Twin Disc, Incorporated
Q1 2018 Earnings Call Transcript

Published: 27 Oct 2017

[Operator:]

Good day and welcome to the Twin Disc Inc. Fiscal First Quarter 2018 Investor Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Stan Berger of SM Berger. Please go ahead, sir.

[Stan Berger:]

Thank you, Brian. On behalf of the management of Twin Disc, we’re extremely pleased that you have taken the time to participate in our call, and thank you for joining us to discuss the company’s fiscal 2018 first quarter financial results and business outlook. Before I introduce management, I would like to remind everyone that certain statements made during the course of this conference call, especially those that state management's intentions, hopes, beliefs, expectations or predictions for the future are forward-looking statements. It is important to remember that the company’s actual results could differ materially from those projected in such forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements are contained in the company’s Annual Report on Form 10-K, copies of which may be obtained by contacting either the company or the SEC. By now, you should have received a copy of the news release which was issued this morning before the market opened. If you have not received a copy, please call Annette Mianecki at 262-638-4000, and she will send a copy to you. Hosting the call today are John Batten, Twin Disc's President, Chief Executive Officer; and Jeff Knutson, the company’s Vice President of Finance, Chief Financial Officer, Treasurer and Secretary. At this time, I will turn the call over to John Batten. John?

[John Batten:]

Thank you, Stan, and good morning everyone. Welcome to our fiscal 2018 first quarter conference call. As usual we will begin with a short summary statement and then Jeff and I will be happy to take your questions. Before Jeff goes over the first quarter results, I would just like to take a few moments to go over some of the operational and market highlights from the quarter. As the increased year-over-year shipment levels and backlog numbers increase, it is obvious the conditions have improved in some of our product end markets. The North American pressure pumping fleet continued to add horsepower both through new rig construction and overhauls of ideal equipment. But we also saw widespread demand in aftermarket parts for all of our products. Also in the quarter, we saw a nice year-over-year increase for the demand of our higher horsepower hydraulic power take-offs which serve our broader industrial market. Our marine markets remain mixed in the quarter with our global patrol boat and North America inland river markets remaining active, while our global offshore markets with at least 25% of the fast supply vessels and offshore vessels taken out of service and most of our marine markets, Asian marine markets, remaining soft. We also continued success in eastern Canada fishing markets with higher commodity prices and lower fuel cost drove more demand for our marine transmission. Besides the obvious benefit of a six month backlog growing 35% sequentially and about 90% versus a year ago, management feels the most significant milestone this quarter was achieving a 30% gross margin level on $45 million in sales. While we know that there is more work to do on our cost structure and our first quarter restructuring costs reflect their determination to address these costs globally, hitting 30% at $45 million, shows us that the restructuring work we have done here in our domestic operations coupled with the efficiency improvement programs we have enacted in the last 12 months, are working and beginning to pay off. Jeff will have more of an explanation on the restructuring cost and the reversal of the tax evaluation allowance. But both of these reflect our efforts to have the most efficient global manufacturing and operational organizations going forward. Much of our focus over the last two year has been on our domestic operations which saw the brunt of the demand drop. We feel that this activity has stabilized and the charges this quarter reflect our efforts in Europe where we are striving for more shared services both backroom and operational among our European plants. There will be more work to come. With that, I will turn it over to Jeff for some comments on the financials.

[Jeff Knutson:]

Thanks, John, and good morning everyone. I will briefly run through the first quarter numbers in a little more detail. Sales of $45.1 million for the quarter were up $9.2 million or nearly 26% from the prior year first quarter. So it represents the third consecutive quarter of year-over-year growth demonstrating now a sustained growth trend. The primary driver for improved revenue in the quarter was the improved shipments of oil and gas transmission units into North America along with North American aftermarket demand also led by oilfield activity. While we have had encouraging signs in our European and North American marine markets and global patrol craft markets, global industrial demand and Asian commercial marine remain flat through the first quarter. Our gross margin percent for the quarter improved by 520 basis points to 30.8% compared to 25.6% in the prior year first quarter and as John noted, a significant improvement, certainly volume driven with a positive mix as well but also reflects the improved operating efficiencies and a global reduction in fixed costs. This marks the first time in the history of the company that we achieved at 30% margin results on sales less than $50 million demonstrating that reduced cost structure and improved productivity we have been creating with the many actions we have taken over the past several quarters. Spending on marketing, engineering and administrative costs for fiscal 2018 first quarter increased $1.2 million or roughly 10% compared to the prior year first quarter, but decreased as a percent of sales from 34.8% in the fiscal 2017 first quarter to 30.3% in the current quarter. The increase in spending was related to increases in the global bonus expense, stock compensation and volume driven salary spend. We invested $1.2 million in the quarter related to restructuring actions to drive additional cost reduction and efficiencies, primarily at our European operation. With the improved volume and margin performance, our operating loss improved by $2.6 million compared to the prior year's [$5 million] [ph] increase in restructuring expense. The significant tax benefit for the quarter was primarily related to the reversal of a $2.8 million valuation allowance in a foreign jurisdiction driven by improved recent operating results and execution of certain tax planning opportunity. Excluding this significant item, the first quarter effective rate was 68.2%. This rate also benefitted from a reduction in the reserve for uncertain tax positions following the successful conclusion of an IRS audit, which had a magnified impact on the effective tax rate due to the near breakeven pretax results. Net income for the quarter of $3.4 million or $0.29 per diluted share marks the second consecutive profitable quarter following seven negative quarters. Positive EBITDA of $442,000 for the quarter reflects a $2.2 million improvement over the fiscal 2017 first quarter, despite the incremental $1 million in restructuring charges. On a trailing 12 month basis, we are now essentially at breakeven EBITDA after now two positive quarters in a row. Balance sheet remains in a strong position with $7.2 million of net cash, debt to total capital of 6% over $18 million availability on our revolving credit facility. While inventory has increased $3.8 million since the end of fiscal 2017, this reflects growing demand along with a positive exchange impact of $1.7 million. Free cash flow was negative $2.9 million in the first quarter hampered by the fiscal 2017 global bonds payment and the increased inventory. But this reflects an improvement over the prior year negative free cash flow of $3.2 million. We have spent $1.5 million on capital improvements during the first quarter of fiscal 2018 and we anticipate spending in the $7 million to $9 million range for the full fiscal 2018 as we invest in modern equipment, global sourcing programs and in products. And with that I will now turn it back to John for some final comments.

[John Batten:]

Looking at our outlook for fiscal 2018, there is no doubt that we feel we are in a much better place than we were a year ago, even six months ago. The North American pressures pumping fleet is finally addressing their horsepower gap in a big way. Our industrial markets appear to be improving and we see a lot of marine projects ahead of us. Only offshore marine remains a question mark for us. How much we improve in fiscal 2018 will depend on the collective efforts of our internal operations coupled with our supply chain. We have tried to anticipate this increase in demand but it will take a lot of hard work to ensure that our suppliers can keep up with us. This is turning into a global effort as more and more pressure is put on our supply chain with increased demand from a lot of entities, not just Twin Disk. With that, Brian, I will turn it over for questions.

[Operator:]

[Operator Instructions] And we will now take our first question from Josh Chan with Baird.

[Josh Chan:]

Congrats on getting the gross margin and backlog improvements. So on the gross margin, obviously you got over 30% this quarter. Typically Q1 is the softest margin quarter if I remember right and so do you expect basically to stay above that level for the rest of the year?

[John Batten:]

I think if nothing changes in the mix dramatically, yes. I think that this -- again historically seasonally the lowest in revenue level and the lowest in gross margin. So, yes, I think this is a stepping stone for quarters to come.

[Josh Chan:]

Okay. Great. Good to hear. So on the oil and gas business, can you still book and ship if you get an order today or does that fall into backlog given kind of production schedules and things like that.

[John Batten:]

We are still -- any orders that we are taking today these will show up in our six month backlog. We are actually still probably able to deliver on some models in that four to five months timeframe but right now we are scheduling out in the calendar of 2018. And that is somewhat based on our internal constrictions but is also based on customers. What they are able to build at their facility. So I see most of what we are booking right now really is for, I would say, a calendar 2018 Q1 delivery.

[Josh Chan:]

Okay. And then how do you see this demand shaping, kind of maybe a little bit beyond. Are you having at least initial discussions with customers about kind of the pacing after the beginning of '18.

[John Batten:]

Yes. I mean we are talking about potential builds beyond what they have on order. Again, theme from other call is it tends to be different at each customer but I would say even if the price of oil stays the same, gas stays the same and the fracking activity stays the same, there is a growing horsepower gap coming. So what we have all seen in calendar 2017, again pressure pumping hours stay the same, oil stays the same, everything is point towards a growing gap as more and more equipment, existing equipment has to be taken offline. So we have seen a balance of rebuilding equipment. Rebuilding our current equipment that hasn’t been -- not maintained but hasn’t been rebuilt for a long time. We see new construction of rigs and we have also seen our models being purchased and taking out a different transmission. So there is a mix of that across the market but I think the broader theme is, if price stays the same, the number of hours for pumping for oil and gas stays the same. There is a growing horsepower gap coming in the next couple of years. So if you were [making] [ph] -- it's encouraging. I mean I can't point to orders being placed for the fourth quarter of calendar 2018 or into 2019. But certainly the conversations we are having with our customers, it's point to, I think most people are recognizing that there is a horsepower gap coming and it's just the economics of how does each customer, what they have to do to address that horsepower gap.

[Josh Chan:]

All right. That sounds good. On the marine side of the business, you talked about maybe some improvement ahead. So when do you think that that might happen and what areas are you referring to?

[John Batten:]

Well, certainly the inland, what we consider our, kind of the traditional core business of the [deep case] [ph] transmissions along the river and some tug activity in North America. That seems to be going well. Certainly there is activity in similar types of vessels in Europe. That seems to be getting better. The area that again still seems to be not soft, we have some -- it's soft. We still see some construction activity but the biggest concern in marine still is the offshore. And I think that is tied to obviously the confidence level on future and growing exploration in the Gulf of Mexico in Southeast Asia. So if there is one market specific globally that still remains a question mark, it's the offshore market. If there is one market geographically that still is soft, I would say it's most of the Asian marine markets. But orders, I would say, in the market have improved year-over-year but it's still coming off a very low level. And then as I mentioned, the industrial markets for us, driven really by North America and Europe, seem to be doing better certainly in the new products that we have released. The higher horsepower, hydraulic power takeoffs. We are doing much better than we were a year ago. And just in general, new units seem better this quarter versus a year ago.

[Josh Chan:]

All right that’s great. And then lastly for me. Do you expect any further restructuring charges in the upcoming quarters?

[John Batten:]

I would say, Josh, yes. Again, addressing how we operate in Europe, streamlining that organization. We have, I would say one medium sized plant and three smaller one and certainly what we did in this course is just addressing, streamlining I would say the shared services and how we are going to operate going forward.

[Josh Chan:]

Okay. Any way to kind of bucket the size of the future charges? Are they going to be smaller than like you did this quarter or?

[John Batten:]

Josh, I would say it's hard to say and it certainly would be, let's just say manageable actions. I would look for anything larger than we have ever done in the past. I am not trying to telegraph anything like that. But just continued actions that make sense. Really to right size our cost structure but also streamline where we do each type of product or each type of operation. And it also really reflects where we are finding the best sources of raw material and machine component. So we are just trying to make the European organization much more streamlined.

[Operator:]

[Operator Instructions] And we will now take our next question from Rand Gesing with Neuberger Berman.

[Rand Gesing:]

I guess the question I have, given this building visibility into perhaps horsepower gap. Do you think that could make this oil and gas experience for you guys, this cycle, a bit different, a bit more sustainable? Or if it does sort of come to fruition, is it just sort of continue what we have had the last two times that has been sort of a short term, road to the short term period where activity has been very strong and then a drop off. I am just wondering if we get this horsepower gap pieces to come to fruition because it's a little bit different [indiscernible].

[John Batten:]

I think, I do think that what's similar to the last time, I would kind of go back to that 2011 or 2012. Is I do that the actual horsepower gap is probably very similar. But what is different this time is I think the experience of five years ago is still very fresh. Five, six years ago, still very fresh in everyone's mind about the overbuild. And I think we too soon, too quickly added too much horsepower. The other thing that I think is going to, did make this one different is when you go back to 2011, 2012, everybody had a lot of cash and their balance sheets were very clean and they could afford to buy too much too soon, too quickly. I think what's different this time is those economics just aren't there. So I think that is what potentially could make this a more sane buildout is that it's going to literally be limited by each customer because each company is in a different situation. Some are similar, some are different. They just can't afford to overbuild. So I think that is going to add, I hope some sanity to -- if the gap turns out to be as big as we think it is and other people think it is, you just can't have everyone overbuilding at once. So I am hopeful that this one will be more metered and more measured out. That’s certainly my hope. But a lot of times we have seen that history does repeat itself.

[Rand Gesing:]

Yes. You guys have done pretty well from a share perspective in the last couple of, kind of got an up cycle. How do you feel about this particular moment in time as it relates to share.

[John Batten:]

I still think it's a good deal, the stock. And I think that the fulfillment is...

[Rand Gesing:]

No, no. I am talking about -- I am sorry, I am talking about your market share. Your market share in pressure pump.

[John Batten:]

Feeling pretty good, Rand. I am feeling pretty good. When I look at the projects that have been out there, the ones that we -- you know we haven't won all of them but we are certainly losing a lot fewer than we used to. So, again, yes, I am feeling pretty good about seeing us rebuild our stuff and it's already out in people's fleet. I am seeing new orders for new construction and I certainly love seeing our stuff being purchased to replace other equipment in the field. So all in all, I am feeling very good about it.

[Rand Gesing:]

Are you seeing enough of that? Because I think there is sort of a tendency to use all Allison or all you guys, or what have you. Are you seeing a little bit more of that conversion or is it just the guys that are typical Twin Disc size are the ones ordering.

[John Batten:]

No, I am seeing more conversion.

[Operator:]

[Operator Instructions] And now we will take our next question from Mario Gabelli with GAMCO Investors, Inc.

[Mario Gabelli:]

I look forward to seeing you, John you and Jeff, questions that I couldn’t ask in private I will ask in public. You know everyone is saying companies like the ones we are involved in that have half a billion of market cap, are too small in the scale up. I am looking at the way you handled your inventory. Inventories were down in the fourth quarter but receivables up, I mean just like the first quarter. The receivables which was surprising with the big [indiscernible] sale, inventories were up and the receivables down, which is unusual. But looking to scale, how do you think about you handle the corporate overhead and corporate costs of being public in an environment where when you have got a $250 million market cap, it's kind of tiny. Do you look at partnering up with other organizations? Do you look at the joint ventures, do you look at taking your cash flow and using it to make acquisitions? Kind of just 30 second observation.

[John Batten:]

Sure. Mario, it's John. We look at all of it. Certainly some of the things that we have done on the corporate structure and the cost of being public, for the first time in 100 years we changed our audit firm. And again, realizing that a company of course $250 million, having a big four accounting firm may not be the right fit for us. So that’s...

[Mario Gabelli:]

So that saved you a $150,000 but you are spending it on Sarbanes-Oxley. You are doing a lot of things that you don’t need to do. I got it.

[John Batten:]

I am happy to report it saved a lot more than that. But, no, certainly on, I guess I would say the biggest impact on being public would be growing. And certainly what you mentioned on acquisition, partnering up with people, are all things that we are actively looking at to grow the top line. Because you are absolutely right, staying at this level is...

[Mario Gabelli:]

Okay. You guys have launched the products, you are going to have cyclical recovery in a lot of your markets. We talked to all the pressure pumping companies that we have got a good handle on all of that and the market share with Allison, that you might, aside from sharing with the rest of those on the call. But independent of all of that, what else have you worked on in that technology area or in your R&D that we haven't seen in public forum yet that we should think about. What areas and what sectors and what products, if any, that you are toying?

[John Batten:]

Sure. I would think the one area that we can, I would say combine both organic growth and then also in corporate development would be, the shift in hybrid has been very, I would say, not quick at all and not slow but it has begun to trickle into the marine markets. And you can have diesel electric and you can have pure hybrid. Certainly it's been very fragmented. So for us to look at expanding our content and sales organically and adding key components through acquisition, as the marine market transitions into more and more hybrid forms. It's an area where we can double, maybe triple our content per vessel. And we certainly have a lot of pieces of the puzzle to design and put that whole system together but there are key things that we need to add. And certainly the many components, it's not just the marine transmission anymore or controls. There are electric motors, there are invertors, there are different types of control systems. So as we think about going forward and being, we were just a clutch and then a gearbox company. We have added controls. Certainly moving into that space for us provides a huge opportunity to accelerate growth.

[Mario Gabelli:]

Yes. When I see you all talk about taking that technology on marine based into a land based opportunities, because we had a company called [Stefcom] [ph] which BorgWarner just bought, doing something similar. Look forward to seeing you both. Take care. Thanks very much. Unfortunately I have four calls at one time. Take care.

[Operator:]

[Operator Instructions] And it appears there are no further questions at this time. Mr. John Batten, I would like to turn the conference back over to you for any additional or closing remarks.

[John Batten:]

Thank you, Brian. And thank you for joining our conference call today. We appreciate your continuing interest in Twin Disc and hope that we have answered all of your questions. If not, please feel free to call Jeff or myself. And we look forward to speaking with you again in February following the close of our fiscal 2018 second quarter. Brian, now I will turn the call back to you.

[Operator:]

Thank you. And ladies and gentlemen, that concludes today's conference call. We thank you for your participation.