Westport Fuel Systems
Annual Report 2016

Plain-text annual report

WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT 1750 West 75th Avenue, Suite 101 Vancouver, British Columbia V6P 6G2 Canada T +1 604-718-2000 F +1 604-718-2001 www.wfsinc.com Table of Contents Table of Contents LETTER TO SHAREHOLDERS SUSTAINABILITY REPORT CATALYST FOR INNOVATION KEY COLLABORATIONS THE REPORT: OUR APPROACH AND SCOPE FOOTNOTES MANAGEMENT'S DISCUSSION & ANALYSIS BUSINESS OVERVIEW AND GENERAL DEVELOPMENTS SELECTED ANNUAL FINANCIAL INFORMATION RESULTS FROM OPERATIONS CAPITAL REQUIREMENTS, RESOURCES & LIQUIDITY SHARES OUTSTANDING CRITICAL ACCOUNTING POLICIES & ESTIMATES NEW ACCOUNTING PRONOUNCEMENTS & DEVELOPMENTS DISCLOSURE CONTROLS & PROCEDURES SUMMARY OF QUARTERLY RESULTS RELATED PARTY TRANSACTIONS BUSINESS RISKS & UNCERTAINTIES AUDITOR REPORTS CONSOLIDATED FINANCIAL STATEMENTS CONSOLIDATED BALANCE SHEET CONSOLIDATED STATEMENTS OF OPERATIONS & COMPREHENSIVE INCOME (LOSS) CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY CONSOLIDATED STATEMENTS OF CASH FLOWS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS RECENT MATERIAL ANNOUNCEMENTS INFORMATION FOR SHAREHOLDERS 2 | WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT 3 4 4 5 6 10 11 11 16 17 23 24 25 26 27 28 30 30 31 34 34 35 36 37 38 58 59 Letter To Shareholders Letter to Shareholders Dear Fellow Shareholders, 2016 was a transformative year that brought together two industry leaders to form Westport Fuel Systems, the global leader in advanced clean-burning fuel systems and components. We entered 2016 with clear goals and we are pleased to report our progress plus next steps to make Westport Fuel Systems a sustainable, profitable company that delivers value to customers, employees and shareholders. With our merger closed on June 1, 2016, we immediately began executing on our integration plans. Our global leadership team is focused on improving operating efficiencies and reducing expenses while ensuring that we continue to provide our customers with leading products and technology solutions and exceptional service. At year-end, we had already achieved almost a substantial portion of our stated merger synergy targets plus higher Adjusted EBITDA from operations in the third and fourth quarters. We accelerated our efforts to capture operating efficiencies and reduce our expenses by consolidating the manufacturing, distribution and corporate footprint, and stream-lining our corporate costs. The results of these efforts started to emerge in the second half of 2016 and with additional work and activities underway, we expect to see more improvements in 2017. The strategic review of the product and brand portfolio that began upon the close of the merger was completed in late 2016. In early 2017 we sold the assets of the Auxiliary Power Unit (“APU”) business for $70 million and announced plans to divest the majority of assets remaining in the Industrial Business Segment. By narrowing our focus along with improving our financial base, we can concentrate on growing market share for our unmatched alternative fuel technologies and bringing to market new products that can drive results for the long term. It is our knowledge, technical expertise, deep patent portfolio, and strategic OEM relationships that make Westport Fuel Systems the leader in our market. The efforts to strengthen our balance sheet were successful in 2016, beyond the closing of the merger. The Cartesian investment brought additional cash to support our global growth initiatives through upfront payments and a convertible note. Additionally, we completed other non-core asset sales around the globe. In 2017, we expect to build on this success with additional non-core asset sales and further right-sizing of our cost structure. We are pleased to report that our Westport High Pressure Direct Injection 2.0 ("Westport™ HPDI 2.0") technology advanced through the validation and testing phases. We are on track to ship the first commercial components to our OEM launch partner by end of 2017, a significant milestone for the company. This is the culmination and commercialization of many years of work and highlights our expertise and experience along with a deep patent portfolio that makes Westport Fuel Systems a market leader. We are excited about the potential of Westport™ HPDI 2.0 as it provides customers with cost savings, lower GHG emissions, and the ability to run entirely on renewable fuels - all while matching the performance of vehicles fueled by diesel. Today Westport Fuel Systems is the premier global company for the engineering, manufacturing, and supply of alternative fuel systems and components. We are driving innovation to power a cleaner tomorrow by delivering performance, fuel efficiency and environmental benefits to address the challenges of climate change and urban air quality. Serving customers in more than 70 countries through our leading transportation and automotive brands, over 600 patents and applications, and with a dedicated team of employees, we can change the way the world moves. Calendar year 2017 is well underway with the momentum to build on our transformation and the strong finish to 2016. Our key initiatives for 2017: • Launch Westport™ HPDI 2.0 commercial components to our OEM partner • Execute our strategic plan and portfolio rationalization • Strengthen our balance sheet • Capture remaining merger synergies and drive operational excellence The 2017 year is already off to a good start and we look forward to updating you as we make further progress. On behalf of our Board of Directors, the management team and employees around the world, thank you for your continued interest and support of Westport Fuel Systems. Sincerely, Nancy S. Gougarty Chief Executive Officer Ashoka Achuthan Chief Financial Officer WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT | 3 Sustainability Report Sustainability Report Driving Innovation to Power a Cleaner Tomorrow Compared to other primary energy use sectors including electricity, industry, and buildings, transportation is the most difficult to decarbonize because of the challenge of economically replacing the energy density of fossil fuels. The current global transportation energy mix is still dominated by petroleum derived fuels like gasoline and diesel (approximately 90%) but we are witnessing the emergence of a more diversified or poly-fuel mix as natural gas, liquid biofuels, electric vehicles, and hydrogen fuel cells are gaining market share through an ability to compete on price, range, and performance.1 Canada and other G20 economies have ratified the Paris Agreement in November 2016 committing to deep decarbonization targets to limit average temperature rise to less than 2°C, and are working on plans to limit temperature rise to 1.5°C. We simply need to accelerate the deployment of clean-technology and low carbon transportation solutions and increase the rate of market penetration. the ambitious 80%-by-2050 emission reduction The extent to which the transport sector is able to make progress on targets incorporated within the Paris Agreement and diversify beyond oil, will be a function of ongoing technology breakthroughs on both fuels and vehicles, political action, shifting demographics, and a range of new public policy considerations that will not only influence how people and freight are moved, but how and where we live. Our 2016 Sustainability Report highlights the new Westport Fuel Systems updates, progress, and challenges in reaching our vision of a sustainable transportation future. We continue to strive to create leading edge technologies that meet or exceed the requirements of legislation and industry codes and standards to shift the transportation sector to gaseous fuels. Working in conjunction with our partners, we are committed to delivering low-emission gaseous fuel solutions that will meet the demand for high-efficiency, high- performance, and low-carbon transportation. A Catalyst For Innovation The heightened focus on the environmental performance of the transportation sector with more stringent requirements for increased engine efficiency, improved urban air quality, and greenhouse gas ("GHG") emission reductions has put pressure on engine and vehicle manufacturers, but also introduced an opportunity for collaboration and innovation. 4 | WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT New Engine Efficiency Standards The United States Environmental Protection Agency (“EPA”) and the National Highway Traffic Safety Administration (“NHTSA”) jointly released the Phase 2 GHG emissions and fuel efficiency standards for medium- and heavy-duty vehicles in August 2016. These rules are the product of nearly two years of extensive consultation with industry partners and set a high standard for the freight sector. Freight transport by road is a vital part of the North American economy but also a major source of GHG emissions. The new EPA/ NHTSA rules for GHG emissions and fuel efficiency from medium- and heavy-duty trucks will create a new competitive dynamic in the trucking industry. Westport Fuel Systems is well-positioned to deliver best-in-class engines and vehicles that meet increasingly stringent regulatory frameworks. Next generation natural gas engines and vehicles including Westport High Pressure Direct Injection 2.0 (Westport™ HPDI 2.0) and Enhanced Spark Ignition ("Westport™ ESI") technologies comply with the new rule and offer significant GHG emission reduction benefits through the combination of low-carbon fuels and high-efficiency engines. In particular, Westport™ HPDI 2.0 has been proven to deliver diesel-like performance and fuel efficiency while providing a reduction in GHG emissions of 18-20% compared to current diesel engines. Improved Urban Air Quality The California Air Resources Board (“CARB”) adopted optional low oxides of nitrogen (“NOx”) emission standards for on-road heavy- duty engines in 2013. For California to meet its 2023 and 2023 ambient ozone air quality standards, CARB estimates that it will require a 90% reduction in NOx emissions below 2010 baseline levels measured in the South Coast air basin.2 The Cummins Westport ISL G Near Zero became the first mid-range engine in North America to receive emissions certifications from both the U.S. EPA and CARB that meet the 0.02 g/bhp-hr optional Near Zero NOx Emissions standards for medium-duty truck, urban bus, school bus, and refuse applications. Methane emissions have also been cut dramatically through the combined use of closed crankcase ventilation and revised catalyst formulations. According to CARB, when fueled by renewable natural gas ("RNG"), a transit bus using the ISL G NZ has total emissions equivalent to a battery electric bus powered by electricity generated in a clean natural gas fueled power plant.3 The Potential Of RNG Transportation grade natural gas is increasingly being produced from non-fossil sources, in the form of renewable natural gas or Sustainability Report | A Catalyst for Innovation This chart shows the fuel carbon intensity on a per unit energy basis. For example, for 1 MJ of energy of CNG made from landfill gas and used in an engine, the total amount of CO2 WTW that results is about 85% lower than using 1 MJ of diesel. This chart addresses only the fuel, and as such does not take into account engine tailpipe emissions of methane, or any differences in engine efficiency. biomethane. Feedstocks for RNG include landfill gas (“LFG”), municipal solid waste (“MSW”), waste water treatment plants (“WWTP”), or agricultural manure. Substantial carbon intensity reductions can be achieved by turning these waste products into transportation fuel, thereby eliminating direct emissions of carbon dioxide ("CO2") and methane that occur naturally and without any end-use benefit. There is an urgent need for sustainable, low-carbon solutions for the transportation and energy sectors. Because natural gas vehicles can operate with 100 percent renewable natural gas or any percentage of blended renewable and conventional gas, they are a promising technology for freight transportation now and into the future as renewable fuels are expected to represent a greater market share of fuel consumed. When vehicle efficiency and tailpipe emissions are accounted for, RNG (in this case from landfill gas) can reduce the greenhouse gas emissions of natural gas heavy duty trucks by approximately 75% compared to the level produced from equivalent diesel trucks.4 Key Collaborations In 2016 Industry leadership begins with outreach and dialogue and we have contributed to many technical working groups, committees, and advisory panels to learn, share our expertise, and help build a body of knowledge about natural gas vehicles, their benefits, and challenges with deployment. While the economic value proposition remains the primary driver of natural gas for transportation, policy makers, OEM partners and industry stakeholders are looking to the other compelling energy, environmental, and sustainability benefits. It is critical for Westport Fuel Systems to contribute sound, intelligent, data driven, and defensible analysis to a discussion on sustainable mobility and the transition to alternative fuels. Business For Social Responsibility Landfill Gas fuel carbon intensity from GREET (greet.es.anl.gov) life-cycle emissions model maintained by Argonne National Labs. FUTURE OF FUELS WWW.BSR.ORG WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT | 5 The scope of this report relates only to our operations in British Columbia, Canada. We recognize the limitation of this narrow scope given the global reach of the new Westport Fuel Systems. As much of 2016 was spent in post-merger integration activities and product portfolio rationalization, we have identified a need to extend the scope of our sustainability report to encompass all of our global operations and are working to establish processes to achieve this goal. While the majority of our engine testing and development occurs in Vancouver, we recognize that we must tell a more complete story about our activities, success and challenges. This report discloses data from January to December 2016. Historical data from the past four fiscal years have been included for comparative purposes, where appropriate. Report Content This report has been developed in accordance with the Global Reporting Initiative ("GRI") G3 standard reporting guidelines. The GRI is an independent institution that provides a standard framework for sustainability reporting across companies and industries. We have applied the principles of materiality and stakeholder inclusiveness as recommended by the GRI to assess the relevance of sustainability priorities to Westport Fuel Systems and our stakeholders. Westport has self-declared this report to correspond to application level B in the six-level grid of the GRI G3 guidelines. Application Level B requires us to disclose our performance on at least twenty core economic, social and environmental indicators. Determining Material Issues The intent of the new GRI G4 materiality review process is to ensure that content included in our annual sustainability report represents the key environmental, economic, and social issues that are most critical to our stakeholders. In 2016 we undertook an extensive internal risk management exercise which will guide and supplement our process for determining materiality in accordance with the framework of the new G4 reporting guidelines. We reviewed our existing mechanisms for gathering stakeholder feedback and sought additional input where possible to organize our findings using the prioritization matrix system recommended by GRI. Sustainability Report | Key Collaborations Westport Fuel Systems has been a member of Business for Social Responsibility (“BSR”) since 2012 and was a founding member of the Future of Fuels working group. The mission of Future of Fuels is to identify and promote transportation fuel pathways that enhance the sustainability and availability of emerging alternative fuel choices. The working group’s objectives are to develop tools and research to map, measure, and manage a sustainable transition to low-carbon commercial freight, convene value chain stakeholders to identify and address the greatest challenges to the deployment of sustainable fuels, and build partnerships that catalyze and test low-carbon commercial freight solutions. In 2016, Future of Fuels launched its Fuel Tool developed by technical experts and member companies including PepsiCo, Shell, Suncor, Coca-Cola, UPS, Volvo, Walmart, and Westport Fuel Systems. It is an interactive tool able to provide data for fleet owners to measure the average climate emissions for different fuels and technology, to understand the range of related environmental impacts, and enable them to implement practices to achieve desired sustainability results from their fleet and suppliers. Environmental Defense Fund PUMP TO WHEELS METHANE LEAKAGE STUDY The Environmental Defense Fund (“EDF”) has a history of cross- sector collaboration and balanced environmental analysis. In 2012, the EDF initiated a series of studies with academic and industry partners to better understand the source and quantity of methane emissions along the natural gas supply chain. Westport Fuel Systems was a core supporting member of a multi-partner study initiated by EDF and conducted by the Center for Alternative Fuels, Engines and Emission (“CAFEE”) at West Virginia University. The study was published in 2016 in the journal Environmental Science & Technology and offers a critical baseline by which ongoing product and technology enhancements can be measured, as it represents the first significant effort to quantify actual in-use methane emissions from natural gas filling stations and heavy-duty vehicles. The natural gas vehicle industry has already implemented technology solutions to dramatically minimize, or in some cases, eliminate the largest sources of methane emissions from vehicle tailpipe, crankcase ventilation, and dynamic venting that were identified in the study. Our Approach And Scope This is our eighth published sustainability report, documenting our strategy, programs and achievements related to the environment, the safety of people and products, our employees, and our community. 6 | WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT GRI INDICATOR INDEX LEGEND AA1 (we report on this indicator) BB2 (we partially report on this indicator) ECONOMIC PERFORMANCE EC1 EC2 Direct economic value generated and distributed (2016 Audited Financial Statements) Financial implications and risks and opportunities of climate change (Climate Change Risks and Opportunities) SOCIAL PERFORMANCE HR3 LA1 LA3 LA6 LA7 SO1 SO2 SO3 PR1 PR2 Employee training on human rights (Human Rights) Total workforce by employment type, employment contract, and region (Employee) Benefits provided to full-time, part-time and temporary employees (Employee) Workforce represented in Occupational Health and Safety Committees (Health and Safety) Rates of injury, occupational disease, lost days, and work-related fatalities (Health and Safety) Nature, scope and effectiveness of programs to manage impact on communities (Community Impacts) Percentage and total number of business units analyzed for risks related to corruption (Anti-Corruption Efforts) Percentage of employees trained on anti-corruption policies and procedures (Anti-Corruption Efforts) Life cycle stages: health and safety impacts of products-assessed for improvements (Product Responsibility) Total number of incidents of non-compliance with regulations and voluntary codes concerning health and safety impacts of products (Health and Safety) ENVIRONMENTAL PERFORMANCE EN3 EN4 EN5 EN6 EN7 EN8 Direct energy consumption by primary energy source (Energy) Indirect energy consumption by primary source (Energy) Energy saved due to conservation and efficiency efforts (Energy) Initiatives to provide energy-efficient or renewable based products and reductions (Energy) Initiatives to reduce indirect energy consumption and reductions achieved (Energy) Total water withdrawal by source (Water) EN16 Total direct and indirect greenhouse gas emissions Gas Emissions) (Greenhouse EN18 EN22 EN23 EN28 Initiatives to reduce GHG emissions and reductions achieved (Greenhouse Gas Emissions) Total amount of waste by type and disposal method (Waste Generation and Diversion) Total number and volume of significant spills (Waste Generation and Diversion) Value of fines and non-monetary sanctions for environmental non- compliance (Environmental Compliance) Social Performance Indicators HUMAN RIGHTS Westport Fuel Systems is dedicated to preserving all fundamental and universally recognized human rights as outlined by the United Sustainability Report | Report Content the Nations and International Labour Organization. Our commitment is stated and reinforced by our Code of Conduct which is reviewed and signed annually by each of our employees. TOTAL WORKFORCE Westport Fuel Systems is committed to providing a healthy work environment, defined by respectful relationships, professional development and advancement potential and an execution-focused culture to capitalize on business opportunities. We are dedicated to ensuring that Westport Fuel Systems remains an employer of choice in all our locations. A similar benefits package is offered to both full-time and part-time employees.5 HEALTH AND SAFETY The health and safety of our employees, facilities, and communities is an integral part of Westport Fuel Systems operations. When gauging world-class safety performance, recordable injury rates and lost-time injury rates are statistical, comparative industry measures. Our results are indicative of our ongoing and significant commitment to injury prevention, risk mitigation, regulatory compliance, and continuous safety improvement. Our Health and Safety Committee members are champions for workplace safety. Westport Fuel Systems maintains a Health and Safety Committee in British Columbia or approximately one Committee for every 300 employees. Our Committee is made up of cross-functional management and employee representatives who advise and recommend action on any unresolved workplace health and safety issues brought to them. SAFETY INCIDENTS as of Dec. 31 2016 2015 2014 2013 2012 Recordable injury frequency Recordable injury rate6 Lost time injury frequency Lost time injury rate7 0 1 3 5 2 0.00 0.33 0.96 1.22 0.46 0 1 1 2 1 0.00 0.33 0.32 0.49 0.23 Our Vancouver-based employees achieved a significant safety milestone as we did not record any recordable injuries or lost time injuries in 2016. We continue to put the health and safety of our employees at the center of our operational priorities. Community Impacts The importance of being a good neighbour is captured within our Environmental Policy statement. Westport Fuel Systems geographic location, with our technical facilities adjacent to homes, schools, and other businesses requires us to monitor and manage the potentially adverse impacts our operations might have on our immediate neighbors. Our Facilities Engineering Group maintains a preventative maintenance schedule for key equipment to WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT | 7 Sustainability Report | Report Content minimize the likelihood of environment releases and noise levels in excess of municipal by-laws. Westport Fuel Systems responds to community concerns regarding our facilities, infrastructure, noise levels and environmental impacts in a timely manner. We did not receive any external complaints in 2016. Anti-Corruption Efforts Our expectations for individual integrity and ethical, moral and legal conduct are outlined in our Code of Conduct. The Code of Conduct has mandated compliance with all applicable laws in the jurisdictions where we operate and has always prohibited the giving or receiving of improper payments to influence business decisions. In addition, Westport Fuel Systems maintains a confidential ethics hotline to provide an avenue for employees to raise concerns about corporate conduct. The policy includes the reassurance that they will be protected from reprisals or victimization for “whistle blowing” in good faith. Product Responsibility Quality and safety are imperatives across the product life cycle. Our Quality Management System ("QMS") is certified to ISO 9001:2008 standards for the design, assembly and commercialization of its LNG fuel systems. Westport Fuel Systems QMS comprises the organization’s policies and procedures that aim to ensure that customer requirements are met with consistency, resulting in enhanced customer confidence and satisfaction. The QMS, other internal requirements and engineering systems have contributed to no incidents of non-compliance with regulations and voluntary codes concerning the health and safety impacts of our products. Internal systems and processes have been established to ensure that the health and safety impacts of our products are assessed in each of the following life-cycle stages: HEALTH AND SAFETY IMPACTS ASSESSED AT LIFE-CYCLE STAGE Development of product concept Research and development Certification Manufacturing and production Marketing and promotion Storage, distribution, and supply Use and service Disposal, reuse or recycling Status YES YES YES YES YES YES YES PARTIAL Community Engagement Being active in the community has always been central to Westport Fuel Systems values. Since 2002, Westport Fuel Systems has been a strong supporter of the United Way of the Lower Mainland. From modest beginnings, our annual workplace campaign has grown 8 | WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT steadily and in 2016 our cumulative fundraising total reached $1.34 million CDN. UNITED WAY OF THE LOWER MAINLAND COMMUNITY SCHOOLS Westport Fuel Systems is a proud partner of the United Way and Vancouver School Board’s Community Schools Program. Community schools provide safe and structured after-school activities to students aged 6-12. After-school programs play a critical role in providing structured, supervised time for children to be active, to develop positive social skills, and to build overall capabilities. Studies have linked participation in these programs with greater academic success, increased self-confidence and self-esteem, and better relationships with peers and adults. Through this partnership, Westport Fuel Systems employees lead classes over seven weeks in cooking, acrobatics, guitar, electronics, and visual arts at Lloyd George Elementary School. CANADIAN BLOOD SERVICES Westport Fuel Systems has been a member of the Canadian Blood Services’ Partners for Life Program since 2001. This nationwide program is designed to encourage group donations from business and community organizations. Each year, we set a target, coordinate group donations and allow employees to take time from work to donate. Environmental Performance Indicators ENVIRONMENTAL COMPLIANCE Compliance with applicable federal, provincial, and municipal regulations is a baseline environmental performance standard and we believe that leading organizations must go beyond minimum environmental requirements. Since its inception in 1996, Westport Fuel Systems has not received any fines or non-monetary sanctions for environmental non-compliance. WATER is an It is expected that climate change will impact global water resources. increasingly critical component of each Water use organization’s sustainability performance. Despite this, only the largest industries in British Columbia have water meters with data logging capability and the city of Vancouver does not currently provide meters to light industrial or commercial customers such as Westport Fuel Systems. Our calculations indicate that Westport Fuel Systems facilities cumulatively have an average daily rate of water use of approximately 13.5 m³ per day. Engine and fuel system component testing activities use process water that flows in a closed-loop thereby minimizing total water withdrawals. Water conserving domestic appliances and fixtures have been installed at all locations in an effort to further reduce our impact. We recognize that providing only an estimate and not actual water use is a limitation of our current sustainability report. ENERGY CONSUMPTION Our energy consumption in 2016 was comparable to 2015. This is due in part to product development cycles but also to our ability to test components on systems capable of recycling fuel, and a greater focus on energy efficiency improvements. The bulk of our LNG test rigs continue to operate on liquid nitrogen and we continue to return power to the grid through the use of transient dynamometers in our test cells. ENERGY CONSUMPTION (values in gigajoules) DIRECT Diesel LPG LNG CNG NG returned Net direct consumption INDIRECT Electrical for the 12 months ending Dec. 31 2014 2015 2013 2012 2016 414 0 749 0 2,000 2,722 2,250 0 0 35 5,714 5,436 21,730 8,559 8,466 18,991 18,887 35,449 38,148 28,802 (500) (4,351) (13,937) (1,024) (1,860) 24,619 20,721 45,242 48,405 37,693 10,065 12,576 16,249 14,956 12,239 GREENHOUSE GAS EMISSIONS The Greenhouse Gas Protocol developed by the World Business Council on Sustainable Development (“WBSCD”) is the globally accepted standard for greenhouse gas emissions accounting. The organizational boundary of this inventory includes all of Westport Fuel Systems British Columbia-based facilities and includes both scope one and scope two emissions. We have not measured scope three emissions to date. GREENHOUSE GAS INVENTORY8 (unaudited) Sustainability Report | Report Content Finding comparable organizations against which to benchmark our GHG emissions remains a challenge, as the research and development of new engine technologies is necessarily an energy- intensive process. There are currently no regulatory requirements for a company of our size to disclose its emissions.9 The process of compiling a GHG inventory provides an important foundation for understanding reduction opportunities and measuring progress. internationally- Westport Fuel Systems works recognized Carbon Disclosure Project to inventory and make public our GHG emissions. We have identified future opportunities to reduce the impacts of our operations, as well as opportunities to integrate climate change risk into our risk management procedures and overall business strategy. through the WASTE GENERATION AND DIVERSION Waste reduction, reuse and recycling programs are well established and well-maintained. Using formulas based on bin size and frequency of collection, Westport Fuel Systems generates approximately 200 tonnes of waste annually. Reducing the amount of waste sent to landfill remains a priority and we have launched employee education and awareness efforts to communicate the importance of minimizing the amount of waste generated. We extend the opportunity for employees to recycle electronics, batteries, confidential paper, and some hazardous waste like paint through our waste minimization program. Our Facilities Engineering Group tracks the amount of waste recycled via our hazardous waste program, scrap materials collection and office waste initiatives. TYPES OF HAZARDOUS AND SOLID WASTE RECYCLED Absorbent pads & materials Beverage containers Aluminum Batteries Cardboard Coolant Diesel E-waste Filters/rags Light bulbs Lube oil Organics & kitchen waste Paper Steel Hard & soft plastic Plastic oil pails Solvents Viscor Wastewater Wood (values in tonnes CO2 equivalent) Total Scope 1 Direct Emissions Total Scope 2 Indirect Emissions Total GHG impact for the 12 months ended Dec. 31 2014 2013 2015 2012 2016 1,442.8 1,272.8 2,389.7 2,576.1 2,224.2 251.0 303.0 413.0 387.0 288.0 1,693.8 1,575.8 2,802.7 2,963.1 2,512.2 WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT | 9 Sustainability Report | Footnotes Footnotes 1. http://www.bsr.org/reports/BSR_Future_of_Fuels_Understanding_Impacts_of_Fuels.pdf 2. https://www.arb.ca.gov/msprog/hdlownox/hdlownox.htm 3. http://www.gladstein.org/pdfs/On-Road_Pathways.pdf and https://www.forbes.com/sites/trucksdotcom/2016/04/11/natural-gas-engine-cummins-on-way/ #1ff0f9e5d8ba 4. The graphs shown here are illustrative, based on the assumptions within GREET, the lifecycle emissions model maintained by Argonne National Labs. However, the carbon intensity of renewable natural gas can be highly variable based on the type of feedstock, the geography, energy consumption to produce the biomethane, and the outcome for the feedstock if not used to make RNG. 5. Part-time employees must work at least three days per week to be eligible for the same benefits package as full-time employees. Casual employees or contractors are not eligible for benefits. 6. The recordable injury incident rate is the annualized rate of occupational injuries and illness per 100 employees. It is a calculation of the number of injuries x 200,000/employee hours worked. First aid classified injuries are not included. 7. The lost time injury rate is a calculation of the total number of lost time injuries x 200,000/employee hours worked. Lost days refer to scheduled work days and the count begins on the next scheduled work day immediately after the injury. 8. The GHG Protocol methodology used at this time only includes emissions associated with fuel consumption and not energy and emissions associated with fuel production, distribution and transport. 9. In Canada, Large Final Emitters (“LFEs”)—facilities that emit the equivalent of 100,000 tonnes or more of carbon dioxide (CO2) equivalents per year—are required to disclose their emissions. 10 | WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT Management's Discussion and Analysis Basis of Presentation This Management’s Discussion and Analysis (“MD&A”) for Westport Fuel Systems Inc. (formerly known as Westport Innovations Inc.; “Westport Fuel Systems”, the “Company”, “we”, “us”, “our”) is intended to assist readers in analyzing our financial results and should be read in conjunction with the audited consolidated financial statements, including the accompanying notes, for the fiscal year ended December 31, 2016. Our in consolidated accordance with generally accepted accounting principles in the United States (“U.S. GAAP”). The Company’s reporting currency is the U.S. dollar. This MD&A is dated as of March 31, 2017. Additional information relating to Westport Fuel Systems, including our Annual Information Form (“AIF”) and Form 40-F, is available on SEDAR at www.sedar.com and on EDGAR at www.sec.gov. All financial information is reported in U.S. dollars unless otherwise noted. financial statements have been prepared Forward Looking Statements This MD&A contains forward-looking statements that are based on the beliefs of management and reflects our current expectations as contemplated under the safe harbor provisions of Section 21E of the United States Securities Act of 1934, as amended. Such statements include but are not limited to statements regarding the orders or demand for our products, our investments, cash and capital requirements, the intentions of partners and potential customers, the performance of our products, our future market opportunities, availability of funding and funding requirements, our estimates and assumptions used in our accounting policies, our accruals, including warranty accruals, our financial condition, timing of when we will adopt or meet certain accounting and regulatory standards and the alignment of our business segments. These statements are neither promises nor guarantees but involve known and unknown risks and uncertainties that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed in or implied by these forward looking statements. These risks include risks related to revenue growth, operating results, liquidity, industry and products, general economy, conditions of the capital and debt markets, government or accounting policies and regulations, technology innovations, as well as other factors discussed below and elsewhere in this report, including the risk factors contained in the Company’s most recent AIF filed on SEDAR at www.sedar.com. The forward- Management's Discussion and Analysis looking statements contained in this MD&A are based upon a number of material factors and assumptions which include, without limitation, market acceptance of our products, product development delays in contractual commitments, the ability to attract and retain business partners, competition from other technologies, price differential between natural gas and liquefied petroleum gas, unforeseen claims, exposure to factors beyond our control as well as the additional factors referenced in our AIF. Readers should not place undue reliance on any such forward looking statements, which speak only as of the date they were made. We disclaim any obligation to publicly update or revise such statements to reflect any change in our expectations or in events, conditions or circumstances on which any such statements may be based or that may affect the likelihood that actual results will differ from those set forth in the forward looking statements except as required by applicable legislation. The forward looking statements contained in this document speak only as of the date of this MD&A. Except as required by applicable legislation, Westport does not undertake any obligation to release publicly any revisions to these forward looking statements to reflect events or circumstances after this MD&A, including the occurrence of unanticipated events. The forward looking statements contained in this MD&A are expressly qualified by this cautionary statement. Business Overview and General Developments Fuel Systems Solutions, Inc. ("Fuel Systems") and Westport Innovations Inc. ("Westport"), two companies with a strong foundation of innovation and technology leadership in the alternative fuels space were both key players in the development of the global market for gaseous fueled engines and vehicles for transportation and industrial applications. The merger of these two leaders in June 2016 has created Westport Fuel Systems, a premier global company for the engineering, manufacturing, and supply of alternative fuel systems and components. Our new corporate vision - “Driving Innovation to Power a Cleaner Tomorrow” - encompasses our mandate to deliver best in-class alternative fuel engines, fuel systems, and components. Global trends in greenhouse gas emission reduction regulations and increasingly stringent urban air quality requirements further solidifies our strategy to develop technology solutions and commercialize products that original equipment manufacturers ("OEMs") will need to meet demanding regulatory frameworks. With a broad range of alternative fuel capabilities in liquefied petroleum gas ("LPG"), compressed natural gas ("CNG"), liquefied natural gas ("LNG"), renewable natural gas ("RNG"), and hydrogen and our innovative proprietary technologies, Westport Fuel Systems is well positioned in key on-road, industrial, and high horsepower market segments. WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT | 11 Management's Discussion and Analysis | Business Overview and General Developments Our Automotive and Industrial businesses are the solid foundation of our market leadership position and source of competitive advantage. We have been able to realize synergies through a post- merger strategic assessment of our entire portfolio with emphasis on streamlining our operating lines as well as our product and brand portfolios. The outcome of this work has been a more focused portfolio with capital and resources targeted to the businesses that will drive long-term profitability. In the Automotive segment, we are leveraging our increased scale, customer base, and global sales and distribution networks to continue growing market share; a strategy we believe will lead to a stronger financial position. In addition to our significant operational competency in well-established automotive and industrial markets, our investment in new technologies is expected to drive future growth. Westport Fuel Systems has a track record of innovation, specialized engineering capabilities, and a deep patent portfolio resulting in a strong intellectual property position. We are on track to ship the first commercial Westport High Pressure Direct Injection 2.0 ("Westport™ HPDI 2.0") components to our European OEM launch partner in 2017. Our fully integrated Westport™ HPDI 2.0 system matches the “diesel-like” power, torque, and fuel economy benefits of a true compression ignition engine powered by natural gas, with reduced greenhouse gas emissions, and the capability to run entirely on renewable fuels. Westport Fuel Systems has a compelling value proposition. We offer technology solutions for global environmental challenges, we occupy a premier technology leadership position, and we have a range of brands and products for diverse applications and markets. Our team has the specialized technical knowledge and engineering that can conceive, prototype, demonstrate, and talent commercialize the next generation of gaseous fueled technologies with our OEM partners. Our operationally focused leadership team has deep expertise in successful organizational restructuring, customer satisfaction, and financial discipline. We are building a sustainable, profitable company that delivers value to customers, shareholders, employees, and the environment. During 2016, the end markets for our Automotive business continued to be challenging as a result of low oil prices. However, we did see encouraging signs of growth in the fourth quarter of 2016, with our revenue increased by 5% sequentially over the third quarter, and these continued into the early part of 2017. Overall we have seen some market consolidations among suppliers, and we have added market share in some markets as weaker players exit the industry. Importantly, our Automotive and Industrial divisions were profitable in both the third and fourth quarters of 2016. Liquidity and Going Concern In August 2014, the FASB issued ASU Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. Under the new standard, management must evaluate whether there are conditions or events, considered in the 12 | WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT aggregate, that raise substantial doubt about the Company’s ability to continue as a going concern within one year after the date that the financial statements are issued. This evaluation initially does not take into consideration the potential mitigating effect of management’s plans that have not been fully implemented as of the date the financial statements are issued. When substantial doubt exists under this methodology, management evaluates whether the mitigating effect of its plans sufficiently alleviates substantial doubt about the Company’s ability to continue as a going concern. The mitigating effect of management’s plans, however, is only considered if both (1) it is probable that the plans will be effectively implemented within one year after the date that the financial statements are issued, and (2) it is probable that the plans, when implemented, will mitigate the relevant conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued. Generally, to be considered probable of being effectively implemented, the plans must have been approved before the date that the financial statements are issued. This standard was adopted by the Company at December 31, 2016. The Company's financial statements have been prepared on the basis that the Company will continue as a going concern. At December 31, 2016, the Company's cash and cash equivalents were $60.1 million and its long-term debt was $79.0 million, of which $48.1 million matures in 2017. The Company incurred significant recurring losses and negative cash flows from operating activities during 2016, 2015 and 2014, and anticipates incurring additional losses and cash outflows through 2017, largely due to the start up of production and commercial distribution of HPDI in the fourth quarter of 2017. Principal Conditions or Events that Require Management's Consideration The factors which raise substantial doubt as to the Company’s ability to continue as a going concern are as follows: a. Forecast operating and capital investment requirements: After the merger with Fuel Systems and given the low oil price environment experienced in most of 2015 and 2016, the Company has been rationalizing its operations to achieve the necessary synergies required in order to become cash flow positive from operations. The Company expects to generate positive cash flows from operations throughout its business in 2017 and beyond except for its Technology Investments segment where the Company expects significant costs for final development, testing and capital expenditures on its HPDI program with a major OEM in fiscal 2017. Overall, the Company forecasts negative cash flows from operating activities in 2017. b. Significant debt maturing in 2017 is the CDN$55.0 million Debentures ("Debentures") maturing on September 15, 2017. Management's Discussion and Analysis | Business Overview and General Developments This debt is classified as current liabilities on the consolidated balance sheet as at December 31, 2016. Details of this loan can be found in note 15(a) to the consolidated financial statements. Management's Assessment and Conclusion Management's Plans Management considered the following factors and management’s plans to alleviate or mitigate substantial doubt: a. Asset sales: In conjunction with its rationalization and synergy program, the Company has a number of initiatives to simplify the number of businesses that the Company will focus on. As a result, the Company has identified a number of non-core assets that it has or would make available for sale, subject to appropriate terms and conditions in the circumstances. The Company has been active in discussions with interested parties and two of these initiatives are in the final stages of negotiation. The Company expects final binding agreements to be signed in April 2017 and closing to occur shortly thereafter. These two non-core assets sales are expected to contribute significant proceeds to the Company and would be used to fund the forecasted operating and capital investment requirements for HPDI commercialization. The Company continues to examine other assets to determine whether it is in the best interest of the Company to monetize these assets in the next year or continue to hold and invest in these assets. The Company’s decisions with respect to these assets may depend on its ability to raise additional financings as discussed below. The Company's Board of Directors has approved a sales process and timeline for the sale of certain assets in the event that the financing is not obtained when required. b. Maturing Debt: The holders of the CDN$55.0 million Debentures have the option to extend, a maximum of six times, the maturity date for an additional period of six months each time (i.e. if all extensions made, an additional three years) provided that greater than CDN $10.0 million of the aggregate principal amount of the Debentures remains outstanding. At the date of these financial statements, the Debenture holders have not elected to extend and have until August 1, 2017 to do so. The Company has engaged financial advisors to assist with alternative sources of funding. As of the date of these financial statements, the Company has held discussions and received interest including draft term sheets from potential lenders that would allow the Company to refinance a portion of the Debentures. In addition, the Company has initiated discussions with a representative of the Debenture holders on extending or replacing the Debentures with new financing. While there can be no assurance that the Company will be able to borrow on terms that are acceptable to the Company, management believes that it is probable that new loan(s) to refinance a portion of the Debentures, either with the Debenture holders or new lenders, will be entered into on a timely basis. Management is confident that the cash on hand at December 31, 2016 of $60.1 million, the estimated proceeds from the sales of non- core assets and the estimated proceeds from financing as discussed above will provide the cash flow necessary to fund operations over the next year to March 31, 2018 and as a result, Management has determined that substantial doubt has been alleviated by Management’s plans at a probable level of assurance. Management cautions the readers that there is no absolute assurance that the Company will be able to conclude all of the non- core assets sales and raise the financing necessary, under satisfactory terms and conditions, to continue as a going concern. If the Company was not to continue as a going concern, significant adjustments may be required to the carrying value of its assets and liabilities in the accompanying consolidated financial statements and the adjustments could be material. Merger Integration The process of the merger integration is underway, and significant achievements have been made to integrate the two businesses. Items to highlight are as follows: • The executive team is in place with Nancy Gougarty, CEO, Ashoka Achuthan, CFO, Andrea Alghisi, COO of the Automotive and Industrial divisions, Thom Rippon, CTO and EVP, Innovation Group and Jack Keaton, EVP, Innovation Group. • Facility integration and closures commenced and will continue as management assesses the various business lines and manufacturing facilities. Facilities in Argentina, China, the U.S. (New York, Plymouth, Sterling Heights and Union City) and Vancouver, Canada were either closed, sold, merged or in the case of Vancouver, a decision was made not to relocate into the new office space. An $11.8 million restructuring charge for these facility closures was recorded. The annual savings and costs avoided as a result of closed or vacant facilities are approximately $4.3 million annually (Note 14 "Restructuring" of our annual consolidated financial statements). • The closure of the New York office and the merger of two public companies to one public company was completed by September 30, 2016. This will result in savings in Board of Director fees, audit fees, insurance fees, listing fees, and personnel expenses. The annual savings are forecasted to be $4.4 million per year, excluding $0.5 million of rent, which is captured above. • The US Automotive business of Fuel Systems was merged into Westport Fuel Systems Dallas during the quarter ended September 30, 2016. WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT | 13 Management's Discussion and Analysis | Business Overview and General Developments • Reductions in workforce in the Corporate and Technology Investments group in Vancouver are forecasted to be annual savings of $2.5 million. A $4.0 million restructuring charge resulted from this reduction in workforce. • Our post merger integration task forces continue to review the business and operations to determine other synergies and efficiencies. Additionally, these task forces are capturing and consolidating restructuring actions of Westport and Fuel Systems that were underway at the time of the merger. Approximately $19 million in annual savings have been achieved to date. Total annual savings and merger synergies of $30 million are on track and expected to be achieved by 2018. • Inventory and accounts receivable have been reduced by $32.1 million from the second quarter of 2016 (first consolidated quarter of Westport Fuel Systems) to the fourth quarter of 2016. Working capital management will continue to be a top priority of the Company. HPDI Westport’s next generation of HPDI technology, Westport™ HPDI 2.0 will provide heavy duty vehicle and engine OEMs with a vertically integrated natural gas solution with competitive price and comparable performance, and fuel economy. Earlier generation natural gas engines for heavy duty trucks use spark ignition to initiate natural gas combustion, which reduces the high torque and fuel efficiency that is the hallmark of current diesel engines. Spark ignition uses a lower compression ratio and develops higher exhaust temperatures than the diesel engine upon which it is based, thereby requiring extensive changes of both internal and external engine components and, in most cases, changes to the vehicle’s powertrain and cooling systems. Like a diesel engine, Westport™ HPDI 2.0 system uses compression ignition to initiate combustion. Our fully integrated Westport™ HPDI 2.0 system matches the power, torque, and fuel economy and thermal characteristics of the base diesel engine, with minimal change to engine components. It is the only natural gas engine technology that can achieve thermal efficiency within 1% of current generation high efficiency heavy duty diesel engines, with inherently low methane emissions. Westport™ HPDI 2.0 system components are designed to integrate easily with modern, highly efficient diesel base engines, and have been developed and validated to meet the quality and durability standards required for heavy duty long haul trucks. A key component of the Westport™ HPDI 2.0 system is a new family of high pressure fuel injectors, co-developed with Delphi Automotive PLC, that is designed to provide better cost, smaller size and improved packaging compared to prior generation Westport™ HPDI injector designs. Westport’s cryogenic technologies enable the use of LNG for fuel storage on the vehicle, which results in smaller and lighter fuel tanks compared to CNG fuel storage systems. The Westport™ HPDI 2.0 system includes new LNG fuel 14 | WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT tanks and pumps that have been completely redesigned for reduced cost, improved quality and much higher durability than earlier generation LNG tank systems. A critical issue facing heavy duty truck OEMs is increasing pressure to reduce greenhouse gas emissions from their vehicles. In the U.S., the Environmental Protection Agency (“EPA”) and NHTSA jointly introduced new Greenhouse Gas and Fuel Efficiency Standards in August 2016. These new Standards require heavy duty truck OEMs to reduce the average greenhouse gas emissions from the trucks they sell by 25% from the current level by 2027. Similar standards are under consideration in other jurisdictions, including the European Union. to The Westport™ HPDI 2.0 system reduces greenhouse gas the equivalent diesel engine by emissions compared approximately 20% on a tank-to-wheels basis when using geologic natural gas. The system is also capable of using 100% renewable fuels, such as methane from landfill sites or municipal wastewater treatment sources, as well as a renewable diesel pilot fuel. When using these fuels, greenhouse gas emissions can be reduced by 80% or more compared to the equivalent diesel engine. OEMs have a choice from many technologies, including more efficient tires, intelligent transmissions, waste heat recovery and improved aerodynamics, all of which can contribute to the reduction of greenhouse gas emissions. But none of these technologies provides a 20%, or higher, reduction in greenhouse gases in a single step. The Company believes that our HPDI system will provide OEMs with an attractive option for their greenhouse gas reduction requirements. High-horsepower applications (16 litre or greater) including locomotives, mine-haul trucks, and marine vessels face similar regulatory pressure to reduce greenhouse gas emissions. These demanding engine applications consume large amounts of fuel and often operate in jurisdictions where LNG offers a significant cost advantage over diesel, thereby also providing more favourable economics for the use of natural gas. Westport Fuel Systems’ proprietary technologies for fuel storage and delivery such as the P200 cryogenic pump for high-volume applications like locomotive tenders and mine-haul trucks is an example of our innovation in natural gas fuel supply expertise. Our first Westport™ HPDI 2.0 customer, a European heavy duty truck OEM, will launch the first application of this technology into their heavy duty truck line in late 2017, with series production to start in early 2018. Product development for this program is now essentially complete, and we are currently engaged in the final validation of manufacturing processes and field testing with selected truck fleets. Operating Business Units As a result of the merger with Fuel Systems, we analyzed our operating segments and the principal focus of the operating business units are summarized below: Management's Discussion and Analysis | Business Overview and General Developments AUTOMOTIVE BUSINESS SEGMENT (PREVIOUSLY BRANDED AS WESTPORT OPERATIONS) The Westport Fuel Systems Automotive segment designs, manufactures and sells CNG & LPG components and systems for passenger cars, light-duty trucks and medium-duty vehicles including OEM, delayed OEM (“DOEM”) & Aftermarket segments. The portfolio of products includes pressure regulators, injectors, electronic control units, valves and filters, in addition to complete bi-fuel, mono-fuel and dual-fuel LPG and CNG conversion kits. The Automotive segment also designs, manufactures, and sells a wide range of CNG compressors and refueling systems, from BRC FuelMaker home appliance for individuals or small fleets, to complete refueling stations branded CUBOGAS. We serve more than 70 countries with a strong customer base in Europe, the Americas, Asia, and a growing presence in Africa. Products are either sold directly to the OEM or through a local distributor. We supply a large number of global OEMs including Volkswagen, Tata, GAZ, FCA, General Motors, Ford, Maruti Suzuki, Honda, Volvo Car, Hyundai, and Kia as well as Aftermarket distributors and customers. INDUSTRIAL BUSINESS SEGMENT The Westport Fuel Systems Industrial division designs and manufactures alternative fuel components and systems for off-road mobile and stationary equipment, and heavy-duty on-road vehicles as well as the development of complete emissions certified and non-certified engines for forklifts and other industrial equipment. In addition, our auxiliary power unit (“APU”) products for Class 8 diesel trucks and locomotives offer significant environmental benefits and cost of operation savings by reducing or displacing diesel fuel usage while these engines idle. Fuel system components and systems are primarily sold under the IMPCO, Beam-Garretson, and GFI brands, engines under the Westport Power brand and APU’s under the ComfortPro brand. Engines in forklifts, aerial platforms, sweepers, turf equipment, power generators and other industrial equipment have long been workhorses of developed countries and comprise a significant portion of our global business. With key jurisdictions seeking a broader consensus on the regulation of emission sources in an attempt to further reduce air pollution, many countries have legislated, and we believe will continue to legislate, emission standards for this type of equipment. Our industrial brands focus on serving the market with fuel systems, services and emission certified engine packages. With the imposition of new emissions regulations, OEMs will require advanced technologies that permit the use of gaseous fuels in order to satisfy not only new regulations but also their customers’ requirements for durability, performance and reliability. All of our products are designed, tested and validated in accordance with our own internal requirements, as well as tested and certified with major regulatory and safety agencies throughout the world, including Underwriters Laboratories in North America, TÜV in Europe, and the EPA and the California Air Resources Board (“CARB”) in the U.S.. CORPORATE AND TECHNOLOGY INVESTMENTS SEGMENT The Corporate & Technology Investments segment is responsible for current and advanced research and development programs, corporate oversight, and general administrative duties. Examples of our leading technologies include fully integrated combustion solutions, fuel injectors, and fuel storage and delivery solutions including cryogenics. The corporate oversight and general administrative functions for the Company are grouped under this unit. fuel economy. Developed Westport’s next generation of HPDI technology, Westport™ HPDI 2.0 will provide global vehicle and engine OEMs with a vertically integrated natural gas solution with attractive price, performance, to OEM quality standards, and Westport™ HPDI 2.0 system components are manufactured in partner facilities, offer ready integration into OEM operations globally. A key component of the Westport™ HPDI 2.0 system is a brand new family of high pressure fuel injectors, co-developed with Delphi, designed to provide better cost, smaller size and improved packaging compared to prior generation Westport™ HPDI injector designs. Westport and Delphi have entered into a joint development agreement which will combine our intellectual property and engineering strengths to co-develop and manufacture high- pressure natural gas fuel injectors designed for multiple engine OEMs. The family of injectors are developed with core components of Westport's HPDI 2.0 fuel system. CUMMINS WESTPORT INC. JOINT VENTURE CWI, our 50:50 joint venture with Cummins, Inc. ("Cummins"), serves the medium and heavy-duty on highway engine markets. CWI engines are offered by many OEMs for use in transit, school and shuttle buses, conventional trucks and tractors, and refuse collection trucks, as well as specialty vehicles such as short-haul port drayage trucks and street sweepers. CWI is the leading supplier of natural gas engines to the North American medium- and heavy- duty truck and transit bus industries. All CWI natural gas engines are dedicated 100% natural gas engines. The fuel for CWI engines can be carried in tanks on the vehicle as CNG or LNG. All engines are also capable of operating on up to 100% RNG. CWI is a Delaware corporation owned 50% by Westport Power Inc. ("WPI"), a wholly-owned subsidiary of Westport Fuel Systems, and 50% by Cummins. The board of directors of CWI is comprised of WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT | 15 Management's Discussion and Analysis | Business Overview and General Developments three representatives from each of Westport Fuel Systems and Cummins. On February 19, 2012, Westport Fuel Systems, Cummins and CWI entered into a Second Amended and Restated Joint Venture Agreement (the "Amended JVA") governing the operations of CWI which amended the focus of CWI's future product development investments to North American markets, including engines for on-road applications between the displacement range of 5.9 litres through 12 litres, and to have these engines manufactured in Cummins' North American plants. The purpose of the joint venture is to engage in the business of selling, marketing and developing spark-ignited natural gas or propane engines for on-highway use. CWI utilizes Cummins' supply chain, back office systems and distribution and sales networks. The joint venture term is scheduled to end on December 31, 2021. WEICHAI WESTPORT INC. JOINT VENTURE Weichai Westport inc. ("WWI") is a joint venture between Westport, Weichai Holding Group Co. Ltd. ("Weichai") and Hong Kong Peterson (CNG) Equipment Ltd. focusing on the Chinese market. WWI develops, manufactures and sells advanced, alternative fuel engines and parts that are widely used in city bus, coach, and heavy- duty truck applications in China or exported to other regions globally. On April 20, 2016, the Company sold a portion of its economic interest in WWI to Cartesian Capital Group ("Cartesian"), a related party, for an upfront payment of $6.3 million plus a potential future payment based on Cartesian's return on investment. A loss on sale of investment of $5.2 million was recognized in the quarter ended June 30, 2016. On August 20, 2016, the Company sold a portion of the investment to Weichai Power Co., Ltd and Weichai for $7.4 million and recognized a gain on sale of $2.7 million. In addition, the Company received a dividend of $3.2 million from WWI net of withholding taxes. Commencing April 20, 2016, the Company no longer has the ability to exercise significant influence over the joint venture and, therefore, with effect from that date accounts for its interest by the cost method. Adjustment to Financial Information The Company has adopted a change in accounting policy for warranties as adopted by the Company's joint venture, CWI. All comparative numbers have been adjusted to reflect the new policy. See Income from investments sections in this MD&A or note 8(a) in the consolidated financial statements for additional details. 16 | WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT Selected Annual Financial Information The following table sets forth a summary of our financial results for 2016, 2015 and 2014. The 2016 results include seven months results from Fuel Systems as a result of the merger. As reflected in the consolidated financial statements note 8(a), the net losses in 2015 and 2014 have been adjusted for a change in accounting policy at CWI. SELECT CONSOLIDATED STATEMENTS OF OPERATIONS DATA (expressed in millions of USD, except per share amounts and shares outstanding) Total revenue[1] Gross margin[2] GM % Net loss[3] Net loss per share —basic and diluted[3] Weighted average shares outstanding Years ended December 31 2015 (Adjusted) 2014 (Adjusted) 2016 $ 224.9 $ 103.3 $ 130.6 48.3 21.5% (97.6) (1.07) 18.1 17.5% (99.2) (1.55) 29.6 22.7% (148) (2.34) 91,028,504 64,109,703 63,130,022 1. 2016 revenue includes sales from Fuel Systems' business for the seven- month period since the June 1, 2016 merger. 2. Gross margin is calculated as revenue less cost of product revenue. The Company has modified current and prior years' gross margin to include manufacturing depreciation in cost of sales, which is the presentation historically adopted by Fuel Systems, that the Company has elected to adopt for the entire group. 3. Included in the year ended December 31, 2016 is a bargain purchase gain of $35.8 million related to the acquisition of Fuel Systems. The net losses for 2015 and 2014 have been adjusted to reflect the change in accounting policy adopted by CWI. See income from investments sections in this MD&A or note 8(a) in the consolidated financial statements for additional details on the change in accounting policy. The following table sets forth a summary of our financial position as at December 31, 2016 and December 31, 2015: SELECTED BALANCE SHEET DATA (expressed in millions of United States dollars) Dec 31, 2016 Dec 31, 2015 (Adjusted) Cash and short-term investments $ 60.9 $ Total assets 331.5 27.8 213.7 Long-term debt, including current portion Long-term royalty payable, including current portion Total Liabilities Shareholders' equity 79 62.5 21.6 246 85.4 — 142.1 71.6 Management's Discussion and Analysis | Selected Annual Financial Information The following table sets forth a summary of the financial results of CWI for 2016, 2015 and 2014. REVENUES (2016 / 2015) SELECTED CWI STATEMENTS OF OPERATIONS DATA (expressed in millions of U.S. dollars) Years ended Dec 31 2016 2015 Change $ % Automotive - Westport $ 86.9 $ 100.1 $ (13.2) (13)% (expressed in millions of United States dollars) Years ended Dec 31 2015 (Adjusted) 2014 (Adjusted) 2016 Automotive - Fuel Systems Total Automotive Total revenue Gross margin GM % $ 276.5 $ 331.9 $ 337.2 Industrial - Fuel Systems 77.1 101.4 71.7 27.9% 30.6% 21.3% Corporate and Technology Investments Net income before income taxes 16.7 48.1 26.2 CWI WWI Net income attributable to the Company 78.2 165.1 54.7 5.1 276.5 29.9 N/A 100.1 N/A 3.2 331.9 186.0 78.2 65.0 54.7 N/A 65 % N/A 1.9 59 % (55.4) (17)% (156.1) (84)% 5.6 16.3 9.8 Total segment revenues $ 531.3 $ 621.2 $ (89.9) (14)% Results from Operations Less: Equity investees' revenues Total consolidated revenues 306.4 517.9 (211.5) (41)% $ 224.9 $ 103.3 $ 121.6 118 % The following tables summarize results by segment for 2016, 2015 and 2014. Automotive Items Affecting Comparability of Results The year ended December 31, 2016 includes seven months of Fuel Systems' results and this is reported in the "Automotive - Fuel Systems" and "Industrial" segments in the tables below. In addition, WWI results are only included in total segment revenue for the three months ended March 31, 2016, as WWI has no longer been considered an operating segment in subsequent periods due to the Company's reduced interest pursuant to a sale to the Cartesian Capital Group (Cartesian). The Company’s 2015 income statement does not include any Fuel Systems results. However, where meaningful, information for Fuel Systems for the prior year has been provided for comparison purposes. Revenue 2016 / 2015 Total consolidated revenues increased $121.6 million, or 118% from $103.3 million in 2015 to $224.9 million in 2016. The following table summarizes revenues by segment for the year ended December 31, 2016 compared to the year ended December 31, 2015: Automotive revenue for the year ended December 31, 2016 was $165.1 million compared to $100.1 million for 2015. Total revenue includes sales from Fuel Systems' business for the seven-month period since the June 1, 2016 acquisition. Excluding the acquisition, Westport's automotive revenue declined 13% in 2016 compared to 2015. Approximately, 2% of this decrease is due to the decline in the Euro against the U.S. dollar. The remaining decrease is due to softness in the end markets of Europe, Argentina and the United States as a result of low oil prices and other factors impacting local economies. Fuel Systems' Automotive revenue for the seven months period since the acquisition through to December 31, 2016 was $78.2 million compared to $100.1 million for the same seven months period from 2015. Sales in Europe and Argentina have been impacted by lower exchange rates and softer end markets resulting from the decline in oil prices. Sales in the final quarter of 2016 were the strongest of the year as some stability returned to oil prices in the latter half of the year. Industrial Industrial revenue for the year ended December 31, 2016 was $54.7 million. This revenue is entirely from the Fuel Systems' business for the period since the June 1, 2016 acquisition and compares to $54.9 million for the seven months from the prior year. Corporate and Technology Investments Corporate and Technology Investments revenue for the year ended December 31, 2016 increased $1.9 million, or 59% from $3.2 million to $5.1 million. The increase is primarily driven by revenue generated through new OEM partnerships related to the Company's WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT | 17 Management's Discussion and Analysis | Results from Operations HPDI technology. The Company met several key milestones in relation to HPDI during 2016 with OEM partners. unfavourable impacts of foreign currency translation from the Euro to the US dollar equivalent. Corporate and Technology Investments Revenue for the year ended December 31, 2015 decreased $0.4 million or 11% from $3.6 million to $3.2 million. The decrease is primarily driven by unfavourable impacts of foreign currency translation from the Canadian to the US dollar equivalent. CWI CWI revenue for the year ended December 31, 2015 decreased $5.3 million, or 2% from $337.2 million to $331.9 million. CWI product revenue for the year ended December 31, 2015 decreased $9.6 million, or 3%, to $274.0 million on sales of 9,940 units compared to $283.6 million and 10,512 units for the year ended December 31, 2014, which was primarily attributed to the decline of the price of oil and other macroeconomic conditions. CWI parts revenue for the year ended December 31, 2015 was $57.8 million compared with $53.7 million for the year ended December 31, 2014 which was primarily attributed to the increase of natural gas engine population in service. WWI WWI revenue for the year ended December 31, 2015 decreased $432.5 million, or 70%, from $618.5 million to $186.0 million. WWI shipped 15,956 units in 2015 compared with 51,006 units for the year ended December 31, 2014. Westport’s WWI results were in- line with general market conditions in China and in-line with diesel truck sales. Truck demand remains subdued, as demonstrated by the decrease of recent monthly commercial vehicle sales in China year-over-year, according to China Association of Automotive Manufacturers ("CAAM"). Gross Margin 2016 / 2015 Total consolidated gross margin increased $30.2 million, or 167% from $18.1 million in 2015 to $48.3 million in 2016. The following table presents gross margin by segment for 2016 compared to 2015: CWI CWI revenue for the year ended December 31, 2016 decreased $55.4 million, or 17% from $331.9 million to $276.5 million. CWI product revenue for the year ended December 31, 2016 decreased $68.8 million, or 25%, to $205.2 million on sales of 7,232 units compared to $274.0 million and 9,940 units for the year ended December 31, 2015, which was primarily attributed to weak market demand caused by sustained lower oil prices and competition with higher efficiency diesel engines. CWI parts revenue for the year ended December 31, 2016 was $71.2 million compared with $57.8 million for the year ended December 31, 2015 which was primarily attributed to a higher engine population in service. 2015 / 2014 Total segment revenues decreased $465.1 million, or 43% from $1,086.3 million in 2014 to $621.2 million in 2015. The following table summarizes total revenue by segment for the years ended December 31, 2015 compared to the year ended December 31, 2014: REVENUES (2015 / 2014) Years ended Dec 31 2015 2014 Change % $ $ 100.1 $ 127.0 $ (26.9) (21)% 3.2 331.9 186.0 3.6 337.2 618.5 (0.4) (11)% (5.3) (2)% (432.5) (70)% $ 621.2 $ 1,086.3 $ 465.1 (43)% 517.9 955.7 (437.8) (46)% $ 103.3 $ 130.6 $ (27.3) (21)% (expressed in millions of U.S. dollars) Automotive - Westport Corporate and Technology Investments CWI WWI Total segment revenues Less: Equity investees' revenues Total consolidated revenues Automotive Automotive Westport revenue for the year ended December 31, 2015 decreased $26.9 million, or 21% from $127.0 million to $100.1 million. Automotive - Westport was impacted significantly by the decline in the price of oil and the strengthening of the US dollar. Revenue from European operations for the year ended December 31, 2015, including the Prins Autogassystemen Holding B.V. ("Prins") acquisition increased by €6.2 million, while revenue from North American operations decreased by approximately $17.1 million. The decrease in revenue from North American operations was driven by decreases in Westport's Ford qualified vehicle modifier ("QVM") business, decreased sales of Westport iCEPACK, and a decrease in engineering service contracts. A further decrease of approximately $12.0 million in revenue was driven by 18 | WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT Management's Discussion and Analysis | Results from Operations Change margin percentage would have been $15.6 million and 29%, respectively, compared to $15.1 million and 28% for the seven months from the prior year. GROSS MARGIN (2016 / 2015) Year ended Dec 31, 2016 % of Revenue Year ended Dec 31, 2015 (Adjusted) (1) % of Revenue $ % CWI $ 14.5 16.7% $ 14.9 14.9% $ (0.4) (3)% 15.3 19.6% N/A N/A 15.3 N/A 29.8 14.4 18.0% 26.3% 14.9 N/A 14.9% 14.9 100 % N/A 14.4 N/A Gross margin decreased $24.3 million to $77.1 million, or 27.9% of revenue for the year ended December 31, 2016, compared to $101.4 million or 30.6% of revenue, for the year ended December 31, 2015 as a result of a 27% decrease in engines sold during the period. 2015 / 2014 4.1 80.4% 3.2 100.0% 0.9 28 % 77.1 27.9% 101.4 30.6% (24.3) (24)% 3.0 10.0% 21.4 11.5% (18.4) (86)% $ 128.4 24.2% $ 140.9 22.7% $(12.5) (9)% Total consolidated gross margin decreased $11.5 million or 39% from $29.6 million in 2014 to $18.1 million in 2015. The following table presents gross margin by segment for 2015 compared to 2014: (expressed in millions of U.S. dollars) Automotive - Westport Automotive - Fuel Systems Total Automotive Industrial Corporate and Technology Investments CWI WWI Total segment gross margin Less: Equity investees' gross margin 80.1 26.1% 122.8 23.7% (42.7) (35)% Total consolidated gross margin $ 48.3 21.5% $ 18.1 17.5% $30.2 167 % 1. The net losses for 2015 have been adjusted to reflect the change in accounting policy adopted by CWI. See income from investments sections in this MD&A or [note 8a] in the consolidated financial statements for additional details on the change in accounting policy. Automotive Gross margin increased $14.9 million to $29.8 million,or 18.0% of revenue, for the year ended December 31, 2016 compared to $14.9 million or 14.9% of revenue for the year ended December 31, 2015. The increase in gross margin was a result of the merger with Fuel Systems. Excluding the merger and the decrease in 2016 inventory obsolescence provision compared to 2015, Automotive gross margin would have decreased by $3.6 million. The decrease is due to a 13% decrease in revenue and changes in product mix in our European businesses. Fuel Systems' gross margin includes $1.4 million for amortization of the inventory fair value adjustment recorded on acquisition. Excluding this adjustment, the gross margin and gross margin percentage would have been $16.7 million and 21%, respectively compared to $19.5 million and 19.5% for the seven months from the prior year. The increase in the gross margin percentage was the result of direct material cost reduction activities, restructuring of the US automotive business and lower warranty charges. Industrial Gross margin is entirely from the Fuel Systems' business for the period since the June 1, 2016 acquisition and includes $1.2 million for amortization of the inventory fair value adjustment recorded on acquisition. Excluding this adjustment, the gross margin and gross GROSS MARGIN (2015 / 2014) Year ended Dec 31, 2015 (Adjusted) (1) Year ended Dec 31, 2014 (Adjusted) (1) % of Revenue (Adjusted) (1) Change % of Revenue (Adjusted) $ (Adjusted) (1) % (Adjusted) $ 14.9 14.9% $ 26.0 20.5% $ (11.1) (43)% 3.2 100.0% 3.6 100.0% (0.4) (11)% 101.4 30.6% 21.4 11.5% 71.7 52.5 21.3% 29.7 41 % 8.5% (31.1) (59)% $ 140.9 22.7% $ 153.8 14.2% $ (12.9) (8)% 122.8 23.7% 124.2 13.0% (1.4) 1 % (expressed in millions of U.S. dollars) Automotive - Westport Corporate & Technology Investments CWI WWI Total segment gross margin Less: Equity investees' gross margin Total consolidated gross margin $ 18.1 17.5% $ 29.6 22.7% $ (11.5) (39)% 1. The net losses for 2015 and 2014 have been adjusted to reflect the change in accounting policy adopted by CWI. See Income from investments sections in this MD&A or note 8(a) in the consolidated financial statements for additional details on the change in accounting policy. Automotive - Westport Automotive - Westport gross margin decreased $11.1 million to $14.9 million, or 14.9% of revenue, for the year ended December 31, 2015 compared to $26.0 million, or 20.5% of revenue for the year ended December 31, 2014. The decrease in gross margin percentage is due to inventory obsolescence charges of $8.7 million in 2015 compared to $2.1 million in the prior year. Adjusted gross the margin would have been 23.6% of revenue without WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT | 19 Management's Discussion and Analysis | Results from Operations obsolescence, compared to 22.1% in the prior year. Gross margin also decreased due to lower revenue and changes in product mix. CWI CWI gross margin increased $29.7 million to $101.4 million, or 30.6% of revenue from $71.7 million or 21.3% of revenue for the year ended December 31, 2015. The increase in CWI gross margin percentage was due primarily to a favourable decrease in net warranty adjustments and net extended coverage claims compared to the year ended December 31, 2014. Reliability of the ISL G engine has continued to improve as a result of hardware and calibration changes. See Income from investments sections in this MD&A or note 8(a) in the consolidated financial statements for additional details on the change in accounting policy. WWI WWI gross margin decreased $31.1 million to $21.4 million, from $52.5 million. The decrease in gross margin relates to a decrease in the number of engines sold. Gross margin as a percentage of revenue increased from 8.5% to 11.5% as a result of changes in product mix and product pricing. Research & Development Expenses 2016 / 2015 The following table presents details of research and development (“R&D”) expense by segment for 2016 compared to 2015: RESEARCH & DEVELOPMENT (2016 / 2015) Years ended Dec 31 Change the Canadian to the US dollar equivalent. Automotive Fuel Systems R&D expenses decreased $1.3 million. Fuel Systems' Automotive R&D expense for the seven months ended December 31, 2016 was $5.7 million, compared to $7.0 million for the seven months from the prior year, a decrease of $1.3 million, due to restructuring and reduction in workforce at the US Automotive business. Industrial Industrial R&D expenses for the seven months since the Fuel Systems' acquisition during the year ended December 31, 2016 were $4.1 million compared to $4.0 million for the seven months from the prior year. Corporate and Technology Investments Corporate and Technology Investments research and development expenses increased $0.7 million from $39.2 million to $39.9 million as the Company prepares for the 2017 commercial launch of Westport™ HPDI 2.0. 2015 / 2014 The following table presents details of R&D expense by segment for the year ended December 31, 2015 compared to year ended December 31, 2014: RESEARCH & DEVELOPMENT (2015 / 2014) Years ended Dec 31 Change (expressed in millions of U.S. dollars) 2015 2014 $ % Automotive - Westport $ 13.6 $ 21.3 $ (7.7) (36)% Corporate and Technology Investments Total research and development 39.2 55.3 (16.1) (29)% $ 52.8 $ 76.6 $ (23.8) (31)% (expressed in millions of U.S. dollars) 2016 2015 $ % Automotive - Westport $ 9.7 $ 13.6 $ (3.9) (29)% Automotive 5.7 15.4 4.1 N/A 13.6 N/A 39.9 39.2 5.7 1.8 4.1 0.7 N/A 13 % N/A 2 % Automotive R&D expenses decreased $7.7 million due to reduction in program expenses, decreased headcount, and favorable impacts of foreign currency translation from the Euro and the Canadian to the US dollar equivalent. $ 59.4 $ 52.8 $ 6.6 13 % Corporate and Technology Investments Automotive - Fuel Systems Total Automotive Industrial - Fuel Systems Corporate and Technology Investments Total research and development Automotive Corporate and Technology Investments R&D expenses decreased $16.1 million from $55.3 million to $39.2 million due to reduction in program expenses, prioritizing of investment programs, decreased headcount and favorable impacts of foreign currency translation from the Canadian to the US dollar equivalent. Automotive Total Automotive R&D expenses for the year ended December 31, 2016 increased by $1.8 million primarily due to the R&D costs associated with Fuel Systems, offset by lower R&D costs of Westport. The Westport R&D expense decreased $3.9 million as a result of closing the Australia research facility in June 2016, reductions in program expenses, decreased headcount, and favorable impacts of foreign currency translation from the Euro and 20 | WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT Selling, General and Administrative Expenses 2016 / 2015 The following table presents details of Selling, General and Administrative (“SG&A”) expense by segment for 2016 compared to 2015: SELLING, GENERAL & ADMINISTRATIVE (2016 / 2015) Years ended Dec 31 Change (expressed in millions of U.S. dollars) 2016 2015 $ % Automotive - Westport $ 16.3 $ 18.3 $ (2.0) (11)% Automotive - Fuel Systems Total Automotive 11.8 N/A 11.8 $ 28.1 $ 18.3 $ Industrial - Fuel Systems 6.0 N/A N/A 54 % N/A 2 % 9.8 6.0 0.7 35.1 34.4 $ 69.2 $ 52.7 $ 16.5 31 % Corporate and Technology Investments Total selling, general and administrative Automotive Automotive SG&A expenses for the year ended December 31, 2016 increased by $9.8 million primarily due to the SG&A expenses from Fuel Systems offset by lower SG&A expense of Westport. Westport SG&A expenses decreased $2.0 million due to a reduction in workforce. Fuel Systems' Automotive SG&A expenses for the seven months ended December 31, 2016 was $11.8 million compared to $19.1 million for the seven months from the prior year, a decrease of $7.3 million due to restructuring and reduction in workforce of the US Automotive and Argentina businesses. Industrial Industrial SG&A expenses for the seven months ended December 31, 2016 were $6.0 million compared to $6.5 million for the seven months from the prior year. Corporate and Technology Investments Corporate and Technology Investments SG&A expenses increased $0.7 million due to an increase of $2.5 million relating to merger transaction costs compared to 2015, offset by lower salary expenses from our restructuring activities. 2015 / 2014 The following table presents details of SG&A expense by segment for the year ended December 31, 2015 compared to the year ended December 31, 2014: Management's Discussion and Analysis | Results from Operations SELLING, GENERAL & ADMINISTRATIVE (2015 / 2014) (expressed in millions of U.S. dollars) 2015 2014 $ % Years ended Dec 31 Change Automotive - Westport Corporate and Technology Investments Total selling, general and administrative Automotive SG&A $ 18.3 $ 30.5 $ (12.2) (40)% 34.4 35.3 (0.9) (3)% $ 52.7 $ 65.8 $ (13.1) (20)% Automotive SG&A expenses decreased $12.2 million due to decreased headcount and favorable impacts of foreign currency translation from the Euro and the Canadian to the US dollar equivalent. Corporate and Technology Investments Corporate and Technology Investments SG&A expenses decreased $0.9 million due to decreased headcount and favorable impacts of foreign currency translation from the Canadian to the US dollar equivalent. Within 2015 SG&A are costs of $4.5 million related to the merger between the Company & Fuel Systems. Without these merger costs, SG&A would have decreased 15.3% year over year. Restructuring Restructuring expenses recognized for the year ended December 31, 2016 were $19.0 million. Beginning in the third quarter of 2016, the Company initiated a series of restructuring activities which include the consolidation of facilities in Argentina, Canada, China and the United States. This resulted in an implementation of a reduction in workforce resulting in employee severance, onetime termination benefits and contract termination costs. Refer to the consolidated financial statements note 14 for additional details. Foreign Exchange Gains & Losses Foreign exchange gains and losses reflected net realized gains and losses on foreign currency transactions and the net unrealized gains and losses on our net U.S. dollar denominated monetary assets and liabilities in our Canadian operations that were mainly composed of cash and cash equivalents, short-term investments, accounts receivable and accounts payable. In addition, the Company has foreign exchange exposure on Euro denominated monetary assets and liabilities where the functional currency of the subsidiary is not the Euro. For the year ended December 31, 2016, we recognized a net foreign exchange loss of $6.4 million with the decline in the Canadian dollar and Euro relative to the U.S. dollar. A majority of the foreign exchange loss for the year ended December 31, 2016 is unrealized. WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT | 21 Management's Discussion and Analysis | Results from Operations For the year ended December 31, 2015, we recognized a net foreign exchange gain of $11.6 million with the movement in the Canadian dollar relative to the U.S. dollar. This compares to a net foreign exchange gain of $3.4 million for the year ended December 31, 2014. Depreciation & Amortization Depreciation and amortization for the year ended December 31, 2016 was $16.0 million compared to $13.7 million for the year ended December 31, 2015 and $18.7 million for the year ended December 31, 2014. The amount included in cost of sales was $4.7 million for the year ended December 31, 2016, $1.9 million for the year ended December 31, 2015 and $3.1 million for the year ended December 31, 2014. The increase in 2016 is due to the acquisition of Fuel Systems and consolidation of property, plant and equipment. Income From Investments Income from investments primarily relates to our 50% interest in CWI, accounted for by the equity method. Up until the end of the first quarter of 2016, the Company also recorded its 35% interest in WWI using the equity method; however, due to our sale of a portion of our economic interest in WWI on April 20, 2016, we no longer have the ability to exercise significant influence and, therefore, with effect from that date we account for our interest using the cost method. The decrease in income from investments results primarily from lower revenues and gross margins for CWI in the current year compared to the prior year and due to the change in accounting policy described below. During the fourth quarter of 2016, CWI changed its method for determining its warranty liability to exclude, from the estimated cost to settle claims, the parts margin it expects to earn on parts sold and used to service warranty claims. This change was accounted for as a change in accounting policy and the comparative balances were adjusted on a retrospective basis. The Company's income from investments, accumulated deficit and long-term investments have been adjusted to reflect this change in accounting policy. The effect of the change was to increase the income from investments in 2014 by $1.6 million, decrease the income from investments in 2015 by $0.8 million and decrease the income from investments in 2016 by $4.0 million. Opening accumulated deficit at January 1, 2014 was decreased by $3.2 million. 22 | WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT INCOME FROM INVESTMENT ACCOUNTED FOR BY THE EQUITY METHOD (expressed in millions of U.S. dollars) CWI – 50% interest income (loss) WWI Other Years ended Dec 31 2015 (Adjusted) 2014 (Adjusted) 2016 $ 5.6 $ 16.4 $ 0.2 — 1.0 0.2 9.8 6.0 0.1 Income from investment accounted for by the equity method $ 5.8 $ 17.6 $ 15.9 Interest On Long-term Debt and Amortization of Discount Expense Interest on long-term debt and amortization of discount expense primarily relates to our interest expense on Canadian dollar and Euro denominated debentures. INTEREST ON LONG-TERM DEBT & AMORTIZATION OF DISCOUNT EXPENSE (expressed in millions of U.S. dollars) Years ended Dec 31 2014 2015 2016 Canadian debentures – 9% per annum Senior financing facilities Convertible note – 9% per annum Amortization of discount and non- cash interest expense $ 3.7 $ 3.9 $ 0.7 0.9 5.5 0.9 — 0.7 Total Interest on long-term debt $ 10.8 $ 5.5 $ 3.7 1.6 — 0.5 5.8 Interest on long-term debt for the year ended December 31, 2016 of $10.8 million is higher compared to the year ended December 31, 2015 due to additional interest accrued on the convertible debt and the Cartesian royalty payable. Interest on long-term debt for the year ended December 31, 2015 of $5.5 million was lower compared to the year ended December 31, 2014 due to favorable impacts of foreign currency translation from the Euro and the Canadian to the US dollar equivalent. Bargain Purchase Gain Bargain purchase gain from acquisition of Fuel Systems was $35.8 million as the fair value of assets acquired and liabilities assumed exceeded the total of the transaction date fair value of consideration paid. Income Tax Expense Income tax expense for the year ended December 31, 2016 was $5.0 million compared to an income tax expense of $0.7 million for the year ended December 31, 2015 and an income tax recovery of $0.6 million for year ended December 31, 2014. The increase for the year ended December 31, 2016 primarily relates to higher distributable earnings from our investment in CWI. The increase in income tax expense for the year ended December 31, 2015 compared to the year ended December 31, 2014 primarily relates to lower distributable earnings from our investment in CWI and a recovery of the deferred income tax liability relating to the intangible and goodwill impairment charges. Capital Requirements, Resources and Liquidity This “Capital Requirements, Resources and Liquidity” section contains certain forward looking statements. By their nature, forward-looking statements require us to make assumptions and are subject to inherent risks and uncertainties. Readers are encouraged to read the “Forward Looking Statements” and “Basis of Presentation” sections of this MD&A, which discusses forward- looking statements and the “Business Risks and Uncertainties” section of this MD&A and of our AIF. Key elements to our continuing liquidity are refinancing our debt when it comes due and the sale of non-core assets. While our Automotive and Industrial divisions generate positive cash flows, these cash flows are not sufficient to offset the significant capital investment and research and development expenditures required to support our HPDI production start-up during 2017. The majority of the HPDI investment, both in terms of R&D and capital spend completes in 2017. At December 31, 2016, the Company's cash and cash equivalents and short term investments were $60.9 million and our longterm debt was $79.0 million, of which $48.1 million matures in 2017. The Company incurred significant recurring losses from operations as well as negative cash flows from operating activities during 2016, 2015 and 2014, and anticipates incurring additional losses and negative cash flows through 2017. See the Business Overview and General Developments section in this MD&A for further discussion on liquidity and going concern. Asset Sales During 2016, the Company completed the following significant asset sales: (i) The Company sold a portion of its economic interest in WWI to Cartesian and to Weichai related companies for $13.7 million. (See Management's Discussion and Analysis | Results from Operations note 8(b) "Weichai Westport Inc." of our consolidated financial statements). (ii) On July 29, 2016, the Company sold its test cell and other assets in Plymouth, Michigan for $12.2 million. A gain of $1.4 million was recorded on the sale. Further asset sales are expected as we continue to integrate Fuel Systems and align the two businesses. As at December 31, 2016, our cash, cash equivalents and short- term investment position was $60.9 million, an increase of $33.1 million from $27.8 million at December 31, 2015. Cash and cash equivalents consist of guaranteed investment certificates, term deposits and bankers acceptances with maturities of 90 days or less when acquired. Short-term investments consist of investment grade bankers’ acceptances, term deposits and commercial paper. We invest primarily in short-term paper issued by Schedule 1 Canadian banks, R1 high rated corporations and governments. The Company has sustained net losses since inception and as at December 31, 2016 has an accumulated deficit of $956.9 million. The Company’s ability to continue as a going concern is dependent on its available cash, its ability to find new sources of financing or raise cash through the sale of assets while in pursuit of operating profitability. There can be no assurance that the Company will be successful in achieving its objectives. Management believes that the cash balances available as of December 31, 2016, proceeds from asset sales, cost cutting measures and its ability to find new sources of financing, provide sufficient funds for the Company to meet its obligations beyond the next 12 months. The accompanying financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern. Cash Flow from Operating Activities We prepare our statement of cash flows using the indirect method. Under this method, we reconcile net loss to cash flows from operating activities by adjusting net loss for those items that impact net loss but may not result in actual cash receipts or payments during the period. These reconciling items include but are not limited to depreciation and amortization, stock-based compensation expense, unrealized from investments accounted for by the equity method, provisions for inventory reserves and doubtful accounts, and changes in the consolidated balance sheet for working capital from the beginning to the end of the period. foreign exchange gain, income 2016 COMPARED TO 2015 In 2016, our net cash flow used in operating activities was $79.6 million, an increase of $10.5 million from the net cash flow used in operating activities in the year ended December 31, 2015. The increase was primarily driven by our increased loss from operations. WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT | 23 Management's Discussion and Analysis | Capital Requirements, Resources & Liquidity 2. On January 11, 2016, The Company entered into a financing agreement with Cartesian to support the Company's global growth initiatives. The financing agreement immediately provided $17.5 million in cash (the “Tranche 1 Financing”). In consideration for the funds provided to the Company, Cartesian is entitled to royalty payments in respect of the Tranche 1 Financing based on the greater of (i) a percentage of amounts received by the Company on select high pressure direct injection systems and joint venture products in excess of agreed thresholds through 2025 and (ii) stated fixed amounts per annum (referred to as the long-term royalty payable). The carrying value is being accreted to the expected redemption value using the effective interest method, which is approximately 23% per annum. Throughout the entire term of these financing arrangements, the Company is required to meet certain financial and non-financial covenants. As of December 31, 2016, the Company is in compliance with all covenants under the financing arrangements. 3. The Company is obligated to repay funding received from Industrial Technologies Office ("ITO") in the form of royalties equal to the greater of $1.0 million (CDN $1.4 million) or 0.33% of the Company's gross annual revenue from all sources, including CWI, provided that gross revenue exceeds $10.1 million (CDN$13.5 million) in any aforementioned fiscal year, until the earlier of March 31, 2018 or until cumulative royalties total of $21.0 million (CDN$28.2 million) has been repaid. As at December 31, 2016, $2.6 million remains accrued in accounts payable and accrued liabilities (December 31, 2015 - $2.4 million). As at December 31, 2016, cumulative royalties of CDN $13.0 million have been paid. Shares Outstanding For the year ended December 31, 2016, the weighted average number of shares used in calculating the loss per share was 91,028,504. During the year ended December 31, 2016, we granted 684,402 RSUs and PSUs (together the “Share Units”). The Common Shares, share options and Share Units outstanding and exercisable as at the following dates are shown below: SHARES OUTSTANDING (weighted average exercise prices are presented in Canadian dollars) Common Shares outstanding Share Units Outstanding (1)(2) Exercisable Dec 31, 2016 Mar 30, 2017 Shares / units WAEP Shares / units WAEP 110,109,092 110,213,277 6,664,591 1,891,008 N/A N/A 6,453,457 2,288,156 N/A N/A 1. As at December 31, 2016, excludes 6,740 (March 30, 2017 - 0) of phantom share units, respectively, which when vested, are exercisable in exchange for a cash payment and do not result in the issuance of common shares. 2. As at December 31, 2016, includes 1,695,000 (March 30, 2017 - 1,670,000) PSUs with payout levels ranging between 0% and 150% upon achieving the required performance criteria over the measurement period. None of these PSUs are currently known to be issuable based on the prior achievement of the required 150% conversion ratio as at the date hereof, however such awards have not yet vested. CASH FLOW FROM INVESTING ACTIVITIES Our net cash from investing activities consisted primarily of cash acquired from the acquisition of Fuel systems, dividends received from joint ventures and the sale of assets and investments, offset by purchases of property, plant and equipment property (“PP&E”). 2016 COMPARED TO 2015 In 2016, our net cash flow received from investing activities was $76.6 million, an increase of $60.2 million. The acquisition of Fuel Systems during the period included $45.3 million of acquired cash which resulted in positive cash flows from investing activities. The sales of the Weichai investment and Plymouth plant asset also returned positive investment cash flows of $13.0 million and $11.7 million, respectively. Dividends received from joint ventures decreased by $7.1 million to $13.4 million, primarily as a result of lower revenue and profits at CWI. Cash Flow from Financing Activities 2016 COMPARED TO 2015 In 2016, Our net cash flow from financing activities increased compared to 2015 by $34.3 million, due to proceeds from the Cartesian financing: issuance of $17.5 million in the form of convertible debt and $17.5 million in royalties payable. In 2015, our net cash used for financing activities was $2.9 million, because our repayment of operating lines of credit and long term facilities was greater than our infusion of cash from drawing on operating lines of credit. CONTRACTUAL CASH FLOWS (expressed in millions of U.S. dollars) Carrying Amount Contractual Cash Flows < 1yr 1-3 yrs 4-5 yrs > 5 yrs Accounts payable and accrued liabilities Long-term debt, principal(1) Long-term debt, interest(1) Long-term royalty payable(2) Operating lease commitments Royalty payments (3) $ 93.2 $ 93.2 $ 93.2 — — — 79.0 79.7 48.8 4.4 22.2 4.3 — 11.7 4.9 3.9 2.7 0.2 21.6 46.0 1.5 9.6 16.8 18.1 10.8 57.0 9.3 16.8 10.8 20.0 2.6 3.8 0.1 3.8 — — $207.2 $ 291.4 $157.8 $ 38.5 $ 52.5 $ 42.6 1. For details of our long-term debt, principal and interest, see note 15 of the consolidated financial statements. 24 | WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT Management's Discussion and Analysis | Critical Accounting Policies & Estimates Critical Accounting Policies and Estimates Our consolidated financial statements are prepared in accordance with U.S. GAAP, which requires us to make estimates and assumptions that affect the amounts reported in our consolidated financial statements. We have identified several policies as critical to our business operations and in understanding our results of operations. These policies, which require the use of judgment, estimates and assumptions in determining their reported amounts, include our accounting of CWI as variable interest entity, warranty liability, revenue recognition, inventories, and property, equipment, furniture and leasehold improvements. The application of these and other accounting policies are described in Note 3 of our calendar year 2016 annual consolidated financial statements. Actual amounts may vary significantly from estimates used. Revenue Recognition The Company recognizes revenue upon transfer of title and risk of loss, generally when products are shipped provided there is (1) persuasive evidence of an arrangement, (2) there are no uncertainties regarding customer acceptance, (3) the sales price is fixed or determinable and (4) management believes collectibility is reasonably assured. The Company recognizes service revenue from research and development arrangements based on the contracts and the ability of the Company to measure its performance. Depending on the contract, revenues may be recognized using the milestone, percentage of completion, or completed contract methods of accounting. All costs incurred related to revenue earned from research and development contracts are recorded as research and development expense as incurred. Variable Interest Entities Inventories A variable interest entity (“VIE”) is any type of legal structure not controlled by voting equity but rather by contractual and/or other financial arrangements. Interests in VIEs are consolidated by the company that is the primary beneficiary. The Company’s interest in CWI is a VIE but it is determined that there is no primary beneficiary. Warranty Liability Estimated warranty costs are recognized at the time we sell our products and included in cost of revenue. We use historical failure rates and costs to repair product defects during the warranty period, together with information on known products to estimate the warranty liability. The ultimate amount payable and the timing will depend on actual failure rates and the actual cost to repair. We review our warranty provision quarterly and record adjustments to our assumptions based on the latest information available at that time. Since a number of our products are new in the market, historical data may not necessarily reflect actual costs to be incurred, and this exposes the Company to potentially significant fluctuations in liabilities and our statement of operations. New product launches require a greater use of judgment in developing estimates until claims experience becomes available. Product specific experience is typically available four or five quarters after product launch, with a clear experience trend not evident until eight to twelve quarters after launch. We generally record warranty expense for new products upon shipment using a factor based upon historical experience from previous engine generations in the first year, a blend of actual product and historical experience in the second year and product specific experience thereafter. Adjustments to and estimated future direct warranty costs are accrued and charged to cost of revenue in the period when the related revenues are recognized while indirect warranty overhead salaries and related costs are charged to cost of revenue in the period incurred. The Company’s inventories consist of the Company’s fuel system products (finished goods), work-in-progress, purchased parts and assembled parts. Inventories are recorded at the lower of cost and net realizable value. Cost is determined based on the lower of weighted average cost or first-in, first-out and net realizable value. The cost of fuel system product inventories, assembled parts and labour and production work-in-progress overhead including depreciation. The Company provides inventory write-downs based on excess and obsolete inventories determined primarily by future demand forecasts. In addition, the Company records a liability for firm, noncancelable, and unconditional purchase commitments with manufacturers for quantities in excess of the Company’s future demand forecast consistent with its valuation of excess and obsolete inventory. includes materials, Property, Plant and Equipment and Intangible Assets We consider whether or not there has been an impairment in our long-lived assets, such as equipment, furniture and leasehold improvements and intangible assets, whenever events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. If such assets are not recoverable, we are required to write down the assets to fair value. When quoted market values are not available, we use the expected future cash flows discounted at a rate commensurate with the risks associated with the recovery of the asset as an estimate of fair value to determine whether or not a write down is required. IMPAIRMENT OF PROPERTY, PLANT AND EQUIPMENT During the year ended December 31, 2016, the Company recorded an impairment charge of $2.7 million. The impairment resulted WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT | 25 Management's Discussion and Analysis | Critical Accounting Policies & Estimates primarily from the write-down of engineering test equipment. The method used to determine the fair value of the equipment was based on utilization of assets and was recorded in the Corporate and Technology segment. INTANGIBLE ASSETS Based on the revenue and operating results and decline in the oil price, the Company concluded there were impairment indicators as of November 30, 2016 and November 30, 2015 requiring the performance of a long-lived assets impairment test for customer contracts, technology and other intangibles. The Company completed its assessments at November 30, 2016 and November 30, 2015 respectively and concluded that intangible assets were not impaired. New Accounting Pronouncements and Developments Adopted in 2016 GOING CONCERN In August 2014, the FASB issued ASU 2014-15. Presentation of Financial Statements - Going Concern provides guidance about management’s responsibility is substantial doubt about an entity’s ability to continue as a going concern, along with the required disclosures. to evaluate whether there CHANGE IN ACCOUNTING POLICY As previously noted, CWI changed its method for determining its warranty liability to exclude, from the estimated cost to settle claims, the parts margin it expects to earn on parts sold and used to service warranty claims. These changes were accounted for as change in accounting policy and the comparative balances were restated on a retrospective basis. The Company's income from investments, accumulated deficit and long-term investments balances have been adjusted to reflect this change in accounting policy. To Be Adopted In The Future REVENUE In May 2014, Financial Accounting Standards Board (“FASB”) issued ASU 2014-09, Revenue From Contracts With Customers (“Topic 606”). Topic 606 removes inconsistencies and weaknesses in revenue accounting requirements, provides a more robust framework for addressing revenue issues, improves comparability of revenue recognition practices across entities, industries, 26 | WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT jurisdictions and capital markets, provides more useful information to users of financial statements through improved disclosure requirements and simplifies the preparation of financial statements by reducing the number of requirements to which an entity must refer. The guidance in this update supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific guidance throughout the Industry Topics of the Codification. Topic 606 is effective for public entities with reporting periods beginning after December 15, 2017. The Company is evaluating the impact of this new standard to the financial statements. SIMPLIFYING THE MEASUREMENT OF INVENTORY (TOPIC 330) In July 2015, the FASB issued ASU 2015-11, which requires an entity to measure inventory at the lower of cost or net realizable value, which consists of the estimated selling prices in the ordinary course of business, less reasonably predictable cost of completion, disposal, and transportation. For public entities, the updated guidance is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The guidance is to be applied prospectively with earlier application permitted as of the beginning of an interim or annual reporting period. The Company does not anticipate a material impact to the Company’s financial statements as a result of this change. INVENTORY LEASES (TOPIC 842) In February 2016, the FASB issued ASU 2016-02, which increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, and interim periods within those years for public business entities with early adoption permitted. The Company has not yet evaluated the impact of the adoption of this new standard. STATEMENT OF CASH FLOWS (TOPIC 230): CLASSIFICATION OF CERTAIN CASH RECEIPTS AND CASH PAYMENTS In August 2016, the FASB issued ASU 2016-15, which provides cash flow classification guidance on eight specific cash flow issues to reduce diversity in practice for which authoritative guidance did not previously exist. ASU 2016-15 is effective for public entities in annual and interim periods in fiscal years beginning after December 15, 2017, with early adoption permitted. The Company does not anticipate a material impact to the Company's financial statements as a result of this change. Management's Discussion and Analysis | Disclosure Controls & Procedures Disclosure Controls and Procedures and Internal Controls Over Financial Reporting Evaluation of Disclosure Controls and Procedures Our disclosure controls and procedures are designed to provide reasonable assurance that relevant information is gathered and reported to senior management, including the Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”), on a timely basis such that appropriate decisions can be made regarding public disclosures. As of the end of the period covered by this report, we evaluated, under the supervision and with the participation of management, including the CEO and CFO, the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (“Exchange Act”). The CEO and CFO have concluded that as of December 31, 2016, our disclosure controls and procedures were effective to ensure that information required to be disclosed in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified therein and accumulated and reported to management to allow timely discussions regarding required disclosures. Management's Report On Internal Control Over Financial Reporting The Company's management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) promulgated under the Exchange Act. Our internal control over financial reporting is designed under our supervision, and affected by the Company’s board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s consolidated financial statements for external reporting purposes in accordance with U.S. GAAP and the requirements of the SEC, as applicable. There are inherent limitations in the effectiveness of internal control over financial reporting, including the possibility that misstatements may not be prevented or detected. Accordingly, even effective internal controls over financial reporting can provide only reasonable assurance with respect financial statement preparation. Furthermore, the effectiveness of internal controls can change with circumstances. to All internal control systems, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues have been detected. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under potential future conditions, regardless of how remote. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Management, including the CEO and CFO, has evaluated the effectiveness of our internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act, in relation to criteria described in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on this evaluation, management has determined that our internal control over financial reporting was effective as of December 31, 2016. KPMG LLP, our independent registered public accounting firm, has audited our consolidated financial statements and expressed an unqualified opinion thereon. KPMG has also expressed an unqualified opinion on the effective operation of our internal control over financial reporting as of December 31, 2016. KPMG's audit report on effectiveness of internal control over financial reporting is included in the consolidated financial statements of this filing. WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT | 27 Management's Discussion and Analysis | Summary of Quarterly Results Summary of Quarterly Results Discussion of The Quarter Ended December 31, 2016 Our revenues and operating results can vary significantly from quarter to quarter depending on the timing of product deliveries, product mix, acquisitions, product launch dates, research and development project cycles, timing of related government funding, impairment charges, stock- based compensation awards and foreign exchange impacts. Net loss has and can vary significantly from one quarter to another depending on operating results, gains and losses from investing activities, recognition of tax benefits and other similar events. The following table provides summary unaudited consolidated financial data for our last eight quarters: SELECTED CONSOLIDATED QUARTERLY OPERATIONS DATA (unaudited and adjusted(5)) (expressed in millions of United States dollars except for per share amounts) 2015 2016 Three months ended: Mar 31 Jun 30 Sep 30 Dec 31 Mar 31 Jun 30(1) Sep 30 Dec 31 Product revenue Service and other revenue Total revenue Cost of product and parts revenue(2) Gross margin Gross margin percentage Net loss for the period EBITDA(3) Adjusted EBITDA(4) Loss per share Basic Diluted Income from unconsolidated joint ventures CWI net income attributable to the Company(5) WWI net income attributable to the Company $ 27.0 $ 24.6 $ 21.3 $ 24.9 $ 23.5 $ 44.0 $ 73.5 $ 79.5 1.0 28.0 23.1 3.2 27.8 18.6 1.0 22.3 21.5 0.2 25.1 22.1 0.5 24.0 17.6 4.9 $ 9.2 $ 0.8 $ 3.0 $ 6.4 $ 0.4 44.4 34.4 10.0 17.5% 33.1% 3.6% 12.0% 26.7% 22.5% (17.4) $ (20.1) $ (37.2) $ (24.5) $ (24.6) $ 3.7 (11.9) $ (14.4) $ (32.3) $ (20.5) $ (19.3) $ 10.6 2.6 76.1 62.8 13.3 $ 0.9 80.4 61.8 18.6 17.5% 23.1% (33.5) $ (43.2) (24.0) $ (31.6) $ $ $ (9.4) $ (7.3) $ (9.6) $ (13.5) $ (11.9) $ (10.3) $ (7.8) $ (9.1) (0.27) $ (0.31) $ (0.58) $ (0.38) $ (0.38) $ (0.27) $ (0.31) $ (0.58) $ (0.38) $ (0.38) $ 0.05 0.04 $ $ (0.31) $ (0.43) (0.31) $ (0.43) 5.7 0.3 $ $ 3.8 0.1 $ $ 3.7 0.1 $ $ 3.1 0.5 $ $ 0.5 0.2 $ 1.5 $ 2.8 $ 0.8 — — — $ $ $ $ $ $ $ $ 1. Includes the one month period of results from the merger with Fuel Systems and a bargain purchase gain of $42.9 million for the three months ended June 30, 2016, and further reduced by $7.1 million to $35.8 million for the three months ended December 31, 2016. 2. The Company has modified current and prior quarters' gross margin to include manufacturing depreciation in cost of sales, which is the presentation historically applied by Fuel Systems that the Company has elected to adopt for the entire group. 3. The term EBITDA (earnings before interest, taxes, depreciation and amortization) does not have a standardized meaning according to U.S. GAAP. See non- GAAP measures for more information. 4. The term Adjusted EBITDA is not defined under U.S. GAAP and is not a measure of operating income, operating performance or liquidity presented in accordance with U.S. GAAP. Westport Fuel Systems defines Adjusted EBITDA as EBITDA adjusted for amortization of stock-based compensation, unrealized foreign exchange gain or loss, and non-cash and other adjustments. See non-GAAP measures for more information. 5. The Company's income from investments, retained earnings and long-term investments have also been adjusted to reflect a change in accounting policy in its joint venture, CWI. See consolidated financial statements note 8(a). Three Months Ended December 31, 2016 & 2015 Our consolidated revenue for the three months ended December 31, 2016 was $80.4 million, a increase of $55.3 million, or 220.3%, from $25.1 million for the three months ended December 31, 2015. The increase in revenue was primarily a result of the merger with Fuel Systems. Our consolidated net loss for the three months ended December 31, 2016 was $43.2 million, or a loss of $0.43 per share compared to a net loss of $24.5 million, or a loss of $0.38 per share, for the three months ended December 31, 2015. The increase in net loss primarily relates to higher operating costs in 2016 as a result of the merger, an adjustment to the bargain purchase gain recorded in the fourth quarter of 2016 and lower income from investments. Non-GAAP Measures We use certain non-GAAP measures to assist in assessing our financial performance. Non-GAAP measures do not have any standardized meaning prescribed in U.S. GAAP and are therefore unlikely to be comparable to similar measures presented by other companies. 28 | WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT Management's Discussion and Analysis | Summary of Quarterly Results EBITDA The term EBITDA (earnings before interest, taxes, depreciation and amortization) is a non-GAAP financial measure. The Company defines EBITDA as loss before income taxes adjusted for interest expense (net) and depreciation and amortization. Management believes that EBITDA is an important indicator commonly reported and widely used by investors and analysts as an indicator of the Company’s operating performance and ability. The intent is to provide additional useful information to investors and analysts and such measures do not have any standardized meaning under U.S. GAAP. These measures should not be considered in isolation or as a substitute for measures of performance prepared in accordance with U.S. GAAP. Other issuers may define EBITDA differently. QUARTERLY EBITDA DATA 2015 2016 Three months ended: Mar 31 Jun 30 Sep 30 Dec 31 Mar 31 Jun 30 Sep 30 Dec 31 Loss before income taxes Interest expense, net(1) Depreciation EBITDA $ $ (16.9) $ (19.5) $ (37.0) $ (25.1) $ (24.7) $ 4.2 $ (32.3) $ (39.8) 1.4 3.6 1.6 3.5 1.4 3.3 1.3 3.3 2.3 3.1 2.7 3.7 3.1 5.2 4.3 3.9 (11.9) $ (14.4) $ (32.3) $ (20.5) $ (19.3) $ 10.6 $ (24.0) $ (31.6) 1. Interest expense, net is defined as the aggregate of bank charges, interest, and other, interest on long term-debt and amortization of discount. EBITDA decreased by $6.6 million from a loss of $24.0 million for the three months ended September 30, 2016 to a loss of $31.6 million in the three months ended December 31, 2016 primarily as a result of an adjustment to the bargain purchase gain recorded in the fourth quarter of 2016 and lower income from investments. Adjusted EBITDA The terms EBITDA and Adjusted EBITDA are not defined under U.S. GAAP and are not measures of operating income, operating performance or liquidity presented in accordance with U.S. GAAP. Adjusted EBITDA is used by management to review operational progress of its business units and investment programs over successive periods and as a long-term indicator of operational performance since it ties closely to the unit’s ability to generate sustained cash flows. QUARTERLY ADJUSTED EBITDA DATA Three months ended: Mar 31 Jun 30 Sep 30 Dec 31 Mar 31 Jun 30 Sep 30 Dec 31 $ (11.9) $ (14.4) $ (32.3) $ (20.5) $ (19.3) $ 10.6 $ (24.0) $ (31.6) 2015 2016 EBITDA Stock based compensation Unrealized foreign exchange (gain) loss Goodwill impairment Asset impairment Inventory impairment from product line closure Bargain purchase gain Merger and financing costs Amortization fair value inventory adjustment recorded on acquisition (Gain) loss on sale of investments Loss on disposal of assets Restructuring, termination and other exit costs Other Adjusted EBITDA 3.5 0.5 4.0 1.3 2.3 4.1 2.9 (7.1) 3.4 (2.9) 4.7 (1.2) 3.3 3.3 (8.0) 18.7 5.5 3.2 1.3 2.1 2.0 0.3 0.8 1.0 4.3 0.4 1.9 (3.9) 17.5 0.2 (42.9) 4.5 0.7 6.3 4.1 1.2 8.1 2.7 1.3 7.1 (0.3) 1.5 0.9 $ (9.4) $ (7.3) $ (9.6) $ (13.5) $ (11.9) $ (10.3) $ (7.8) $ (9.1) 1. The Company's income from investments, retained earnings and long-term investments have also been adjusted to reflect a change in accounting policy in its joint venture, CWI. See consolidated financial statements note 8(a). WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT | 29 Management's Discussion and Analysis | Summary of Quarterly Results The Company defines Adjusted EBITDA as EBITDA adjusted for stock-based compensation, unrealized foreign exchange gain or loss, and non-cash and other unusual adjustments. Adjusted EBITDA has limitations as an analytical tool, and when assessing the Company’s operating performance, investors should not consider Adjusted EBITDA in isolation, or as a substitute for net loss or other consolidated statement of operations data prepared in accordance with U.S. GAAP. Among other things, Adjusted EBITDA does not reflect the Company’s actual cash expenditures. Other companies may calculate similar measures differently than Westport Fuel Systems, limiting their usefulness as comparative tools. The Company compensates for these limitations by relying primarily on its U.S. GAAP results. Related Party Transactions Related party balances and transactions have increased due to the Cartesian financing and acquisition of Fuel Systems. See Note 20 of the Consolidated financial statements as at December 31, 2016 for details of related party transactions. Subsequent Events On March 24, 2017, the Company renegotiated its €10.0 million senior revolving financing facility with annual payments on the principal ranging from €0.7 million to €2.2 million until the loan is paid off in full on December 31, 2022. See note 15(b) of the consolidated financial statements for details. Business Risks And Uncertainties An investment in our business involves risk and readers should carefully consider the risks described in our AIF and other filings on www.sedar.com and www.sec.gov. Our ability to generate revenue and profit from our technologies is dependent on a number of factors, and the risks discussed in our AIF, if they were to occur, could have a material impact on our business, financial condition, liquidity, results of operation or prospects. While we have attempted to identify the primary known risks that are material to our business, the risks and uncertainties discussed in our AIF may not be the only ones we face. Additional risks and uncertainties, including those that we do not know about now or that we currently believe are immaterial may also adversely affect our business, financial condition, liquidity, results of operation or prospects. A full discussion of the risks impacting our business is contained in the AIF for the year ended December 31, 2016 under the heading “Risk Factors” and is available on SEDAR at www.sedar.com. 30 | WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT Reports Independent Auditors’ Report Of Registered Public Accounting Firm To the Shareholders of Westport Innovations Inc. We have audited the accompanying consolidated financial statements of Westport Innovations Inc., which comprise the consolidated balance sheet as at December 31, 2015, the consolidated statements of operations and comprehensive income, shareholders’ equity and cash flows for the years ended December 31, 2015 and December 31, 2013 and notes, comprising a summary of significant accounting policies and other explanatory information. Management’s Responsibility for the Consolidated Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with U.S. generally accepted accounting principles, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditors’ Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards and the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on our judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, we consider internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by Reports management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of Westport Innovations Inc. as at December 31, 2015, and its consolidated results of operations and its consolidated cash flows for the years ended December 31, 2015 and December 31, 2013, in accordance with US generally accepted accounting principles. Comparative Information Without modifying our opinion, we draw attention to [Note 3(a)] to the consolidated financial statements which indicates that the comparative information presented as at and for the year ended December 31, 2014 has been adjusted for the adoption of new accounting standards in 2015. The consolidated financial statements of Westport Innovations Inc. as at and for the year ended December 31, 2014, excluding the adjustments described in [Note 3(a)] to the consolidated financial statements, were audited by another auditor who expressed an unmodified opinion on those financial statements on March 9, 2015 (October 15, 2015 as to the change in reportable segments discussed in [Note 23] to the consolidated financial statements). As part of our audit of the consolidated financial statements as at and for the year ended December 31, 2015, we audited the adjustments described in [Note 3(a)] to the consolidated financial statements that were applied to adjust the comparative information presented as at and for the year ended December 31, 2014. In our opinion, the adjustments are appropriate and have been properly applied. We were not engaged to audit, review, or apply any procedures to the December 31, 2014 consolidated financial statements, other than with respect to the adjustments described in [Note 3(a)] to the consolidated financial statements. Accordingly, we do not express an opinion or any other form of assurance on those financial statements taken as a whole. Other Matter We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Westport Innovations Inc.’s internal control over financial reporting as of December 31, 2015, based on the criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO"), and our report dated March 29, 2016 expressed an unmodified (unqualified) opinion on the effectiveness WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT | 31 Reports of Westport Innovations Inc.’s internal control over financial reporting. KPMG LLP, Chartered Professional Accountants, March 29, 2016, Vancouver, Canada Report Of Independent Registered Public Accounting Firm To the Shareholders of Westport Innovations Inc. We have audited Westport Innovations Inc.’s (“the Company”) internal control over financial reporting as of December 31, 2015, based on the criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring the Treadway Commission (COSO). The Organizations of Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included the accompanying “Management’s Report on Financial in Statements and Assessment of Internal Control over Financial Reporting”. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that 1. pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; 32 | WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT 2. provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and 3. provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2015, based on the criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). We also have audited, in accordance with Canadian generally accepted auditing standards and the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of the Company as of December 31, 2015, and the consolidated statements of operations and comprehensive income, shareholders’ equity and cash flows for the years ended December 31, 2015 and December 31, 2013 and our report dated March 29, 2016 expressed an unqualified opinion on those consolidated financial statements. KPMG LLP, Chartered Professional Accountants, March 29, 2016, Vancouver, Canada Report Of Independent Registered Public Accounting Firm To the Board of Directors and Shareholders of Westport Innovations Inc. We have audited, before the effects of the adjustments to retrospectively apply accounting standards adopted in 2015 as discussed in Note 3 to the consolidated financial statements, the accompanying consolidated financial statements of Westport Innovations Inc. and subsidiaries (the “Company”), which comprise the consolidated balance sheet as of December 31, 2014, and consolidated statements of operations and comprehensive (loss) income, changes in shareholders’ equity and cash flows for the year ended December 31, 2014 and a summary of significant accounting policies and other explanatory information, (the 2014 consolidated financial statements before the effects of the adjustments discussed in [Note 3] to the consolidated financial statements are not presented herein). Management's Responsibility for the Consolidated Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditor’s Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with Canadian generally accepted auditing standards and the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor's judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity's preparation and fair presentation of the consolidated financial statements in order the in to design audit procedures the includes evaluating circumstances. An audit also appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. that are appropriate We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, such 2014 consolidated financial statements, before the effects of the adjustments to retrospectively apply accounting standards adopted in 2015 as discussed in [Note 3] to the Reports consolidated financial statements, present fairly, in all material respects, the financial position of Westport Innovations Inc. and subsidiaries as at December 31, 2014, and its financial performance and its cash flows for the year ended December 31, 2014 in accordance with accounting principles generally accepted in the United States of America. Other Matter We were not engaged to audit, review, or apply any procedures to the adjustments to retrospectively apply accounting standards adopted in 2015 as discussed in [Note 3] to the consolidated financial statements and, accordingly, we do not express an opinion on any other form of assurance about whether such retrospective adjustments are appropriate and have been properly applied. Those retrospective adjustments were audited by other auditors. /s/ Deloitte LLP Chartered Professional Accountants, Vancouver, Canada March 9, 2015 (October 15, 2015 as to the change in reportable segments discussed in [Note 23] to the consolidated financial statements) WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT | 33 Consolidated Financial Statements Consolidated Financial Statements CONSOLIDATED BALANCE SHEET (expressed in thousands of United States dollars, except share amounts) 2016 2015 (Adjusted, [note 8]) ASSETS Current Assets Cash and cash equivalents Short-term investments Accounts receivable [note 6] Inventories [note 7] Prepaid expenses Long-term investments [note 8] Property, plant and equipment [note 10] Intangible assets [note 11] Deferred income tax assets [note 19b] Goodwill [note 12] Other long-term assets LIABILITIES & SHAREHOLDERS’ EQUITY Current Liabilities Accounts payable and accrued liabilities [note 13] Current portion of restructuring obligation [note 14] Current portion of deferred revenue Current portion of long-term debt [note 15] Current portion of royalty payable [note 16] Current portion of warranty liability [note 17] Restructuring obligation [note 14] Deferred revenue Long-term debt [note 15] Long-term royalty payable [note 16] Warranty liability [note 17] Deferred income tax liabilities [note 19b] Other long-term liabilities SHAREHOLDERS' EQUITY Share capital [note 18] Authorized: Unlimited common shares, no par value Unlimited preferred shares in series, no par value Issued: 110,109,092 (2015 – 63,380,819) common shares Other equity instruments Additional paid in capital Accumulated deficit Accumulated other comprehensive income COMMITMENTS AND CONTINGENCIES [note 21] $ $ $ 60,057 $ 848 77,178 70,624 5,055 213,762 13,422 59,682 22,858 3,767 2,923 15,046 331,460 $ 93,245 $ 5,408 4,656 48,097 1,500 6,834 159,740 8,715 3,559 30,935 20,062 6,936 9,803 6,272 246,022 1,042,410 20,926 10,079 (956,890) (31,087) 85,438 27,143 696 38,324 35,660 3,475 105,298 35,142 42,527 22,307 2,538 3,008 2,863 213,683 57,454 — 1,779 8,257 — 5,554 73,044 — 1,513 54,190 — 8,437 3,570 1,302 142,056 937,029 16,460 9,837 (859,317) (32,382) 71,627 See accompanying notes to consolidated financial statements. Approved on behalf of the Board: Brenda J. Eprile Director Warren Baker Director $ 331,460 $ 213,683 34 | WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT Financial Statements | Consolidated Statements of Operations & Comprehensive Income (Loss) CONSOLIDATED STATEMENTS OF OPERATIONS & COMPREHENSIVE INCOME (LOSS) (expressed in thousands of United States dollars, except share and per share amounts) Years ended December 31 2016 2015 (Adjusted, [note 8]) 2014 (Adjusted, [note 8]) Product revenue Service and other revenue COST OF REVENUE & EXPENSES Cost of product revenue Research and development General and administrative Sales and marketing Restructuring, termination and other exit costs [note 14] Foreign exchange (gain) loss Depreciation and amortization [note 10] [note 11] Impairment of long lived assets, net [note 8] [note 10] [note 11] [note 12] Provision for inventory purchase commitments [note 21b] Loss from operations Income from investments accounted for by the equity method Interest on long-term debt and amortization of discount Bargain purchase gain from acquisition (note 5) Interest and other income (expense), net of bank charges Loss before income taxes INCOME TAX EXPENSE (RECOVERY) [note 19] Current Deferred $ 220,448 $ 97,844 $ 4,407 224,895 176,552 59,413 48,204 20,949 19,000 6,408 11,308 4,843 — 346,675 (121,780) 5,838 (10,773) 35,808 (1,656) (92,563) 2,002 3,008 5,010 5,460 103,304 85,232 52,777 35,201 17,496 — (11,601) 11,736 22,722 — 213,563 (110,259) 17,551 (5,529) (186) (98,423) 1,245 (514) 731 118,015 12,554 130,569 101,053 76,580 40,319 25,489 — (3,433) 15,536 29,604 4,106 289,254 (158,685) 15,863 (5,849) 114 (148,557) 606 (1,185) (579) Net loss for the year OTHER COMPREHENSIVE INCOME (LOSS) Cumulative translation adjustment Comprehensive loss LOSS PER SHARE Basic and diluted $ $ $ (97,573) $ (99,154) $ (147,978) (1,295) (16,889) (96,278) $ (116,043) $ (15,201) (163,179) (1.07) $ (1.55) $ (2.34) WEIGHTED AVERAGE COMMON SHARES OUTSTANDING Basic and diluted 91,028,504 64,109,703 63,130,022 See accompanying notes to consolidated financial statements. WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT | 35 Financial Statements | Consolidated Statements of Shareholders' Equity CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (expressed in thousands of United States dollars, except share amounts) Common shares outstanding Share capital Other equity instruments Additional paid in capital Accumulated deficit Accumulated other comprehensive income (loss) Total shareholders' equity January 1, 2014 (Adjusted [note 8]) 62,733,762 $ 916,497 $ 13,834 $ 8,205 $ (612,185) $ (292) $ 326,059 Issue of common shares: On exercise of stock options 43,071 374 — (132) On exercise of share units 608,975 10,701 (10,701) In connection with acquisition 94,914 3,285 Stock-based compensation Net loss for the year Other comprehensive loss — — — — — — (3,285) 7,919 — — — — 1,764 — — — — — — (147,978) — December 31, 2014 (Adjusted [note 8]) 63,480,722 930,857 7,767 9,837 (760,163) Issue of common shares: On exercise of share units In connection with acquisition Stock-based compensation Net loss for the year Other comprehensive loss 575,024 325,073 — — — 5,010 1,162 — — — (5,010) — 13,703 — — — — — — — — — — (99,154) — December 31, 2015 (Adjusted [note 8]) 64,380,819 937,029 16,460 9,837 (859,317) Issue of common shares: On exercise of share units 845,491 6,639 (6,639) In connection with acquisition Beneficial conversion feature on convertible debt Stock-based compensation Net loss for the year Other comprehensive loss DECEMBER 31, 2015 44,882,782 98,742 655 — — — — — — 10,450 — — — — — (97,573) — — 242 — — — — 1,295 110,109,092 $ 1,042,410 $ 20,926 $ 10,079 $ (956,890) $ (31,087) $ 85,438 — — — — — (15,201) (15,493) — — — — (16,889) (32,382) — — — — 242 — — 9,683 (147,978) (15,201) 172,805 — 1,162 13,703 (99,154) (16,889) 71,627 — 99,397 242 10,450 (97,573) 1,295 See accompanying notes to consolidated financial statements. 36 | WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT Financial Statements | Consolidated Statements of Cash Flows Years ended December 31 2015 (Adjusted [note 8]) 2014 (Adjusted [note 8]) 2016 $ (97,273) $ (99,154) $ (147,978) CONSOLIDATED STATEMENTS OF CASH FLOWS CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES (expressed in thousands of United States dollars) Net loss for the year Items not Involving Cash Depreciation and amortization Stock-based compensation expense Unrealized foreign exchange gain Deferred income tax (recovery) expense Income from investments accounted for by the equity method Accretion of long-term debt Impairment of long lived assets, net Inventory write-downs to net realizable value Bargain purchase gain from acquisition Provision for inventory purchase commitments Change in fair value of derivative liability and bad debt expense Restructuring obligations Changes in Non-Cash Operating Working Capital Accounts receivable Inventories Prepaid expenses Accounts payable and accrued liabilities Deferred revenue Warranty liability CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES Purchase of property, plant and equipment Sale of short term investments, net Maturity (purchase) of short-term investments, net Acquisitions, net of acquired cash [note 5] Proceeds on sale of investments Proceeds on sale of assets Dividends received from joint ventures CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES Repayment of operating lines of credit and long term facilities Drawings on operating lines of credit Finance costs incurred Proceeds from stock options exercised Issuance of convertible debt and royalty payable Effect of foreign exchange on cash and cash equivalents Increase (decrease) in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year SUPPLEMENTARY INFORMATION Interest paid Taxes paid, net of refunds Non-Cash Transactions 16,015 10,450 6,408 3,008 (5,838) 4,945 4,843 7,104 (35,808) — 1,670 14,123 (4,675) 26,152 881 (20,650) (5,212) (5,473) (79,630) (9,347) 1,000 — 45,344 12,965 13,219 13,398 79,579 (12,789) 9,184 — — 35,000 31,395 4,570 32,914 27,143 13,654 14,871 (11,601) (514) (17,551) 876 22,722 8,743 — — 587 — 975 (5,997) 661 9,526 (1,507) (5,359) 18,666 9,683 (3,434) (1,185) (15,863) 2,139 29,604 2,102 — 4,106 1,338 — 11,629 (1,367) (556) (4,749) (5,096) (5,797) (69,068) (106,758) (4,845) — — 787 — — 20,464 16,406 (8,308) 5,432 — — — (2,876) (10,601) (66,139) 93,282 (10,249) — 31,369 (3,053) — — 3,200 21,267 (9,540) 17,797 (2,033) 242 — 6,466 (6,206) (85,231) 178,513 93,282 4,702 871 3,285 $ $ 60,057 $ 27,143 $ 4,339 $ 2,479 4,551 $ 1,238 Shares issued on exercise of share units 98,742 1,162 See accompanying notes to consolidated financial statements. WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT | 37 Financial Statements | Notes to Consolidated Financial Statements Notes to Consolidated Financial Statements 1. Company Organization and Operations Westport Fuel Systems Inc. (the “Company”, formerly known as Westport Innovations Inc.) was incorporated under the Business Corporations Act (Alberta) on March 20, 1995. On June 1, 2016, the Company merged with Fuel Systems Solutions, Inc. The Company engineers, manufactures and supplies alternative fuel systems and components for use in the transportation and industrial markets on a global basis. The Company's components & systems control the pressure and flow of gaseous alternative fuels, such as propane and natural gas used in internal combustion engines. 2. Liquidity and going concern In August 2014, the FASB issued ASU Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. Under the new standard, management must evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the Company’s ability to continue as a going concern within one year after the date that the financial statements are issued. This evaluation initially does not take into consideration the potential mitigating effect of management’s plans that have not been fully implemented as of the date the financial statements are issued. When substantial doubt exists under this methodology, management evaluates whether the mitigating effect of its plans sufficiently alleviates substantial doubt about the Company’s ability to continue as a going concern. The mitigating effect of management’s plans, however, is only considered if both (1) it is probable that the plans will be effectively implemented within one year after the date that the financial statements are issued, and (2) it is probable that the plans, when implemented, will mitigate the relevant conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued. Generally, to be considered probable of being effectively implemented, the plans must have been approved before the date that the financial statements are issued. This standard was adopted by the Company at December 31, 2016. These financial statements have been prepared on the basis that the Company will continue as a going concern. At December 31, 2016, the Company's cash and cash equivalents were $60,057 and its long-term debt was $79,032, of which $48,097 matures in 2017. The Company incurred significant recurring losses and negative cash flows from operating activities during 2016, 2015 and 2014, 38 | WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT and anticipates incurring additional losses and cash outflows through 2017, largely due to the start up of production and commercial distribution of HPDI in the fourth quarter of 2017. PRINCIPAL CONDITIONS OR EVENTS THAT REQUIRE MANAGEMENT'S CONSIDERATION a. Forecast operating and capital investment requirements After the merger with Fuel Systems and given the low oil price environment experienced in most of 2015 and 2016, the Company has been rationalizing its operations to achieve the necessary synergies required in order to become cash flow positive from operations. The Company expects to generate positive cash flows from operations throughout its business in 2017 and beyond except for its Technology Investments segment where the Company expects significant costs for final development, testing and capital expenditures on its HPDI program with a major OEM in fiscal 2017. Overall, the Company forecasts negative cash flows in 2017. b. Maturing debt Significant debt maturing in 2017 is the CDN $55,000 Debentures ("Debentures") maturing on September 15, 2017. This debt is classified as current liabilities on the consolidated balance sheet as at December 31, 2016. Details of this loan can be found in [note 15a] to these consolidated financial statements. MANAGEMENT'S PLANS Management considered the following factors and management’s plans to alleviate or mitigate substantial doubt: a. Asset sales In conjunction with its rationalization and synergy program, the Company has a number of initiatives to simplify the number of businesses that the Company will focus on. As a result, the Company has identified a number of non-core assets that it has or would make available for sale, subject to appropriate terms and conditions in the circumstances. The Company has been active in discussions with interested parties and two of these initiatives are in the final stages of negotiation. The Company expects final binding agreements to be signed in April 2017 and closing to occur shortly thereafter. These two non-core assets sales are expected to contribute significant proceeds to the Company and would be used to investment requirements for HPDI commercialization. forecasted operating and capital fund the The Company continues to examine other assets to determine whether it is in the best interest of the Company to monetize these assets in the next year or continue to hold and invest in these assets. The Company’s decisions with respect to these assets may depend on its ability to raise additional financings as discussed below. The Company's Board of Directors has approved a sales process and timeline for the sale of certain assets in the event that the financing is not obtained when required. b. Maturing debt The holders of the CDN $55,000 Debentures have the option to extend, a maximum of six times, the maturity date for an additional period of six months each time (i.e. if all extensions made, an additional three years) provided that greater than CDN$10,000 of the aggregate principal amount of the Debentures remains outstanding. At the date of these financial statements, the Debenture holders have not elected to extend and have until August 1, 2017 to do so. the Company has The Company has engaged financial advisors to assist with alternative sources of funding. As of the date of these financial statements, the Company has held discussions and received interest including draft term sheets from potential lenders that would allow the Company to refinance a portion of the Debentures. In addition, initiated discussions with a representative of the Debenture holders on extending or replacing the Debentures with new financing. While there can be no assurance that the Company will be able to borrow on terms that are acceptable to the Company, management believes that it is probable that new loan(s) to refinance a portion of the Debentures, either with the Debenture holders or new lenders, will be entered into on a timely basis. MANAGEMENT'S ASSESSMENT AND CONCLUSION Management is confident that the cash on hand at December 31, 2016 of $60,057, the estimated proceeds from the sales of noncore assets and the estimated proceeds from financing as discussed above will provide the cash flow necessary to fund operations over the next year to March 31, 2018, and as a result, Management has that substantial doubt has been alleviated by determined Management’s plans at a probable level of assurance. Management cautions the readers that there is no absolute assurance that the Company will be able to conclude all of the non-core assets sales and raise the financing necessary, under satisfactory terms and conditions, to continue as a going concern. If the Company was not to continue as a going concern, significant adjustments may be required to the carrying value of its assets and liabilities in the the accompanying consolidated adjustments could be material. financial statements and 3. Significant accounting policies A. BASIS OF PRESENTATION The consolidated financial statements include the accounts of the Company, its wholly owned subsidiaries and variable interest Financial Statements | Notes | 2. Liquidity and Going Concern entities (“VIEs”) for which the Company is considered the primary beneficiary. All intercompany balances and transactions have been eliminated on consolidation. These consolidated in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). financial statements are presented B. FOREIGN CURRENCY TRANSLATION The Company’s functional currency is in the Canadian dollars and its reporting currency for its consolidated financial statement presentation is the United States dollar. The functional currencies for the Company's subsidiaries include the following: United States, Canadian ("CDN") and Australian dollars, Euro, Argentina Peso, Chinese Renminbi (“RMB”), Swedish Krona, Japanese Yen and Indian Rupee. The Company translates assets and liabilities of non- U.S. dollar functional currency operations using the period end exchange rates, shareholders’ equity balances using the weighted average of historical exchange rates, and revenues and expenses using the monthly average rate for the period with the resulting exchange differences recognized in other comprehensive income. Transactions that are denominated in currencies other than the functional currency of the Company’s operations or its subsidiaries are translated at the rate in effect on the date of the transaction. Foreign currency denominated monetary assets and liabilities are translated to the applicable functional currency at the exchange rate in effect on the balance sheet date. Non-monetary assets and liabilities are translated at the historical exchange rate. All foreign exchange gains and losses are recognized in the statement of operations, except for the translation gains and losses arising from available-for-sale instruments, which are recorded through other through disposal or comprehensive impairment. income until realized Except as otherwise noted, all amounts in these financial statements are presented in U.S. dollars. For the periods presented, the Company used the following exchange rates: FOREIGN CURRENCY TRANSLATION Year end exchange rate Avg. for yr. ended (expressed in thousands of United States dollars) 2016 2015 2016 2015 2014 Canadian Dollar Australian Dollar Euro Argentina Peso RMB Swedish Krona Japanese Yen Indian Rupee 0.74 0.72 1.06 0.06 0.14 0.11 0.01 0.01 0.72 0.73 1.09 0.08 0.15 0.12 0.01 0.02 0.76 0.74 1.11 0.07 0.15 0.12 0.01 0.02 0.78 0.75 1.11 0.11 1.16 0.12 0.01 0.02 0.91 0.90 1.33 0.12 0.16 0.15 0.01 0.02 WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT | 39 Financial Statements | Notes | 3. Significant Accounting Policies C. CASH AND CASH EQUIVALENTS Cash and cash equivalents includes cash, term deposits, bankers acceptances and guaranteed investment certificates with maturities of ninety days or less when acquired. Cash equivalents are considered as held for trading and recorded at fair value with changes in fair value recognized in the consolidated statements of operations. D. ACCOUNTS RECEIVABLE, NET Accounts receivable are measured at amortized cost. The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. Past due balances over 90 days are reviewed individually for collectability. If the financial condition of the Company’s customers were to deteriorate, adversely affecting their ability to make payments, additional allowances would be required. Based on management’s assessment, the Company provides for estimated uncollectible amounts through a charge to earnings and a credit to a valuation allowance. Balances that remain outstanding after the Company has used reasonable collection efforts are written off through a charge to the valuation allowance and a credit to accounts receivable. E. INVENTORIES The Company’s inventories consist of the Company’s fuel system products (finished goods), work-in-progress, purchased parts and assembled parts. Inventories are recorded at the lower of cost and net realizable value. Cost is determined based on the lower of weighted average cost or first-in, first-out . The cost of fuel system product inventories, assembled parts and work-in-progress includes materials, labour and production overhead including depreciation. The Company provides inventory write-downs based on excess and obsolete inventories determined primarily by future demand forecasts. In addition, the Company records a liability for firm, noncancelable, and unconditional purchase commitments with manufacturers for quantities in excess of the Company’s future demand forecast consistent with its valuation of excess and obsolete inventory. F. PROPERTY, PLANT AND EQUIPMENT Depreciation expense on equipment used in the production and manufacturing process is included in cost of sales. All other depreciation is included in the depreciation and amortization expense line on the statement of operations. Property, plant and equipment are stated at cost. Depreciation is provided as follows: 40 | WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT PROPERTY, PLANT AND EQUIPMENT DEPRECIATION Assets Buildings Basis Rate Straight-line 15 years Computer equipment and software Straight-line Furniture and fixtures Straight-line 3 years 5 years Machinery and equipment Straight-line 8-10 years Leasehold improvements Straight-line Lease term G. LONG-TERM INVESTMENTS The Company accounts for investments in which it has significant influence, including VIEs for which the Company is not the primary beneficiary, using the equity method of accounting. Under the equity method, the Company recognizes its share of income from equity accounted investees in the statement of operations with a corresponding increase in long-term investments. Any dividends paid or payable are credited against long-term investments. The Company accounts for investments in which it does not exercise significant influence using the cost method of accounting. H. FINANCIAL LIABILITIES Accounts payable and accrued liabilities, short-term debt and long- term debt are measured at amortized cost. Transaction costs relating to long-term debt are netted against long-term debt and are amortized using the effective interest rate method. I. RESEARCH AND DEVELOPMENT COSTS Research and development costs are expensed as incurred and are recorded net of government funding received or receivable. J. GOVERNMENT ASSISTANCE The Company periodically applies for financial assistance under available government incentive programs, which is recorded in the period it is received or receivable. Government assistance relating to the purchase of property, plant and equipment is reflected as a reduction of the cost of such assets. Government assistance related to research and development activities is recorded as a reduction of the related expenditures. K. INTANGIBLE ASSETS Intangible assets consist primarily of the cost of intellectual property, trademarks, technology, customer contracts and non- compete agreements. Intangible assets are amortized over their estimated useful lives, which range from 5 to 20 years. L. IMPAIRMENT OF LONG-LIVED ASSETS The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. If such conditions exist, assets are considered impaired if the sum of the undiscounted expected future cash flows expected to result from the use and eventual disposition of an asset is less than its carrying amount. An impairment loss is measured at the amount by which the carrying amount of the asset exceeds its fair value. When quoted market prices are not available, the Company uses the expected future cash flows discounted at a rate commensurate with the risks associated with the recovery of the asset as an estimate of fair value. M. GOODWILL IMPAIRMENT Goodwill is recorded at the time of purchase for the excess of the amount of the purchase price over the fair values of the identifiable ,assets acquired and liabilities assumed. Goodwill is not amortized and instead is tested at least annually for impairment, or more frequently when events or changes in circumstances indicate that goodwill might be impaired. This impairment test is performed annually at November 30. Future adverse changes in market conditions or poor operating results of underlying assets could result in an inability to recover the carrying value of the goodwill, thereby possibly requiring an impairment charge. A two-step test is used to identify a potential impairment and to measure the amount of impairment, if any. The first step is to compare the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill is considered not impaired; otherwise, goodwill is impaired and the loss is measured by performing step two. Under step two, the impairment loss is measured by comparing the implied fair value of the reporting unit goodwill with the carrying amount of goodwill. Fair value is determined using widely accepted valuation techniques, which may include discounted cash flows and market multiple analyses. These types of analyses contain uncertainties because they require management to make assumptions and to apply judgment to estimate industry economic factors and the profitability of future business strategies. N. WARRANTY LIABILITY Estimated warranty costs are recognized at the time the Company sells its products and are included in cost of revenue. The Company provides warranty coverage on products sold for a period ending two years from the date the products are put into service by customers. Warranty liability represents the Company’s best estimate of warranty costs expected to be incurred during the warranty period. Furthermore, the current portion of warranty liability represents the Company’s best estimate of the costs to be Financial Statements | Notes | 3. Significant Accounting Policies incurred in the next twelve-month period. The Company uses historical failure rates and costs to repair defective products to estimate the warranty liability. New product launches require a greater use of judgment in developing estimates until claims experience becomes available. Product specific experience is typically available four or five quarters after product launch, with a clear experience trend not evident until eight to twelve quarters after launch. The Company records warranty expense for new products upon shipment using a factor based upon historical experience from previous engine generations in the first year, a blend of actual product and historical experience in the second year and product specific experience thereafter. The amount payable by the Company and the timing will depend on actual failure rates and cost to repair failures of its products. O. REVENUE RECOGNITION The Company recognizes revenue upon transfer of title and risk of loss, generally when products are shipped provided there is (1) persuasive evidence of an arrangement, (2) there are no uncertainties regarding customer acceptance, (3) the sales price is fixed or determinable and (4) management believes collectibility is reasonably assured. The Company recognizes service revenue from research and development arrangements based on the contracts and the ability of the Company to measure its performance. Depending on the contract, revenues may be recognized using the milestone, percentage of completion, or completed contract methods of accounting. All costs incurred related to revenue earned from research and development contracts are recorded as research and development expense as incurred. P. INCOME TAXES The Company accounts for income taxes using the asset and liability method. Under this method, deferred income tax assets and liabilities are determined based on the temporary differences between the accounting basis and tax basis of the assets and liabilities and for loss carry-forwards, tax credits and other tax attributes, using the enacted tax rates in effect for the years in which the differences are expected to reverse. The effect of a change in tax rates on the deferred income tax assets and liabilities is recognized in income in the period that includes the enactment date. The Company recognizes deferred income tax assets to the extent the assets are more-likely-than-not to be realized. In making such a determination the Company considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax- planning strategies, and results of recent operations. If it is determined that, based on all available evidence, it is more-likely- than-not that some or all of the deferred income tax assets will not be realized, a valuation allowance is provided to reduce the deferred income tax assets. WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT | 41 Financial Statements | Notes | 3. Significant Accounting Policies The Company uses a two-step process to recognize and measure the income tax benefit of uncertain tax positions taken or expected to be taken in a tax return. The tax benefit from an uncertain tax position is recognized if it is more-likely-than-not that the position will be sustained upon examination by a tax authority based solely on the technical merits of the position. A tax benefit that meets the more-likely-than-not recognition threshold is measured as the largest amount that is greater than 50% likely to be realized upon settlement with the tax authority. To the extent a full benefit is not expected to be realized, an income tax liability is established. Any change in judgment related to the expected resolution of an uncertain tax position is recognized in the year of such a change. 4. Accounting Changes A. NEW ACCOUNTING PRONOUNCEMENTS ADOPTED IN 2016 Going Concern In August 2014, the FASB issued ASU 2014-15. Presentation of Financial Statements - Going Concern, which provides guidance about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern, along with the required disclosures. B. CHANGE IN ACCOUNTING POLICY The Company's joint venture, Cummins Westport Inc ("CWI"), changed its method for determining its warranty liability to exclude, from the estimated cost to settle claims, the parts margin it expects to earn on parts sold and used to service warranty claims. These changes were accounted for as change in accounting policy and the comparative balances were restated on a retrospective basis. The Company's income from investments, accumulated deficit and long-term investments balances have been adjusted to reflect this change in accounting policy. C. NEW ACCOUNTING PRONOUNCEMENTS TO BE ADOPTED IN THE FUTURE Revenue In May 2014, Financial Accounting Standards Board (“FASB”) issued ASU 2014-09, Revenue From Contracts With Customers (“Topic 606”). Topic 606 removes inconsistencies and weaknesses in revenue accounting requirements, provides a more robust framework for addressing revenue issues, improves comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets, provides more useful information 42 | WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT to users of financial statements through improved disclosure requirements and simplifies the preparation of financial statements by reducing the number of requirements to which an entity must refer. The guidance in this update supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific guidance throughout the Industry Topics of the Codification. Topic 606 is effective for public entities with reporting periods beginning after December 15, 2017. The Company is evaluating the impact of this new standard to the financial statements. Simplifying the Measurement of Inventory (Topic 330): Inventory In July 2015, the FASB issued ASU 2015-11, which requires an entity to measure inventory at the lower of cost or net realizable value, which consists of the estimated selling prices in the ordinary course of business, less reasonably predictable cost of completion, disposal, and transportation. For public entities, the updated guidance is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The guidance is to be applied prospectively with earlier application permitted as of the beginning of an interim or annual reporting period. The Company does not anticipate a material impact to the Company’s financial statements as a result of this change. Leases (Topic 842) In February 2016, the FASB issued ASU 2016-02, which increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, and interim periods within those years for public business entities with early adoption permitted. The Company has not yet evaluated the impact of the adoption of this new standard. Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments In August 2016, the FASB issued ASU 2016-15, which provides cash flow classification guidance on eight specific cash flow issues to reduce diversity in practice for which authoritative guidance did not previously exist. ASU 2016-15 is effective for public entities in annual and interim periods in fiscal years beginning after December 15, 2017, with early adoption permitted. The Company does not anticipate a material impact to the Company's financial statements as a result of this change. 5. Business Combinations: MERGER WITH FUEL SYSTEMS On June 1, 2016 ("the acquisition date"), the Company completed a merger with Fuel Systems Solutions, Inc. ("Fuel Systems"). Fuel Systems shareholders received 2.4755 Westport common shares for each share of Fuel Systems common stock owned. The Company issued 44,882,782 common shares to former Fuel Systems shareholders and 653,532 restricted stock units of the Company to replace outstanding Fuel Systems restricted stock units in connection with the merger. No replacement awards were issued for other equity instruments pursuant to the merger agreement. The merger was accounted for as a business combination, with Westport deemed to be the acquirer. The Company determined the purchase price using the Nasdaq closing share price on the acquisition date at $2.20 per share, which resulted in total purchase consideration of $99,397, which includes the fair value of the common shares issued of $98,742 and the fair value of the restricted stock units related to pre-combination services of $655. The Company incurred total acquisition related costs of $9,890 in 2015 and 2016 under the Corporate and Technology Investments segment, which were expensed as incurred. This business combination resulted in a bargain purchase transaction, as the fair value of assets acquired and liabilities assumed exceeded the total of the transaction date fair value of equity issued by $35,808. The Company believes it was able to acquire the assets of Fuel Systems for less than their fair value due to the weakness in the alternative fuel sector. The following table summarizes the final allocation of the purchase price to the fair values of assets acquired and liabilities assumed at the date of the the acquisition, as well as measurement period. the adjustments made during Financial Statements | Notes | 5. Business Combinations PURCHASE PRICE ALLOCATION Preliminary Purchase Price Allocation as of June 1, 2016 Measurement Period Adjustments Final Purchase Price Allocation as of December 31, 2016 $ 45,344 $ 42,165 72,734 37,192 4,240 1,911 12,962 (58,401) (15,888) 142,259 (42,862) — 789 826 600 — (3,964) — (5,305) — 45,344 42,954 73,560 37,792 4,240 (2,053) 12,962 (63,706) (15,888) (7,054) 135,205 7,054 (35,808) Consideration allocated to: Cash and cash equivalents Accounts receivable Inventory Property, plant and equipment Intangible assets Deferred income taxes, net Other assets Accounts payable and accrued liabilities Other liabilities Total net identifiable assets Bargain purchase gain Total $ 99,397 $ — $ 99,397 The fair value of $42,954 of accounts receivable acquired was based on the amounts expected to be collectible. The fair value of $73,560 assigned to inventory was based on estimated selling prices net of selling costs associated with finished goods, and replacement value for raw materials and unassembled components. Property, plant and equipment of $37,792 was determined based on depreciated replacement cost values. The fair value of intangible assets of $4,240 primarily relates to brand value associated with the BRC, IMPCO and ComfortPro brands. The intangible assets are being amortized over their estimated useful life of ten years. The fair value of $63,706 assigned to accounts payable and accrued liabilities acquired was based on the expected amount to be paid and contingent liabilities recognized at the acquisition date. Adjustments made in the measurement period include $4,000 settlement of a patent infringement and $1,305 to settle remaining claims. Since the acquisition date, Fuel Systems' total revenue was $132,850 and generated a net loss of $5,049. PROFORMA RESULTS The following unaudited supplemental proforma information presents the consolidated financial results as if the acquisition of Fuel Systems had occurred on January 1, 2015. This supplemental proforma information has been prepared for comparative purposes and does not purport to be indicative of what would have occurred WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT | 43 Financial Statements | Notes | 5. Business Combinations had the acquisition been made on January 1, 2015, nor are they indicative of any future results. 8. Long-term Investments PROFORMA RESULTS Revenue Revenue for the year Fuel Systems (prior to merger) Proforma revenue for the year Net loss Years ended Dec 31 2015 2016 224,895 103,304 96,833 321,728 263,397 366,701 Net loss for the year (97,573) (99,154) Fuel Systems, net of transaction costs (prior to merger) Proforma adjustments(1) Proforma net loss for the year (6,249) (47,135) (28,951) (1,575) $ (132,773) $ (147,864) 1. Includes adjustments for the bargain purchase gain, additional interest expense for the convertible debt in all periods, and for transaction costs related to the merger with Fuel Systems. 6. Accounts Receivable ACCOUNTS RECEIVABLE Dec 31, 2016 Dec 31, 2015 Customer trade receivable $ 73,341 $ 35,517 Due from related parties [note 20] Other receivables Income tax receivable Allowance for doubtful accounts 488 5,010 1,638 (3,299) $ 77,178 $ 1,165 3,617 1,047 (3,022) 38,324 7. Inventories INVENTORIES Purchased parts Work-in-process Finished goods Total Dec 31, 2016 Dec 31, 2015 $ $ 46,475 $ 4,403 19,746 70,624 $ 20,864 3,485 11,311 35,660 During the year ended December 31, 2016, the Company recorded write-downs to net realizable value of approximately $7,104 (year ended December 31, 2015 - $8,743; year ended December 31, 2014 - $2,102). 44 | WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT LONG-TERM INVESTMENTS Dec 31, 2016 Dec 31, 2015 Cummins Westport Inc. (a) Weichai Westport Inc. (b) Other equity accounted investees Total long-term investments $ $ 10,950 1,824 $ 648 13,422 $ 14,762 19,065 1,315 35,142 A. CUMMINS WESTPORT INC. The Company entered into a joint venture with Cummins Inc. (Cummins) on March 7, 2001. The joint venture term is scheduled to end on December 31, 2021 and can be terminated under certain circumstances before the end of the term, including in the event of a material breach of the agreement by, or in the event of a change of control of, one of the parties. On February 20, 2012, the joint venture agreement ("JVA") was amended and restated to provide for, among other things, clarification concerning the scope of products within CWI. In addition, the parties have revised certain economic terms of the JVA. Prior to February 20, 2012, the Company and Cummins shared equally in the profits and losses of CWI. Under the amended JVA, profits and losses are shared equally up to an established revenue baseline, then any excess profit will be allocated 75% to the Company and 25% to Cummins. The Company has determined that CWI is a variable interest entity ("VIE"). Cummins and Westport each own 50% of the common shares of CWI and have equal representation on the Board of Directors. No one shareholder has the unilateral power to govern CWI. The Board of Directors has power over the operating decisions and to direct other activities of CWI that most significantly impact CWI’s economic performance as set forth in the governing documents. As decision-making at the Board of Directors’ level requires unanimous approval, this power is shared. Accordingly neither party is the primary beneficiary. The Company recognized its share of CWI’s income and received dividends as follows: CWI REVENUES & EXPENSES Years ended Dec 31 2016 2015 (Adjusted) 2014 (Adjusted) Investment income under the equity method Dividends received $ 5,606 $ 16,339 $ 10,198 20,646 9,777 3,200 During the fourth quarter of 2016, CWI changed its method for determining its warranty liability to exclude, from the estimated cost to settle claims, the parts margin it expects to earn on parts sold to Financial Statements | Notes | 8. Long-term Investments dealers and used to service warranty claims. This change was accounted for as a change in accounting policy and the comparative balances were restated on a retrospective basis, with the following after tax impact to CWI and the Company: CWI TAX IMPACT CWI INCOME Product revenue Parts revenue CWI Impact Company Impact Cost of revenue and expenses Years ended Dec 31 2016 2015 (Adjusted) 2014 (Adjusted) $ 205,235 $ 274,033 $ 283,551 71,230 57,849 53,683 276,465 331,882 337,234 Opening accumulated deficit decrease (January 1, 2014) Increase to 2014 income from investment Decrease to 2015 income from investment $ 6,314 $ 3,157 3,283 (1,533) 1,641 (766) Decrease to 2016 income from investment (8,064) (4,032) Net change to accumulated deficit (December 31, 2016) — — Assets, liabilities, revenue and expenses of CWI, as adjusted for the change in accounting policy, are as follows: CWI ASSETS & LIABILITIES December 31, 2016 December 31, 2015 (Adjusted) Current assets Cash and short-term investments Accounts receivable Other current assets $ 95,623 $ 5,018 209 Long-term assets Property, plant and equipment Deferred income tax assets Total assets Current liabilities Current portion of warranty liability Current portion of deferred revenue Accounts payable and accrued liabilities Long-term liabilities Warrant liability Deferred revenue Other long-term liabilities Total liabilities 114,053 4,632 287 1,212 46,177 166,361 1,074 45,231 147,245 $ $ $ $ $ $ $ $ $ 26,206 $ 30,922 20,070 $ 13,858 7,125 $ 53,401 $ 27,282 $ 41,788 $ 2,863 $ 71,933 $ 11,852 56,632 31,461 45,859 2,908 80,228 125,334 $ 136,860 Cost of product and parts revenue 199,317 230,508 265,584 Research and development 36,066 30,165 21,131 General and administrative 1,136 1,414 1,202 Sales and marketing 23,047 21,236 22,514 Foreign exchange (gain) loss Bank charges, interest and other 8 695 28 817 34 805 Income from operations Interest and investment income Income before taxes Income tax expense (recover) Current Deferred Income for the year 260,269 284,168 311,270 16,196 47,714 25,964 552 367 260 16,748 48,081 26,224 4,680 19,785 21,514 856 5,536 11,212 (1,565) (13,754) 18,220 29,861 7,760 18,464 B. WEICHAI WESTPORT INC. On April 20, 2016, the Company sold a portion of its economic interest in Weichai Westport Inc. (WWI) to Cartesian Capital Group (Cartesian), a related party, for an upfront payment of $6,300 plus a potential future payment based on Cartesian's return on investment. A loss on sale of investment of $5,238 was recognized in the quarter ended June 30, 2016. On August 20, 2016, the Company sold a portion of the investment to Weichai Power Co., Ltd and Weichai Holding Group Co., Ltd for $7,372 and recognized a gain on sale of $2,696. In addition, the Company received a dividend of $3,200 from WWI net of withholding taxes. Commencing April 20, 2016, the Company no longer has the ability to exercise significant influence over the joint venture and, therefore, with effect from that date accounts for its interest by the cost method. WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT | 45 Financial Statements | Notes | 9. Variable Interest Equity 9. Variable Interest Equity Cummins and Westport each own 50% of the common shares of CWI and have equal representation on the Board of Directors. No one shareholder has the unilateral power to govern CWI. The Board of Directors has power over the operating decisions and to direct other activities of CWI that most significantly impact CWI’s economic performance as set forth in the governing documents. As decision-making at the Board of Directors’ level requires unanimous approval, this power is shared. Accordingly, neither party is the primary beneficiary. The Company has not historically provided and does not intend to provide financial or other support to CWI that the Company is not contractually required to provide. The carrying amount and maximum exposure to losses relating to VIEs in which the Company holds a significant variable interest but is not the primary beneficiary, and which have not been consolidated, were as follows: Balance at Dec 31 2016 2015 (Adjusted) Carrying amount Maximum exposure to loss Carrying amount Maximum exposure to loss Equity method investment Accounts receivable $ 10,950 $ 10,950 $ 14,762 $ 14,762 1,165 1,165 236 236 10. Property, Plant & Equipment PROPERTY, PLANT & EQUIPMENT Cost Accumulated depreciation Net book value December 31, 2016 Land and buildings $ 4,471 $ 1,127 $ 3,344 Computer equipment and software Furniture and fixtures Machinery and equipment Leasehold improvements Total 2016 December 31, 2015 Land and buildings Computer equipment and software Furniture and fixtures Machinery and equipment Leasehold improvements 9,230 6,703 7,044 2,641 2,186 4,062 77,120 34,754 42,366 14,346 6,622 7,724 $ 111,870 $ 52,188 $ 59,682 $ 2,706 $ 165 $ 2,541 7,171 5,163 6,234 2,084 937 3,079 70,415 36,739 33,676 10,394 8,100 2,294 Total 2015 $ 95,849 $ 53,322 $ 42,527 46 | WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT Based on declining revenue and operating results, which were impacted by lower oil prices, the Company concluded that there were impairment indicators, requiring the performance of a long- lived assets impairment test during the years ended December 31, 2016 and 2015. During the year ended December 31, 2016, the Company recorded an impairment charge of $2,708. The impairment resulted primarily from the write-down of engineering test equipment in Vancouver, Canada. The method used to determine the fair value of equipment was based on utilization of assets and the write-down was recorded in the Corporate and Technology Investments segment. During the year ended December 31, 2015, the Company recorded an impairment charge of $4,015. The impairment resulted primarily from the write-down of OrcaTM LNG trailers ("Orcas") which provide in-yard fleets convenient refueling in the absence of a permanent liquefied natural gas (LNG) solution. The method used to determine fair value was recent sales of Orcas and the impairment charge was recorded in the Automotive business segment. Depreciation expense for the year ended December 31, 2016 was $12,836 (year ended December 31, 2015 - $10,703; year ended December 31, 2014 - $14,106). The amount of depreciation expense included in cost of sales for the year ended December 31, 2016 was $4,707 (year ended December 31, 2015 - $1,918; year ended December 31, 2014 - $3,130). 11. Intangible Assets INTANGIBLE ASSETS Cost Accumulated depreciation Net book value December 31, 2016 Patents and trademarks $ 20,770 $ Technology Customer contracts Other intangibles 11,419 4,735 319 5,093 $ 15,667 3,068 6,053 171 1,667 5,366 148 Total 2016 December 31, 2015 $ 37,243 $ 14,385 $ 22,858 Patents and trademarks $ 16,964 $ Technology Customer contracts Other intangibles 12,025 4,862 283 4,094 $ 12,870 2,663 4,952 118 2,199 7,073 165 Total 2015 $ 34,134 $ 11,827 $ 22,307 Based on declining revenue and operating results, which were impacted by lower oil prices, the Company concluded there were impairment indicators as of November 30, 2016 and November 30, 2015 requiring the performance of a long-lived assets impairment test for trademarks, customer contracts, and technology. The Company completed its assessments at November 30, 2016 and November 30, 2015, respectively, and concluded that intangible assets were not impaired. During the year ended December 31, 2016, amortization of $3,179 (December 31, 2015 - $2,951; year ended December 31, 2014 - $4,560) was recognized in the statement of operations. 13. Accounts Payable and Accrued Liabilities Financial Statements | Notes | 11. Intangible Assets 12. Goodwill A continuity of goodwill is as follows: GOODWILL Dec 31, 2016 Dec 31, 2015 Balance, beginning of period: $ 3,008 $ 23,352 Measurement period adjustments [note 4a] Impairment losses Impact of foreign exchange changes — — 149 (18,707) (85) (1,786) Balance, end of period $ 2,923 $ 3,008 The Company completed its annual assessment at November 30, 2016 and concluded the remaining goodwill of $2,923 related to the Netherlands reporting unit under the Automotive business segment was not impaired. Based on the revenue and operating results of the Italian reporting unit, which is within the Automotive segment in the nine months ended September 30, 2015, the decline in the outlook for the remainder of 2015 and future years and the decline in the Company's share price, the Company concluded there were impairment indicators requiring an interim goodwill impairment assessment as of September 30, 2015. Based on the Company's 2015 assessment, it was determined that the carrying amount of goodwill exceeded the implied fair value of goodwill and as a result, an impairment of $18,707 was recorded in the Italian reporting unit in 2015. For 2016 and 2015, the fair value of the reporting units was determined using the present value of expected future cash flows discounted at a rate equivalent to a market participant’s weighted- average cost of capital. The estimates and assumptions regarding expected future cash flows and the appropriate discount rates are in part based upon historical experience, financial forecasts and industry trends and conditions. ACCOUNTS PAYABLE & ACCRUED LIABILITIES Trade accounts payable Accrued payroll Accrued interest Due to related parties [note 20] Taxes payable Other payables Dec 31, 2016 Dec 31, 2015 $ 70,411 $ 42,851 13,356 1,977 1,191 941 5,369 3,839 1,037 — 2,014 7,713 Total $ 93,245 $ 57,454 14. Restructuring, Termination and Other Exit Obligations: RESTRUCTURING, TERMINATION AND OTHER EXIT OBLIGATIONS Years ended Dec 31, 2016 Termination Lease-exit Total Balance, beginning of period $ — $ — $ — Additions Additions: Interest and other Payments Impact of foreign exchange Balance, end of period Less: Current portion Long-term portion 7,198 11,802 19,000 — 509 509 (3,876) (1,196) (5,072) (44) (270) (314) 3,278 $ 10,845 $ 14,123 (2,903) (2,505) (5,408) 375 $ 8,340 $ 8,715 $ $ Beginning in the third quarter of 2016, the Company initiated a series of restructuring activities which included the consolidation of facilities in Argentina, Canada, China and the United States. This resulted in an implementation of a reduction in workforce resulting in employee severance, one-time termination benefits and contract termination costs associated with the restructuring activities. The Company incurred a charge of $7,198 associated with such termination obligations. The Company recorded restructuring charges on leases during the year ended December 31, 2016. One lease is in New York, US, and has a lease end date of March 2017. The Company exited the premises in September 2016 and is no longer using this space. The Company has also exited its car service and racing facility in Cherasco, Italy and has a lease end date of April 30, 2017. The other lease is in Vancouver, Canada. The Company has a 10 year lease commitment for 116,000 square feet of office space; however, the Company has notified the lessor that it does not intend to occupy the space. With respect to these leases, the Company recorded a WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT | 47 Financial Statements | Notes | 14. Restructuring, Termination and Other Exit Obligations C. SENIOR REVOLVING FINANCING On January 11, 2016, the Company entered into a financing agreement with Cartesian. As part of the agreement, on June 1, 2016, convertible debt was issued in exchange for 9.0% convertible unsecured notes due June 1, 2021, which are convertible into common shares of the Company in whole or in part, at Cartesian's option, at any time following the twelve month anniversary of the closing at a conversion price of $2.17 per share. Interest is payable annually in arrears on December 31 of each year during the term. The convertible debt is held by a related party as Peter Yu, founder and managing partner of Cartesian, became a member of the Board of Directors of the Company in January 2016. D. OTHER BANK FINANCING Other bank financing consists of various secured and unsecured bank financing arrangements that carry rates of interest ranging from 0.75% to 3.9% and have various maturities out to 2022. Security includes a building owned by the Company in the Netherlands and certain accounts receivable in one of our Italian subsidiaries. Approximately $6,700 of this financing is renewable as additional accounts receivables are pledged. E. CAPITAL LEASE OBLIGATIONS The Company has capital lease obligations that have terms of three to five years at interest rates ranging from 2.3% to 11.0% (2015 - 3.1%% to 4.9%). Throughout the entire term of these financing arrangements, the Company is required to meet certain financial and non-financial covenants. As of December 31, 2016, the Company is in compliance with all covenants under the financing arrangements. The principal repayment schedule of the long-term debt is as follows for the years ending December 31: LONG-TERM DEBT REPAYMENT SCHEDULE 2017 2018 2019 2020 Subordinated debenture notes Senior revolving financing Convertible debt Other bank financing Capital lease obligations Total $ 40,463 $ 739 $ — $ 6,449 $ 446 $ 48,097 — 1,688 — 1,794 — 1,900 — — — 316 316 316 195 64 46 30 2,199 2,174 2,262 24,300 2021+ — 4,432 17,286 2,552 $ 40,463 $10,553 $ 17,286 $ 9,949 $ 781 $ 79,032 charge to earnings of $11,802. The liability is equal to the present value of rent and other direct costs for the period of time space is expected to remain contracted but unoccupied, less any expected rent to be paid to the Company by a tenant under a sublease over the remainder of the lease term. The cash flows have been discounted at 15% and the lease is expected to terminate in June 2026. 15. Long-Term Debt LONG-TERM DEBT Dec 31, 2016 Dec 31, 2015 Subordinated debenture notes (a) $ 40,463 $ Senior financing (b) Convertible debt (c) Other bank financing (d) Capital lease obligations (e) Balance, end of period Current portion Total 10,553 17,286 9,949 781 79,032 (48,097) $ 30,935 $ 38,359 10,859 — 12,435 794 62,447 (8,257) 54,190 A. SUBORDINATED DEBENTURE NOTES The subordinated debenture notes are unsecured, mature on September 15, 2017 and bear interest at 9% per annum, payable in cash semi-annually in arrears on March 15 and September 15 of each year during the term. The holders of the Debentures have the option to extend, a maximum of six times, the maturity date for an additional period of six months each time (i.e. if all extensions made, an additional three years) provided that greater than CDN$10,000 of the aggregate principal amount of the Debentures remains outstanding. At the date of these financial statements, the Debenture holders have not elected to extend and have until August 1, 2017 to do so. B. SENIOR FINANCING The €10,000 senior revolving financing facility is denominated in Euros and bears interest at the 6-month Euribor plus 2.6% (2.3% as at December 31, 2016). Subsequent to year end on March 24, 2017, the €10,000 financing facility was renewed. The loan bears an interest at the 6-month Euribor plus 3.3% and can increase or decrease by 30 basis points based on an annual leverage ratio calculation. Interest is paid semi-annually. The Company has pledged its interest in EMER S.p.A. as a general guarantee for its senior revolving financing. 48 | WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT 16. Long-term Royalty Payable 17. Warranty Liability Financial Statements | Notes | 16. Long-term Royalty Payable On January 11, 2016, The Company entered into a financing agreement with Cartesian to support the Company's global growth initiatives. The financing agreement immediately provided $17,500 in cash (the “Tranche 1 Financing”). In consideration for the funds provided to the Company, Cartesian is entitled to royalty payments in respect of the Tranche 1 Financing based on the greater of (i) a percentage of amounts received by the Company on select high pressure direct injection systems and joint venture products in excess of agreed thresholds through 2025 and (ii) stated fixed amounts per annum (subject to adjustment for asset sales). The carrying value is being accreted to the expected redemption value using the effective interest method, which is approximately 23% per annum. A continuity schedule of the long-royalty payable is as follows: LONG TERM ROYALTY PAYABLE SCHEDULE Balance, beginning of year Issuance of debentures Accretion expense Balance, end of year Current portion Long-term portion MINIMUM REPAYMENTS INCLUDING INTEREST 2017 2018 2019 2020 2021 2022 and thereafter $ Dec 31, 2016 — 17,500 4,062 21,562 (1,500) $ 20,062 For years ending Dec 31 $ $ $ 1,500 3,426 6,164 7,722 9,054 18,113 45,979 WARRANTY LIABILITY Years ended Dec 31 2015 2014 2016 Balance, beginning of year $ 13,991 $ 23,109 $ 28,845 Warranty assumed on acquisition Warranty claims Warranty accruals 5,180 — 1,952 (7,353) (9,438) (10,709) 2,811 427 2,734 Impact of foreign exchange changes Balance, end of year Less: Current portion Long-term portion (859) (107) 287 $ 13,770 $ 13,991 $ 23,109 $ (6,834) $ (5,554) $ (9,696) $ 6,936 $ 8,437 $ 13,413 18. Share Capital, Stock Options & Other Stock-based Plans On June 1, 2016, the Company issued 44,882,782 common shares to former Fuel Systems' shareholders and 653,532 restricted stock units in connection with the merger described in note 5. During the year ended December 31, 2016, the Company issued 845,491 common shares, net of cancellations, upon exercises of share units and in connection with earn out payments, (year ended December 31, 2015 – 900,097 common shares). The Company issues shares from treasury to satisfy stock option and share unit exercises. A. SHARE UNITS The compensation program sets out provisions where the restricted share units ("RSUs") and performance share units ("PSUs") (together, the “Units”) will be granted to the Company’s executive if performance milestones are achieved as management determined at the discretion of the Human Resources and Compensation Committee of the Company’s Board of Directors. These performance milestones are focused on achievement of key cash management, profitability and revenue growth objectives. Vesting periods and conditions for each Unit granted pursuant to the Westport Omnibus Plan are at the discretion of the Board of Directors and may include time based, share price or other performance targets. The value assigned to issued Units and the amounts accrued are recorded as other equity instruments. As Units are exercised or vested and the underlying shares are issued from treasury of the Company, the value is reclassified to share capital. During the year ended December 31, 2016, the Company recognized $10,450 (year ended December 31, 2015 - $14,871; WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT | 49 Financial Statements | Notes | 18. Share Capital, Stock Options & Other Stock-based Plans year ended December 31, 2014 – $9,683) of stock-based compensation associated with the Westport Omnibus Plan and the former Amended and Restated Unit Plan. AGGREGATE INTRINSIC VALUES OF SHARE UNITS A continuity of the Units issued under the Westport Omnibus Plan and the former Amended and Restated Unit Plan as of December 31, 2016, December 31, 2015 and December 31, 2014 are as follows: STOCK OPTION PLAN SUMMARY (stock option values expressed in Canadian dollars) Outstanding, beginning of period Granted Exercised / Vested Forfeited / Expired Outstanding, end of year Options exercisable, end of year Dec 31, 2016 Dec 31, 2015 Dec 31, 2014 # WAEP # WAEP # WAEP 9,657,921 $ 7.62 5,337,873 $ 10.27 1,200,591 $ 23.68 684,402 2.90 5,556,630 6.74 5,792,162 10.54 (845,491) 10.26 (575,024) 11.49 (608,975) 19.52 (2,832,241) 6.60 (661,558) 10.34 (1,045,905) 21.75 6,664,591 $ 6.75 9,657,921 $ 7.62 5,337,873 $ 10.27 1,891,008 $ 7.77 1,150,294 $ 9.58 142,166 $ 11.67 WAEP = weighted average exercise price (C$) During 2016, 684,402 (2015 - 5,556,630) share units were granted to employees. This included 684,402 RSUs (2015 - 2,861,630) and nil PSUs (2015 - 2,695,000). Values of RSU awards are generally determined based on the fair market value of the underlying common share on the date of grant. RSUs typically vest over a three year period so the actual value received by the individual depends on the share price on the day such RSUs are settled for common shares, not the date of grant. PSU awards do not have a certain number of common shares that will issue over time - the number depends on future performance and other conditions tied to the payout of the PSU. The vesting of the 1,695,000 remaining PSU's from the 2015 grant is conditional upon Shareholders of Westport approving an increase in the number of awards available for issuance pursuant to the Westport Omnibus Plan. As a result these PSU's are being treated as a liability until this condition is met. As at December 31, 2016, $6,594 of compensation expense related to Units has yet to be recognized in results from operations and will be recognized over a weighted average period of 1.2 years. B. AGGREGATE INTRINSIC VALUES The aggregate intrinsic value of the Company’s share units at December 31, 2016 and 2015 are as follows: 50 | WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT Outstanding Exercisable Exercised (values in CDN$) Dec 31, 2016 Dec 31, 2015 $ 10,130 $ 26,849 2,874 1,285 3,198 1,599 C. STOCK-BASED COMPENSATION Stock-based compensation associated with the Unit plans and the stock option plan is included in operating expenses as follows: STOCK-BASED COMPENSATION IN OPERATING EXPENSES Years ended Dec 31 2015 2014 2016 Research and development $ 6,010 $ 9,915 $ 1,749 General and administrative 2,334 $ 2,224 $ 5,884 Sales and marketing 2,106 $ 2,732 $ 2,050 Total $ 10,450 $ 14,871 $ 9,683 19. Income Taxes A. PROVISION INCOME TAX PROVISION Years ended Dec 31 2015 (Adjusted, Note 8) 2014 (Adjusted, Note 8) 2016 Loss before income taxes $ (92,563) $ (98,423) $ (148,557) Expected income tax recovery (24,066) $ (25,580) $ (38,628) Increase (reduction) in income taxes resulting from Non-deductible stock-based compensation 2,176 $ 3,553 $ 2,495 Other permanent differences 5,854 $ (76) $ Withholding taxes 1,109 $ 1,429 $ (446) 969 Foreign tax rate differences, foreign exchange and other adjustments Non-taxable income from equity investment (4,561) $ (138) $ 7,409 925 $ (4,313) $ (4,162) Change in valuation allowance 32,583 $ 21,036 $ 25,784 Goodwill impairment — $ 4,820 $ Change in uncertain tax position 301 $ Bargain purchase gain (9,311) $ — $ — $ 4,748 1,252 — Income tax expense (recovery) $ 5,010 $ 731 $ (579) The Company’s income tax provision differs from that calculated by applying the combined enacted Canadian federal and provincial statutory income tax rate of 26% for the year ended December 31, 2016 (year ended December 31, 2015 – 26%; year months ended December 31, 2014 – 26%) as follows: B. DEFERRED INCOME TAX The significant components of the deferred income tax assets and liabilities are as follows: DEFERRED INCOME TAX ASSETS & LIABILITIES Dec 31, 2016 Dec 31, 2015 Deferred income tax assets Net loss carry forwards $ 191,685 $ 129,653 Intangible assets Property, plant and equipment Warranty liability Foreign tax creidts Inventory Research and development Other 10,319 11,829 4,072 5,233 4,104 4,710 17,114 3,792 7,317 4,220 — 2,206 3,140 7,831 Total gross deferred income tax assets 249,066 158,159 Valuation allowance (245,299) (153,099) Total deferred income tax assets 3,767 5,060 (4,945) (596) (4,262) (9,803) (4,566) (1,177) (349) (6,092) Deferred income tax liabilities Intangible assets Property, plant and equipment Other Total deferred income tax liabilities Total net deferred income tax liabilities Allocated as follows Deferred income tax assets Deferred income tax liabilities Total net deferred income tax liabilities $ (6,036) $ (1,032) The valuation allowance is reviewed on a quarterly basis to determine if, based on all available evidence, it is more-likely-than not that some or all of the deferred income tax assets will not be realized. The ultimate realization of deferred income tax assets is dependent on the generation of sufficient taxable income during the future periods in which those temporary differences are expected to reverse. If the evidence does not exist that the deferred income tax assets will be fully realized, a valuation allowance has been provided. The deferred income tax assets have been reduced by the uncertain tax position presented in note 19(f). Financial Statements | Notes | 19. Income Taxes C. INCOME TAX EXPENSE / RECOVERY The components of the Company’s income tax expense (recovery) are as follows: INCOME TAX EXPENSE (RECOVERY) Net income (loss) before income taxes Current Deferred Total Year ended Dec 31, 2016 Canada United States Italy Other Year ended Dec 31, 2015 (Adjusted, note 8(a)) Canada United States Italy Other Year ended Dec 31, 2014 (Adjusted, note 8(a)) Canada United States Italy Other $ (100,143) $ 57 $ 788 $ 845 14,926 (4,324) 7 192 — 7 1,440 1,632 (3,022) 1,746 780 2,526 $ (92,563) $ 2,002 $ 3,008 $ 5,010 $ (44,739) $ 793 $ 228 $ 1,021 (22,227) (20,695) (10,762) 9 389 54 — (566) (176) 9 (177) (122) $ (98,423) $ 1,245 $ (514) $ 731 $ (86,143) $ 165 $ 301 $ 466 (49,577) 8 — (3,834) 521 (1,463) (9,003) (88) (23) 8 (942) (111) $ (148,557) $ 606 $ (1,185) $ (579) LOSS CARRY-FORWARDS 2020 Expiring in: 2017 2018 2019 2021+ Total Canada Italy United States Sweden Other Total $ — $ — $ — $ — $ 437,967 $ 437,967 — — — — — — — — — — 972 6,023 4,632 — 16,622 16,622 — 110,403 110,403 — 18,843 14,144 18,843 25,771 $ — $ 972 $ 6,023 $ 4,632 $ 597,979 $ 609,606 Certain tax attributes are subject to an annual limitation as a result of the acquisition of Fuel Systems which constitutes a change of ownership as defined under Internal Revenue Code Section 382. WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT | 51 $ (6,036) $ (1,032) D. LOSS CARRY-FORWARDS 3,767 (9,803) 2,538 (3,570) The Company has loss carry-forwards in the various tax jurisdictions available to offset future taxable income as follows: Financial Statements | Notes | 19. Income Taxes E. DEFERRED INCOME TAX LIABILITY The Company has not recognized a deferred income tax liability for certain undistributed earnings of foreign subsidiaries which are essentially investments in those foreign subsidiaries and are permanent in duration. F. TAX RESERVES The Company records uncertain tax positions in accordance with ASC No. 740, Income Taxes. As at December 31, 2016, the total amount of the Company’s uncertain tax benefits was $2,745 (year ended December 31, 2015 - $1,230). If recognized in future periods, the uncertain tax benefits would affect our effective tax rate. The Company files income tax returns in Canada, the U.S., Italy, and various other foreign jurisdictions. All taxation years remain open to examination by the Canada Revenue Agency, the 2013 to 2016 taxation years remain open to examination by the Internal Revenue Service and the 2011 to 2016 taxation years remain open to examination by the Italian Revenue Agency, and various years remain open in the other foreign jurisdictions. 20. Related Party Transactions The Company is reporting a larger number of related party transactions compared to 2015 as a consequence of the appointments of Mr. Peter Yu (Cartesian financing) and Mr. Mariano Costamagna (Fuel Systems merger) as directors of the Company. Subsequent to year end, Mr. Costamagna resigned from the Board of Directors. The following table sets forth amounts that are included within the captions noted on the consolidated balance sheets, representing related party transactions with the Company: RELATED PARTY TRANSACTIONS Receivables Entities related to Mariano Costamagna (a) Cummins Westport Inc. (b) Ideas & Motion S.r.L. (c) Total Payables Entities related to Mariano Costamagna (a) Years ended Dec 31 2015 2014 $ $ $ 237 $ 236 15 — 1,165 — 488 $ 1,165 1,191 $ — A. ENTITIES RELATED TO MARIANO COSTAMAGNA INCLUDE: Bianco S.p.A, TCN S.r.L., Biemmedue S.p.A, MTM Hydro S.r.L., Immobiliare IV Marzo, Delizie Bakery S.r.L., Galup S.r.L., TCN Vd 52 | WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT S.r.L., Europlast S.r.L., A.R.S. Elettromeccanica S.r.L., Ningbo Topclean Mechanical Technology Co. Ltd., and Erretre S.r.L.. B. PURSUANT TO THE AMENDED AND RESTATED JOINT VENTURE AGREEMENT Westport engages in transactions with CWI (see note 8 (a)). Amounts receivable relate to costs incurred by the Company on behalf of CWI. The amounts are generally reimbursed by CWI to the Company in the month following the month in which the payable is incurred. C. IDEAS & MOTION S.R.L Ideas & Motion S.r.L Is an Italian consulting and services company in which the Company owns an equity ownership interest of 14.28%. OTHER RELATED PARTY TRANSACTIONS 2016 2016 Purchases Sales Purchases Sales Related party company Entities related to Mariano Costamagna (a) $ Cummins Westport Inc. (b) Ideas & Motion S.r.L. (c) 2,592 $ 412 $ — $ — — 2,744 — 43 — 5,742 — — Total $ 2,592 $ 3,199 $ — $ 5,742 D. OTHER TRANSACTIONS WITH RELATED PARTIES: The Company leases buildings under separate facility agreements from IMCOS Due S.r.L., a real estate investment company owned 100% by Mariano Costamagna and members of his immediate family. The terms of these leases reflect the fair market value of such properties based upon appraisals. The Company made payments to IMCOS Due S.r.L. of $1,475 for the year ended December 31, 2016 (2015 - nil). Peter Yu, founder and managing partner of Cartesian, was elected as a Director in January 2016 in connection with the Investment Agreement. The convertible debt (note 15(c)) and royalty payable (note 16) are related party balances. In addition, the Company sold a portion of its economic interest in WWI to Cartesian (note 8(b)). The Company has not made any cash payments to Cartesian relating to the convertible debt or royalty payable as at December 31, 2016, but has accrued interest in accordance with the terms of the agreements. 21. Commitments and Contingencies A. CONTRACTUAL COMMITMENTS The Company has obligations under operating lease arrangements that require the following minimum annual payments during the respective fiscal years: CONTRACTUAL COMMITMENTS 2017 2018 2019 2020 2021 Thereafter Total $ 9,347 9,134 7,686 6,298 4,548 19,996 $ 57,009 As disclosed in note 14, the Company has recorded restructuring charges on several leases. Any income received from subleasing the leases will reduce the minimum annual payments required by the Company. For the year ended December 31, 2016, the Company incurred operating lease expenses of $5,675 (year ended December 31, 2015 - $3,763; year ended December 31, 2014 - $3,879). The Company is a party to a variety of agreements in the ordinary course of business under which it is obligated to indemnify a third party with respect to certain matters. Typically, these obligations arise as a result of contracts for sale of the Company’s product to customers where the Company provides indemnification against losses arising from matters such as product liabilities. The potential impact on the Company’s financial results is not subject to reasonable estimation because considerable uncertainty exists as to whether claims will be made and the final outcome of potential claims. To date, the Company has not incurred significant costs related to these types of indemnifications. The Company is engaged in certain legal actions in the ordinary course of business and believes that the ultimate outcome of these actions will not have a material adverse effect on our operating results, liquidity or financial position. B. PURCHASE COMMITMENTS The Company purchases components from a variety of suppliers and contract manufacturers. During the normal course of business, in order to manage manufacturing lead times and help ensure adequate component supply, the Company enters into agreements with suppliers and contract manufacturers. A portion of our reported estimated purchase commitments arising from these agreements are firm, noncancelable, and unconditional commitments. The Company may be subject to penalties, and may lose important Financial Statements | Notes | 21. Commitments and Contingencies suppliers, if it is unable to meet its purchase commitments. In 2014, the Company entered into several long-term fixed price contracts to purchase parts to produce certain products. These contracts represent firm purchase commitments which are evaluated for potential market value losses. The Company estimated a loss on these firm purchase commitments with reference to the estimated future sales price of these products and recognized a provision for inventory purchase commitments of $4,106 in 2014. The provision is recognized in other payables in accounts payable and accrued liabilities. During 2015 and 2016, no additional loss for provision for inventory purchase commitments was accrued and the provision has been drawn down to $751 as at December 31, 2016. 22. Segment Information The financial information for the Company’s business segments evaluated by the Chief Operating Decision Maker ("CODM") includes the results of CWI as if they were consolidated, which is consistent with the way the Company manages its business segments. As CWI is accounted for under the equity method of accounting, an adjustment is reflected in the tables below to reconcile the segment measures to the Company’s consolidated measures. The Company’s business operates in four operating segments: AUTOMOTIVE BUSINESS SEGMENT (PREVIOUSLY BRANDED AS WESTPORT OPERATIONS) The Westport Fuel Systems Automotive division designs, manufactures and sells compressed Natural Gas (CNG) and liquid petroleum gas (LPG) components and systems for passenger cars and light-duty trucks and medium-duty vehicles including OEM, delayed OEM (“DOEM”) and Aftermarket. The portfolio of products includes pressure regulators, injectors, electronic control units, valves and filters, in addition to complete bi-fuel, mono-fuel and dual-fuel LPG and CNG conversion kits. During the first quarter of 2015, the Company realigned the structure of the company's internal organization. The realignment combined, our historical operating segments, Westport Applied Technologies, Westport On-Road Systems and Westport Off-Road Systems into a single operating segment, Automotive Business Segment (previously branded as Westport Operations). This change reflects the manner in which operating decisions and assessing business performance is currently managed by the CODM. As the Company narrows its focus within certain business units, including its investments in joint ventures, and defers certain products and related programs, the CODM manages the combined businesses as a whole. Therefore, the Automotive Business Segment provides more meaningful information to users of the Company’s financial statements. All comparable periods presented have been revised to reflect this change. WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT | 53 Financial Statements | Notes | 22. Segment Information INDUSTRIAL BUSINESS SEGMENT Financial information by business segment as follows: The Westport Fuel Systems Industrial division designs and manufactures alternative fuel components and systems for off-road mobile and stationary equipment, and heavy-duty on-road vehicles as well as the development of complete emissions certified and non-certified engines for forklifts and other industrial equipment. CORPORATE AND TECHNOLOGY INVESTMENTS SEGMENT The Corporate and Technology Investments segment is responsible for current and advanced research and development programs, corporate oversight, and general administrative duties. The corporate oversight and general administrative duties function for the company is grouped under this unit. CUMMINS WESTPORT INC. JOINT VENTURE CWI, our 50:50 joint venture with Cummins, serves the medium and heavy-duty on highway engine markets. CWI engines are offered by many OEMs for use in transit, school and shuttle buses, conventional trucks and tractors, and refuse collection trucks, as well as specialty vehicles such as short-haul port drayage trucks and street sweepers. WEICHAI WESTPORT INC. JOINT VENTURE WWI is a joint venture between Westport, Weichai Holding Group Co. Ltd. (Weichai) and Hong Kong Peterson (CNG) Equipment Ltd. focusing on the Chinese market. WWI develops, manufactures and sells advanced, alternative fuel engines and parts that are widely used in city bus, coach, and heavy-duty truck applications in China or exported to other regions globally. On April 20, 2016, the Company sold a portion of its economic interest in WWI [note 8b] and the Company discontinued reporting of WWI results on an equity basis. As the Company no longer has significant influence in the joint venture, the Company does not consider WWI a business segment. The accounting policies for the reportable segments are consistent with those described in note 3. The CODM evaluates segment performance based on the net operating income (loss), which is before income taxes and does not include depreciation and amortization, impairment charges, restructuring charges, foreign exchange gains and losses, bank charges, interest and other expenses, interest and other income, gain on sale of long-term investments and bargain purchase gain. 54 | WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT REVENUE Automotive Industrial Corporate and Technology Investments CWI WWI 2016 Years ended Dec 31 2015 $ 165,071 $ 100,108 $ 126,988 — 54,662 2015 — 5,162 3,196 3,581 276,465 331,882 29,931 185,967 337,234 618,465 Total segment revenues 531,291 621,153 1,086,268 Less: equity investees' revenue (306,396) (517,849) (955,699) Total consolidated revenues $ 224,895 $ 103,304 $ 130,569 OPERATING LOSS Automotive Industrial Corporate and Technology Investments Restructuring Years ended Dec 31 2016 2015 2015 $ (19,157) $ (21,855) $ (35,952) 3,746 — — (76,118) (77,283) (92,456) (19,000) — — Foreign exchange gain (loss) (6,408) 11,601 3,433 Impairment of long lived assets, net Provision for inventory purchase commitments CWI WWI (4,843) (22,722) (29,604) — — (4,106) 29,782 51,011 21,555 718 3,784 78,502 Total segment operating loss (91,280) (55,464) (58,628) Less: equity investees’ operating income (30,500) (54,795) (100,057) Consolidated operating loss (121,780) (110,259) (158,685) ADDITIONS TO LONG-LIVED ASSETS Automotive Industrial Corporate and Technology Investments Total consolidated revenues Years ended Dec 31 2016 2015 2015 $ 3,310 $ 1,350 $ 2,278 747 — — 5,290 3,495 7,971 $ 9,347 $ 4,845 $ 10,249 It is impracticable for the Company to provide geographical revenue information by individual countries; however, it is practicable to provide it by geographical regions. Product and service and other revenues are attributable to geographical regions based on location of the Company’s customers and presented as a percentage of the Company’s product and service revenues are as follows: REVENUE BY REGION % of total product revenue and service and other revenue, years ended Dec 31 2015 2014 2016 Europe Americas (including USA) Asia Others 54% 32% 12% 2% 48% 40% 12% —% 47% 42% 11% —% As at December 31, 2016, total goodwill of $2,923 (December 31, 2015 - $3,008) was allocated to the Automotive segment. As at December 31, 2016, total long-term investments of $12,876 (December 31, 2015 - $34,716) was allocated to the Corporate and Technology Investments segment and $546 (December 31, 2015 - $426) was allocated to Automotive segment. Long-lived assets information by geographic area: LONG-LIVED ASSETS BY REGION December 31, 2016 Italy Canada United States Rest of Europe Asia Pacific Less: equity investees' long lived assets Total consolidated long- lived assets December 31, 2015 Italy Canada United States Rest of Europe Asia Pacific Less: equity investees' long lived assets Total consolidated long- lived assets Fixed Assets Intangible Assets Total $ 26,713 $ 19,942 $ 46,655 22,157 1,377 23,534 5,613 3,119 3,154 — 4,462 — 5,613 7,581 3,154 60,756 25,781 86,537 $ $ (1,074) — (1,074) 59,682 $ 25,781 $ 85,463 6,212 $ 19,531 $ 25,743 18,875 14,210 3,076 7,767 494 — 5,135 155 19,369 14,210 8,211 7,922 50,140 25,315 75,455 (7,613) — (7,613) $ 42,527 $ 25,315 $ 67,842 Financial Statements | Notes | 22. Segment Information Total assets are allocated as follows: TOTAL ASSETS Automotive Industrial Corporate and Technology Investments and unallocated assets CWI WWI Less: equity investees’ total assets Total consolidated assets Dec 31, 2016 241,975 $ $ 65,717 Dec 31, 2015 157,452 — 23,768 147,245 — 478,705 (147,245) $ 331,460 $ 56,231 171,189 125,724 510,596 (296,913) 213,683 The Company’s long-lived assets consist of property, plant and equipment (fixed assets), intangible assets and goodwill. 23. Financial Instruments A. FINANCIAL RISK MANAGEMENT The Company has exposure to liquidity risk, credit risk, foreign currency risk and interest rate risk. B. LIQUIDITY RISK Liquidity risk is the risk that the Company will not be able to meet its financial obligations as they are due. The Company has sustained losses and negative cash flows from operations since inception. At December 31, 2016, the Company has $60,905 of cash, cash equivalents and short-term investments. The following are the contractual maturities of financial obligations as at December 31, 2016: WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT | 55 Financial Statements | Notes | 23. Financial Instruments CONTRACTUAL OBLIGATIONS & COMMITMENTS Carrying amount Contractual cash flows Years < 1 1–3 4–5 5+ Accounts payable & accrued liabilities Subordinated debentures notes(1) Senior revolving financing(2) Convertible debt Senior financing(3) Capital lease obligations Long-term royalty payable Operating lease commitments Royalty(4) $ 93,245 $ 93,245 $ 93,245 $ — $ — $ — 40,463 43,727 43,727 — — — 10,553 11,793 1,039 4,026 4,336 2,392 17,286 24,456 1,575 3,150 19,731 — 9,949 10,476 6,893 767 758 2,058 781 826 473 268 85 — 21,562 45,979 1,500 9,590 16,776 18,113 10,845 2,577 57,009 9,347 16,820 10,846 19,996 3,831 — 3,831 — — $ 207,261 $ 291,342 $157,799 $38,452 $52,532 $42,559 1. Includes interest at 9%. 2. Includes interest at rates disclosed in note 15(b). 3. Includes interest at rates disclosed in note 15(b). 4. The Company is obligated to repay funding received from Industrial Technologies Office ("ITO") in the form of royalties equal to the greater of $1,005 (CDN $1,350) or 0.33% of the Company's gross annual revenue from all sources, including CWI, provided that gross revenue exceeds $10,055 (CDN$13,500) in any aforementioned fiscal year, until the earlier of March 31, 2018 or until cumulative royalties total of $21,003 (CDN $28,200) has been repaid. As at December 31, 2016, $2,577 remains accrued in accounts payable and accrued liabilities (December 31, 2015 - $2,387). As at December 31, 2016, cumulative royalties of CDN $12,991 have been paid. C. CREDIT RISK Credit risk arises from the potential that a counterparty to a financial instrument fails to meet its contractual obligations and arises principally from the Company’s cash and cash equivalents, short- term investments and accounts receivable. The Company manages credit risk associated with cash and cash equivalents and short- term investments by regularly consulting with its current bank and investment advisors and investing primarily in liquid short-term paper issued by Schedule 1 Canadian banks, R1 rated companies and governments. The Company monitors its portfolio, and its policy is to diversify its investments to manage this potential risk. The Company is also exposed to credit risk with respect to uncertainties as to timing and amount of collectability of accounts receivable and other receivables. As at December 31, 2016, 91% (December 31, 2015 - 85%) of accounts receivable relates to customer receivables, and 9% (December 31, 2015 - 15%) relates to amounts due from related parties, income tax and value added 56 | WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT taxes receivables. In order to minimize the risk of loss for customer receivables, the Company’s extension of credit to customers involves review and approval by senior management as well as progress payments as contracts are executed. Most sales are invoiced with payment terms in the range of 30 days to 90 days. The Company reviews its customer receivable accounts and regularly recognizes an allowance for doubtful receivables as soon as the account is determined not to be fully collectible. Estimates for allowance for doubtful debts are determined on a customer-by- customer evaluation of collectability at each balance sheet reporting date, taking into consideration past due amounts and any available relevant information on the customers’ liquidity and financial position. D. FOREIGN CURRENCY RISK Foreign currency risk is the risk that the fair value of future cash flows of financial instruments will fluctuate because of changes in foreign currency exchange rates. The Company conducts a significant portion of its business activities in foreign currencies, primarily the United States dollar and the Euro. Cash and cash equivalents, short-term receivable, accounts payable, and long-term debt that are denominated in foreign currencies will be affected by changes in the exchange rate between the Canadian dollar and these foreign currencies. investments, accounts The Company’s functional currency is the Canadian dollar. The U.S. dollar amount of financial instruments subject to exposure to foreign currency risk reflected in the consolidated balance sheet at December 31, 2016 is as follows: FOREIGN CURRENCY RISK IN BALANCE SHEET U.S. dollars Cash and cash equivalents $ Accounts receivable Accounts payable Long-term debt, including current portion Long-term royalty payable, including current portion 9,732 9,780 4,353 17,286 21,562 E. INTEREST RATE RISK Interest rate risk is the risk that the fair value of future cash flows of a financial instrument will fluctuate because of changes in market interest rates. The Company is subject to interest rate risk on certain long-term debt with variable rates of interest. The Company limits its exposure to interest rate risk by continually monitoring and adjusting portfolio duration to align to forecasted cash requirements and anticipated changes in interest rates. If interest rates for the year ended December 31, 2016 had increased or decreased by 50 basis points, with all other variables Financial Statements | Notes | 23. Financial Instruments held constant, net loss for the year ended December 31, 2016 would have increased or decreased by $67. markets. Level 3 valuations are undertaken in the absence of reliable Level 1 or Level 2 information. F. FAIR VALUE OF FINANCIAL INSTRUMENTS As at December 31, 2016, cash and cash equivalents and short- term investments are measured at fair value on a recurring basis and are included in Level 1. The carrying amounts reported in the balance sheets for cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate their fair values due to the short- term period to maturity of these instruments. The Company’s short-term investments are recorded at fair value. The long-term investments represent our interest in CWI, which is accounted for using the equity method, and WWI and other investments, which are accounted for using the cost method. The carrying values reported in the consolidated balance sheet for the unsecured subordinated debenture notes (note 15) is greater than its fair value based on a recent financing the Company performed with Cartesian (note 16). The approximate fair value of the unsecured subordinated debenture notes is approximately $38,848 (CDN $52,159). Additionally, the interest rate on the notes approximates the interest rate being demanded in the market for debt with similar terms and conditions. The carrying value reported in the balance sheet for senior financing agreements (note 15(b)) approximates their fair values as at December 31, 2016, as the interest rates on the debt is floating and therefore approximates the market rates of interest. The Company’s credit spread in these subsidiaries also has not substantially changed from the premiums currently paid. The Company categorizes its fair value measurements for items measured at fair value on a recurring basis into three categories as follows: LEVEL 1 Unadjusted quoted prices in active markets for identical assets or liabilities. LEVEL 2 Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. LEVEL 3 Inputs for the asset or liability that are not based on observable market data (unobservable inputs). When available, the Company uses quoted market prices to determine fair value and classify such items in Level 1. When necessary, Level 2 valuations are performed based on quoted market prices for similar instruments in active markets and/or model–derived valuations with inputs that are observable in active 24. Subsequent Events On March 24, 2017, the Company renegotiated its €10,000 senior revolving financing facility. See [note 15b] to these financial statements for details. WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT | 57 Recent Material Announcements Recent Material Announcements On April 17, 2017, Westport Fuel Systems announced that it had entered into a definitive agreement to sell the assets of its Auxiliary Power Unit (APU) business. On May 1, 2017, Westport Fuels Systems announced that it had closed the sale for net proceeds of approximately $60 million US dollars, after adjusting for estimated net working capital, transaction costs, hold back amounts and other deal related expenses. The divestiture is consistent with Westport Fuel Systems strategy to streamline its business and product lines and focus on alternative fuel solutions for the transportation and automotive industries. 58 | WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT Information for Shareholders DIRECTORS & EXECUTIVE OFFICERS Committees Name / position Ashoka Achuthan CFO Andrea Alghisi COO Automotive and Industrial Group Residence Chicago, Illinois Tortona, Italy Jim Arthurs Executive Vice President North Vancouver, British Columbia Warren J. Baker Director Brenda J. Eprile Chair & Director Nancy S. Gougarty CEO and Director Anthony Harris Director Colin Johnston Director Avila Beach, California North York, Ontario Leesville, South Carolina Alameda, California Turin, Italy Jack Keaton Executive Vice President Vancouver, British Columbia Scott Mackie Director Rodney T. Nunn Director Milford, Michigan Chatham, Ontario Thomas G. Rippon Executive Vice President White Rock, British Columbia Peter M. Yu Director New York City, New York AU HR NC • • • • • • • • • • • Start date Nov 2013 June 2016 Jan 2014 Sep 2002 Oct 2013 Feb 2013 June 2016 June 2016 Apr 2014 Sept 2016 Mar 2016 Sep 2013 Jan 2016 Committees are as follows: AU = Audit; HR = Human Resources & Compensation; NC = Nominating & Corporate Governance Corporate Information Information for Shareholders Legal Counsel Bennett Jones LLP, Calgary, Alberta, Canada Auditors KPMG LLP, Independent Registered Public Accounting Firm, Vancouver, British Columbia, Canada Annual Meeting Of Shareholders WHEN: Wednesday, June 28, 2017 at 09:00 AM (Eastern) WHERE: 100 Hollinger Crescent, Kitchener, Ontario Westport Fuel Systems on the Net Topics featured can be found on our websites: WESTPORT FUEL SYSTEMS wfsinc.com FUEL FOR THOUGHT (blog) blog.westport.com YOUTUBE FACEBOOK TWITTER youtube.com/westportdotcom facebook.com/westportdotcom twitter.com/westportdotcom CUMMINS WESTPORT cumminswestport.com The information on these websites is not incorporated by reference into this Annual Report. Financial results, Annual Information Form, news, services, and other activities can also be found on the Westport Fuel Systems website, on SEDAR at sedar.com, or at the SEC at www.sec.gov. Shareholders and other interested parties can also sign up to receive news updates in a variety of formats including email, Twitter, and RSS feeds: westport.com/contact/ subscriptions STOCK LISTINGS NASDAQ Toronto Stock Exchange WPRT WPRT Contact Information 1750 West 75th Avenue, Suite 101 Vancouver, BC, Canada V6P 6G2 T 604-718-2000 F 604-718-2001 invest@wfsinc.com Westport Shareholder Services Shareholders with questions about their account—including change of address, lost stock certificates, or receipt of multiple mail- outs and other related inquiries—should contact our Transfer Agent and Registrar: Computershare Trust Company of Canada 510 Burrard Street, 2nd Floor, Vancouver, BC, Canada V6C 3B9 T 604-661-9400 F 604-661-9401 Forward-Looking Statements Certain statements contained in this Annual Report constitute "forward-looking statements". When used in this document, the words "may", "would", "could", "will", "intend", "plan", "anticipate", "believe", "estimate", "expect", "project" and similar expressions, as they relate to us or our management, are intended to identify forward-looking statements. In particular, this Annual Report contains forward-looking statements pertaining to the following: WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT | 59 Information for Shareholders • Our efforts to capture operating efficiencies and reduce our expenses and the results of such efforts in the future; • Future asset sales and right-sizing of Westport's cost structure and the results of such activities; and • The timing and effect of the launch of Westport HPDI 2.0 commercial components with OEM launch partners. Such statements reflect management's current views with respect to future events and are subject to certain risks and uncertainties and are based upon a number of factors and assumptions. Actual results may differ materially from those expressed in the foregoing forward-looking statements due to a number of uncertainties and risks, including the risks described in Westport's Annual Information Form and in the documents incorporated by reference into this Annual Report and other unforeseen risks, uncertainties, factors and assumptions include, without limitation: risks. Such • market acceptance of our products; • product development delays and delays in contractual commitments; • changing environmental regulations; • the ability to attract and retain business partners; • the success of our business partners and OEMs with whom we partner; • future levels of government funding and incentives; • limitations in our ability to successfully integrate acquired businesses; • the ability to provide the capital required for research, product development, operations and marketing; and • risks related to the merger with Fuel Systems Solutions Inc., including, but not limited to: failure to realize the anticipated benefits of the merger with Fuel Systems and to successfully integrate the two companies. You should not rely on any forward-looking statements. Any forward- looking statement is made only as of the date of this Annual Report. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as otherwise required by law. The forward- looking statements in this Annual Report are expressly qualified by this cautionary statement. 60 | WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT please recycle WESTPORT FUEL SYSTEMS INC. 2016 ANNUAL REPORT | 61 

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