Broadwind Energy, Inc. (NASDAQ:BWEN)
Q2 2014 Earnings Conference Call
July 31, 2014, 11:00 AM ET
Joni Konstantelos - Investor Relations
Pete Duprey - President and Chief Executive Officer
Stephanie Kushner - Executive Vice President and Chief Financial Officer
Katja Jancic - Sidoti & Company
Welcome to the Q2 2014 Broadwind Energy Incorporated Earnings Conference Call. My name is John and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. I will now turn the call over to Joni Konstantelos.
Thank you. Good morning and welcome to Broadwind Energy's Second Quarter 2014 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 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 our President and CEO, Pete Duprey.
Thanks, Joni, and thanks everyone for joining the call. We had a fantastic quarter both financially and operationally. Our sales grew 29%. We expanded margins by 470 basis points. And we had a major milestone by achieving operating profitability the first time in Broadwind's history.
Our Gearing business is finally showing some positive trends as our efforts in the past several quarters are beginning to generate some results. Orders were very strong. Wait deliveries have been reduced and our inventory turns have improved from 4 to 6 compared to last quarter. We also settled our union contract negotiations at the gearing facility.
From a market perspective, things are pretty positive. The wind market is still showing signs of strength for 2015 and 2016. We continue to see utilities rate-facing wind assets, primarily due to the more efficient turbines being deployed today. Both onshore and offshore oil markets are strong. And drilling for natural gas seems to be picking up. The customer demand for gearing use in mud and frac pumps is picking up nicely. The steel market seems to be spending more on CapEx to retool their facilities for greater auto demand coupled with a somewhat better economic outlook. Mining remains one market that seems flat.
Turning to orders, our Gearing segment booked over $18 million in new orders during the quarter, which is the highest quarterly order rate in four years. Those orders were a nice mix of replacement wind gearing, oil and gas, and industrial gearing. The Gearing business has been very focused on adding to the sales force and improving our on-time delivery. The business has made some good progress in this area during the quarter.
Additionally in services, we've seen a significant increase including activity in Q2 orders, and they were 69% over the prior year, the highest quarterly order rate in that segment since Q4 of 2012. The orders are primarily for blade repair and other in-field services mainly gearbox swaps.
In Towers, there were no new orders during the quarter, but we did announce a $34 million tower order after quarter-end. Our tower production capacity is two-thirds sold out for 2015 and we're in late-stage discussions to fill the remaining 2015 capacity and are discussing 2016 and beyond. I fully expect further progress in Q3 in filling out 2015. The backlog at the end of Q2 was $222 million, up 56% from the prior year, not including the $34 million order we received after quarter-end.
Turning to Slide 5, even without the PTC, the wind market is full of activity. Earlier this month, Microsoft announced it had entered into a 20-year power purchase agreement with a wind farm near Chicago. In fact, 12 leading companies, including GM, Wal-Mart, Facebook, Bloomberg and others have joined forces to push for more access to renewables, including wind power. This creates an expanded customer base for wind energy.
Within the past six months, a number of wind developers have formed yield cos, in which completed wind farms are transferred into publicly-traded financing yield cos to help finance these assets. It's similar in many ways to an MLP, in which a substantial portion of the cash flow is paid out to shareholders. This is a very efficient way to finance projects and should be a catalyst for growth.
Also, the EPA recently released its preliminary plan to regulate CO2 emissions, targeting a 30% reduction in CO2 emissions by 2030. The states have until 2016 to develop their individual plans to achieve these targets. So all their coal plants likely to be retired, wind should start to grow on a reasonable level of this power generation replacement. Although the price of carbon is not specifically set, the regulation starts to send the message that generation with greater carbon intensity will have limits and utilities will need to have a more diverse generation mix, which should help the wind industry.
The natural gas inventories are currently 30% below their five-year average. And according the Energy Information Administration, replenishment of these resources is now expected to happen quickly, which should result in an increase in the production in natural gas. We're also paying close attention to Ohio, where the Governor recently approved a two-year freeze on the state's RPS requirements, during which state regulators will review the targets. Now one state does not by itself make a trend, but we will watch to see how this plays out. Given the manufacturing base of wind components that come from Ohio, it's really unfortunate that this state legislature decided to take this action.
Finally, we know things aren't going all that well in Washington. The feeling is there is support for a PTC extension in the [lane to a discussion] after the election. An interesting statistic by the American Wind Energy Association indicated that 78% of wind projects' capacity is located in districts currently held by Republicans. Hopefully this could be a catalyst for some compromise in Washington.
We had a very strong quarter in Gearing. Our operating metrics improved substantially during the quarter, and we believe this represents an inflection point for the business. Productivity increased 2.4 percentage points from last quarter and over 8 percentage points from a year ago. The consolidation of our Cicero, Illinois, gear facilities into one is helping to drive some of these results. With a greater focus on streamlining production and reducing the amount of work-in-process on the shop floor, we're able to increase inventory turns from 4 to 6 compared to last quarter. Our commercial efforts are starting to bear fruit as well, as we recorded bookings in this segment and are seeing positive trends in most of our end markets.
Additionally, we reduced our past due backlog by over 70% compared to Q2 2013. We continue to make progress in reducing the defect rate and we've seen a significant improvement in sales per direct labor employee compared to Q2 of last year.
Earlier in the quarter, we started a CI initiative focused on reducing cycle time. Early results show that cycle times are cut on average by more than 50% on nearly 80% of our production. These trends are mainly the result of our continuous improvement efforts and the relentless push to examine processes and ways to do things smarter and more efficiently. Continuous improvement is starting to become embedded in our culture. We recognize that we have ways to go, but I'm pleased with the progress that we're making. And I feel confident we are headed in the right direction.
With that, I'll turn the call over to Stephanie to go over the financials in more detail.
Thanks, Pete. Referring to Slide 7, total Q2 revenue was $68.4 million, bringing first half revenue to $127 million, which is 29% of up to 2013 figure. And with the gross profit margin of 13.4% in the quarter, we're confident of finishing the year at the high end of our 2014 gross margin guidance of 10% to 12%.
Operating expense was $6.5 million, including a $750,000 reserve related to the potential settlement of the SEC investigation regarding accounting issues in 2009 and 2010. This investigation has been underway for nearly four years, and we are in negotiation to finally put it behind us. Because the negotiations are ongoing, we do not have certainty about whether and at what cost an agreement can be reached.
Despite this unbudgeted item, operating expense as a percent of sales was down to 9.5% in the quarter and 9.8% year-to-date. With our volume growth and continued cost focus, possible lines down of our restructuring activities, we are getting good operating leverage at both the gross profit and operating income line. That is 28% of our year-over-year incremental revenue hit the income line this quarter.
Adjusted EBITDA rose to $5.9 million for the quarter, at the high end of my guidance. And diluted EPS totaled $0.12, in line with our projection, and as Pete mentioned, our first ever quarter of net profitability from operations. We also reported positive EPS in last year's second quarter, but that included the $3.6 million or $0.25 per share gain on the sale of our South Dakota plant, which was part of our restructuring plan. So all totaled, we reported a very significant improvement in the quarter, in line with our guidance.
Towers delivered a very strong quarter, producing 119 towers and generating revenue of nearly $53 million. The section count was 380, a little lower than expected, because the ramp-up of production in our Abilene plant has been slower than planned due to difficulties hiring and training an expanded workforce. In addition, industrial weldment sales, particularly for one large mining customer, continued below plan. We are engaged in an elevated level of weldment bidding activity, so expected to show growth in the second half of the year.
Due to the strong tower results, operating income for the segment was $8.6 million or 16.2% of sales. This was ahead of the 13% figure I guided to. We enjoyed long production runs at our Manitowoc facility and benefited from some volume savings and variable overhead as well. In the third quarter, we have a tower model change operating at Abilene, which will likely complicate production. So while we are expecting volumes to continue in the 110 to 120 tower range, our operating margin will probably be closer to 13% or 14%.
Pete talked about the significant operating improvements in Gearing. Their Q2 results were in line with the guidance I provided on the last call. On $12.4 million of sales, we recorded an EBITDA margin of about 5% and our operating loss narrowed by more than 50%. High depreciation and amortization continued to be a drag on operating income at current production volumes, although there have been improvements since last year. In the same quarter of 2013, depreciation and amortization totaled $2.7 million or 26% of sales against $1.8 million or 15% of sales for this quarter.
With industry average levels for non-cash charges in the range of 3% to 5% of sales, we need to grow volume, minimize capital spending and let depreciation charges less before our profit levels will reach a normalized rate. We expect a similar reduction in depreciation in 2015 with the run-off of stepped-up depreciation that was associated with the assets acquired in the 2007 acquisition. Together with topline growth, this should move us closer to profitability in this segment.
We have six more gearing sales agents in place today versus April and our expanded commercial efforts are making an impact. For Gearing, the Q2 book-to-bill ratio increased to 150%. And for the first half of the year, our orders totaled $27 million, up 56% from the first half 2013 figure. Our June 30th backlog was above $25 million. And as you can see in the bottom left-hand quadrant, we continued to enjoy a diverse customer base in this segment.
Q3 revenues should be similar to this quarter, around $12 million with an operating loss improvement of about the same magnitude, a loss of less than $2 million this year versus the 2013 Q3 operating loss of $5.4 million.
Services Q2 results were in line with our guidance, with revenue of $3.5 million and an EBITDA loss of $1 million. In 2013 by comparison, we had $1.1 million of revenue from the completion of a one-time industrial drivetrain assembly order. As shown on the bottom graph, we continue to add to our field service technician headcount and responded to the stronger construction environment.
We expect our Q3 operating results to improve sequentially. With the increased demand for blade repairs and improvements and our oil trucks sold out, Q3 revenue should reach about $5 million and the operating loss should narrow.
On the next slide, working capital climbed to $26 million or 10% of three-month annualized revenues at the end of the quarter. The rise was due to lower customer deposits and lower payables balances due to some change in payment terms for steel. These factors were partially offset by reductions in work-in-process inventories for gearing, where they have made those significant operational improvements. Operating working capital should drop sharply between now and year-end due to receipt of scheduled customer deposits to support 2015 tower production.
Turning to the next slide, liquidity remained strong at quarter-end. Debt plus capital leases totaled $4.4 million at a composite average interest rate under 2%, thanks to the low and zero-interest rate grant. Net debt remains negative $7.2 million at June 30th. And our $20 million credit line was undrawn as well. We expect available liquidity to continue to improve this year with lower working capital and rising cash balances by year-end.
During the quarter, we modify our credit line to raise this year's capital expenditure limit to $10 million. Although we have made no commitments at this time, we are evaluating capital spending, which would raise our annual tower production capacity in our existing facilities by 50 to 80 units by eliminating some power mix in our plants. We expect to make a decision about this investment before year-end.
And turning to the financial outlook, we project revenue in the $65 million to $68 million range in Q3, up from $60.9 million in 2013. We are projecting a small positive operating profit and EPS of $0.02 to $0.06 per share. We've also updated our full year outlook modestly. We have reduced our revenue outlook range to $255 million to $265 million, a full year average gross margin at the high end of the 10% to 12% range, and SG&A of 9% to 10%. Full year EBITDA should exceed $16 million and our EPS should grow modestly in the second half.
And with that, I'll turn the call back over to Pete for questions.
(Operator Instructions) And we have a question from Katja Jancic from Sidoti & Company.
Katja Jancic - Sidoti & Company
What capital expenditures do you expect this year and maybe next year, what are your expectations?
I think this year we're going to end up with about $7 million in total, including the completion of our restructuring project. And then next year, I think the question mark is whether we undergo this tower plant expansion or not, because that in and of itself could be on the order of $6 million to $8 million. I think we'll have a better feel for that as the year progresses. But absent that, our normal run rate is about 2% or so of our sales or $4 million or $5 million.
The CapEx on the towers is really just, as Stephanie said in her prepared comments, was really to eliminate some bottlenecks. It's not really building a new tower plant. It's really adding some capacity in some other areas.
Katja Jancic - Sidoti & Company
What will determine the decision of whether or not you really want to make this step?
I think we're discussing with our customers today their outlook for the next couple of years and really trying to pin down some additional orders in '16 that might trigger us to really want to spend some capital to get additional throughput.
Katja Jancic - Sidoti & Company
Going forward, when the restructuring is almost completed, how do you see the Gearing segment turning on? What growth do you expect from it?
I think you're starting to see it. We had nice growth this quarter compared to last quarter. As I said in some of my prepared remarks, we're seeing the steel market being fairly robust, oil and gas market is growing nicely. So we're seeing more and more opportunities. We've expanded our sales force and they're starting to bring new opportunities. So I think year-over-year growth in the 20% range is a reasonable target for that business and they should be able to achieve that.
Katja Jancic - Sidoti & Company
Are you looking to expand the sales team even more?
No, I think we have a pretty good complement right now. So we've brought on some additional manufacturers' reps. I think we've got about eight manufacturers' reps onboard now. And I think we'll let them start delivering on some new sales opportunities and then maybe evaluate later next year.
Katja Jancic - Sidoti & Company
Now if I understood correctly, if you do the tower expansion, upgrades, that would be covered with the line of credits?
Or cash on hand. We actually think we'll finish this year with cash on hand up over $25 million.
And I'm showing no further questions. I'll turn it back over to you, Pete.
Okay. Well, just to recap, I think it was a great quarter. I think you're really starting to see as businesses turn around, how we're able to scale the business. Primarily on a financial basis, we're starting to see much more drop to the bottomline. We're very focused on profitability. We're at a point where we'll start to realize some of those NOLs, so that would be nice. And we're really optimistic about the future and look forward to sharing some more great results next quarter.
Thanks for attending the call.
Thank you, ladies and gentlemen. That concludes today's conference. Thank you for participating. You may now disconnect.
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