Broadwind, Inc. (BWEN) Q1 2018 Earnings Report, Transcript and Summary

Good morning, and welcome to the Broadwind Energy First Quarter 2018 Earnings Conference Call. [Operator Instructions]. Please note, this 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, Steven. Good morning, and welcome to Broadwind Energy's First Quarter 2018 Earnings Conference Call. With me today are Broadwind's President and CEO, Stephanie Kushner; and Broadwind's Vice President and CFO, Jason Bonfigt. This morning's earnings new release is available on our website at bwen.com. 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 the Stephanie Kushner.

Thank you, Joni, and good morning. Following a difficult second half of 2017, Broadwind is on a recovery path. Our operating management in Manitowoc, Wisconsin and Abilene, Texas successfully restarted tower production following very low demand in the fourth quarter of last year. Our revenue recovered to $30 million, up nearly 70% from last quarter, but not sufficient to generate positive EBITDA. We are on track with our customer diversification initiative. We set a target of booking more than $40 million of revenue this year from customers outside of our normal core. $12 million or 42% of our Q1 orders were from what we considered diverse customers, including several new heavy fabrications customers, a new gas turbine manufacturer and growth with a number of mining industry gear customers. We're taking steps to exit the CNG business and consolidate Abilene-based manufacturing facilities later this year, which will eliminate about $2 million annual earnings drag. I'm pleased to announce that we've named Eric Blashford as the COO of Broadwind, following his nearly 4 years managing our towers business. Under his leadership, we've made good progress in towers and heavy fabrications, improving our manufacturing processes and using continuous improvement tools to improve product margins. He will bring this expertise to our other businesses. Eric has more than 30 years' experience in the heavy equipment market and brings a vision for building on our core tower manufacturing design and welding skills to enter other heavy fabrication markets. He will join us in next quarter's call to talk about operational progress. We booked $28 million in new orders, down from a year ago, but up sharply about 75% from the previous 3-quarter average. In Towers and Heavy fab, we booked $7.8 million split between towers and other large fabrication. In gearing, orders about doubled mainly because of strong demand for gears going into frac pumps. Process Systems orders totaled $4.9 million, for a book-to-bill of 113%. Our quarter-end backlog totaled $136 million, of which approximately $90 million is shippable this year. The U.S. wind development pipeline strengthened again in the first quarter, rising to 33.4 gigawatts, which is up 40% from a year ago. Power purchase agreement announcements were strong as well, the highest quarterly level in 5 years. Utilities and industrial customers continue to respond to the compelling value proposition of wind energy. The 33-gigawatt pipeline will support installations during the next few years. As shown on the right, the current estimate is for about 8-gigawatts to be installed this year, rising to 10.9 in 2019 and nearly 13 in 2020. Separately, we've seen that about 10 gigawatts were qualified for the 80% production tax credit in 2021. So 2021 appears to be shaping up another strong year. I spoke last quarter about how tariff and trade uncertainties are clouding the picture for our steel-based businesses. As shown on the left, about half of the material cost of a turbine is steel in some form. And for towers, the steel content approaches 200 tons, mainly in the form of steel plate. Although protective duties and tariffs effectively blocked towers manufactured in China, Chinese steel flows to other parts of Asia and is used by other manufacturers who export towers outside of their region. The price of steel in China has long been below the U.S. so this is not new for us. Of course, it's very expensive to ship a tower to the U.S. depending in part on open shipping capacity and fuel costs. And inland shipping from the ports is potentially another significant cost factor. We monitor the relationship between the steel price differential and the shipping costs relative to where the tower will be erected. Following the Section 232 announcement by the President, domestic steel companies raised their quoted price for steel plate by about 50%. However, as the implementation of the tariffs has been delayed and a number of countries have been exempted at least for the time being, that price spike has moderated. Because tower steel requirements for most of this year will be met by purchases priced before the tariffs were enacted, we're only now seeing early signs of price escalation. But we are monitoring this closely for the fourth quarter and beyond. Our Gearing business is also impacted by steel price escalation, but material cost while significant represent a smaller portion of the total buy. And we have the ability to pass through steel surcharges with most of our customers, nonetheless we are managing this potential exposure carefully as well. Turning to the next slide. The market for U.S. gears continues to strengthen. The multiyear growth estimate has been raised to 9%. Oil and gas demand is up 22%, driven primarily by a frac gear demand, although we are also seeing early signs of demand for mud pump gears as well. On the frac pump side, the installed base of fracking capacity is slated to rise by about 3 million horsepower this year, which represents about a 60% growth from the additions in 2017. Together with the replacement units, we believe this translates into about 2,500 new gearboxes, and we are currently supplying about half of the market either in loose gears or in completed gearboxes. While we know this is a cyclical business, it gives us a baseload of serial production and should help us optimize our plant over time. The global gas turbine market remains weak. About 34 gigawatts were installed last year and the outlook for 2018 remains low at that level or below. For Red Wolf, demand for new turbines drove about half its sales in 2017. The balance was for the aftermarket. We're expanding our focus on aftermarket opportunities and targeting a broader range of service companies, and we continue to prospect for opportunities outside of the gas turbine market. And with that, I'll turn the call over to Jason to talk more specifically about the quarter's result.

Thank you, Stephanie. As expected, we started to see a recovery in our towers business in Q1, primarily the results of increased tower sales following an extremely challenging second half of 2017. Broadwind sales were $30 million, a $12.2 million sequential improvement. As a result of the higher plant utilization, gross profit improved to effectively breakeven from negative 17.5% in Q4. Quarterly operating expenses were up $800,000, however, Q4 was below our normalized run rate due to $700,000 onetime benefit related to releasing an environmental reserve associated with an [indiscernible] facility. As a result, operating expenses were up only modestly when we compared to the sales increase. Our EBITDA loss was $1.6 million, but significantly improved over a challenging fourth quarter. From a year-over-year comparison perspective, our tower factories were essentially sold out in the prior year quarter as our customers were focused on meeting the production tax credit qualification deadline. In the current period, we are beginning to rebuild our workforce to meet higher demand levels from our customers. Last year in our Gearing business was only starting to see a recovery in its end markets, evidenced by increased coding and order levels. And today, our end markets and our backlog are healthy. Resources are now focused on our manufacturing processes and improving the supply chain and building a business that can generate acceptable returns. Our EPS loss was $0.32 for the quarter versus a positive $0.43 in the prior year, primarily driven by the $0.34 onetime benefit related to that Red Wolf acquisition. Moving to our Towers and Heavy fabrication segment. Orders for the quarter were $7.8 million or $5.3 million sequential improvement. The order improvement is encouraging because it's driven by multiple factors, including tower orders in excess of our backlog and growth in our heavy fabrication orders. Our Heavy Fabrication business, which operates in mining and other industrial markets, utilizes similar manufacturing processes and core competencies as our towers business and this is a key diversification initiative for us. These markets are improving and we are making strategic investments to support further growth. We revised the key metric reporting from towers sold to sections sold, as sections sold represents a better measure of activity levels due to the variability of tower designs we are now producing. We sold 143 tower sections during the quarter, up from only 9 sections sold in Q4. Both of our plants were essentially restarting production from historically low levels. Despite the production restart, we still produced 4 different tower designs in Q1, including a large prototype tower. These challenges are a testament to the team's effort in manufacturing process improvements achieved over the past several years. As a result, Q1 sales were $16.8 million versus $4.2 million in Q4 and EBITDA was near breakeven, a $3 million sequential improvement. Q1 '17 was a strong quarter for towers as production levels were at our capacity, filling our customer requirements to meet the 100% PTC qualification deadline. As a result, the business generates $7 million of EBITDA or 14.3% margins in the prior year. The year-over-year degradation in EBITDA was primarily driven by the 64% reduction in tower sections sold, and additionally, we had unfavorable product mix in Q1 from the current year. PPA pricing trends are showing a more competitive environment amongst various forms of power generation and we are seeing this cascade into other supply chain. Lastly, we incurred a onetime cost of rebuilding and training our workforce to support higher production levels estimated at $400,000. Our 2018 priorities are unchanged from the last call, our commercial efforts continue to be focused on expanding our tower customer list and we think a stronger market will be a tailwind for us. We talked about pricing pressure for new PPAs. And we have resources focused on offsetting this pressure through process improvements. We're excited about the fabrication business. And we are focused on driving profitable growth and improving our capabilities including the installation of a large horizontal machining center in Q1. In the second quarter, we expect revenues to increase to $22 million to $24 million as a result of improved plant utilization and the lack of startup cost, EBITDA should improve to $1 million to $1.5 million. In our Gearing segment, we booked $15.4 million of orders in Q1 over double the prior year and versus sequential results. We are continuing to see strength in oil and gas market, as Stephanie mentioned. The surge in orders was driven by our customers securing production slots and locking in material pricing, during what has been a volatile period following the tariff announcement. As you can see on the graph that highlights our revenue by market, oil and gas revenue is approaching $5 million per quarter, a significant increase since 2016 and above 2014 levels. The shift to these customer types has moved the business into more of a serial production environment. And this is a significant shift for us, but affords us the ability to optimize production processes on longer production runs. We remain focused on a fuller diversification and expansion in other markets, notably mining and other industrial. Revenue was up 3.5% sequentially and more than double the prior year quarter. We had breakeven EBITDA in Q1 below our expectations as the residual impact of Q4 supply chain disruptions and higher activity levels that led to unplanned manufacturing variances. In general, we're seeing an improvement in the supply chain with more consistent deliveries, but lead times for raw materials and outside services are extending. Restarting the supply chain has introduced complexity into the business and raw material flow has been inconsistent. So the team is focused on removing internal bottlenecks. So as flow improves, we can maximize production. The year-over-year nearing of operating loss from $1.5 million to $600,000 was primarily driven by the aforementioned volume increases and higher plant utilization, it was offset by higher scrap and rework expenses as we work through startup issues on several new products. We are monitoring material pricing and lead times closely, and I would note that we generally do not assume material price risk as the majority of our materials are procured at the time of our customer order and have contractual mechanisms to pass on any escalation. In Q2, we expect revenues to be at or above Q1 levels generating positive EBITDA. We expect our margins to improve throughout the year and closer to our longer-term goals of 10% to 12% EBITDA margins as we make these operational improvements. Moving to Process Systems segment. Orders for the quarter were $4.9 million, up sequentially from $2.4 million in Q4 due to improvement in natural gas turbine part orders and $0.5 million order for residual piece of CNG equipment. Revenue is within guidance at $4.4 million, but down sequentially due to lower part sales for natural gas turbines. Our EBITDA loss was $300,000 primarily driven by the learning curve associated with newer mining in oil and gas products we introduced into our plants. In the 10-Q that we will be filing later today, we highlight a $900,000 restructuring event that contemplates the exit of our Abilene fabrication and CNG facility at the end of the new market tax credit compliance period in Q3 and our facility exit at the end of 2018. We have incurred $150,000 of restructuring expenses to date. We plan to shift the backlog and resources associated with this plant to other tower plants, which should improve the production flow and financial performance of the business. The exit of this facility will mark the end of a new market tax credit compliance period and in Q3, we expect the $2.6 million loan to be forgiven. We're focused on expanding our existing relationships in the natural gas turbine market and we're beginning to see opportunities to diversify the Red Wolf business. In Q2, we expect revenues to mirror Q1 and EBITDA to improve slightly. Our cash conversion cycle ended the quarter at 44 days, a 10% improvement over year-end 2017. Our Q4 statistics were distorted by the lower tower production, and our DSO was above historical norms as certain customers delayed scheduled payments into 2018. Inventory turns are improving as we have more consistent flow at our manufacturing facilities and lastly, DPO decreased by 2 days in the quarter. Our operating working capital cents per dollar sales decreased to $0.12 from $0.16 in Q4 and as indicated in the chart in the right, back into a more comfortable range. Operating working capital increased from $11.4 million to $14.3 million, primarily driven by the elevated tower production levels. Our customers are tightening working capital practices. The largest impact to us will be the receipt of deposits closer to 3 or 4 months in advance of production compared to 6 months in prior years. But we are raising our deposit requirements on longer lead time gearbox orders to grow our deposit balances. Moving to our balance sheet. As I mentioned before, operating working capital increased by approximately $3 million during the quarter, driven by increased AR and inventory associated with higher production levels in late Q1. We had $21.2 million of debt and capital -- debt and capital leases, up from $16.7 million at year-end. We had $1.2 million of equipment financing during the quarter and had slightly higher utilization of our credit facility. Cash was effectively 0 as collections are automatically applied to our line of credit balance, which is a customary practice on asset-based lending structures. To break up the debt and lease balance further, we had roughly $3 million of forgivable loans, $4 million of equipment notes and leases, $14 million used under our $25 million credit line with CIBC, and we had an additional $10 million of availability under the line. We had an approximately $0.25 million of new CapEx in Q1, down significantly compared to the 2016 and 2017 run rate as our Abilene expansion optimization investments are complete. We do not have any significant planned capital investments for 2018 and are managing to 1.5% to 2.5% of revenue rate, which should be considered more of a maintenance CapEx rate for our businesses. That concludes my remarks and I'll turn the call back Stephanie.

Thanks, Jason. So as we progressed in 2018, which is a recovery year for Broadwind, we're focused on a handful of key initiatives. First, continuing to build momentum with customer diversification. Entering 2017, we were too concentrated with a handful of large customers. When our tower customers merged and rationalized inventory, we were impacted severely. Red Wolf was similarly impacted with business with a large domestic gas turbine manufacturer turned down sharply in early 2017. We've identified about a dozen customers where we're focused on initiating or expanding business with a full year target of more than $40 million. We are preparing to exit an 80,000 square-foot production facility in Abilene, Texas and expected to close the sale next quarter on the idled 159,000 square-foot Cicero gearing facility, where we recently completed environmental remediation actions. These steps will reduce our space by 21% and represent the final phase of a multiyear 40% manufacturing footprint consolidation effort we kicked off several years ago. We're updating our systems configurations to support the change in our sales mix and our Tower and Heavy fab business were adding complexity as we entered new markets for large welded structures, and our systems need to support the added complexity this brings. In gearing, we've added a growing volume of serial gear production, and we are expanding our presence in custom gearbox manufacturing. Again, we need to ensure that our system support both of these growth areas. In Towers, where turbine pricing have been highly competitive, we are working on continuous improvement initiatives to improve the manufacturability of the towers and offset margin pressures. And we moved our corporate CI expert into our Gearing business to do the same with respect to our serial production there. And lastly, as I said, we're managing through steel escalation risk across our businesses to make sure that doesn't have a material impact on our margins. Following a tough 2017, I feel optimistic about our past forward -- and look forward to updating you on our future success. So this completes our prepared remarks, and I'll turn the call over to Steven for Q&A.

[Operator Instructions]. And our first question comes from Justin Clare with Roth Capital Partners.

So first off, if we look beyond Q2 of this year. I think previously you've talked about reaching a quarterly run rate of revenue of $40 million and potentially generating positive EBITDA. Can you just give us an update there on what your expectations are and what we could expect for Q3 and Q4?

So I think we -- so we do expect to have positive EBITDA in Q2. I don't think it will be quite up to the $40 million, we're saying $36 million to $38 million. And then we would expect to remain positive for the rest of the year. Our visibility on Q3 is pretty good. Q4, we're not certain how much growth we'll get there. But overall, I think it's going to be a much better series of quarters ahead of us.

Okay, great. And then just moving to U.S. demand in the wind market. Can you help us understand what may be driving this shift in demand toward the PTC exploration year? And what could that mean for your order flow in 2018, '19 and 2020? And then specifically for 2018, can you give us a sense for whether you think your key tower customer could exceed the baseload production of $50 million in year?

Okay. Let's see. So multipart. I do think our large customer is gaining some momentum in the market, which is potentially a good thing for us., but I probably can't say a lot more than that. I do think they will end up purchasing above their minimums in this contract year. You talked about a shift I don't think there is so much a shift on installation. We've had a little bit of a leg down in 2017 because of the tax uncertainty, which going back to Slide 5 caused that to be kind of a steeper kink up from '17 to 2020. I think the good news and maybe I didn't say it very clearly is that, whereas previously we thought the decline in 2021 might be significant, it now looks like there will be new 2021 demand on the range of 10 gigawatts.

Okay, great. And then you talked about pricing pressure in the wind market in terms of the PPAs and that having an effect on the supply chain. Can you just talk about how much prices maybe declining for your towers or towers section. And then how much of this decline can you offset with lower cost?

Okay. Well, for us, the absolute biggest thing is volume. Volume and consistency as well gives us tremendous opportunity to improve margin. So if you look at towers, their margins were down maybe 20% and 15% of that was volume-related. Actually probably less than 5% of it was price because that also included the impact of the startup inefficiencies. So we are -- so we work very, very consistently and persistently on cost out and continuous improvement initiatives that help keep bringing down our tower cost and improving the manufacturability. There is a turbine model that we -- well, you get variability with models as well but there is a turbine model that we've built recently, that we had built maybe a year ago. And the margins were consistent even though there was some reduction in the price.

Okay. And then one more for me. So you've talked about $40 million in orders outside of the core customer base that you're targeting. Can you share what the mix of those orders might be based on your segments? Like, how much of that could be from new tower customers versus Gearing versus Process Systems?

Every segment has a target that they are working to, the smallest target is probably in Red Wolf because they are early along in the process. And the gears, heavy fab and towers also have significant targets. But I guess, I don't really want to share the individual numbers because we're not sure exactly where it's going to come from because we have so many different possibilities out there.

Our next question comes from Chris Morgan with Macquarie.

So you received another waiver from the bank on the credit line covenant. And I was just wondering based on your conversations, how comfortable you are that the bank will continue to grant future waivers, if needed?

I think we've talked about the forecast that we're going to achieve for the year. So we don't believe we're going to have any future issues under our -- receiving any or having any violations under the covenants. But they have been supportive kind of working through this with us. So, I mean, I think the relationship is strong.

Cool. Okay. And then the next question would be, should we be expecting continued constraints on tower production 2Q '18 as you continue to ramp up operations or was most of those constraints are 1Q '18 issue coming off of almost no production in 4Q '17?

Yes, so we were hiring quite a few people kind of to ramp up in specifically in our Abilene facility, where we grew from approximately 80 people only, and then up about 50. So it was a pretty significant growth there. So we have more of a stale population of people right now and the workforce. So we feel confident that we're not going to have those residual issues slipping into Q2.

One of the things that we monitor closely is that -- is our hiring success with welders, because that's probably one of the more skilled occupations that we've been delighted recently to be able to add a number of new welders into the company. Either for towers, either for towers or for some in the heavy fabrication market.

Okay. And then I think you guys had mentioned that there will be a less favorable product mix within Towers and Heavy Fabrications and just if I can get a little bit more color on that what exactly kind of shift are we expecting? And then, secondly, where the risk to margin pressures in 2018 are really stemming coming from? I think you guys had mentioned that volumes matter obviously, but how much of it is that versus steel prices or potentially other factors?

We were talking about an unfavorable mix during Q1. We're not suggesting that, that mix deteriorates in Q2 and going forward.

I would say on the steel question. We haven't seen any impact yet. And we're optimistic that some of the steel pricing ambitions will dissipate depending, of course, on what happens with the tariffs. So some of the -- some of the bilateral settlement deals that are being negotiated so far seem to be fairly moderate. So for us, the main thing is to be absolutely on top of all of our input prices and make sure that we're managing that as aggressively and then in a timely of a manner as we possibly can.

Okay. And then kind of as my last follow-on. Obviously, we were pleased to see the pickup in orders particularly for towers. But curious if you guys have any insights or feel as to how margins at the OEMs are evolving? Add to what extent any changes in those margins might potentially be passed through to your business?

I think what we're seeing in the turbine OEM, I think the margin reset, if you will, is behind them and things have moderated or stabilized. So I think that's a good thing for us.

[Operator Instructions]. I'm showing no further questions. This concludes our question-and-answer session. I'd like to turn the conference back over to Stephanie Kushner for any closing remarks.

Thank you very much. Thank you for your interest. As I said, we're looking forward to making improvements during the course of this year and having some better call -- better things to talk about, okay. Thank you. Bye-bye.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.