Broadwind, Inc. (BWEN) Q3 2013 Earnings Report, Transcript and Summary

Hello, and welcome to the Quarter 3 2013 Broadwind Energy, Inc. Earnings Conference Call. My name is Sherry, and I will be your conference operator for today's call. [Operator Instructions] At this time, I'd like to turn the call over to Joni Konstantelos.

Thank you. Good morning, and welcome to Broadwind Energy's Third Quarter 2013 Earnings Conference Call. With me today are Broadwind's President and CEO, Peter Duprey; and Broadwind's Executive Vice President and CFO, Stephanie Kushner. This morning's earnings news release is available on our website at www.bwen.com. Second slide, please. Before we begin today, I would like to caution you that this call will include some forward-looking statements regarding our plans and market outlook and also will reference some non-GAAP financial measures. Actual results may differ materially from these forward-looking statements. Please refer to our SEC filings and consider the incorporated risks and uncertainties disclosed there, including our Form 8-K and the attached news release filed with the SEC this morning, and our Form 10-Q, which will be filed later today. We assume no obligation to update any forward-looking statements or information. Having said that, I will turn the call over to our President and CEO, Pete Duprey.

Thanks, Joni, and thanks, everyone, for joining the call. This morning, we reported our third quarter results. Overall, we had another solid quarter, beating our revenue and EBITDA estimates, booking $87 million in new orders and adding another $6 million of cash. Towers had their strongest revenue and EBITDA quarter on record. After quarter end, we booked another $106 million in tower orders. The Gearing segment, however, had a challenging quarter, and we're continuing to work through some of the market and operational challenges. I'll talk in more detail about this later in the call. In Services, we did see some recovery in Q3 from the first -- from a weak first half of the year, but sales continued to lag behind the prior year due to low turbine construction activity and lower gearbox repair activity. Turning to the market outlook. We expect the market to be strong in 2014 and '15. We are active in lobbying for a PTC extension that will continue to drive out cost to the point where wind can compete with fossil fuels without government subsidies. The oil sector remains strong in our Gearing business. This has offset some of the weakness in the natural gas sector. According to the U.S. Energy Information Administration, in 2013, the U.S. is expected to be the largest oil producer over both Saudi Arabia and Russia. In the natural gas market, 4 liquefaction terminals have been approved and are expected to go online between 2015 and 2019, which represents about 10% of the current supply in natural gas. This, with continued switching to natural gas as a transportation fuel and increased consumption for industrial purposes, should create upward pricing pressure on natural gas, resulting in wind being an even more attractive alternative. Turning to orders. Towers booked $70 million in new orders during the quarter, and we announced another $106 million in new tower orders after the quarter, as I mentioned. Our tower manufacturing capacity is about 500 towers and is substantially sold out for 2014, and we're booking orders into 2015. Gearing orders increased during the quarter, mainly for replacement wind gearing, as well as some industrial gearbox work. Service orders during the quarter were ahead of the first half run rate, but still lag from the prior year. Our backlog is $167 million, up 17% from Q2 and 68% from Q3 of last year. Including the $106 million tower order that we announced in October, our current backlog is approaching $255 million, a level that Broadwind hasn't seen since Q3 of 2009. We're seeing some positive trends in the wind energy market from a demand perspective. With the uncertainty around the cost of carbon in the future, it's difficult for utility executives to know what investments to make in power generation resources. As the economy rebounds, albeit slowly, utilities are going to meet the -- need to make some capacity investments. Many utilities are adding wind energy to their portfolios. The question is why. Well, one reason is the levelized cost of wind energy is getting closer to grid parity with fossil fuels. Thus, utilities have an easier time with public utility commissions to rate-base wind assets. The cost of carbon of a wind investment is 0, so there's no carbon risk. The capital cost of a wind asset is higher than a traditional fossil generation, but the fuel is free. Thus, embedded in a wind energy investment is a natural hedge against volatile fossil fuel prices. The mixture of wind and natural gas can replace older and less efficient coal generation at a much lower emissions rate in those states that have good wind regimes. Now let's talk about the wind -- or the Gearing business, which had a tough quarter. The turnaround in the business is clearly a priority with me. We just completed our long-range planning process and are developing our 2014 budget. As part of the process, we conducted a number of focus groups and did more detailed market analysis. From this emerged 3 main catalysts for change in the business. The first is sales execution. Next, on-time delivery. And finally, improving first-pass yields. Let's talk about sales execution. The markets in which we operate, market penetration rate is key. Today, our market penetration is in the low-single digits in the markets that we serve. Because of the size of the markets, increasing our market share by 4% to 5% would be significant growth for us and is both realistic and attainable. Thus, increasing market share will be one area of strategic focus in the coming months and years. To achieve this, we've recently added a new sales leader with over 35 years of precision gearing and gearbox sales experience. We're having targeted manufacture reps with deep gearing experience in some of the markets that we already serve. Additionally, we're adding engineering resources who can work more closely with our customers to better understand their requirements, work on cost initiatives and, perhaps, most importantly, develop a deeper, longer-term relationship. We saw an uptick in orders in Q3 as a result of some of these initial efforts. Turning to on-time delivery. We know the industry and our Gearing business could not always deliver to our promise dates. Thus, many customers build in additional delivery cushion. Our commercial and operations teams are very focused on improving on-time delivery and eliminating wasted steps in the process. The biggest culprit is dwell time between process steps. A series of Kaizen events were held in the summer and we're starting to see some benefits. There's still a long way to go, but greater attention to the process, I believe that we can see a dramatic improvement in 2014. Finally, first pass yields are another area of focus. Ensuring that we are doing things right the first time is key to eliminating waste and rework. Having production in one consolidated facility is a good first step, which should substantially be completed by the end of the year. A series of Kaizen events were scheduled in the fourth quarter to improve first-pass yield in the business. We will report on our progress on the next call. So we have the right building blocks to grow and be profitable with our focus on continuous improvement starting to take root. I am confident we can reap similar benefits in our Gearing business, as we've seen from our Towers segment. I'll now turn the call over to Stephanie who will cover the -- she'll cover the financials in more detail.

Thanks, Pete. Turning to Slide 7. On $62.4 million of revenue, our third quarter gross profit margin of 9.1% was a big improvement. This brings the year-to-date average gross margin to 7.6%. This is a stronger improvement than we'd forecast and reflects the outstanding operational result for Towers. Q3 operating expense is $6.9 million included the $1.5 million EPA fine. So you can see that excluding that item, we spent $5.4 million on $62 million in revenue or 8.7%. Both of these figures support our 2014 outlook for gross margin of 9% to 11% and operating expense of 9% to 10%. Our adjusted EBITDA was $2.6 million, including the effect of the EPA settlement, which was frankly higher than we'd expected. The higher charge was offset by the stronger tower results, enabling us to finish the quarter in line with our EBITDA guidance. The EPS loss of $0.18 was higher than guidance because of slightly higher restructuring expenses due to timing and slightly higher interest and other expense, as well as a $0.10 per share impact of the environmental charge. Turning to Slide 8. The graph on the left shows the year-to-date gross margin, excluding restructuring, of 7.6%, nearly double the run rate for 2012 and slightly above the 6% to 7% full year range that I suggested last quarter. The improvement is due to the strong performance of the Tower business and also because some of the restructuring activities we have completed, which have reduced our operating footprint by about 400,000 square feet. The margin was negatively impacted by weak performance from Gearing and Services, but these factors were more than offset by the strong Tower results. On the operating expense side, you can see that SG&A percent was flat with last year's, when you exclude the other components of operating expense, that is, the impact of the onetime regulatory settlement and the intangible amortization expense. With the rise in sales volumes booked for 2014 despite planned increases in sales and engineering headcount, we're still looking at a 9% to 10% operating expense rate. Slide 9, please. Towers turned in a record quarter. We sold 124 towers, which included $4 million worth of towers that were produced and carried over from Q2 because we were waiting for final customer inspection. During the third quarter, we produced only 3-section towers, versus last year when we were producing a number of 5-section towers. Therefore, while our tower count was up more than 30% year-over-year, our section count, which is more representative of our activity level, was up only 18%. Our margins benefited from producing at a higher level and because we had a much less complex order mix. Only 2 tower models running through our plants this quarter versus 5 different models being produced in Q3 of last year. These factors boosted productivity significantly and reduced overtime. The one negative factor in the quarter for Towers was lower industrial weldments activity, due to reduced purchases from a large mining equipment customer. We've not made the progress we would have liked in diversifying our customer base for large weldments. Having just finished our annual long-range planning process, we are redoubling our efforts to resource and expand this business. Tower operating margins were nearly 14% in the quarter, an impressive improvement from under 5% a year ago. We believe that low-double-digit operating margins can be sustained for at least the next 2 to 3 years because of stability in order flow and continuous improvement initiatives, which will continue to boost our efficiency and lower our manufacturing costs. Our 9-month operating margin was about 11%, probably a good run rate estimate for the next 2 years. For the final quarter of the year, we should produce and sell another 105 to 110 towers, a slightly lower run rate than the most recent quarter due to fewer workdays. We're projecting a slightly lower operating margin in the quarter, closer to about 10% due to the reduced volume and a slightly more challenging production mix. Next slide, please. Gearing had another difficult quarter with $10.4 million in revenue and an operating loss of $5.7 million, including the $1.5 million EPA fine. Excluding the onetime impact of the fine, EBITDA was down $2 million on a $900,000 reduction in sales. Although the volume reduction was only about 8%, this quarter's production mix had lower gross margins than a year ago due both to some inaccurate cost estimating on gearbox orders and production difficulties with the products we haven't made before. Using CI tools, we're making changes to both our estimating and production processes and expect to see early improvements in Q4. Also in Q4, our consolidation activities will be minimal. Q4 should have sales closer to $12 million and breakeven EBITDA. By 2014, we should be EBITDA positive again and working towards healthier double-digit margins, which are typical of this industry. Slide 11. Revenue for Services was $3.7 million, down $3.2 million from Q3 2012. Of the reduction, about half was due to lower new turbine construction activity, as illustrated in the chart in the bottom right-hand corner. Despite increased development activity in recent months, preliminary industry data indicates that in the U.S., fewer than 50 turbines have been brought online during the first 3 quarters of the year. The other half of the reduction was due to lower blade retrofit activity and gearbox rebuilds. Sharply lower field construction activity has driven customers to in-source some of their nonconstruction activity in order to maintain their tech resources. Although we have initiated some cost reductions, we are trying to balance the need to reduce losses against our interest in maintaining headcount within the segment to support the likely improvement in activity later this year and into 2014. At the low revenue run rate, we lost $1.3 million in operating income and $800,000 of EBITDA in this segment. Q4 is traditionally a weak quarter for Services, so we expect revenues in the $2 million range and about a $1 million EBITDA loss. On Slide 12, working capital remains very low at $4 million or 2% of sales. This is impacted very significantly by the high level of customer deposits we have received, mainly to support field purchases for towers. However, I don't want this factor to overshadow the solid cash management results in other areas. During the quarter, our receivables came down to 31 days outstanding, with record low past due amounts. And inventory balances came down, in part due to shipping towers that had been finished during the prior quarter. The impact was to raise our inventory turns to 7.1x versus 6.5x last quarter. So even in the absence of the steel advances, our working capital would've been a very competitive 10% of 3-month average sales. Good focus on the part of the collections and operations folks. As a result of the improvement in EBITDA and lower working capital requirements, operating cash flow for the 9 months totaled to $21.5 million. Turning to the next slide. Liquidity continues to look great. We acquired a new piece of gearing equipment during the quarter, which was partially financed through a $1.5 million capital lease at a competitive interest rate. As a result, the debt plus capital lease balance rose slightly to $5.8 million at quarter end. We generated $6 million of operating cash flow, so that net debt was again negative, $18.2 million or nearly $1.26 per share. Our credit line remains undrawn today and we expect it to be undrawn into next year. Turning to the next slide, the financial outlook. We expect revenue of between $55 million and $58 million in Q4, down from the previous quarter, mainly because of about 15 fewer towers. While we still expect to be producing at a quarterly run rate of 125 towers in 2014, we're not there yet. On our projected level of sales, we expect a gross margin in the 7% to 8% range and adjusted EBITDA above $2 million. That will still put us within our full year guidance of $9 million to $10 million of EBITDA. A few items on my final slide. First, a restructuring update. We have now incurred $9.4 million of the total restructuring cash outlays, both capital and expense. So 81% of these expenditures are behind us. We have completed the move of almost all of the gearing equipment, with the exception of equipment supporting one product line, which is being rebuilt and upgraded coincident with the transfer. These final pieces will not be in place until mid-2014. There are a couple of other items of note this quarter. First, the regulatory settlement. This $1.5 million fine relates to manufacturing process wastewater disposal practices, which were in place when we acquired the Gearing business in 2007. Since bringing an environmental health and safety executive on to our management team, in addition to dedicated EHS professionals in each of our businesses, we have evaluated and modified, where necessary, all of our EHS practices across the corporation. We're confident that we are in compliance today with all material regulations. And finally, we are filing a Form 8-K this afternoon, indicating that we are making a change in audit firms, moving from Grant Thornton to KPMG. KPMG has a solid client base within our industry and a strong practice within publicly traded manufacturing clients. We think this change is good for the long-term future of Broadwind. As noted in the 8-K, we have no disagreements with Grant. We believe this change positions the company well for the future. And with that, I'll turn the call back over to Pete for questions.

[Operator Instructions] And our first question comes from Angie Storozynski of Macquarie.

So first of all, you mentioned that you're already getting orders for towers in 2015. Can you give us a sense about -- if there were not to be an extension of ITC past the end of this year, I mean, is there any contingency embedded in those tower contracts? Do you feel like the recent IRS interpretation of the start of construction will allow for projects to be added to -- wind farms to be added to 2015 and still qualify for the ITC if it were not to be extended?

Yes, Angie. The Internal Revenue Service -- the treasury recently came out with clarification on the PTC extension, and not going into the details, they basically said as long as you start your project by the end of 2013 and finish it by the end of 2015, they're really not going to question whether or not you qualify for the PTC credit. So essentially, as a result of the change in the language around start of construction, we effectively got a 3-year extension. So I think that clarification helps. So we think that '14 and '15 are going to be very good years for the wind industry, and we're pretty active in lobbying Washington. And I think we're going to really try to get another extension and likely a lame-duck session in '14 that would hopefully give us another extension similar to what got passed in 2013, get another -- effectively, another 3-year extension and work like hell to drive costs out of the costs of wind energy to be able to better compete with fossil fuels.

Okay. And then secondly -- so did you see any response from your competitors in the Towers business? Is anybody coming back -- I mean, any manufacturing capacity coming back online to compete with you in the Towers business?

Yes, they're basically -- a couple of main competitors, Trinity is obviously our main competitor. Their order rate was way up in the third quarter. But they're also, I think, leaving capacity open for tank cars, they have a fairly significant backlog in tank cars. We do know that Marmont, who traditionally has been in Québec, and they bought our tower facility in South Dakota, they're getting that facility up and running. It had a capacity of about 5 -- or I'm sorry, 150 towers. And I think they're adding to that. So they may be able to produce 300 towers a year. So I think -- we feel very comfortable that there's enough supply in that domestic market to have a very reasonable industry going forward. So we're not -- we don't see a lot of excess capacity right now. The one thing we are keeping an eye on is Korea and Indonesia to make sure that -- because they were not part of the trade case that we filed against Vietnam and China. So if -- our outlook might change a little bit if Korea were to start sending a lot of towers over into the U.S., but we don't see that at this time.

Okay. And then lastly, you're not giving up on your Services business, but it doesn't seem like you're getting any traction. And I mean, what needs to -- you think it's just more of a -- your distribution channels? Or do you think there needs to be a shift in the market that the OEMs and the wind farm operators still maintaining their facilities in-house?

I would say that we underestimated for 2013 the dramatic dropoff in build rate. So I think Stephanie mentioned that basically 50 megawatts have been placed in-service in the first 3 quarters. So what most owner-operators did who had teams of people who supported construction and commissioning activities took those people and put them on nonroutine maintenance. So that impacted our business fairly dramatically. We are developing some new products, primarily around up-tower, gear servicing, enhancing our blade service offering; our DriveMAX programs and our BladeMAX programs. So I think the whole key to service industry is being able to help an owner-operator or an OEM drive costs out of servicing a turbine or helping them improve the performance of the turbine. We've got some products out on the market. And we're starting to get some traction on that. I'm not at the point where I want to give up on the Services business. It's been a tough year. I do think it's going to come back as -- there's going to be a lot of building going on next year. I think we can help a lot of customers and continue on some of our own internal R&D to develop value-added products for those customers.

[Operator Instructions] Our next question comes from Beth Lilly of Gabelli Asset Management.

It's Beth Lilly from Gabelli Asset Management. We've been called a lot of things but stable asset management, that's a new one. So Stephanie, I wanted -- on the call, you talked about the difference between tower orders and section count, and can you explain a little bit of the difference and what you mean by tower orders are going to be lower because the section counts are lower? Can you explain that to us?

I think what I was trying to say is in the fourth quarter, our -- both our towers and our sections, and maybe I was too -- maybe I was kind of vague about that, but both our towers and sections are going to be a little lower than they were in the third quarter because the third quarter, we benefited from the carryover of some sections that were actually produced before June 30, but then fell into the third quarter revenue. So I...

Let me take a step back to the -- a tower is really 3 sections, 3 to 5. but most of what we're producing now is a 3-section tower. So...

Okay. So to the extent that the section production is lower then that's going to make the Tower production lower, right? Because you put 3 sections together to make a tower.

Yes, typically, it's going to be the same relationship. I think one of the clarifications I was making was that year-to-year, the 2 didn't move in sync because we had last year some 5-section towers that we don't have now.

Okay. So if going forward, will we see -- just so I can understand this. Well, when you talk about section demand or section orders, that in essence, is going to be a sense of how strong tower orders are? Right. Okay.

So if we're going to produce 500 towers next year, which is our objective, it's going to be 1,500 sections.

Okay. And why do you break out the difference between section orders and tower orders?

Only reason is, when we look at our main activity driver internally, it's a section and there are time periods when we have more or fewer sections per tower, so on some of the metrics, if we were just to talk to you about towers would be confusing.

It'd be fine if everything was a 3-section tower, but if you throw a 5-section tower in there, then your metrics are off with just looking at towers.

Yes, like this quarter versus last quarter, our tower count was up 30%, but our section count was only up 18%.

And our next question comes from Arthur Friedman of Friedman Asset Management.

I wanted to talk quickly about the Gearing turnaround with the process improvement. I just want to understand, is the process improvement about returning to the customer repaired gearboxes, what exactly is the process improvement? Or does it have to do with shipping out the tower, the completed towers?

So the process -- well, we're doing process improvement in all of the businesses. I'll take the first part of your question is around gearing. So just as a little background, the company has been a long-term industrial gearbox manufacturer. In 2005, shifted predominantly to 2 main customers in the wind energy market, producing wind energy loose gearing. So that shift to really 2 main customers that might have represented 80% of the revenue, created a very different manufacturing environment than we're having today where we've shifted back to more of an industrial focus. And in making those shifts, I think we greatly disrupted the flow of the business. And as we're shifting back to both loose gearing for a larger set of customers and looking to do more completed gearboxes because the more value-add, the higher the margin. As we make those shifts, we've gone through some, I would say, hiccups. We've also at the same time been consolidating 2 manufacturing facilities that are within 3 miles of each other into one facility. So a lot of change going on. And I think that's -- as well as the market, as we've shifted into industrial gearing, we went into the gas market and we went into the mining market, both of which are a bit soft right now. So a lot of market change, a lot of operational changes. So this year, we, in essence, took what I would call almost a timeout and said, we're going to relook at all of our processes, relook at how we leverage systems and really build a business that's scalable for the future. So you hear me talk a lot about continuous improvement and Kaizen events, that's what that's about. So we're retooling our processes to take out waste, to improve on-time delivery, which we think is a competitive advantage. So a lot of work going on, on the process side. And we think it's an investment that will pay off in the future.

That clarifies, because I do process improvement as well. That's very interesting, that. Another question I have is, if you take out the $1.1 million fine wouldn't your net loss have just been $1.1 million?

Well the fine was actually $1.5 million.

Right. But your loss from continuing operations is $2.6 million. So would that have reduced that to $1.1 million?

That's right.

Right. Okay. So that's actually -- it sounds to me like you're really on the right track. I mean, that's almost even.

Yes. Thanks for that comment. It was -- the fine was really $0.10 out of that $0.18.

Right, Right. Okay. I just wanted to point that out because I think that's a key factor. And the last question I have is, have you thought about -- I see what you're saying about the irregular maintenance. Is there any way you could develop some sort of a -- or do you have it now, a product offering of regular scheduled maintenance, sort of like what the air-conditioner and furnace people do where they try and sell you a regularly scheduled maintenance package. Do you have anything like that or thought about anything like that?

Yes. That's usually what's called in the wind industry, O&M services. And we started going into O&M services, we found that there were a lot of players, a couple of guys in a truck and then the original equipment manufacturers were also operating O&M services. So it became a very competitive market. With our competency in gearboxes and drivetrains and blades, we felt that, that was a higher margin business, albeit a little more seasonal. And so -- but we still think that if we were to go into pure O&M, we just not likely to have the margins that we need. So I think we may take a few accounts that are maybe in our backyard as base revenue. But I think we still want to continue down the path of really this nonroutine maintenance around the gearbox. Now the other initiative we're starting to develop is really drivetrain services in adjacent markets like mining, oil and gas. Because where a lot of the wind farms are, there's a lot of exploration going on for oil, gas and -- so we think that our techs are trained really to do multiple types of drivetrains. So that's really kind of a growth opportunity as we look forward.

And then at this time, we have no further questions. I'll turn the call back to Pete Duprey for final remarks.

Yes, I'd just like to wrap this up and say that I think Towers had an exceptional quarter. It's the best one on record. We are fully aware of the challenges in Gearing and Services, and we're spending a lot of time in those businesses. Overall, I think the quarter was solid. When you take the fine out, our EBITDA was $4.1 million, which, I think, was significant improvement over last year and over the previous quarter. I think we have the tools in place. The results that we reported to date in 2013 and our unwavering focus on operational execution, I'm confident we can achieve our milestone of profitability in 2014. And I really look forward to kind of wrapping up the year and talking more on our call in February about really our plans in more detail for 2014 and showing how we could deliver on our results in '13. So again, I'm actually looking forward to talking about that in the coming months. So thanks for joining the call, and we'll talk again in a few months.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.