Broadwind, Inc. (BWEN) Q3 2016 Earnings Report, Transcript and Summary

Good morning and welcome to the Broadwind Energy Q3 2016 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. Please also note today’s event is being recorded. I would now like to turn the conference over to Joni Konstantelos, Director of Investor Relations. Please, go ahead.

Thank you. Good morning and welcome to Broadwind Energy’s third quarter 2016 earnings conference call. With me today are Broadway’s President and CEO, Stephanie Kushner and Broadwind’s Vice President and Corporate Controller, Jason Bonfigt. This morning’s earnings news release is available on our website at 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 Stephanie Kushner.

Thanks, Joni and good morning. We performed well against our plans this quarter. We reported revenue of $43 million, which was on plan and consistent with guidance. We saw a nice uptick in our gross profit margin, 12.5% in the quarter. This reflects good execution in towers and better manufacturing equipment and expense management in gearing. Our cost reduction efforts were on track. In the quarter, we generated $1.2 million of income from continuing operations or $0.08 a share. Our cash position spiked in the quarter, rising to $24 million. I should caution that cash balances have declined in October and are expected to end the year closer to $15 million because we're making some significant disbursements to support our capital investments. Our credit line remains undrawn. In a release yesterday, we announced that we’ve closed on a new credit facility with private bank, which provides us good liquidity to support our working capital needs and growth investments. The initial credit line is $20 million with a $5 million accordion that we should be able to access early next year. This new credit line replaces the one we have previously, which has been retired. On the next slide, at the beginning of this year I laid out three near-term priorities. First, to double order intake. To-date, we’ve booked $243 million of new orders more than the total for the last two years combined. Our backlog contains orders that extend into 2019. Our second priority was to maintain consistent tower production. We are ahead of our delivery schedule on both locations and we're continuing to make solid progress with improvements to our production efficiencies. The final priority was cost management. As I said, our year-over-year savings totaled $6.5 million as of September 30. Of the total, $3 million was from lower cost for indirect labor and SG&A head count also favorable were lower depreciation of $1.7 million, the absence of a $900,000 environmental reserve we took last year and number of other reductions ranging from renegotiated property taxes to lower professional fees. Turning to the wind market, U.S. wind energy markets remain strong and our visibility continues to improve. Recent data from Bloomberg New Energy Finance shows that a number of projects are under way and a larger number have been announced. At this point, we have good confidence that annual win capacity additions in the U.S. will range between 7.5 gigawatts and 10.5 gigawatts per year through the end of the decade. That drives demand for 3,500 to 4,500 new towers each year. As we discussed last quarter, the combination of the extension and phase down of the PTC, some more generous IRS provision and the generally positive environment have combined to provide an unprecedented longer range time horizon for the industry. We're using this horizon to focus on investments that will automate some key processes and on improving our competitiveness. On the next slide, as the recent data from HIS and the American Gear Manufacturers Association indicates, the U.S. market for gearing remains weak and we're not planning on a meaningful recovery in 2017. The weakness stems from disruption in the oil and gas and mining industries, which is exacerbated by the impact of the strong dollar, which is boosting imports. Our focus is on growing our customer base in the wind energy replacement gearing market, which is growing and on improving execution to support share gains from existing and new customers in the industrial space. On the next slide, orders and backlog, although more than double last year this was not a strong quarter for orders. We booked an additional $23.5 million of tower orders, but only $2.2 million of new gearing orders, which brought Broadwind’s cumulative orders to $243 million for the 9 months. The low gearing order intake was disappointing and we are expanding our commercial resources in this business. Oil and gas orders remain very low and orders from steel customers, which were relatively strong earlier in the year, have trailed off. On a positive note, recent quoting activity for gearing has improved and we expect to see higher orders in the fourth quarter. Turning to the income statement, as I said, our $42.6 million sales figure was in line with guidance. The top line reduction from the prior year quarter was due to lower material prices in towers and the downturn in gearing sales to oil and gas and mining customers. Our gross margin was 12.5% more than double the prior year, which brought the year-to-date figure to 10.1%. As we are demonstrating much improved operating consistency, we expect margins to stay at or above 10% in Q4. Operating expenses down both for the quarter and year-to-date and we expect to continue to realize savings moving forward. Our cost reduction efforts are helping and we also benefited from the absence of an environmental reserve established last year. Partly offsetting these favorable items was increased incentive compensation expense as we have moved into a position of cumulative positive operating income, which is the basis for our incentive comp to pay out this year. Our income from operations was $1.4 million in the quarter and $1.32 million year-to-date and we generated $3.3 million of adjusted EBITDA and $0.08 of EPS. Turning to our towers and weldment segment, our $38 million revenue was down $5 million from last year on flat tower sales and in line with guidance. The year-over-year reduction was due to $6 million in lower material prices mainly steel. We generally lock-in steel prices at the same time that we bid a tower or we provide for a pass-through adjustment should material prices change. So this reduction basically reflects for lower steel prices that were negotiated late last year. I should also note that we've been building some four-section towers recently, which is distorting our reported tower count, at least in the year-over-year comparison. As shown in the bottom left hand table, we are expecting to finish the year with about 450 towers sold, but our production activity measured by section count will actually be more than 5% higher. Our operating income jumped to 10.7% of sales and EBITDA rose to 13.8%, which was higher than the 11% I had guided to. We continue to see productivity gains in our Abilene plant and actually produced better than we expected even leading up to and coming out of a planned maintenance shut down early in the quarter. Due to good production flow, we actually produced 4% more sections than last year and built inventory in the quarter, which gave us some overhead absorption advantage. Given the mix of bottles we’re producing in the fourth quarter, I don't think our margins will stay this high, but should return to the 9% operating income level with EBITDA margins of 11%. Regarding our objectives for this segment, we are continuing to sell production slots for 2017 and are targeting new markets for our industrial weldments business. Our cost reduction progress is bearing some fruit and the capital we are investing to improve the efficiency of our paint processes and expand capacity in Abilene is on track. Turning to gearing, I commented on the low gearing order intake. The comparison is particularly tough because last year's Q3 included a $7 million order for wind gearing, which covered some requirements into 2017 as well. Revenue was $4.6 million in the quarter in line with guidance. The operating loss was halved on this lower revenue due to lower depreciation, improved manufacturing throughput and cost reduction activities plus the absence of an environmental reserve we did last year on a vacant property where we’re commencing remediation. And we achieved breakeven EBITDA for the first quarter this year. We expect similar results in Q4 about $5 million in sales and approximately $700,000 operating loss and breakeven EBITDA. Given the weak market, we are focused in this business on improving labor productivity, managing costs and expanding our sales activity. As you can see in the bottom left hand graph, we worked diligently to improve our financial results in this business despite the market headwinds. On the next slide, our liquidity remains strong with cash up to $24.3 million despite some increase in receivables and inventories. The improvement is of course driven by operating results, but also because our customer deposits and payable are considerably higher than year-end. We have some significant disbursement slated in the fourth quarter both for materials and for our capital investments and expect the year-end cash balance to be in the $15 million to $17 range. As you can see on the right hand slide, we were in the unusual position at 9/30 of having essentially a net $0 operating working capital balance, a situation we haven't seen since the end of 2013 and which we expected to rebound back into the yellow banded range we consider normal for our business. At this point, our total debt balance is $3.2 million, including $600,000 in capital leases, which funded the purchase of some mobile material handling equipment earlier this year. The balance of $2.6 million was a government subsidized loan, which will be largely forgiven in 2018. In summary then, our tower plants are operating well and our tower production is consistent and slightly ahead of schedule. The wind energy market is strong and we have good and improving visibility going out several years. Our gearing business is slogging through a tough market environment, but managing costs well and improving operational consistency. We achieved breakeven EBITDA in the quarter and will continue to manage for little or no cash burn in this business. We're on target with our cost reduction efforts and should save $8 million or more this year from fixed overhead and operating expenses. Our Q4 results should be for revenue of $44 million to $46 million. I'm being cautious regarding Q4 earnings because of some changes in tower model mix and I'm looking for operating income in the $500,000 range. This should bring year-end operating income to $1.5 million to $2 million and full year EBITDA above $9 million. This concludes my remarks and I will turn it back over for questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Today's first question comes from Angie Storozynski of Macquarie. Please go ahead.

Thank you. So we’ve been hearing from a couple of wind tower developers that actually contrary to our expectations they are starting to accept deliveries of high wind turbines ahead of the start of construction of new wind farms in order to capture the PTC benefit at 100% rate. I mean we had expected that they would be just making prepayments, but now they're talking about actually accepting deliveries. Do you feel like this is going to maybe inflate your orders come at the first half of 2017 or are you hearing some commentary about OEMs making advanced purchases for our equipment in general?

Yes, I think that for safe harbor purposes there are a number of components that are getting a little bit of a surge between now and April and they actually have until April to take delivery. So I’d say a couple of things, they don’t actually take physical delivery. So, in our case, for example, we have laid down yards and it's not unusual for us to have tower sections that are on hold for a customer that they've – that they were holding for them that they have paid for. I don't think it’s an ordinance surge, but I think what will happen as the PPC steps down is there will always be a desire to be qualifying for the highest level of PTC you can. So I think it will probably keep pulling until the – and you know keep pulling things forward a little. But it's not really different from what we've seen in the past.

Okay.

It's sort of like rushing to get your RD tax credit. It’s the same thing you kind of – things tend to be kind of strong as you're coming to one of those break points.

Okay. But – so two questions here. So, one, the 30% expansion of your production capacity at the Abilene plants. Is this supported already by some visible contracts or basically it's more of a market expectation or your expectation in the market going to grow and hence you'll be able to sell this capacity? And then, two, as you know start producing more and deliveries take some time, does it significantly boost your working capital needs about the ones not necessarily from the last quarter, but just from previous couple of quarters?

Let’s see – I will answer your last question first. I think our working capital is distorted today and as you can see from that chart, however, it is pretty volatile. And it can be volatile high because it has in the past been volatile high because we've had operational problem or because difficulties with the supply chain and so on. And it’s kind of volatile low right now because of customer deposits. So as – in our financial management role we want to make sure we always have good flexibility that's one of the reasons we put in the new credit line and it’s got a little bit more flexibility. Having said that, I don't see anything that's going to take us kind of above the top end of that band and probably not even that high for the foreseeable future. Sorry, I’m trying to remember exactly the phrasing you earlier...

Yeah, the expansion of the Abilene facility by far it depends? – you have orders?

I think as we’ve announced we have kind of a minimum of a third of our production booked or we had as of maybe a little bit earlier this year that continues to build and we continue to be negotiating actively. When we look at – if you go back to that Bloomberg chart, there are a lot of projects that are announced and we know that the market in the Texas region is very strong, so that was really what gave us confidence. And if you remember, it's not only a capacity expansion, but it also puts in a second coatings line, which gives us more operational flexibility, gives us the ability to handle multiple model. And you know frankly prevents the recurrence of any sort of production snafu similar to the one we experienced last year. So there were certainly some insurance in that investment as well as capitalizing on what is going to be probably a several year quite strong market in that region.

And so following this expansion what will be your annual maximum capacity for the tower? And I know that probably --- this depends on the type of towers, but…?

Yeah, so for three-section towers, we are basically going from 500 to 550.

And that's – is that typical, it has to be – section tower is the difficult tower now?

Well, last year it was the typical power, this year we are seeing some force action. The wind market is getting – the turbine manufacturers are getting more sophisticated, so there is a little more variability in the section count. But we're also getting more effective at building turbines that work well in lower wind regimes, which tend to be shorter. I guess the answer is I don't quite know. We haven't seen anything more than a four-section tower, but we're still doing predominantly three-section towers.

Okay. And margin wise, is there – do you feel like for instance the market is getting together as far as the supply of towers and as such would give you a little bit more of a pricing power?

That’s a tough one. So it’s erratic and it’s regional and it’s project driven. So certainly projects that are close to our plans, we have more pricing power, projects that are further away, we start having transport cost differences. So we cannot control that very well. So really what we are doing, we're working very hard, we're taking advantage of having some good visibility and we're spending a lot of time on engineering out costs and improving our overall productivity and profit and cost profile. So we’re controlling what we can control, we're trying to be as savvy as we can about the market and most importantly take advantage of this multiyear visibility that we have.

Great, thank you.

Thanks, Angie.

And our next question today comes from Jeff Osborne of Cowen and Company. Please go ahead.

Hi, Jeff.

Hi, good morning and congratulations on the strong margin profile. I just want to focus on the gearing segment if we could, you mentioned the coating activities picked up here in the quarter and you expected an increase in the fourth quarter. Can you just talk about particular end markets that you might see some strength in?

We are seeing – well, we are actually seeing just a little bit of uptick in the markets that have been down the most, the oil and gas and mining and then we're still making good progress on the wind replacement gearing side. On the steel side, we think a lot of those customers tend to have annual capital budgets and as the year progresses, they use up their capital dollars. So in Q4, they are starting to look again at kind of reloading that capital plan for 2017 deliveries, so maybe some improvements coming through there as well.

Got it. And just on the wind gearing side, for example, NextEra, I think, two months ago talked about evaluating that it commit to this sort of evaluating -- repowering 3 gigawatts to 4 gigawatts of wind turbines that are somewhat older. And I think given the new IRS rules, if you have 80% of the fair value of being replaced, you can kind of reapp for the PTC. Most of the folks that I’ve talked to suggest that putting in new plate and gears would accomplish that financial hurdle. Are you seeing any of your partners like your Gearbox Express or anyone else starting to see repowering as an opportunity or are these just kind of planned maintenance in terms of the wind carrying projects?

We're sure talking about it a lot, but I can't say that we have seen any material orders coming out of them.

Got it.

But I think that’s a good observation.

So potential upside for next year then?

Perhaps yeah.

And then should we still think about the incremental margins in gearing in that kind of 30%, 35% range or is that trending higher with some of the cost actions that you’ve taken. I'm just trying to get a sense of as that market hopefully improves in 2017, 2018, what the profitability profiled will be?

I think those are still good incremental margins, a lot of the cost work we've done is below the variable margin level, it’s more in our manufacturing overhead and operating expenses. So I think you can still use that.

Perfect. I might have missed in response to the prior questioner’s question, but did you actually update what the coverage ratio is for 2017 at this point? I know you said it was a third earlier in the year, so a ballpark-ish figure, are you at more than 50% covered for 2017 in terms of that that capacity that you have between the two locations?

Let’s see – I'm trying to think – I don't think we've updated it per se, we had, I think, we said we’re at a third with the big order we got earlier this year and then we’ve booked another $20 million to $24 million, probably closer to 40%.

Okay. Thank you very much. Appreciate it, Stephanie.

All right. Thanks, Jeff.

[Operator Instructions] I’m showing no further questions. I’d like to turn the conference back over to Stephanie Kushner for any closing remarks.