Westport Innovations Shows Progress, but Challenges Remain

Over the past several quarters, Westport Innovations has begun taking major steps to cut costs and transition its business from research and development to commercialization and profitability, and, needless to say, it's been tough. Factor in a huge drop in oil prices, making the financial benefit of natural gas engines less compelling, and challenging economic conditions in key markets in Europe and Asia, and the company is right in the middle of a race against time to cut costs and improve profits before a serious cash crunch puts it further on the ropes.

With the second quarter's financial results now out, we can get a better idea of how the company's efforts are playing out. Let's take a closer look at the things that stood out the most, including the company's cost-control measures, what's happening at its big joint ventures, and what's going on with the transition from R&D company to OEM supplier and profitable manufacturer.

Lower expensesandimproving margins are slowing rate of cash burnEasily the biggest problem that Westport management has had to confront over the past year-plus is cash burn. Just one year ago, Westport had almost $169 million in cash and short-term investments. That had fallen to $60.6 million at the end of the second quarter. However, the company has cut operating costs and improved margins in its operating units. Here's a look at operating expenses:

Data source: Westport earnings presentations. All numbers in thousands except cash & equivalents, which are in millions.

Operating expenses are down across the board since last year, while since March they are relatively flat. However, Westport used significantly less cash last quarter compared to prior periods, cutting cash burn from more than $20 million in Q1 to $10.6 million in the second quarter.

What the table above doesn't show is the improved gross margins, with product costs falling $4.4 million on a $2.4 million decline in product revenue. Westport also collected $3.3 million in service revenue in the quarter, versus $1 million in Q1. Gross profit dollars nearly doubled to $9.7 million.

Lower operating costs and better margins both helped. President and COO Nancy Gougarty made these her key areas of focus since coming aboard two years ago.

But that's not all that helped. Westport earned $6.2 million in income from its joint ventures with Cumminsand WeiChai in the first quarter,and $3.5 million in Q2. The $6.2 million in payments from the first quarter would have been paid in Q2, further helping offset cash used in operations. This compares to $1.4 million in the first half of 2014.

Speaking of the joint ventures...After incredible growth at WeiChai Westport over the past few years, sales fell off a cliff in 2015. Revenue is down 60% so far as China's economy begins to show serious signs of slowing. There's also some impact of China's work on emissions regulations, which may be slowing sales while the market waits for details to emerge. However, Westport management remains bullish on the long-term outlook, stating that new regulations are almost guaranteed to favor low emissions like those of natural gas engines.

If there's any good news at WWI, it's that margins have doubled to nearly 12% after a steady decline in China's ultra-competitive landscape, one that brought margins near the low single digits last year. The question is whether they will hold firm when sales rebound.

Things are looking up at Cummins Westport. After a lackluster few quarters, Q2 engine unit sales grew 18%, and engine revenue was up 22% from last year. Total revenue, which includes both engine and parts revenue, was up 17% in the quarter. After the company finally moved past last year's warranty problems, gross margin percent almost tripled, going from 11% in the first half of 2014 to 31% so far this year.

The margin compression at WWI made it seem unlikely that the joint venture would pay big profits to Westport, but Cummins Westport's ability to produce profitable revenue is incredibly important for the larger company right now.

Making the transitionIt's probably a tired refrain for many investors, but Westport continues to focus on the shift from product and market development to profitable manufacturing of products that OEMs will take to market. So far this year the company has announced several new products, including the new Volvo Drive-E bi-fuel V60 and 2016FordF-150, which will be available in both CNG and propane autogas -- but these products aren't expected to begin shipping before the fourth quarter.

The big driver remains HPDI 2.0 for heavy-duty trucking applications. So far,Volvo AB(Not the car company, but the truck and machinery company) has come closest, having announced a 13-liter HPDI engine only to delay it last year. It's looking like the reason for the delay is tied to HPDI 2.0, which Westport will build in partnership withDelphi, one of the largest fuel injector manufacturers in the world, and in a facility that won't be ready before some time in early 2016.

While the delay has been hard on the company (and maybe harder on shareholders), partnering with Delphi could make a huge difference due to the latter company's expertise and reputation in the fuel injector business. At any rate, the recent announcement that the engineering phase of development -- a cooperation with European truck heavyweight Daimler AG -- was complete marked another step forward in commercial development of the technology. Westport says there are a total of five development partners, meaning that there are at least two more than have yet to formally announce products.

Nonetheless, 2015 looks like it's going to be a year of recovery in the core business, while 2016 will be the year for HPDI to finally come to market.

Looking forwardWestport has to make it there first. The good news is, even as sales continue to lag -- and it's likely that 2016 will be the soonest any of the company's major investments pay off -- management's cost cutting steps and refocusing R&D on more near-term projects are making a difference. Management also said that it was making progress on up to $50 million in non-core asset sales, and that the first transaction would likely close in the fourth quarter. If the company can further improve margins and keep costs in line, that would go a long way toward bridging the gap.

It's still early to call it a turnaround, but there has been progress the past two quarters. Only time will tell how it plays out. Stick around -- it's going to be an interesting ride.

The article Westport Innovations Shows Progress, but Challenges Remain originally appeared on Fool.com.

Jason Hall owns shares of and options for Westport Innovations. The Motley Fool recommends Cummins, Ford, and Westport Innovations. The Motley Fool owns shares of Cummins and Westport Innovations. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.