WPRT - Westport Fuel Systems: Deteriorating Liquidity Increases Risk Of Near-Term Dilution

2023-08-10 00:56:42 ET

Summary

• Westport Fuel Systems reported mediocre second quarter results, with a slight topline beat offset by weaker-than-expected profitability.
• Increased gross profits were largely offset by higher sales and marketing expenses. As a result, adjusted EBITDA was up just slightly on both a year-over-year and sequential basis.
• Despite favorable working capital movements, liquidity decreased by almost $20 million sequentially to $52.3 million due to a reduction in debt and royalty obligations as well as higher capital expenditures.
• But given expectations for ongoing, negative free cash flow in H2 and limited access to corporate debt, Westport will likely have to consider issuing convertible debt or outright selling new equity later this year in order to avoid going concern language in the 2023 annual report.
• Considering the lack of near-term catalysts and very real possibility of near-term shareholder dilution, I would advise investors to remain on the sidelines.

Note:

I have covered Westport Fuel Systems Inc. ( WPRT ) previously, so investors should view this as an update to my earlier articles on the company.

After the close of Tuesday's session, Westport Fuel Systems Inc. or "Westport" reported mediocre second quarter results with a slight top line beat offset by weaker-than-expected profitability:

Revenue outperformance was driven by the company's Independent Aftermarket ("IAM") segment which saw increased sales volumes to Africa, Eastern Europe and South America while the OEM business experienced some pressure due to key customer Volvo ( VLVLY , VOLAF , VOLVF ) transitioning to a new series of LNG trucks, lower sales in India and decreased sales of hydrogen-related products:

That said, gross margin in the OEM segment improved due to higher unit pricing on HPDI systems, increased spare part sales and higher engineering services revenue:

On the flip side, IAM segment gross margin was impacted by a lower-margin sales mix and inflation in South America:

Unfortunately, the company's increased gross profit was largely offset by higher sales and marketing expenses. In addition, Westport incurred corporate consulting expenses related to the proposed HPDI joint venture with Volvo.

As a result, Adjusted EBITDA was up just slightly on both a year-over-year and sequential basis:

While Q2 operating cash flow benefited from favorable working capital movements, liquidity was down by almost $20 million on a sequential basis, mostly due to an aggregate $15 million reduction in debt and royalty obligations and $4.5 million in capital expenditures.

The company ended Q2 with $52.3 million in cash and cash equivalents which apparently caused management to discuss liquidity in more detail on the conference call :

Although we believe we have sufficient liquidity to continue as a going concern beyond August '24, long-term financial sustainability of the company will depend on our ability to generate sufficient positive cash flows from all of our operations, specifically through profitable sustainable growth and from the ability to finance our long-term strategic objective and operations. (...)

We'll continue to be prudent in our liquidity management and multiple steps are being taken to do so. Additional debt remains an option as we look to solidify our balance sheet. We continue to do what is necessary to ensure we are adequately and fully capitalized.

Please note that the company expects to receive an initial $28 million cash payment from Volvo upon establishment of the proposed HPDI joint venture currently targeted for H1/2024:

Our recent HPDI JV announcements with Volvo is an inflection point for Westport financially. Volvo's payment for their 45% share with the joint venture includes an initial $28 million and an earnout of up to $45 million, which is a clear signal of their commitment to the future growth of HPDI. And this also helps shore up our balance sheet. The joint venture is focused on driving global adoption of HPDI, in the long-term improves efficiencies and scale, while in the short-term we have a partner to share in the required investments including working capital and capital costs.

But given expectations for ongoing, negative free cash flow for the remainder of the year and very limited prospects for near-term debt financing, Westport will likely have to consider other options which might result in the issuance of convertible debt or even an outright equity sale later this year in order to avoid going concern language in the 2023 annual report.

Disappointingly, based on management's initial assessment, Westport won't be able to consolidate the joint venture's financial results thus likely causing a meaningful top line hit next year.

On the flip side, cash flows should benefit from the elimination of costs and investment requirements related to HPDI.

Bottom Line

Westport Fuel Systems Inc. reported mediocre Q2 results with a strong IAM segment sales performance offset by weaker-than-expected profitability.

Reading between the lines of management's prepared comments and statements made during the questions-and-answers session of the conference call, the company's H2 performance isn't likely to improve substantially.

Considering the apparent lack of near-term catalysts and the very real possibility of Westport issuing convertible debt or even outright equity before the end of the year, I would advise investors to remain on the sidelines.

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