When natural gas engine technology leader Westport Innovations, Inc. (NASDAQ:WPRT) last reported earnings after its third quarter in 2014, the company also announced a series of major cost-cutting steps to help the company transition from "market creation" to profitable manufacturing. Westport released its fourth-quarter financial results after the market close on March 9, and it did manage to make some serious progress in cost reduction over the past two quarters. The highlights:
- Gross margin increased significantly for Westport's core operations.
- R&D and operations expenses fell $24.1 million from the prior year.
- Both joint ventures contributed to increased profits.
- Sales at all segments, including joint ventures, rose 15% to $1.1 billion in 2014.
However, even with those improvements, the company burned through $116.6 million in 2014 and entered 2015 with just $94 million in cash and short-term investments. The company's cost-cutting efforts will need to have an impact on cash burn going forward. Let's look at three key things management did to better position the company for the future.
1. Housekeeping efforts should reduce cash burn
For the full year, Westport spent $65.8 million on selling, general, and administrative expenses, versus $75.2 million in 2013, a $9.4 million reduction. Peeling back the layers, we see that corporate and technology spending increased $7.6 million, or 27% for the year, while the on-road and off-road segments reduced costs by $23.2 million, largely because of headcount reduction and facility consolidation.
The other major cost reduction was in research and development, where costs fell 16%, good for a $14.7 million reduction. The bulk of that reduction was in corporate and technology investments, which houses the majority of the company's R&D investments. Management said on the earnings call that these costs will fall even further in 2015, as the company continues to rationalize its development projects from more than 40 in 2014, to around 23 in 2015. CEO David Demers stressed that the company wasn't "walking away" from the other 20-something projects but simply facing the reality that it must develop near-term projects that can contribute to the bottom line today, while longer-term products will have to wait for investment when there are dollars to allocate and the products closer to market viability.
It's also important to note that these two cost centers -- SG&A and R&D -- are connected, in that by consolidating parts of the segments of the business, the company can not only reduce its costs but also get more value from each dollar spent for operations or product development.
2. Joint-venture profitability
In the earnings preview for Westport, I highlighted my hopes that the JVs with Cummins in North America and Weichai in China -- CWI and WWI, respectively -- could help the company by increasing their profitability, meaning more profits paid to Westport. That happened in the fourth quarter, and in a pretty big way.
While CWI's $8.1 million payout to Westport in 2014 was $1.3 million less than in 2013, $7.2 million of it came last quarter. This is a resounding "yes" to questions about CWI's recovery from early 2014 warranty problems. Simply put, there's a high probability that this joint venture will contribute meaningful profits to Westport's bottom line in 2015.
Similarly, WWI paid $6 million in profits to Westport in 2014, with $3.6 million of that amount coming in the fourth quarter. Gross margin -- an area I was convinced was unlikely to improve at WWI -- increased to 8.5% for the year, versus 8% in 2013. According to management, WWI shipped 51,000 engines in the year and has better than 70% market share in China.
3. Kicking the "path to profitability" plan down the road, but for a "good" reason
For about a year, Westport management has been guiding to adjusted EBITDA-positive results by the end of 2015. However, CFO Ashoka Achuthan stated on the call that the unforeseen collapse in energy prices, combined with pretty serious foreign currency exchange weakness, meant that the company is adjusting its target to "mid-2016."
This is a disappointment, but it's not a major surprise. The reality is, management needs to be conservative with its guidance right now, because of the uncertainty and uncontrollable nature of the challenges the company is facing. With that said, it's looking as if -- at least so far -- the currency headwinds are a bigger challenge for the company than cheap oil. Frankly, this is the better problem to have. If demand had remained weak, that's a much harder problem to "fix" than currency issues, which are cyclical in nature and can be a net positive as often as they are a negative.
On the earnings call, more than one member of management commented on the relative strength of the Chinese market and on sales into transit and refuse applications even with diesel prices comparatively down over the past year. Furthermore, trucking application sales also have been strong, even with adoption rates slower to grow than many in the industry expected them to be by now.
Looking ahead: Too early to call it yet
Because of a number of one-time charges, it's tough to see -- after only one quarter -- just how much the company has reduced its cost structure so far. Just as importantly, reducing costs will only get Westport so far, because this is a problem the company will have to sell its way out of.
With that in mind, if the bottom-line improvements at the JVs and the big improvements in gross margins at the operating segments prove sustained, then Westport should have plenty of cash on hand to make it through 2015. However, looking at 2016 and beyond, the company needs to see big sales gains in one of its core businesses this year, or it's going to have to raise capital in some manner.
Does that mean shareholders are due for dilution in the next year? It's possible, but that's the least of what they should be worried about. The company did make progress this past quarter, but it's still too early to tell whether it really turned the corner or just bought more time.