margin. Revenues for the full year 2021 increased 24% to $312 million due to the continued recovery of sales volumes in our OEM and independent aftermarket businesses, and the addition of $13.8 million in revenue from our fuel storage business. In 2021, we generated 21% higher sales volumes to our initial OEM launch partner in heavy-duty OEM. We saw rapid growth in our light-duty OEM sales volumes in India and experienced a recovery in sales volumes in the independent aftermarket, notwithstanding the headwinds from the pandemic supply chain disruption and fuel price volatility. Further, we are seeing growth in our newer businesses in electronics and hydrogen. Gross margin increased significantly year-over-year by 22% to $48.2 million, mainly due to higher sales volumes across all our businesses and the addition of the fuel storage business. This was partially offset by the HPDI price reduction, a lower margin sales mix in the independent aftermarket and higher material costs caused by the supply chain shortages, which we were not able to pass on effectively to our customers. Fiscal year 2020 also included large COVID-19-related wage subsidies that were partially offset by a $2.4 million field campaign charge. We reported net income of $13.7 million for the full year 2021 compared to a net loss of $7.4 million for the prior year. The improvement in net income was driven by several factors, primarily the increase in gross margin of $8.7 million, $9.7 million in higher income from CWI, an income tax recovery of $8.9 million related to an Italian government COVID-19 tax relief program and a bargain purchase gain of $5.9 million on the acquisition of Stako. This was partially offset by $5 million less in government subsidies received compared to 2020. Adjusting for nonrecurring items per our definition of adjusted EBITDA, we generated $17.5 million in adjusted EBITDA in 2021 compared to $14.7 million in the prior year. Turning to our business segments. OEM revenue for the fourth quarter of $57.4 million was marginally lower than $58.8 million in 2020. Revenue decreased by $1.4 million in the fourth quarter due to lower HPDI sales volumes to our initial OEM launch partner and the negative impact of the price reduction given at the beginning of the year. The late OEM revenues were also worse year-over-year due to lower sales volumes caused by supply chain shortages of vehicles to convert from our OEM partners. This was partially offset by additional revenue of $6.7 million from our fuel storage business. For the full year, OEM revenue of $195.5 million increased by $45.9 million or 31% over the prior year. The increase was mainly due to the aforementioned higher sales volumes in our heavy-duty and light-duty OEM businesses, $13.8 million in fuel storage and increased sales growth in our electronics business. The impact of COVID-19 was significant in the prior period, which was impacted by plant shutdowns combined with lower light-duty OEM sales to German and Russian OEMs. Although heavy-duty OEM revenue was higher year-over-year from better sales volumes, the positive momentum on customer demand was impacted by manufacturing delays caused by the shortage of semiconductors from our initial OEM launch partner. Although the long-term outlook for HPDI sales volumes is positive, there's also near-term pressure on sales volumes caused by the rapid increase in volatility in LNG prices. For the fourth quarter 2021, gross margin decreased year-over-year by $1.5 million to $5.1 million, or 9% of revenue compared to $6.6 million or 11% of revenue for the same prior year period. The decrease in gross margin and gross margin percentage was mainly due to an increase in material costs stemming from the global supply chain disruption across all business segments, increasing sales mix of light-duty OEM sales to India and the aforementioned HPDI price reduction. This was partially offset by the additional gross margin from the fuel storage business. As India will play an important role in our light-duty OEM growth strategy, we are evaluating opportunities to localize production and other value creation initiatives to improve our margins. Turning to the independent aftermarket. Revenue for the fourth quarter and full year 2021 were $25.3 million and $116.9 million, respectively, compared to $25.1 million and $102.9 million for the same prior year periods. Revenue growth in 2021 was primarily due to higher sales to African and South American markets, offset by softness in demand from the Russian and Turkish market due to the rapid increase in LPG prices. We expect to see continued improvement in revenues from the independent aftermarket business segment for the full year of 2022, but temper expectations in the near term due to volatile LPG prices in our key markets and disruption from the Russia-Ukraine conflict. Gross margin decreased significantly year-over-year by $2.2 million to $4.2 million, or 17% of revenue this past fourth quarter compared to $6.4 million or 25% of revenue for the same prior year period. The decrease in gross margin and gross margin percentage was due to the evolving change in sales mix toward lower-margin African and other emerging markets, slower-than-expected recovery of sales volumes in Western Europe and higher material costs due to the global supply chain disruption. The prior year also benefited from government subsidies, which resulted in a higher gross margin percentage. To counter this margin pressure, we are actively pursuing cost rationalization, manufacturing productivity enhancements and sales volume growth. Turning to liquidity. As we have discussed over the quarters, we have made great strides to strengthen our balance sheet and liquidity to fund the growth in our heavy-duty OEM and other businesses through raising equity and refinancing our debt to better match the expected organic cash flow profile to the debt repayment. As at year-end, our cash position was $124.9 million and our debt was $79 million. During the fourth quarter, we closed the refinancing of our loans with our banking partner Export Development Canada into one $20 million term loan be payable over 5 years. We are very appreciative of the support and relationship EDC has and continues to provide Westport Fuel Systems. Another significant boost to our near-term liquidity was derived from the termination of the CWI joint venture. On February 7, 2022, we agreed to sell 100% of our shares in CWI to Cummins for proceeds of approximately $22.2 million, along with our interest in the joint venture's intellectual property for an additional $20 million. We received proceeds of $31.4 million, net of a $10.8 million holdback after the closing date. Moving away from financing activities, net cash used in operating activities was $43.8 million in 2021. The use of cash is driven by operating losses of the heavy-duty OEM business due to the lack of scale and a large increase in working capital, specifically inventory caused by a buildup of heavy-duty OEM inventory for customer growth, supply chain disruption and inflation. We are proactively managing our working capital to monetize the inventory and optimizing purchasing levels in the evolving supply chain landscape. Risks from the Russia-Ukraine conflict and volatile fuel prices will also cause near-term pressure on revenues and margins. Although the headwinds in 2022 are very challenging, we believe in the long-term fundamentals of our products that deliver affordable clean transportation solutions will prevail. With that, I would like to turn it back to David.

Thank you, Richard. To recap, I'm proud of our team. We made important progress in our strategic positioning for the long term, and we recovered from the pandemic and supply chain challenges in the last 2 years. Despite the new challenges facing us in 2022, we see the need for our product and the need to decarbonize transportation will persist. In the coming months, you'll find us participating in various investment conferences, including but not limited to, the Coremark Inflection Conference, Oppenheimer's Annual Emerging Growth Conference and the RBC Capital Markets Automotive Conference, and we'll be participating at the Ad-TECHSPO in Long Beach, California in May. This is North America's largest clean transportation technology and clean fleet events where we'll be providing an update on our latest development with hydrogen and HPDI. 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.

Could you provide more details about HPDI 3.0? I know you mentioned performance benefits, but I’m curious if those are related to HPDI specifically or if they come from the next-generation engine platforms you've mentioned. Additionally, what is your current level of activity with this technology? Do you have any ongoing development programs at the moment?

Yes, great question. So glad to talk about HPDI 3.0. I think the context, just to paint a picture of that needs to be real clear. In the market and media today, many people think the internal combustion engine is going away. But yet we see with our partners around the world that people are continuing to invest in advancing internal combustion engines. And the development of internal combustion engines is far from complete, and there are more improvements to be made. Fundamentally, in this day and age, that means lower emissions from the base engine and more performance, more efficiency from the base engine. For us, as a fuel system supplier, that means that we need to upgrade our fuel systems to match the engine improvements that are being made. So very specifically, basically, to make cleaner, more efficient engines, you need to increase the working pressure in the combustion chamber. And so as the working pressures go up, the pressures for our fuel system need to go up to match and keep pace. And so that's what we're doing. That work entails increasing the capability of our systems to match and complement the upgrades to the base engines. We see this across the industry in the work we're doing with various customers for applying our technology, whether it's with hydrogen or with natural gas.

Okay. That's helpful. Maybe just turning to hydrogen a little bit here. And I know HPDI, along with the rest of your business near term, it's a little tough to call given a lot of cross currents. But as you think about hydrogen in the HPDI version, just curious how that might be helping the LNG HPDI version or discussions with OEMs, given that maybe they don't hesitate to go HPDI with LNG, if they have the potential to migrate to something down the road and obviously, everyone's got to be looking at hydrogen?

Yes. So the process our customers and OEMs around the world are going through evaluating different technologies and trying to choose the path forward. If they could put all their eggs in one basket because they were sure of what the future lies ahead, this is an ongoing evolving process as they learn about different technologies. And when I talk about different technologies, I'm including the full list of electrification, fuel cell and even autonomy, all the things that you read about and hear about in the industry. And so with respect to our hydrogen developments, we see this as helping our customers to understand the potential for a green hydrogen future in long-haul trucking and what that economic and technical equation looks like. And as per the paper that we published last year in combination or partnership with ABL, we see our HPDI with hydrogen as a very economic and really an easy path forward to use green hydrogen very effectively because we have this significant efficiency improvement versus diesel and natural gas on a combustion engine using hydrogen HPDI. It also offers more performance, more power, and more torque. So better efficiency, more power and more torque gives it an advantage that even extends its lead over other technologies from both a technical and a commercial standpoint where it's very affordable to adopt HPDI onto an internal combustion engine as compared to the alternative of creating a fuel cell vehicle. This really is an education process that as we generate more data and demonstrate to customers through the partnerships and projects that we're doing with Scania, this then factors into their work and their decision-making on where to place their bets and what priorities to make internally for future technology. And so, seeing that HPDI can take an OEM all the way to a zero-carbon hydrogen solution with more torque and more efficiencies than they have today on their engines is a compelling vision that allows them to think about, okay, let's consider HPDI even sooner and we can use it today with fossil natural gas and biogas. This trend I mentioned earlier about biogas increasing as a share of the fuel supply to the marketplace is important for everyone's mission to try and clean up transportation. Reusing natural gas or methane that would otherwise go into the environment is an environmentally beneficial scenario that HPDI enables.

Maybe the last question for me. I just want to hear your thoughts on plans in North America. I know it has only been about a month and a half since the end of CWI, but what are your current thoughts regarding North America?

Yes. The North American business case for natural gas is also improving right now. I mentioned in my comments that these fuel price differentials are really the driver of our business. We see a widening gap where in North America, diesel prices are going up more than natural gas prices. And so the advantage for natural gas is growing in this moment, which is a positive sign. Additionally, as mentioned in my comments, we'll be going to the Ad-TECHSPO this year. We really look forward to joining that independently at Westport Fuel Systems this year and showing the trucking industry what we have to offer with HPDI for natural gas, HPDI for biogas and HPDI with hydrogen. These are excellent combinations of fuels and our technology that could be an important part of what trucking does in North America. So we're eager and excited. We recognize that, at the same time, there are steps that need to be taken. Some of our customers are already present in North America, so we're hopeful that this could accelerate the path towards commercialization in the near future.

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

The question concerns the EU market and what visibility you have regarding the demand and pricing in the HPDI heavy-duty market. Are you observing a decline? Has that decline already occurred, or are you just starting to see how the market is trending in the current pricing environment?

Thank you for your question. Currently, we are experiencing higher LNG prices in the EU market compared to historical levels, which is certainly a challenge for our business. The ongoing Russia-Ukraine conflict and the issues surrounding Nord Stream 2 also impact the market concerning our product. We have noticed some decrease in demand, but we are optimistic that this is a temporary situation. Two years ago, at the onset of the COVID-19 pandemic, we experienced a similar decline in demand as we adjusted to the new normal and the future requirements. I believe this situation will also be temporary. Ultimately, I am confident that there is a need for clean and efficient transportation of goods, which our systems facilitate economically on a continuous basis. We will need to monitor how everything unfolds, but in the near term, we are observing some moderation in demand and hopefully a recovery in the upcoming quarters.

Okay. Good. Richard mentioned that you expect the independent aftermarket to grow in 2022 despite the current challenges. I wanted to clarify your perspective on growth in the independent aftermarket given the current environment.

Yes. I would tell you that the independent aftermarket is already a sizable business around the world for us on the order of 1/3 of our revenues. We aren't expecting super strong doubling or tripling type growth. But nonetheless, we do see opportunities in various markets around the world that are opening up and becoming new markets for us. We've mentioned in prior discussions, Egypt, Algeria, and India. Currently, in the last period, we’re seeing some softening in places like Turkey and Poland. But now with the outbreak of the conflict, I think LPG becomes increasingly something that local governments want to make available. We now have some of the largest price differentials today between petrol and LPG in various markets in Europe. We expect that to persist and to drive our growth in those markets. So we are hopeful, and our outlook is positive with respect to the aftermarket business continuing to be an important and growing part of our business.

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

So David, just with respect to the macro developments in Russia, EU, et cetera, are there any accounts receivables or funds tied to those markets that may be at risk?

And so we're monitoring this very carefully. You can imagine with respect to our business in Russia that with all the sanctions being put in place, there's a high degree of anxiety and additional friction in the system. So, as I mentioned in my comments, some slower payments have started to occur. I think that's just the banks being careful to ensure they follow all the sanctions precisely. We're not doing business today with any government entities in Russia, but we do have customers in Russia who are seeking clean transportation and affordable transportation, and we aim to continue to help those customers access those. But it is getting more challenging as the days of this conflict roll on. Our outlook on that business is quite guarded that we could see it actually come down to zero in the future, depending on what happens. Nonetheless, we are being cautious about what we do and changing our terms to our customers, so we get paid in advance and things like this. We do not foresee any significant risk from that perspective. Just something we manage.

Understood. And sort of the gaps from that market towards revenues and margins, et cetera, are there other avenues for you to maybe make up some of those? Or do you just have to get through this and that situation has to normalize before you can make some recoveries from those markets?

Yes, it's truly hard to say. I think in general, we should expect that our sales in Russia will decline, and that will press on us. Nonetheless, one of the advantages we have in the company is that we are present in 70 markets around the world. Russia and Ukraine are just two of those markets. We have plenty of opportunities in other places. As mentioned earlier, this price differential between petrol and LPG, for example, in a number of markets is widening rather than shrinking, and we see some bright spots in the business around the world. We are hopeful those will offset or more than offset any decline we might see in Russia. That will be a challenge for us, but that is certainly our goal.

Our next question comes from Colin Rusch of Oppenheimer.

Can you talk a little bit about the Cummins testing process and the duration? How long do you think that's going to take before you're able to get some sort of results, you can speak of that?

Yes. So this, for us, sorry?

Yes, specifically regarding hydrogen, I apologize for the clarification.

Yes, no problem. Yes, the work we're doing with Cummins is as announced on hydrogen. So we are getting that started now, and I expect that to be completed within the year. The actual pace isn't something we control because it is done in partnership with our partner. There may be some big delays, as seen with our work with Scania, last year. We don't expect the same kind of delays with Cummins, but it's to be demonstrated as opposed to known in advance. I think I can say confidently, we'll have some progress within this year. A secondary factor that will matter in the marketplace is, when we finish that work, what does Cummins say and allow us to say in the marketplace? So our customers have that important right to decide what we say as the supplier. We have that as the highest priority on our to-do list.

Sounds good. And then just around the supply chain, obviously, you guys saw some of this stuff coming early around back in 2020 around COVID and pointed to have inventory on hand to get that. With some of the things that we're seeing right now in China and potential for some other disruptions given the conflict in Europe, what can you talk about formable points in your supply chain now and how you're managing that?

Yes. I would tell you that we haven't had any severe problems at this point in time, but we're absolutely on top of it with respect to managing the supply chain. These sanctions that come into place are something that cannot be ignored and have to be abided by, and that's what we do. At the same time, we're not sourcing any materials from Russia, and we don't have a significant exposure to Ukraine. One commodity that's challenging for us is steel for our plant at Stako, but this is just one example. Nonetheless, there are other sources. We have not experienced trouble that we haven't been able to manage. But I would tell you there is some anxiety with it because we don't know what tomorrow holds, and we're working very hard to manage it without needing to increase our inventories the way we did during the COVID period. Hopefully, we're in a good position, and we'll manage it day-by-day.

Our next question comes from Bill Peterson of JPMorgan.

I know you kind of refrained or wanted to refrain from providing forward guidance. But the Russia, Ukraine kind of started towards the end of February. Can you comment just on the demand trends with the OEM and IAM at least heading into that, at least if not quantitatively, at least qualitatively?

Yes. Sure, Bill. Good to hear you this morning. So as a general premise, we had a good fourth quarter, and we've seen a little bit of softness in the first quarter so far. But generally, we have demand and order books that are not as exciting as we'd like to see, but they're okay so far. We have not seen a tail-off in demand; in fact, we've seen some uptick in demand in certain markets around the world as people recognize these big price differentials, and customers are increasingly interested in our products. So on one hand, that is a somewhat ambiguous answer, I apologize, because we are seeing a continuation of the recovery trend coming out of COVID into 2022 at the same time that we are experiencing anxiety-driven volatility in fuel prices, which tempers the market. Hence, no guidance for today because it's challenging to see how all this will play out near term and through the later parts of this year, especially how long will the conflict last, for example, and what actions will be taken around the world. Nonetheless, my overriding principle is that in tough times, people tend to look for less expensive solutions and access to lower-cost fuels. I believe that price differential will be the key driver of markets around the world for us, as it has always been and I expect it will always be going forward.

No, that's helpful. I guess maybe just speaking on the cost side and some of your cash outlays and so forth. Again, understanding you may not want to provide kind of quantitative, but I guess, how should we think about your OpEx trajectory as well as CapEx given, I guess, some of the pauses or near-term dynamics? And how should we think about that trending through the year for 2022?

I want to handle that one, Bill. Look, in terms of CapEx, we're in the range of $15 million to $20 million, depending on our programs. I mean, we're obviously trying to rationalize our CapEx, it would be more prudent during this period of time. The HPDI itself here, as David mentioned earlier at the outset of the call, like the HPDI 3.0, there are longer-term programs. It would be foolish for us not to continue. We're on a timeline with our launch partners. So those things will have to continue. But $15 million or so would be a good number in terms of CapEx. In terms of OpEx trend, material costs and inflation are showing up, and we've provided that guidance. Having said that, we're taking actions to offset those through our productivity initiatives that are ongoing. For the time being, I'd say they're relatively stable in terms of percentages. We're spending more on R&D, but you'll see that sort of show up in our P&L. The G&A should be more or less the same as you see there. Margins are the ones coming under more pressure, and unfortunately, it's a little hard to model that just given how many markets we're in. The fourth quarter was particularly disappointing compared to our expectations. We are working toward improving those margins to get closer to our targeted rates.

That's good color. And maybe just kind of a big picture question. And again, recognizing it's hard to call how some of these geopolitical things turn out. But if we were to reconvene a year from now, what are the key milestones we should be looking out for? What would you have accomplished during this year that we look back on and call it a success?

Yes. So let me just look back on 2021. I think really important in 2021 were the developments that we started with customers. One of the key markers to note is when we install our HPDI fuel system on a new engine; almost doesn't matter what fuel we're using. That's a significant step toward starting a program that will lead to production for me. We can't reach the finish line unless we get to the start line and get moving. The work we're doing with Scania, the work that we announced with Cummins, the projects we have with AVL and 2P, I expect all of these will have important milestones through this year. Some of those milestones will be announced, hopefully, and we'll show progress towards further commercialization of HPDI. We are still pursuing our business interests in India and China and see great opportunities there. I look forward to sharing more about those projects throughout the year. Yes, I think we'll be able to share some significant business progress as we go forward, and you should definitely look for that.

Our next question comes from Mac Whale of Cormark Securities.

I was wondering if you could provide some detail on how a narrowing in the spread between gaseous fuels and diesel and gasoline affects recovery time or when we might see the impact of that swing.

Yes. It's a really good question. It doesn't have a clear answer because it truly depends on the products and the markets and the channels we sell into. We sell products for three-wheelers in India that are super inexpensive. We sell high-end HPDI systems in the European market for big trucks, and everything in between. Every market's a bit different. We sell directly to OEMs, who also have dealers and inventory. I would inform you that there are delays in the systems that complicate categorization. For example, if we see it within 3 weeks or 3 months. That said, most markets have kind of a normal range, a 30% discount on gaseous fuel versus petrol or a 35% discount to diesel between LNG. When that metric changes, it draws attention, and consumers and fleets will react and this behavior comes back to us. The time constants are tough to call and hard to categorize.

Okay. Would you say that's essentially a lost sale? Is that a situation where a fleet manager is considering replacing a vehicle this quarter or during this time period, and therefore, we won’t see that reflected until the next cycle? Or is it a delay followed by pent-up demand?

Yes. I think it's more of the latter. I think it's more a delay. So especially regarding volatility. When fuel prices fluctuate, it often leads to fleet managers saying, 'Let's wait and see before placing that order.' I believe in most cases, it's a delay rather than a permanent loss. Orders will come when conditions improve, assuming they do.

Yes. That makes sense. I guess, whether you're going to downsize or upsize your fleet is more about the fleet outlook on their business as opposed to...

Yes, that's right. Fleets are buying a mix of natural gas vehicles and various technologies, and it's their decision on the mix and what they are going to buy that influences when they place orders. When the economy is challenging, they sometimes delay their purchases. All of those are consistent behaviors of fleets around the world, driven by macroeconomics and fuel prices.

Yes. Okay. And then Richard, I think you already answered a question on R&D, thinking about OpEx. What percentage of that spend of the OpEx in general or maybe you want to talk about R&D, would you say is stuff you're going to spend regardless of your revenues and margins? I guess I'm trying to understand what level of OpEx spending is sort of not negotiable because you're looking at certain programs that won't be impacted by quarters of revenue or margin; you just say we are doing this this year, and so we're going to spend X millions on this. I wonder what that looks like.

I would say for R&D, probably 90% to 100%. We are pushing funding for those programs. We raised the money specifically to accelerate our growth. Over the period from 2016 to even up to 2020, we were starving for funding, especially going into COVID. We're trying to accelerate, particularly on the heavy-duty side. There are things that we need to get done. That's why we're approaching closer to the 100% mark on R&D spending. Where you'll see austerity measures is in G&A and OpEx, which we are examining as we navigate these challenging times.

Right. When you look at the trends, you obviously have more cash on the balance sheet. It increased in 2021 by a few million, around $4 million or $5 million. Do you expect that to go higher from there again, or is it likely to remain flat?

More flat line.

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

Just wanted to revisit the aftermarket business and the 10 points of gross margin differential sequentially. How much of that was the regional mix? On your slide, you have three points; what I'm trying to get is, is the majority of it the overemphasis of India in Q4? And then as a related question, if we think about Russia being weaker in 2022, does that segment have some of the same pressures that linger, assuming that Russia is a more profitable market relative to others?

Jeff. The answer is yes. For sure, there was a lot more emphasis on India. That was a significant portion of it. We did also see inflation which impacted our ability to pass costs on. You don't see that in the margin percentage because we are passing those costs without a markup to protect market share; it’s case by case. With respect to Russia, roughly half of the business is in the independent aftermarket, around $12.5 million or so, and this will impact our aftermarket business.

And Stako, their sales out of Poland, where do those go geographically, $6 million, $7 million a quarter from that?

Those sales are mainly directed toward Renault in Western Europe. So they are less impacted by the ongoing conflict from a revenue perspective.

And then my last question was just on the localization in India. Could you walk through what the CapEx burden of something like that would be? And is that in the $15 million to $20 million guidance that you provided or commentary you provided for 2022?

It's not in the $15 million. It would be more of an investment that would happen over the next few years. David, maybe over to you. I would think around $5 million is roughly what that would be, but I'll let the expert answer that better than I.

Yes. As we look at the Indian market, we are currently responding to the need for added capacity. We've been able to address that without CapEx just through operational patterns. Some goods we make are already coming from our joint venture in India, while others are produced in Italy and North America. We have a distributed supply base. The localization effort is more about sourcing subcomponents locally rather than a substantial CapEx investment. Therefore, the few million investment will likely be distributed over time.

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

Yes. Thanks, everybody, for your time this morning and for your questions and the discussion. Enjoyed it very much. The year past was a generally good one for us. I feel good about what we accomplished. We set the groundwork for our future. I'm very happy about our hydrogen work and excited about what we can bring back to the marketplace with news throughout the year. A fair bit of challenge lies ahead, but we feel quite strong that we're well-positioned to manage that as we managed through the COVID period; we'll manage through this one, too. We will continue on our path to deliver clean transportation affordably across markets worldwide. Thank you for your time, and I look forward to seeing you at the various conferences soon.

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